BA 101 Introduction to Business 16. Basic Accounting Concepts

What Is Accounting? Financial Accounting Management Communication Measuring Interpreting Decision Making Accounting is the system a business uses to identify, measure, and communicate financial information to others, inside and outside the organization. Because outsiders and insiders use accounting information for different purposes, accounting has two distinct facets. Financial accounting is concerned with preparing financial statements and other information for outsiders such as stockholders and creditors (people or organizations that have lent a company money or have extended them credit); management accounting is concerned with preparing cost analyses, profitability reports, budgets, and other information for insiders such as management and other company decision makers. To be useful, all accounting information must be accurate, objective, consistent over time, and comparable to information supplied by other companies.

What Accountants Do Tax Accounting Bookkeeping Financial Analysis Cost Some people confuse the work accountants do with bookkeeping, which is the clerical function of recording the economic activities of a business. Although some accountants do perform bookkeeping functions, their work generally goes well beyond the scope of this activity. Accountants design accounting systems, prepare financial statements, analyze and interpret financial information, prepare financial forecasts and budgets, and prepare tax returns. Some accountants specialize in certain areas of accounting, such as cost accounting (computing and analyzing production costs), tax accounting (preparing tax returns and interpreting tax law), or financial analysis (evaluating a company’s performance and the financial implications of strategic decisions such as product pricing, employee benefits, and business acquisitions).

How Are Financial Statements Used? An accounting system is made up of thousands of individual transactions—debits and credits to be exact. During the accounting process, sales, purchases, and other transactions are recorded and classified into individual accounts. Once these individual transactions are recorded and then summarized, accountants must review the resulting transaction summaries and adjust or correct all errors or discrepancies before they can close the books, or transfer net revenue and expense items to retained earnings. The slide above presents the process for putting all of a company’s financial data into standardized formats that can be used for decision making, analysis, and planning. To make sense of these individual transactions, accountants summarize them by preparing financial statements.

Understanding Financial Statements Income Statement Balance Sheet Cash-Flow Statement Financial statements consist of three separate yet interrelated reports: the balance sheet, the income statement, and the statement of cash flows. Together these statements provide information about an organization’s financial strength and ability to meet current obligations, the effectiveness of its sales and collection efforts, and its effectiveness in managing its assets. Organizations and individuals use financial statements to spot opportunities and problems, to make business decisions, and to evaluate a company’s past performance, present condition, and future prospects. In sum, they’re indispensable.

Statement of Financial Position The Balance Sheet Statement of Financial Position Calendar Year Fiscal Year The balance sheet, also known as the statement of financial position, is a snapshot of a company’s financial position on a particular date. This statement includes all elements in the accounting equation and shows the balance between assets on one side and liabilities and owners’ equity on the other side. Every company prepares a balance sheet at least once a year, most often at the end of the calendar year, covering from January 1 to December 31. However, many business and government bodies use a fiscal year, which may be any 12 consecutive months. Assets can consist of cash, things that can be converted into cash, and equipment. Current assets include cash and other items that will or can become cash within the following year. Fixed assets are long-term investments in buildings, equipment, furniture and fixtures, transportation equipment, land, and other tangible property used in running the business. Fixed assets have a useful life of more than one year. Liabilities represent claims against the company’s assets. The balance sheet gives subtotals for current liabilities (obligations that will have to be met within one year of the date of the balance sheet) and long-term liabilities (obligations that are due one year or more after the date of the balance sheet), and then it gives a grand total for all liabilities. The owners’ investment in a business is listed on the balance sheet under shareholders’ equity. Shareholders’ equity for a corporation is presented in terms of the amount of common stock that is outstanding, meaning the amount that is in the hands of the shareholders. Shareholders’ equity also includes a corporation’s retained earnings—the portion of shareholders’ equity that is not distributed to its owners in the form of dividends. Assets Liabilities Owners’ Equity

The Income Statement Revenues Cost of Goods Sold Operating Expenses Net Operating Income Net Income After Taxes The income statement shows an organization’s profit performance over a specific period of time, typically one year. It summarizes all revenues (or sales), the amounts that have been or are to be received from customers for goods or services delivered to them, and all expenses, the costs that have arisen in generating revenues. Expenses and income taxes are then subtracted from revenues to show the actual profit or loss of a company, a figure known as net income—profit, or the bottom line.

Cash-Flow Statement Operations Investments Financing In addition to preparing a balance sheet and an income statement, all public companies and many privately owned companies prepare a statement of cash flows to show how much cash the company generated over time and where it went. The statement tracks cash flows from operations, investments, and financing. It reveals the increase or decrease in the company’s cash for the period and summarizes (by category) the sources of that change. From a brief review of this statement you should have a general sense of the amount of cash created or consumed by daily operations, the amount of cash invested in fixed or other assets, the amount of debt borrowed or repaid, and the proceeds from the sale of stock or payments for dividends. In addition, an analysis of cash flows provides a good idea of a company’s ability to pay its short-term obligations when they become due. Financing