Financial Accounting

Accounting information provided to external users;

The “two” functions of accounting (financial)

measure business activity of a company & to communicate those measurements to external parties for decision-making purposes

Financing Activities

Transactions the company has with investors and creditors

Investing Activities

transactions involving the purchase & sale of resources that are expected to benefit the company for several years (long-term)

Operating Activities

(cash) transactions that relate to the primary operations of the company; meaning customers

Corporation

Company legally separate from its owners; stockholders have limited liability

Sole proprietorship

Business owned by one person.

Partnership

Business owned by two or more people.

Assets equation (accounting equation)

Assets = Liabilities + Stockholders’ Equity

What are Assets?

Total resources of the company

Liabilities

Amounts owned to creditors

Stockholders’ Equity

Owners’ claim to resources

Revenues

The amount recognized when the company sells products/provides services to customers

Expenses

The costs of providing products, services & other business activities during the current period

Net income

The difference between revenues & expenses (i.e. profit/earnings)

Dividends

Cash payments to stockholders (not expenses!)

Financial Statements

Periodic reports published by the company to provide information to external users.

Types of financial statements

Income statement, balance sheet, cash flow statement & stockholders’ equity statement.

When is there net income?

If revenue > expenses

When is there net loss?

When revenue < expenses

Stockholders’ Equity equation

Stockholders’ Equity = Common Stock (external) - Retained Earnings (internal)

What are dividends not?

They aren’t expenses! a distribution of net incomepaid to shareholders from retained earnings.

Balance Sheet

Presents the financial position of the company on a particular date

2 important components of the annual report?

management discussion & analysis (MD&A) and Note disclosures

Management Discussion & Analysis (MD&A)

Management’s views on significant events, trends, and uncertainties pertaining to the company’s operations and resources.

Note disclosures

Additional information to explain the information presented in the financial statements or to provide information not included in the financial statement.

What are the rules of financial accounting called?

Generally Accepted Accounting Principles

(GAAP)

Global standard for accounting is known as?

International Accounting Standards Board (IASB)

Organization for accounting standards in the US is known as?

Financial Accounting Standards Board (FASB); Governed by the SEC

What is the role of auditors?

Ensure that management properly applies GAAP in financial statements & adding credibility to the financial statements for creditors and investors.

Four characteristics of financial reporting?

comparability, verifiability, timeliness & understandability

What do accountants do?

Communicate information to investors & creditors based on measuring information from companies

What do investors & creditors do?

Make decisions about companies based on financial information

Other names for an income statement?

profit and loss statement, statement of earnings, & statement of operations

What is common stock equal to?

Ending common stock = Beginning common stock + New issuances

Retained Earnings equation

Ending retained earnings = Beginning retained earnings + Net income - Dividends

What must be true in the case of assets on the balance sheet?

Total assets must equal total liability & stockholders’ equity

Another name for a balance sheet would be?

Statement of Financial Position

External transactions

Transactions between the company and a separate company or individual

Internal transactions

Transactions that don’t include an exchange with a separate economic entity

Six steps to measure external transactions

1. Use source documents to identify accounts affected by an external transaction

2. Analyze the impact of the transaction on the accounting equation

3. Asses whether the transaction results in a debit or credit to account balances

4. Record the transaction in a journal using debits and credits

5. Post the transaction to the general ledger

6. Prepare a trial balance

What is an Account?

Record of all transactions related to a particular item over a period of time

Types of accounts

Asset, Liability & Stockholders’ Equity Accounts

Asset Accounts

Examples: Cash, Supplies, & Equipment

Liability Account Examples:

Accounts Payable, Salaries Payable, Utilities Payable, & Taxes Payable

Stockholders’ Equity Account Examples

Common Stock & Retained Earnings

Chart of Accounts

List of all account names used to record transactions

Debits Effects on account?

Increase assets, decrease liabilities and decrease stockholders’ equity

Credits effects on accounts?

Decrease assets, increase liabilities and increase stockholders’ equity

Retained Earnings account

Stockholders’ equity account that normally has a credit balance; has three components: revenues, expenses and dividends

What does debit mean?

