Accounting and Business Law
Domain 2: Accounting and Business Law
This domain covers the accounting cycle and the legal framework for business transactions. You need to know how transactions flow into financial statements and how enforceable agreements are formed.
Core rules and concepts
- Accounting equation: Assets = Liabilities + Equity. Every transaction keeps it in balance.
- Double-entry accounting: each transaction affects at least two accounts, and debits equal credits. Debits increase assets and expenses; credits increase liabilities, equity, and revenue.
- Accounting cycle: analyze transactions, journalize, post to the ledger, prepare an unadjusted trial balance, adjust, prepare statements, and close temporary accounts.
- GAAP principles include revenue recognition, matching, historical cost, full disclosure, and consistency.
- Contracts require offer, acceptance, consideration, capacity, legality, and sometimes a writing under the Statute of Frauds. A void contract has no legal effect; a voidable contract can be canceled by one party.
Worked example
A company buys equipment for $12,000, paying $4,000 cash and signing a note for $8,000. Debit Equipment $12,000; credit Cash $4,000; credit Notes Payable $8,000. Assets increase by a net $8,000 ($12,000 equipment minus $4,000 cash), and liabilities increase by $8,000, so the equation balances. Depreciation later allocates the equipment's cost over its useful life; it is not a cash outflow.
Traps
Do not debit an increase in a liability. Do not record revenue merely because cash was received if the work is not performed; revenue recognition depends on earning. An offer made in jest is not an offer. A contract without consideration is generally unenforceable. Do not confuse a void contract with a voidable one.