Principles of Financial Accounting Study Guide and Chapter Summaries – Christine Jonick (UNG Press, 2017) BBA / B.Com

Principles of Financial Accounting is the first accounting textbook of Christine Jonick, Ed.D., written for the Accounting I course at the University of North Georgia and published by University of North Georgia Press under the University System of Georgia. It is free to share under a Creative Commons licence. Its seven chapters cover the accounting cycle for service and merchandising businesses, adjusting and closing entries, inventory, cash and receivables, fixed assets, investments, liabilities, bonds, stockholders’ equity, the statement of cash flows and financial statement analysis.

For BBA and B.Com students this is a short and practical way to learn debits and credits for the first time. The book builds from a simple cash-basis business to a full corporation, and almost every idea comes with a worked journal entry and a note explaining which account goes up or down. This page gives a summary, key points, a tip, a common mistake and two practice questions for every chapter, plus a study plan and an honest note on which parts are dated, so you know what to expect before you open the official book.

Book Overview

Chapter List

Chapter 1: Accounting Cycle for the Service Business – Cash Basis

Difficulty: Medium · Key topics: accounts and balances, five account types, net income, journal, debit and credit rules, ledger, posting, normal balance, trial balance, income statement, closing entries, accounting equation, retained earnings statement, balance sheet

The first chapter starts from one idea: a business keeps running balances in accounts, and every account is an asset, a liability, stockholders’ equity, revenue or an expense. A transaction is first written in the journal, with debits on the left and credits on the right, then posted to the ledger, where each account keeps its own normal balance and is tested with a trial balance. The chapter then builds the income statement, explains temporary accounts and closing entries into Retained Earnings, adds balance sheet accounts, and ends with the accounting equation, the retained earnings statement, the balance sheet and changes in stockholders’ equity.

Key Points:

• Every account belongs to one of five categories: assets, liabilities, stockholders’ equity, revenue or expenses.
• Revenue minus expenses is net income; if expenses are higher, the result is a net loss.
• Debit means the left column and credit means the right column, and the debit line of an entry is written first.
• The journal records transactions in date order; the ledger regroups the same amounts by account, and posting is the copying step between them.
• An account’s normal balance is the side that increases it, so assets and expenses normally carry debit balances.
• Revenue, expense and dividend accounts are temporary and are closed into Retained Earnings; balance sheet accounts are permanent and carry forward.
• The accounting equation is Assets = Liabilities + Stockholders’ Equity, and Common Stock + Retained Earnings = total stockholders’ equity.

Memory Tip: Start every entry with Cash. Money in means debit Cash, money out means credit Cash, and then you only have to decide the other account.

Common Mistake: Reading debit as “decrease” and credit as “increase”. In this book they only mean left and right, and whether an account goes up or down depends on its type.

Important Questions:

• What is the difference between the journal and the ledger? The journal lists every transaction in date order, while the ledger regroups the same amounts by account and keeps a running balance for each one.
• Why are closing entries needed? They move the balances of revenue, expense and dividend accounts into Retained Earnings so these temporary accounts start the next period at zero.

Chapter 2: Accounting Cycle for the Service Business – Accrual Basis

Difficulty: Hard · Key topics: accrual basis, matching principle, adjusting entries, deferred expenses, depreciation, deferred revenue, accrued expenses, accrued revenue, effect of missing adjustments

Chapter 2 switches from the cash basis to the accrual basis, where revenue is recorded when it is earned and expenses when they are incurred, whether or not cash has moved. A timeline example shows the matching principle by cutting jobs and costs into the month they belong to. The long middle of the chapter teaches adjusting entries in two families: deferrals, where cash moves first (supplies, prepaid rent, insurance and taxes, depreciation, unearned fees), and accruals, where cash moves later (unpaid wages, taxes and interest, and revenue earned but not yet billed). It closes by showing how leaving out one adjustment distorts the statements.

Key Points:

• The accrual basis records events when they happen; the cash basis records them only when cash changes hands.
• The matching principle puts expenses in the same period as the revenue they helped to earn.
• A deferred expense is paid first and used later: it starts as an asset, and the adjusting entry moves the used part to expense.
• Deferred revenue is cash received before the work is done; it sits in a liability such as Unearned Fees until it is earned.
• An accrued expense debits an expense and credits a payable; accrued revenue debits Accounts Receivable and credits a revenue account.
• Accumulated Depreciation is a contra asset account, and book value is cost minus accumulated depreciation.
• Missing a single adjustment makes revenue, net income, assets and stockholders’ equity wrong at the same time.

