Financial and managerial accounting through statements, adjusting entries, cost behavior, CVP and budgets. Ten lessons connect recognition, calculations and decisions.
US nongovernmental GAAP financial-accounting foundation, with FASB Topic 606 revenue and Topic 330 inventory scope stated explicitly. Internal managerial methods are planning models, not GAAP requirements. Simple corporations and manufacturers; no tax advice, auditing qualification, consolidation, financial instruments or full professional accounting coverage.
Arithmetic, percentages, elementary algebra and careful reading of dates. No prior accounting required.
Course outline
The equation is a recognition model
Separate business resources, obligations, owner funding and earned revenue.
Connect the financial statements
Reconcile profit, retained earnings, the balance sheet and cash.
Journal entries without sign guessing
Use debits and credits to record economic events and test trial balances.
Adjust the period, not the cash
Recognize prepaid consumption, earned advances and accrued expenses at cutoff.
Inventory is a cost flow, not a sales price
Compute goods available, cost of goods sold and inventory under stated assumptions.
Depreciation allocates cost; disposal tests the balance
Separate asset cost, accumulated depreciation, book value and disposal gain.
Cash flows reconcile profit to liquidity
Classify cash flows and build a simple indirect operating bridge.
Cost behavior and product cost answer different questions
Classify costs by behavior and function, then estimate within a relevant range.
Contribution margin, CVP and relevant decisions
Use contribution to cover fixed costs and evaluate a constrained special order.
Budgets connect sales, production, cash and control
Build a production and materials plan, then compare costs at actual activity.
Sources and curriculum note
Sources fetched October 4, 2026. FASB ASUs below document the introduced rules and are not substitutes for the current Codification or all subsequent amendments. All organizations, transactions, rates and numeric examples are original hypotheticals, not company data.
Read every lesson below. The interactive reader above contains the same explanations, with visual tools and quizzes.
1. The equation is a recognition model
Learning goal: Separate business resources, obligations, owner funding and earned revenue.
Financial accounting communicates an entity's financial position and performance to people outside it. Managerial accounting serves internal decisions, so its reports may organize the same data by product, activity or future scenario rather than by external reporting rules. This course uses US nongovernmental GAAP for financial examples and explicit internal planning assumptions for managerial examples. The FASB Codification is authoritative; textbooks and this course are explanations, not standards. [S1, S2]
Assets = liabilities + equity is a relationship, not a rule that cash received must be revenue. A bank loan adds cash and a liability. Owner investment adds cash and contributed equity. Revenue earned by providing a service increases equity through income, whether the customer pays now or later. Expenses reduce income and equity; dividends are owner distributions, not expenses. Each event must preserve the equation. [S1, S4]
Accrual reporting asks when the economic activity is recognized, not merely when cash moves. For a simple customer contract under Topic 606, identify the contract and performance obligations, determine the transaction price, allocate it and recognize revenue as those obligations are satisfied. A payment before a service is delivered normally creates a contract liability in our uncomplicated examples. It is not an immediate profit. Complex contracts, collectibility, variable consideration and exceptions require more analysis. [S3]
Always name the entity and the reporting period. The owner's personal cash is not the business's cash until a business transaction occurs. Our examples assume enforceable fixed-price contracts, no sales taxes or income taxes, and no financing component unless stated. A balanced equation can still contain a wrong classification. Use both the equation and the underlying event to test an answer.
Worked example
A studio receives owner cash 20,000, borrows 8,000 and buys equipment for 6,000 cash. Show its equation.
A shop receives owner investment 15,000 and a loan 4,000, then earns 3,000 on account and pays 800 rent expense. With no other events, what is ending equity? Explain why the loan is excluded.
Mental model: Classify the event before balancing the equation.
Common trap: Treating every cash receipt as revenue.
2. Connect the financial statements
Learning goal: Reconcile profit, retained earnings, the balance sheet and cash.
