May 15, 2006 Monday
Chapter 1: The Financial Statements
Objectives:
1. Use accounting vocabulary for decision making
2. Apply accounting concepts and principles
3. Use the accounting equation to describe an organization
4. Evaluate operating performance, financial position and cash flows 5. Explain the relationships among the financial statements
Use of Accounting Information
A. Managers
1. Accounting helps manager‟s measure revenue, expenses and profits.
2. Accounting measures the cost of the investment.
3. Accounting measures the cost of obtaining funds or financing operations. B. Investors - the financial statements (accounting information) provide the information one
needs to help make informed investment decisions
Use accounting vocabulary for decision making
A. What is Accounting? - It is an information system that measures, processes and
communicates financial information about an economic entity to interested persons by means
of financial statements. Accounting is both:
1. the language of business
2. an information System
B. Who uses Accounting Information?
1. Individuals
2. Business Managers
3. Investors
4. Creditors
5. Government regulatory agencies
6. IRS
7. Non-profit organizations
8. Employees, labor unions, etc.
C. Two general accounting categories
1. Financial Accounting - provides information to external users
2. Managerial Accounting - provides information for internal use by management D. Types of business organizations
1. Proprietorship - one owner with unlimited liability
2. Partnership - two or more owners with unlimited liability
3. Corporation - owned by shareholders with limited liability; ownership evidenced by
number of shares of stock held; run by the board of directors who are elected by the
stockholders; legally separate from its owners (stockholders) so it can enter into
contracts, sue and be sued and own buy and sell property.
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Apply accounting concepts and principles
A. How do accountants measure, process and communicate financial information? They
use guidelines or GAAP (Generally Accepted Accounting Principles) - guidelines that
have developed over time that govern how accountants measure, process and communicate
financial information.
1. Primary objective - provide information that is useful for making investment and
lending decisions - information that is relevant, reliable and comparable.
2. Three organizations involved in GAAP:
a. FASB (Financial Accounting Standards Board)
b. SEC (Securities and Exchange Commission)
c. AICPA (American Institute of Certified Public Accountants)
B. Principles and Concepts discussed in Chapter 1:
1. The entity concept - each business is an economic unit kept separate from other
businesses.
2. The reliability (objectivity) principle - actual costs are usually more reliable than
market value, therefore records should be based on actual costs.
3. The cost principle - actual costs should be used when recording assets and services.
4. The going concern principle - assumes that the business will remain in operation
indefinitely.
5. The stable-monetary-unit concept - ignores the effects of inflation on the accounting
records (assumes that the dollar is stable).
Example: Suppose you purchased land on Jan 1 for $100,000. You had to borrow $100,000 from the bank to pay for the land. The bank appraised the land at $105,000 and charged you 10% interest for 2 years. During the same year you receive an offer for the land for $110,000 but you
do not want to sell the land. At what value will you report the land on the balance sheet? (Answer:
$100,000.)
May 16, 2006 Tuesday
Chapter 1: The Financial Statements, cont.
Use the accounting equation to describe an organization
A. The accounting equation: - basic tool for compiling the financial statements
Assets = Liabilities + Owners’ Equity
B. What do these terms mean?
1. Assets - economic resources owned by the business that are anticipated to profit
future operations. What the business owns to make money. For example: buildings,
land, and inventory.
2. Liabilities - debts of the business payable to outsiders (creditors). The most
common form of liability is debts payable (owed).
3. Owners’ Equity - owners‟ residual claim to the assets (Assets - Liabilities)
a. Proprietorships and partnerships - owners‟ equity = Capital
b. Corporations - stockholders’ equity = two main categories:
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1. Paid-in or contributed capital - amount invested in the corporation by
its owners (stockholders). This is how owners of a corporation get money
into a business.
2. Retained earnings - income or profit (revenue - expenses) that has
been reinvested in the company.
a. Revenue - amounts earned by the business by delivering goods
or services (increase net income (NI) and retained earnings
(RE)). Basically, what is earned in course of doing regular
business.
b. Expenses - costs of operating a business (decrease NI and RE)
c. Net loss - expenses>revenues (decrease RE) – spending more
than you make.
d. Dividends - distributions of assets to the stockholders
(decrease RE). This is not paid to sole proprietorships, as they
have no stock.
Evaluate a company’s operating performance, financial position, and cash flows
A. Income Statement - provides information as to how well the company performed or operated during the period by summarizing revenues, expenses and net income or loss for the
period.
