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FINANCIAL ACCOUNTING SUMMARY DOC
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Document covering all the main principles covered in any international business undergrad first-year financial accounting course. Based on the textbook linked.
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Fiche FINANCIAL ACCOUNTING – Preparing for the finalLECTURE 1
Accounting is an information system that:
• Measures business activities, Processes data into reports, and Communicates results to
decision makers. It helps companies, shareholders and managers make decisions about:
o Sources of funding and capital
o Costing and pricing
o Analyze performance of business groups
Forms of Business Organization:
• Proprietorship (single owner)
o small retail stores, personally liable for all business’ debts
• Partnership (two or more parties as co-owners)
o Incomes and losses flow through to partners
o Small and medium sized companies
o General partnerships have mutual agency and unlimited liability
o In limited-liability partnerships, only liable up to the investment put in
• Corporation (owned by shareholders)
o Able to raise large sums of capital by issuing shares
o Legally distinct from its owners
o Shareholders have no personal obligation for the corporation’s debts, limited
liability
Accounting Standards:
à International Financing Reporting Standards IFRS à formulated by the International Accounting
Standards Board (IASB)
à Generally Accepted Accounting Principles GAAP à formulated by the Financial Accounting Standards
Board (FASB)
ASSETS = LIABILITIES + OWNER’S EQUITY
Þ Assets are resources expected to produce future benefit
o Cash and cash equivalents
o Inventories
o Property, plant, equipment
Þ Liabilities – debts payable to outsiders
o Accounts payable
o Income taxes payable
o Long-term debt
Þ Owner’s Equity – shareholder’s interest in the assets
o Paid-in capital
o Retained earnings
Owner’s Equity
, • Assets – Liabilities = Owner’s Equity
• A corporation’s equity is called shareholders’ equity and has two parts:
o Paid-in capital: amount shareholders invested in the business
o Retained earnings: amount of earned income kept for use in the business
• Components:
o Revenues à inflow of resources from delivering goods or services, INCREASE in
retained earnings
o Expenses à outflow of resources due to the cost of operations, DECREASE
retained earnings
o Dividends à distribution of assets to shareholders, DECREASE retained earnings
Flow of financial statements
Þ Income statement (records revenues and expenses for the period)
o Net income = Total revenues and gains – total expenses and losses
Þ Statement of retained earnings
Þ Balance sheet
o AKA statement of financial position
o Reports assets, liabilities, and shareholders’ equity
o Reflects the company’s position at a specific moment in time
o Represents the shareholders’ ownership of the business’s assets (common
shares, retained earnings, treasury stock, etc.)
Þ Statement of cash flows (measures cash receipts and payment)
o Operating activities (cash flows from selling goods and services to customers)
o Investing activities (cash flows from purchasing and selling long term assets)
o Financing activities (cash flows from borrowing or repaying funds or equity
transactions)
Equity – owner’s residual interest in the entity after deducting liabilities
• Net income increases total equity
• Net losses and dividends decrease total equity
• Net income (net loss) flows from the income statement to the statement of changes in
equity
Current Assets – expected to be used or converted to cash within one business cycle
Þ Cash and cash equivalents, short-term investments, accounts receivable, prepaid
expenses
Long-term Assets – expected to benefit the company beyond the next fiscal year
Þ Property, plant, and equipment PPE, long-term investments, intangible assets
Current liabilities – debts due within one year
Þ Accounts payable, salaries payable, short-term notes payable, accrued liabilities
Long-term liabilities – debts payable after one year
, Þ Long-term notes payable, long-term bonds payable
Relationship between financial statements (steps)
1) Net income from Income statement à statement of equity change
2) Closing balance of equity from statement of equity change à flows into balance sheet
3) Closing balance of cash from statement of cash flows à balance sheet
LECTURE 2
ASSETS = LIABILITIES + EQUITY
1. Shareholder’s Equity = Share Capital + Retained Earnings
2. Retained Earnings = Net income – Dividends
3. Net income = Revenue – Expense
Retained Earnings = Revenue – Expense – Dividends
Hence, Shareholders’ equity = share capital + [Revenue – Expense – Dividends]
A transaction is any event with a financial impact on the business that can be measured reliably.
Þ Example: company X sells cars, borrows money, pays for materials, pays salaries and
taxes, and buys equipment (all separate transactions)
Þ A transaction will affect the accounting equation
PAYING “ON ACCOUNT” à agreeing/promising to pay within a certain time limit – this is
accounts payable (only used for on account transactions related to ONLY inventories/supplies &
utilities
Accounting is a DOUBLE ENTRY SYSTEM à for every transaction, at least two accounts will be
affected – DEBIT = CREDIT
T-ACCOUNTS record increases and decreases in a specific asset, liability, equity, revenue, or
expense
Final form of the rules of debit and credit
, Record/JOURNALIZE transactions in the books
A journal is a chronological record of transactions
3 steps:
1. Specify each account affected by the transaction and classify by type
2. Determine if each account is increased or decreased (debit or credit)
3. Record in the journal (write debit first)
4. Posting to a ledger
LECTURE 3
ACCRUAL ACCOUNTING
• Records impact of transactions when they occur
• Records income when earned & expenses when incurred
• When a business performs a service or makes a sale or incurs an expense, the
accountant records the transaction even if the business receives or pays no cash
CASH-BASIS ACCOUNTING
• Records only cash transactions – cash receipts & cash payments
• Fails to capture the underlying economic phenomenon
• Results in incomplete financial statements
• Cash receipts are treated as revenues and cash payments are handled as expenses
The Time-Period Concept
Þ Accounting information is reported at regular intervals
Þ Basic accounting period is one year
Þ Companies also prepare financial statements for interim periods
The REVENUE PRINCIPLE
§ Revenue is to be recorded when EARNED – never before
§ This means when goods are delivered to the customer
§ Revenue is recorded for cash or value that the entities expect to receive in exchange
§ Risks and rewards of ownership of the goods transferred to the buyer
§ What amount of revenue to record à If you have a buy-back policy (after 1 year), you
cannot recognize the entire sale as revenue. i.e., product for 300 euros, at time of sale
only 150 is recorded.
The Expense Recognition Principle
§ Two steps:
o Identify all expenses incurred during the period
o Measure the expenses and recognize them in the same period in which any
related revenues are earned
o To recognize an expense with related revenues means to subtract expenses from
related revenues to compute net income or net loss
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