ACG 2021 Financial Accounting Chapter One: The Financial Statements

The Accounting System

What is accounting Been in place for hundreds of years System Language 1494 Luca Pacioli's Summa de Arithmetica Geometria Proportionalita (A Review of Arithmetic, Geometry and Proportions) First written description of double-entry accounting Incan khipus cryptic assemblages of string and knots May have been used for record-keeping (i.e. accounting) Gary Urton and Carrie Brezine Annotated Khipu on Flickr System Of recording business transactions Language Whether knots Debits or Credits written in a journal Digital values stored on a computer We’ve been accounting for many, many years

Information System Model

The Accounting System An Information System Inputs to the system are business events Sales Purchases Inventory (things to re-sell, things to use in building), buildings Payroll Processing takes place in the various Journals and General Ledger where transactions are stored Financial Statements are the Outputs and represent Summary Information Income Statement Statement of Retained Earnings Balance Sheet Cash Flows

Accounting Information System Procedures, Techniques and Resources to Collect & Disseminate Relevant Business Information to Interested Users Individuals (Management) Investors & Creditors Taxing Authorities Non-Profit Organizations

Accounting (The Language of Business) Is... The process of identifying, measuring, and communicating economic information (via reports) to permit informed judgments and decisions by users of the information. Balance Sheet – Resources Income Statement – Results of Operations Cash Flow – Management of Asset

Language Dialects Financial Accounting Managerial Accounting Tax Accounting Governmental (non-profit) Accounting

ACG 2021 Who are we Accounting for: Business Forms And Accounting Rules and Assumptions

Accounting Assumptions Business activity occurs via distinct entities Sole Proprietorship Partnerships Corporations Business activity is conducted via measurable, observable transactions Transactions can be described using standard units of measurement ($’s) in accounts (Valuation)

Forms of Business Organization Proprietorship Has a single owner Proprietor is personally liable for debts of the business Not a separate legal entity For accounting, the proprietorship is a separate entity from the proprietor

Forms of Business Organization Partnerships Two or more partners are co-owners Each partner can be liable for all the debts of the partnership Not a separate legal entity For accounting, the partnership is a separate entity from its partners

Forms of Business Organization Corporations May have many owners (stockholders) Stockholders are not personally liable for debts of the business Is a separate legal entity Stockholders elect a Board of Directors to appoint corporate officers and set policies

Accounting Guidelines Formulated by the Financial Accounting Standards Board (FASB) Generally Accepted Accounting Principles (GAAP) The Entity Concept A business is separate & distinct from it’s owners The Reliability Principle Accounting records are based on the most objective evidence available The Historical Cost Principle $’s are recorded at time of transaction (actual cost) $’s that a willing buyer paid a willing seller Not some point in the future The Going-Concern Principle The Entity will not go Out-of-Business The Stable-Monetary-Unit Concept the monetary unit’s ($’s) purchasing power is stable (ignores inflation)

ACG 2021 Financial Accounting The Accounting Equation Assets = Liabilities + Owners Equity

The Accounting Equation Assets = Liabilities + Owner’s Equity Claims against Economic Resources Economic Resources If assets are 100,000 and liabilities are 70,000.. …..OE? 30,000

Assets Economic resources (value, $’s) Owned and Controlled by business entity Expected to produce a benefit in the future Cash Investments Accounts Receivable Inventory Buildings, Equipment, Gold Mines, Patents Identify some assets

Liabilities Economic obligations (debt) of a business Accounts Payable Notes Payable Accrued Expenses: Payroll that we owe Taxes that we owe Rent, Insurance, etc. that we owe Money we borrowed and of course owe Claims by Creditors Convey Assets This means that the creditor expects an asset (most often cash) be given for what is owed Perform Service This means that the creditor expects a service (like prepare a tax return, or provide rental retail space) be given for what is owed

Owner’s Equity The owner’s claim on the entity’s assets Capital (for Proprietorship or Partnership) Stockholders’ equity (for Corporation) Share’s of Stock Net assets Assets – liabilities = owner’s equity

