2. Chapter 3- Accounting and Financial Statements Pr. SAMLAL Zoubida

3. The Nature of Accounting The accounting system is a series of steps performed to analyze, record, quantify, accumulate, summarize, classify, report, and interpret economic events and their effects on an organization and to prepare the financial statements.

4. Accounting as an Aid to Decision Making Fundamental relationships in the decision- making process: Event Accountant’s analysis & recording Financial Statements Users

5. Financial and Management Accounting The major distinction between financial and management accounting is the users of the information. – Financial accounting serves external users. – Management accounting serves internal users, such as top executives, management, and administrators within organizations.

6. Financial and Management Accounting The primary questions about an organization’s success that decision makers want to know are: 1-What is the financial picture of the organization -on a given day? 2- How well did the organization do during a given period?

7. CHART OF ACCOUNTS The Chart of Accounts is organized using three different methods. 1.First: Accounting Types 2.Second: Order of Liquidity - the ease of converting to cash without loss of value 3.Third: Account Numbers 6

8. 7 TYPES OF ACCOUNTS 1.Assets - Things you own 2.Liabilities - Things you owe 3.Equity - Owners Stake in Company 4.Revenue - Income through Sales of the Products of the Business 5.Costs of Goods Sold - Costs to provide the service or to manufacture or acquire the product the business sells 6.Expenses - Things that are paid for that are consumable and are part of the cost of running a business 7.Other Revenue and Expenses - Revenue and Expenses that are unusual cases and are not directly related to the business product and are not usual costs of running a business. 7

9. ORDER OF LIQUIDITY The Chart of Accounts’ second method of organization is Order of Liquidity. Liquidity refers to the expectation that the item can be converted to cash at least close to its current value within one year. Accounts are listed in descending order of liquidity within their accounting types, with cash at the top of the list for Assets. The liquidity classification is so important that Assets and Liabilities are divided into the Subtypes of Current and Long Term/Fixed to group items of similar liquidity together. 8

10. ACCOUNT NUMBERS Assigning Account numbers starts by assigning a range of numbers to each Accounting Type. The number of digits will be important in your software system so when using ranges in the 1000’s there are 4 digits, and the Account Numbers would range from 1000 to 9999. 9

11. ACCOUNT NUMBERS Assets: 1000’s – Current Assets 1000 – 1499; Fixed Assets 1500 -1999 Liabilities: 2000’s – Current Liabilities 2000 – 2499; Long Term Liabilities 2500 - 2999 Equity: 3000’s Revenue: 4000’s Costs of Goods Sold: 5000’s Expenses: 7000’s Other Revenue: 8000’s Other Expenses: 9000’s 10

12. Use of Funds (Debit) Accounting Types Each Accounting Type under the “Funds/Use of Funds” Category increases in value or balance with each debit (Use of Funds) transaction entry and decreases in value or balance with each credit (Source of Funds) transaction entry. Use of Funds Accounts are sometimes referred to as Debit Accounts. 11

13. Use of Funds (Debit) Accounting Types Positive balances for these accounts are balances where total debits > total credits to the account and their balances should show in the Debit Column. 1.Assets 2.Costs of Goods Sold 3.Expenses 4.Other Expenses 12

14. Source of Funds (Credit) Accounting Types Each Accounting Type under the “Source of Funds” Category increases in value or balance with each credit (Source of Funds) transaction entry and decreases in value or balance with each debit (Use of Funds) transaction entry. Source of Funds Accounts are sometimes referred to as Credit Accounts. 13

15. Source of Funds (Credit) Accounting Types Positive balances for these accounts are balances where total credits > total debits to the account and their balances should show in the Credit Column. 1.Liabilities - Things you owe 2.Equity - Owners’ Stake in Company 3.Revenue - Income through Sales of the Products of the Business 4.Other Revenues - Revenues that are unusual cases and are not directly related to the business product and are not usual revenues from running a business. 14

16. FINANACIAL STATEMENTS

17. Financial Statements – Income Statement – Statement of Retained Earnings – Balance Sheet – Statement of Cash Flows Management Discussion and Analysis Notes to Financial Statements Auditor's Report ANNUAL REPORT

