ACG 2021Financial Accounting

Chapter One:

The Financial Statements

The Accounting System

What is accounting• Been in place for hundreds of years

– 1494 Luca Pacioli's Summa de Arithmetica Geometria Proportionalita (A Review of Arithmetic, Geometry and Proportions)

• First written description of double-entry accounting– Incan khipus

• cryptic assemblages of string and knots– May have been used for record-keeping (i.e. accounting) Gary Urton and Carrie Brezine

• Annotated Khipu on Flickr

• System– Of recording business transactions

• Language– Whether knots– Debits or Credits written in a journal– Digital values stored on a computer– We’ve been accounting for many, many years

Information System Model

The Accounting System

• An Information System– Inputs to the system are business events

• Sales• Purchases

– Inventory (things to re-sell, things to use in building), buildings– Payroll

– Processing takes place in the various Journals and General Ledger where transactions are stored

– Financial Statements are the Outputs and represent SummarySummary Information

• Income Statement• Statement of Retained Earnings• Balance Sheet• Cash Flows

Accounting Information System

• Procedures, Techniques and Resources to– Collect & Disseminate– Relevant Business Information to Interested

Users• Individuals (Management)• Investors & Creditors• Taxing Authorities• Non-Profit Organizations

Accounting (The Language of Business) Is...• The process of identifying, measuring, and

communicating economic information (via reports) to permit informed judgments and decisions by users of the information.– Balance Sheet – Resources– Income Statement – Results of Operations– Cash Flow – Management of Asset

Language Dialects

• Financial AccountingFinancial Accounting

• Managerial Accounting

• Tax Accounting

• Governmental (non-profit) Accounting

ACG 2021

Who are we Accounting for:Business Forms

AndAccounting Rules and Assumptions

Accounting Assumptions

• Business activity occurs via distinct entities– Sole Proprietorship– Partnerships– Corporations

• Business activity is conducted via measurable, observable transactions

• Transactions can be described using standard units of measurement ($’s) in accounts (Valuation)

Forms of Business Organization

• Proprietorship– Has a single owner– Proprietor is personally liable

• for debts of the business

– Not a separate legal entity– For accounting, the proprietorship is a

separate entity from the proprietor

Forms of Business Organization

• Partnerships– Two or more partners are co-owners– Each partner can be liable for all the debts of

the partnership– Not a separate legal entity– For accounting, the partnership is a separate

entity from its partners

Forms of Business Organization

• Corporations– May have many owners (stockholders)– Stockholders are not personally liable for

debts of the business– Is a separate legal entity– Stockholders elect a Board of Directors to

appoint corporate officers and set policies

Accounting Guidelines

• Formulated by the Financial Accounting Standards Board (FASB)

• Generally Accepted Accounting Principles (GAAP)– The Entity Concept

• A business is separateseparate & distinctdistinct from it’s owners– The Reliability Principle

• Accounting records are based on the most objectiveobjective evidence available

– The Historical Cost Principle• $’s are recorded at timetime of transaction (actual actual cost)

– $’s that a willing buyer paid a willing seller– Not some point in the future

– The Going-Concern Principle• The Entity will not go Out-of-Business

– The Stable-Monetary-Unit Concept• the monetary unit’s ($’s) purchasing power is stable (ignores inflation)

ACG 2021Financial Accounting

The Accounting Equation

Assets = Liabilities + Owners Equity

The Accounting Equation

Assets = Liabilities + Owner’s Equity

EconomicResources

Claims againstEconomicResources

Assets

• Economic resources (value, $’s)

• Owned and Controlled by business entity

• Expected to produce a benefit in the future– Cash– Investments– Accounts Receivable– Inventory– Buildings, Equipment, Gold Mines, Patents

Liabilities

• Economic obligations (debt) of a business– Accounts Payable– Notes Payable– Accrued Expenses:

• Payroll that we owe• Taxes that we owe• Rent, Insurance, etc. that we owe

– Money we borrowed and of course owe• Claims by Creditors

– Convey Assets• This means that the creditor expects an asset (most often cash) be

given for what is owed– Perform Service

• This means that the creditor expects a service (like prepare a tax return, or provide rental retail space) be given for what is owed

Owner’s Equity

The owner’s claim on the entity’s assets• Capital (for Proprietorship or Partnership)• Stockholders’ equity (for Corporation)

• Share’s of Stock

• Net assets

Assets – liabilities = owner’s equity

Stockholders’ Equity

• For a corporation, stockholders’ equity is divided into two main categories.– Paid in capital

