1- Intro to Financial Accounting

7/31/2019 1- Intro to Financial Accounting

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Chapter 1

INTRODUCTION TO

FINANCIAL ACCOUNTING


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ACCOUNTING

The art of classifying, recording, summarizing and communicating in asignificant manner and in terms of money, transactions and events whichare in part at least of a financial character, and interpreting the resultstherefore.

Classifying / Identifyinginvolves selecting those events that are consideredevidence of economic activity relevant to a particular organization (transactions).

Recordingalso known as journalizing, is the process of keeping a

chronological diary of measured events in an orderly and systematic manner. In

recording, economic events are also classified and summarized. It is putting in

writing of economic transactions.

Communicating / Interpretingdescribing and reporting the recorded data to

interested users. They are communicated through the preparation and

distribution of accounting reports e.g. financial statements.


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Brief History of Accounting

The origins of accounting are generally attributed to the wordof Luca Pacioli, a famous Italian Renaissance mathematician.

In his text Summa de Arithmetica, Geometria, Proportione et

Proportionalite,Pacioli described a system to ensure thatfinancial information was recorded efficiently and accurately.

With the advent ofIndustrial Age in the 19th century and later,the emergence of large corporations, a separation of the

owners from the managers of businesses took place. As aresult, the need to report the status of the business enterprisetook an increasing importance , to ensure that managers actedin accord with owners wishes


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Users of Accounting Information

Individualsmanaging bank accounts, evaluating job prospects, investments, anddeciding whether to rent or buy a house.

Businesses- setting goals for the organization, to evaluate their progress, and takecorrective action e.g. which building and equipment to purchase, how muchmerchandise inventory to keep on hand, and how much cash to borrow.

Investorsaccounting helps them to evaluate what income they can reasonablyexpect on their investment.

Creditorslenders determine the borrowers ability to meet scheduled paymentsthrough accounting information. They are interested in information that enablesthem to determine whether amounts owing to them will be paid when due.

Government Regulatory Agencies- accounting provides financial statements of anenterprise for statistics, income taxes, etc.

Nonprofit organizations- they deal with budgets, payrolls, rent payments, and thelike e.g. churches, hospitals, government agencies and colleges


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RELEVANT GENERALLY ACCEPTED ACCOUNTING PRINCIPLES(GAAPs)

1. CONSERVATISM CONCEPT. You are allowed to provide for all possible losses,

but you should never, never anticipate gains. Also, normally among several possible

alternatives, the alternative with the lowest figure will be chosen.

2. COST CONCEPT. Financial transactions are recorded at acquisition cost rather

than at market value. The accounting records only reflect at what price the properties

were acquired, not what they are presently worth.

3. DUAL ASPECT CONCEPT. Each financial transaction affects at least two

accounts. As such, accounting is often referred to as a double-entry system.

4. ENTITY CONCEPT. Personal transactions should be segregated from business

transactions. Nonbusiness transactions should not be recorded in the books.

5. GOING-CONCERN CONCEPT. An entity is in business to make a profit and does

not envision an immediate liquidation of the business. Current resale values of

properties are not primarily significant to the owners since the intent of the business

is to use the properties rather than to sell them.


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6. CONSISTENCY CONCEPT. Once an accounting method has been chosen, it

must be consistently used every accounting period. Changing accounting methods

from time to time would only make comparative analyses difficult and inconclusive,

and also, the government internal revenue does not allow the arbitrary changing of

accounting methods.

7. MONEY-MEASUREMENT CONCEPT. All financial transactions must be capableof being measured in terms of money. Transactions are recorded in terms of

monetary values and not in terms of economic values or the purchasing power.

8. MATERIALITY CONCEPT. The recording and treatment of events or transactions

are to be dictated by the usefulness of the results. If a financial transaction, when

recorded or omitted, would grossly distort any of the financial statements, then thattransaction is said to be material and should be recorded.

9. MATCHING CONCEPT. All the costs/expenses for the period must be properly

matched with all the revenues for the same period. Any expense or revenue before

or after this period must be excluded.


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10. TIME-PERIOD CONCEPT. An accounting period or an accounting cycle can be

a month, a quarter, six months, or one year. Owners of a business usually prefer

regular monthly reports to keep track of their operations; those for outsiders are

usually done intermittently or for one-year period.

11. REALIZATION CONCEPT. Revenues are normally recognized at the time goods

or services are provided to the customers at the price agreed upon, and not upon the

actual collection of the income unless the cash basis of accounting is being used.

Expenses are likewise normally recognized at the time they are incurred, and not

upon the actual payment of the expenses unless the cash basis of accounting is

being used. The actual realization of the cash in or cash out is not necessary for the

transaction to be recorded under the accrual basis of accounting.

12. RELIABILITY CONCEPT. The accounting data must be dependable and legally

defensible. They must reflect an honest basis of measurement and must be properly

documented.


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13. COMPARABILITY CONCEPT. Financial data to be comparable must have acommon base. The same or similar businesses may be compared as long as the

accounting method and period are the same. The same accounting practices must

be applied from period to period.

14. DISCLOSURE CONCEPT. The financial statements of a business must be

reliable and reflective of its operations. Full disclosure must be made in the financialreports, especially those provided to outside parties. Footnotes may also be

included.