B. Statement of Retained Earnings - reports the portion of net income that has been kept in the business and reports the changes in retained earnings during the period. (Exhibit 1-8) 1. The income reported on the income statement is added to the beginning balance of
retained earnings.
2. The board of directors decides whether to retain income for use in the business or to pay
dividends. If they decide to pay dividends, the amount of the dividends is deducted on the
statement of retained earnings.
3. RE = Beg RE + NI - Div
C. Balance Sheet – “How much cash do we have today?” Reports the company‟s financial position at a particular date based on the balance sheet equation:
assets = liabilities + owners’ equity
1. Assets - economic resources
a. Current Assets - assets the company expects to convert to cash, sell or
consume within the operating cycle or year whichever is longer (cash,
receivables ,inventory and prepaid expenses)
b. Long-term Assets - assets the company expects to use for more than a year
(property, plant, and equipment). These assets are partially used or depreciated.
c. Intangible and other assets
a. Intangible assets have no physical form (patents, trademarks, goodwill)
b. Other assets are assets that do not “fit” anywhere else on the balance sheet
2. Liabilities - debts
a. Current Liabilities - debts due in one year or the operating cycle whichever is
longer (accounts payable, accrued expenses payable, short-term notes payable,
taxes payable)
b. Long-term Liabilities - debts that are due in the long-term (mortgages, bonds
etc.)
3. Owners’ or Stockholders’ Equity - residual claim on the assets (contributed capital
<stock>, and retained earnings). The retained earnings amount comes from the
statement of retained earnings.
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D. Statement of Cash Flows – reports cash provided or used by the company by reporting:
1. Cash generated from Operating Activities – cash revenues and expenses of the
business. Cash from current assets, current liabilities.
2. Cash generated from Investing Activities - buying and selling of long term assets.
Only long-term assets.
3. Cash generated from Financing Activities – the way a company acquires funds
used for investing and operating activities (borrowing from a bank, issuing stock and
paying dividends). Only long-term liabilities and stockholder‟s equity.
Explain the relationships among the financial statements
A. Income statement - revenues and expenses
1. Revenues - expenses = NI or NL; reported on the income statement
2. Net income or loss is reported on the Statement of Retained Earnings
B. Statement of Retained Earnings reports:
Beginning balance of retained earnings
+ Net Income
- Dividends
Ending balance of Retained Earnings (reported on the balance sheet under
stockholders‟ equity)
C. Balance Sheet - reports assets, liabilities and owners‟ equity based on the balance sheet equation (Assets must = Liabilities + Owners’ Equity)
D. Statement of Cash Flows - reports cash flows from operating, investing and financing activities and the ending cash balance is also reported on the balance sheet.
May 17, 2006 Wednesday
Chapter 2: Processing Accounting Information
Objectives:
1. Analyze business transactions
2. Understand how accounting works
3. Record business transactions in the ledger
4. Use a trial balance
5. Analyze transactions for quick decisions
Analyze business transactions
A. Transaction – an event that can be measured and recorded; affects the financial position of
a business. If you hire an employee, no transaction has occurred until the first day they start
working.
B. Account - basic storage unit for accounting data.
1. You can think of it like a filing system that allows a business to sort out transactions.
2. It shows all increases and decreases in an asset, liability and stockholders‟ equity, and
revenues and expenses, during a period.
3. Accounts are grouped based on the accounting equation: A = L + SE and a listing of
the accounts is called a chart of accounts.
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C. Assets - economic resources of the business
1. they can be used in the business now or
2. they will benefit the business in the future
3. Examples: cash, receivables, inventory, prepaid expenses, land, building, furniture,
and equipment
D. Liabilities - debts or other obligations of the business
1. must be satisfied in the future
2. Examples: all payables and accrued expenses (i.e. unearned revenue) E. Stockholders’ Equity - owners (investors) residual claim on the assets that remains after
deducting the liabilities.
1. Similar terms are “shareholders‟ equity (corporation) or owners‟ equity
2. Common stock, retained earnings, dividends, revenues, and expenses are all
stockholders’ equity accounts.
F. Revenues - income earned from selling products or performing services. Revenues increase
net income, retained earnings, and therefore increase stockholders‟ equity
G. Expenses - costs incurred in operating a business. Expenses decrease net income,
therefore retained earnings and in turn decrease stockholders‟ equity
H. Analyze transactions according to their effect on the accounting equation. Remember the
accounting equation must always balance after each transaction is recorded.
