1. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Module 3 Accounting Transactions and Financial Statements

2. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP The Accounting Cycle These are the steps followed in preparing financial statements It is called a cycle since it repeats itself in every accounting period Chapter 3 covers the white boxes and Chapters 4 and 5 cover the purple boxes

3. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Financial Statements Financial Statements report on the financial performance of the organization Financial Statements are the primary means of financial communication. Producing the statements follows a definite cycle called the Accounting Cycle (Chapter 3) A complete set of financial statements usually consists of –the Statement of Financial Position (Balance Sheet), –The Statement of Activities (Income Statement) –Statement of Functional Expenses (statement of expenses by program or fund area) –Cash Flow Statement

4. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Statement of Activities (Income Statement) Reports revenues earned against expenses (general and program related) incurred by a business over a period of time Surplus (Deficit) = Revenues – Expenses Revenues are earned by collecting donations, pledges, receiving grants, fund raising activities as part of the agency’s main operations Expenses are those costs incurred by the agency in the course of generating income. –Program related expenses –General expenses (rent, salaries, utilities)

5. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Example: Statement of Activities (Income Statement) Statement of Activities Income Government Grants Pledges and Donations Endowment Interest Income 50000 30000 10000 Total Income Expenses Salaries Expense Rent Expense Utilities Expense Depreciation Total Expenses Surplus/Deficit 90000 70000 2400 1600 10000 84000 6000

6. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Statement of Financial Position (Balance Sheet) Also known as Balance Sheet Reports the financial position of the business at a point in time It describes financial position by listing the types and dollar amounts of assets, liabilities and equity The main sections of a Balance Sheet are the Assets, Liabilities and Equity sections, such that the equation assets - liabilities = equity is always maintained

7. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Assets Assets are resources available and controlled by the organization for current or future benefit Assets –Cash, the most liquid of all assets –Donations Receivable: amounts owed to the agency by donors for goods or services provided through operations –Grants Receivable are amounts owed by granting organizations (governments) from grant proposals –Prepaid Expenses, advanced payments made for expenses. Prepaid expenses are assets until the asset is consumed (insurance, rent) –Equipment, are assets not sold in the course of operations, but used to deliver services (computers, desks, toys, supplies) over the course of several accounting periods –Buildings and Land are assets because they provide a location in which to operate the agency

8. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Liabilities Liabilities are obligations to transfer assets or provide services to other entities. Liabilities –Accounts Payable: Money owed to suppliers for products or services bought on credit –Unearned Revenue, when customers pay in advance for products or services. –Wages, amounts owed to employees for services provided, but for which they have not yet been paid –Taxes payable, amounts owed to governments for sales tax or income taxes accumulated but not yet paid. –Mortgages or loans, money owed to lending institutions or individuals for money they have loaned to the organization

9. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Equity Accounts Accumulated Surplus/Deficit is the owner’s claim on the assets of the agency Can also be considered as net assets, the amount of assets remaining after deducting liabilities Accumulated Surplus can be increased when owner’s bring more personal assets into the business Accumulated Surplus can also be increased through Retained Surplus, the amount of surplus that is kept in the agency at the end of an accounting period Accumulated Surplus is decreased if there is a deficit in a period or if an owner makes a withdrawal

10. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Statement of Financial Position (Balance Sheet) Example Statement of Financial Position Current Assets Cash2500 Current Liabilities AP5000 Pledges Receivable10000 Rent Payable1200 Supplies1000 Insurance Payable10000 Fixed Assets Wages Payable10000 School Bus10000Long Term Liabilities Educational Tools15000 Loan30000 Endowment Fund30000Accumulated Surplus12300 Total Assets68500Total Liabilities & Surplus68500

11. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Income Recognition Principle Income can be recognized at –When a donation is received in cash –When a pledge is received (and there is confidence the pledgor will actually pay) –On award of a government grant –Passage of time (as in the case of interested earned on an endowment)

12. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP The Accounting Equation Assets = Liabilities + Accumulated Surplus Assets – Liabilities = Accumulated Surplus Anytime one side of the equation changes, the other must change by the same amount, maintaining balance Double Entry Accounting is the means through which balance is maintained: For every transaction, there are entries in at least 2 accounts (Chapter 3)

13. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Accounts An account is a detailed record of increases and decreases in a specific asset, liability, equity, revenue or expense item Separate accounts are kept for each type of asset, liability, equity, revenue or expense item. Balance Sheet accounts (like cash, Donations Receivable, Accounts Payable, etc) are “As at” accounts, showing the status of these items at the end of a period Statement of Activities (Income Statement) accounts are “flow through” accounts, measuring the amount of revenue and expense occurring through a period A Chart of Accounts or Ledger is a list of all the accounts used by an agency, often showing an account number

14. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP T-Account We have been using these in our sample problems so far It is a helpful tool to help illustrate how the various agency transactions affect the various accounts and how they relate to each other The left side is always labeled debit and the right, credit Depending on which side of the balance sheet the account in question is on, entries on either the right or left could be increases or decreases for that account. Account Title Debit sideCredit Side

15. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Double Entry Accounting The most common way to keep accounting records Means that for every transaction, there is an affect and a record written into at least 2 accounts to always ensure that the accounting equation is in balance Rules to remember: –Increases to assets are debited (entered on left side) of asset accounts. Decreases are credited (entered on right side) –Increases in liabilities are credited (entered on right side) to liability accounts. Decreases are debited (entered on left) –Increases in owner’s equity are credited (right side) and decreases are debited left side) –Revenues (or increases in revenues) are credited to revenue accounts, expenses (or increases) are debited to expense accounts Illustrate: A donation is made in cash, hydro expense paid, cash is used to buy groceries

16. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Organizing Accounts A ledger is a collection of all accounts on the books A Chart of Accounts is a numeric list of accounts Some accounting systems and accountants are familiar with an account numbering system as outlined on p92 In general the first digit provides a clue to the type of account with subsequent digits providing further detail

17. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Journal Entries We have already been doing these, this is Step 2 in the Accounting Cycle Consists the following info: –Date of transaction –Titles of the affected accounts –Dollar amount of each debit or credit –Transaction explanation for future reference Double entry accounting requires that every transaction will affect at least 2 accounts. –Those that affect 3 or more accounts are called Compound Journal Entries Note that the accounts involved do not need to be on opposite sides of the balance sheet –Ex: A cash purchase of furniture vs. purchase of furniture on credit

18. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP An example For purposes of illustration lets consider a few common economic events that may occur in a particular month at a daycare for special needs children: 1.The agency starts off with $1000 in cash brought to the agency by the founders 2.On March 1, the agency receives cheques and cash from parents for daycare services for the coming month in the amount of $10000. 3.On March 3, the daycare learns that it has been awarded a government grant to provide such services. The grant will be paid in April and will be in the amount of $12000 4.On March 7, the school bus driver stops to fill up the bus. The bus takes $100 to fill 5.On March 16, the cook goes to the grocery store to buy groceries for the lunches. The daycare has a business arrangement with the grocer such that the grocer will place the cost of the groceries on the daycare’s tab and allows the daycare to pay the tab at the end of the month. 6.On March 25, the executive director and payroll clerk consider how much has been earned by employees, but not yet paid to employees.

19. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Journal Entries DateAccount Titles and explanationPRDebitCredit OpenCash1011000 Bal. Accumulated Surplus4011000 Mar 1Cash10110000 Income60010000 Mar 3Grants Receivable15012000 Income60012000 Mar 7Fuel Expense725100 Cash101100 Mar 16Groceries Expense720500 Cash201500 Mar 25Wages Expense7153500 Wages Payable2053500

20. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Journal Entries Date column: the transaction date Account title and explanation: the names of the accounts affected by the transaction. Some journal entries place a short, plain-english, description of the transaction so the record keeper remembers the event PR: Posting Reference column: a place to enter the account number if accounting number is being applied to the books Debit and Credit columns: Places to enter the amounts affecting the specific account for the transaction

21. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Posting Journal Entries Step 3 in the Accounting Cycle –The process of posting or transferring entries from the journal to the ledger CashAccounts Payable OB 1000 Mar 1 10000 100 Mar 7 500 Mar16 Grants ReceivableWages Payable Mar 3 120003500 Mar 25 Fuel ExpenseAccumulated Surplus Mar 7 1001000 OB Groceries ExpenseIncome Mar 16 50010000 Mar 1 Wages Expense12000 Mar 3 Mar 25 3500

22. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Trial Balance Step 4 in the Accounting Cycle A trial balance is run to simply check whether debits and credits balances It is a useful summary for understanding how the agency transactions affected accounts during the period Also makes the creation of the Statement of Financial Position (Balance Sheet), Statement of Activities (Income Statement) and Statement of Accumulated Surplus (Statement of Equity) easier

23. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Trial Balance 5 Steps to a care-free trial balance –Identify account balances either from the ledgers or from the T- accounts –List each account, in the same order of as the Chart of Accounts (usually asset accounts come first, followed by liability accounts, then Accumulated Surplus accounts), and their debit or credit sums –Add up all the debits –Add up all the credits –Make sure they equal Now for the moment you’ve all been waiting for…….

24. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP An example Unadjusted Trial Balance DebitCredit Cash10400 Grants Receivable12000 Accounts Payable Wages Payable3500 Accumulated Surplus1000 Income22000 Fuel Expense100 Groceries Expense500 Wages Expense3500 Totals26500

25. Financial Accounting Dave Ludwick, P.Eng, MBA, PMP Onward…. Chapter 4