An income statement reports revenues and expenses over a period. A balance sheet reports assets, liabilities and equity at a date. A cash-flow statement reports cash movement over a period. A statement of equity explains changes in ownership interests. The dates matter: one statement is a snapshot; the others are bridges between snapshots. Notes supply policies and detail that the face of a statement cannot carry. [S1]
For this simplified corporation, net income = revenues - expenses. Ending retained earnings = beginning retained earnings + net income - dividends. Retained earnings is accumulated undistributed accounting income, not a separate pot of cash. Equity includes contributed capital as well as retained earnings, and can contain other components in real companies. Our examples omit other comprehensive income and treasury stock. [S1]
Profit and cash can diverge without error. Credit revenue raises income before collection; depreciation lowers income without a current cash payment; borrowing brings in cash without earning income. A profitable business can lack enough cash to meet obligations. Conversely, a cash-rich business may be funded by debt rather than by operations. Do not read the ending cash balance as the year's profit. [S1, S8]
A statement analysis starts with links, then interpretation. Check whether income flows into retained earnings, whether the equation balances and whether beginning cash plus net cash change equals ending cash. A current ratio compares current assets with current liabilities, but timing, asset quality and industry context affect its meaning. No single ratio proves solvency. Our calculations use consistent reporting dates and dollars, not market valuations.
Beginning retained earnings is 6,200. This year revenue is 21,000, expenses are 15,800 and dividends are 1,500. Contributed capital is 9,000 and liabilities are 7,300. What are total ending assets? Show both bridges.
Mental model: Statements answer different questions but must reconcile.
Common trap: Confusing accumulated retained earnings with cash.
3. Journal entries without sign guessing
Learning goal: Use debits and credits to record economic events and test trial balances.
Debit means the left side of an account; credit means the right. Neither means good, bad, cash received or cash paid. Assets and expenses normally increase with debits. Liabilities, contributed capital and revenue normally increase with credits. Distributions normally have debit balances. Contra accounts reverse the usual balance of the related class: accumulated depreciation is a credit-balance contra asset. [S4, S7]
For each transaction, identify what changes, which account class each item belongs to, and whether it increases or decreases. Only then choose the side. A cash purchase of equipment debits equipment and credits cash. Paying a previously recorded payable debits the liability and credits cash, with no new expense. Paying for this month's rent instead debits expense. The event, not the word paid, decides the entry. [S4]
Every entry has equal total debits and credits. Posting transfers those effects to account balances. A trial balance checks equality of debit and credit balances, but it cannot prove that every transaction was recorded or classified correctly. Omitting a whole balanced entry or charging equipment to expense instead of an asset can leave the trial balance equal. Financial statement preparation therefore also requires recognition and cutoff checks. [S14]
This course uses compact entries and dollar amounts rather than a full ledger interface. Read each pair as an entry in the stated entity's books. In a service business, earning 2,000 on account debits accounts receivable and credits revenue; collecting it later debits cash and credits receivable. Recording revenue on both dates would double count one service. Explain what obligation or right remains after each entry.
Worked example
Buy supplies for 900 on credit, then pay 500 of the balance.
Purchase: Dr Supplies 900; Cr Accounts payable 900.
Payment: Dr Accounts payable 500; Cr Cash 500.
Supplies remain 900 until consumption is recognized.
Accounts payable remaining = 900 - 500 = 400.
Practice problem and solution
A firm buys 1,600 supplies on credit, uses 650 and pays 900 to the supplier. What is ending supplies? Show the three entries and distinguish the payable balance.
Purchase Dr Supplies 1,600 / Cr Payable 1,600; use Dr Supplies expense 650 / Cr Supplies 650; pay Dr Payable 900 / Cr Cash 900. Supplies = 950; payable = 700.
Mental model: Debit and credit are positions; account meaning determines the effect.
Common trap: Assuming a balanced trial balance proves correct classification.
4. Adjust the period, not the cash
Learning goal: Recognize prepaid consumption, earned advances and accrued expenses at cutoff.
