ACC 255

Chapter 1: Introduction to Accounting

• Definition of Accounting: Language of business for decision-making and telling a company's financial story.

• Applicability: Essential for all business professionals (consultants, marketing, HR).

Who Uses Accounting to Make Decisions?

• Key Stakeholders: Investors, customers, suppliers, creditors, employees, competitors, regulators.

Financial vs. Managerial Accounting

• Financial Accounting: Information for external users (stockholders, creditors).

• Managerial Accounting: Information for internal users (managers, company officers).

• Key Differences:

  • Primary Users: Financial (External), Managerial (Internal).

  • Primary Reports: Financial (Financial statements, annual report), Managerial (Internal reports like budgets).

  • Verification: Financial (Audited by CPA), Managerial (No external audit).

The Accounting Equation

• Equation: $\text{Assets} = \text{Liabilities} + \text{Equity}$

• Interpretation:

  • Assets: What the company owns.

  • Liabilities: What the company owes.

  • Equity: Owner's claim to company resources.

Keeping Things in Balance

• Concept: Every transaction must maintain balance in the accounting equation. If an asset increases, a liability or equity must also increase, or another asset must decrease.

Calculating Net Income

• Definition: Profit for a company over a specific duration, indicating financial performance.

• Equation: $\text{Net Income} = \text{Revenue} - \text{Expenses}$

  • Revenues: Amounts recognized when selling products or services.

  • Expenses: Costs incurred in providing products/services.

Financial Statements

• Definition: Periodic reports to inform external users.

• Main Financial Statements:

  1. Income Statement: Reports revenues, expenses, and net income over a period (month, quarter, year).

  2. Statement of Stockholder’s Equity: Summarizes changes in stockholders' equity accounts over a period.

  3. Balance Sheet: Reflects financial position at a singular point in time (Assets = Liabilities + Equity).

  4. Statement of Cash Flows: Measures cash inflows and outflows over a period (operating, investing, financing activities).

Connecting the Financial Statements

• Net income from the income statement flows into the statement of stockholders' equity.

• Ending balances from the statement of stockholders' equity appear in the equity section of the balance sheet.

Accounting Standards: U.S. and Global

• U.S. Standards: FASB creates Generally Accepted Accounting Principles (GAAP).

• Global Standards: IASB establishes International Financial Reporting Standards (IFRS).

The Annual Report & Auditor

• Annual Report (10-K): Public companies must provide to shareholders, includes financial statements, CEO letter, audit report.

• Auditor: Independent individual hired to ensure financial statements comply with GAAP, providing credibility.

Chapter 2: Income Statement

• Purpose: Reports company profit (or loss) over a specific timeframe.

• Equation: $\text{Net Income} = \text{Revenue and Gains} - \text{Expenses and Losses}$

• Gains and Losses: Increases/decreases in net income from transactions outside normal operations (e.g., selling old equipment).

• Multi-step Income Statement Subtotals:

  1. Gross Profit: $\text{Sales Revenue} - \text{Cost of Goods Sold}$

  2. Operating Income: $\text{Gross Profit} - \text{Operating Expenses}$

  3. Pretax Income: $\text{Operating Income} \pm \text{Non-operating items}$

  4. Net Income: $\text{Pretax Income} - \text{Tax Expense}$

Statement of Stockholders’ Equity

• Purpose: Summarizes changes in equity accounts during a period.

• Components:

  • Contributed Capital: Owner investments.

  • Retained Earnings: Accumulated net income minus dividends.

  • Equation: $\text{Ending RE} = \text{Beginning RE} + \text{Net Income} - \text{Dividends}$

Balance Sheet

• Purpose: Financial standing at a point in time.

• Equation: $\text{Assets} = \text{Liabilities} + \text{Stockholders’ Equity}$

• Components:

  • Assets: Current (within 1 year) and Long-term (over 1 year).

  • Liabilities: Current (due within 1 year) and Long-term (due beyond 1 year).

