Introduction to Financial

Accounting
What is Accounting?

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What is Accounting?

Accounting lies between

 100% objective and
 100% subjective

The purpose of accounting

 Valuation perspective
 Information perspective

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The Purpose of Financial Accounting

Financial statements are the primary

means of communicating financial
information to parties outside the
business organization.
Balance Sheet
Income Statement

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Stakeholders
 Generally Accepted
Accounting Principles
Generally Accepted Accounting Principles
known as GAAP are the commonly understood
and accepted conventions for gathering,
organizing, and reporting the financial history
of an organization.

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 Institutional Context
Securities and Exchange Commission
(SEC) – The federal government agency to
determine the financial statements that public
companies must provide to stockholders and
the measurement rules they must use in
producing these statements

Financial Accounting Standards Board

(FASB) -- A private, not-for-profit organization
to work out the detailed rules that become
GAAP.

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Accounting Concepts
Assumptions
Business entity: Transactions of the business are
separate from transactions of owners.

Going concern: The entity will not go out of business in

the near future.

Unit-of-measure: Accounting measures are in the

national monetary unit ($).

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Accounting Concepts
Principles
Historical cost: Cash equivalent cost given up is the basis
for initial recording of elements.

Revenue recognition: Record revenues when earned and

measurable (exchange complete, earnings complete
and collection probable).

Matching: Record expenses when incurred in earning

revenue.

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Accounting Concepts
Constraints
Cost-benefit: Benefits of recording and reporting
information should outweigh costs.

Materiality: Relatively small amounts not likely to influence

decisions are to be recorded in most cost/beneficial way.

Conservatism: Exercise care not to overstate assets and

revenues or understate liabilities and expenses.

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 Financial Statements

Financial Statements
 Balance Sheet
 Income Statement
 Statement of Cash Flows
 Statement of Retained Earnings

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 KRAN CORP.
Balance Sheet
At December 31, 20A
(In thousands of dollars)
Assets
Cash $ 4,895
Accounts receivable 5,714
Inventories 8,517
1. Name
Plant and equipmentof entity 7,154
Land (the separate-entity assumption) 981
2. Title
Total assets of statement $ 27,261
Liabilities and Stockholders'
3. Specific date Equity
Liabilities
(financial snapshot at a specific
Accounts payable $ 7,156
point in time)
Notes payable 9,000
4. Unit measure
Total liabilities $ 16,156
(thousands of dollars)
Stockholders' Equity
Contributed capital $ 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
12 Total liabilities and stockholders' equity $ 27,261
 KRAN CORP.
Balance Sheet
At December 31, 20A
(In thousands of dollars)
Assets are Assets
Cash $ 4,895
listed by their
Accounts receivable 5,714
ease of Inventories 8,517
conversion into Plant and equipment 7,154
cash. Land 981
Total assets $ 27,261
Liabilities and Stockholders'
Amount of cashEquity
in the company’s bank
Cash Liabilities
account.
Accounts payable
Accounts $ 7,156
Amounts owed by customers from prior
Notes payablesales.
receivable 9,000
Partial and completed but unsold$ 16,156
Total liabilities
Inventories
product. Equity
Stockholders'
Plant and capital
Contributed $ 2,000
Retained
Factories
earnings
and production machinery.
9,105
equipment
Total stockholders' equity 11,105
13 Land Property on which factories are located.
Total liabilities and stockholders' equity $ 27,261
 KRAN CORP.
Balance Sheet
At December 31, 20A
(In thousands of dollars)
Assets
Cash $ 4,895
Accounts receivable 5,714
Accounts Amounts Inventories
owed to suppliers for prior 8,517
payable purchases.Plant and equipment 7,154
Notes Amounts owed
Land on written debt 981
payable contracts. Total assets $ 27,261
Liabilities and Stockholders' Equity
Liabilities
Accounts payable $ 7,156
Notes payable 9,000
Total liabilities $ 16,156
Stockholders' Equity
Contributed capital $ 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
14 Total liabilities and stockholders' equity $ 27,261
 KRAN CORP.
Balance Sheet
At December 31, 20A
(In thousands of dollars)
Assets
Cash $ 4,895
Accounts receivable 5,714
Inventories 8,517
Plant and equipment 7,154
Land 981
Total assets $ 27,261
Liabilities and Stockholders' Equity
Contributed Amounts invested in theLiabilities
business by
capital Accounts payable
stockholders. $ 7,156
Retained Notesnot
Past earnings payable
distributed to 9,000
earnings stockholders.
Total liabilities $ 16,156
Stockholders' Equity
Contributed capital $ 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
15 Total liabilities and stockholders' equity $ 27,261
 KRAN CORP.
Balance Sheet
At December 31, 20A
(In thousands of dollars)
Assets
Use $ on the Cash $ 4,895
Accounts receivable 5,714
first item in a Inventories 8,517
group Plant and equipment 7,154
and on the Land 981
group total. Total assets $ 27,261
Liabilities and Stockholders' Equity
Liabilities
Accounts payable $ 7,156
Notes payable 9,000
Assets = LiabilitiesTotal
+ Stockholders’
liabilities Equity $ 16,156
Stockholders' Equity
Contributed capital $ 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
16 Total liabilities and stockholders' equity $ 27,261
 Income Statement
 Reports the revenues less the expenses of
the accounting period (month, quarter, or
year).
 Indicates the success or failure of the firm’s
operation
 If revenues exceed expenses, the result is a
net income. If expenses exceed revenue,
the result is a (net loss).
 “Net income” is also called “earnings.”
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 KRAN CORP.
Income Statement
For the Year Ended December 31, 20A
(In thousands of dollars)

