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Accounting

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1) Identifies 2) Records and 3) Communicates economic events of an organization to interested users (includes book keeping function)

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Internal Users

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business departments (Marketing, Management, HR, Finance, etc.)

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External Users

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Creditors and Investors

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Generally Accepted Accounting Principles (GAAP)

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set of standards developed by the FASB that are generally accepted and universally practiced - indicates how to report economic events

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Standard Setting Bodies

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1) Financial Accounting Standards Board (FASB) 2) Securities and Exchange Commission (SEC) 3) International Accounting Standards Board (IASB)

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Historical Cost Principle (Cost Principle)

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companies must record assets at cost

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Fair Value Principle

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Assets and liabilities should be reported at fair value (the price to sell an asset or settle a liability)

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Monetary Unit Assumption

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Requires company accounting records to include only transaction data that can be expressed in terms of money

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Economic Entity Assumption

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Activities of the economic entity must be kept separate and distinct from the activities of its owner or other economic entities

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Forms of Ownership

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1) Proprietorship (one person) 2) Partnership (pair or small group) 3) Corporation

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Corporation

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- Ownership divided into stocks - Separate legal entity organized under state law - Limited liability

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Basic Accounting Equation

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Assets = Liabilities + Stockholder's Equity - Underlying framework for recording and summarizing economic events - Claims creditors (liabilities) MUST be paid before ownership claims (stockholder's equity)

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Assets

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- Resources a business owns - Provide future services or benefits - E.G. Cash, Equipment, Supplies, etc.

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Liabilities

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- Claims against assets (debts and obligations) - Party to whom money is owed (creditors) - E.G. Accounts Payable, Notes Payable, etc.

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Stockholder's Equity

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- Ownership claims on total assets - Referred to as residual equity - Common Stock and Retained Earnings

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Common Stock

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Represent total amount paid in by stockholder's for shares they purchase (increases stockholder equity)

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Revenue

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Results from business activity entered into for purpose of earning income (increases S.E.) - E.G. Sales, Fees, Services, Commissions, Interest, Royalties and Rent

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Dividends

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Distribution of cash or assets to stockholders NOT AN EXPENSE (part of S.E.; decreases retained earnings)

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Expenses

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Cost of an asset consumed OR service used in process of earning revenue - E.G. Salaries expense, Rent expense, Utilities expense, etc. (decreases S.E.)

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Transactions

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ONLY business's economic activity recorded by accountants (external and internal) - dual effect on accounting equation

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Expanded Accounting Equation

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Assets = Liabilities + (Common Stock + (Revenues - Expenses - Dividends))

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Net Income (Net Loss)

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- Results of time period between revenue and expense - Determines ending balance of retained earnings (increase revenue & decrease expense = Income) (decrease revenue & increase expense = Loss)

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Financial Statements

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- Income Statement - Retained Earning Statement - Balance Sheet - Statement of Cash Flow

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Income Statement

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Report profitability of company operations over a specific period of time - List revenue first, followed by expense - shows net income (loss) - needed for ending balance in Retained Earnings Statement

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Retained Earning Statement

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Reports change in retained earnings for a specific period of time - Time period is always the same as income statement - Ending balance needed for Balance Sheet

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Balance Sheet

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- Reports assets, liabilities, and S.E. on specific date - Assets first, followed by liabilities and then S.E. (Basic Accounting Equation) - "Snapshot" of company financial condition

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Statement of Cash Flow

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Information on cash receipts and payments for a specific time period

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Account

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Record of increases or decreases in a specific asset, liability, equity, revenue or expense item - Debt = "left" - Credit = "Right"

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Double Entry System

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Each transaction must affect two or more accounts to keep Basic Accounting Equation in balance - Recording done by debiting at least one accounting and crediting another DEBITS MUST EQUAL CREDITS

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Debit Balance

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When debit amount is greater than credit amount

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Credit Balance

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When debit amount is less than credit amount

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Normal Balance

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Account's typical increasing side

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Steps in the Recording Process

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1) Analyze each transaction 2) Enter each transaction into a journal 3) Transfer journal information into ledger accounts

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Business Documents

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Provide evidence of transaction E.G. Sales slips, check, bills, cash register tape

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The Journal

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Book of original entry Transactions recorded in chronological order Contribution to Recording Process: - Disclose complete effects of transaction - Provides chronological order - Helps prevent or locate errors because the Dr. and Cr. Accounts can be easily compared