  • Stockholders’ Equity: Owner’s claims (Common stock, Retained earnings).

Statement of Cash Flows

• Purpose: Measures cash activity (inflows/outflows) over a period.

• Equation: $\text{Net Income} \pm \text{Changes in Operating, Investing, Financing Activities} = \text{Increase/Decrease in Cash} + \text{Beginning Cash} = \text{Ending Cash}$

• Sections: Operating, Investing, Financing activities.

Chapter 3: Recording Transactions

• Definition: Documenting business transactions that affect the accounting equation.

• Key Concept: Each transaction has a dual effect, impacting at least two accounts and keeping $\text{Assets} = \text{Liabilities} + \text{Stockholders Equity}$ balanced.

• Debits (DR):

  • Increase in assets; decrease in liabilities and equity. (Left side)

• Credits (CR):

  • Increase in liabilities and equity; decrease in assets. (Right side)

• Normal Balances: Debit for Dividends, Expenses, Assets (DEA); Credit for Liabilities, Owners’ Equity, Revenues (LOR).

• Journal Entry: Chronological record of transactions using debits/credits.

• General Ledger (GL): Collection of all accounts and their transactions.

• T-Accounts: Simplified GL showing debits and credits for each account.

• Trial Balance: List of all accounts and their balances, ensuring total debits equal total credits.

Chapter 4: Accrual vs. Cash Basis Accounting

• Accrual-Basis Accounting: Records events as they occur; revenue when earned, expenses when incurred. Allowed by GAAP.

• Cash-Basis Accounting: Records revenue when cash is received and expenses when cash is paid. Not part of GAAP.

• Revenue Recognition Principle: Revenues recorded when earned, regardless of cash timing.

• Expense Recognition Principle: Expenses recognized when resources are used, regardless of cash timing.

• Adjusting Journal Entries (AJE): Made at period-end to update records for timing differences.

  • Four Types: Prepaid Expenses, Deferred Revenue, Accrued Expenses, Accrued Revenues.

• Closing Process: Zeros out temporary accounts (revenues, expenses, dividends) into retained earnings, carrying permanent accounts (assets, liabilities) forward.

Chapter 5: Revenue Recognition

• Revenue Recognition Principle: Recognize revenue when earned, and for the expected amount.

  • Can be at a single point in time (e.g., sale of goods) or over time (e.g., service contracts).

• Net Revenue: Gross revenue minus sales returns and sales discounts.

• Credit Sales: Immediate good/service, deferred payment (Accounts Receivable).

• Allowance Method for Uncollectible Accounts: Required by GAAP to estimate bad debts.

  • Allowance for Uncollectible Accounts (AUA): Contra asset, estimated uncollectible funds.

  • Bad Debt Expense (BDE): Cost of uncollectible debts.

• Receivables Analysis:

  • Receivables Turnover Ratio: Frequency receivables turn into cash.

  • Average Collection Period: Days until receivables are collected.

• Notes Receivable: Formal credit arrangement, often with interest.

Chapter 1: Introduction to Accounting

• Definition of Accounting: Language of business for decision-making and telling a company's financial story.

• Applicability: Essential for all business professionals (consultants, marketing, HR).

Who Uses Accounting to Make Decisions?

• Key Stakeholders: Investors, customers, suppliers, creditors, employees, competitors, regulators.

Financial vs. Managerial Accounting

• Financial Accounting: Information for external users (stockholders, creditors).

• Managerial Accounting: Information for internal users (managers, company officers).

• Key Differences:

  • Primary Users: Financial (External), Managerial (Internal).

  • Primary Reports: Financial (Financial statements, annual report), Managerial (Internal reports like budgets).

  • Verification: Financial (Audited by CPA), Managerial (No external audit).

The Accounting Equation

• Equation: $\text{Assets} = \text{Liabilities} + \text{Equity}$

• Interpretation:

  • Assets: What the company owns.

  • Liabilities: What the company owes.

  • Equity: Owner's claim to company resources.

