1. Accounting cycle
1.1. .
2. Accounting equation
2.1. Basic
2.1.1. Assets = Liabilities + Equity
2.1.1.1. Assets
2.1.1.1.1. resources a business owns that should have the capacity to provide future services or benefits, such service potential or future economic benefit eventually results in cash inflows.
2.1.1.2. Liabilities
2.1.1.2.1. claims against assets, existing debts and obligations.
2.1.1.2.2. Payables
2.1.1.2.3. types
2.1.1.3. Equity
2.1.1.3.1. he ownership’s claim on a company’s total assets.
2.1.1.3.2. Residual Equity
2.1.1.3.3. Consists of
2.2. Expanded
2.2.1. Assets = Liabilities + Share Capital-Ordinary + Revenues - Expenses - Dividends
3. Financial Statements
3.1. looks like
3.1.1. .
3.1.2. .
3.2. contains
3.2.1. Income Statement
3.2.1.1. presents the revenues and expenses and resulting net income or net loss for a specific period of time
3.2.1.2. PS: Does not include investments and dividend transactions between the shareholders and the business
3.2.1.3. Net income/loss = revenues – expenses
3.2.1.3.1. Net Income
3.2.1.3.2. Net Loss
3.2.2. Comprehensive Income Statement
3.2.2.1. presents other comprehensive income items that are not included in the determination of net income.
3.2.3. Statement of Cash Flow
3.2.3.1. summarizes the information about the cash inflows (receipts) and outflows (payments) for a specific period of time
3.2.3.2. Answers where the cash came from, what the cash was used for and what the change cas in the balance during the period
3.2.3.3. free cash flow = net cash provided by operating activities - capital expensitures - cash dividends
3.2.3.4. sources of information
3.2.3.4.1. comparative statements of financial position
3.2.3.4.2. current income statement
3.2.3.4.3. additional information
3.2.3.5. It reports
3.2.3.5.1. The cash effects of a company’s operations during a period (cash receipts, payments and net changes)
3.2.3.5.2. Its investing activities
3.2.3.5.3. Its financing activities
3.2.3.5.4. The net increase or decrease in cash during that period
3.2.3.5.5. The cash amount at the end of the period
3.2.3.6. summary
3.2.3.6.1. .
3.2.3.7. indirect method
3.2.3.7.1. adjusts net income from items that do not affect cash.
3.2.3.7.2. Most companies use it for two reasons: easier and less costly to prepare, and it focuses on the differences between income and net cash flows from operating activities.
3.2.3.7.3. steps
3.2.3.8. direct method
3.2.3.8.1. steps
3.2.3.9. helps in assessing
3.2.3.9.1. the entity's ability to generate future cahs flows
3.2.3.9.2. the entity's ability to pay dividents and meet obligations
3.2.3.9.3. the reasons for the difference between net income and net cash used by operating activities
3.2.3.9.4. the cash investments and the financial transactions during the period
3.2.3.10. events classified under the Statement of Cash Flow
3.2.3.10.1. operating activities
3.2.3.10.2. investing activities
3.2.3.10.3. financial activities
3.2.3.11. types of cash inflows and outflows
3.2.3.11.1. .
3.2.4. Statement of Financial Position / Balance Sheet
3.2.4.1. reports the assets, liabilities, and equity of a company at a specific date, like a snapshot of the company’s financial condition at a specific moment in time
3.2.4.2. Classified Statement of Financial Position
3.2.4.2.1. classified
3.2.4.2.2. Helps to determine whether the company has enough assets to pay its debts as they come due, and the claims of short and long-term creditors on the company’s total assets
3.2.4.2.3. contains
3.2.4.2.4. Liquidity
3.2.4.2.5. depreciation
3.2.4.2.6. Operating Cycle
3.2.5. Retained Earnings Statement
3.2.5.1. summarizes the change in retained earrings for a specific period of time
3.2.5.2. The information provided by this statement indicates the reasons why retained earnings increased or decreased during the period. If there is a net loss, it is deducted with dividends in the retained earnings statement