I. Entity concept - each business has records distinct from each other and their owner,
therefore, the business will exclude personal transactions of the owners as well as
transactions of other businesses
Understand how accounting works
A. Double-entry system: based on the principle of “duality”; effort and reward, source and
use, giving and receiving etc. or the dual effects of all business transactions (each
transactions affects at least two accounts)
1. In accounting, duality is represented by offsetting debits and credits; debits always
equal credits so the system is always in balance
2. To an accountant, debit means left, and credit means right
B. The T-account - abbreviated form of an account used for illustration but we are going to use
this account for recording.
Account Name
Debit entries Credit entries
(left side) (right side)
C. Rules of Debit and Credit (keep the accounting equation in balance)
1. Increases in assets = recorded on the left (debit) side of the account
Decreases in assets = recorded on the right (credit) side of the account
2. Increases in liabilities and stockholders’ equity ( + )= recorded on the right
(credit) side of the account
Decreases in liabilities and stockholders’ equity (-) = recorded on the left (debit)
side of the account.
Assets = Liabilities + Stockholders’ equity
debit credit debit credit debit credit
+ - - + - +
Remember that stockholders‟ equity consists of and is affected by different accounts, so that we
can expand the equation
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Stockholders equity
Assets = liabilities + common stk. + retained earnings - dividends + revenues -expenses
common stock retained earnings dividends revenues expenses
- + - + +` - - + + - debit credit debit credit debit credit debit credit debit credit
Note: because expenses and dividends decrease owner's equity, an increase in an expense or withdrawal is a debit
- Because revenues increase owner's equity, an increase in revenue is a credit.
- After each transaction is recorded, the equation must remain in balance
D. The amount remaining in the account after all the increases and decreases are recorded is called the balance (beginning balance + increases - decreases)
May 18, 2006 Thursday
Chapter 2: Processing Accounting Information, cont.
Record business transactions
A. Business transactions are normally recorded in the Journal - a chronological listing of all
the business transactions; sometimes it is called the book of original entry. We will not be
doing formal journal records in this course but will be recording directly in the ledgers. You
should know for business purposes, that a transaction always is recorded in the journal and
then transferred (posted) to the ledger.
B. Transaction Analysis
1. Identify the transaction from the source document (sales invoice or check stub).
2. Identify the types of accounts affected (asset, liability, expense etc.)
3. Determine which accounts increase and decrease
4. Apply the rules of debit and credit
5. Write the transaction in the journal (we are going to write them directly in the ledger) and
verify that the totals balance
6. Post from the journal to the ledger (we will not need to do this as we will be recording in
the ledger
a. journal – shows the complete effect of each transaction, therefore it gives more
information than the ledger.
b. ledger - group of accounts grouped together to form a book called the general
ledger; the correct order is the balance sheet order i.e. assets, liabilities and
stockholders‟ equity.
c. posting - transferring or copying from the journal to the ledger
Use the trial balance
A. The trial balance - a list of each ledger account that has a balance, with debit balances in the left column and credit balances in the right column. (Exhibit 2-12)
B. The trial balance proves that the ledger is in balance; it is not one of the formal financial
statements but rather a tool to help the accountant prepare the financial statements. C. If the total of the debits and credits are NOT equal, an error has been made in the journal,
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ledger or trial balance
D. Common Errors:
1. Posting incorrectly
2. Mathematical errors
a. Transposition - digits are written in the wrong order (evenly divisible by 9 i.e. $567 is
written as $657; $657-$567=$90)
b. Slide - one or more zeroes are added or left off (evenly divisible 9 i.e. $1000 written
as $100; $1000-$100=900)
3. Omitting or entering account balances in the wrong column in the trial balance. To find
the error, calculate the difference in the column balances (debit/credit) and divide by 2. E. Equal balances only prove that equal debits and credits were posted so the Balance Sheet should balance but not that the Balance Sheet is correct.
F. Chart of accounts:
1. Lists all of the accounts by number beginning with assets, liabilities, stockholders‟ equity,
revenue and expenses.
2. Normal balance of the account is the side used to record increases
Normal Balance
Assets Liabilities
Expenses Revenues
Dividends Common Stock
Retained Earnings
Analyze transactions for quick decisions
1. A quick way to analyze a transaction is to skip the journal and look directly at the ledger.
This is never done in a formal accounting system but we will be using this method in this
course.
2. Therefore, journalize and post in one step instead of two.
May 22, 2006 Monday
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May 24, 2006 Wednesday
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