1. 4. Capital, Assets and Introduction to Accounting
František Sudzina

2. The long term goal
The goal of every business is to maximize the benefits for its owners
We can look at the benefits for owners from many aspects; the owners’ goals can be to
maximize profits,
to maximize the company’s value, etc.
These two goals require to produce the best product with the lowest possible costs

3. Example
Imagine you have just finished high school and your uncle has given you 2 million CZK. You have a couple of options what to do with that money. You can use it to travel, or you can buy a luxurious car and find a job for 15,000 CZK monthly, for example. The third option is that you use the money to finance your studies because you expect to earn 50,000 CZK/month after finishing your studies. This means that you give up the joy from traveling or from a luxurious car in order to earn more money in the future because of additional education.

4. Capital
In order to start a business, you need some investment at the beginning; this investment can be cash, land, machinery, or our own knowledge and skills
The example illustrates the principle of capital
When the capital is created, there is a decision to postpone current consumption for the future
But that is not enough; somebody has to make an investment – produce a capital good that is able to increase the work productivity

5. Capital
In this case, it was you who was the investor; you had an investment opportunity – to invest into your education and the sources for this investment – a gift from your uncle and your ability to get a university degree
It is clear from this example that postponed consumption or savings precede the investment
Sometimes the person who is postponing the consumption is the same person who is making an investment

6. Capital
But in the market economics these are usually not the same people
Those, who save, usually do not always have investment opportunities, and that is why they lend capital to those, who have opportunities
For example, they put their savings to banks and then banks lend this money to companies with investment opportunities
Others allocate capital in business companies so they become their partners or shareholders

7. Business as a system
Business is a system whose goal is to change inputs into outputs
Inputs can be buildings, machines, material, human potential
Output is a product or a service.
In order to quantify or to compare against each other or among the industry the individual inputs, parts, and the results of processes, we need to convert all of them to a universal value - this value is money; the way this is done is called accounting

8. Development of accounting
Single-entry accounting
Dual-entry accounting
Resources, events, agents

9. Chart of accounts
list of accounts with their identifiers, i.e. with their account numbers
in some countries (e.g. Germany), the numbering
is mandatory – given e.g. by the law
- in some countries (e.g. Sweden), the numbering is/was suggested but not mandatory
in some countries (e.g. Denmark), the numbering is up to the company itself
the number of digits in account numbers differs between countries - companies “split” an account by using additional digits in countries where numbering is mandatory

10. Types of accounts
1. Asset accounts-resources owned by the company, e.g. asset accounts are cash on hand, cash in bank, real estate, inventory, prepaid expenses, goodwill, and accounts receivable
2. Liability accounts-obligations of the company, e.g.
accounts payable, bank loans, bonds payable, and
accrued expenses
3. Equity accounts-residual equity of the company, e.g. common stock, paid-in capital, retained earnings
4. Revenue or income accounts-company's earnings,
e.g. sales, service revenue and interest income
5. Expense accounts-company's expenditures, e.g. utilities, rents, depreciation, interest, and insurance

11. Chart of accounts in Sweden - BAS

12. Accounting At the beginning of an accounting year, there are
zeroes at income statement accounts
final values from the previous accounting year at balance sheet accounts
During an accounting year, you
only add values to income statement accounts (a company purchases something, you increase the expense account; a company sells something, you increase the revenue account)
both add and subtract value to/from balance sheet accounts (a company purchases something, you decrease the cash account; a company sells something, you increase the cash account)

13. Accrual Basis and Cash Basis
The accrual basis of accounting
recognizes revenues and expenses
when they occur regardless of when
cash is received or disbursed.
The cash basis of accounting recognizes
revenue and expense when cash is
received and disbursed.
There are two approaches to accounting, the cash basis and the accrual basis. You may not realize it, but you are probably already familiar with the cash basis. We keep our checkbooks on the cash basis. We simply record the receipts and payments of cash. Many small nonprofit organizations use the cash basis of accounting. In contrast, corporations measure income and financial position using the accrual basis of accounting. The accrual basis recognizes the impact of transactions on the financial statements in the periods when revenues and expenses occur instead of when the company receives or pays cash. That is, a company records revenue when it earns it, and it records expenses when it uses resources—not necessarily when cash changes hands. With the cash basis of accounting, revenue and expense recognition occurs when the company receives and pays out cash.

14. Accrual Basis and Cash Basis
The major deficiency of the cash basis
of accounting is that it is incomplete.
It fails to match efforts and accomplishments
in a manner that properly measures economic
performance and financial position.
The major deficiency of the cash basis of accounting is that it fails to match efforts and accomplishments (expenses and revenues) in a manner that properly measures economic performance. Moreover, it omits key assets (such as accounts receivable and prepaid rent) and key liabilities (such as accounts payable) from balance sheets that measure financial position.

