ACG 2021
Financial 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
Summary 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 Accounting
Managerial Accounting
Tax Accounting
Governmental (non-profit) Accounting
ACG 2021
Who are we Accounting for:
Business Forms
And
Accounting 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 separate & distinct from it’s owners
– The Reliability Principle
• Accounting records are based on the most objective evidence
available
– The Historical Cost Principle
• $’s are recorded at time of transaction (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 2021
Financial Accounting
The Accounting Equation
Assets = Liabilities + Owners Equity
The Accounting Equation
Assets = Liabilities + Owner’s Equity
Economic
Resources
Claims against
Economic
Resources
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 incomeproducing 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 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 for
the period
–
Expenses for
the period
End of
Start of
=
the period
the period
Ending
Beginning + Net income
Dividends
balance of
balance of or (or Net loss) –
=
for the
for the
retained
retained
–
period
period
earnings
earnings
Accounting Equation Expanded
(again)
• Assets = Liabilities + Paid-in Capital –
Dividends + Revenue – Expenses
Retained Earnings
Transactions
• A simultaneous exchange between one
accounting entity and another accounting
entity:
– Customers
– Suppliers
– Employees
– Owners
• Each party Gives and Receives
something of value ($’s)
Chapter 1
Exercise 1-4
ACG 2021
Financial Accounting
The Financial Statements
The Financial Statements
•
•
•
•
Balance Sheet
Income Statement
Statement of Retained Earnings
Statement of Cash Flows
Balance Sheet
Rank
Place
Situation
Standing
• Assets used to reach company objectives
• $’s represent One Particular Point in Time
– Snapshot
• What is the company’s financial position
at the end of a period?
Assets = Liabilities + Owner’s Equity
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 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 Among
the Financial Statements
ABC Company
Income Statement –
Year Ended December 31, 2006
Revenues
$700,000
Expenses
670,000
Net income
$ 30,000
Relationships Among
the Financial Statements
ABC Company
Statement of Retained Earnings
Year Ended December 31, 2006
Beginning retained earnings
$180,000
Net income
30,000
Cash dividends
(10,000)
Ending retained earnings
$200,000
Relationships Among
the Financial Statements
ABC Company
Balance Sheet
December 31, 2006
Assets
Cash
All other assets
Total assets
$ 25,000
275,000
$300,000
Liabilities
Total liabilities
Stockholders’ equity
Common stock
Retained earnings
Other equity
Total liabilities and stockholders’ equity
$120,000
40,000
200,000
(60,000)
$300,000
Relationships Among
the Financial Statements
ABC Company
Statement of Cash Flows
Year Ended December 31, 2006
Net cash provided by operating activities$ 90,000
Net cash used for investing activities
(110,000)
Net cash provided by financing activities 40,000
Net increase in cash
20,000
Beginning cash balance
5,000
Ending cash balance
$ 25,000