15. IMPARTIALITY CONCEPT. The financial reports must not contain personal

bias. They must be objective, not subjective. Personal feeling/opinions must not be

allowed to cloud the real issues.


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Basic Financial Statements and Their Elements

* BALANCE SHEET

- also called statement of financial condition, is an itemized statement ofthe assets, liabilities and proprietorship of the business.

- It is a statement reflecting the financial condition (ability to meet itsobligations as they fall due) of the business, its debts to outsiders, and theequity of the owner or members.

It answers the questions: How much property does the business own?

How much does the business owe to outsiders?

How much is the owner or owners worth?

Financial Statements are the formal reports prepared by accountants. These

statements show the financial effects of transactions and other events by grouping

them into broad classes according to their economic characteristics.


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Parts of Balance Sheet:

A. Headingcomposed of the following:- Name of the business, if any, or name of the owner, if there is no

business name.

- Name of the form or statement

- Date of the Statement

B. Bodycomposed of two divisions. One division contains the assets and theother contains the liability and proprietorship section


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I. Assetsproperties owned by the business or upon which the business has a

vested equitable interest. They are comprise of anything of economic value to

the owner and which is legally free for him to dispose.

Classifications of Assets:

A. Current assetseasily converted to cash within an accounting period

Examples:

Cash and Cash Equivalents

Currency - Any form of money that is in public circulation . It

includes in both hard money (coins) and soft money (paper money).

Bank balances - The amount of money in a bank account

Negotiable money orders - financial instrument, issued by a bank or

other institution, allowing the individual named on the order to receive

a specified amount of cash on demand.

Checks. Demand draft drawn on a bank against its maker's (drawer's)

funds, to pay the stated amount of money to the bearer or named party

Accounting Elements in the Balance Sheet


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Accounts receivable

Normally abbreviated as A/R, these are funds that customers currently owe to a

company. They've received the company's products, but haven't yet paid for those goodsor services.

Notes Receivable

Loans made to others.

Prepaid Insurance

Premiums that are paid in advance.

Office Supplies

Are assets from purchase to use.

Inventories

These are the components and finished products that a company has currently

stockpiled to sell to customers


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B. Non-current or fixed assetsare permanent in nature and they are acquired for use

rather than reselling. They are not expected to be consumed or converted into cash any

sooner than at least one year's time.

Examples: Land

Land is considered a fixed asset but, unlike other fixed assets, is not

depreciated, because land is considered an asset that never wears out.

Buildings

Buildings are categorized as fixed assets and are depreciated over time.Your place of business - garage, plant, store.

Office equipment

This includes office equipment such as copiers, fax machines, printers, and

computers used in your business.

Machinery

This figure represents machines and equipment used in your plant to produce

your product. Examples of machinery might include lathes, conveyor belts, or a

printing press.

Vehicles

This would include any vehicles used in your business.


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II. Liabilitiesthe things owed by the business. They are financial obligations or

debts of the business in favor of persons or parties other than the owner/s.

Classification of Liabilities:

A. Current Liabilities

Accounts payable

This is comprised of all short-term obligations owed by your business to

creditors, suppliers, and other vendors. Accounts payable can include supplies

and materials acquired on credit.

Notes payable

This represents money owed on a short-term collection cycle of one year or

less. It may include bank notes, mortgage obligations, or vehicle payments.

Accrued payroll and withholding

This includes any earned wages or withholdings that are owed to or foremployees but have not yet been paid.


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Unearned Revenue

- You've been paid, but haven't delivered.

Salaries Payable

- Salaries you owe employees.

Interest Payable

- Interest you owe.

Taxes Payable

- Taxes you owe.


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B. Non-Current Liabilities:

Bonds Payable

Bond - is a promise to repay the principal along with interest (coupons) on

a specified date (maturity).

A debt instrument issued for a period of more than one year with the

purpose of raising capital by borrowing.

Mortgage payableMortgage -The long-term financing used to purchase property . The

property itself serves as collateral for the mortgage until it is paid off.

Obligation listed as a long-term liability in a firm's balance sheet, except

the obligation's current portion (due within a year of the balance sheet date)

which is listed as a current liability.

Long-term notes


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III. Capital/ Owners Equity - represents the residual interest in the assets of the

enterprise. If there are no debts, business property is the capital. Therefore, at any

time, capital is equal to property less total debts of the business.

- net worth - owners equity- proprietorship - equity


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Income Statement - reports the revenues earned by a company during a given

period of time and all the expenses which were incurred in earning those revenues.

a. Revenue - refers to the sales and other income generating activities.

Effect:

- increasing assets or decreasing liabilities

b. Expenses - refers to necessary operating costs such as salaries, expenses and

other operating expenses (material, labor, overhead)


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Types of Business Organizations

Proprietorshiphas a single owner

Partnership- joins two or more individuals together as co-owners

Corporation - a business owned by stockholders

Types of Business Organizations (as to source of income)

Service Type - those which derive their income from sales of services to clients or

customers

Examples: Car repair shops, hospitals, apartment houses, travel agencies, etc.

Merchandising or Trading Typebusinesses which buy goods, and without

changing their form, sell them at a profit.

Examples: Department stores, drug stores, sari-sari stores, rice dealers, etc.

Manufacturing Typethose businesses who buy raw materials, convert them to

finished goods before finally selling them at a profit.

Examples: garment factories, paper mills, bottling companies, etc.

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1- Intro to Financial Accounting

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