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ENVIRONMENT OF ACCOUNTING. GAAP. NATURE OF ACCOUNTING. An information system designed to : Collect, Process, and Report economic data to interested parties to assist them in making decisions Areas of accounting Financial Accounting = external decision makers (investors and creditors) - PowerPoint PPT Presentation
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Fin Acctg Concepts - 1
ENVIRONMENT OF ACCOUNTING
GAAP
Fin Acctg Concepts - 2
NATURE OF ACCOUNTING
An information system designed to : Collect, Process, and Report economic data to interested parties to assist them in making decisions
Areas of accounting– Financial Accounting = external decision makers
(investors and creditors)– Management Accounting = internal decision makers– Specialized areas
• Tax Accounting• Regulatory Accounting
“Accounting is the language of business”
Fin Acctg Concepts - 3
“FINANCIAL STATEMENT PACKAGE”
Formal financial statements
Footnotes
Supplementary information
Attestation reports
Fin Acctg Concepts - 4
FORMAL FINANCIAL STATEMENTS
Income statement
Balance sheet
Statement of stockholders’ equity– Retained earnings
Statement of cash flows
Fin Acctg Concepts - 5
INCOME STATEMENTStatement of Earnings
Report on the operations of the entity
Listing of Revenues, Gains, Expenses, & Losses
Covers a period of time
Fin Acctg Concepts - 6
STATEMENT OF FINANCIAL POSITION
Balance Sheet Report on the financial position of
the entity
Listing of Assets, Liabilities, & Owners’ Equity items
A specific point in time
Fin Acctg Concepts - 7
STATEMENT OF STOCKHOLDERS’ EQUITY
“Retained earnings”
Report on the changes in Retained Earnings
Covers a period of time
Link between the Balance Sheet & Income Statement
Fin Acctg Concepts - 8
STATEMENT OF CASH FLOWS
Report on financial activities of the entity
Shows the changes in cash (and cash equivalents)
Covers a period of time
Fin Acctg Concepts - 9
OTHER INFORMATION
Footnotes– Refers to a specific item or section
Supplementary information– All additional disclosures
Fin Acctg Concepts - 10
ATTESTATION REPORTS
Management report
Report of the audit committee
Report of the independent auditor (CPA)
Fin Acctg Concepts - 11
BASIC ACCOUNTING EQUATION[Corporation]
Assets = Liabilities + Stockholders’ Equity
Contributed(Paid-in)
Capital
Retained Earnings
Net Income (+)Net loss (-) Dividends (-)
Declared
Revenues & Gains (+) Expenses & Losses (-)
ParValue
ExcessOverPar
Fin Acctg Concepts - 12
Issuing Stock to Investors
@Cambridge Business Publishers, 2009
After getting the business plan approved, Simon and Sue opened a Cup-A-Jo Coffee franchise by investing equipment worth $60,000 and cash totaling $300,000 in exchange for common stock.
Assets = Liabilities +Shareholders'
EquityCash Equipment Intangible Assets Loan Payable Common Stock
300,000 60,000 360,000
Assets increase by $360,000.Shareholders’ equity increases by $360,000.
Fin Acctg Concepts - 13
Obtaining a Bank Loan
@Cambridge Business Publishers, 2009
Acting on behalf of Cup-A-Jo Coffee, Simon obtained a $90,000 bank loan to be repaid equally at the end of each year for 8 years at 7% annual interest.
Assets = Liabilities +Shareholders'
EquityCash Equipment Intangible Assets Loan Payable Common Stock
90,000 90,000
Assets increase by $90,000. Liabilities increase by $90,000.
Fin Acctg Concepts - 14
Purchase of Franchise
@Cambridge Business Publishers, 2009
Cup-A-Jo acquired franchise rights for an 8-year period at a cost of $240,000 paid in cash.
Assets = Liabilities +Shareholders'
EquityCash Equipment Intangible Assets Loan Payable Common Stock
-240,000 240,000
Assets increase by $240,000, andAssets decrease by $240,000.
Because the franchise rights represent future economic benefits, the cost is an asset.
