1. Financial Accounting Fundamentals
Information for Decisions
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2. Importance of Accounting
is a
system that
Accounting
Identifies
Records
information
that is
Relevant
Communicates
Accounting is the process of identifying, recording and communicating information that is relevant, reliable, and comparable. The goal of the accounting process is to provide helpful information to users of financial information. Quality information may help users reach more informed decisions.
Reliable
to help users make better decisions.
Comparable

3. Accounting Activities
Identifying Business Activities
Recording Business Activities
Communicating Business Activities
Not all transactions entered into by a business entity are capable of being recorded. Our first task as accountants is to identify those transactions that may be recorded in the accounting system.
In recording business transactions, we must follow the rules of double-entry bookkeeping. We will spend a significant amount of time early in the course discussing in detail the rules of the accounting process.
Next, we should follow standard formatting when reporting information to users outside the organization. External users include stockholders of the company, lenders, various governmental agencies, and others.

4. Users of Accounting Information
External Users
Lenders
Shareholders
Governments
Consumer Groups
External Auditors
Customers
Internal Users
Managers
Officers/Directors
Internal Auditors
Sales Staff
Budget Officers
Controllers
In addition to the external users we referred to on the previous slide, accountants also prepare reports for internal users. Managers of the business need information to help direct and control operations of a business. The sales/marketing department needs information about customers and products. Officers of the company need information to develop strategic plans.

5. Users of Accounting Information
External Users
Financial accounting provides external users with financial statements.
Internal Users
In this book we will spend most of our time developing financial accounting information for external users. Some of the material we cover will prove useful to managers and other internal decision makers.
Managerial accounting provides information needs for internal decision makers.

6. Legal Liability
Management is legally responsible to the stockholders to act in their interest.
Auditors are legally responsible to the stockholders to conduct a thorough and independent audit.
If management or auditors fail in their duties, investors and others may sue to recover any losses that might occur as a result the failure.
You have faced ethical situations in school and will face similar situations at work. We should be capable of identifying ethical concerns and analyzing our options, that is, what is the right and wrong thing to do. Making an ethical decision means we choose the best option available under the circumstances.

7. Generally Accepted Accounting Principles
Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP).
Relevant Information
Affects the decision of its users.
Reliable Information
Is trusted by users.
Financial accounting in governed by a set of rules we call Generally Accepted Accounting Principles, or GAAP for short.
Generally accepted accounting principles identify three major characteristics of information. First, the information must be relevant. Relevant information impacts the decision of the informed user for financial information. Second, the information must be reliable. Finally, the information must be comparable. Comparability helps us compare financial information from one period with that of the next period.
Comparable Information
Is helpful in contrasting organizations.

8. Setting Accounting Principles
Financial Accounting Standards Board is the private group that sets both broad and specific principles.
The Financial Accounting Standards Board is recognized as the group in the private sector that makes specific accounting principles. If an accountant departs from the principles established by the F A S B, proper disclosure of the departure must be made.
In the public sector, the Securities and Exchange Commission has the authority to establish accounting principles for companies reporting to the agency. Currently, the Securities and Exchange Commission has accepted all pronouncements of the F A S B for use by reporting companies.
The Securities and Exchange Commission is the government group that establishes reporting requirements for companies that issue stock to the public.

9. Principles of Accounting
Objectivity Principle
Accounting information is supported by independent, unbiased evidence.
Cost Principle
Accounting information is based on actual cost.
The objectivity principle states that accounting information must be unbiased and based upon independent evidence.
The cost principle tell us that accounting information is based upon actual cost incurred. We refer to this cost as historical cost.
The going-concern principle states that, in the absence of information to the contrary, the business entity is assumed to continue operations into the foreseeable future.
Now
Future
Going-Concern Principle
Reflects assumption that the business will continue operating instead of being closed or sold.

10. Principles of Accounting
Monetary Unit Principle
Express transactions and events in monetary, or money, units.
Revenue Recognition Principle
Recognize revenue when it is earned.
Proceeds need not be in cash.
Measure revenue by cash received plus cash value of items received.
Business Entity Principle
A business is accounted for separately from other business entities, including its owner.
The monetary unit principle tells us that we will only record accounting information that can be expressed in monetary units, usually dollars in the United States.
The revenue recognition principle states that revenue is to be recorded in the accounts of the company when it is earned. We need not wait until cash is received before we recognize revenue. It may be difficult to follow this principle in the beginning of the course because you are probably a cash basis individual. You usually wait until cash is paid or received before recognizing a transaction.
The business entity principle tells us that we must separate out the transaction of individual owners of a business from those of the business.

