M12 Accounting and Finance

Introduction to Accounting

• Definition of Accounting:

  • Accounting is the process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information.

  • Provided by the American Accounting Association, it states that information is primarily financial and presented in monetary terms.

• Importance of Financial Information:

  • Financial information allows businesses to track their accounts and avoid insolvency.

  • Essential questions that financial information answers:

  • How much cash does the business need to pay its bills and employees?

  • Is the business profitable or losing money?

  • How much product should be produced and sold?

  • What are the costs associated with goods or services?

  • What are daily, monthly, and annual expenses?

  • How much money do customers owe and are they paying on time?

  • How much money does the business owe to vendors and creditors?

Stakeholders in Accounting Information

• Three Primary Audiences for Accounting Information:

  1. Internal Users: Individuals within the organization (e.g., management, employees).

  2. External Users: Individuals outside the organization (e.g., investors, creditors, tax authorities).

  3. Regulatory Bodies: Organizations that ensure compliance and regulation (e.g., the SEC and FASB).

• Usage by Different Stakeholders:

  • Internal users (e.g., HR, production managers) need information to make operational decisions.

  • External users (e.g., investors, banks) evaluate financial outcomes for decision-making regarding investments and loans.

The Language of Accounting

• Accounting as the Language of Business:

  • Accounting is referred to as the language of business due to its critical role in providing financial information.

  • Similarly, not-for-profit organizations also utilize accounting for financial communication.

Types of Accounting

• Financial Accounting:

  • Focuses specifically on external reporting, mainly through financial statements.

  • Operates under Generally Accepted Accounting Principles (GAAP) to ensure consistency and comparability.

• Managerial Accounting:

  • Aimed at internal stakeholders for decision-making purposes.

  • Not bound by GAAP, allowing more flexibility in the presentation of information.

• Tax Accounting:

  • Concerned with compliance with tax laws and minimizing tax liabilities, based on the Internal Revenue Code.

Financial Statements Overview

• Key Financial Statements:

  1. Income Statement: Reflects the profitability of a company over a given period.

  2. Statement of Owner's Equity: Shows changes in retained earnings over time.

  3. Balance Sheet: Provides a snapshot of a company's financial position at a specific time.

  4. Statement of Cash Flows: Shows inflows and outflows of cash over a period.

Detailed Breakdown of Financial Concepts

• Assets:

  • Economic resources owned or controlled by a business that has positive economic value.

  • Includes cash, accounts receivable, inventory, equipment, etc.

• Liabilities:

  • Obligations or debts that the organization owes to external parties, representing future sacrifices of economic benefits.

• Equity:

  • The residual interests in the assets of the entity after deducting liabilities; often referred to as owner’s equity or shareholders' equity.

Accounting Equation

• Accounting Equation:

  • The foundation of accounting is summarized in the accounting equation:
    $Assets = Liabilities + Owner's Equity$

  • This equation must always balance, ensuring accuracy in financial reporting.

Financial Statement Preparation Order

• Preparation Sequence:

  1. Income Statement

  2. Statement of Retained Earnings

  3. Balance Sheet

  4. Statement of Cash Flows

Examples of Financial Statements

Income Statement Example:

• Metro Courier Incorporated:

  • For the month ended 01/31/2020:

  • Revenues:

    • Service Revenue: $60,000

  • Expenses:

    • Salary Expense: $900

    • Utility Expense: $1,200

  • Net Income:

    • Calculation:
      $Net Income = Total Revenues - Total Expenses = 60,000 - 2,100 = 57,900$

Statement of Owner's Equity Example:

• Metro Courier Incorporated:

  • For the month ended 01/31/2020:

  • Beginning Retained Earnings: $0

  • Net Income: $57,900

  • Total Increase: $57,900

  • Ending Retained Earnings: $57,900

Balance Sheet Example:

• Metro Courier Incorporated:

  • As of 01/31/2020:

  • Assets:

    • Cash: $66,800

    • Accounts Receivable: $5,000

    • Total Assets: $88,100

  • Liabilities:

    • Accounts Payable: $200

  • Total Liabilities: $200

  • Equity:

    • Common Stock: $30,000

    • Retained Earnings: $57,900

    • Total Equity: $87,900

  • Total Liabilities and Equity: $88,100

Statement of Cash Flows Overview:

• Purpose of Statement:

  • Reports cash receipts and cash disbursements during an accounting period, classified into operating, investing, and financing activities.

• Importance:

  • Provides vital information regarding cash health, which is critical for management, investors, and creditors.

Conclusion

• Importance of Accounting Knowledge:

  • Essential for making informed personal and professional financial decisions.

  • Understanding accounting can influence tax decisions, budgeting, and investment planning.