Intro to Financial Accounting

Accounting consists of three basic activities it—

identifies, records, and communicates the economic events of an organization to interested users.

Communication process is known as

financial reporting

Most common accounting reports are known as

financial statements

PepsiCo accumulates all sales transactions over a certain period of time and reports the data as one amount in the company’s financial statements. Such data are said to be reported

in the aggregate

A vital element in communicating economic events is the accountant’s ability to

analyze and interpret the reported information.

Analysis

involves use of ratios, percentages, and data visualization (graphs and charts) to highlight significant financial trends and relationships.

Interpretation

involves explaining the uses, meaning, and limitations of reported data.

Bookkeeping

Involves only the recording of economic events

Data analytics

involves analyzing data, often employing both software and statistics, to draw inferences.

Four types of Data Analytics

Descriptive, Diagnostic, Predictive, and Prescriptive

Descriptive

What happened?

Diagnostic

Why did it happen?

Predictive

What is likely to happen?

Prescriptive

What should we do about it?

Internal Users

managers who plan, organize, and run a business. Include marketing manager, production supervisors, finance directors, and company officers.

External users

individuals and organizations outside a company who want financial information about the company.

Most common type of external users

investors and creditors

Investors (owners)

use accounting information to buy, hold, or sell ownerships shares of a company.

Creditors (such as suppliers and bankers)

use accounting information to evaluate the risks of granting credit or lending money.

Generally accepted accounting principles (GAAP)

Standards that are generally accepted and universally practiced. These standards indicate how to report economic events. Various users need financial information.

Standard-setting bodies

Financial Accounting Standards Board (FASB), Securities and Exchange Commission (SEC), International Accounting Standards Board (IASB)

The primary standard setting body in the United States is the

Financial Accounting Standards Board (FASB)

The agency of the U.S. government that oversees U.S. financial markets and accounting standard-setting bodies

Securities and Exchange Commission (SEC)

Many countries outside the U.S. have adopted the accounting standards issued by the

International Accounting Standards Board (IASB). These standards are called the International Financial Reporting Standards (IFRS)

Historical Cost Principle

dictates that companies record assets at their cost.

Companies use the historical cost principle to

value assets not only at the time the asset is purchased but also over the time the asset is held.

Fair Value Principle

states that assess and liabilities should be reported at fair value (the price received to sell an asset or settle a liability.

Monetary Unit Assumption

requires that companies include in the accounting records only transaction data that can be expressed in money terms.

Economic Entity Assumption

requires that activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities.

Forms of Business Ownership

Proprietorship, partnership, corporation

Proprietorship

Owned by one person, Owner is often manager/operator, Owner receives any profits, suffers any losses, and is personally liable for all debts of the business.

Partnership

Owned by two or more persons, Often retail and service-type businesses, Generally unlimited personal liability, Partnership agreement

Corporation

Ownership divided into shares of stock, Separate legal entity organized under state corporation law, Limited liability, Ease of ownership transfer, Unlimited life

Two basic elements of a business

what it owns and what it owes

Accounting Equation

Assets = Liabilities + Stockholders’ Equity

Basic accounting equation

Assets must equal the sum of liabilities and stockholders’ equity.

If a business is liquidated,

claims of creditors (liabilities) must be paid before ownerships claims (stockholders’ equity)

Assets

Resources a business owns. Provide future services or benefits. Cash, accounts receivable, supplies, equipment, etc.

Liabilities

Claims against assets (debts and obligations). Creditors (party to whom money is owed). Accounts payable, notes payable, salaries and wages payable, sales and real estate taxes payable, etc.

Stockholders’ Equity

Ownership claim on total assets. Referred to as residual equity. Common stock and retained earnings.

Common Stock (investments by stockholders)

represents the total amount paid in by stockholders for the shares they purchase.

Retained Earnings section of the balance sheet:

revenues, expenses, and dividends

Dividends

the distribution of cash or other assets to stockholders. They reduced retained earning, but are not an expense.

Revenues

the increases in assets or decreases in liabilities resulting from the sale of goods or the performance of services in the normal course of business

Common sources of revenue

sales, fees, services, commissions, interest, dividends, royalties, and rent.

Expenses

the cost of assets consumed or services used in the process of generating revenue.

Common expenses are

salaries expense, rent expense, utilities expense, tax expense, etc.

Transactions

are a business’s economic events recorded by accountants. Can be external or internal, but not all actives represent transactions.

External transactions

involve economic events between the company and some outside enterprise

Internal transactions

economic events that occur entirely within one company

Examples of economic events

the sale of snack chips by PepsiCo, the provision of telephone services by AT&T, and the payments of wages by Meta

Accounting and accounting information system

The system of collecting and processing transaction data and communicating financial information to decision-makers

Factors that shape an accounting information system

the nature of the company’s business, the types of transactions, the size of the company, the volume of data, and the information demands of management and others

Four Financial Statements

Income statement, retained earnings statement, balance sheet, statement of cash flows

Income statements

resents the revenues and expenses and resulting net income or net loss for a specific period of time

Retained earnings statement

summarizes the changes in retained earnings for a specific period of time

balance sheet

reports the assets, liabilities, and stockholders’ equity of a company at a specific date.

lists assets at the top, followed by liabilities and stockholders’ equity.

Statement of cash flows

summarizes information about the cash inflows (receipts) and outflows (payments) for a specific period of time

Answers the following:

• Where did the cash come from?

• What was the cash used for?

• What was the change in cash balance?

Chapter 2

two

Account

an individual accounting record of increases and decreases in a specific asset, liability, stockholders’ equity, revenue, or expense item

An account consist of three parts:

1. A title

2. A left or debit side

3. A right or credit side

Debit

indicates the left side of an account. increase assets, decrease liabilities

Credit

indicates right side of an account. decrease assets, increase liabilities.

What causes a debit balance

If the sum of debit entries are greater than the sum of credit entries, the account will have a debit balance.

What causes a credit balance

If the sum of credit entries are greater than the sum of debit entries the account will have a credit it balance

Normal balance

the side where increases in the account are recorded.

Common stock

issued to investors in exchange for the stockholders’ investment

The common stock account is

increased by credits and decreased by debits

Retained earnings

the net income that is retained in the business. represents the portion of stockholders’ equity that has been accumulated through the profitable operations of the company

Dividend

a distribution by a corporation to its stockholders. the most common form of distribution is a cash dividend.

The journal

referred to as the book of original entry

general journal

the most basic form of journal every company has

Journalizing

entering transaction data in the journal

Simple entry

entries that only involve two accounts, one credit and one debit

Compound entry

an entry that requires three or more accounts

Ledger

the entire group of accounts maintained by a company

A general ledger

contain all the asset, liability, and stockholders’ equity accounts.

Chart of accounts

Chart lists the accounts and the account numbers that identify their location in the ledger.

Trial balance

a list of accounts and their balances at a given time

Steps for preparing a trial balance

1. List the account titles and their balances in the appropriate debit or credit column

2. Total the debit and credit columns

3. Verify the equality of the two columns