11. = + Accounting Equation Liabilities Equity Assets Liabilities & Equity
The basic accounting equation states that assets are equal to liabilities plus equity of a company. The equation makes sense because in a general way it states that assets must be equal to the claims against those assets. If you have an asset we can have two broad categories of claims against that asset. First, we may have claims by creditors, liabilities. Finally, after all creditor claims are satisfied, the residual owners, and stockholders, have a claim on those assets.
Liabilities & Equity
Assets

12. Resources owned or controlled by a company
Assets A1
Cash
Accounts Receivable
Notes Receivable
Resources owned or controlled by a company
Vehicles
Land
Assets may be viewed as resources owned or controlled by an entity. They include such items as cash, accounts receivable (amounts owed to the company by customers), land, building and equipment, and supplies.
Buildings
Store Supplies
Equipment

13. Assets Current assets include
Cash: checking and savings accounts; petty cash.
Accounts receivable: amounts owed to a company from its customers.
Notes receivable: similar to A/R but usually has an interest component.
Supplies: products on hand to be used by the company (ex: office supplies).
Inventory: products on hand designated for sale to customers.
Prepaid expenses: amounts paid for future expenses.

14. Assets
Property, plant, and equipment are assets that are used in the production of goods and services. These productive assets are long-term in nature, and include the following:
Land: property upon which the productive facilities are located.
Building: the physical structure of the company’s operations.
Machinery and Equipment: include operating machinery, vehicles, computers, copy machines, etc.

15. Assets
Long-term investments are assets acquired by the company to provide long-term benefits to the company. Long-term investments include:
Long-term notes receivable owed to the company (from customers or others).
Investments in stock of other companies: held for expectation of dividends and/or stock price increase.
Investment in bonds of other companies: held for expectation of dividends and/or stock price increase.
Other assets, like land, held for the long term.

16. Assets
Intangible assets are long-lived assets that have no physical substance. Examples include:
Patents: legal claim to produce and sell a product.
Copyrights: legal claims to books, art, music and other created works.
Goodwill: recognized when one company buys another company, and the purchase price is greater than the fair value of the identifiable net assets.

17. Creditors’ claims on assets
Liabilities A1
Accounts Payable
Notes Payable
Creditors’ claims on assets
Liabilities represent the claims of creditors on the entity’s assets. Liabilities include accounts payable (amounts we owe to creditors for assets purchased on account), notes payable, taxes payable, and wages payable (amounts we owe to our employees at the end of the accounting period).
Wages Payable
Taxes Payable

18. Liabilities
Current liabilities are obligations expected to be paid (or services expected to be performed) within the next year or operating cycle. The elimination of the current liabilities requires the use of current assets (most commonly cash). Examples include:
Accounts payable: owed to suppliers
Wages payable: owed to employees
Interest payable: owed to banks
Short-term notes payable
Current maturities of long-term debt
Unearned revenues: owed to customers

19. Liabilities
Long-term liabilities are obligations expected to require payments beyond the current year. Examples of long-term liabilities include:
Notes payable: amounts owed to banks and other creditors beyond the current year.
Mortgage payable: amounts owed to mortgage company beyond the current year.
Bonds payable: amounts owed to investors holding bond investments issued by the company, where payments of principal and interest are beyond the current year.

20. Equity Owner’s claim on assets Retained Earnings Contributed Capital
The equities of an entity include investments by owners, contributed capital, and payments to those owners (dividends). Retained earnings represents all of the accumulated earnings of a corporation that have not been distributed to shareholders.
Dividends

21. Stockholders’ Equity
Common stock: shares of stock issued to owners to to reflect ownership.
Additional paid in capital: excess amounts contributed by shareholders for various activities.
These are activities from the owners.

22. Expanded Accounting Equation
Liabilities
Equity
Assets = +
Liabilities
Equity
Assets = +
Revenues
Expenses
Common Stock
Dividends _ +
Here is a breakdown of the equity section of the of the accounting equation to show the mathematical signs we will be using to keep track of investments by owners, common stock, payments to owners (dividends), revenues and expenses. Notice that revenues increase equity and expenses reduce equity.
Retained Earnings

23. Retained Earnings
Retained earnings represent the excess earnings retained in the company after dividends have been paid to shareholders. This represents the equity generated by the company for the shareholders.
Retained earnings is affected by
revenues (earned by the company)
expenses (costs incurred by the company)
dividends (amounts distributed by the company to its shareholders)

24. Transaction Analysis Equation
The accounting equation MUST remain in balance after each transaction.
Liabilities
Equity
Assets = +
During the process of recording business transactions, it is important that we always keep the accounting equation in balance. We can’t let our books get out of balance. You have probably heard this term before, but may not have been sure what we meant by keeping the books in balance.