• The amount that investors have given to the corporation

– In exchange for shares of stock

– Retained earnings• The amount of Earnings the company has either

earned (profit) or lost over time• The amount of dividends that have been paid to

investors

The Accounting Equation Expanded

• Assets = Liabilities + Owners Equity• Replace Owners Equity with:

– Paid-in capital - amount invested by its owners - common stock

• Increases Owners Equity– Retained earnings - amount earned by income-

producing activities and kept for use in the business

• Dividends – distributions of assets to stockholders– Decreases Retained Earnings

Assets = Liabilities + Paid-in capital + Retained earnings

The Accounting Equation

• Retained Earnings accumulate Revenues and Expenses of an Organization and Dividends that have been paid– Revenues – Sales of Product or Services

• increases Retained Earnings from delivering goods or services to customers

– Measured by corresponding increase in Asset received as payment

– Expenses – goods or services Consumed Consumed from Revenue Generation

• decreases Retained Earnings that result from operations– Measured by historical cost of assets given up in the sale or

consumed to make the sale

Components of Retained Earnings

Revenues forthe period

–Expenses for

the period

=Net income(or Net loss)

for theperiod

Dividendsfor theperiod

Endingbalance ofretainedearnings

End ofthe period

Start ofthe periodBeginningbalance ofretainedearnings

+or–

=–

Accounting Equation Expanded (again)• Assets = Liabilities + Paid-in Capital –

Dividends + Revenue – Expenses

Retained Earnings

Transactions

• A simultaneous exchangesimultaneous exchange between one accounting entity and another accounting entity:– Customers– Suppliers– Employees– Owners

• Each party GivesGives and Receives Receives something of valuevalue ($’s)

Chapter 1

Exercise 1-4

ACG 2021Financial Accounting

The Financial Statements

The Financial Statements

• Balance Sheet

• Income Statement

• Statement of Retained Earnings

• Statement of Cash Flows

Balance Sheet

• Assets used to reach company objectives• $’s represent One Particular Point in Time

– Snapshot

• What is the company’s financial positionposition at the end of a period?

Assets = Liabilities + Owner’s Equity

RankPlace

SituationStanding

Balance Sheet

• Assets appear in order of Liquidity– Easily Turned into Cash

• Why?– So Creditors can quickly

ascertain if a company has enough “Cash” to pay back what is owed

– So Creditors can quickly ascertain what collateral a company has against possible loans that might be made

• Liabilities appear in order in which they will be paid– Within 1 year or less– Greater then 1 year

• Stockholders Equity shows the amount contributed by investors & the amount of Income retained by the company– Dividends are paid out of

this retained amount (but NOT with it)

Income Statement

• Presents information about profitability• How well did the company perform during the period?

– Revenue – Amount paid or promised to paypromised to pay for goods or services of the firm, increase of assets

– Expenses – Costs of providing goods or services to the customer, using up of assets

• Temporary (periodic) Retained Earnings accounts

Revenues – Expenses

Net Income (Loss)

Statement of Retained Earnings

• The portion of a firms Net Income retained by the business

• Why did the company's retained earnings change during the year?

Beginning retained earnings+Net income or (-Net loss) - Dividends Ending retained earnings

Statement of Cash Flows

• Changes to Cash during a specific time period• How much cash did the company generate and

spend during the year?

Operating cash flows+ Investing cash flows+ Financing cash flows

Increase (decrease) in cash

Information Reported in the F/S

Relationships Amongthe Financial Statements

ABC CompanyIncome Statement –

Year Ended December 31, 2006Revenues $700,000Expenses 670,000Net income $ 30,000

Relationships Amongthe Financial Statements

ABC CompanyStatement of Retained EarningsYear Ended December 31, 2006

Beginning retained earnings $180,000Net income 30,000Cash dividends (10,000)Ending retained earnings $200,000

Relationships Amongthe Financial Statements

ABC CompanyBalance Sheet

December 31, 2006Assets

Cash $ 25,000All other assets 275,000Total assets $300,000

LiabilitiesTotal liabilities $120,000

Stockholders’ equityCommon stock 40,000Retained earnings 200,000Other equity (60,000)Total liabilities and stockholders’ equity $300,000

Relationships Amongthe Financial Statements

ABC Company Statement of Cash Flows Year Ended December 31, 2006Net cash provided by operating activities$ 90,000Net cash used for investing activities (110,000)Net cash provided by financing activities 40,000Net increase in cash 20,000Beginning cash balance 5,000Ending cash balance $ 25,000