Principles of Accounting, Volume 1: Financial Accounting PDF Download – Franklin, Graybeal et al. (OpenStax) BBA / B.Com

Principles of Accounting, Volume 1: Financial Accounting is the OpenStax textbook for the first university accounting course. It was written by senior contributing authors Mitchell Franklin, Patty Graybeal and Dixon Cooper with a team of contributing authors, and you can download it free as a PDF from the official OpenStax site. Its 16 chapters cover the role of accounting, the four financial statements, recording and adjusting transactions, closing the books, merchandising, accounting information systems, fraud and internal controls, receivables, inventory, long-term assets, current and long-term liabilities, corporation and partnership accounting, and the statement of cash flows.

The preface says the book is designed for both accounting and non-accounting majors, which makes it a natural fit for BBA and B.Com students who meet debits and credits for the first time. It explains the why as well as the how, with worked examples and a business story that continues through each chapter. This page gives a summary, key points, a tip, a common mistake and two practice questions for every chapter, plus a study plan, so you know what to read first before you open the official book.

Book Overview

Chapter List

Chapter 1: The Role of Accounting in Society

Difficulty: Easy · Key topics: accounting as the language of business, financial versus managerial accounting, internal and external users, for-profit, governmental and not-for-profit entities, stakeholders, equity and debt financing, GAAP, careers, CPA and CMA

The opening chapter defines accounting as the process of organizing, analyzing and communicating financial information for decision-making, and calls it the language of business. It separates financial accounting, which reports historical results to outsiders such as investors and creditors, from managerial accounting, which uses financial and nonfinancial data inside the firm. It then sorts organizations into for-profit (manufacturing, retail and service), governmental and not-for-profit, names the stakeholders who rely on accounting data, and closes with career paths, employers and professional certifications.

Key Points:

• Accounting is the process of organizing, analyzing and communicating financial information that is used for decision-making.
• Financial accounting is historical and reports to external users; managerial accounting is mainly for internal users and also uses nonfinancial information.
• Internal users are managers and employees; external users include investors, lenders, financial analysts and government agencies.
• Businesses raise capital in three ways: profitable operations, selling ownership (equity financing) and borrowing (debt financing).
• Guidelines for the profession are called accounting standards or generally accepted accounting principles (GAAP), and publicly traded companies must file with the SEC.
• Common certifications are CPA, CMA, CIA, CFE, CFA and CFP, and career paths include auditing, taxation, consulting and financial planning.

Memory Tip: Think “inside versus outside”. Managerial accounting serves people inside the company, and financial accounting serves people outside it.

Common Mistake: Picturing accounting as only number-crunching for accountants. The chapter shows that communication skills matter and that people in almost every career use accounting information.

Important Questions:

• What is the difference between financial and managerial accounting? Financial accounting measures performance in money terms, is historical and reports to external users such as investors and creditors. Managerial accounting uses financial and nonfinancial information to help managers inside the organization make decisions.
• Who are the main stakeholders who use accounting information? Stockholders (owners), creditors and lenders, governmental and regulatory agencies, customers, and managers and other employees. Each group relies on financial information to make its own decisions.

Chapter 2: Introduction to Financial Statements

Difficulty: Easy · Key topics: sole proprietorship, partnership, corporation, income statement, statement of owner’s equity, balance sheet, statement of cash flows, accounting equation, current and noncurrent items, ten elements, working capital, current ratio

This chapter introduces the four financial statements and how they connect. It starts with the three legal forms of business, then explains the income statement (revenues, expenses, gains, losses and net income), the statement of owner’s equity (investments by owners, distributions and net income), the balance sheet and the statement of cash flows, which exists because most statements use accrual accounting. It adds current versus noncurrent items, the accounting equation, the ten statement elements, the order and heading format for preparing statements, and the liquidity measures working capital and the current ratio.

Key Points:

• The four statements are the income statement, statement of owner’s equity, balance sheet and statement of cash flows.
• The income statement covers a period of time, while the balance sheet shows financial position on a given date.
• The accounting equation is Assets = Liabilities + Owner’s Equity, and it shows what the business owns and who has claims on it.
• Assets and liabilities settled in one year or less are current; otherwise they are noncurrent.
• There are ten elements: revenues, expenses, gains, losses, assets, liabilities, equity, investments by owners, distributions to owners and comprehensive income.
• Working Capital = Current Assets – Current Liabilities, and Current Ratio = Current Assets / Current Liabilities.

Memory Tip: The income statement is a movie of a period, and the balance sheet is a photograph of one date.

Common Mistake: Treating money the owner takes out as an expense. The statement of owner’s equity shows it as a distribution, and it never appears on the income statement.

Important Questions:

• What are the four financial statements and what does each show? The income statement shows performance for a period, the statement of owner’s equity shows how net worth changed, the balance sheet shows assets, liabilities and equity on one date, and the statement of cash flows shows cash inflows and outflows for a period.
• What is the accounting equation and why does it matter? Assets = Liabilities + Owner’s Equity. It shows what the organization owns and the sources of, or claims against, those resources, and it must always stay in balance.