25. Financial Statements Income Statement Statement of Retained EarningsP1
Income Statement
Statement of Retained Earnings
Balance Sheet
Statement of Cash Flows
There are four fundamental financial statements used in accounting.
1. The income statement shows our revenues and expenses.
2. The statement of owner’s equity shows the change in the owners’ equity during the current period.
3. The balance sheet is a listing of all asset, liability, and equity account balances.
4. The statement of cash flows shows where the company got its cash and how it spent its cash.
The first financial statement that we prepare is the income statement. Let’s get started. 34

26. The Income Statement
The income statement shows the components of net income in detail.
Revenues represent the inflow of assets (or decrease in liabilities) due to a company’s operating activities.
Expenses represent the outflow of assets (or increases in liabilities) due to a company’s operating activities.
The general formula for the I/S is:
Revenues - Expenses = Net Income

27. The Income Statement Format
Operating revenues
Sales
Fees earned
Other revenues
Less: Operating expenses
Cost of goods sold
Wage expense
Rent expense
Selling expense
Depreciation expense
Other expenses
Net Income

28. Net income is the difference between Revenues and Expenses.
Income Statement P1
Net income is the difference between Revenues and Expenses.
Net income is defined as the difference between revenues and expenses. If expenses exceed revenues, we have a net loss rather than net income. Financial statements have a three line title with the company name, the name of the statement, and the period covered by the report. In our case, we had total revenues of three thousand dollars and total expenses of eight hundred dollars, so net income for the month ended December 31, 2007, was two thousand, two hundred dollars. After completing the income statement, we may prepare the statement of retained earnings.
The income statement describes a company’s revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities.

29. The Statement of Retained Earnings
The statement of retained earnings calculates the changes in the retained earnings component of stockholders’ equity:
Beginning retained earnings
Plus: Net income
Less: Dividends
Ending retained earnings
Formula: REBegin + NI Div = REEnd

30. Statement of Retained EarningsP1
The net income of $2,200 increases Retained Earnings by $2,200.
In the statement of retained earnings, we start with the balance at the beginning of the period, add net income earned during the period, and deduct any dividends paid, resulting in the ending balance in retained earnings. The company was started this month, so the beginning balance in retained earnings was zero. During December net income of two thousand, two hundred dollars was earned. In addition, five hundred dollars in dividends was paid, so the ending balance in retained earnings is one thousand, seven hundred dollars. After we complete this statement, we can prepare the balance sheet.

31. Balance Sheet P1
The Balance Sheet describes a company’s financial position at a point in time.
The balance sheet is an inventory of assets, liabilities and equity at the end of the month. Our total assets are equal to twenty six thousand, nine hundred dollars. This includes cash of ninety seven hundred dollars, supplies of twelve hundred dollars, and equipment of sixteen thousand dollars.
Liabilities include accounts payable of twelve hundred dollars and notes payable of four thousand dollars. The common stock account has a balance of twenty thousand dollars and we just calculated the ending balance in retained earnings of seventeen hundred dollars. You can see that the books are in balance because total assets are equal to total liabilities plus equity.
Creditors have claims against our assets of five thousand, two hundred dollars. The owner has claims to assets of twenty one thousand, seven hundred dollars.

32. The Statement of Cash Flows
Cash flows from operating activities:
Collections from sales, rent, interest, etc.
Cash paid to suppliers and employees, and for rent, selling activities, interest, and taxes etc.
Cash flow from investing activities:
Proceeds from sale of investment securities, land, buildings, equipment, etc.
Purchase of investment securities, land, buildings, equipment, etc.
Cash flow from financing activities:
Proceeds from issuance of notes, debt, sale of equity, etc.
Payments on notes, debt, dividends, etc.

33. Statement of Cash FlowsP1
We will cover the statement of cash flows in detail in a later chapter. Notice that the statement is divided into three major sections; (1) cash flows from operating activities; (2) cash flows from investing activities; and (3) cash flows from financing activities. The statement reconciles to the ending cash balance of nine thousand, seven hundred dollars.