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Financial Accounting Fundamentals
Information for DecisionsInformation for Decisions
IdentifiesIdentifies
RecordsRecords
CommunicatesCommunicatesRelevantRelevant
ReliableReliable
ComparableComparable
Importance of Accounting
AccountingAccountingis a
system that
information
that is
to help users make better decisions.
to help users make better decisions.
C1
Identifying Business Activities
Recording Business Activities
Communicating Business Activities
Accounting ActivitiesC 1
Users of Accounting Information
External Users
•Lenders
•Shareholders
•Governments
•Consumer Groups
•External Auditors
•Customers
Internal Users
•Managers
•Officers/Directors
•Internal Auditors
•Sales Staff
•Budget Officers
•Controllers
C 2
Users of Accounting Information
External Users
Financial accounting provides external users with financial
statements.
Internal Users
Managerial accounting provides information needs for internal
decision makers.
C 2
Legal Liability
•Management is legally responsible to the stockholders to act in their interest.•Auditors are legally responsible to the stockholders to conduct a thorough and independent audit.•If management or auditors fail in their duties, investors and others may sue to recover any losses that might occur as a result the failure.
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).
Generally Accepted Accounting Principles
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.
C 5
The Securities and Exchange Commission is the government group that establishes
reporting requirements for companies that issue stock to the public.
The Securities and Exchange Commission is the government group that establishes
reporting requirements for companies that issue stock to the public.
Setting Accounting Principles
Financial Accounting Standards Board is the private group that sets both broad and
specific principles.
Financial Accounting Standards Board is the private group that sets both broad and
specific principles.
C 5
Principles of Accounting
Now Future
Going-Concern PrincipleReflects assumption that the
business will continue operating instead of being closed or sold.
Cost PrincipleAccounting information is
based on actual cost.
Objectivity PrincipleAccounting information is supported by independent,
unbiased evidence.
C 5
Principles of Accounting
Revenue Recognition Principle1. 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.
Monetary Unit PrincipleExpress transactions and events in
monetary, or money, units.
Business Entity PrincipleA business is accounted for
separately from other business entities, including its owner.
C 5
AssetsLiabilities & Equity
Accounting Equation
LiabilitiesLiabilities EquityEquityAssetsAssets = +
A1
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
AssetsA1
Assets
Current assets includeCash: checking and savings accounts; petty cash.Accounts receivable: amounts owed to a company from its customers.Notes receivable: similar to A/R but usually has an interest component. Supplies: products on hand to be used by the company (ex: office supplies).Inventory: products on hand designated for sale to customers.Prepaid expenses: amounts paid for future expenses.
Assets
Property, plant, and equipment are assets that are used in the production of goods and services. These productive assets are long-term in nature, and include the following:
Land: property upon which the productive facilities are located.Building: the physical structure of the company’s operations.Machinery and Equipment: include operating machinery, vehicles, computers, copy machines, etc.
Assets
Long-term investments are assets acquired by the company to provide long-term benefits to the company. Long-term investments include:
Long-term notes receivable owed to the company (from customers or others).Investments in stock of other companies: held for expectation of dividends and/or stock price increase.Investment in bonds of other companies: held for expectation of dividends and/or stock price increase.Other assets, like land, held for the long term.
AssetsIntangible assets are long-lived assets that have no physical substance. Examples include:
Patents: legal claim to produce and sell a product. Copyrights: legal claims to books, art, music and other created works.Goodwill: recognized when one company buys another company, and the purchase price is greater than the fair value of the identifiable net assets.
Taxes Payable
Taxes Payable
Wages Payable
Wages Payable
Notes Payable
Notes Payable
Accounts Payable
Accounts Payable
Creditors’ claims on
assets
Creditors’ claims on
assets
LiabilitiesA1
LiabilitiesCurrent liabilities are obligations expected to be paid (or services expected to be performed) within the next year or operating cycle. The elimination of the current liabilities requires the use of current assets (most commonly cash). Examples include:
Accounts payable: owed to suppliersWages payable: owed to employeesInterest payable: owed to banksShort-term notes payableCurrent maturities of long-term debtUnearned revenues: owed to customers
LiabilitiesLong-term liabilities are obligations expected to require payments beyond the current year. Examples of long-term liabilities include:
Notes payable: amounts owed to banks and other creditors beyond the current year.Mortgage payable: amounts owed to mortgage company beyond the current year.Bonds payable: amounts owed to investors holding bond investments issued by the company, where payments of principal and interest are beyond the current year.
Owner’sclaim on
assets
Owner’sclaim on
assets
DividendsDividends
Contributed Capital
Contributed Capital
Retained Earnings
Retained Earnings
EquityA1
Stockholders’ EquityCommon stock: shares of stock issued to owners to to reflect ownership.Additional paid in capital: excess amounts contributed by shareholders for various activities.These are activities from the owners.
LiabilitiesLiabilities EquityEquityAssetsAssets = +
Expanded Accounting Equation
RevenuesRevenues ExpensesExpensesCommon
StockCommon
StockDividendsDividends__ ++ __
Retained Earnings
LiabilitiesLiabilities EquityEquityAssetsAssets = +
A1
Retained EarningsRetained earnings represent the excess earnings retained in the company after dividends have been paid to shareholders. This represents the equity generated by the company for the shareholders. Retained earnings is affected by
revenues (earned by the company)expenses (costs incurred by the company)dividends (amounts distributed by the company to its shareholders)
Transaction Analysis Equation
The accounting equation MUST remain in balance after each transaction.
LiabilitiesLiabilities EquityEquityAssetsAssets = +
A2
Financial Statements
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows
P1
The Income Statement•The income statement shows the components of net income in detail.•Revenues represent the inflow of assets (or decrease in liabilities) due to a company’s operating activities.•Expenses represent the outflow of assets (or increases in liabilities) due to a company’s operating activities.•The general formula for the I/S is:
Revenues - Expenses = Net Income
The Income Statement FormatOperating revenues
Sales Fees earnedOther revenues
Less: Operating expensesCost of goods soldWage expenseRent expenseSelling expenseDepreciation expenseOther expensesNet Income
Net income is the difference between
Revenues and Expenses.
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 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.
Income StatementP1
The Statement of Retained Earnings
The statement of retained earnings calculates the changes in the retained earnings component of stockholders’ equity:
Beginning retained earningsPlus: Net incomeLess: DividendsEnding retained earnings
Formula: REBegin + NI - Div = REEnd
The net income of $2,200 increases Retained Earnings by $2,200.
The net income of $2,200 increases Retained Earnings by $2,200.
Statement of Retained EarningsP1
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.
Balance SheetP1
The Statement of Cash FlowsCash flows from operating activities:
Collections from sales, rent, interest, etc.Cash paid to suppliers and employees, and for rent, selling activities, interest, and taxes etc.
Cash flow from investing activities:Proceeds from sale of investment securities, land, buildings, equipment, etc. Purchase of investment securities, land, buildings, equipment, etc.
Cash flow from financing activities:Proceeds from issuance of notes, debt, sale of equity, etc.Payments on notes, debt, dividends, etc.
Statement of Cash FlowsP1