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Journalizing

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Enter transaction data into journal

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The Ledger

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Contains the entire group of accounts maintained by the company - Assets (Cash, Supplies, Equipment, etc.) - Liabilities (Accounts Payable, etc.) - S.E. (Expense, Revenue, Dividends, Retained Earnings, Common Stock)

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Posting

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Process of transferring amounts from journal to ledger accounts

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Chart of Accounts

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Accounts and Account Numbers arranged in a sequence in which they are presented in financial statements 100s - Assets 200s - Liabilities 300s - S.E. 400s - Revenues 500s - Expenses

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Trial Balance

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Statement of all Dr. and Cr. in double-entry accounting book Each account is analyzed to determine whether it is complete and up-to-date for financial statement purposes

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Limitations of Trial Balance

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May still balance even when: - Transaction not journalized - Correct journal entry not posted - Journal entry posted twice - Incorrect accounts used in journalizing or posting - Off setting errors are made in recording the amount of transaction

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International Financial Reporting Standards (IFRS)

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- Developed by IASB (over 115 countries) - Simpler requirements ("principle-based") - Same recording process, different measurements than GAAP ("fair value measurements")

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Time Period Assumption (Periodicity Assumption)

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- Accountants divide economic life of business into artificial time periods - Generally a month, quarter, or year

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Fiscal Year

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Accounting period that is one year in length

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Calendar Year

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January 1st to December 31st

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Interim Periods

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- Monthly and quarterly periods - Most large companies prepare both quarterly and annual financial statements

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Accrual-Basis Accounting

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- Transactions recorded in the periods in which the events occur - Companies recognize revenues when they perform service - Expenses are recognized when incurred

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Cash-Basis Accounting

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- Revenues recorded when cash is received - Expenses recorded when cash is payed - Not in accordance with GAAP

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Revenue Recognition Principle

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Recognize revenue in the accounting period in which performance obligation is satisfied (after service request; before payment)

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Expense Recognition Principle

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Match expenses with revenues in period when company makes efforts to generate revenues "Expenses follow revenues"

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Adjusting Entries

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- Ensure that revenue recognition and expense recognition principles are followed - Necessary because trial balance may not contain up-to-date information - Required every time company prepares financial statements - Includes one income statement and balance sheet account

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Deferrals

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Expenses and revenues that are recognized at a date later than the point when cash was originally exchanged Two types: - Prepaid Expense - Unearned Revenues

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Prepaid Expenses

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- Payments of Expenses that will benefit more than one accounting period - CASH BEFORE EXPENSE RECORDED - Expires with passage of time or through use - E.G. Insurance, Rent, Supplies, Equipment, Advertising, Buildings ADJUSTING ENTRY: Increase (Dr.) expense account Decrease (Cr.) asset account

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Depreciation

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- Process of allocating the cost of asset to expense over its useful life - Buildings, Equipment, Vehicles (provide service for many years) are recorded as assets, rather than expense, on date acquired - Does not attempt to report actual change in value of asset

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Contra Asset Accounts

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- Accounts that have increase, decrease and normal balances opposite to the account to which they relate - E.G. Accumulated Depreciation (Cr.) (appears just after the account it offsets on balance sheet)

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Book Value

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Difference between cost of any depreciable asset and its accumulated depreciation

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Unearned Revenues

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- Receipt of cash that is recorded as a liability because the service has not been performed - Cash receipt before revenue recorded - E.G. Rent, Airline Ticket, Magazine Subscription, Customer Deposit - Adjusting Entry records revenue for services performed during period and shows as liability that remains at end of accounting period ADJUSTING ENTRY: - Increase (Dr.) liability account - Decrease (Cr.) Revenue account

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Accruals

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Made to record: Revenues for services performed but not yet recorded at statement date OR Expenses incurred but not yet paid or recorded at statement date

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Accrued Revenues

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- Revenues for services performed but not yet received in cash or recorded - REVENUE RECORDED BEFORE CASH RECEIPT - E.G. Rent, Interest, Services performed - Adjusting entry records the receivable that exists and records revenue for services performed ADJUSTING ENTRY: Increase (Dr.) Asset account Increase (Cr.) Revenue account