Chapter 3: Analyzing and Recording Transactions

Difficulty: Medium · Key topics: FASB, GAAP, accounting principles and assumptions, double-entry bookkeeping, debits and credits, normal balance, expanded accounting equation, chart of accounts, journal, T-accounts, trial balance

Following Mark Summers and his dry-cleaning business, this chapter builds the recording process. It begins with FASB, the SEC, GAAP and the conceptual framework, then lists the principles and assumptions: revenue recognition, expense recognition, cost, full disclosure, separate entity, conservatism, monetary measurement, going concern and time period. It then covers double-entry bookkeeping, debits, credits and normal balances, the expanded accounting equation and the chart of accounts, and the first four steps of the accounting cycle: analyze transactions, journalize them, post to T-accounts and prepare a trial balance.

Key Points:

• FASB sets financial reporting standards in the United States, and the SEC regulates stock markets and checks that companies follow GAAP.
• The revenue recognition principle records revenue when it is earned, and the expense recognition (matching) principle records expenses in the same period as the related revenue.
• The cost principle records assets at their value on the date of acquisition, based on a verifiable transaction rather than an estimate.
• Debits go on the left of a T-account and credits on the right; assets, expenses and dividends have a normal debit balance.
• A journal is the book of original entry, and the general ledger collects every account with its balance.
• A trial balance lists all accounts with nonzero balances, and errors are found by retracing each step of the process.

Memory Tip: Use DEAD CLIC. Debits increase Dividends, Expenses and Assets, and Credits increase Liabilities, Income (revenue) and Capital (equity).

Common Mistake: Thinking debit means decrease and credit means increase, as on a bank statement. In accounting they only mean left and right, and the effect depends on the type of account.

Important Questions:

• What are the first four steps of the accounting cycle? Step 1 identifies and analyzes transactions, step 2 records them in a journal, step 3 posts the journal entries to the general ledger and step 4 prepares an unadjusted trial balance.
• What do the revenue recognition and expense recognition principles require? Revenue is recorded when it is earned, which means when the product or service has been provided. Expenses incurred to produce that revenue must be matched with it in the same period.

Chapter 4: The Adjustment Process

Difficulty: Hard · Key topics: accrual versus cash basis, accounting period, fiscal year, interim periods, deferrals, prepaid expenses, unearned revenues, accruals, adjusting entries, adjusted trial balance, ten-column worksheet

This chapter covers steps 5 to 7 of the accounting cycle. It explains accrual accounting, calendar and fiscal years and interim periods, and why a trial balance can be out of date even without an error. It then splits adjusting entries into deferrals (prepaid expenses and unearned revenues) and accruals (accrued revenues and accrued expenses), shows how to journalize and post them for Printing Plus, and ends with the adjusted trial balance, the financial statements built from it and the ten-column worksheet.

Key Points:

• Accrual accounting records revenues and expenses in the period they occur, whether or not cash changes hands.
• A fiscal year is any twelve-month reporting period that does not run from January 1 to December 31, and an interim period is any period shorter than a year.
• Prepaid expenses are assets paid for before use, such as supplies, insurance and depreciation, and unearned revenues are customer payments received before the service is given.
• Accrued revenues are earned but not yet recorded or collected, and accrued expenses are incurred but not yet recorded or paid.
• Every adjusting entry has one income statement account and one balance sheet account, and cash is never part of it.
• The adjusted trial balance lists all accounts including adjustments and is used to prepare the income statement, statement of retained earnings and balance sheet.

Memory Tip: In a deferral the cash comes first and the event later (prepaid, unearned). In an accrual the event comes first and the cash later (accrued revenue, accrued expense).

Common Mistake: Putting Cash into an adjusting entry. If cash moved, a normal journal entry already recorded it, so an adjustment only updates the other side.

Important Questions:

• What are the four types of adjusting entries? Prepaid expenses and unearned revenues (deferrals), and accrued revenues and accrued expenses (accruals). Each one brings a revenue or expense account and a balance sheet account up to date at the end of the period.
• Why are adjusting entries needed if the bookkeeper made no mistake? Not every transaction produces a source document that tells the bookkeeper to make an entry. Some balances, such as supplies used or wages earned, change with time, so they must be updated at period end.

Chapter 5: Completing the Accounting Cycle

Difficulty: Medium · Key topics: closing entries, temporary and permanent accounts, Income Summary, retained earnings, post-closing trial balance, cash versus accrual basis, classified balance sheet, liquidity, working capital, current ratio

This chapter finishes the cycle with steps 8 and 9, and it says plainly that step 10, reversing entries, is optional and left to later courses. It explains why temporary accounts are closed and permanent accounts carry forward, then walks through the four closing entries using the Income Summary account and the post-closing trial balance. A later section argues for accrual over cash accounting, introduces the classified balance sheet and uses working capital and the current ratio to judge liquidity. An appendix runs the whole cycle for Clip’em Cliff’s barber shop.

Key Points:

• Closing entries zero out temporary accounts and move the period’s result into retained earnings.
• Temporary accounts are revenues, expenses, dividends and Income Summary; permanent accounts are assets, liabilities and equity.
• The four closing entries close revenues to Income Summary, close expenses to Income Summary, close Income Summary to Retained Earnings and close dividends to Retained Earnings.
• The post-closing trial balance contains only permanent accounts and confirms that debits equal credits and temporary accounts are zero.
• A classified balance sheet splits assets and liabilities into current and long-term groups.
• Liquidity means having enough cash to pay bills when they fall due, but a company that is too liquid may not be using its assets efficiently.

