Fundamentals of Financial Accounting
Financial accounting records, classifies and summarises transactions, then reports them to external users through the statement of financial position, statement of profit or loss, and statement of cash flows. Master the double-entry rule (every debit has an equal credit), the accounting equation (Assets = Liabilities + Equity), and the accrual basis: revenue is recognised when earned and expenses when incurred, not when cash moves. Know the adjusting entries - accruals, prepayments, depreciation, and closing inventory - because these separate profit from cash flow.
Traps to watch
- Confusing capital expenditure (asset) with revenue expenditure (expense).
- Forgetting that a trial balance balancing does not prove correctness - compensating errors still balance.
- Mixing up the treatment of drawings (reduces equity, not an expense).
- Sign errors in the bank reconciliation and suspense accounts.
Worked example
A business pays a 12-month insurance premium of 2,400 on 1 April; year-end is 31 December. Monthly cost = 2,400 / 12 = 200. Nine months are consumed (April–December) = 1,800 expense; the remaining 600 is a prepayment (current asset). The adjusting entry debits Insurance Expense 1,800 and Prepaid Insurance 600, crediting Bank 2,400 at payment. Rule of thumb: if cash has moved but the benefit is future, it is an asset; if the benefit is consumed, it is an expense.