4. Recording process
4.1. T-account
4.1.1. Composition
4.1.1.1. Title
4.1.1.2. Debit (left) Dr.
4.1.1.2.1. records increases in cash
4.1.1.3. Credit (right) Cr.
4.1.1.3.1. records decreases in cash
4.1.2. Double-Entry System
4.1.2.1. records in appropriate accounts the dual effect of each transaction. This ensures the accuracy of the recorded amounts and the detection of errors
4.1.2.2. For each transaction, Debit must equal Credit
4.1.3. Application to
4.1.3.1. Assets and Liabilities
4.1.3.1.1. Normal Balance
4.1.3.1.2. Asset Account
4.1.3.1.3. Liability Account
4.1.3.1.4. .
4.1.3.2. Equity
4.1.3.2.1. Share Capital-Ordinary
4.1.3.2.2. Retained Earnings
4.1.3.2.3. Dividends
4.1.3.2.4. Revenues and Expenses
4.2. Journal
4.2.1. an accounting record in which transactions are initially recorded in chronological order
4.2.2. process
4.2.2.1. 1) Analyze each transaction in terms of its effect on the accounts 2) Enter the transaction information in the journal 3) Transfer the journal information to the appropriate accounts in the ledger
4.2.2.2. How to wite a complete entry
4.2.2.2.1. 1) The date of the transaction. 2) The accounts and amounts to be debited and credit. 3) A brief explanation of the transaction.
4.2.2.2.2. 1 The date of the transaction is entered in the Date column 2 The debit account title is entered first the extreme left margin of the column headed “Account Titles and Explanation,” and the amount of the debit is recorded in the Debit column 3 The credit account title (account to be credited) is indented and entered on the next line in the column headed “Account Titles and Explanation,” and the amount of the credit is recorded in the Credit column 4 A brief explanation of the transaction appears on the line below the credit account title. A space is left between journal entries. 5 The column titled Ref. (reference) is left blank when the journal entry is made. It is used later when the journal entries are transferred to the individual accounts
4.2.3. entries
4.2.3.1. simple entry
4.2.3.1.1. a journal entry that involves only 2 accounts (debit and credit)
4.2.3.2. compound entry
4.2.3.2.1. a journal entry that involves 3 or more accounts
4.3. Ledger
4.3.1. the entire group of accounts maintained by a company, provides the balance in each of the accounts
4.3.2. general ledger
4.3.2.1. a ledger that contains all asset, liability and equity accounts
4.3.3. Three-column form of account
4.3.3.1. a form with columns for debit, credit and balance amounts in an account.
4.3.3.2. The balance is determined after each transaction
4.3.3.3. .
4.3.4. posting
4.3.4.1. the procedure of transferring journal entries to the ledger accounts, done in chronological order.
4.3.4.2. steps
4.3.4.2.1. 1) In the ledger, in the appropriate columns of the account(s) debited, enter the date, journal page, and debit amount shown in the journal. 2) In the reference column of the journal, write the account number to which the debit amount was posted. 3) In the ledger, in the appropriate columns of the account(s) credited, enter the date, journal page, and credit amount shown in the journal. 4) In the reference column of the journal, write the account number to which the credit amount was posted.
4.3.5. chart of accounts
4.3.5.1. a list of account numbers that identify their location in the ledger, the numbering system that identifies the accounts usually starts with the statement of financial position accounts and follows with the income statement
4.4. Trial Balance
4.4.1. a list of accounts and their balances at a given time.
4.4.2. The trial balance proves the mathematical equality of debits and credits after posting.
4.4.3. .
4.4.4. steps
4.4.4.1. 1) List the account titles and their balances in the appropriate debit or credit column 2) Total the debit and credit columns 3) Verify the equality of the two columns
4.4.5. limitations
4.4.5.1. A trial balance does not guarantee freedom from recording errors, even when the trial balance columns agree
4.4.5.2. The trial balance may balance even when: ▪ A transaction is not journalized ▪ A correct journal entry is not posted ▪ A journal entry is posted twice ▪ Incorrect accounts are used in journalizing or posting ▪ Offsetting errors are made in recording the amount of a transaction
4.4.5.3. Thus, trial balance does not prove that the company has recorded all transactions or that the ledger is correct
5. Adjusting Entries
5.1. entries made at the end of an accounting period to ensure that companies follow the revenue recognition and expense recognition principles.
