Accounting lec 1-fa 1

Lecture-1INTRODUCTION TO FINANCIAL

ACCOUNTING

By: Shahid Akbarshahidakbar32@yahoo.co

m

All you got to do isListen, use Common Sense and Grab the

Concepts Step by Step

IdentifiesIdentifies

RecordsRecords

CommunicatesCommunicatesRelevantRelevant

ReliableReliable

ComparableComparable

AccountingAccounting

is a

system that

information

that is

to help users make better decisions.

to help users make better decisions.

Identifying Business Activities

Recording Business Activities

Communicating Business Activities

Accounting

FinancialAccounting

ManagementAccounting

External Users Internal Users

Reportingto

Reportingto

For reporting financial position and financial performance to external users.Balance Sheet, Income Statement, etc.

For planning, control and decision making by Internal Users.Monthly sales report, Production analysis report , Internal memos etc.

Shareholders

External auditor

Suppliers

Lenders

Labors unions

Governments & agencies

Board of Directors

Managers

External Users

Internal Users

Information Needs and Costs

Benefits

Costs

Information RequirementsInternal requirements by Management for better decision making, planning and controlExternal requirements by Regulatory authorities, International frameworks, Government agencies etc.

Administrative costsFees for Expert opinionsAdditional burden on employeesSurveys and Researchesetc

Type of Costs incurred

>Benefits drawn from information should be greater

than the cost incurred to produce that information.

Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP).

Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP).

Relevant Information

Relevant Information

Affects the decision of its users.

Affects the decision of its users.

Reliable InformationReliable Information Is trusted by users.

Is trusted by users.

Comparable Information

Comparable Information

Is helpful in contrasting organizations.

Is helpful in contrasting organizations.

Accounting Principles

Matching Principle

Company records the expenses it incurred to generate the revenue

reported.

Revenue Recognization Principle

Cost Principle

Full Disclosure PrincipleCompany reports the details behind

financial statements that would impact users decisions.

Accounting information is based on actual cost

•Cost is measured on a cash or equal to cash basis

1. Recognize revenue when it is earned.

2. Proceeds need not be in cash.3. Measure revenue by cash

received plus cash value of items received.

Accounting Assumptions

Monetary Unit assumption Express transactions and events in

monetary, or money, units.

Business Entity assumption A business is accounted for

separately from other business entities, including its owner.

Time period Assumption

Life of a company can be divided into time periods .

Now Future

Going-Concern PrincipleReflects assumption that the

business will continue operating instead of being closed or sold.

Types of businesses

Advantages:- Owner’s total control- Least regulated- Minimal accounting and reporting requirementsDisadvantages:- Limited Resources- Unlimited Liability- Management problems- Owner dies, Business dies

Advantages:- Larger resources- Risk sharing- Experience pool- Minimal accounting and reporting requirementsDisadvantages:- Unlimited liability- Limited resources- Conflicts & disputes- Existence uncertainty- Non-transferability

Advantages:- Can raise capital- Limited risk- Ownership transferability- Perpetual existence- Board experienceDisadvantages:- Registrations - Administrative and regulatory costs- Excessive accounting and reporting requirements- Organizational issues- Complex structure- Double Taxation

Sole Proprietorship

Partnership

Corporation

Owners of a corporation are called shareholders (or stockholders).

When a corporation issues only one class of stock, we call it common stock (or capital

stock).

Characteristics Proprietorship Partnership CorporationBusiness entity yes yes yesLegal entity no no yesLimited liability no no yesUnlimited life no no yesBusiness taxed no no yesOne owner allowed yes no yes

Characteristics Proprietorship Partnership CorporationBusiness entity yes yes yesLegal entity no no yesLimited liability no no yesUnlimited life no no yesBusiness taxed no no yesOne owner allowed yes no yes

**

Board of Directors

Share holder (s)

Managers

Business

appointhire

manage & run

audit

Financial Auditors

produce

External Users

distributed to

Financial Reports

1. Balance Sheet

2. Income Statement

3. Statement of Cash Flows

4. Statement of Stockholders’ Equity

A Balance Sheet is a quantitative summary of the financial position of a business at any point in time.