Adjusting entries make the accounts reflect activity in the reporting period before statements are prepared. A deferral begins with cash paid or received before the related expense or revenue. An accrual recognizes an expense or revenue before the associated cash settlement. These timing patterns are different from correcting an error, although both can require journal entries. [S4]
A prepaid insurance asset is reduced as coverage is consumed: debit insurance expense and credit prepaid insurance. A customer advance is a liability until the promised service is satisfied: debit contract liability and credit revenue when earned. An accrued wage expense debits wage expense and credits wages payable. Neither adjustment requires current cash movement. The balance sheet captures the remaining future benefit or obligation. [S3, S4]
Use dates and the remaining balance, not a memorized fraction. If a twelve-month policy starts on October 1, coverage used through December 31 is three months. If a liability includes 900 of service not yet supplied, it must remain a liability at cutoff. A supplied service recorded as an advance forever understates revenue; an unsupplied service recorded as revenue early overstates it. [S3, S4]
Our examples assume straight-line coverage and evenly supplied services where stated. Revenue is not always recognized by elapsed time: that treatment is justified only when it faithfully reflects satisfaction in the particular simple contract. Prepare an unadjusted balance, calculate what remains or is owed, then record the difference. The adjusted balances, rather than the original cash amounts, belong in the statements.
Worked example
A 3,600 annual insurance policy begins November 1. Adjust at December 31.
Monthly coverage cost = 3,600 / 12 = 300.
Two months consumed = 600.
Dr Insurance expense 600; Cr Prepaid insurance 600.
Adjusted prepaid insurance = 3,000.
Practice problem and solution
A six-month 4,800 insurance policy begins September 1. At November 30 there are also 1,100 unpaid earned wages. What total expense comes from these two adjustments? Explain the remaining insurance asset.
Three months × 800 = 2,400 insurance expense. Add wages 1,100 for total 3,500. Remaining prepaid insurance = 4,800 - 2,400 = 2,400.
Mental model: Adjust for what was used, earned or owed by the reporting date.
Common trap: Moving income across periods because cash has not moved.
5. Inventory is a cost flow, not a sales price
Learning goal: Compute goods available, cost of goods sold and inventory under stated assumptions.
Inventory is an asset while goods remain available for sale. On sale, their assigned cost becomes cost of goods sold; sales revenue is a separate amount based on the customer transaction. Goods available at cost = beginning inventory + purchases, and cost of goods sold + ending inventory must reconcile to that total in our examples without shrinkage. Inventory unit costs are not retail prices. [S5]
FIFO assigns earlier costs to cost of goods sold first; periodic weighted average divides total available cost by total available units. These are cost-flow assumptions and need not describe the physical picking order. When purchase prices rise, FIFO often leaves higher recent costs in ending inventory and lower earlier costs in cost of goods sold. Comparisons depend on the actual layers and transaction pattern. [S5]
US GAAP permits LIFO, but we calculate only FIFO and periodic weighted average here. Do not substitute perpetual moving average when the prompt says periodic. For inventory not measured using LIFO or the retail method, Topic 330 uses the lower of cost and net realizable value. NRV is estimated selling price less reasonably predictable completion, disposal and transportation costs. LIFO and retail inventory retain a different lower-of-cost-or-market framework, so this lesson's NRV rule is not universal. [S6]
Inventory measurement can reduce reported income without reducing current cash. If FIFO cost is 1,000 but NRV is 900, an illustrative write-down recognizes a 100 loss and reduces inventory to 900. Our toy goods have no freight, returns, discounts, taxes or shrinkage unless stated. Separate the assignment of original cost from the later recoverability test; both affect the final carrying amount.
Worked example
Beginning stock is 20 units at 8; purchase 30 at 12; sell 35. Find FIFO COGS and ending stock.
Available cost = 20×8 + 30×12 = 520.
FIFO COGS = 20×8 + 15×12 = 340.
Remaining 15 units at 12 = 180 inventory.
340 + 180 = 520; sales price is unnecessary.
