Lecture 1
Accounting consists of 3 basic activities:
- Identifying = select economic events.
- Recording = record, classify, and summarize.
- Communicating = prepare accounting reports.
Identifying and recording is known as bookkeeping.
Organization’s that use accounting:
- Companies, from sole proprietorships to huge conglomerates.
- Non-profit organizations.
- Government organizations.
Types of companies:
- Sole proprietorships:
o No legal difference between the owner(s) and the company.
o The main objective of the company is to create value for the owner(s).
o The value of a company to its owner(s) is called equity.
An increase in equity (profit) is income to the owner(s).
- Partnerships:
o Similar to proprietorships but with more than one person.
o Common in professional services (lawyers, accountants, etc.).
- Corporations:
o A legal entity, it can own and owe things just like a human.
o It can borrow money from a bank.
o Formal separation of ownership and decision making.
o It is owned by 1 or more owners: limited liability, owners can be humans or
other corporations, shares can be transferred.
Accounting in corporations:
- Owners of the corporation are not necessarily actively involved in decision making.
- Owners (shareholders) invest their money in the corporation in the expectation of
receiving a positive return.
- Owners want periodic information about what their share of the corporation is
worth. At least once per year and corporations are required to publish an annual
report.
The value of a corporation to its owners is: what the corporation owns minus what is owes.
Equity = assets - liabilities
Assets = what the organization owns.
E.g. cash, inventory, machines, buildings, patents, trademarks, accounts receivables.
Liabilities = what the organization owes.
E.g. bank loans, bonds, accounts payable, unpaid salaries, unpaid taxes.
Revenues = increases in the value of the firm due to the firm’s operations.
E.g. sales, fees, interest.
1
,Expenses = the cost of assets consumed, or services used in the process of earning revenue.
E.g. salaries, rent, utilities, materials.
Net income = the difference between the revenues and expenses in a period.
The value of a corporation’s equity can change in 2 different ways:
- Operations: revenues and expenses resulting a net income (or a net loss).
- Transactions with owners.
Share Capital – Ordinary = amount that shareholders have invested in the corporation.
Retained Earnings = income from previous periods not (yet) paid out as dividends.
A=L+E
A = L + SC + RE
A = L + SC + (REV – EXP – DIV)
Who else (besides owners) needs information about a firm’s economic situation?
- Potential owners.
- Creditors (e.g. banks).
- Suppliers.
- Customers.
- Non-profit organizations.
- Government agencies.
o Chamber of Commerce, SEC (in US), AFM, DNB, etc.
o Tax authorities.
- Managers and employees!
Financial accounting: users outside the organization (including owners).
Subject to laws, regulations and standards.
Management accounting: users inside the organization.
Annual reports contain several financial statements:
- Statement of financial position / balance sheet.
- Income statement.
- Comprehensive income statement.
- Retained earnings statement.
- Statement of cash flows.
Lecture 2
2 main financial statements:
- Statement of financial position / balance sheet.
- Income statement.
Other financial statements provide additional information (comprehensive income
statement) or zoom in on changes in certain assets (cash) or equity components.
2
,Statement of financial position (balance sheet):
- Discloses an organizations’ financial position at a specific point in time.
- Lists categories of assets, liabilities and components of equity.
Income statement (statement of earnings / profit & loss statement):
- Discloses change in the value of equity due to the company’s operations during a
period.
- Lists revenues and expenses.
Assume there are no transactions with shareholders, then:
Change in assets = change in liabilities + net income.
Net income = change in assets – change in liabilities.
An account = a record of increases and decreases in a specific asset, liability, or equity
component. Traditionally, accounts were kept in books. Nowadays, everything is automated
in spreadsheets or ERP systems: SAP, Oracle, etc.
Assets have “debit accounts”.
Liabilities have “credit accounts”.
Revenues have “credit accounts”. It increases equity.
Expenses have “debit accounts”. It decreases equity.
3
, Explanation:
- An increase in assets requires a debit entry. A decrease in assets requires a credit
entry.
- A decrease in revenues requires a debit entry. An increase in revenues requires a
credit entry.
- Etc.
Number of accounts in the general ledger varies between 20 and thousands. Organizations
typically use a numbering system, with categories of accounts.
The recording process:
Transaction occurs results in data record entered in a journal (ERP) posted to
accounts in the ledger (= grootboek).
The journal = the book of original entry (journalizing).
- Discloses the complete effects of a transaction.
- Provides a chronological record of transactions.
- Helps to prevent/locate errors as debit and credit amounts can be easily compared.
Credit entries have a tab in front of the account title (in Dutch we use the word “aan”
instead of a tab).
Posting = transferring journal entries to the ledger accounts.
The general ledger = the collection of accounts.
Net income is calculated and transferred from the income statement to the statement of
financial position where it becomes part of equity.
Accounting standard:
- International Accounting Standards Board (IASB).
o International Financial Reporting Standards (IFRS).
- Financial Accounting Standards Board (FASB).
o US Generally Accepted Accounting Principles (US GAAP).
4
