Transcript Document

Fin Acctg Concepts - 1
ENVIRONMENT OF ACCOUNTING
Fin Acctg Concepts - 2
NATURE OF ACCOUNTING
 An information system designed to : Collect,
Process, and Report economic data to
interested parties to assist them in making
decisions
 Areas of accounting
– Financial Accounting = external decision makers
(investors and creditors)
– Management Accounting = internal decision makers
– Specialized areas
• Tax Accounting
• Regulatory Accounting
“Accounting is the language of business”
Fin Acctg Concepts - 3
“FINANCIAL STATEMENT PACKAGE”
 Formal financial statements
 Footnotes
 Supplementary information
 Attestation reports
Fin Acctg Concepts - 4
FORMAL FINANCIAL STATEMENTS
 Income statement
 Balance sheet
 Statement of stockholders’ equity
– Retained earnings
 Statement of cash flows
Fin Acctg Concepts - 5
INCOME STATEMENT
Statement of Earnings
 Report on the operations of the entity
 Listing of Revenues, Gains, Expenses, &
Losses
 Covers a period of time
Fin Acctg Concepts - 6
STATEMENT OF FINANCIAL POSITION
Balance Sheet
 Report on the financial position of the
entity
 Listing of Assets, Liabilities, & Owners’
Equity items
 A specific point in time
Fin Acctg Concepts - 7
STATEMENT OF STOCKHOLDERS’ EQUITY
“Retained earnings”
 Report on the changes in Retained
Earnings
 Covers a period of time
 Link between the Balance Sheet &
Income Statement
Fin Acctg Concepts - 8
STATEMENT OF CASH FLOWS
 Report on financial activities of the
entity
 Shows the changes in cash (and cash
equivalents)
 Covers a period of time
Fin Acctg Concepts - 9
OTHER INFORMATION
 Footnotes
– Refers to a specific item or section
 Supplementary information
– All additional disclosures
Fin Acctg Concepts - 10
ATTESTATION REPORTS
 Management report
 Report of the audit committee
 Report of the independent auditor
(CPA)
Fin Acctg Concepts - 11
BASIC ACCOUNTING EQUATION
[Corporation]
Assets = Liabilities + Stockholders’ Equity
Contributed
Retained
Earnings
(Paid-in)
Capital
Par
Value
Excess
Over
Par
Net Income (+)
Net loss (-)
Revenues & Gains (+)
Dividends (-)
Declared
Expenses & Losses (-)
Fin Acctg Concepts - 12
Issuing Stock to Investors
After getting the business plan approved, Simon and
Sue opened a Cup-A-Jo Coffee franchise by investing
equipment worth $60,000 and cash totaling $300,000 in
exchange for common stock.
Cash
300,000
Shareholders'
Assets
= Liabilities +
Equity
Equipment Intangible Assets
Loan Payable
Common Stock
60,000
360,000
Assets increase by $360,000.
Shareholders’ equity increases by $360,000.
@Cambridge Business Publishers, 2009
Fin Acctg Concepts - 13
Obtaining a Bank Loan
Acting on behalf of Cup-A-Jo Coffee, Simon obtained a
$90,000 bank loan to be repaid equally at the end of
each year for 8 years at 7% annual interest.
Cash
90,000
Assets
= Liabilities +
Equipment Intangible Assets
Loan Payable
90,000
Assets increase by $90,000.
Liabilities increase by $90,000.
@Cambridge Business Publishers, 2009
Shareholders'
Equity
Common Stock
Fin Acctg Concepts - 14
Purchase of Franchise
Cup-A-Jo acquired franchise rights for an 8-year period
at a cost of $240,000 paid in cash.
Cash
-240,000
Assets
= Liabilities +
Equipment Intangible Assets
Loan Payable
240,000
Shareholders'
Equity
Common Stock
Because the franchise rights represent future economic
benefits, the cost is an asset.
Assets increase by $240,000, and
Assets decrease by $240,000.
@Cambridge Business Publishers, 2009
Fin Acctg Concepts - 15
Balance Sheet after Pre-Opening Events
Cash
Assets
Equipment
300,000
60,000
=
Intangible Assets
360,000
90,000
90,000
-240,000
150,000
240,000
60,000
450,000
Assets
Cash
Equipment
Intangible Assets
Total assets
Liabilities
+
Loan Payable
Shareholders'
Equity
Common Stock
$150,000
60,000
240,000
$450,000
@Cambridge Business Publishers, 2009
240,000
90,000
=
90,000
360,000
+
360,000
Liabilities & Shareholders' Equity
Liabilities
Loan payable
Shareholders' Equity
Common Stock
$ 90,000
Total liab. & shareholders' equity
$450,000
360,000
Fin Acctg Concepts - 16
Buying Inventory
Cup-A-Jo purchased $84,000 of inventory consisting of
coffee, tea, cream, flavoring, etc., on credit due in 30
days.