Practice problem and solution
There are 40 units at 9 and 60 units at 11, with 70 units sold. Under periodic weighted average, what is ending inventory after an NRV test of 9.50 per remaining unit? Show average cost and the write-down.
Available cost = 360 + 660 = 1,020; average cost = 10.20. Remaining 30 units cost 306. NRV = 30×9.50 = 285. Carry inventory at 285; write-down = 21. Assumed eligible non-LIFO, non-retail inventory.
Mental model: Assign cost, reconcile the rollforward, then test measurement.
Common trap: Using selling prices in cost of goods sold or treating the NRV rule as universal.
6. Depreciation allocates cost; disposal tests the balance
Learning goal: Separate asset cost, accumulated depreciation, book value and disposal gain.
A long-lived productive asset provides benefits beyond the purchase period. Capitalized cost is then allocated across useful periods through depreciation for tangible depreciable assets. Straight-line depreciation = (cost - estimated residual value) / estimated useful life. Land is ordinarily not depreciated. Our examples provide all eligible cost and exclude repairs, impairment and tax depreciation. [S7]
Depreciation expense reduces income and accumulated depreciation increases as a contra asset. The cash outflow happened at acquisition, so this period's depreciation is not another cash purchase. Book value = cost - accumulated depreciation in our unimpaired examples. It is neither a cash reserve nor an appraisal of what the equipment could sell for. Residual value and useful life are estimates, not promises. [S7]
Before disposal, bring depreciation up to the disposal date under the stated convention. Remove both original cost and accumulated depreciation. Compare sale proceeds with the asset's book value: proceeds above book value create a gain; below create a loss. Neither a gain nor a loss equals total cash proceeds. The cash-flow statement separately classifies the asset sale. [S7, S8]
We use whole years or an explicit fraction of a year, and assume the asset is ready for use when its depreciation period starts. A real policy may use a different convention. A change in estimate is not the same as correcting an error; this course does not calculate revised estimates or impairment. Always state cost, residual value, useful life and elapsed service time before inserting numbers. That makes a numerical answer auditable rather than lucky.
Worked example
Equipment costs 18,000, residual value is 3,000 and life is five years. Sell after two complete years for 11,500.
Proceeds 11,500 less book value 12,000 = loss 500.
Practice problem and solution
An asset costs 27,000, residual value is 3,000 and life is six years. It is sold after three full years and six months for 14,500. With straight-line depreciation updated through sale, what is the gain? Show the disposal-date book value.
Annual depreciation = 24,000/6 = 4,000. At 3.5 years, accumulated depreciation = 14,000 and book value = 13,000. Gain = 14,500 - 13,000 = 1,500.
Mental model: Book value is unallocated cost, not market value or cash.
Common trap: Comparing sale proceeds with original cost.
7. Cash flows reconcile profit to liquidity
Learning goal: Classify cash flows and build a simple indirect operating bridge.
Operating cash flows arise from the principal revenue-producing activities and related items; investing cash flows include acquiring or selling long-lived assets; financing flows include obtaining and returning debt or owner capital. Under the US GAAP conventions used here, cash interest paid is operating and dividends paid are financing. A noncash equipment purchase by issuing a note is not a cash investing payment; it needs appropriate noncash disclosure. [S1, S8]
The indirect method starts with net income and adjusts it to operating cash flow. Add depreciation back because it reduced income without a current operating cash payment. Subtract a gain on equipment sale because its accounting effect is in income while sale cash belongs in investing. These adjustments do not erase the transaction; they prevent mixing income and cash classifications. [S8]
For ordinary operating working capital in the simplified bridge, an increase in receivables is subtracted: some recognized revenue has not been collected. An increase in inventory is subtracted: more cash is tied up in stock. An increase in operating payables is added: some recognized costs have not been paid. These signs are not universal for every balance-sheet account. Debt and equipment belong elsewhere. [S8]
Beginning cash + operating + investing + financing cash flows = ending cash. Check the cash bridge even when the income bridge looks reasonable. Our problems omit acquisitions, exchange-rate effects, taxes, restricted cash and complex noncash movements. If those exist, raw changes in balance-sheet accounts may not equal the operating adjustments. The purpose is to explain a cash result, not to argue that more cash always means healthier operations.