Memory Tip: Closing is resetting the scoreboard. Temporary accounts go back to zero for the next game, and permanent accounts keep their scores.

Common Mistake: Closing dividends to Income Summary. Dividends are not an expense, so the book closes them directly to Retained Earnings.

Important Questions:

• What are the four closing entries? Close revenues to Income Summary, close expenses to Income Summary, close the Income Summary balance to Retained Earnings, and close dividends to Retained Earnings. After posting, every temporary account shows a zero balance.
• What is the difference between temporary and permanent accounts? Temporary accounts (income statement accounts, dividends and Income Summary) are closed at the end of each period. Permanent accounts (assets, liabilities and equity) are not closed, and their balances carry into the next period.

Chapter 6: Merchandising Transactions

Difficulty: Medium · Key topics: merchandising versus service, operating cycle, purchase and sales discounts, returns and allowances, perpetual and periodic systems, cost of goods sold, FOB shipping point and destination, multi-step income statement, gross profit margin

Using J&J Games, this chapter moves from service firms to merchandisers that buy and resell goods. It explains purchase and sales transactions on cash or credit, discounts such as 2/10, n/30 and returns and allowances, and compares perpetual and periodic inventory systems. It then records purchases and sales under the perpetual system, including the extra cost of goods sold entry, treats freight-in under FOB shipping point and FOB destination, and builds multi-step and simple income statements. An appendix repeats the entries under the periodic system.

Key Points:

• Merchandisers add Merchandise Inventory and Cost of Goods Sold to the picture, and their operating cycle includes buying, selling and collecting.
• 2/10, n/30 means a 2% discount if paid within 10 days, otherwise the full amount is due in 30 days.
• Sales Discounts and Sales Returns and Allowances are contra revenue accounts that reduce Sales.
• Under the periodic system, COGS = Beginning Inventory + Net Purchases – Ending Inventory.
• Under the perpetual system, each sale needs two entries: one for the sale and one that debits COGS and credits Merchandise Inventory.
• FOB shipping point means the buyer owns goods in transit and pays freight; FOB destination means the seller owns them until delivery and pays freight.

Memory Tip: Ownership moves at the “FOB” place. At the shipping point the buyer takes over at the seller’s door, and at the destination the buyer takes over at their own.

Common Mistake: Recording a perpetual-system sale without the cost entry. Revenue alone leaves Merchandise Inventory too high and COGS missing.

Important Questions:

• What does the credit term 2/10, n/30 mean? The buyer gets a 2% discount for paying within 10 days, and if it does not take the discount, the full payment is due within 30 days of the sale.
• What is the difference between perpetual and periodic inventory systems? A perpetual system updates Merchandise Inventory and Cost of Goods Sold constantly, while a periodic system updates them only at scheduled times, such as the end of the period, after a physical count.

Chapter 7: Accounting Information Systems

Difficulty: Medium · Key topics: input, processing, output and storage, source documents, manual and computerized systems, special journals, cash receipts and disbursements journals, sales and purchases journals, subsidiary ledgers, controlling accounts

Using Shane’s growing tennis-lesson business, this chapter explains the accounting information system, from paper journals and ledgers to computerized files. It describes the four parts of the system (input, processing, output and storage) and then the special journals that save time on repeated transactions: sales, purchases, cash receipts and cash disbursements, with the general journal for everything else. It shows how to post to subsidiary ledgers daily and to the general ledger monthly, and how to prepare schedules of accounts receivable and payable. A final section looks at careers that mix accounting with information systems.

Key Points:

• An accounting information system records transactions in journals and ledgers or in computer files, and its steps are input, processing, output and storage.
• A source document is the record that a transaction took place, and it is often used at the input stage.
• The cash receipts journal always debits Cash, and the cash disbursements journal always credits Cash.
• The sales journal always debits Accounts Receivable and credits Sales, and the purchases journal credits Accounts Payable.
• The general journal is used for transactions that fit nowhere else, mainly adjusting and closing entries and often returns.
• The total of each subsidiary ledger must equal its controlling account in the general ledger, Accounts Receivable or Accounts Payable.

Memory Tip: Ask “Is cash involved?” first. If yes, use the cash receipts or cash disbursements journal. If no, use the sales, purchases or general journal.

Common Mistake: Posting the total of the Other Accounts column to the general ledger. There is no such account, so each entry in that column is posted separately.

Important Questions:

• Why do businesses use special journals? The same types of transactions happen again and again, so special journals group them, save time and let the monthly column totals be posted to the general ledger instead of every entry.
• How do a subsidiary ledger and its controlling account relate? The subsidiary ledger holds the details of each customer or supplier account, and its total must equal the Accounts Receivable or Accounts Payable balance in the general ledger. A schedule of the individual balances proves this.

