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:
Income Statement: Reports revenues, expenses, and net income over a period (month, quarter, year).
Statement of Stockholder’s Equity: Summarizes changes in stockholders' equity accounts over a period.
Balance Sheet: Reflects financial position at a singular point in time (Assets = Liabilities + Equity).
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:
Gross Profit: \text{Sales Revenue} - \text{Cost of Goods Sold}
Operating Income: \text{Gross Profit} - \text{Operating Expenses}
Pretax Income: \text{Operating Income} \pm \text{Non-operating items}
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:
Income Statement: Reports revenues, expenses, and net income over a period (month, quarter, year).
Statement of Stockholder’s Equity: Summarizes changes in stockholders' equity accounts over a period.
Balance Sheet: Reflects financial position at a singular point in time (Assets = Liabilities + Equity).
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:
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}.
Operating Income: \text{Gross Profit} - \text{Operating Expenses}
Example: 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}.
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}.
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.