Net income is 12,000, including a 1,000 equipment-sale gain. Depreciation is 3,000; AR rises 2,500; inventory falls 800; operating AP falls 1,300. Find operating cash flow and explain why sale proceeds are not inserted here.
Operating cash = 12,000 + 3,000 - 1,000 - 2,500 + 800 - 1,300 = 11,000. Remove the gain from operating income; total cash proceeds are reported in investing, not in this bridge.
Mental model: Noncash and timing adjustments translate income into operating cash.
Common trap: Adding sale proceeds to the operating bridge or treating all liabilities as operating.
8. Cost behavior and product cost answer different questions
Learning goal: Classify costs by behavior and function, then estimate within a relevant range.
Cost classifications depend on the question. A manufacturing product cost includes direct materials, direct labor and manufacturing overhead; these costs attach to inventory and become cost of goods sold when units are sold. Selling and administrative costs are normally period costs in the basic model. Direct or indirect describes traceability to a cost object, not variability. Factory rent can be fixed manufacturing overhead. [S9, S12, S15]
A variable cost changes in total with activity while its per-unit amount stays constant in a simple linear model. A fixed cost stays constant in total within the relevant range while its per-unit amount falls as units rise. A mixed cost has fixed and variable components: total cost = F + vQ. A step cost jumps when capacity changes. Classification needs both an activity driver and a range; fixed never means fixed forever. [S9]
The high-low method estimates a mixed cost by using the observations with the highest and lowest activity, not necessarily highest and lowest cost. Variable rate = change in total cost / change in activity. Then F = observed total cost - vQ at either selected point. The two points provide a rough estimate, not a causal proof or a good fit to every observation. Unusual activity or a capacity change can make it misleading. [S9]
Our toy estimates assume one driver, no inflation and a stable relevant range. Do not extrapolate beyond the stated capacity without checking. Keep dollars per unit separate from total dollars. For a decision about selling one more unit, total fixed cost per unit may be less useful than the incremental variable cost; for external inventory reporting, manufacturing overhead still matters. Those are different reporting purposes, not competing definitions of the same answer.
Worked example
At 500 machine hours cost is 5,500; at 900 hours it is 7,100. Estimate cost at 750 hours.
Estimated cost = 6,500, assuming the same range and driver.
Practice problem and solution
A mixed cost is 8,200 at 600 hours and 11,000 at 1,000 hours. Estimate total at 850 hours in the same range. Show the variable rate and fixed component.
v = 2,800/400 = 7 per hour. F = 8,200 - 7×600 = 4,000. Estimated cost = 4,000 + 7×850 = 9,950.
Mental model: Specify cost object, activity driver and relevant range.
Common trap: Calling a fixed manufacturing cost a period cost just because it is fixed.
9. Contribution margin, CVP and relevant decisions
Learning goal: Use contribution to cover fixed costs and evaluate a constrained special order.
Contribution margin per unit = selling price - variable cost per unit. Total contribution margin = sales - total variable costs, and operating income = contribution margin - fixed costs. The contribution format sorts costs by behavior, unlike an external gross-margin statement that separates cost of goods sold from selling and administrative expense. Gross margin and contribution margin are not interchangeable. [S9, S10]
For one product with positive unit contribution, break-even units = fixed costs / unit contribution. Round upward when only whole units can be sold. Units for a target operating income = (fixed costs + target income) / unit contribution. Margin of safety is actual or planned sales minus break-even sales. These models assume constant prices and unit variable costs, fixed costs within range, and a fixed sales mix for multiproduct extensions. [S10, S16]
A special order needs incremental analysis, not simply an allocated full-cost comparison. With idle capacity, no displaced sales and no new fixed costs, incremental revenue less incremental variable cost can increase income. At full capacity, include contribution from regular sales that must be forgone. Sunk costs are already incurred and cannot change between choices; avoidable fixed costs can be relevant. Capacity, customer reaction and long-run pricing still matter. [S11]
Our examples state all incremental costs and ignore taxes. Positive contribution does not guarantee that an entire business is profitable or that accepting an order is strategically wise. A low price may harm regular demand; a new order may need tooling or extra supervision. First calculate the short-run effect under the stated assumptions, then name what information could change the decision. This separates a correct model result from an unsupported business recommendation.