Chapter 8: Fraud, Internal Controls, and Cash

Difficulty: Medium · Key topics: fraud triangle, internal controls, Sarbanes-Oxley Act, PCAOB, separation of duties, petty cash, imprest fund, bank reconciliation, outstanding checks, deposits in transit, financial statement fraud, tone at the top

This chapter opens with a manager’s advice about hiring honest people and a statistic on restaurant theft. It explains Donald Cressey’s fraud triangle (incentive, opportunity and rationalization), defines internal controls and the Sarbanes-Oxley Act of 2002 and the PCAOB, and lists the elements of control: clear responsibilities, documentation, insurance, separating assets from custody, separating duties and technology. It then shows the petty cash fund, management’s responsibility and the tone at the top, bank reconciliations with journal entries, and how companies cook the books, with Enron and HealthSouth as examples.

Key Points:

• The fraud triangle has three elements, incentive, opportunity and rationalization, and each must be present for workplace fraud to occur.
• Internal controls are policies and procedures set by management to protect assets and make operations efficient.
• The Sarbanes-Oxley Act of 2002 created the PCAOB and applies to public companies, but good controls matter for businesses of any size.
• Core control elements are clear responsibilities, proper documentation, adequate insurance, separation of assets from custody, separation of duties and technology.
• A petty cash fund is an imprest account: it is debited only when set up or increased, and replenishing debits expenses and credits Cash.
• A bank reconciliation adjusts the bank balance for outstanding checks and deposits in transit, and the book balance for service charges and interest earned.

Memory Tip: Fraud needs Incentive, Opportunity and Rationalization. A company cannot control a person’s motives, so controls are built to remove the opportunity.

Common Mistake: Debiting Petty Cash each time the fund is replenished. The Petty Cash account stays at the fixed amount, and replenishment is recorded with expense debits and a Cash credit.

Important Questions:

• What are the three elements of the fraud triangle? Incentive (or pressure), opportunity and rationalization. The chapter says all three must be present, and good internal controls aim to take away the opportunity.
• What items does a bank reconciliation adjust for? The bank statement balance is adjusted for outstanding checks and deposits in transit. The company’s book balance is adjusted for items such as service charges and interest earned, and these need journal entries.

Chapter 9: Accounting for Receivables

Difficulty: Medium · Key topics: revenue recognition, matching, credit card sales, direct write-off method, allowance for doubtful accounts, aging of receivables, receivables turnover, earnings management, percentage of completion, notes receivable

Using Skateboards Unlimited, this chapter shows how credit sales create accounts receivable and when revenue is recognized. It compares the direct write-off method with the allowance method and the three ways to estimate bad debts: the income statement method (percentage of credit sales), the balance sheet method (percentage of receivables) and the aging method. It then uses receivables turnover and days’ sales in receivables to judge collection, explains earnings management, covers revenue on long-term projects, and compares notes receivable with accounts receivable, including honored and dishonored notes.

Key Points:

• Revenue is recognized when a product or service is provided, and expenses are matched with it in the same period.
• A credit card sale adds a credit card expense, and the card company pays the sale price less its fee.
• The direct write-off method records bad debt only when an account is known to be uncollectible, while the allowance method estimates it in the period of the sale.
• The income statement method uses a percentage of credit sales; the balance sheet and aging methods use outstanding receivables.
• Receivables turnover = Net Credit Sales / Average Accounts Receivable, and Days’ Sales in Receivables = 365 / Turnover.
• Interest on a note = Principal x Annual Rate x Part of the Year, and a dishonored note converts to accounts receivable.

Memory Tip: The income statement method looks at sales (what flowed in), and the balance sheet methods look at the receivables still on the books.

Common Mistake: Applying the estimate percentage to the wrong base. The income statement method uses credit sales, but the balance sheet and aging methods use accounts receivable.

Important Questions:

• What is the difference between the direct write-off method and the allowance method? Direct write-off records Bad Debt Expense only when an account is known to be uncollectible. The allowance method estimates uncollectible accounts at period end, debiting Bad Debt Expense and crediting Allowance for Doubtful Accounts, so the expense matches the related sales.
• How are accounts receivable turnover and days’ sales in receivables calculated? Turnover is net credit sales divided by average accounts receivable, and it shows how many times receivables are collected in a period. Days’ sales in receivables is 365 divided by the turnover, and it shows the average days to collect.

Chapter 10: Inventory

Difficulty: Hard · Key topics: periodic and perpetual updating, cost of goods available for sale, specific identification, FIFO, LIFO, weighted average, consignment, lower of cost or market, gross profit method, retail method, inventory errors, inventory turnover, days’ sales in inventory

This chapter explains how a company assigns costs to ending inventory and cost of goods sold. It sets out periodic and perpetual updating and the four cost flow methods (specific identification, FIFO, LIFO and weighted average), and works through the same data under each, first periodically and then perpetually, with journal entries. It adds consignment, FOB, lower of cost or market, the gross profit and retail estimating methods and the effect of rising and falling prices. It then shows how inventory errors distort the income statement and balance sheet and uses inventory turnover and days’ sales in inventory to judge efficiency.

