Intro to Financial Accounting Notes, Kai Chen PDF

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Lecture notes and slides for accounting, includes examples and formulas. From chapters 1 to 4. bu127 notes and slides examples...

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Accounting Notes Chapter 1: Four Basic Financial Statements - Four financial statements are normally prepared by profit-making organizations for use by shareholders, creditors, and other external decision makers: - Statement of Financial Position - Reports the economic resources it owns and the sources of financing for those resources. - Statement of Earnings (the main component of the statement of comprehensive income) Reports its ability to sell goods for more than their cost to acquire and sell. - Statement of Changes in Equity - reports additional contributions from or payments to shareholders, and the amount of earnings the company reinvested for future growth. - Statement of Cash Flows - Reports its ability to generate cash and how it was use The Statement of Financial Position - The purpose of the statement of financial position (balance sheet) is to report the financial position (amount of assets, liabilities, and shareholders’ equity) of an accounting entity at a particular point in time. - The heading of the statement of financial position identifies four significant items related to the statement: - Name of the accounting entity. - Title of the statement. - Specific date of the statement. - Unit of measure. - Accounting Entity - The organization for which financial data are to be collected and reported. - Statement of financial position has three major captions: - Assets, liabilities, and shareholders’ equity. - The basic accounting equation explains their relationship:

Assets - Economic resources controlled by the entity as a result of past business events. - Liabilities and shareholders’ equity are the sources of financing for the company’s economic resources. - Assets may be listed on the statement of financial position in either increasing or decreasing order of their convertibility to cash.

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Most Canadian companies list their assets beginning with the most-liquid asset, cash, and ending with the least-liquid assets. Liabilities - Indicate the amount of financing provided by creditors. They are the company’s debts or obligations. - Similarly, liabilities may be listed by either increasing or decreasing order of maturity. Shareholders’ Equity - Indicates the amount of financing provided by owners of the business and reinvested earnings. - Contributed Capital - The investment of cash and other assets in the business by the shareholders is called . - Retained Earnings - The amount of earnings (profits) reinvested in the business (and thus not distributed to shareholders in the form of dividends). Most financial statements include the monetary unit sign (in Canada, $) beside the first amount in a group of items (e.g. the cash amount in the assets). - It is common to place a single underline below the last item in a group before a total or subtotal (e.g., Other assets). - A double underline is placed below group totals (e.g., Total assets). - The same conventions are followed in all four basic financial statements. The Statement of Earnings (also called income statement, statement of operations, statement of comprehensive income) - Reports the accountant’s primary measure of performance of a business, revenues less expenses during the accounting period. - While the term profit is used widely for this measure of performance, accountants prefer to use the technical terms net income or net earnings.

Revenues - Companies earn revenue from the sale of goods or services to customers. Revenues normally are amounts expected to be received for goods or services that have been delivered to a customer, whether or not the customer has paid for the goods or services. Expenses - Represent the monetary value of resources the entity used up, or consumed, to earn revenues during the period. Net Earnings (also called the “bottom line”) - The excess of total revenues over total expenses incurred to generate revenue during a specific period.

The Statement of Cash Flows - Divides a company's cash inflows (receipts) and outflows (payments) into three primary categories of cash flows in a typical business:

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Cash flows from operating, investing, and financing activities. Reported revenues do not always equal cash collected because some sales may be on credit. Expenses reported on the statement of earnings may not be equal to cash paid out during the period because expenses may be incurred in one period and paid for in another. Net earnings (revenues minus expenses) does not usually equal the amount of cash received minus the amount paid during the period. Therefore, because the statement of earnings does not provide information concerning cash flows, the statement of cash flows is prepared to report inflows and outflows of cash. The statement of cash flows equation describes the causes of the change in cash reported on the statement of financial position from the end of the last period to the end of the current period:

Cash Flows from Operating Activities (CFO) - Cash flows that are directly related to generating earnings. Cash Flows from Investing Activities (CFI) - Cash flows related to the acquisition or sale of the company’s property, plant, and equipment, and investments. Cash Flows from Financing Activities (CFF) - Directly related to the financing of the company itself. They involve both receipts and payments of cash from/to investors and creditors (except for suppliers). Relationships Among the Statements: - Net earnings from the statement of earnings results in an increase in ending retained earnings on the statement of changes in equity. - Ending retained earnings from the statement of changes in equity is one of the three components of shareholders’ equity on the statement of financial position. - The change in cash on the statement of cash flows added to the cash balance at the beginning of the year equals the balance of cash at the end of the year, which appears on the statement of financial position.