Fin Acctg Concepts - 15
Balance Sheet after Pre-Opening Events
@Cambridge Business Publishers, 2009
Assets = Liabilities +Shareholders'
EquityCash Equipment Intangible Assets Loan Payable Common Stock
300,000 60,000 360,000 90,000 90,000-240,000 240,000 150,000 60,000 240,000 90,000 360,000
450,000 = 90,000 + 360,000
Assets Liabilities & Shareholders' EquityCash $150,000 Liabilities Equipment 60,000 Loan payable $ 90,000Intangible Assets 240,000 Shareholders' Equity
Common Stock 360,000
Total assets $450,000 Total liab. & shareholders' equity $450,000
Fin Acctg Concepts - 16
Buying Inventory
@Cambridge Business Publishers, 2009
Cup-A-Jo purchased $84,000 of inventory consisting of coffee, tea, cream, flavoring, etc., on credit due in 30 days.
Assets increase by $84,000.Liabilities increase by $84,000.
Beginning balances
Assets = Liabilities + Shareholders' Equity
CashAccounts
Rec. InventoryEquip-ment
Accum. Deprec.
Intang. Assets
Accts. Pay.
Taxes Payable
Loan Payable
Common Stock
Retained Earnings
150,000 0 0 60,000 0 240,000 0 0 90,000 360,000 0
84,000 84,000
Fin Acctg Concepts - 17
Selling to Customers
@Cambridge Business Publishers, 2009
Cup-A-Jo sold coffee during the year for $305,000. Of this amount, Cup-A-Jo collected $270,000. The balance is still owed at December 31. The cost of the coffee sold was $70,000.
Assets increase by $305,000 and decrease by $70,000—a net increase of $235,000. Shareholders’ equity increases by $305,000, and
decreases by $70,000—a net increase of $235,000.
Assets = Liabilities + Shareholders' Equity
CashAccounts
Rec. InventoryEquip-ment
Accum. Deprec.
Intang. Assets
Accts. Pay.
Taxes Payable
Loan Payable
Common Stock
Retained Earnings
150,000 0 0 60,000 0 240,000 0 0 90,000 360,000 0270,000 35,000
-70,000
305,000 -70,000
Fin Acctg Concepts - 18RELATIONSHIP OF FINANCIAL
STATEMENTS
AssetsLiabilitiesOwners’ equity
AssetsLiabilitiesOwners’ equity
Revenues - Expenses=
Net Income (or Loss)
Balance 1-1-x2(+/-) Net income or loss - Dividends = Balance 12-31-x2
Income StatementFor Year 2
Statement of Retained EarningsFor Year 2
Balance Sheet12-31-x1
Balance Sheet12-31-x2
Fin Acctg Concepts - 19
GENERALLY ACCEPTEDACCOUNTING CONCEPTS
Reasons for Generally Accepted Accounting Principles (GAAP)
Entities influencing GAAPGAAP
Fin Acctg Concepts - 20
GAAP
Generally Accepted Accounting Principles (GAAP)– The guidance U.S. companies currently use to
measure and report performance– Is very flexible
•Allows management judgment•Different methods of measurement allowed
@Cambridge Business Publishers, 2009
Who prepares a company’s
financial statements?
Management
Fin Acctg Concepts - 21
GAAP FAQs
Why did GAAP arise?– To mutually benefit the capital market
participants who use financial statements– To help evaluate risk and return– To give confidence to users that information
helps make better decisions Created by Financial Accounting Standards Board
(FASB)• Overseen by the Securities and Exchange
Commission (SEC)SEC has the ultimate power to set accounting
standards@Cambridge Business Publishers, 2009
Fin Acctg Concepts - 22
International Accounting Standards
Attempt to harmonize accounting standards through creation of International Financial Reporting Standards (IFRS)
Some countries are using IFRS– European Union converted in 2005
Recent impact on U.S.– Late 2007, U. S. SEC voted to allow foreign
registrants to file financial statements with the U.S. using IFRS•Previously required to use or reconcile to
U.S. GAAP
@Cambridge Business Publishers, 2009
22
Fin Acctg Concepts - 23
Proposed SEC Roadmap for IFRS
#-Staggered adoption possible based on earliest adoption in 2015 or 2016.