• Example: If a company has $50,000 in Cash (Asset) and$20,000 in Accounts Payable (Liability), its Equity must be $30,000. Thus,$50,000 = 20,000 + 30,000.

Keeping Things in Balance

• Concept: Every transaction must maintain balance in the accounting equation. If an asset increases, a liability or equity must also increase, or another asset must decrease.

Calculating Net Income

• Definition: Profit for a company over a specific duration, indicating financial performance.

• Equation: $\text{Net Income} = \text{Revenue} - \text{Expenses}$

  • Revenues: Amounts recognized when selling products or services.

  • Expenses: Costs incurred in providing products/services.

• Example: A software company earns $100,000 in service revenue and incurs$40,000 in salaries expense and $10,000 in rent expense. Net Income =$100,000 - (\text{40,000} + \text{10,000}) = \text{50,000}.

Financial Statements

• Definition: Periodic reports to inform external users.

• Main Financial Statements:

  1. Income Statement: Reports revenues, expenses, and net income over a period (month, quarter, year).

  2. Statement of Stockholder’s Equity: Summarizes changes in stockholders' equity accounts over a period.

  3. Balance Sheet: Reflects financial position at a singular point in time (Assets = Liabilities + Equity).

  4. Statement of Cash Flows: Measures cash inflows and outflows over a period (operating, investing, financing activities).

Connecting the Financial Statements

• Net income from the income statement flows into the statement of stockholders' equity.

• Ending balances from the statement of stockholders' equity appear in the equity section of the balance sheet.

Accounting Standards: U.S. and Global

• U.S. Standards: FASB creates Generally Accepted Accounting Principles (GAAP).

• Global Standards: IASB establishes International Financial Reporting Standards (IFRS).

The Annual Report & Auditor

• Annual Report (10-K): Public companies must provide to shareholders, includes financial statements, CEO letter, audit report.

• Auditor: Independent individual hired to ensure financial statements comply with GAAP, providing credibility.

Chapter 2: Income Statement

• Purpose: Reports company profit (or loss) over a specific timeframe.

• Equation: $\text{Net Income} = \text{Revenue and Gains} - \text{Expenses and Losses}$

• Gains and Losses: Increases/decreases in net income from transactions outside normal operations (e.g., selling old equipment).

• Multi-step Income Statement Subtotals:

  1. Gross Profit: $\text{Sales Revenue} - \text{Cost of Goods Sold}$

     • Example: A retail store sells goods for $20,000 (Sales Revenue) that cost them$12,000 (Cost of Goods Sold). Gross Profit = $20,000 - \text{12,000} = \text{8,000}.</p></li></ul></li><li><p><strong>Operating Income</strong>:$ \text{Gross Profit} - \text{Operating Expenses} $</p><ul><li><p><strong>Example</strong>: Building on the previous example, if the company has$3,000 in rent and $1,000 in utilities (Operating Expenses). Operating Income =$8,000 - (\text{3,000} + \text{1,000}) = \text{4,000}.

  2. Pretax Income: $\text{Operating Income} \pm \text{Non-operating items}$

     • Example: If the company from above also earned $200 in interest revenue (non-operating item). Pretax Income =$4,000 + \text{200} = \text{4,200}.

  3. Net Income: $\text{Pretax Income} - \text{Tax Expense}$

     • Example: If the company from above has a tax expense of $1,000. Net Income =$4,200 - \text{1,000} = \text{3,200}.

Statement of Stockholders’ Equity

• Purpose: Summarizes changes in equity accounts during a period.

• Components:

  • Contributed Capital: Owner investments.

  • Retained Earnings: Accumulated net income minus dividends.

• Equation: $\text{Ending RE} = \text{Beginning RE} + \text{Net Income} - \text{Dividends}$

• Example: A company starts the year with $50,000 in Retained Earnings (Beginning RE). During the year, it earns$10,000 in Net Income and pays $2,000 in Dividends. Ending RE =$50,000 + \text{10,000} - \text{2,000} = \text{58,000}.

