Chapter 1
Financial Statements: Personal Accounting
23
In Summary
Describe the purpose of accounting
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Accounting identifies, measures and communicates financial activities. This can be done for
an individual or a business.
Describe the balance sheet and the income statement
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The balance sheet is a permanent record that records what you own (assets), what you owe
(liabilities) and your net worth.
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The income statement is a temporary record and is used to determine the change in net worth
(revenue minus expenses) over a period of time.
Define an accounting period
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An accounting period is the time frame in which the financial statements are prepared.
Explain how the accounting equations works
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The accounting equation: Assets = Liabilities + Net Worth. All transactions must be recorded
in a way to ensure the accounting equation is always balanced.
Explain accrual-based accounting
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Accrual-based accounting recognizes revenue and expenses in the time period in which they
occur, regardless of when the payment is received or made.
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The change in net worth is recognized when the activity occurs, not when cash is transferred.
Explain how to account for debt and assets
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Buying assets or selling them for the value shown on the balance sheet does not affect net
worth, it is simply an exchange of one asset for another.
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Borrowing money and repaying debt will only affect assets and liabilities.The income state-
ment and net worth will not be affected.
Explain how to account for prepaid expenses
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Prepaid expenses are expenses paid for before the expense is incurred. Initially they are
recorded as an asset on the balance sheet. Once the expense has been incurred, the asset is
reduced and an expense is recorded on the income statement.
Distinguish between capital and revenue
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Capital includes irregular items such as gifts that increase net worth. Revenue items also
increase net worth but are earned and are recorded on the income statement.
Demonstrate how double entries are recorded inT-accounts
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T-accounts are used to track the increases and decreases in the value of assets, liabilities, net
worth, revenue and expenses.
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