Introduction to Accounting

Accounting Activities

• Identifying: Recognizing economic events relevant to a business.

• Recording: Systematically documenting transactions.

• Communicating: Preparing accounting reports and analyzing/interpreting information for users.

Accounting Users

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

• External Users: Investors, creditors, tax authorities, regulatory agencies, and others outside the organization.

Accounting Standards

• GAAP (Generally Accepted Accounting Principles): Common set of accounting principles, standards, and procedures.

• IFRS (International Financial Reporting Standards): International standards for financial reporting.

• FASB (Financial Accounting Standards Board): Sets accounting standards in the US.

• IASB (International Accounting Standards Board): Develops IFRS.

Measurement Principles

• Historical Cost Principle: Assets are recorded at their cost.

• Fair Value Principle: Assets and liabilities are reported at fair value (the price received to sell an asset or paid to transfer a liability).

Assumptions in Accounting

• Monetary Unit Assumption: Only transactions that can be expressed in monetary terms are included.

• Economic Entity Assumption: Activities of the entity are separate from those of its owners or other entities.

• Time Period Assumption: The life of a business can be divided into time periods for reporting purposes.

• Going Concern Assumption: The business will continue operating in the foreseeable future.

Basic Accounting Equation

• Assets = Liabilities + Equity

• Assets: Resources owned by a business.

• Liabilities: Obligations or debts owed to outsiders.

• Equity: Owner's claim on assets.

Equity

• Share Capital – Ordinary: Amounts paid in by shareholders for ordinary shares.

• Retained Earnings: Cumulative net income retained in the business after dividends.

• Dividends: Distributions of earnings to shareholders.

• Equation:

Financial Statements

• Income Statement: Reports revenues and expenses for a specific period, showing net income or loss.

• Statement of Financial Position (Balance Sheet): Shows assets, liabilities, and equity at a specific date.

• Statement of Cash Flows: Reports cash inflows and outflows from operating, investing, and financing activities.

• Statement of Changes in Equity: Summarizes changes in equity during the period.

Transaction Analysis

The Recording Process

• Account: A record of increases and decreases in a specific asset, liability, or equity item.

• Double-Entry System: Each transaction affects at least two accounts (debits and credits).

• Normal Balances: Assets and expenses have debit balances; liabilities, equity, and revenues have credit balances.

Example Table: Normal Balances

Trial Balance

• Lists all accounts and their balances at a given time.

• Debits must equal credits.

Accrual Accounting Concepts

Adjusting Entries

• Ensure revenue and expense recognition principles are followed.

• Required every time a company prepares financial statements.

Types of Adjusting Entries

• Prepayments: Prepaid expenses and unearned revenues.

• Accruals: Accrued revenues and accrued expenses.

Depreciation

• Allocates the cost of a long-lived asset over its useful life.

• Recorded as an expense.

• Formula:

Merchandising Operations

Inventory Systems

• Perpetual System: Maintains continuous records of inventory.

• Periodic System: Updates inventory records at the end of the period.

Sales Transactions

• Sales revenue is recognized when goods are transferred to the buyer.

• Sales returns, allowances, and discounts reduce sales revenue.

Inventory

Inventory Costing Methods

• FIFO (First-In, First-Out): Oldest inventory costs are assigned to cost of goods sold first.

• LIFO (Last-In, First-Out): Most recent inventory costs are assigned to cost of goods sold first.

• Weighted Average: Cost of goods available for sale is averaged over all units.

Lower of Cost or Net Realizable Value

• Inventory is reported at the lower of cost or net realizable value.

Internal Controls and Reporting Cash

Fraud and Internal Control

• Fraud: Dishonest act by an employee for personal benefit at a cost to the employer.

• Internal Control: Processes to safeguard assets, enhance accuracy, and ensure compliance with laws.

• Principles include: Establishment of responsibility, segregation of duties, documentation, physical controls, independent verification, and human resource controls.

Bank Reconciliation

• Compares the company’s cash records with the bank statement to identify differences.

Receivables and Investments

Accounts Receivable

• Amounts owed by customers for goods or services sold on credit.

• Reported at net realizable value (accounts receivable less allowance for doubtful accounts).

Notes Receivable

• Written promises for amounts to be received, usually with interest.

• Interest calculation:

Long-Lived Assets

Plant Assets

• Physical assets used in operations (e.g., land, buildings, equipment).

• Depreciation allocates the cost over the asset’s useful life.

Intangible Assets

• Non-physical assets (e.g., patents, copyrights, trademarks).

• Amortization is used for intangible assets with finite lives.

Current Liabilities

Types of Current Liabilities

• Accounts payable, notes payable, unearned revenues, accrued liabilities.

• Reported at their settlement value.

Time Value of Money

Present and Future Value Concepts

• Money has a time value due to its earning potential.

• Present value formula:

Long-Term Liabilities

Bonds Payable

• Long-term debt instruments issued to raise capital.

• Reported at carrying value (face value adjusted for any premium or discount).

Stockholders' Equity

Shareholders’ Rights

• Vote, receive dividends, share in assets upon liquidation, preemptive right to new shares.

Issuing Shares

• Shares can be issued at par, above par (premium), or below par (discount).

Dividends

• Distributions of profits to shareholders, declared by the board of directors.

Statement of Cash Flows

Purpose

• Reports cash inflows and outflows from operating, investing, and financing activities.

Preparation Methods

• Direct Method: Lists cash receipts and payments.

• Indirect Method: Adjusts net income for non-cash items and changes in working capital.

Financial Statement Analysis

Types of Analysis

• Horizontal Analysis: Compares financial data over time.

• Vertical Analysis: Expresses items as a percentage of a base amount.

• Ratio Analysis: Evaluates relationships between financial statement items.

Key Ratios

GAAP vs IFRS

Comparison

• Both provide frameworks for preparing financial statements.

• GAAP is more rules-based; IFRS is more principles-based.

• Differences exist in presentation, measurement, and disclosure requirements.

Additional info: Some explanations and formulas have been expanded for clarity and completeness based on standard Financial Accounting curriculum.