Memory Tip: Sort every adjustment with one question: has the cash already moved? If yes, it is a deferral; if not yet, it is an accrual.

Common Mistake: Treating the whole payment for a multi-month item as this month’s expense, or leaving it as an asset for ever. The adjusting entry splits the cost between the part used up and the part still waiting.

Important Questions:

• What is the difference between a deferral and an accrual? In a deferral the cash moves before the revenue is earned or the expense is used up; in an accrual the revenue or expense builds up before any cash or journal entry exists.
• Why is Unearned Fees a liability? The business has been paid but still owes the customer a service, so the amount becomes revenue only as the work is done.

Chapter 3: Accounting Cycle for a Merchandising Business

Difficulty: Medium · Key topics: merchandising versus service, inventory, Sales, multi-step income statement, perpetual system, purchase and sales discounts, FOB terms, periodic system, inventory shrinkage, closing entries

Chapter 3 moves from service firms to merchandisers that buy products and resell them. It separates inventory from supplies and equipment, introduces the Sales account, and builds the multi-step income statement, which sets Cost of Merchandise Sold against net sales to show gross profit. Under the perpetual inventory system it walks through purchases, returns, early-payment discounts such as 2/10, net 30, the seller’s gross and net methods, and the yearly estimate for sales returns. It then covers who pays freight under FOB shipping and FOB destination, the periodic system with its temporary accounts, inventory shrinkage and the closing entries.

Key Points:

• Inventory is goods bought for resale, while supplies are items used up in running the business.
• Net sales are sales less returns and discounts, and gross profit is net sales minus Cost of Merchandise Sold.
• The perpetual system updates Merchandise Inventory at every purchase and sale; the periodic system waits for a physical count at the end of the period.
• The terms 2/10, net 30 mean a 2% discount if the invoice is paid within 10 days, otherwise the full amount is due in 30 days.
• With FOB shipping the buyer owns the goods in transit and adds freight to inventory; with FOB destination the seller pays and records Delivery Expense.
• The periodic system uses Purchases, Purchases Returns, Purchases Discounts and Freight-in instead of Merchandise Inventory during the period.
• Inventory shrinkage is the gap between the records and the physical count, and it is charged to Cost of Merchandise Sold.

Memory Tip: Follow the ownership. FOB shipping means the goods are the buyer’s as soon as they leave the seller’s dock, so the buyer pays for the truck; with FOB destination they stay the seller’s until they arrive.

Common Mistake: Treating a purchase discount as extra income. For the buyer under the perpetual system it lowers the cost of the inventory.

Important Questions:

• What is the difference between the perpetual and periodic inventory systems? The perpetual system keeps a running inventory balance after every transaction, while the periodic system finds ending inventory and cost of merchandise sold only after a physical count.
• Who pays the freight under FOB destination? The seller, because it still owns the goods in transit; it records Delivery Expense and the buyer records nothing.

Chapter 4: Assets in More Detail

Difficulty: Hard · Key topics: FIFO, LIFO, average cost, lower of cost or market, bank reconciliation, notes receivable, uncollectible accounts, depreciation methods, disposal of fixed assets, gains and losses, intangible assets, investments in stocks and bonds

Chapter 4 is the longest chapter, about 96 pages, and takes the asset side of the balance sheet one topic at a time. It begins with inventory: FIFO, LIFO and average cost under both inventory systems, lower-of-cost-or-market and the physical count. It then covers cash and bank reconciliation, notes receivable with interest, and uncollectible accounts under the direct write-off and allowance methods. Fixed assets follow, with three depreciation methods, disposal by discard, sale or trade-in, and the way gains, losses and intangible assets appear on the statements. The last sections explain investments in stocks and in bonds.

Key Points:

• FIFO sends the oldest costs to Cost of Merchandise Sold, LIFO the newest, and average cost the mean; when prices rise, FIFO shows the lowest cost and LIFO the highest.
• Lower-of-cost-or-market follows conservatism: inventory is reported at the lower of what was paid and its current market value.
• A bank reconciliation compares the cash ledger with the bank statement and records items the books missed, such as NSF checks, bank charges and errors.
• The direct write-off method suits rare bad debts, while the allowance method books a yearly estimate in the contra asset Allowance for Doubtful Accounts.
• Depreciation spreads cost over useful life by straight-line, units-of-production or declining-balance methods, and land is never depreciated.
• When a fixed asset is discarded, sold or traded in, book value is compared with what is received, and the difference is a gain or a loss shown below net income from operations.
• Intangible assets such as patents are amortized, goodwill is not, and stock investments use the fair value method below 20% ownership and the equity method from 20% to 50%.

