1-1 Accounting Basics Prepared/Edited by Nita S. Edwards, CPA

1-2 The Language of Business Accounting is an information system  Measures business activities  Processes data into reports  Communicates results to people and organizations Accounting is used to make decisions

1-3 Users of Accounting Individuals Investors & Creditors Taxing Authorities Nonprofit Organizations

1-4 Financial and Management Accounting FINANCIAL Provides information for external users :  Investors  Bankers  Government agencies MANAGEMENT Provides information for internal users:  Managers of the company

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-5 G A A P GAAP is an acronym for Generally Accepted Accounting Principles U.S. GAAP is formulated by the Financial Accounting Standards Board (FASB) FASB’s Conceptual Framework states that accounting should be:  Relevant  Reliable  Comparable  Consistent

1-6 Debits and Credits Credit – Entry on the right side of an account – Will increase an account with a Normal Credit Balance Cash CreditDebit Debit – Entry on the left side of an account – Will increase an account with a Normal Debit Balance

1-7 Assets – Balance Sheet – Permanent Economic resources that provide a future benefit Examples:  Cash  Inventory  Equipment  Land  Buildings

1-8 Liabilities – Balance Sheet - Permanent Outsiders claims to assets  Include debts payable to creditors Examples:  Accounts payable – liability for goods or services purchased on credit  Notes payable – written promise to pay on a certain date (bank loan)

1-9 Owners’ Equity – Balance Sheet - Permanent Owners’ claim on a business Includes Initial Investments less Withdrawals/Dividends and Retained Earnings Retained Earnings is the accumulation of Net Income/Losses. A corporation’s equity is called Stockholders’ Equity

1-10 Revenue – Income Statement - Nominal Sales from Merchandise or Services Presented on the Income Statement Closed at the end of the Period Normal Balance is a Credit Examples:  Rent Revenue  Service Revenue  Sales Revenue

1-11 Expenses – Income Statement - Nominal Costs of doing business Presented on the Income Statement Closed at the end of the Period Normal Balance is a Debit Examples:  Salaries Expense  Utilities Expense  Insurance Expense

1-12 Net Income Revenue – Expenses = Net Income or Net Loss Net Income/Loss Reported on Income Statement Net Income/Loss is included in Retained Earnings

1-13 The Accounting Equation = Liabilities Owners’ Equity +

1-14 Accounting Equation Assets = Liabilities + Owners’ Equity Or Assets – Liabilities = Owners’ Equity  Assets are either owned by the Creditors (Liabilities) or Investors (Equity).  The Equation must always balance.

1-15 Accounting Equation Example Assets =Liabilities +Owners’ Equity (a)$50,000$20,000 (b)$30,000$10,000 (c)$40,000$15,000 $70,000 $20,000 $25,000

The Accounting Cycle Journalize Transactions Post to General Ledger Prepare Trial Balance Complete Adjusting Entries Prepare Adjusted Trial Balance Prepare Financial Statements Close Permanent Accounts Post Closing Trial Balance 1-16

The Financial Statements Report company’s results to the public Four Statements  Income Statement  Statement of Retained Earnings  Balance Sheet  Statement of Cash Flows 1-17

The Income Statement Measures operating performance for the period Reports revenue and expenses and resulting net income (or loss) Also includes gains and losses 1-18

Statement of Retained Earnings Shows increases and decreases to retained earnings Increase: net income Decrease: dividends 1-19

Balance Sheet Measures financial position Reports assets, liabilities and shareholders’ equity Assets and liabilities are categorized  Current and Long-term 1-20

Balance Sheet Categories Current assets  Converted to cash or used within one year  Cash, Short-term Investments, Accounts Receivable, Inventory Long-term  Property, plant, and equipment  Intangible assets  Investments  Other 1-21

Balance Sheet Categories Current liabilities  Due within one year of balance sheet date  Accounts payable, salaries payable, taxes payable, short-term borrowings Long-term liabilities  Long-term notes payable, mortgage payable 1-22

Balance Sheet Categories Stockholders’ Equity  Paid-in capital Common stock  Retained Earnings 1-23

Statement of Cash Flows Shows inflows and outflows of cash by category:  Operating activities  Investing activities  Financing activities 1-24

Cash Flow Categories Operating  Cash generated from day-to-day business activities  Related to selling goods and services to customers Investing  Cash invested in long-term assets  Related to purchasing and selling plant assets and investments 1-25

Cash Flow Categories Financing  How a company obtains resources to finance business  Related to long-term debt and equity (issuing stock) 1-26

Relationships of Financial Statements Net Income (bottom line of Income Statement) flows to Statement of Retained Earnings Ending Retained Earnings flows to Balance Sheet Cash balance from Balance Sheet flows Statement of Cash Flows 1-27 Financial Statements should be prepared in order since the amount on one statement flows the next

INCOME STATEMENT RETAINED EARNINGS STATEMENT BALANCE SHEET STATEMENT OF CASH FLOWS NET INCOME ENDING RETAINED EARNINGS ENDING CASH 1-28

Reference 1-29 Harrison, W.T., Horngren, C.T. and Thomas, B. (2009). Financial accounting, 8 th edition. Boston, MA: Pearson Prentice- Hall.

Questions? 1-30