Income statement shows the performance of a company, how did the company made net income out of revenues.

Cash flow statement is concerned with the cash inflows and outflows of the company

This statement shows the changes in owners’ interest and application of retained earning between two accounting periods

Statement of Cash flows

The movement of money into or out of a business, is called

JeansCo

EmployeesCreditorsPurchase of assetsInvestmentsDividends

CustomersLoansShare issue

Cash Inflo

w

Cash Inflo

w

Cash Outflo

w

Cash Outflo

w

Overview: What is Cash flow

Statement of Cash flows

11

Overview: Types of Cash flows

Operational Cash flows: received or spent as a result of company’s business activities

Selling clothing

Purchasing merchandize Paying

salaries

Statement of Cash flows

22

Overview: Types of Cash flows

Investment Cash flows: spent or received through company’s investing activities

Loan repaymentsFixed assets

Investing inStocks & bonds

Statement of Cash flows

33

Overview: Types of Cash flows

Financing Cash flows: cash received through debt or paid out as debt repayments

Issuance of stocks

Repaying loans

Bank loan

Statement of Cash flows

Managers affect cash by three types of decisions:

1. Operating decisions

2. Financing decisions

3. Investing decisions

Typical Activities Affecting Cash

Statement of Cash flows

Typical Activities Affecting CashOperating activities are transactions that affect the purchase, processing, and selling of a company’s products and services

Making sales

Collecting accounts receivable

Purchasing inventory

Paying accounts payable

The first major section of the statement of cash flows is labeled cash flows from operating activities

Statement of Cash flows

Typical Activities Affecting CashFinancing decisions are concerned with how to obtain or repay cash

Financing activities are a company’s transactions that obtain resources from debt and equity transactions

Issuance of additional stock

Borrowing money from the bank

Repaying previous loans

The financing section on the statement is labeled cash flows from financing activities

Statement of Cash flows

Typical Activities Affecting CashInvesting decisions include the choices to acquire or dispose of long-term productive assets or long-term investments

Investing activities are transactions that acquire or dispose of assets that are expected to provide services for more than one year

- Purchasing or disposing of equipment

The investing section on the statement is labeled cash flows from investing activities

Statement of Cash flows

Typical Activities Affecting CashCash Inflows Cash Outflows

Operating Activities: Collections from customers Cash payments to suppliers Interest and dividends collected Cash payments to employees Other operating receipts Interest and taxes paid Other operating cash payments Investing Activities: Sale of property, plant, and equipment Purchase of property, plant, and equipment Sale of securities that are not Purchase of securities that are not cash equivalents cash equivalents Receipt of loan repayments Making loans Financing: Borrowing cash from creditors Repayment of amounts borrowed Issuing equity securities Repurchase of equity shares (including the Issuing debt securities purchase of treasury stock) Payment of dividends

Cash Inflows Cash Outflows Operating Activities: Collections from customers Cash payments to suppliers Interest and dividends collected Cash payments to employees Other operating receipts Interest and taxes paid Other operating cash payments Investing Activities: Sale of property, plant, and equipment Purchase of property, plant, and equipment Sale of securities that are not Purchase of securities that are not cash equivalents cash equivalents Receipt of loan repayments Making loans Financing: Borrowing cash from creditors Repayment of amounts borrowed Issuing equity securities Repurchase of equity shares (including the Issuing debt securities purchase of treasury stock) Payment of dividends

Balance SheetA Balance Sheet is a quantitative summary of the financial position of a business at any point in time. It summarizes the assets, liabilities and the shareholders’ equity of a company.Assets

Liabilities

Owner’s Equity

+=Assets

Liabilities

An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity e.g, land & building, plant & machinery, fixtures, delivery vans etc.