Assets
Cash
150,000
Accounts
Rec.
0
Inventory
0
=
Equipment
60,000
84,000
Accum.
Deprec.
0
Intang.
Assets
Liabilities
Taxes
Loan
Accts. Pay. Payable Payable
240,000
0
0
84,000
Assets increase by $84,000.
Liabilities increase by $84,000.
Beginning balances
@Cambridge Business Publishers, 2009
+ Shareholders' Equity
90,000
Common
Stock
360,000
Retained
Earnings
0
Fin Acctg Concepts - 17
Selling to Customers
Cup-A-Jo sold coffee during the year for $305,000. Of this
amount, Cup-A-Jo collected $270,000. The balance is still
owed at December 31. The cost of the coffee sold was $70,000.
Assets
Accounts
Cash
Rec.
150,000
0
270,000 35,000
Inventory
0
=
Equip- Accum.
ment Deprec.
60,000
0
-70,000
Intang.
Assets
240,000
Liabilities
+ Shareholders' Equity
Taxes
Loan
Common Retained
Accts. Pay. Payable Payable
Stock
Earnings
0
0
90,000
360,000
0
305,000
-70,000
Assets increase by $305,000 and
decrease by $70,000—a net increase of $235,000.
Shareholders’ equity increases by $305,000, and
decreases by $70,000—a net increase of $235,000.
@Cambridge Business Publishers, 2009
Fin Acctg Concepts - 18
RELATIONSHIP OF FINANCIAL
STATEMENTS
Balance Sheet
12-31-x1
Income Statement
For Year 2
Assets
Liabilities
Owners’ equity
Revenues - Expenses
=
Net Income (or Loss)
Statement of Retained Earnings
For Year 2
Balance 1-1-x2
(+/-) Net income or loss
- Dividends
=
Balance 12-31-x2
Balance Sheet
12-31-x2
Assets
Liabilities
Owners’ equity
Fin Acctg Concepts - 19
GENERALLY ACCEPTED
ACCOUNTING CONCEPTS
 Reasons for Generally Accepted
Accounting Principles (GAAP)
 Entities influencing GAAP
Fin Acctg Concepts - 20
GAAP
 Generally Accepted Accounting Principles (GAAP)
– The guidance U.S. companies currently use to
measure and report performance
– Is very flexible
• Allows management judgment
• Different methods of measurement allowed
Who prepares
a company’s
financial
statements?
@Cambridge Business Publishers, 2009
Management
Fin Acctg Concepts - 21
GAAP FAQs
 Why did GAAP arise?
– To mutually benefit the capital market participants who
use financial statements
– To help evaluate risk and return
– To give confidence to users that information helps make
better decisions
 Created by Financial Accounting Standards Board (FASB)
• Overseen by the Securities and Exchange Commission
(SEC)
SEC has the ultimate power to set accounting
standards
@Cambridge Business Publishers, 2009
Fin Acctg Concepts - 22
22
International Accounting Standards
 Attempt to harmonize accounting standards through
creation of International Financial Reporting
Standards (IFRS)
 Some countries are using IFRS
– European Union converted in 2005
 Recent impact on U.S.
– Late 2007, U. S. SEC voted to allow foreign
registrants to file financial statements with the U.S.
using IFRS
• Previously required to use or reconcile to U.S.
GAAP
@Cambridge Business Publishers, 2009
Fin Acctg Concepts - 23
Proposed SEC Roadmap
for IFRS
#-Staggered adoption possible based on earliest
adoption in 2015 or 2016.