Memory Tip: Book value is what is left of an asset. Accumulated Depreciation grows by exactly the amount that book value shrinks, and the two always add back to cost.

Common Mistake: Depreciating land, or depreciating a machine below its residual value. Neither is allowed, and both inflate expenses.

Important Questions:

• When is the allowance method used instead of direct write-off? When a company has bad debts all the time. It estimates the loss in advance with Bad Debt Expense and Allowance for Doubtful Accounts so the expense lands in the same year as the sales.
• How do you find the gain or loss when a fixed asset is sold? Work out book value on the sale date (cost minus accumulated depreciation) and compare it with the cash received; more cash is a gain, less cash is a loss.

Chapter 5: Liabilities in More Detail

Difficulty: Hard · Key topics: sales tax payable, payroll withholdings, employer payroll taxes, notes payable, interest calculation, installment loans, bonds payable, discount and premium, carrying amount, calling bonds

Chapter 5 looks at what a business owes. It starts with sales tax, which is collected from customers into Sales Tax Payable and passed to the state, not treated as an expense. The payroll section follows gross pay down to net pay and then adds the employer’s own payroll taxes. Notes payable come next, including short-term interest-bearing and discounted notes and a long-term installment note whose payments split into interest and principal. The longest part explains bonds: face amount, contract and market rates, issue at face value, at a discount or at a premium, carrying amount, interest, calling bonds and partial redemptions.

Key Points:

• Sales tax collected is a liability in Sales Tax Payable; it is not part of Sales and it is not a business expense.
• Net pay is gross pay less income tax, Social Security and Medicare withholdings, and the book’s examples use 6.2% and 1.45% for the last two.
• The employer also matches Social Security and Medicare and pays unemployment taxes, so an employee costs more than gross pay.
• Interest equals principal times annual rate times time, and the book simplifies by using a 360-day year.
• Bonds pay interest twice a year and repay the face amount at maturity, so a bond of n years has 2n interest payments plus the final repayment.
• A contract rate below the market rate means the bonds are issued at a discount (a contra liability), and a rate above it means a premium.
• When bonds are called, the carrying amount is compared with the amount paid, and the difference is a gain or a loss on redemption.

Memory Tip: If the bond pays less than the market, investors want a price cut, so it sells at a discount. If it pays more than the market, they pay extra, so it sells at a premium.

Common Mistake: Crediting Bonds Payable for the cash received. The liability is always the face amount, and any discount or premium goes in its own account.

Important Questions:

• Why is sales tax not an expense of the business? It is the customers’ money collected for the state, so it is held in a liability until it is paid over.
• Why do some bonds sell at a discount? Their contract rate is lower than the market rate, so investors pay less to make the bond as attractive as competing bonds, while the company still repays the full face amount at maturity.

Chapter 6: Stockholders’ Equity in More Detail

Difficulty: Medium · Key topics: corporations, par value, issuing stock, non-cash issuance, treasury stock, cash dividends, stock dividends, stock splits, preferred stock, equity section of the balance sheet

Chapter 6 returns to the equity side of the accounting equation and looks inside a corporation. It explains that a corporation is a separate legal entity with limited liability, then shows how stock is issued for cash at par or above par, with the extra credited to Paid-in Capital in Excess of Par, and how it is issued for non-cash assets such as land. Treasury stock buybacks, cash dividends with their declaration, record and payment dates, stock dividends and stock splits follow. The chapter ends with the equity section of the balance sheet and dividend calculations for cumulative and non-cumulative preferred stock.

Key Points:

• A corporation is a separate legal entity, and its stockholders can lose no more than the amount they invested.
• Common Stock is credited only in multiples of par value; any extra paid per share goes to Paid-in Capital in Excess of Par.
• Treasury stock is a contra equity account, and shares outstanding equal shares issued minus treasury shares.
• A cash dividend has a declaration entry and a payment entry, and no entry on the date of record.
• A stock dividend moves value from Retained Earnings into paid-in capital using the market value, and no cash leaves the company.
• A stock split changes the number of shares, par value and price per share, but not total value, and needs no journal entry.
• Preferred stockholders are paid first, and cumulative preferred shares collect missed dividends in arrears before common stockholders get anything.

Memory Tip: Remember the three dividend dates as declare, record, pay. Only the first and the last need a journal entry.

Common Mistake: Counting treasury shares when working out a dividend. Dividends are paid only on shares outstanding.

Important Questions:

• What is the difference between cumulative and non-cumulative preferred stock? With cumulative preferred stock, missed dividends carry forward and must be paid before common stockholders receive anything; non-cumulative preferred stock never catches up.
• How does a stock split differ from a stock dividend? A split changes the share count and par value with no journal entry, while a stock dividend moves an amount from Retained Earnings into paid-in capital.