5.2. Necessary because
5.2.1. - Some events are not recorded daily because it is not efficient to do so. - Some costs are not recorded during the accounting period because these costs expire with the passage of time rather than as a result of recurring daily transactions. - Some items may be unrecorded. - Adjusting entries are required every time a company prepares financial statements, which consists of income statement account and one statement of financial position account.
5.3. types
5.3.1. Accruals
5.3.1.1. Accrued Revenues
5.3.1.1.1. Revenues for services performed but not yet received in cash or recorded.
5.3.1.1.2. adjusting entry
5.3.1.2. Accrued Expenses
5.3.1.2.1. Expenses incurred but not yet paid in cash or recorded
5.3.1.2.2. adjusting entry
5.3.1.2.3. types
5.3.2. Defferals
5.3.2.1. expenses or revenues that are recognized at a date later than the point when cash was originally exchanged
5.3.2.2. Types
5.3.2.2.1. Unearned Revenues
5.3.2.2.2. Prepaid Expenses
5.3.2.3. alternative treatment for defferals
5.3.2.3.1. prepaid expenses
5.3.2.3.2. unearned revenues
5.4. Adjusted Trial Balance
5.4.1. a list of accounts and their balances after the company has made all adjustments
5.4.2. The purpose of an adjusted trial balance is to prove the equality of the total debit balances and the total credit balances in the ledger after all adjustments. The accounts contain all data necessary for financial statements, the adjusted trial balance is the primary basis for the preparation of financial statements
5.4.3. The amounts affected by the adjusting entries are highlighted, then compared to those in the unadjusted trial balance.
5.5. Adjusted Financial Statements
5.5.1. Companies can prepare financial statements directly from the adjusted trial balance. Companies also prepare the statement of financial position from the asset and liability accounts and the ending Retained Earnings balance as reported in the retained earnings statement
6. Closing the Books
6.1. formally recognize in the ledger the transfer of net income (or net loss) and Dividends to Retained Earnings, which shows the results of these entries
6.2. Types of Accounts
6.2.1. Temporary accounts
6.2.1.1. relate only to a given accounting period, including all income statement accounts and the Dividends account
6.2.1.2. These accounts are closed.
6.2.1.3. Closing entry also produces a zero balance in each temporary account
6.2.1.4. Income Summary
6.2.1.4.1. a temporary account used in closing revenue and expense accounts, which is followed by transferring the resulting net income or net loss to Retained Earnings
6.2.2. Permanent accounts
6.2.2.1. relate to one or more future accounting periods, consisting of all statement of financial position accounts
6.2.2.2. These accounts are not closed.
6.3. process
6.3.1. 1. Debit each revenue account for its balance, and credit Income Summary for total revenues 2. Debit Income Summary for total expenses, and credit each expense account for its balance 3. Debit Income Summary and credit Retained Earnings for the amount of net income 4. Debit Retained Earnings for the balance in the Dividends account, and credit Dividends for the same amount
6.3.2. posting closing entries
6.3.2.1. Here, all temporary accounts have zero balances after posting the closing entries. Retained Earnings represents the accumulated undistributed earnings of the corporation at the end of the accounting period. This balance is shown on the statement of financial position and is the ending amount reported on the retained earnings statement The account balance is then entered below the single underline and is carried forward to the next period
7. Worksheet
7.1. a multiple-column form used in the adjustment process and in preparing financial statements, it is a working tool and not a permanent accounting record. The use of a worksheet is optional
7.2. steps
7.2.1. 1. Prepare a Trial Balance on the Worksheet - include all accounts with balances from ledger, the trial balance amounts come directly from ledger accounts 2. Enter the Adjustments in the Adjustments Columns - use a different letter (keying) to identify the debit and credit for each adjusting entry. Companies do not journalize the adjustments until after they complete the worksheet and prepare the financial statements. Also input total adjustments columns and check for equality. 3. Enter Adjusted Balances in the Adjusted Trial Balance Columns - for each account, the amount in the adjusted trial balance columns in the balance that will appear in the ledger after journalizing and posting the adjusting entries. Combine trial balance amounts with adjustment amounts to obtain the adjusted trial balance. Total adjusted trial balance columns and check for equality. 4. Extend Adjusted Trial Balance Amounts to Appropriate Financial Statement Columns - extend all revenue and expense account balances to the income statement columns. Extend all asset and liability account balances, as well as Share Capital — Ordinary and Dividends account balances, to the statement of financial position columns. 5. Total the Statement Columns, Compute the Net Income (or Net Loss), and Complete the Worksheet - the debit amount balances the income statement columns; the credit amount balances the statement of financial position columns. The difference between the totals of the two income statement columns determines net income or net loss. Net income is extended to the credit column of the statement of financial position columns (Net loss would be extended to the debit column)
7.3. .