Revenues
Sales revenue
1. Name of entity $ 37,436
2. Title of statement
Expenses
3. Specific
Cost of goodsdate
sold(Unlike the balance sheet, this
$ 26,980
statement
Selling, covers
general a specified period
and administrative of time.)
3,624
4. Unit measure
Research (in thousands of dollars)
and development 1,982
Interest expense 450
Total expenses 33,036
Pretax income $ 4,400
Income tax expense 1,100
18 Net income $ 3,300
 KRAN CORP.
Income Statement
For the Year Ended December 31, 20A
The income statement is divided into
(In thousands of dollars)
three major captions.
 Revenues
Sales revenue $ 37,436
 Expenses
Cost of goods sold $ 26,980
Selling, general and administrative 3,624
Research and development 1,982
Interest expense 450
Total expenses 33,036
Pretax income $ 4,400
Income tax expense 1,100

19 Net income $ 3,300
 KRAN CORP.
Income Statement
For the Year Ended December 31, 20A
(In thousands of dollars)

Revenues
Sales revenue $ 37,436
Expenses
Revenues are earned from the sale of goods or
Cost of goods sold $ 26,980
services.
Selling, general and administrative 3,624
Research
Revenue andisdevelopment 1,982
recognized in the period in which
Interest
goods expense 450
and services are sold, not necessarily
Totalthe period in which cash is received. 33,036
expenses
Pretax income $ 4,400
Income tax expense 1,100
20 Net income $ 3,300
 MAXIDRIVE CORP.
Expenses are theIncome
dollar amount of resources used
Statement
up by the
Forentity to earn
the Year revenues
Ended Decemberduring a period.
31, 20A
(In thousands of dollars)
An expense is recognized in the period in which
goods and services are used, not necessarily
Revenues
the period in which cash is paid.
Sales revenue $ 37,436
Expenses
Cost of goods sold $ 26,980
Selling, general and administrative 3,624
Research and development 1,982
Interest expense 450
Total expenses 33,036
Pretax income $ 4,400
Income tax expense 1,100
21 Net income $ 3,300
 KRAN CORP.
Statement of Cash Flows
For the Year Ended December 31, 20A
(In thousands of dollars)

Cash flows from operating activities:

Cash collected from customers $ 33,563
Cash paid to suppliers and employees (30,854)
1. Name
Cash of interest
paid for entity (450)
2. Title
Cash paidofforstatement
taxes (1,190)
Net cash flow from operating activities $ 1,069
3. Specific date (Like the income statement, this
Cash flow from investing activities:
statement
Cash covers
paid to purchase a specified period
equipment $ of time.)
(1,625)
4. Unit
Net cash measure (in thousands
flow from investing activities of dollars) (1,625)
Cash flow from financing activities:
Cash received from bank loan $ 1,400
Cash paid for dividends (1,000)
Net cash flow from financing activities 400
Net decrease in cash during the year $ (156)
Cash at beginning of the year 5,051
Cash at end of the year $ 4,895
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 KRAN CORP.
Statement of Cash Flows
For the Year Ended December 31, 20A
(In thousands of dollars)