Chapter 7: Capstone Experiences

Difficulty: Hard · Key topics: four financial statements, statement of cash flows, operating, investing and financing activities, indirect and direct methods, horizontal and vertical analysis, common-size statements, ratio analysis, accounting careers

Chapter 7 pulls the book together. It first reviews the income statement, the retained earnings statement and the balance sheet, then teaches the fourth statement, the statement of cash flows, which is prepared last. Transactions are sorted into operating, investing and financing activities, and the operating section is built with the indirect method and shown again with the direct method. The second half is financial statement analysis: horizontal and vertical analysis, common-size statements and a long run of ratios grouped as liquidity, solvency, profitability and return measures. Section 7.5 closes the book with a look at accounting as a profession.

Key Points:

• The statement of cash flows has three sections, operating, investing and financing, and each ends in a net cash flow figure.
• The indirect method starts with net income and adjusts for depreciation, gains and losses, and changes in current operating assets and liabilities; the direct method gives the same total.
• Investing activities involve long-term assets, while financing activities include issuing stock or bonds, paying dividends and buying treasury stock.
• Horizontal analysis compares each line across years using the earlier year as the base, and vertical analysis shows each line as a percentage of one total, such as sales.
• Common-size statements keep only the percentages, so companies of different size can be compared.
• Liquidity ratios include the current ratio, the quick ratio, receivables turnover and inventory turnover; later ratios cover solvency, profitability and return.
• No ratio means much by itself; it must be compared with past results, other companies or an industry standard.

Memory Tip: Ask which of three things happened to the cash: it ran the business (operating), it bought or sold long-term things (investing), or it funded the business (financing).

Common Mistake: Adding depreciation back in the indirect method because it is a “cash inflow”. It is added back only because it reduced net income without using any cash.

Important Questions:

• How do the indirect and direct methods differ? Both give the same cash flow from operating activities; the indirect method starts from net income and adjusts it, while the direct method lists cash receipts and cash payments.
• What does the current ratio measure? The ability to pay current liabilities from current assets, found by dividing current assets by current liabilities.

Back Matter: Accounts Summary Table

Back matter · Difficulty: Easy · Key topics: account types, increase and decrease side, normal balance, financial statement, close out or not

The book ends with one cumulative Accounts Summary Table covering every account used in the seven chapters. It groups accounts by type (asset, contra asset, liability, contra liability, stockholders’ equity, contra stockholders’ equity, revenue or gain, contra revenue and expense or loss) and shows for each group which side increases it, which side decreases it, its normal balance, the statement it appears on and whether it is closed out at the end of the period. It also marks the temporary periodic-system accounts with an asterisk.

Key Points:

• Assets, expenses and losses increase with a debit; liabilities, equity, revenue and gains increase with a credit.
• Contra accounts run the opposite way to the account they adjust, for example Accumulated Depreciation against assets and Discount on Bonds Payable against liabilities.
• Balance sheet accounts are not closed, while income statement accounts and the dividend accounts are closed each period.
• Cash Dividends and Stock Dividends are shown on the retained earnings statement and are closed to Retained Earnings.

Memory Tip: Copy the table once by hand from memory before an exam. If you can predict the increase side and normal balance of each group, the journal entries follow.

Important Questions:

• Which accounts are closed at the end of the period? Revenue and gain accounts, contra revenue accounts, expense and loss accounts, and the dividend accounts; balance sheet accounts carry forward.
• What is the normal balance of a contra asset account? A credit balance, the opposite of the asset it reduces.

How to Study This Book

Principles of Financial Accounting has seven chapters in about 300 pages. The book does not divide itself into parts and has no preface or appendices, so this page gives one block per chapter and one block for the Accounts Summary Table at the end. Because there are fewer than thirty chapters, nothing is grouped. The book’s own checklists use the University of North Georgia course code ACCT 2101, and it is designed to be read in order, since every chapter reuses the debit and credit rules from the one before.

Match the chapters to your course outline in four steps. Chapters 1 and 2 are the foundation: the five account types, the journal, ledger and trial balance, the first three statements, and then adjusting entries. Chapter 3 adds merchandising and inventory flow. Chapters 4, 5 and 6 are the detail chapters, one for assets, one for liabilities and one for stockholders’ equity, and your teacher may not cover all of their sections. Chapter 7 comes last because the statement of cash flows and the ratios use balances from everything before it. Refer to sections by their titles, because the book numbers two different sections 6.4 (issuing stock for non-cash assets, and treasury stock).