Key Points:

• Cost of goods available for sale is beginning inventory plus purchases, and it splits into ending inventory (balance sheet) and cost of goods sold (income statement).
• The four cost flow methods are specific identification, FIFO, LIFO and weighted average, and they estimate cost flow, not the physical flow of goods.
• In rising prices, FIFO gives a larger ending inventory, lower cost of goods sold and higher profit than LIFO; in falling prices the effects reverse.
• A perpetual system needs no major period-end adjustment, and most modern systems use it because of efficiency and accuracy.
• An overstated ending inventory understates COGS and overstates net income, assets and equity; beginning inventory errors affect only the income statement.
• Inventory turnover shows how fast inventory sells, and days’ sales in inventory shows how long it takes, which helps spot obsolete or excess stock.

Memory Tip: FIFO sends the oldest costs to the income statement and leaves the newest on the balance sheet. LIFO does the opposite.

Common Mistake: Assuming the cost flow method must match the physical movement of goods. A company can sell its oldest items first and still use LIFO for costing.

Important Questions:

• How do inventory errors affect the financial statements? An error in beginning inventory affects only the income statement. An error in ending inventory affects both statements: an overstatement understates cost of goods sold and overstates net income, assets and equity, and an understatement does the reverse.
• What are the four inventory cost flow methods? Specific identification, first-in first-out (FIFO), last-in first-out (LIFO) and weighted average cost. They give different cost of goods sold, net income and inventory balances from the same purchases.

Chapter 11: Long-Term Assets

Difficulty: Medium · Key topics: tangible and intangible assets, capitalized costs, property, plant and equipment, repairs and maintenance, historical cost, salvage value, straight-line, units-of-production, double-declining-balance, depletion, amortization, goodwill, sale of an asset

Using Liam’s silk-screening machine, this chapter looks at assets used for more than one year. It separates tangible assets from intangibles such as patents, trademarks, copyrights and goodwill, and decides which costs are capitalized and which are expensed, including repairs that extend useful life. The longest section applies straight-line, units-of-production and double-declining-balance depreciation, partial years, depletion of natural resources and amortization. It then covers intangible assets, revising life or salvage value, obsolescence and the gain or loss when an asset is sold.

Key Points:

• Fixed assets are recorded at historical cost, including all costs to acquire the asset and make it ready for use.
• Depreciation allocates cost over useful life, using cost, salvage value and useful life in years or units.
• Liam’s $10,000 machine with a $1,000 salvage value and a five-year life gives straight-line depreciation of $1,800 a year.
• Natural resources are depleted using units consumed, and finite intangible assets are amortized, usually straight-line.
• Amortization usually has no salvage value and credits the intangible asset directly, with no accumulated amortization account.
• A sale gives a gain if cash received is above net book value, a loss if below, and neither if equal.

Memory Tip: Straight-line gives the same expense every year, units-of-production follows use, and double-declining-balance is heavy early and lighter later.

Common Mistake: Treating depreciation as a drop in market value or as cash being saved for a replacement. It is only an allocation of historical cost over the asset’s useful life.

Important Questions:

• How is straight-line depreciation calculated? (Cost – Salvage Value) / Useful Life. For a $10,000 machine with a $1,000 salvage value and a five-year life, that is $1,800 of depreciation expense each year.
• How does amortization differ from depreciation? Amortization applies to intangible assets. It usually has no salvage value, normally uses the straight-line method and credits the intangible asset itself instead of an accumulated amortization account. Intangibles with an indefinite life are tested yearly for impairment instead.

Chapter 12: Current Liabilities

Difficulty: Medium · Key topics: accounts payable, unearned revenue, current portion of notes payable, sales tax payable, contingent liabilities, warranties and litigation, short-term notes payable, payroll, FICA, FUTA, SUTA

Using Summer Eatery, this chapter covers debts due within the operating period. It defines current liabilities and shows the entries for accounts payable, unearned revenue, the current portion of a long-term note, interest accrued and sales tax payable. It then explains contingent liabilities under the two FASB tests (probable and reasonably estimable) and the four ways to treat them, followed by short-term notes payable created by a purchase or a bank loan. The last section builds payroll entries: gross pay, involuntary and voluntary deductions, and the employer’s matching taxes and payroll costs.

Key Points:

• Current liabilities arise from past activities and are due within the operating period, normally one year.
• Unearned revenue is recorded as a liability when cash is received in advance, and it becomes revenue when the product or service is delivered.
• Sales tax collected is credited to Sales Tax Payable and later paid to the government, so it is not the company’s revenue.
• A contingent liability is recorded only if the loss is probable and can be reasonably estimated; probable but not estimable and reasonably possible cases are disclosed in notes only, and remote cases need nothing.
• Net pay is gross pay minus involuntary deductions (income tax, Social Security, Medicare) and voluntary deductions (such as health insurance).
• The book uses 6.2% for Social Security and 1.45% for Medicare, 7.65% together and matched by the employer, plus FUTA and SUTA paid by the employer; these are United States rates from 2017 and 2018.

Memory Tip: A contingency is booked only when it is both probable and estimable. A remote one gets silence, and the cases in between get a note.

Common Mistake: Counting sales tax collected as sales revenue. The business holds it for the government, so it is a liability until it is paid.

Important Questions:

• How is a contingent liability treated? It is recognized and disclosed if the loss is probable and can be reasonably estimated. If it is probable but not estimable, or reasonably possible, it is only disclosed in the notes. If it is remote, there is no recognition or disclosure.
• How is an employee’s net pay calculated? Net pay is gross pay minus involuntary deductions, such as federal, state and local income taxes, Social Security and Medicare, and minus voluntary deductions, such as health insurance, retirement contributions and union dues.