Left side

What does credit mean?

Right Side

Common mistake in journal entries

Don’t forget to indent the credit account names

In every transaction what must be equal?

Total debits = total credits

What does an asset account normally have?

Debit balance meaning the asset account increases

What does a credit account normally have?

Credit balance meaning it increases the accounts balances

What is posting?

Process of transferring the debit and credits Post information from the journal to individual general ledger accounts

General ledger

Provides each account with its individual transactions and resulting account balance in a single collection

T-account

Simplified version of a general ledger account

Cash-Basis Accounting

Transactions recorded only at the time cash is received or paid

Accrual Basis accounting

Recording of transactions such as Assets, Liabilities, Revenues & Expenses

Accrual vs cash basis accounting

The difference is in the timing of when we record those revenues and expenses

Which type of accounting is part of GAAP

Accrual-basis accounting

What is not allowed for most major companies?

Cash-basis accounting

Prepaid Expenses

When a company pays cash (or is obligated to pay) in order to acquire an asset that is not used until a late period.

Examples of prepaid expenses?

Rent, Supplies, Depreciable assets

What is recorded with an adjusting entry associated with a prepaid expense?

Credit of an asset

What is the equivalent to the book value of an asset?

Cost of the asset “net of the accumulated depreciation

Accrued Expenses

Occur when a company has used costs in the current period, but the company hasn’t yet paid cash for those costs.

Accrued Revenues

Occur when a company provides products or services, but hasn’t yet received cash.

What are accounts receiveable?

A form of Revenue

When are adjusting entries needed?

When cash flows occur before or after revenue/expenses related activity (i.e. prepayment or accrual)

Closing entries two purposes:

Transfer balance of temporary accounts (revenues, expenses & dividends) to the retained earnings account.

Reduce balances of these temporary accounts to zero to prepare them for measuring activity in the next period.

Incorrect Financial Statements

Errors or Fraud

Errors

Accidental errors in recording transactions or applying accounting rules

Fraud

A person intentionally deceives another person for perosnal gain or to damage that person

Occupational fraud

The use of one’s occupation for personal enrichment through the deliberate misuse/misapplication of the employer’[s resources.

Fraud triangle

Top: Opportunity, left: motivation, right; Rationalization

Opportunity

The situation allows fraud to occur

Motivation

Someone feels the need to commit fraud, such as the need for money.

Rationalization

Justification from the deceptive act by the one committing the fraud

Internal controls

Attempt to eliminate the opportunity element of fraud.

Internal controls do what?

Safeguard the company’s assets & improve the accuracy and reliability of accounting information

Enron fraud history

Avoided reporting billions in debt and losses

WorldCom fraud

Misclassified expenditures to overstate assets and profitability

Sarbanes-Oxley Act (2002)

Established guidelines: Internal control procedures & Auditor-client relations

Which companies fall under the Sarbanes-Oxley Act of 2002?

Only companies that are required to file financial statements with the SEC

Control environment

Management’s overall attitudes and actions

Risk assesment

Careful consideration of internal and external risk factors

Control activities

Variety of policies and procedures used to protect a company’s assets

Monitoring

The supervision of internal controls that must occur on an ongoing basis

Information and communication

Depends on the reliability of the accounting information system itself.

Preventative controls (control activities)

Separation of duties, physical controls, proper authorization, employee management, and e-commerce controls

Separation of duties

A set of procedures intended to separate employees duties for authorizing transactions were, recording transactions and controlling the related assets

Physical controls

A set of procedures that interest assets in accounting records are kept safe.

Proper authorization

A set of procedures designed to prevent in proper use of the companies resources.

Employee management

Providing employees with appropriate guidance to ensure that they have the knowledge necessary to carry out their job duties.

E-commerce controls

A set of procedures specifically designed to ensure only authorized personnel are able to conduct e-commerce transactions.

Detective Controls (control activities)

Reconciliation, performance, reviews, and audits

Reconciliations

Management should periodically determine whether the amount of physical assets of the company (cash, supplies, inventory, and other property) agree with that accounting records.

Performance reviews

The actual performance of individuals are processes should be checked against their expected performance.