8. Analysis
8.1. financial statement analysis
8.1.1. evaluation of a company's
8.1.1.1. liquidity
8.1.1.1.1. the liquidity of the borrower is important to evaluate the safety of the loan (short-term creditor)
8.1.1.2. profitability
8.1.1.2.1. analyses the company's ability to survive over a long period of time (long-term creditor)
8.1.1.3. solvency
8.1.1.3.1. the ability of a company to meet its long-term debts and other financial obligations.
8.1.2. Shareholders look at the profitability and solvency of a company to estimate likelihood of dividends and growth potential of investments
8.1.3. comparative analysis
8.1.3.1. To obtain information about increases or decreases, or whether the cash amount of a company is adequate in relation to the company’s need for cash, we need comparisons
8.1.3.1.1. intracompany basis
8.1.3.1.2. industry averages
8.1.3.1.3. ontercompany basis
8.1.4. tools of analysis
8.1.4.1. horizontal analysis
8.1.4.1.1. a technique for evaluating a series of financial statement data over a period of time and is used primarily in intracompany comparisons. Its purpose is to determine increase or decrease (in amount or percentage).
8.1.4.1.2. .
8.1.4.1.3. example
8.1.4.2. vertical analysis
8.1.4.2.1. a technique to express each financial statement item as a percentage of a base amount. Base for asset items is total assets and for equity and liability items it is total equity and liabilities. Is used in both, intra- and intercompany comparisons.
8.2. ratio analysis
8.2.1. Ratio analysis expresses the relationship among selected items of financial statement data.
8.2.1.1. expression
8.2.1.1.1. percentage
8.2.1.1.2. rate
8.2.1.1.3. proportion
8.2.1.2. liquidity ratios
8.2.1.2.1. current ratio
8.2.1.2.2. acid-test ratio
8.2.1.2.3. accounts receivable turnover
8.2.1.2.4. inventory turnover
8.2.1.3. profitability ratios
8.2.1.3.1. profit margin
8.2.1.3.2. asset turnover
8.2.1.3.3. return on assets
8.2.1.3.4. return on ordinary shareholher's equity
8.2.1.3.5. earnings per share (EPS)
8.2.1.3.6. price-earnings ratio
8.2.1.3.7. payout ratio
8.2.1.4. solvency ratios
8.2.1.4.1. debt to assets ratio
8.2.1.4.2. times interest earned
8.3. sustainable income
8.3.1. the most likely level of income to be obtained by a company in the future. It differs from net income by the amount of unusual revenues, expenses, gains and losses included current year’s income. Helps to estimate future earnings without “noise” of unusual items.
8.3.2. discounted operations
8.3.2.1. refer to the disposal of a significant component of a business. Example: a company sell its unprofitable chemical division.
8.3.2.2. The sale is reported on the income statement under “Discounted operations” consists of 2 parts:
8.3.2.2.1. the income (loss) from operations
8.3.2.2.2. gain / loss on disposal of the component
8.3.3. changes in accounting principle
8.3.3.1. occur when the principle used in the current year is different from the on one used in the preceding year (First FIFO, then average-cost-method).