Chapter 13: Long-Term Liabilities

Difficulty: Hard · Key topics: long-term funding, notes payable, bonds payable, bond indenture, face value, premium and discount, market rate and stated rate, effective-interest method, amortization schedule, carrying value, bond retirement

Starting from Olivia’s car loan, this chapter explains how businesses raise long-term money by borrowing. It compares the types of long-term funding and the main bond terms found in the bond indenture, then shows how the market interest rate against the stated rate decides whether a bond sells at face value, at a premium or at a discount. It computes interest with the effective-interest method and amortization tables, and records the life of a bond: issue, semiannual interest payments and retirement at par. An appendix compares debt and equity financing and shows how interest points and loan term change a loan.

Key Points:

• A bond indenture is the legal document that states the principal, maturity date, stated interest rate and other terms of the bond.
• Bonds sell at face value, at a premium or at a discount depending on the market rate when they are sold.
• There is an inverse relationship between bond price and market interest rate.
• A discount bond’s carrying value rises to face value at maturity, and a premium bond’s carrying value falls to face value.
• Under the effective-interest method, interest expense = carrying value x market interest rate, while cash paid = face value x stated rate.
• Carrying value is the Bonds Payable balance combined with the Discount or Premium account.

Memory Tip: If the market rate is higher than the bond’s stated rate, the bond sells at a discount. If it is lower, the bond sells at a premium.

Common Mistake: Calculating interest expense on the face value. The effective-interest method uses the carrying value times the market rate, and only the cash payment uses face value times the stated rate.

Important Questions:

• Why do bonds sell at a discount or at a premium? A bond’s price depends on the market interest rate at the time of sale compared with its stated rate. When the stated rate is below the market rate, investors pay less than face value (discount), and when it is above, they pay more (premium).
• What is the effective-interest method? A method that calculates interest expense for each period as the bond’s carrying value multiplied by the market interest rate. The difference between that expense and the cash interest paid is the discount or premium amortization, shown in an amortization table.

Chapter 14: Corporation Accounting

Difficulty: Hard · Key topics: corporate form, limited liability, debt versus equity financing, IPO, common and preferred stock, par value, authorized, issued and outstanding shares, treasury stock, dividends, stock splits, retained earnings, earnings per share

Following Chad and Rick’s restaurant, this chapter explains how a corporation raises equity. It lists the advantages (separate legal entity, limited liability, transferable ownership, continuing existence, ease of raising capital) and disadvantages (organization costs, regulation, double taxation), weighs debt against equity, and covers IPOs, the secondary market and common and preferred stock. It then records issuing stock at par, no-par and stated value, treasury stock, cash, property and stock dividends and stock splits. It ends with retained earnings, the statement of stockholders’ equity, prior period adjustments and earnings per share.

Key Points:

• The corporate form gives limited liability: the most investors can lose is the amount they invested.
• Shares are authorized, issued and outstanding, and they are measured by market value or par value; no-par stock may carry a stated value.
• Stock issued above par credits Common Stock for par and Additional Paid-in Capital for the excess; stock issued for property or services is recorded at fair market value.
• Treasury stock is the company’s own stock bought back, and it is a contra-equity account, not an asset.
• A small stock dividend is under 25% of outstanding shares and is recorded at market value; a large one is over 25% and is recorded at par or stated value.
• EPS = profit for common shareholders / weighted average common shares outstanding, and a prior period adjustment changes the opening retained earnings.

Memory Tip: For a cash dividend, declaration creates the liability, the record date decides who gets paid, and the payment date settles it.

Common Mistake: Showing treasury stock as an asset. The company cannot own itself, so the repurchase reduces stockholders’ equity.

Important Questions:

• What are the advantages and disadvantages of the corporate form? Advantages are a separate legal entity, limited liability, transferable ownership, continuing existence and ease of raising capital. Disadvantages are the cost of organization, regulation and potential double taxation.
• How do small and large stock dividends differ? A small stock dividend (under 25% of outstanding shares) reduces Retained Earnings by the market value of the shares. A large one (over 25%) reduces Retained Earnings and credits Stock Dividends Distributable at par or stated value.

Chapter 15: Partnership Accounting

Difficulty: Medium · Key topics: mutual agency, unlimited liability, partnership agreement, forming a partnership, income and loss allocation, admission of a partner, bonus, withdrawal of a partner, dissolution

Using Ciara and Dale, who admit a third partner, Remi, this chapter treats partnerships as an alternative to corporations. It weighs the main advantage, no tax at the business level, against mutual agency and unlimited liability, and describes related entity forms that offer liability protection. It records how a partnership is formed, with noncash assets at current market values, and compares allocating income by fixed ratios, capital balances or a mix. It then covers admitting or withdrawing a partner, with or without a bonus, and the four ordered steps for dissolving a partnership.