Balance Sheet

• Purpose: Financial standing at a point in time.

• Equation: $\text{Assets} = \text{Liabilities} + \text{Stockholders’ Equity}$

• Components:

  • Assets: Current (within 1 year) and Long-term (over 1 year).

  • Liabilities: Current (due within 1 year) and Long-term (due beyond 1 year).

  • Stockholders’ Equity: Owner’s claims (Common stock, Retained earnings).

• Example: At year-end, a company has assets of $75,000 (Cash, Equipment), liabilities of$25,000 (Accounts Payable, Loan Payable), and stockholders' equity of $50,000 (Common Stock, Retained Earnings).$75,000 = 25,000 + 50,000.

Statement of Cash Flows

• Purpose: Measures cash activity (inflows/outflows) over a period.

• Equation: $\text{Net Income} \pm \text{Changes in Operating, Investing, Financing Activities} = \text{Increase/Decrease in Cash} + \text{Beginning Cash} = \text{Ending Cash}$

• Sections: Operating, Investing, Financing activities.

• Example: A company starts with $10,000 cash. Cash from operating activities is$5,000. It buys equipment for $3,000 (investing activity). It takes out a loan for$2,000 (financing activity). Increase/Decrease in Cash = $5,000 - \text{3,000} + \text{2,000} = \text{4,000}. Ending Cash =$10,000 + \text{4,000} = \text{14,000}.

Chapter 3: Recording Transactions

• Definition: Documenting business transactions that affect the accounting equation.

• Key Concept: Each transaction has a dual effect, impacting at least two accounts and keeping $\text{Assets} = \text{Liabilities} + \text{Stockholders Equity}$ balanced.

• Debits (DR):

  • Increase in assets; decrease in liabilities and equity. (Left side)

• Credits (CR):

  • Increase in liabilities and equity; decrease in assets. (Right side)

• Normal Balances: Debit for Dividends, Expenses, Assets (DEA); Credit for Liabilities, Owners’ Equity, Revenues (LOR).

• Journal Entry: Chronological record of transactions using debits/credits.

• General Ledger (GL): Collection of all accounts and their transactions.

• T-Accounts: Simplified GL showing debits and credits for each account.

• Trial Balance: List of all accounts and their balances, ensuring total debits equal total credits.

Chapter 4: Accrual vs. Cash Basis Accounting

• Accrual-Basis Accounting: Records events as they occur; revenue when earned, expenses when incurred. Allowed by GAAP.

• Cash-Basis Accounting: Records revenue when cash is received and expenses when cash is paid. Not part of GAAP.

• Revenue Recognition Principle: Revenues recorded when earned, regardless of cash timing.

• Expense Recognition Principle: Expenses recognized when resources are used, regardless of cash timing.

• Adjusting Journal Entries (AJE): Made at period-end to update records for timing differences.

  • Four Types: Prepaid Expenses, Deferred Revenue, Accrued Expenses, Accrued Revenues.

• Closing Process: Zeros out temporary accounts (revenues, expenses, dividends) into retained earnings, carrying permanent accounts (assets, liabilities) forward.

Chapter 5: Revenue Recognition

• Revenue Recognition Principle: Recognize revenue when earned, and for the expected amount.

  • Can be at a single point in time (e.g., sale of goods) or over time (e.g., service contracts).

• Net Revenue: Gross revenue minus sales returns and sales discounts.

• Credit Sales: Immediate good/service, deferred payment (Accounts Receivable).

• Allowance Method for Uncollectible Accounts: Required by GAAP to estimate bad debts.

  • Allowance for Uncollectible Accounts (AUA): Contra asset, estimated uncollectible funds.

  • Bad Debt Expense (BDE): Cost of uncollectible debts.

• Receivables Analysis:

  • Receivables Turnover Ratio: Frequency receivables turn into cash.

  • Average Collection Period: Days until receivables are collected.

• Notes Receivable: Formal credit arrangement, often with interest.