Financial Accounting Week 1: Chapter 1
What is Accounting?
accounting consist of three basic activities:
1. Recording
2. Identifying
3. Communicating
an organization’s economic events to interested users.
Organizations that use accounting are:
● Companies
From sole proprietorships to hugo conglomerates
● Non-profit organizations
● Government organizations
Types of companies:
- Sole proprietorships
- Partnerships
- Corporations
Proprietorships and Partnerships:
Many companies start out as proprietorships:
- There is no distinction between private money and company money
- Proprietors have unlimited liability for all debts of their company
- Profit is private income
Partnerships are similar to proprietorships, but with more than one person
- Common in professional service
Corporations:
Corporation is a legal entity => It can own things, just like a human
For example: The corporation can buy a bottle of hot sauce
- The owner(s) of the firm would not own the hot sauce, the corporation would own it
Similarly, the corporation can borrow money from a bank
- The corporation - not the owner(s) of the corporation would owe the money to the bank
Corporations have formal separation of ownership and decision making.
A corporation is owned by one or more owners
- Owner have limited liability
- Each owner owns a percentage of the corporation
- Owners can be humans or other corporations
- Ownership 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 corporations, expecting of receiving a positive return
- Owners want periodic information about what their share of the corporation is worth
Understanding the structure of corporations:
Who makes the decision?
- Owners typically hire managers to make decisions on their behalf
- Often managers are owners themselves
Periodically, owners will want to be informed about what managers have done with their money
Specifically, they will want to know how the value of their ownership shares has changed in a period
Assets and Liabilities:
Assets = are what the organization owns
Liabilities = are what the organization owes
Assets:
Examples:
Cash, Inventory, Computer Equipment, Machines, Buildings, Patents, Trademarks
Liabilities
Examples:
Bank loans, Bonds, Accounts payable (amount owed to suppliers), Unpaid Salaries, Unpaid Taxes
Owners’ Equity:
Equity is the term that is used to describe the value of the corporation to its owners
- Equity is the difference between what the corporation owns and what the corporation owes
Accounting in a Corporation:
Owners of corporations will want to what the managers are doing with their money
- What their share of the company is worth
The corporation’s equity changes as the corporation does things.
- The corporation's operations affect what it owns and what is ows
- Notice that: equity only changes if the total value of what it owns and what it ows changes
- For example: Exchanging one asset for another does not change the value of the corporation.
Which economic events are registered?
,External and internal transactions that affect what the organization owns (assets), and or what the
organization owes (liabilities)
- This includes transactions that do and transactions that do not affect equity
- In other words, changes in the value of the firm and changes in how this value is involved
in assets and liabilities.
Revenue and Expenses
Company activities result in revenue and expenses.
- Positive (revenue( and negative (expenses) change the value of equity
Common sources of revenue are: Sales, fees, interest etc.
Expenses are the cost of assets consumed or services used in the process of earning revenue
- Common expenses are: Salaries, rent, utilities, materials etc.
Net income
The difference between the revenue and expenses in a period is referred to as the Net Income of that
period
- Net income is the change in the value of a company’s equity in the period due to the company's
operations in that period
Changes in the value of equity:
The value of a company’s equity can change in two different ways:
1. Operations => revenues and expenses resulting in net income (or a net loss)
2. Transaction with owners
Transactions with owners:
Shareholders can invest in the corporation
- (Buy shares)
Shareholders can be paid by the corporation
- Dividend
Changes in equity
Increases: Decreases:
Investments by shareholders => Dividend to shareholders
Revenues => EQUITY Expenses
, Bookkeeping:
The process of identifying and recording transactions is called bookkeeping
Each transaction has a dual effect on the accounting equation
- Remember: the accounting equation always holds
Who else (besides owners) needs information about a firm’s economic situation?
1. Potential owners
2. Creditors (e.g, banks)
3. Suppliers
4. Customers
5. Managers
6. employees
7. Non-profit organizations
8. Government agencies
- Chamber of commerce: SEC (in US), AFM, DNB
Types of accounting:
Accounting = identifying and recording economic events
=>
1. Financial Accounting = users outside the organization (including events
2. Management Accounting = Users inside the organization
Financial Accounting versus Management Accounting:
Financial accounting is subject to laws, regulation and standards
- Management accounting is not
In most countries, organizations are required by law to periodically publish specific financial statements
for outside users.
- At least annually (in ‘’annual reports’’)
Financial Statements:
Annual reports contain several financial statements:
➔ Statement of financial position / Balance sheet
➔ Income statement
➔ Comprehensive income statement
➔ Retained earnings statement
➔ Statement of cash flows