Worked example
Price is 80, variable cost 50, fixed cost 18,000. Find break-even and units for 9,000 target income.
Unit contribution = 80 - 50 = 30.
Break-even = 18,000 / 30 = 600 units.
Target quantity = (18,000 + 9,000) / 30.
Target = 900 units; this is operating income before tax.
Practice problem and solution
A product sells for 65, with variable cost 39 and fixed costs 15,000. How many whole units are required for at least 8,000 operating income? Show rounding and verify the adjacent lower unit count.
Unit contribution = 26. Required units = 23,000/26 = 884.615..., so 885. Income at 885 = 23,010 - 15,000 = 8,010; at 884 = 22,984 - 15,000 = 7,984, below target.
Common trap: Ignoring capacity opportunity cost or rounding required whole units down.
10. Budgets connect sales, production, cash and control
Learning goal: Build a production and materials plan, then compare costs at actual activity.
A budget is a plan, not a factual forecast guaranteed to occur. The operating-budget chain begins with sales expectations, then production or purchases, materials, labor and overhead, ending with a budgeted income statement. Cash budgets also need collection and payment timing: a sale budget is not a cash receipts budget. Inventory policies connect one period's needs with another's. [S12]
For a manufacturer, required production units = budgeted sales + desired ending finished-goods inventory - beginning finished-goods inventory. Materials required for production = production units × materials per unit. Materials purchases = production needs + desired ending raw-material inventory - beginning raw-material inventory. Use the correct inventory at each step; finished goods and raw materials are not interchangeable. [S12]
A static budget is built at the originally planned activity. A flexible budget recalculates expected revenues and costs at actual activity under the budget's price and cost assumptions. Comparing actual cost with the static budget can mistake extra output for inefficiency. Comparing actual cost with the flexible amount isolates a spending comparison at the same activity, though it still does not establish the cause. [S13]
For a cost variance here, actual cost above the flexible budget is unfavorable and below is favorable, with the variance reported as a magnitude plus a label. Favorable is not automatically good: cheaper materials may create quality failures or delays. Our budgets assume one product, unchanged prices, the stated inventory targets and a relevant range. Taxes, financing, depreciation and capital projects are excluded unless specified. Always reconcile physical units before multiplying by dollar rates.
Worked example
Plan sales 800 units; begin with 100 finished units; want 140 ending units. Each produced unit needs 3 kg. Begin with 200 kg and want 260 kg ending raw material. What must be purchased?
Production = 800 + 140 - 100 = 840 units.
Production material = 840×3 = 2,520 kg.
Purchases = 2,520 + 260 - 200 = 2,580 kg.
At 4 per kg, purchase cost would be 10,320; payment timing is a separate cash-budget question.
Practice problem and solution
Sales are planned at 1,100 units; beginning finished goods are 180 and desired ending goods 220. Each unit needs 2.5 kg. Beginning materials are 300 kg and desired ending materials 350 kg. At 6 per kg, what is the materials purchase budget in dollars? Explain why it is not necessarily this period's cash payments.
Production = 1,100 + 220 - 180 = 1,140 units. Materials used = 1,140×2.5 = 2,850 kg. Purchases = 2,850 + 350 - 300 = 2,900 kg. Purchase budget = 2,900×6 = 17,400. Supplier payment terms and beginning payables determine cash timing.
Mental model: Plan the flows, then compare actual cost at actual activity.
Common trap: Treating purchases or credit sales as same-period cash flows.