18. Financial Accounting Statements Income Statement - reports the results of operations for a specific period of time Retained Earnings Statement - reports the changes in retained earnings for a specific period of time Balance Sheet - reports the assets, liabilities, and stockholders’ equity at a specific date Statement of Cash Flows - reports the cash receipts and payments for a specific period of time 17

19. Management Discussion and Analysis Covers three aspects of a company: – liquidity - ability to pay near term obligations – capital resources - fund operations and expansions – results of operation 18

20. Notes to Financial Statements Provide additional information not included in body of statements Describe accounting policies or explain uncertainties and contingencies 19

21. Auditor's Report Auditor, a professional accountant who conducts an independent examination of the financial accounting data presented by a company. Auditor gives an unqualified opinion if the financial statements present the financial position, results of operations, and cash flows in accordance with GAAP. 20

22. Statement of Cash Flows 21

23. Statement of Cash Flows The Cash Flow Statement (Statement of Cash Flows) provides an overview of the way Funds move through an Entity, how they impact Overall Value and eventually reconcile with Cash Balances and determine Net Cash Flow in any given year. 22

24. 3 Types of Business Activity Financing Investing Operating 23

25. Financing Activities 24 It Takes MONEY to Make MONEY!

26. 2 Ways of Outside Financing of a Corporation Borrowing Money (liabilities) Selling Shares of Stock 25

27. Investing Activities Cash Accounts Receivable Prepaid Rent Buildings, Equipment, Furniture 26 Obtaining the Resources or Assets needed to operate the business Examples of assets...

28. Investing Activities - Examples Purchase or Sale of computers, delivery trucks, furniture, buildings Purchase or Sale of investments 27

29. Remember... Remaining Liquid and Solvent is as important as making a profit because...

30. A Company Can Survive a Long Time Without Profits... but It Can’t Survive Very Long Without CASH!

31. Cash flow statement 1.Operating Activities Net Income + Depreciation Expense (+ Increase and -Decrease in Accumulated Depreciation) + Increases in Current Liabilities + Decreases in Current Assets - Increases in Current Assets - Decreases in Current Liabilities

32. Cash flow statement 2. Investing Activities + Decreases in Long Term/Fixed Assets (Independent of Accumulated Depreciation) - Increases in Long Term/Fixed Assets (Independent of Accumulated Depreciation)

33. Cash flow statement 3. Financing Activities + Increases in Long Term Liabilities/Debt - Decreases in Long Term Liabilities/Debt + Increases in Owners’ Capital - Decreases in Owners’ Capital - Increases in Dividends Beginning Cash Balance - Net Increase/Decrease = Ending Cash Balance

34. Statement of Cash Flows Cash Flows From Operating Activities Net Income$45,104 Depreciation$496 Increase in Payables$1,700 ———— Net Cash Provided by Operating Activities$47,300 ———— Cash Flows From Investing Activities Increase in Fixed Assets$2,950 ———— Net Cash Used by Investing Activities-$2,950 ———— Cash Flows From Financing Activities $0 ———— Net Cash Provided by Financing Activities$0 ———— Increase in Cash and Cash Equivalents (Net Cash Flow)$44,350 Cash and Cash Equivalents at Beginning of Year$0 ———— Cash and Cash Equivalents at End of Year$44,350

35. Income Statement

36. The Income Statement Accounting Types are Revenue, Cost of Goods Sold and Expenses. The Accounts that are not on the Income Statement are on the Balance Sheet. As its name suggests, the purpose of the Income Statement is to report Income. Income = Revenue - Expenses. It is almost that simple, but there is more to the Income Statement than a simple calculation.

37. Income Statement Revenue -Cost of Goods Sold —————- =Gross Margin -Expenses —————- =Operating Income +Other Revenue -Other Expenses —————- =Net Income

38. CSU CORPORATION Income Statement For the Year Ended December 31, 2008 1st- head up the statement name of company name of statement period of time covered

39. Revenues Service revenue $17,000 CSU CORPORATION Income Statement For the Year Ended December 31, 2008 2nd - List the revenues

40. Revenues Service revenue $17,000 Expenses Rent expense $9,000 Insurance expense 1,000 Supplies expense 200 Total expenses10,200 CSU CORPORATION Income Statement For the Year Ended December 31, 2008 3rd - List and total the expenses

41. Revenues Service revenue $17,000 Expenses Rent expense $9,000 Insurance expense 1,000 Supplies expense 200 Total expenses10,200 Net Income $ 6,800 CSU CORPORATION Income Statement For the Year Ended December 31, 2008 4th - Subtract expenses from revenues to obtain net income.