Stockholders’ Equity For a corporation, stockholders’ equity is divided into two main categories. Paid in capital The amount that investors have given to the corporation In exchange for shares of stock Retained earnings The amount of Earnings the company has either earned (profit) or lost over time The amount of dividends that have been paid to investors

The Accounting Equation Expanded Assets = Liabilities + Owners Equity Replace Owners Equity with: Paid-in capital - amount invested by its owners - common stock Increases Owners Equity Retained earnings - amount earned by income-producing activities and kept for use in the business Dividends – distributions of assets to stockholders Decreases Retained Earnings Assets = Liabilities + Paid-in capital + Retained earnings

The Accounting Equation Retained Earnings accumulate Revenues and Expenses of an Organization and Dividends that have been paid Revenues – Sales of Product or Services increases Retained Earnings from delivering goods or services to customers Measured by corresponding increase in Asset received as payment Expenses – goods or services Consumed from Revenue Generation decreases Retained Earnings that result from operations Measured by historical cost of assets given up in the sale or consumed to make the sale

Components of Retained Earnings Revenues for the period – Expenses for the period Start of the period Ending balance of retained earnings End of the period = Beginning balance of retained earnings + or – Net income (or Net loss) for the period – Dividends for the period =

Accounting Equation Expanded (again) Assets = Liabilities + Paid-in Capital – Dividends + Revenue – Expenses Retained Earnings

Transactions A simultaneous exchange between one accounting entity and another accounting entity: Customers Suppliers Employees Owners Each party Gives and Receives something of value ($’s)

Chapter 1 Exercise 1-4

ACG 2021 Financial Accounting The Financial Statements

The Financial Statements Balance Sheet Income Statement Statement of Retained Earnings Statement of Cash Flows

Assets = Liabilities + Owner’s Equity Balance Sheet Rank Place Situation Standing Assets used to reach company objectives $’s represent One Particular Point in Time Snapshot What is the company’s financial position at the end of a period? Assets = Liabilities + Owner’s Equity

Balance Sheet Assets appear in order of Liquidity Why? Easily Turned into Cash Why? So Creditors can quickly ascertain if a company has enough “Cash” to pay back what is owed So Creditors can quickly ascertain what collateral a company has against possible loans that might be made Liabilities appear in order in which they will be paid Within 1 year or less Greater then 1 year Stockholders Equity shows the amount contributed by investors & the amount of Income retained by the company Dividends are paid out of this retained amount (but NOT with it)

Income Statement Presents information about profitability How well did the company perform during the period? Revenue – Amount paid or promised to pay for goods or services of the firm, increase of assets Expenses – Costs of providing goods or services to the customer, using up of assets Temporary (periodic) Retained Earnings accounts Revenues – Expenses Net Income (Loss)

Statement of Retained Earnings The portion of a firms Net Income retained by the business Why did the company's retained earnings change during the year? Beginning retained earnings +Net income or (-Net loss) - Dividends Ending retained earnings

Statement of Cash Flows Changes to Cash during a specific time period How much cash did the company generate and spend during the year? Operating cash flows + Investing cash flows + Financing cash flows Increase (decrease) in cash

Information Reported in the F/S

Relationships Among the Financial Statements ABC Company Income Statement – Year Ended December 31, 2006 Revenues $700,000 Expenses 670,000 Net income $ 30,000

Relationships Among the Financial Statements ABC Company Statement of Retained Earnings Year Ended December 31, 2006 Beginning retained earnings $180,000 Net income 30,000 Cash dividends (10,000) Ending retained earnings $200,000

Relationships Among the Financial Statements ABC Company Balance Sheet December 31, 2006 Assets Cash $ 25,000 All other assets 275,000 Total assets $300,000 Liabilities Total liabilities $120,000 Stockholders’ equity Common stock 40,000 Retained earnings 200,000 Other equity (60,000) Total liabilities and stockholders’ equity $300,000

Relationships Among the Financial Statements ABC Company Statement of Cash Flows Year Ended December 31, 2006 Net cash provided by operating activities $ 90,000 Net cash used for investing activities (110,000) Net cash provided by financing activities 40,000 Net increase in cash 20,000 Beginning cash balance 5,000 Ending cash balance $ 25,000