Notes to Financial Statements - Notes provide supplemental information about the financial condition of a company, without which the financial statements cannot be fully understood. There are three basic types of notes: - The first type provides descriptions of the accounting rules applied in the company’s statements. - The second presents additional detail about a line on the financial statements. - The third type of note presents additional financial disclosures about items not listed on the statements themselves. Responsibilities for the Accounting Communication Process - Effective communication means that the recipient understands what the sender intends to convey. Understandability is the foundation of effective communication. - Decision makers also need to understand the measurement rules applied in computing the numbers on the statements. Accounting Standards Board (AcSB) - The private-sector body given primary responsibility to set the detailed rules that become accepted accounting standards in Canada. - The AcSB is responsible for establishing standards of accounting and reporting by publicly accountable enterprises, private enterprises, government organizations, and not-for-profit organizations. - These standards or recommendations, which are published in the CPA Canada Handbook, have expanded over time because of the increasing diversity and complexity of business practices.

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For Canadian publicly accountable enterprises, the AcSB has determined that they must prepare their financial statements in accordance with International Financial Reporting Standards. - IFRS are a single set of globally accepted high-quality standards, produced by the International Accounting Standards Board (IASB), which is an independent standard-setting board responsible for the development and publication of IFRS. - An older set of International Accounting Standards (IAS) were issued by the Board of the International Accounting Standards Committee, and they complement the accounting standards issued by the IAS. Why Accounting Standards are Important - Companies, their managers, and their owners are most directly affected by the information presented in the financial statements. - Companies incur the cost of preparing the statements and bear the major economic consequences of their publication. These economic consequences include, among others, the following: - Changes to the selling price of a company’s shares. - Changes to the amount of bonuses received by management and employees. - The loss of competitive advantage over other companies. Ethics - Standards of conduct for judging right from wrong, honest from dishonest behaviour, and fair from unfair practices. - Intentional misreporting of financial statements is both unethical and illegal. - Many situations are less clear-cut and require that individuals weigh one moral principle (e.g., honesty) against another (e.g., loyalty to a friend). - When facing an ethical dilemma the following three-step process should be followed: - Identify the effects of the decision on both parties, those who will benefit from the situation (often the manager or employee involved) and those who will be harmed (other employees, owners, creditors, the environment). - Identify alternative courses of action. - Choose the alternative that you would like to see reported on the news. That is usually the ethical choice. Companies take three important steps to assure investors that the company’s records are accurate: - Develop and maintain a system of internal controls over both the records and the assets of a company. - Hire outside independent auditors to attest to the fairness of the statement presentations. - Form a committee/board of directors to oversee the integrity of these safeguards. Independent Auditor - Examines the financial reports to ensure that they represent what they claim and conform to generally accepted accounting principles. - In performing an audit, the independent auditor examines the underlying transactions and the accounting methods used to account for these transactions.

Employment in the Accounting Profession Today - Accountants are usually engaged in professional practice or employed by businesses, government entities, and not-for-profit organizations. - Practice of Public Accounting - Audit or assurance services, management consulting and advisory services and tax services. - Employment by Organizations - External reporting, tax planning, control of assets etc. - Employment by Public and Not-for-Profit Sectors - Charitable organizations, hospitals and universities. Chapter 2: To understand amounts appearing on a company's statement of financial position we need to answer these questions: - What type of business activities cause changes in amounts reported on the statement of financial position from one period to the next? - How do specific activities affect each of these amounts? - How do companies keep track of these amounts? Objective of External Financial Reporting - To provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. Qualitative Characteristics of Useful Accounting Information: - Fundamental characteristics: Relevance, faithful representation. - Enhancing characteristics: Comparability, verifiability, timeliness, understandability. Elements to Be Measured and Reported: - Assets, liabilities, shareholders’ equity, investments by owners, distribution to owners. - Revenues, expenses, gains and losses . - Comprehensive income. Concepts for Measuring and Reporting Information: - Assumptions: Separate entity, stable monetary unit, continuity (going concern), periodicity. - Principles: Mixed-attribute measurement, revenue recognition, full disclosure.

- Constraints: cost. To fulfill the primary objective of providing useful information, the conceptual framework provides guidance on the essential characteristics that determine the usefulness of accounting information. There are two fundamental qualitative characteristics; relevance and faithful representation. - Relevance - Makes a difference in a decision, predictive value, feedback/confirmatory value - Faithful representation - Complete, neutral, reasonably free from error or bias. - These two fundamental characteristics are supported by four enhancing qualitative characteristics: Comparability, verifiability, timeliness, and understandability. - Comparability - Across companies. - Verifiability - Similar results under independent measures. - Timeliness - Information must be available before it loses its usefulness. - Understandability - Allows reasonably informed users to see the significance of the information. - Accounting information that embodies the best balance of these characteristics will be of high quality to external decision makers.

Cost Constraint - Information should be produced only if the perceived benefits of increased decision usefulness exceed the expected costs of providing that information. Recognition and Measurement Concepts: - Separate Entity Assumption - Activities of the business are separate from activities of owners. - Stable Monetary Unit Assumption - Accounting measurements will be in the national monetary unit (i.e., $ in Canada) without any adjustments for changes in purchasing power (i.e., inflation). - Continuity (going concern) Assumption - The business is assumed to continue to operate into the foreseeable future.

