Accounting Principles (GAAP & IFRS)

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📘 1. Accounting Principles (GAAP & IFRS)

a. Accrual Principle

• Revenue and expenses are recorded when earned or incurred, not when cash is received or paid.

• Example: A company performs a service in December but gets paid in January. Under accrual accounting, the revenue is recorded in December.

b. Consistency Principle

• Once a method is chosen (e.g., depreciation method), it should be used consistently across periods.

• Example: If a company uses straight-line depreciation this year, it should not switch to declining balance next year without a good reason.

c. Going Concern Assumption

• Assumes the business will continue operating in the foreseeable future.

• Example: Assets aren't recorded at liquidation value, even if they could be sold for more in a crisis.

d. Matching Principle

• Expenses are matched to the revenues they help generate.

• Example: If a company earns $10,000 in revenue in January and incurs $2,000 in related expenses, both should be recorded in January.

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📗 2. Financial Statements Overview

a. Income Statement (Profit & Loss Statement)

• Shows revenue, expenses, and profit/loss over a specific period.

• Formula:

  Net Income = Revenue - Expenses
  

Example:

Item	Amount
Revenue	$100,000
Cost of Goods Sold	$40,000
Gross Profit	$60,000
Operating Expenses	$20,000
Net Income	$40,000

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b. Balance Sheet

• Snapshot of a company’s financial position at a specific date.

• Formula:

  Assets = Liabilities + Equity
  

Example:

Assets	Amount
Cash	$10,000
Inventory	$20,000
Equipment	$70,000
Total Assets	$100,000

Liabilities	Amount
Loans Payable	$40,000
Equity	$60,000
Total Liab+Eq	$100,000

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c. Cash Flow Statement

• Reports the inflows and outflows of cash during a period.

• Divided into:

  • Operating activities

  • Investing activities

  • Financing activities

Example (partial):

Cash Flows from Operating Activities
Net Income
Depreciation
Changes in Working Capital
Net Cash from Operating

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📙 3. Key Financial Ratios

a. Liquidity Ratios

• Current Ratio = Current Assets / Current Liabilities

  • Example: $50,000 / $25,000 = 2.0 (Good liquidity)

b. Profitability Ratios

• Net Profit Margin = Net Income / Revenue

  • Example: $10,000 / $100,000 = 10%

c. Solvency Ratios

• Debt-to-Equity = Total Liabilities / Total Equity

  • Example: $40,000 / $60,000 = 0.67

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📒 4. Financial Reporting & Compliance

• Companies report financial data to stakeholders (shareholders, regulators, etc.)

• Public companies must comply with regulations:

  • GAAP (in the U.S.)

  • IFRS (International)

• Annual Reports typically include:

  • Auditor’s Report

  • Management Discussion & Analysis (MD&A)

  • Financial Statements

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🧠 Summary Tips

Concept	Key Point
Income Statement	Shows profitability over a period
Balance Sheet	Shows assets, liabilities, and equity
Cash Flow	Tracks cash in and out
GAAP/IFRS	Set rules for consistency & comparability
Ratios	Help assess performance and risk

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