Here is a **1,200-word** comprehensive set of notes on **Financial Accounting**, covering key
concepts, principles, and practices.
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# **Financial Accounting: Key Concepts & Principles**
*(~1,200 Words)*
## **1. Introduction to Financial Accounting**
Financial accounting is the process of recording, summarizing, and reporting financial transactions of
a business to external stakeholders (investors, creditors, regulators). It follows standardized rules
(GAAP or IFRS) to ensure consistency and transparency.
### **Key Objectives:**
- Provide financial information to investors, creditors, and regulators.
- Track business performance (profitability, liquidity, solvency).
- Ensure compliance with legal and tax requirements.
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## **2. Accounting Principles & Concepts**
Financial accounting operates under fundamental principles:
### **(a) Generally Accepted Accounting Principles (GAAP)**
- **Revenue Recognition Principle** → Record revenue when earned, not when cash is received.
- **Matching Principle** → Expenses must match related revenues in the same period.
- **Historical Cost Principle** → Assets recorded at original purchase price.
- **Full Disclosure Principle** → All material financial information must be reported.
### **(b) International Financial Reporting Standards (IFRS)**
- Used globally (except the U.S., which uses GAAP).
- Focuses on **fair value measurement** and **substance over form**.
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## **3. The Accounting Equation & Double-Entry System**
### **Accounting Equation:**
\[ \text{Assets} = \text{Liabilities} + \text{Owner's Equity} \]
### **Double-Entry Accounting:**
- Every transaction affects **at least two accounts** (debit and credit).
- **Example:** Buying equipment for cash:
- **Debit** Equipment (Asset ↑)
- **Credit** Cash (Asset ↓)
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## **4. Financial Statements**
Four core statements provide a financial snapshot:
### **(a) Balance Sheet (Statement of Financial Position)**
- Shows **assets, liabilities, and equity** at a specific date.
- **Formula:**
\[ \text{Assets} = \text{Liabilities} + \text{Shareholders' Equity} \]
### **(b) Income Statement (Profit & Loss Statement)**
- Reports **revenue, expenses, and profit/loss** over a period.
- **Formula:**
\[ \text{Net Income} = \text{Revenue} - \text{Expenses} \]
### **(c) Cash Flow Statement**
- Tracks **cash inflows and outflows** from:
- **Operating activities** (day-to-day business)
- **Investing activities** (buying/selling assets)
- **Financing activities** (loans, equity)
### **(d) Statement of Changes in Equity**
- Shows changes in **owner’s equity** (retained earnings, dividends, share capital).
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## **5. Key Financial Ratios**
Used to assess financial health:
| **Ratio** | **Formula** | **Purpose** |
|-------------------------|----------------------------------|-------------|
| **Current Ratio** | Current Assets / Current Liabilities | Liquidity check |
| **Debt-to-Equity** | Total Debt / Total Equity | Solvency risk |
| **Gross Profit Margin** | (Revenue - COGS) / Revenue | Profitability |
| **ROE (Return on Equity)** | Net Income / Shareholder’s Equity | Investor returns |
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## **6. Accounting for Inventory & Depreciation**
### **(a) Inventory Valuation Methods**
- **FIFO (First-In, First-Out)** → Oldest inventory sold first.
- **LIFO (Last-In, First-Out)** → Newest inventory sold first (not allowed under IFRS).
- **Weighted Average Cost** → Average cost per unit.
### **(b) Depreciation Methods**
- **Straight-Line:** Equal expense each year.
\[ \text{Depreciation} = \frac{\text{Cost - Salvage Value}}{\text{Useful Life}} \]
- **Declining Balance:** Higher expense in early years.
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## **7. Auditing & Internal Controls**
- **Audit:** Independent review of financial statements for accuracy.
- **Internal Controls:** Policies to prevent fraud (e.g., segregation of duties).
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## **8. Limitations of Financial Accounting**
- **Historical Data:** Doesn’t predict future performance.
- **Non-Monetary Factors:** Ignores employee morale, brand value.
- **Subjectivity:** Estimates (e.g., depreciation) can vary.
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## **Conclusion**
Financial accounting is essential for business transparency, compliance, and decision-making. By
following GAAP/IFRS, companies ensure accurate reporting for investors, creditors, and regulators.
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