Financial Accounting Notes

What is Accounting Cycle

The sequence of accounting procedures used to record, classify, and summarize accounting information is often termed the accounting cycle.
At this point, we have illustrated a complete accounting cycle as it relates to the preparation of a balance sheet for a service-type business with a manual accounting system. The accounting procedures discussed to this point may be summarized as follows.

  1. Record transaction in the journal. As each business transaction occurs, it is entered in the journal, thus creating a chronological record of events. This procedure completes the recording step in the accounting cycle.
  2. Post to ledger accounts. The debit and credit changes in account balances are posted from the journal to the ledger. This procedure classifies the effects of the business transactions in terms of specific asset, liability, and owner’s equity.
  3. Prepare a trial balance. A trial balance proves the equality of the debit and credit entries in the ledger. The purpose of this procedure is to verify the accuracy of the posting process and the computation of ledger account balances.
  4. Prepare financial statements. At this point, we have discussed only one financial statement – the balance sheet. This statement shows the financial position of the business at a specific date.

The preparation of financial statements summarizes the effects of business transaction occurring through the date of the statements and completes the accounting cycle.

What is Net Income?

Net income is an increase in owner’s equity resulting from the profitable operation of the business. The opposite of net income, is the decrease in owner’s equity resulting from unprofitable operation of the business, and is called net loss.
Notice that net income does not consist of cash or any other specific asset. Rather, net income is a computation of the overall effects of many business transactions upon owner’s equity. The increase in owner’s equity resulting from profitable operations usually is accompanied by an increase in total assets, though not necessarily an increase in cash. In some cases, however, an increase in owner’s equity is accompanied by a decrease in total liabilities.

The Income Statement: A Preview

An income statement is a one page financial statement, which summarizes the profitability of the business entity over a specified period of time. Net income is determined by comparing for the time period: (1) the sales price of the goods sold and services rendered by the business with (2) the cost to the business of the goods and services used up in the business operations. The technical


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