42. Retained Earning

43. CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 2008 1st- head up the statement name of company name of statement period of time covered

44. CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 2008 Retained earnings, January 1$ 0 2nd - Start with beginning retained earnings

45. CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 2008 Retained earnings, January 1$ 0 Add: Net Income6,800 6,800 3rd - Add net income from the current year - subtotal

46. CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 1998 Retained earnings, January 1$ 0 Add: Net Income6,800 6,800 Less: Dividends 0 Retained earnings, December 31$ 6,800 4th - Subtract current year’s dividends and total

47. Balance Sheet

48. The Balance Sheet The balance sheet equation: Assets = Liabilities + Owners’ Equity or Owners’ Equity = Assets - Liabilities

49. CSU CORPORATION Balance Sheet December 31, 2008 1st- head up the statement name of company name of statement date

50. CSU CORPORATION Balance Sheet December 31, 2008 Assets Cash$ 2,000 Accounts receivable 4,000 Supplies 1,800 Equipment 16,000 Total assets $23,800 2nd - list the assets and total

51. CSU CORPORATION Balance Sheet December 31, 2008 Assets Cash$ 2,000 Accounts receivable 4,000 Supplies 1,800 Equipment 16,000 Total assets $23,800 Liabilities and Stockholders’ Equity Liabilities Accounts payable$ 2,000 Notes payable 5,000 Total liabilities 7,000 3rd - list the liabilities and sub- total

52. CSU CORPORATION Balance Sheet December 31, 2008 4th - list stockholders’ equity subtotal. Add to liabilities, Total

53. CSU CORPORATION Balance Sheet December 31, 2008 Assets Cash$ 2,000 Accounts receivable 4,000 Supplies 1,800 Equipment 16,000 Total assets $23,800 Liabilities and Stockholders’ Equity Liabilities Accounts payable$ 2,000 Notes payable 5,000 Total liabilities 7,000 Stockholders’ equity Common stock 10,000 Retained earnings 6,800 Total Stockholders’ equity 16,800 Total liabilities and stockholders’ equity$23,800

54. CSU CORPORATION Balance Sheet December 31, 2008 Assets Cash$ 2,000 Accounts receivable 4,000 Supplies 1,800 Equipment 16,000 Total assets $23,800 Liabilities and Stockholders’ Equity Liabilities Accounts payable$ 2,000 Notes payable 5,000 Total liabilities 7,000 3rd - list the liabilities and sub- total

55. CSU CORPORATION Balance Sheet December 31, 1998 4th - list stockholders’ equity subtotal. Add to liabilities, Total

56. In what order are financial statements prepared? WHY?

57. Revenues Service revenue $17,000 Expenses Rent expense $9,000 Insurance expense 1,000 Supplies expense 200 Total expenses10,200 Net Income $ 6,800 CSU CORPORATION Income Statement For the Year Ended December 31, 2008 Net Income is needed for the Statement of Retained Earnings.

58. CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 2008 Retained earnings, January 1$ 0 Add: Net Income6,800 6,800 Less: Dividends 0 Retained earnings, December 31$ 6,800 Ending Retained Earnings is needed for the balance sheet.

59. CSU CORPORATION Balance Sheet December 31, 2008 Assets Cash$ 2,000 Accounts receivable 4,000 Supplies 1,800 Equipment 16,000 Total assets $23,800 Liabilities and Stockholders’ Equity Liabilities Accounts payable$ 2,000 Notes payable 5,000 Total liabilities 7,000 Stockholders’ equity Common stock 10,000 Retained earnings 6,800 Total Stockholders’ equity 16,800 Total liabilities and stockholders’ equity$23,800