There is two types of recording systems for financial accounting:
- Cash-basis accounting: which records as cash flows occurs, that is the amount of cash transactions a business have during a period.
- Accrual-basis accounting: records any transaction happens, not to mention cash flows, however must satisfy some rules, which are accounting principles and concepts, such as the time-period concept, revenue principle and the matching principle. The accrual-basis accounting is also required by GAAP (Generally Accepted Accounting Principles).
- Time-period concept: it claims statements must be made at least once a year. Even better in interim periods.
- Revenue principle: revenues are earned when a service or good is delivered or completed.
- Matching principle: revenues and expenses must be correctly identified and distributed between the accounts (some expenses are kind of different as commissions and cost of goods sold; otherwise rent and salary expenses for instance, are time-dependable). After summering all revenues and expenses, expenses must be subtracted from revenues, the result is net income or net loss (as you should have read before that makes the income statement). If there’s any dividend issued, the dividend is, as well, subtracted from the net income or loss, and the final result gives you the retained earnings.
Despite everything we’ve done, accrual-basis should need some adjustments, so they’re bounded by an accounting period (some expenses have not yet accrued or like).
Revenues and expenses are distributed this way:
– Deferrals: paid or received cash in advance, such prepaid expenses and unearned revenues.
– Accruals: recorded before cash transaction, such like accrual expenses, accrual revenues.
– Depreciation: which are the allocation asset´s cost. Plant asset are a typical depreciative asset. However, depreciation costs of intangibles assets (goodwill, trademarks) are called amortization. (There are three ways to allocate depreciation expenses, it’ll be discussed in future posts)
– Supplies account: to record supplies you need the supply expense. Compute supply used during the month minus supply on hand at the end of the month, and you’ll have supply expense.
source: my notes and “financial accounting by horgren and harrison 6th edition”.