8.3.4. statement of comprehensive income
8.3.4.1. comprehensive income = net income + other comprehensive items
8.3.4.2. Accounting standards require that companies adjust most investments in shares and bonds up or down to their actual value.
8.3.4.2.1. Example: a company has ordinary shares of $3,000,000 and retained earnings of $1,500,000 and accumulated other comprehensive loss of $2000.
8.3.4.3. Example: a company purchases shares for $10,000 and at the end of the year, the value of the shares is only $8000.
8.3.4.3.1. If they buy shares and hold them only to sell in near term to generate income (trading security), then they have to report unrealized losses under “other expenses and losses” on the income statement.
8.3.4.3.2. If they hold the shares to sell them sometime in the future, then they don’t have to report it on the income statement. They should report it as part of “other comprehensive income” (not part of the net income).
8.3.4.4. Reporting unrealized gain or loss in equity sections serves two purposes:
8.3.4.4.1. 1. Reduces volatility of net income due to fluctuations in fair value 2. It informs the financial statement user of the gain or loss that would occur if the company sold the securities at fair value
9. Activities
9.1. Identifying
9.2. recording
9.3. communicating
9.3.1. reporting info. in the company's financial statements
9.3.2. analyzing and interpreting info.
10. Merchandise Operations
10.1. Merchandising Company
10.1.1. buys and sells merchandise rather than perform services as their primary source of revenue
10.1.2. companies
10.1.2.1. retailers
10.1.2.1.1. merchandising companies that purchase and sell directly to customers
10.1.2.2. wholesalers
10.1.2.2.1. merchandising companies that sell to retailers
10.1.3. Sales Revenue / Sales
10.1.3.1. the primary source of revenue for merchandising companies is the sale of merchandise
10.1.4. Expenses
10.1.4.1. Cost for Goods Sold
10.1.4.1.1. the total cost of merchandise sold during the period, which is directly related to the revenue recognized from the sale of goods
10.1.4.2. Operating Expenses
10.1.5. Income measurement process
10.1.5.1. gross profit = sales revenue - cost of goods sold
10.1.5.2. net income = gross profit - operating expenses
10.1.6. Flow of Costs
10.1.6.1. ending inventory
10.1.6.1.1. goods that are not sold by the end of the accounting period
10.1.6.1.2. ending inventory = cost of goods available for sale - cost of goods sold
10.1.6.2. .
10.1.6.2.1. cost of goods available for sales = beginning inventory + cost of goods purchased
10.1.6.3. Inventory Systems
10.1.6.3.1. Perpetual Inventory System
10.1.6.3.2. Periodic Inventory system
10.1.7. Operating Cycle
10.1.7.1. The operating cycle of a merchandising company ordinarily is longer than that of a service company. The purchase inventory and its eventual sale lengthen the cycle
10.2. Service Company
10.2.1. Operating Cycle
10.2.1.1. .
11. Users
11.1. Internal Users
11.1.1. MANAGERIAL ACCOUNTING
11.1.1.1. provides internal reports to help users make decisions about their companies, such as comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year
11.1.2. managers who plan, organize and run the business.
11.2. External Users
11.2.1. FINANCIAL ACCOUNTING
11.2.1.1. provides economic and financial information for investors, creditors, and other external users. Includes:
11.2.1.1.1. Taxing Authorities
11.2.1.1.2. Regulatory Agencies
11.2.1.1.3. Customers
11.2.1.1.4. Labor Unions
11.2.2. Investors (owners)
11.2.2.1. use accounting information to decide whether to buy, hold, or sell ownership shares of a company
11.2.3. Creditors (suppliers and bankers)
11.2.3.1. use accounting information to evaluate the risks for granting credit or lending money
12. Accounting Standards
12.1. IASB: International Accounting Standards Board
12.1.1. IFRS: International Financial Reporting Standards
12.1.1.1. 130 countries
12.2. FASB: Financial Accounting Standards Board
12.2.1. GAAP: Generally Accepted Accounting Principles
12.2.1.1. USA
13. Principles
13.1. Fair Value Principle
13.1.1. states that assets and liabilities should be reported at fair value (the price received to see an asset or settle a liability).