Cash flows from operating activities:

Cash collected from customers $ 33,563
Cash paid to suppliers and employees (30,854)
Cash paid for interest (450)
Cash paid for taxes (1,190)
Net cash flow from operating activities $ 1,069
Cash flow from investing activities:
Cash paid to purchase equipment $ (1,625)
Net cash flow from investing activities (1,625)
Cash flow from financing activities:
Cash received from bank loan $ 1,400
Cash paid for dividends (1,000)
Net cash flow from financing activities 400
Net decrease in cash during the year $ (156)
Cash at beginning of the year 5,051
Cash at end of the year $ 4,895
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 Cash Flow Statement
Operating activities – The change in cash
resulting from actions intended to generate
net income.
Investing activities – The change in cash
resulting from actions taken to acquire or
dispose of productive company assets.
Financing activities – The change in cash
resulting from payments to or receipts from
suppliers of money to the firm (e.g., common
shareholders or debt holders).

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Cash Flows Statement
Because . . . and expenses
revenues reported reported do not
do not always equal always equal
cash collected. . . cash paid . . .

Net Income is
usually not equavalent
to the change
in cash for
the period.

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 Retained Earnings Statement
 Indicates amount invested by owners,
amount paid out in dividends, and
amount of net income or net loss for
period.

 Shows changes in retained earnings

balance during period covered by
statement.
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 Retained Earnings Statement

Income of the enterprise.

s R
d by eta
en en ine
ivid ter d
p ri
D
se

Stockholders Retained Earnings

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 KRAN CORP.
Statement of Retained Earnings
For the Year Ended December 31, 20A
(In thousands of dollars)

Retained earnings, January 1, 20A $ 6,805

Net income
1. Name for 20A
of entity 3,300
Dividends for 20A
2. Title of statement (1,000)
Retained
3. Specificearnings,
date (LikeDecember 31,statement,
the income 20A $ 9,105
this
statement covers a specified period of time.)
4. Unit measure (in thousands of dollars)

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 KRAN CORP.
Statement of Retained Earnings
For the Year Ended December 31, 20A
(In thousands of dollars)

Retained earnings, January 1, 20A $ 6,805

Net income for 20A 3,300
Dividends for 20A (1,000)
Retained earnings, December 31, 20A $ 9,105

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 Other Elements of Annual
Reports
 Management Discussion and Analysis

 Notes to Financial Statements

 Auditor's Report

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 Management Discussion and
Analysis
Covers three aspects of a company:
 liquidity- ability to pay near-term
obligations
 capital resources - ability to fund
operations and expansions
 results of operation - profitability
and efficiency

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Notes
 Notes provide supplemental information
about the financial condition of a
company.
 Three types . . .
Describe accounting rules applied.
Present additional detail about an item
on the financial statements.
Provide additional information about an
item not on the financial statements.

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Notes
 Does not have to be numeric
 Examples:
 Description of accounting policies or
explanation of uncertainties and
contingencies
 Company statistics (e.g., market
share, percentage of international
sales, etc.)

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 Auditor's Report
 Auditor, a professional accountant who
conducts an independent examination of
the financial accounting data presented
by a company.

 Auditor gives an unqualified opinion if

the financial statements present the
financial position, results of operations,
and cash flows in accordance with
GAAP.

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Independent Auditors
Overall, I believe
 Auditors express an these financial
opinion as to the statements are
fairness of the financial fair.
statement presentation.
 Unqualified opinion
(clean opinion)
 Qualified opinion
 Adverse opinion

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Some Misconceptions
Are all transactions subject to
precise and objective measurement?

Almost all
accounting
numbers NO!
are influenced
by estimates.

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Some Misconceptions
Some people believe that financial statements report
the market value of the company.

Financial statements
really report the cost of assets,
liabilities and
stockholders’ equity.

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