Key Points:

• The main advantage of a partnership is that the business itself pays no tax; partners pay tax on their share of profit or loss.
• Mutual agency and unlimited liability are the main risks of a standard partnership.
• Noncash assets and liabilities contributed to a partnership are recorded at current market values, and a partner may receive an interest for expertise instead of assets.
• Income can be shared by fixed ratios, by capital account balances or by a combination of the two.
• A new partner can be admitted by investing in the partnership (assets change) or by buying from existing partners (assets do not change).
• A bonus is the gap between a partner’s capital account and the amount paid or invested when a partner is admitted or leaves.

Memory Tip: Dissolution follows four S steps: Sell the noncash assets, Share the gain or loss, Settle the liabilities and Split the remaining cash.

Common Mistake: Splitting the final cash by the income-sharing ratio. The chapter distributes it by partners’ capital account balances, after the gain or loss has been shared.

Important Questions:

• What are the advantages and disadvantages of a partnership? The main advantage is that profit is taxed only once, on the partners’ own tax returns. The main disadvantages are mutual agency and unlimited liability, which can put partners’ personal assets at risk.
• What are the steps to dissolve a partnership? Sell the noncash assets, allocate any gain or loss using the income-sharing ratio, pay off the liabilities, and distribute any remaining cash to the partners based on their capital account balances.

Chapter 16: Statement of Cash Flows

Difficulty: Hard · Key topics: sources and uses of cash, direct and indirect methods, operating, investing and financing activities, noncash expenses, gains and losses, changes in working capital, noncash transactions, free cash flow, cash flows to sales, cash flows to assets

This chapter explains the statement that shows where cash came from and where it went. It describes the purpose of the statement and the direct and indirect methods, then sorts every transaction into operating, investing or financing activities. It builds the operating section by the indirect method: start with net income, add back noncash expenses, reverse gains and losses and adjust for changes in current assets and liabilities. It then completes the statement with investing, financing and noncash items in the Virtual Co. review problem, uses free cash flow and cash ratios, and shows the direct method in an appendix.

Key Points:

• The statement of cash flows presents sources and uses of cash and helps predict future cash flows and judge the quality of earnings.
• Operating cash flows come from normal operations, investing from buying or selling long-term assets, and financing from debt and equity and repaying debt.
• The indirect method starts with net income, adds back depreciation, amortization and depletion, and reverses gains and losses on disposals.
• An increase in a noncash current asset reduces operating cash, and an increase in an operating current liability increases it.
• Noncash investing and financing transactions, such as buying an asset with debt, get special reporting treatment.
• Free cash flow is cash from operations left after planned capital expenditures and dividends, and it is also compared with sales and with total assets.

Memory Tip: For operating current assets, cash moves opposite to the balance (more receivables means less cash). For operating liabilities, cash moves with the balance (more payables means more cash).

Common Mistake: Saying depreciation is added back because it creates cash. It is added back because it was a noncash expense that reduced net income without using any cash.

Important Questions:

• What are the three types of activities on the statement of cash flows? Operating activities (cash from normal operations), investing activities (buying or selling long-term assets) and financing activities (raising money through debt or equity and repaying debt).
• How is cash from operating activities found with the indirect method? Start with net income, add back noncash expenses such as depreciation, amortization and depletion, remove gains and losses on disposals, and adjust for changes in current assets and current liabilities.

Appendices: Financial Statement Analysis, Time Value of Money and Suggested Resources

Appendix · Difficulty: Medium · Key topics: horizontal analysis, vertical analysis, liquidity ratios, solvency ratios, efficiency ratios, profitability ratios, Banyan Goods, present and future value tables, suggested resources

The three end-of-book appendices add tools for using the statements. Financial Statement Analysis uses the sample merchandiser Banyan Goods to show horizontal (trend) analysis, vertical analysis and four families of ratios: liquidity (working capital, current ratio, quick ratio), solvency (debt to equity, times interest earned), efficiency (receivables, total asset and inventory turnover, days’ sales in inventory) and profitability (profit margin, return on total assets, return on equity). Time Value of Money is four tables, and Suggested Resources lists sample statements, software and certification links.

Key Points:

• Horizontal analysis compares one period with another to show trends, and it is most useful over several periods.
• Vertical analysis compares a line item with another line item in the same statement, such as cash as a percentage of total assets.
• The quick ratio is like the current ratio but excludes inventory and prepaid expenses from current assets.
• Times interest earned measures the ability to pay interest from earnings before interest and taxes.
• Return on equity measures how well invested capital, from stock and retained earnings, produces income.
• The Time Value of Money appendix has four tables: present value of $1, present value of an ordinary annuity, future value of $1 and future value of an ordinary annuity.

Memory Tip: Group ratios by the question they answer: can we pay (liquidity), can we survive long term (solvency), are we efficient (efficiency) and do we earn enough (profitability).

Common Mistake: Judging a ratio alone. The appendix says results must be compared with competitors and the industry and with the company’s own past performance.

Important Questions:

• What is the difference between horizontal and vertical analysis? Horizontal analysis (trend analysis) compares the same line item across periods, while vertical analysis expresses each line item as a percentage of a base amount in the same period.
• How is the quick ratio different from the current ratio? Both compare current assets with current liabilities, but the quick ratio counts only the most liquid current assets and leaves out inventory and prepaid expenses, because they can take longer to turn into cash.