Do not skip Chapters 1 and 2. Practise journalizing, posting and the ten adjusting entries by hand until you can say, without looking, which account is debited and which is credited. Chapter 3 depends on Chapter 2, and Chapters 4 to 6 simply add new accounts to the same rules. Read Chapter 3 before section 4.1, because the inventory methods build on the perpetual and periodic systems, and read section 4.5 on depreciation after Chapter 2, which introduces Accumulated Depreciation.

Expect the hardest work in four places. Chapter 2 has ten adjusting entries that look alike, so sort them into deferred expenses, deferred revenue, accrued expenses and accrued revenue. Chapter 4 is nearly a third of the whole book, so study it in three sittings: inventory, cash and receivables (4.1 to 4.4); fixed assets, disposals and intangibles (4.5 to 4.8); and investments (4.9 and 4.10). In Chapter 5, bonds take the most time, so master the at-face-value case first, then the discount and premium cases. In Chapter 7, build the statement of cash flows one section at a time and learn the ratios in their four groups. Chapters 1, 3 and 6 are easier to read.

The PDF teaches through worked journal-entry examples with short notes beside each debit and credit, and Chapters 2, 3 and 4 include checklists of the skills the course expects. It does not contain end-of-chapter problem sets or an answer key, so you will need practice questions from your teacher, your notes or a companion book. A good routine is to cover the answer in each example, write the entry yourself and then compare.

Know the limits before you rely on it. The book teaches US-style financial accounting for a US course, with examples set mostly between 2009 and 2019, and it is not a Pakistan-specific text. The payroll tables in Chapter 5 are headed “for wages paid through December 2013” and use Georgia state rules, so treat the withholding amounts as method practice, not current rates. The investment classes in sections 4.9 and 4.10 follow the rules of the time, and the book does not mention lease accounting, the revenue recognition standard, IFRS, Pakistan or the rupee. Internal control appears only through bank reconciliation in section 4.2. The accounting cycle, merchandising, depreciation, bonds, equity, cash flows and ratios are not dated, so use your teacher’s notes for local tax and reporting rules.

Used In These Programs

This book is used for the Financial Accounting course in BBA and BS Commerce (B.Com). Browse all Financial Accounting books, the wider Accounting tag or the whole BBA category in University Books.

Who Should Read This

Principles of Financial Accounting is written for a student in the first financial accounting course of a BBA or B.Com program. It suits you if you have never seen a journal entry, need a short and clear path through the accounting cycle and the four financial statements, or want a free second book next to your class notes. It is a good read-ahead for ICOM students who plan to continue to a BBA or B.Com. If you want a longer book with end-of-chapter questions, pair it with Principles of Accounting, Volume 1: Financial Accounting, and for cost accounting and budgeting continue to Volume 2: Managerial Accounting. It is not a book for managerial accounting, partnerships, auditing or Pakistani tax law, and it gives only a short look at internal controls, so keep your course notes beside it for those.

Applicable Universities

This book is useful for students at Pakistani universities offering BBA, B.Com and related business programs, including University of the Punjab, University of Karachi, Virtual University, COMSATS, Lahore School of Economics, IBA Karachi, and other HEC-recognized institutions.

Official Copy of Principles of Financial Accounting

Principles of Financial Accounting is free from its official open-textbook page. Click the button below to open the official GALILEO Open Learning Materials page, where you can download the complete PDF.

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Related Books

• Principles of Accounting, Volume 1: Financial Accounting PDF Download – OpenStax (a longer financial accounting book with end-of-chapter questions, useful next to Chapters 1 to 7)
• Principles of Accounting, Volume 2: Managerial Accounting PDF Download – OpenStax (the cost and budgeting side that this book does not cover)
• Principles of Finance PDF Download – OpenStax (bonds, stocks and ratios from Chapters 5 to 7 in a finance course)
• Introduction to Business PDF Download – OpenStax (the business background behind forms of ownership, financing and reporting)

Principles of Financial Accounting gives BBA and B.Com students a short, free guide from the first journal entry to inventory, liabilities, corporations, the statement of cash flows and ratio analysis. Browse more BBA books or the whole University Books section.

Principles of Financial Accounting, by Christine Jonick, Ed.D., University of North Georgia. Published by University of North Georgia Press, Dahlonega, Georgia, under the University System of Georgia, 2017. Licensed under a Creative Commons Attribution-ShareAlike 4.0 International License (CC BY-SA 4.0); the licence does not extend to third-party content under other licences. Access for free at https://oer.galileo.usg.edu/business-textbooks/7/