This allows the company to maintain a separate record of expenses incurred during an accounting period. That debit, however, is recorded in an appropriate expense account rather than in retained earnings itself. For example, an expense represents a decrease in retained earnings, which requires a debit. Notice that increases and decreases in retained earnings are recorded indirectly in revenue, gain, expense, and loss accounts. This arbitrary, but effective, procedure ensures that for each transaction the net impact on the left sides of the accounts always equals the net impact on the right sides of accounts. Accounts on the right side of the equation (liabilities and shareholders’ equity) are increased by credit entries and decreased by debit entries. Accounts on the left side of the accounting equation (assets) are increased by debit entries and decreased by credit entries. Whether a debit or a credit represents an increase or decrease depends on the type of account. In the double-entry system, debit means left side of an account and credit means right side of an account. The double-entry system is used to process transactions.Retained earnings equals net income less distributions to shareholders (primarily dividends) since the inception of the corporation. These are reported as (1) paid-in capital and (2) retained earnings. Shareholders’ equity for a corporation arises primarily from two sources: (1) amounts invested by shareholders in the corporation and (2) amounts earned by the corporation (on behalf of its shareholders).
Assets equal liabilities plus owners’ equity. The accounting equation underlies the process used to capture the effects of economic events. The first objective of any accounting system is to identify the economic events that can be expressed in financial terms by the system.This chapter focuses on the many features that tend to be common to any accounting system. Actual accounting systems differ significantly from company to company. This review establishes a framework for the study of the concepts covered in intermediate accounting. The purpose of this chapter is to review the fundamental accounting process used to produce the financial statements.
Chapter 2: Review of the Accounting Process Chapter 1 explained that the primary means of conveying financial information to investors, creditors, and other external users is through financial statements and related notes.