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Accrued Expenses

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- Expenses incurred but not yet paid in cash or recorded - EXPENSE RECORDED BEFORE CASH PAYMENT - E.G. Interest, Taxes, Salaries - Adjusting Entry records obligation and recognize expense ADJUSTING ENTRY: Increase (Dr.) Expense account Increase (Cr.) Liability account

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Adjusted Trial Balance

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- Prepared after all adjusting entries are journalized and posted - Purpose is to prove equality of debit balances and credit balances in ledger - Primary basis for preparation of all financial statements

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Alternate Treatment

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- Reverse adjusting entries for deferrals Prepaid Expense: Company may increase (Dr.) expense account rather than asset Unearned Revenues: Company may increase (Cr.) revenue account - Results in opposite adjustment relationship

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Relevance

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Makes a difference in business decision Predictive Value: provide accurate expectations about future Confirmatory Value: confirms or corrects prior expectations

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Materiality

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Size makes it likely to influence the decision of an investor or creditor (Company specific aspect of relevance)

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Faithful Representation

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Information accurately depicts what happened (complete, neutral and free of error)

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Comparability

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Results when different companies use same accounting principles

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Verifiable

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Independent observers can obtain similar results using the same methods

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Understandable

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Information is presented in clear and concise fashion

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Consistency

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Company uses same accounting principles and methods each year

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Going Concern Assumption

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Business will remain in operation for the foreseeable future

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Full Disclosure Principle

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Companies must disclose all circumstances and events that would make a difference to financial statement users

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Cost Constraints

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Accounting standard-setters weigh the cost that companies will incur to provide information against benefit that financial statement users will gain from having information available

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Worksheet

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- Multiple-column form used in preparing financial statements - Not a permanent accounting record - May be computerized using spreadsheet program - Prepared using five steps - Optional

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Closing the Books

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At the end of an accounting period, the company makes the accounts ready for the next period

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Temporary Accounts

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Closed at the end of an accounting period - all revenue accounts - all expense accounts - dividends

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Permanent Accounts

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Not closed at the end of an accounting period - all asset accounts - all liabilities accounts - stockholder's equity

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Closing Entries

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- Formally recognize in the ledger the transfer of net income (net loss) and dividends to retained earnings - Companies generally journalize and post closing entries only at the end of annual accounting period - Produce a zero balance in each temporary account

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Post-Closing Trial Balance

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Purpose is to prove the equality of permanent account balances carried forward into the next accounting periods

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Accounting Cycle

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1. Analyze transactions 2. Journalize transactions 3. Post to ledger accounts 4. Prepare trial balance 5. Journalize and post adjusting entries 6. Prepare adjusted trial balance 7. Prepare financial statements 8. Journalize and post closing entries 9. Prepare post-closing trial balance

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Correcting Entries

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- Unnecessary if accounting records are free of error - Made when error is discovered - Must be posted before closing entries

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Classified Balance Sheet

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Presents a snapshot at a point in time - Companies group similar assets and similar liabilities together to improve understanding

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Standard Classifications

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Assets: - Current Assets - Long-term Investments - Property, Plant and Equipment - Intangible Assets Liabilities and Owner's Equity: - Current Liabilities - Long-term Liabilities - Stockholder's Equity

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Current Assets

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Assets that a company expects to convert to cash or use up within one year or operating cycle, whichever is longer (usually listed in expected order)

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Operating Cycle

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Average time it takes to purchase inventory, sell it on account, and then collect cash from customers

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Long-Term Investments

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- Investments in stocks and bonds of other companies - Investments in long-term assets such as land or buildings that is not currently being used in operating activities - Long-term notes receivable

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Property, Plant and Equipment (Fixed Assets)

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Long useful lives Currently used in operations Depreciation: allocating the cost of assets to a number of years Accumulated Depreciation: total amount of depreciation expensed thus far in asset's life

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Intangible Assets

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Long-lived assets that do not have physical substance

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Current Liabilities

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- Obligations the company is to pay within the coming year or its operating cycle - Usually lists notes payable first, followed by accounts payable (items follow in order of magnitude)

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Liquidity

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Ability to pay obligations expected to be due within the next year

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Long-Term Liabilities

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Obligations a company expects to pay after one year

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Reversing Entries

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- Often helpful to reverse some adjusted entries before recording regular transactions of next period - Companies make reversing entry at the beginning of next accounting period - Each reversing entry is the exact opposite of adjusting entry in previous period - Does not change amounts reported in financial statements

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