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Historical Cost Principle - Cash equivalent cost given up is the basis for the initial recording of elements. Assets - Economic resources controlled by an entity as a result of past transactions or events and from which future economic benefits may be obtained. These are the resources that the entity has and can use in its future operations. Current Assets - Assets that will be used or turned into cash, normally within one year. Examples include: - Cash. - Short-term investments. - Accounts receivable. - Inventories. - Prepaid expenses (i.e., expenses paid in advance of use). Non-current Assets - Assets that are considered to be long-term because they will be used or turned into cash over a period longer than the next year. Examples include: - Property, plant, and equipment (at historical cost less accumulated depreciation). - Financial assets. - Goodwill. - Intangible assets. Liabilities - Present debts or obligations of the entity to transfer an economic resource as a result of past events. They represent future outflows of assets (mainly cash) or services to the creditors that provided the corporation with the resources needed to conduct its business. Current Liabilities - Short-term obligations that will be settled within the coming year by providing cash, goods, other current assets or services. Examples include: - Accounts payable. - Short-term debt (or borrowings). - Income taxes payable. - Accrued liabilities. - Provisions. Non-current Liabilities - All of the entity’s obligations not classified as current liabilities. - Long-term debt (or borrowings). - Provisions. Shareholders’ Equity (owners’ equity) - The financing provided to the corporation by both its owners and the operations of the business. - Typically, the shareholders’ equity of a corporation includes the following: 1. Contributed capital. 2. Retained earnings (accumulated earnings that have not been declared as dividends) 3. Other components. Contributed Capital - Financing provided by shareholders. - Shareholders invest in the business by providing cash and sometimes other assets, and receive shares as evidence of ownership.

Earned Capital (Retained Earnings) - Financing provided by operations. - Most companies that operate profitably retain part of their earnings for reinvestment in their business. The other part is distributed as dividends to shareholders. - Retained Earnings - Earnings that are not distributed to shareholders but instead are reinvested in the business by management. Accounting focuses on specific events that have an economic impact on the entity. Transaction - Any event that is recorded as a part of the accounting process. - The first step in translating the results of business events to financial statement amounts is determining which events to include. - Only economic resources and debts resulting from past transactions are recorded on the statement of financial position. Transactions include two types of events: external events and internal events. - External Events - These are exchanges of assets, goods, or services by one party for assets, services, or promises to pay (liabilities) by one or more other parties. - Internal events - These include certain events that are not exchanges between the business and other parties but, nevertheless, have a direct and measurable effect on the accounting entity. Account - A standardized record that organizations use to accumulate the monetary effects of transactions on each financial statement item. - The cumulative result of all transactions that affect a specific account, or its ending balance, is then reported on the appropriate financial statement. To facilitate the recording of transactions, each company establishes a chart of accounts; a list of accounts and their unique numeric codes. - The chart of accounts is organized by financial statement element, with asset accounts listed first (by order of liquidity), followed by liabilities (by order of time to maturity), shareholders’ equity, revenue, and expense accounts, in that order.

Elements of the Statement of Financial Position: - Assets - Economic resources with probable future benefits owned or controlled by the entity. Measured by the historical cost principle. - Liabilities - Probable debts or obligations (claims to a company’s resources) that result from a company’s past transactions and will be paid with assets or services. - Entities that a company owes money to are called creditors. - Shareholders’ Equity - The financing provided by the owners and by business operations. Often referred to as contributed capital. Dual Effects Concept - Every transaction has at least two effects on the basic accounting equation. - Most transactions with external parties involve an exchange by which the business entity both receives something and gives up something in return. The accounting equation must remain in balance after each transaction. - A = L + SE Balancing the Accounting Equation: - Step 1: Ask: What was received and what was given? - Identify the accounts affected by their titles (e.g., cash and accounts payable). - Make sure that at least two accounts change. - Classify each by type of account. Was each account an asset (A), a liability (L), or shareholders’ equity (SE)? - Determine the direction of the effect. - Did the account increase (+) or decrease (−)? Step 2: Verify: Is the accounting equation in balance? - A = L + SE

The Accounting Cycle:

T-Account - A shorthand term for the entire ledger account. The T-account has a left side, called the debit side, and a right side, called the credit side.

A journal entry might look like this:

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By themselves, journal entries do not provide the ending balances in accounts. After the journal entries have been recorded, the bookkeeper posts (transfers) the monetary values to each account affected by the transaction to determine the new account balances. In most computerized accounting systems, this happens automatically upon recording the journal entries.

Statement of Financial Position - Usually, businesses will create a trial balance spreadsheet first for internal purposes before preparing and reporting financial statements for external users. - A trial balance lists the titles of the T-accounts in the first column, usually in financial statement order with their ending debit or credit balances in the next two columns. - Debit balances are indicated in the left column and credit balances are indicated in the right column. Then the two columns are totalled to provide a check on the equality of the debits and credit. Classified Statement of Financial Position - In a classified statement of financial position assets and lia...