13.2. Historical Cost Principle
13.2.1. states companies should record assets at their cost, during the time the asset is purchased, also over the time the asset is held
13.3. Revenue Recognition Principle
13.3.1. the principle that companies recognize revenue in the accounting period in which the performance obligation is satisfied
13.4. Expense Recognition Principle
13.4.1. companies recognize expense in the period in which they make efforts (consume assets or incur liabilities) to generate revenue
13.5. Full Disclosure Principle
13.5.1. accounting principle that dictates companies disclose circumstances and events that make a difference to financial statement users.
13.6. .
14. Qualities of useful accounting information
14.1. Relevance
14.1.1. financial information is capable of making a difference in a decision
14.2. Faithful Representation
14.2.1. the numbers and descriptions match what really existed or happened, they are factual
14.3. comparability
14.3.1. ability to compare the accounting information of different companies because they use the same accounting principles
14.4. consistency
14.4.1. use of the same accounting principles and methods from year to year within a company.
14.5. verifiability
14.5.1. the quality of information that occurs when independent observers, using the same methods, obtain similar results
14.6. timely
14.6.1. information that is available to decision-makers before it loses its capacity to influence decisions
14.7. understandability
14.7.1. information presented in a clear and concise fashion so that users can interpret it and comprehend its meaning
15. Assumptions
15.1. Monetary Unit Assumption
15.1.1. companies include in the accounting records only transaction data that can be expressed in terms of money. Enables accounting to quantify economic events, which is vital to applying the historical cost principle
15.2. Economic Entity Assumption
15.2.1. requires that the activities of the entity (any organization or unit in society) be kept separate and distinct form the activities of its owners and all other economic entities.
15.2.2. a business organized as a separate legal entity, having ownership divided into transferable shares.
15.2.3. rights of shareholders
15.2.4. Ownerships
15.2.4.1. Proprietorship
15.2.4.1.1. a business owned by 1 person
15.2.4.2. Partnership
15.2.4.2.1. a business owned by 2 or more people associated as partners
15.2.4.3. Corporation
15.2.4.3.1. The economic entity assumption doesn’t really apply here since a corporation is already a separate legal entity.
15.2.4.3.2. double taxation is applied
15.2.4.3.3. types
15.2.4.3.4. creation process
15.2.4.3.5. voting rights
15.2.4.3.6. shares
15.2.4.3.7. retained earnings statement
15.2.4.3.8. analysis
15.3. Time Period Assumption / Periodicity Assumption
15.3.1. the artificial time periods into which accountants divide the economic life of a business.
15.3.1.1. interim periods
15.3.1.1.1. monthly and quarterly time periods
15.3.1.2. fiscal year
15.3.1.2.1. an accounting time period that is one year in lenghth
15.3.1.3. calendar year
15.3.1.3.1. january 1st to december 31st
15.4. Going Concern Assumption
15.4.1. the business will remain in operation for the foreseeable future.
16. Transactions
16.1. Internal Transactions
16.1.1. economic events that occur entirely within one company
16.2. External Transactions
16.2.1. involve economic events between the company and some outside enterprise
17. Basis
17.1. Accrual-Basis Accounting
17.1.1. accounting in which companies record transactions that change a company’s financial statements in the periods in which the events occur, such as recognizing revenues and expenses when incurred → In accordance with International Financial Reporting Standards (IFRS))
17.2. Cash-Basis Accounting
17.2.1. accounting basis in which companies record revenue when they receive cash and an expanse when they pay out cash. More for small businesses that have few receivables and payables
18. Constraint
18.1. cost constraint
18.1.1. arises when it is excessively expensive to report certain information in the financial statements. When it is too expensive to do so, the applicable accounting frameworks allow a reporting entity to avoid the related reporting.