23
Fin Acctg Concepts - 24
OBJECTIVES OF FINANCIAL
STATEMENTS
 Help investors and creditors make rational
investment, credit, and related decisions
 Assess the amounts, timing, and uncertainty of
future cash flows
 Information about the economic resources of
the entity, claims to those resources, and
changes in those resources
“ALLOCATION OF ECONOMIC RESOURCES”
Fin Acctg Concepts - 25
USERS OF FINANCIAL STATEMENTS
Assumptions
 Reasonable knowledge of business and
economic activities
 Willing to study the information with
reasonable diligence
Statement of Financial Accounting Concepts No. 1, “Objectives of Financial Reporting
by Business Enterprises”
Fin Acctg Concepts - 26
QUALITIES OF ACCOUNTING
INFORMATION
 Relevance
– Predictive value
– Feedback value
– Timeliness
 Reliability
– Verifiability
– Neutrality
– Representational
faithfulness
 Comparability
 Consistency
Fin Acctg Concepts - 27
ENVIRONMENTAL ASSUMPTIONS
 Separate Entity
 Continuity (Going Concern)
 Time Period (Periodic Measurement)
 Unit of Measure (Monetary)
Fin Acctg Concepts - 28
IMPLEMENTATION PRINCIPLES
 Cost/Exchange Transactions
 Revenue Realization
 Matching
 Full Disclosure
Fin Acctg Concepts - 29
Accounting Information Constraints
 Materiality
– GAAP applies only to economic events significant
enough to affect a user’s decision
 Conservatism
– Applied when trade-offs between qualities are needed
– A reaction to uncertainty
– When in doubt, financial statements should
• Understate assets
• Overstate liabilities
• Delay recognition of revenues
• Accelerate recognition of expenses
@Cambridge Business Publishers, 2009
Fin Acctg Concepts - 30
ELEMENTS OF FINANCIAL
STATEMENTS
 Assets
 Liabilities
 Equity (Owners’)
– Investments by
Owners
– Distributions to
Owners





Revenues
Expenses
Gains
Losses
Comprehensive
Income
Fin Acctg Concepts - 31
BALANCE SHEET
Claims against
resources (Liabilities)
Resources
(Assets)
Remaining claims
accruing to owners
(Owner’s Equity)
Fin Acctg Concepts - 32
BALANCE SHEET ELEMENTS
 Assets
– Economic resources with probable future value
– Controlled by management
– Resulting from past transactions
 Liabilities
– Probable future sacrifices of economic benefits
(debts/obligations)
– Require transfer of assets
– Terms of obligations are specified
– Result from past transactions
 Equity
– Residual interest in the assets of the entity
– “Net assets”
– Represents the “investment” by owners
Fin Acctg Concepts - 33
BALANCE SHEET CLASSIFICATIONS
 Assets
– Current Assets
– Long-term
Investments
– Property, Plant,
and Equipment
– Intangible Assets
– Other Assets
 Liabilities
– Current Liabilities
– Long-term Liabilities
 Stockholders’ Equity
– Contributed Capital
– Retained Earnings
– Other Items
Fin Acctg Concepts - 34
BALANCE SHEET
 Liquidity - length of time until assets are
converted to cash or until a
liability must be paid
 Solvency – the ability of a firm to meet its
debts as they come due
 Financial flexibility - ability of company to
manage its cash flows (deal with
emergencies or take advantage of
unexpected opportunities)
Fin Acctg Concepts - 35
THE INCOME STATEMENT
 Describes a company’s
operating performance
for a specified period of
time
Fin Acctg Concepts - 36





INCOME STATEMENT
ELEMENTS
Revenues
– Inflows of assets (settlement of liabilities)
– From delivery or production of goods or rendering of
services
Gains
– Increases to equity
– From peripheral or incidental transactions
Expenses
– Outflows of assets (incurrance of liabilities)
– Consumption or expiration of assets in an attempt to
generate revenue
Losses
– Decreases in equity
– From peripheral or incidental transactions
Earnings per share
– Basic
– Fully diluted
Fin Acctg Concepts - 37
INCOME STATEMENT
“Multiple-Step”
 Operations section
– Gross margin (Sales - Cost of goods sold)
– Operating expenses




Other items (“nonoperating”)
“Special items”
Net income - “the bottom line”
Earnings per share
Fin Acctg Concepts - 38
INCOME STATEMENT
“Multiple-Step”
 Items within “Income from
continuing operations”
• Unusual OR infrequent gains and losses
 Below “Income from continuing
operations”
• Discontinued Operations
• Extraordinary items (unusual AND
infrequent)
Fin Acctg Concepts - 39
Income Statement (Multiple-Step)
Operations
Other
Special
items
Sales, net
$
Cost of goods sold
Gross margin
Operating expenses:
Selling expenses
$
197,350
General & Admin.
78,500
Depreciation
17,500
Income from Operations
Other revenues & gains:
Interest income
$
62,187
Gain
24,600
Other expenses:
Interest
$
27,000
Loss
9,000
Income from contin. oper. before taxes
Income taxes
Income from contin.operations
$
Extraordinary loss (net of tax of $5,000)
Net income
$
Earnings per share - common stock
785,250
351,800
433,450
293,350
140,100
86,787
(36,000)
190,887
62,500
128,387
-15,000
113,387
$4.25
Fin Acctg Concepts - 40
Which Basis of Accounting is Used?
