PART ONE
BASIC FINANCIAL ACCOUNTING
As an introduction to financial accounting, this section of
the course is designed to familiarize managers with the content,
limitations and uses of general-purpose financial statements of
profit-oriented business firms. Previous training or experience
in financial accounting is not required of participants.
The
primary learning objective is for participants to be able to
interpret and use the basic financial statements prepared for a
business entity. The course is not designed to emphasize the
procedural aspects of statement preparation. However, you will
have the opportunity to prepare some basic financial statements;
you will also analyze and interpret financial statements.
Methods of instruction will include lecture, illustrative
cases, group discussion and assigned cases which provide an
opportunity for hands-on experience with financial statements
and their use.
The technical notes and case material in this
workbook will be used during our class sessions and for selected
reading assignments.
The daily course schedule includes
references to specific sections of this course manual.
PART ONE
BASIC FINANCIAL ACCOUNTING
Page
I.
COMPONENTS OF FINANCIAL STATEMENTS THE BALANCE SHEET ...........................
1
COMPONENTS OF FINANCIAL STATEMENTS THE INCOME STATEMENT ........................
5
III.
THE ABC'S OF FINANCIAL ACCOUNTING ...........
9
IV.
ACCOUNTING CONCEPTS AND PRINCIPLES ..........
18
V.
ALTERNATIVE ACCOUNTING METHODS ..............
21
VI.
ACCOUNTING FOR INCOME TAXES .................
29
VII.
CASH FLOW ANALYSIS ..........................
32
VIII.
WORKING CAPITAL ANALYSIS ....................
41
IX.
FINANCIAL STATEMENT ANALYSIS ................
49
II.
BASIC FINANCIAL ACCOUNTING
A primary function of management is to acquire and utilize
economic resources in order to accomplish the various goals and
objectives of the business enterprise.
Accordingly, the ability to
2
understand financial statements and their information content is an
important skill of successful managers. The basic elements used to
prepare financial statements of a business enterprise are assets,
liabilities, owners' equity, revenues and expenses.
I.
COMPONENTS OF FINANCIAL STATEMENTS - THE BALANCE SHEET
A.
ASSETS - Assets are the physical properties, property
rights, claims and other resources owned or controlled by the
business entity.
1.
2.
Assets are classified as current or non-current.
a.
Current Assets are expected to be converted to cash,
sold or used in business operations within one year
of the balance sheet date.
Current asset examples
include:
cash,
accounts
receivable,
marketable
securities & inventory.
b.
Non-current Assets are assets that are not held for
the purpose of resale to customers. Examples of noncurrent
assets
include:
land,
buildings
and
equipment.
Valuation of Assets (Measurement in $)
a.
Cash - actual cash balances.
b.
Marketable Securities - primarily at current market
value.
c.
Accounts Receivable - net realizable value, which is
the amount of cash expected to be received.
d.
Inventories - historical cost (FIFO, LIFO or average
cost method).
e.
Prepaid Expenses - amount paid in advance for
services to be received in the future.
f.
Land - historical cost to acquire the properties.
g.
B.
Buildings and Equipment - historical cost less
accumulated depreciation.
LIABILITIES - Liabilities are debts and obligations of
the business arising from completed transactions in
which the firm acquired either assets or services.
Most liabilities require the payment of cash at some
future point in time.
1.
Liabilities
are
classified
as
current
or
3
noncurrent.
2.
C.
a.
Current Liabilities require payment within one
year from the balance sheet date. Examples of
current liabilities include accounts payable,
notes payable and accrued liabilities.
b.
Non-current Liabilities are obligations and
debts that will mature beyond one year from the
balance sheet date.
Examples of non-current
liabilities include long-term notes payable,
bonds payable, or mortgage notes payable.
Valuation of Liabilities (Measurement in $)
a. Accounts Payable - amount of cash to be paid in
the future for supplies and materials that the
firm acquired on a credit basis.
b.
Accrued Liabilities - amount of cash to be paid
in the future for services the firm has already
utilized
in
its
operations
(salaries,
royalties, commissions).
c.
Notes Payable - the unpaid principal amount due
to creditors such as commercial banks.
STOCKHOLDERS' EQUITY - Stockholders' equity (or owners'
equity) is the difference between total assets and
total liabilities.
This difference represents the
residual claims of owners against the firm's assets.
Equity is also called net worth or net assets.
1.
The principal sources of stockholders' equity are:
4
2.
D.
a.
Contributed Capital - This consists of common
stock, preferred stock and other sources of
paid-in capital (for a corporation).
b.
Retained Earnings - Retained Earnings is the
cumulative amount of net income reported by the
firm since its formation, less any dividends
paid to stockholders.
Valuation of Stockholder Equity (Measurement in $)
a.
Contributed capital is measured by the value of
assets or services that the company received in
exchange for shares of stock that were issued
to the owners (investors).
b.
Retained Earnings is measured by total net
income of all previous years less dividends
paid during these years. The net income or net
profit for a period is added to the Retained
Earnings element of owners' equity.
THE BALANCE SHEET - The purpose of the balance sheet is
to show the financial position of a business at a
particular date.
