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Summary Financial Accounting: book " Financial Accounting
", Weygandt, Chapter 1-
Financial Accounting (Saxion)
Summary Financial Accounting: book " Financial Accounting
", Weygandt, Chapter 1-
Financial Accounting (Saxion)
Financial accounting
Chapter 1 - What is accounting?
Three activities Accounting: financially understanding the company Three activities:
- Identifies, the economic events relevant to its business.
- Records, the events in order to provide a history of financial activities Systematic Chronological diary of events Measured in monetary units Classifies and summarize economic events
- Communicates, the collected information to interested users by means of accounting reports Financial statements In the aggregate: accumulating all sales transactions over a certain period as one amount in the company’s financial statements - Simplifies transactions - Series of activities making understandable and meaningful Analyze and interpret: - Analysis: percentages, ratios, to highlight significant financial trends and relationships - Interpretation: explaining the uses, meaning and limitations of reported data
Accounting process includes the bookkeeping: only the recording of economic events
Who uses accounting data? Two groups of users of financial information:
- Internal users: are managers who plan, organize and run the business. They need detailed information on a timely basis.
- Managerial accounting: provides internal reports to help users make decisions about their companies. Question asked by internals:
- Finance
- Marketing , what price for maximizing net income?
- Human resource, i.e. pay raises
- Management, which product line is the most profitable?
- External users: are individuals and organizations outside a company who want financial information about the company.
- Investors: owners, use accounting info for decisions to buy, hold, sell or selling ownership shares of a company. i.e. company comparison in size and profitability with others.
- Creditors: suppliers and bankers, use the accounting info to evaluate the risks of granting credit or lending money. i.e. able to pay its debts?
- Economic entity assumption: requires that the activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities. An economic entity can be an organization or unit in society. Governmental unit (city-state: Singapore)
Proprietorship: a business owned by one person.
- Owner is the manager/operator of the business
- Small service-type businesses and small retail stores
- Small amount of money (capital) is necessary to start in business. Owner (proprietor) receives any profits, suffers any losses and is personally liable for all debts in the businesses.
- Accounting records of business activities are kept separate from the personal records and the activities of the owner.
Partnership: a business owned by two or more persons associated as partners.
- Each partner has unlimited liability for the debts of the partnership
- For the accounting process the partnership transactions must be kept separate from the personal activities of the partners
- Partnerships are used to organize retails and service-type businesses, plus professional practices
Corporation: a business organized as a separate legal entity under corporation law and having ownership divided into transferable shares.
- Shareholders enjoy limited liability, not personally liable for the debts of the corporate entity
- Shareholders may transfer all or part of their ownership shares to other investors at any time
- Ownership can be transferred without dissolving the corporation, unlimited life.
The basic accounting equation 2 elements of a business
- What it owns
- What is owes Assets: are resources a business owns. Liabilities and equity: are the rights or claims against these resources. Liabilities: claims of those to whom the company owes money (creditors) Equity: claims of the owners.
Basic accounting equation: Assets = liabilities + equity
- The equation applies to all economic entities
- Provides the underlying framework for recording and summarizing economic events
Assets
- Business uses assets in carrying out such activities as production and sales
- Characteristic possessed by all assets: the capacity to provide future services or benefits
Liabilities: claims against assets – existing debts and obligations.
Businesses borrow money and purchase merchandise on credit, these result economic activities result in various payables:
- Accounts payable: purchasing on credit from suppliers
- Note payable: to its first national bank for the money borrowed to a purchase.
- Salaries and wages: to employees and sales en real estate taxes: to local government
Creditors: persons/entities to whom a business owes money
- Creditors may force the liquidation of a business that does not pay its debts
- The law requires that creditor claims the paid before ownership claims
Equity: the ownership claim on total assets Residual equity: the equity left over after creditors’ claims are satisfied. Distract the liabilities from the assets. Equity consists of:
- Share capital – ordinary: term used to describe the amounts paid in by shareholders for the ordinary shares they purchase.
- Retained earnings: determined by three items: Revenues: are the gross increases in equity resulting from business activities entered into for the purpose of earning income. Positive effect: increase in assets. Decrease in liabilities. Expenses: are the costs of assets consumed or services used in the process of earning revenue. Negative effect: decrease in equity resulting from operating business or an increase in liabilities. Dividends: the distribution of cash or other assets to shareholders. Reduce retained earnings, is not an expense. A business has a net income and has no better use for that income, the business may decide to distribute a dividend to its shareholders.
Using the accounting equation Transactions: are a business economic events recorded by accountants.
- External transaction: involve economic events between the company and some outside enterprise.
- Internal transaction: economic events that occur entirely within one company.
Appendix 1A – accounting career opportunities
Public accounting: individuals offer expert service to the general public.
- Auditing: an independent accountant examines company’s financial statements and provides an opinion how the financial statements present company’s results and financial position.
- Taxation: tax advice, preparing tax returns, and representing clients before governmental agencies.