 Cash basis
– Financial effects are recorded in financial statements when
cash is received or paid
 Accrual basis
– Financial effects are recorded without regard to the timing
of the cash flows
– Accounts that exist under accrual basis
• Accounts receivable
Amounts customers owe for items purchased
• Accounts payable
Amount the company owes for credit purchases
@Cambridge Business Publishers, 2009
Fin Acctg Concepts - 41
Revenue Principle
Revenue should be recognized in the
financial statements when . .
 It is earned, and …
 It is realized or realizable
(measurable)
Fin Acctg Concepts - 42
REVENUE RECOGNITION POINTS
Recognition
before delivery
Design and production,
construction in progress,
minerals discovered
Recognition
at delivery
Goods completed
and ready for sale,
contract complete
Percentage-of
completion method
Delivery of
product or
service
Production
method
Completed
contract
method
RELEVANCE
Point
of sale
method
Recognition
after delivery
Cash collected
for goods or
services
Installment
method
Cost
recovery
method
RELIABILITY
Right of
return expires
Right of
return
expiration
method
Fin Acctg Concepts - 43
Matching
 Once revenues are determined, the
expenses incurred in attempting to
generate the revenue should be
recognized.
 As revenues are earned, certain assets
are consumed and services are used.
Fin Acctg Concepts - 44
Expense Classification
 Direct
 Period
 Allocated
Fin Acctg Concepts - 45
BUSINESS CYCLE
Collect cash
from customer
Customer
receives item
Purchase materials
Convert materials
into finished product
Ship product
& invoice customer
Receive order
from customer
Inspect product
Store product
in warehouse
Fin Acctg Concepts - 46
EXPENDITURES vs. EXPENSES
Expenditures
during 1998
Assets as of
Jan. 1, 1998
Expenses of 1998
Direct
association
with
revenue
Yes
Example: Cost of goods sold
No
Association
with
activities
Yes
Example: Office expenses
No
Yes
Assets as of
12-31-98
Association
with
future
No
Example: Obsolete merchandise
STATEMENT OF CASH FLOWS
Fin Acctg Concepts - 48
STATEMENT OF CASH FLOWS




Nature of Statement
Reports on Financial
Activity
Covers a period of time
(fiscal period)
Explains changes in
cash balance
Cash and equivalents
– Highly liquid shortterm investments
– Treasury bills,
Money-market
funds
Objectives of Statement
 Prediction of future
cash flows
 Evaluation of financial
management
 Determine ability to
pay interest and
dividends
 Explain relationship of
net income to changes
in cash balance
Fin Acctg Concepts - 49
STATEMENT OF CASH FLOW
Components
 Cash flow from Operating Activities
– Result from creation of revenues and expenses
– Items that affect the Income Statement
 Cash flow from Investing Activities
– Result from increases or decreases in long-term
assets
 Cash flow from Financing Activities
– Result from transactions with creditors or
investors
– Generate funds needed to launch or sustain the
business
Fin Acctg Concepts - 50
CASH FLOW FROM OPERATIONS
 Operating Sources of Cash
– Collections from customers
– Receipts of interest
– Receipts of dividends
 Operating Uses of Cash
–
–
–
–
Payments to suppliers
Payments to employees
Payments for interest
Payments for income taxes
Fin Acctg Concepts - 51
CASH FLOW FROM INVESTING
 Investing Uses of Cash
– Acquisition of Operating Assets
– Acquisition of Investments
 Investing Sources of Cash
– Proceeds from sale of Operating Assets
– Proceeds from sale of Investments
Fin Acctg Concepts - 52
CASH FLOW FROM FINANCING
 Financing Sources of Cash
– Proceeds of borrowings
– Proceeds from issuing stock
 Financing Uses of Cash
– Payment of debt
– Purchase of treasury stock
– Payment of cash dividends
Fin Acctg Concepts - 53
NONCASH
INVESTING & FINANCING
ACTIVITIES
 Investing or Financing which DO NOT DIRECTLY
INVOLVE CASH, but which could involve cash.
 These transactions are usually “short-cut” methods
used to reduce the cost of investing or financing
activities
 Examples:
– Acquiring plant assets by issuing long-term debt
– Converting debt into equity (common stock)
Fin Acctg Concepts - 54
CASH FLOW FROM OPERATIONS
Indirect Method
 Net income
 Adjustments for noncash items included in net income
– Depreciation or amortization (additions to net
income)
– Gains (deducted from net income)
– Losses (added to net income)
 Adjustments for changes in working capital items
– Current assets
• Increases = deductions from net income
• Decreases = additions to net income
– Current liabilities
• Increases = additions to net income
• Decreases = deductions from net income