23
Fin Acctg Concepts - 24
OBJECTIVES OF FINANCIAL STATEMENTS
Help investors and creditors make rational investment, credit, and related decisions
Assess the amounts, timing, and uncertainty of future cash flows
Information about the economic resources of the entity, claims to those resources, and changes in those resources
“ALLOCATION OF ECONOMIC RESOURCES”
Fin Acctg Concepts - 25
USERS OF FINANCIAL STATEMENTSAssumptions
Reasonable knowledge of business and economic activities
Willing to study the information with reasonable diligence
Statement of Financial Accounting Concepts No. 1, “Objectives of Financial Reporting by Business Enterprises”
Fin Acctg Concepts - 26
QUALITIES OF ACCOUNTING INFORMATION
Relevance– Predictive value– Feedback value– Timeliness
Reliability– Verifiability– Neutrality– Representationa
l faithfulness
Comparability
Consistency
Fin Acctg Concepts - 27
ENVIRONMENTAL ASSUMPTIONS
Separate Entity
Continuity (Going Concern)
Time Period (Periodic Measurement)
Unit of Measure (Monetary)
Fin Acctg Concepts - 28
IMPLEMENTATION PRINCIPLES
Cost/Exchange Transactions
Revenue Realization
Matching
Full Disclosure
Fin Acctg Concepts - 29
Accounting Information Constraints
Materiality– GAAP applies only to economic events significant
enough to affect a user’s decision Conservatism
– Applied when trade-offs between qualities are needed
– A reaction to uncertainty– When in doubt, financial statements should
• Understate assets• Overstate liabilities• Delay recognition of revenues• Accelerate recognition of expenses
@Cambridge Business Publishers, 2009
Fin Acctg Concepts - 30
ELEMENTS OF FINANCIAL STATEMENTS
Assets
Liabilities
Equity (Owners’)– Investments by
Owners– Distributions to
Owners
Revenues Expenses Gains Losses Comprehensive
Income
Fin Acctg Concepts - 31
BALANCE SHEET
Resources (Assets)
Resources (Assets)
Claims against resources (Liabilities)
Claims against resources (Liabilities)
Remaining claims accruing to owners
(Owner’s Equity)
Remaining claims accruing to owners
(Owner’s Equity)
Fin Acctg Concepts - 32
BALANCE SHEET ELEMENTS Assets
– Economic resources with probable future value– Controlled by management– Resulting from past transactions
Liabilities– Probable future sacrifices of economic benefits
(debts/obligations)– Require transfer of assets– Terms of obligations are specified– Result from past transactions
Equity– Residual interest in the assets of the entity– “Net assets”– Represents the “investment” by owners
Fin Acctg Concepts - 33
BALANCE SHEET CLASSIFICATIONS
Assets– Current Assets– Long-term
Investments– Property, Plant,
and Equipment– Intangible
Assets– Other Assets
Liabilities– Current Liabilities– Long-term
Liabilities
Stockholders’ Equity– Contributed Capital– Retained Earnings– Other Items
Fin Acctg Concepts - 34
BALANCE SHEET
LiquidityLiquidity - length of time until assets are converted to cash or until a liability must be paid
Solvency – the ability of a firm to meet its debts as they come due
Financial flexibilityFinancial flexibility - ability of company to manage its cash flows (deal with emergencies or take advantage of unexpected opportunities)
Fin Acctg Concepts - 35
THE INCOME STATEMENT
Describes a company’s operating performance for a specified period of time
Fin Acctg Concepts - 36
INCOME STATEMENTELEMENTS
Revenues– Inflows of assets (settlement of liabilities)– From delivery or production of goods or rendering of
services Gains
– Increases to equity– From peripheral or incidental transactions
Expenses– Outflows of assets (incurrance of liabilities)– Consumption or expiration of assets in an attempt to
generate revenue Losses
– Decreases in equity– From peripheral or incidental transactions
Earnings per share– Basic – Fully diluted
Fin Acctg Concepts - 37
INCOME STATEMENT“Multiple-Step”
Operations section– Gross margin (Sales - Cost of goods
sold)– Operating expenses
Other items (“nonoperating”) “Special items” Net income - “the bottom line” Earnings per share
Fin Acctg Concepts - 38
INCOME STATEMENT“Multiple-Step”
Items within “Income from continuing operations”
•Unusual OR infrequent gains and losses
Below “Income from continuing operations”
•Discontinued Operations•Extraordinary items (unusual AND
infrequent)
Fin Acctg Concepts - 39
Income Statement (Multiple-Step)
Operations
Other
Specialitems
Fin Acctg Concepts - 40
Which Basis of Accounting is Used?