The fundamental balance sheet
relationship is:
ASSETS = LIABILITIES + STOCKHOLDERS' EQUITY
As an illustration of the balance sheet, examine the
comparative
balance
sheets
of
Alamo
Distributing
Company shown in Exhibit 1.
EXHIBIT 1
ALAMO DISTRIBUTING COMPANY
BALANCE SHEETS
December 31, 20X1 and 20X2
ASSETS
Current Assets:
20X1
20X2
5
Cash
Accounts Receivable (net)
105,000
Inventories (at FIFO Cost)
Prepaid Expenses
4,500
Total Current Assets
Noncurrent Assets (at cost):
Land
Buildings
Equipment
Less: Accumulated Depreciation
(338,000)
Total Noncurrent Assets
Total Assets
$ 70,000
65,000
$ 38,000
31,000
6,000
52,000
$172,000
$199,500
$208,000
$237,000
150,000
150,000
460,000
681,000
(240,000)
$578,000
$730,000
$750,000
========
$929,500
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts Payable
47,000
Notes Payable
Accrued Liabilities
Total Current Liabilities
Notes Payable - Long Term
400,500
Total Liabilities
$503,500
Stockholders' Equity:
Common Stock (no par value)
Retained Earnings
Total Stockholders' Equity
$426,000
Total Liabilities & Stockholder Equity
II.
$ 22,000
$
60,000
18,000
32,000
24,000
$100,000
$103,000
312,000
$412,000
$200,000
138,000
$220,000
206,000
$338,000
$750,000
========
$929,500
========
COMPONENTS OF FINANCIAL STATEMENTS - THE INCOME STATEMENT
A.
REVENUE - Revenue is gross income such as sales or
6
contract fees resulting from an exchange transaction in
which the company provided goods or services to outside
parties.
B.
C.
D.
EXPENSES - Cost of goods, services and other resources
used by the business during a particular time period.
1.
Cost of Goods Sold - cost of inventory delivered to
customers.
2.
Depreciation - systematic allocation of the cost of
buildings and equipment to specific time periods.
3.
Salaries and Wages - costs incurred for services that
are not expected to benefit future periods (the cost
relates to services used in the current period).
MEASUREMENT OF REVENUES AND EXPENSES
1.
With the accrual method of accounting, revenues are
recognized when earned, which is usually at the point
in time that a sale is completed or services are
rendered. The recording of revenues is not dependent
upon cash collections.
2.
Expenses represent the cost of goods, services and/or
other resources that are utilized during a period of
time. The recording of expenses is not dependent
upon cash payments. The matching concept requires
that expenses must be associated with revenues of the
same time period. Expenses are deducted from
revenues to measure net income (profit or earnings)
for a given time period.
THE INCOME STATEMENT - The income statement of a business
entity presents the revenues earned and expenses
resulting from operations of the business for a period of
time.
The comparative income statements of Alamo Distributing
7
Company for the years ending December 31, 20X1 and 20X2
are presented in Exhibit 2. The difference between the
revenues and expenses is the amount of net income for
each year, which represents an increase in the
stockholders' equity of the firm.
EXHIBIT 2
ALAMO DISTRIBUTING COMPANY
INCOME STATEMENTS
For Years Ending December 31, 20X1 and 20X2
20X1
20X2
Sales
$900,000
$1,200,000
Cost of Goods Sold
(350,000)
Gross Profit on Sales
$550,000
Selling Expenses
(133,500)
(238,000)
Income from Operations
$202,000
Income before Taxes
Income Tax Expense
Net Income
$
620,000
(110,000)
Administrative Expenses
Interest Expense
(65,000)
(580,000)
(250,000)
$
236,500
$
171,500
(52,000)
$150,000
(60,000)
(63,500)
$ 90,000
========
$ 108,000
==========
Earnings per Common Share*
$1.80
$1.96
Total Depreciation Expense
included above .....
$ 82,000
*
$
98,000
Based on 50,000 and 55,000 average common shares outstanding
in 20X1 and 20X2, respectively.
E. STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY - a
statement of changes in stockholders' equity summarizes
all changes directly affecting account balances in the
stockholders' equity section of the balance sheet.
Such changes include net income, cash and stock
dividends, issues of common or preferred stock and
8
treasury stock transactions.
Comparative Statements of Changes in Stockholders'
Equity for Alamo Distributing Company are presented in
Exhibit 3. Ending account balances on December 31 of
each year are the amounts appearing in the balance
sheets in Exhibit 1.
EXHIBIT 3
ALAMO DISTRIBUTING COMPANY
* STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For Years Ending December 31, 20X1 and 20X2
STOCKHOLDERS' EQUITY
Balances on January 1, 20X1
Common
Stock
Retained
Earnings
Total
$200,000
$ 78,000
$278,000
90,000
90,000
(30,000)
(30,000)
Net Income for 20X1
Cash Dividends Declared
Balances on December 31, 20X1
$200,000
$138,000
$338,000
Net Income for 20X2
108,000
108,000
Cash Dividends Declared
(40,000)
(40,000)
Common Shares Issued for Cash
20,000
Balances on December 31, 20X2
$220,000
========
*
20,000
$206,000
========
$426,000
========
If there are no significant changes in common stock or
other elements of contributed capital, only a Statement of
Retained Earnings may be presented, as shown in the
Retained Earnings column above.