- Management consulting: installing basic accounting software, providing support service for marketing projects, and merger/acquisition activities.
Private accounting: involved in activities like cost accounting, budgeting, tax planning and preparation.
Governmental accounting
Forensic accounting: accounting, auditing, and investigative skills to conduct investigations into theft and fraud.
Financial Accounting
Chapter 2 – The recording process
The Account
Account: individual accounting record of increases and decreases in a specific asset, liability or equity.
Increases in cash are recorded as debits; decreases in cash are recorded as credits.
Debit and credit procedure Double-entry system: dual effect of each transaction is recorded in appropriate accounts.
Dr./cr. Procedures for assets and liabilities
Equity
- Share – capital Ordinary
- Retained earnings: net income that is kept in the business.
- Dividends: company’s distribution to its shareholders – cash dividend.
- Revenues and expenses.
Steps in the recording process
- Analyse each transaction for its effects on the accounts.
- Enter the transaction information in a journal.
- Transfer the journal information to the appropriate accounts in the ledger. Ledger: entire group of accounts maintained by a company.
The trial balance
= list of accounts and their balances at a given time.
- Trial balance proves equality of debits and credits after posting.
- Trial balance does not prove that the transactions or ledger is correct.
The basics of adjusting entries Adjusting entries: ensure that the revenue recognition and expense recognition principles are followed.
- In order for revenues to be recorded in the period in which services are performed, for expenses to be recognized in the period in which they are incurred
- Adjusting entries are necessary for the trial balance: the 1st^ pulling together of the transaction data, the trial balance may not contain up-to-date and complete data. Reasons: Some events are not recorded daily Some costs not recorded during the accounting period, because the costs expire with the passage of time Some items may be unrecorded
- Adjusting entries are required every time a company prepares a financial statement
- An adjusting entry will include 1 income statement and 1 statement of financial position.
Types of adjusting entries
Deferrals : costs or revenues that are recognized at a date later than the point when cash was originally exchanged.
- Record the portion of the deferred item that was incurred as an expense or recognized as revenue during the current accounting period.
- Prepaid expenses: expenses paid in cash before they are used or consumed. Asset account increased, service or benefit that the company will receive in the future. Costs that expire either with the passage of time (rent) or through use (supplies). Asset overstated, expenses understated
- Supplies Companies recognize supplies expense at the end of the accounting period. At the end the company counts the remaining supplies. Supplies used (expense) = unadjusted balance in supplies – actual costs of supplies.
- Insurance Companies purchase insurance to protect themselves from losses, fire, and theft. Insurance is paid in advance and is recorded as an increase in the asset account and a decrease for the cost of insurance that has expired during the period.
- Depreciation Useful life: the period of service. Long lives: buildings, equipment and vehicles. Depreciation: process of allocating the cost of an asset to expense over its useful life. Allocating an assets cost to the periods in which its used, depreciation does not attempt to report actual change in the value of the asset Accumulated depreciation; contra asset: an account is offset against an asset account on the statement of financial position. Accumulated depreciation offsets the asset equipment. Book value: difference between the cost of any depreciable asset and its related accumulated depreciation.
- Unearned revenues: cash received before services are performed.
- Liabilities are overstated and revenues are understated.
- Adjusting entry for unearned revenues: decrease to liability account and increase to a revenue account.
- Examples: rent, magazine subscriptions
Accruals: the revenue account and the related asset account or the expense account and the related liability account are understated.
- Will increase both a statement of financial position and an income statement account.
- Accrued revenues: revenues for services performed but not yet received in cash.
- An increase to an asset account and an increase to a revenue account
- Examples: rent, interest, services performed but not collected
Preparing financial statements
Financial Accounting
Chapter 4 – completing the accounting cycle
Using a worksheet Worksheet: multiple-column form used in the adjustment process and in preparing financial statements.
- Not a permanent accounting record
- Worksheets make it possible to provide the financial statements to management and other interested parties at an earlier date.
Steps in preparing a worksheet Step 1. Preparing a trial balance Enter the ledger accounts with balances in the account titles. Fill in the debit and credit amounts from the ledger in the trial balance columns
Step 2. Enter the adjustments in the adjustment columns
- Keying. Companies don’t journalize the adjustments until they complete the worksheet and prepare the financial statements.
- When entering the adjustments, in the end all must prove their equality.
Step 3. Enter adjusted balances in the adjusted trial balance columns The amount in the adjusted trial balance columns is the balance that will appear in the ledger after journalizing and posting the adjusting entries.
Step 4. Extend adjusted trial balance amounts to appropriate financial statement columns
- Extend the adjusted trial balance amounts (revenue and expense) to the income statement and the statement of financial position (asset, liabilities, share capital, dividends) columns.
Step 5. Total the statement columns, compute the net income/loss and complete worksheet The net/loss income for the period is the difference between total of the both income statement columns (dr. and cr.)