Cash basis– Financial effects are recorded in financial
statements when cash is received or paid Accrual basis
– Financial effects are recorded without regard to the timing of the cash flows
– Accounts that exist under accrual basis• Accounts receivable
Amounts customers owe for items purchased• Accounts payable
Amount the company owes for credit purchases
@Cambridge Business Publishers, 2009
Fin Acctg Concepts - 41
Revenue Principle
Revenue should be recognized in the financial statements when . .
It is earned, and …
It is realized or realizable (measurable)
Fin Acctg Concepts - 42
REVENUE RECOGNITION POINTS
Design and production,construction in progress,minerals discovered
Goods completedand ready for sale,contract complete
Delivery ofproduct or
service
Cash collectedfor goods or
services
Right ofreturn expires
Recognition before delivery
Recognition after delivery
Recognitionat delivery
Percentage-ofcompletion method
Productionmethod
Completedcontractmethod
Pointof salemethod
Installment method
Costrecovery method
Right ofreturn
expiration method
RELEVANCE RELIABILITY
Fin Acctg Concepts - 43
Matching
Once revenues are determined, the expenses incurred in attempting to generate the revenue should be recognized.
As revenues are earned, certain assets are consumed and services are used.
Fin Acctg Concepts - 44
Expense Classification
Direct
Period
Allocated
Fin Acctg Concepts - 45
BUSINESS CYCLECollect cash
from customer
Purchase materials
Convert materialsinto finished product
Inspect product
Store productin warehouse
Receive orderfrom customer
Ship product& invoice customer
Customerreceives item
Fin Acctg Concepts - 46
EXPENDITURES vs. EXPENSES
Assets as ofJan. 1, 1998
Expendituresduring 1998
Directassociation
withrevenue
Assets as of12-31-98
Associationwith
activities
Associationwith
future
No
No
Expenses of 1998Yes
Yes
Yes
No
Example: Cost of goods sold
Example: Office expenses
Example: Obsolete merchandise
STATEMENT OF CASH FLOWS
Fin Acctg Concepts - 48
STATEMENT OF CASH FLOWS
Nature of Statement Reports on Financial
Activity Covers a period of
time (fiscal period) Explains changes in
cash balance Cash and equivalents
– Highly liquid short-term investments
– Treasury bills, Money-market funds
Objectives of Statement Prediction of future
cash flows Evaluation of financial
management Determine ability to
pay interest and dividends
Explain relationship of net income to changes in cash balance
Fin Acctg Concepts - 49
STATEMENT OF CASH FLOWComponents
Cash flow from Operating Activities– Result from creation of revenues and
expenses– Items that affect the Income Statement
Cash flow from Investing Activities– Result from increases or decreases in long-
term assets
Cash flow from Financing Activities– Result from transactions with creditors or
investors– Generate funds needed to launch or
sustain the business
Fin Acctg Concepts - 50
CASH FLOW FROM OPERATIONS
Operating Sources of Cash– Collections from customers– Receipts of interest– Receipts of dividends
Operating Uses of Cash– Payments to suppliers– Payments to employees– Payments for interest– Payments for income taxes
Fin Acctg Concepts - 51
CASH FLOW FROM INVESTING
Investing Uses of Cash– Acquisition of Operating Assets– Acquisition of Investments
Investing Sources of Cash– Proceeds from sale of Operating
Assets– Proceeds from sale of Investments
Fin Acctg Concepts - 52
CASH FLOW FROM FINANCING
Financing Sources of Cash – Proceeds of borrowings– Proceeds from issuing stock
Financing Uses of Cash– Payment of debt– Purchase of treasury stock– Payment of cash dividends
Fin Acctg Concepts - 53
NONCASHINVESTING & FINANCING
ACTIVITIES Investing or Financing which DO NOT
DIRECTLY INVOLVE CASH, but which could involve cash.
These transactions are usually “short-cut” methods used to reduce the cost of investing or financing activities
Examples:– Acquiring plant assets by issuing long-
term debt– Converting debt into equity (common
stock)
Fin Acctg Concepts - 54
CASH FLOW FROM OPERATIONSIndirect Method
Net income
Adjustments for noncash items included in net income– Depreciation or amortization (additions to net income)– Gains (deducted from net income)– Losses (added to net income)
Adjustments for changes in working capital items– Current assets
• Increases = deductions from net income• Decreases = additions to net income
– Current liabilities• Increases = additions to net income• Decreases = deductions from net income