A present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from enterprise of resources embodying economic benefits e.g., loan, bonds, creditors/account payables etc.Owners’ EquityThis is the amount by which a company is financed through common and preferred shares.This is residual claim of common stockholders in assets after all the liabilities are paid

LandLand

EquipmentEquipment

BuildingsBuildings

CashCash

VehiclesVehicles

Store Supplies

Store Supplies

Notes Receivable

Notes Receivable

Accounts Receivable

Accounts Receivable

Resources owned or controlled

by a company

Resources owned or controlled

by a company

Taxes Payable

Taxes Payable

Wages Payable

Wages Payable

Notes PayableNotes PayableAccounts Payable

Accounts Payable

Creditors’ claims on

assets

Creditors’ claims on

assets

Owner’sclaims

on assets

Owner’sclaims

on assets

RevenuesRevenues

Owner Investments

Owner Investments

Owner Withdrawals

Owner Withdrawals

ExpensesExpenses

LiabilitiesLiabilities EquityEquityAssetsAssets = +

RevenuesRevenues ExpensesExpensesOwner CapitalOwner Capital

Owner Withdrawals

Owner Withdrawals

_ + _

Let’s start a business!J. Scott, forms a consulting business, named

Fast forward and accessories

J.Scott owns and manage the business

mjb@hotinarea.com

The accounts involved are:(1) Cash (asset)(2) J. Scott, Capital (equity)

J. Scott, the owner, contributed $20,000 cash to start the business.

J. Scott, the owner, contributed $20,000 cash to start the business.

The accounts involved are:(1) Cash (asset)(2) Supplies (asset)

Purchased supplies paying $1,000 cash.

Purchased supplies paying $1,000 cash.

The accounts involved are:(1) Cash (asset) (2) Equipment (asset)

Purchased equipment for $15,000 cash.

Purchased equipment for $15,000 cash.

Transaction Analysis

The accounts involved are:(1) Supplies (asset)(2) Equipment (asset)(3) Accounts Payable (liability)

Purchased Supplies of $200 and Equipment of $1,000 on account.

Purchased Supplies of $200 and Equipment of $1,000 on account.

Transaction Analysis

The accounts involved are:(1) Cash (asset) (2) Notes payable (liability)

Borrowed $4,000 from 1st American Bank.

Borrowed $4,000 from 1st American Bank.

The balances so far appear below. Note that the Balance Sheet Equation is still in balance.

Now let’s look at transactions involving revenue, expenses and withdrawals.

Transaction Analysis

The accounts involved are:(1) Cash (asset) (2) Revenues (equity)

Rendered consulting services receiving $3,000 cash.

Rendered consulting services receiving $3,000 cash.

Transaction Analysis

The accounts involved are:(1) Cash (asset)(2) Salaries expense (equity)

Paid salaries of $800 to employees.

Remember that the balance in the salaries expense account actually increases.

But, equity actually decreases because expenses reduce equity.

Remember that expenses decrease equity.

Paid salaries of $800 to employees.

Transaction Analysis

The accounts involved are:(1) Cash (asset)(2) J. Scott, Withdrawals (equity)

J. Scott withdrew $500 from the business for personal use.

Remember that the balance in the J. Scott, Withdrawals account actually increases.

But, equity actually decreases because withdrawals reduce equity.

Remember that withdrawals decrease equity.

J. Scott withdrew $500 from the business for personal use.

Financial StatementsLet’s prepare the Financial Statements

reflecting the transactions we have recorded.

1. Income Statement

2. Statement of Owner’s Equity

3. Balance Sheet

4. Statement of Cash Flows

Net income is the difference between

Revenues and Expenses.

The income statement describes a company’s revenues and expenses

along with the resulting net income or loss over a period of time due to

earnings activities.

The net income of $2,200 increases

Scott’s capital by $2,200.

The Statement of Owner’s Equity explains changes in equity from net income (or net loss)

and from owner investments and

withdrawals for a period of time.

The Balance Sheet describes a company’s

financial position at a point in time.

The Balance Sheet describes a company’s

financial position at a point in time.

The Statement of Cash Flows identifies cash inflows and cash outflows over a period of time.