Download Principles of Accounting, Volume 1: Financial Accounting PDF (Free)

Principles of Accounting, Volume 1: Financial Accounting is free from its official publisher, OpenStax. Click the button below to open the official OpenStax book page, where you can download the complete PDF or read every chapter online in your browser.

How to Study This Book

Principles of Accounting, Volume 1 has 16 chapters and three end-of-book appendices. The book does not divide itself into parts, so this page gives one block per chapter and one block for the appendices. The preface says the two volumes together fit a two-semester course, and this volume is the financial accounting half. Every chapter opens with a short real-life story, such as a dry-cleaning business or a tennis coach, and then builds the topic step by step, so the book is meant to be read in order.

Match the chapters to your course outline in four groups. Chapters 1 and 2 give the foundations: what accounting is and what the four financial statements show. Chapters 3, 4 and 5 are the core, because together they walk through the accounting cycle: steps 1 to 4 in Chapter 3, steps 5 to 7 in Chapter 4 and steps 8 and 9 in Chapter 5. Chapters 6 to 10 apply the cycle to merchandising, information systems, fraud and cash controls, receivables and inventory. Chapters 11 to 16 cover long-term assets, current and long-term liabilities, corporations, partnerships and the statement of cash flows.

Do not skip Chapters 3 to 5. Everything after them uses debits, credits, T-accounts and adjusting entries, so practise those by hand until a journal entry feels routine. Read Chapter 4 before Chapter 5, and Chapter 5 before Chapter 6, because merchandising adds Merchandise Inventory and Cost of Goods Sold to the closing process and the income statement. Chapters 9, 10 and 11 reuse the adjusting entries of Chapter 4: bad debt expense, inventory adjustments and depreciation. Chapter 13 builds on the interest idea from Chapter 12, and Chapter 16 comes last because it uses balances from almost every earlier chapter. Chapter 7 can be read together with Chapter 6, and Chapter 15 can wait until after Chapter 14 or be skipped if your course covers only corporations.

Expect the hardest work in five places. Chapter 4 asks you to sort four types of adjusting entries, Chapter 10 repeats the same data under four cost flow methods and two inventory systems, Chapter 13 introduces bond pricing and the effective-interest method, Chapter 14 packs stock issuance, treasury stock and three kinds of dividends into one chapter, and Chapter 16 asks you to reason about how each balance sheet change affects cash. For Chapter 10, make one comparison table with FIFO, LIFO and weighted average on the same data. For Chapter 16, write the sign rules for each type of account on a single page. Chapters 1, 2, 8 and 15 read more easily.

The practice material is large. Counting the source files gives 339 multiple choice questions, 291 short-answer questions, 436 exercises in Sets A and B, 378 problems in Sets A and B and 80 thought provokers, and the chapters also contain 53 Your Turn boxes, 55 Concepts in Practice boxes and 40 Think It Through boxes. Each Your Turn box shows a worked solution, so do those first and then try the exercises without looking back. The preface says odd-numbered answers to the multiple choice questions and short-answer questions are in the Answer Key and that every other answer is only for instructors, so check your exercise and problem answers with your teacher or a study group.

Know the limits before you rely on it. The book teaches US GAAP, and its legal and tax examples are American: FASB, the SEC, and the FICA, FUTA and SUTA payroll taxes in Chapter 12, which use 2017 and 2018 limits. The book never mentions Pakistan or the rupee, so it has no local tax or company law. It does have 15 IFRS Connection boxes that compare US GAAP with IFRS, and these are worth reading because many countries, including Pakistan, use IFRS. The book names reversing entries but leaves them for later courses, and managerial and cost accounting are in Volume 2, a separate book. Use your teacher’s notes and local case studies for Pakistani 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 Accounting, Volume 1 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 to understand the accounting cycle and the four financial statements, or want a free and readable second book next to your class notes. It is also a useful read-ahead for ICOM students who plan to continue to a BBA or B.Com, and they can pair it with the Punjab board Key to Principles of Accounting ICOM Part 1 to practise the same debit and credit rules at college level. It is not a book for cost accounting, budgeting or decision-making, because those topics are in Volume 2, Managerial Accounting, which is a separate OpenStax book. It also does not teach Pakistani tax law or local reporting rules, 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.

FAQs

Related Books

• Key to Principles of Accounting ICOM Part 1 – Punjab Board (the same debit and credit basics at college level, useful before Chapters 3 to 5)
• Principles of Accounting Key Book ICOM 2nd Year – I.Com Part II (more accounting practice to use alongside the statement and liability chapters)
• Key to Business Mathematics ICOM Part 1 – Punjab Board (basic business calculations such as percentages and interest, used in Chapters 9, 12 and 13)
• Economics 1st Year ICOM Book – Punjab Board (business and market background for the stakeholders and financing in Chapters 1 and 13)

Principles of Accounting, Volume 1: Financial Accounting gives BBA and B.Com students a complete, free guide from the accounting equation and the accounting cycle to inventory, liabilities, corporations and the statement of cash flows. Browse more BBA books or the whole University Books section.

Principles of Accounting, Volume 1: Financial Accounting, by Mitchell Franklin, Patty Graybeal, Dixon Cooper and other contributing authors. OpenStax, Rice University. Free under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International licence (CC BY-NC-SA 4.0). Access for free at https://openstax.org/details/books/principles-financial-accounting