15. Adjustments to the Accounts
Under the accrual basis of accounting, record:
Explicit transactions-day-to-day routine events
Implicit transactions - events that day-to-day
recording procedures temporarily ignore, such as
expiration of prepaid rent or accrual of interest
due to the passage of time.
Earlier, we defined a transaction as any economic event that an accountant should record. Under accrual accounting, accountants record both explicit transactions—day-to-day routine events, such as credit sales, credit purchases, cash received on account, and cash payments on account—
and implicit transactions—events that day-to-day recording procedures temporarily ignore, such as expiration of prepaid rent or accrual of interest due to the passage of time. Explicit transactions are easy to identify because they record market transactions, exchanges of goods and services between the entity and another party. They are generally supported by source documents, clear evidence of transactions, such as sales slips and purchase invoices.
Explicit transactions are easy to identify because
they are supported by source documents.
Implicit transactions are recorded at the end of
each accounting period by using adjusting entries.

16. Principal Adjustments
Four types of principal adjustments:
Expiration of unexpired costs
Recognition (earning) of unearned revenues
We classify the principal adjustments into four types:
1. Expiration of unexpired costs
2. Recognition (earning) of unearned revenues
3. Accrual of unrecorded expenses
4. Accrual of unrecorded revenues
These adjustments are an essential part of accrual accounting. They refine the accountant’s accuracy and provide a more complete and timely measure of efforts, accomplishments, and financial position.
Accrual of unrecorded expenses
Accrual of unrecorded revenues

17. Adjustment Type I: Expiration of Unexpired Costs
Assets other than cash and receivables are viewed as
economic services awaiting future use—prepaid or
stored costs, and they are carried forward to future
periods. The values of assets frequently decline (and
eventually disappear) because of the passage of time.
When a company uses services represented by a
particular cost, the cost expires. An unexpired cost is
any asset that managers expect to become an
expense in future periods.
You can view assets other than cash and receivables as bundles of economic services awaiting future use—prepaid or stored costs that the accounting system carries forward to future periods. The values of assets frequently decline (and eventually disappear) because of the passage of time.

18. Adjustment Type I: Expiration of Unexpired Costs
Rather than immediately charge these costs as
expenses, they are charged as expenses in
future periods when the services are used.
Rather than immediately charging these costs as expenses, we charge them as expenses in future periods when the company uses the services.

19. Expiration of Unexpired Costs
Assets frequently expire because
of the passage of time.
Assets other than cash and receivables
are viewed as economic services
awaiting future use.
Assets frequently expire because of the passage of time. You can view assets other than cash and receivables as bundles of economic services awaiting future use—prepaid or stored costs that the accounting system carries forward to future periods. When a company uses the services represented by a particular cost, we say the cost expires. An unexpired cost is any asset that managers expect to become an expense in future periods.
Unexpired costs are assets that managers
expect to become expenses in future
accounting periods.

20. Adjustment Type II: Unearned Revenue (Deferred Revenue)
Unearned Revenue (deferred revenue) is . . .
A liability recorded when a company
receive collections from customers
before it earns the revenue.
Because customers have already paid in
advance for merchandise or services . . .
Unearned revenue (deferred revenue): Collections from customers that companies receive and record before they earn the revenue. See transaction 6 in Exhibit We call this $3,000 unearned revenue or deferred revenue. Why? Because King Hardware collected cash from customers and recorded the amount received before the company earned it by delivering the merchandise. Unearned revenue is a liability because King Hardware is obligated to deliver the merchandise ordered or to refund the money if it does not deliver the merchandise. Some companies call this account advances from customers or customer deposits. Advance collections of rent and magazine subscriptions are other examples.
An obligation exists to deliver merchandise
or service or refund the customers’ deposits
if the goods or services are not delivered.

21. Adjustment Type III: Accrual of Unrecorded Expenses
Accrue means to accumulate a
receivable or payable during a given
period, even though no explicit
transaction occurs.
Employee wages
Interest expense
To accrue something means to accumulate and record a receivable or payable during a given period even though no explicit transaction occurs. Examples of accrued expenses—expenses reported on the income statement before a company pays for them with cash—are the wages of employees for partial payroll periods and the interest that accumulates on borrowed money before the interest payment is made.

22. Adjustment Type IV: Accrual of Unrecorded Revenues
The recognition of revenues that a
company has earned but has not
yet recorded in its accounts is
. . . the mirror image of the accrual
of unrecorded expenses.
The final type of adjustment, the recognition of revenues that a company has earned but has not yet recorded in its accounts, does not appear in Exhibit It is the mirror image of the accrual of unrecorded expenses. Suppose Security State Bank lends $50,000 in cash to King Hardware on a 3-month promissory note with interest at 1% per month payable at the end of the 3 months.
Interest Revenue

23. Summary of accruals – types I-IV
We summarize these in Exhibit 15-3, which shows accruals of expenses or revenues in the columns and the timing of the accrual compared to the cash flows in the rows.

24. Exercise