- Net income = if total credits exceed the total debits.
- The debit amount balances the income statement columns; the credit amount balances the statement of financial position columns.
Preparing financial statements from a worksheet Income statement, retained earnings statement and statement of financial position are prepared. With a worksheet you can prepare a financial statement before they journalize and post the adjusting entries
Preparing adjusting entries from a worksheet To adjust the accounts, the company must first journalize the adjustments and post them to the ledger.
- Adjusting entries are prepared from the adjustments columns from the worksheet.
Post-closing trial balance = listing permanent accounts and their balances after journalizing and posting of closing entries.
- Prove equality of the permanent account balances carried forward into the next accounting period.
- Permanent financial statement accounts.
Optional steps in the accounting cycle
1. Reversing entry: opposite of the adjusting entry 2. Correcting entry: correcting entry in case of an error made.
On May 10, Mercato Co. journalized and posted a $50 cash collection on account from a customer as a debit to Cash $50 and a credit to Service Revenue $
Classified statement of financial position
Intangible assets: long-lived assets that do not have physical substance, very valuable.
- Goodwill, patent, copyright, trademark, giving company exclusive right of use. Property, plant and equipment: assets with long useful life that the company is operating in its business.
- Land, buildings, machinery, equipment, furniture Long-term investments: investments in ordinary shares and bonds of other companies held for many years and non-current assets that a company is not using in its operating business. Current assets: assets that a company is expected to switch to cash or use within 1year in the operating cycle
- Prepaid expenses, inventories, receivables, short-term investments, cash Operating cycle: average time that it takes to purchase inventory, sell it on account, and collect cash.
Equity: share capital – ordinary, retained earnings. Non-current liabilities: obligations that a company is expected to pay after 1year.
- Bonds payable, mortgages payable, long-term notes payable, lease, pension liabilities. Current liabilities: obligations that a company is expected to pay within the coming year.
- Accounts payable, wages payable, interest payable, taxes payable.
2 Systems to account inventory
- Perpetual inventory system: companies keep detailed records of the costs of each inventory purchase and sale. These records show the inventory that should be on hand for every item.
- Determining the cost of goods sold each time a sale occurs.
- Periodic inventory system: companies do not keep detailed information records of the goods on hand throughout the period.
- Determining the costs of goods sold only at the end of the accounting period.
- Physical inventory to determine the cost of goods on hand
Steps for determining the cost of goods sold o Determine the cost of goods on hand at the beginning of the accounting period o Add to it the cost of goods purchased o Subtract the cost of goods on hand at the end of the accounting period
Additional considerations Selling merchandise with high unit values perpetual system.
- Provides better control over inventories
Recording purchase of merchandise Companies record cash purchases by an increase in inventory and a decrease in in cash. Purchase invoice: should support credit purchases. The invoice indicates the total purchase price and other relevant information
- Under the perpetual inventory system companies record purchases of merchandise for sale in the inventory account
Freight costs Sales agreement: the seller or the buyer is to pay for transporting the goods to the buyer’s place. Freight costs = FOB (shipping point): free on board, means that the seller places the goods free on board the carrier, and the buyer pays the freight costs. FOB (destination): means that the seller places the goods free on board to the buyer’s place of business and the seller pays the freight.
Freights costs incurred by the buyer When the buyer incurs the transportation costs, these costs are considered part of the cost of purchasing inventory. Therefore, the buyer debits (increases) the account Inventory.
Freight costs incurred by the seller Freight costs incurred by the seller on outgoing merchandise are an operating expense to the seller. These costs increase an expense account titled Freight-Out or Delivery Expense. May 4 Freight-Out (or Delivery Expense) 150 Cash 150 (To record payment of freight on goods sold)
When the seller pays the freight charges, it will usually establish a higher invoice price for the goods to cover the shipping expense.
Purchase return: return of goods to the seller. Purchase allowance: purchaser may choose to keep the merchandise if seller is willing to grant a deduction from the price.
Purchase discount: buyer can permit to claim a cash discount for the payment. Sauk Stereo pays the balance due of €3,500 (gross invoice price of €3,800 less purchase returns and allowances of €300) on May 14, the last day of the discount period. The cash discount
is , and Sauk Stereo pays May 14 Accounts Payable 3, Cash 3, Inventory 70 (To record payment within discount period)
Recording sales of merchandise
Business document: support of every sales transaction, with written evidence. Cash register: provides evidence of cash sales Sales invoice: support for a credit sale. Shows date of sale, customer name, sales price, other relevant information.
Sales returns & allowance (contra revenue account)
= seller accepts goods back from the buyer or grants a reduction in the purchasing price. May 8 Sales Returns and Allowances 300 Accounts Receivable 300 (To record credit granted to Sauk Stereo for returned goods) 8 Inventory 140 Cost of Goods Sold 140 (To record cost of goods returned) Sales discount May 14 Cash 3, Sales Discounts 70 Accounts Receivable 3,
