Accounting

Basics of Financial Accounting

 ? What is Accounting

• A system by which we record & interpret the results / status of a

business into numbers by using an agreed upon methodologies.
• Accounting process serves several purposes:
 Providing a record of assets owned, amounts owed to others,
and monies invested.
 Providing reports showing the financial position of an
organization and the profitability of its operations.
 Provides a way of measuring an organization’s effectiveness.
 Helps stakeholders monitor an organizations activities and
performance.
 Enables potential investors to evaluate an organization and
make decisions.
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Accounting as an Information System
• An accounting information system (AIS) is a system designed
to transform financial and other data into information.
• Accounting information systems perform this transformation
whether thorough manual or computerized systems.

Trial
Supporting Journal Ledger Financial
Balance
voucher Statements

Input Data Processing Output

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Users of Financial Statements
Internal External
Users Users
Shareholders
Management
Lenders / Creditors
Employees
Regulatory Authorities

Customers
Analysts
Potential Investors

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The Annual Report

• The Major & most important output of the accounting system is

the “Annual Report”.
• It consists of the following:
1) Management Report / Chairman’s Letter.
2) The Balance Sheet.
3) The Income Statement.
4) The Statement of Retained earnings.
5) The Statement of Cash Flows.
6) Auditor’s Report.
7) Footnotes.

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Accounting Assumptions
• Separate entity
A corporation has a separate entity from its owners.
• Going concern assumption
The business is going to be operating for the
foreseeable future.
• Stable monetary unit assumption
e.g. the U.S. dollar
• Fixed time period assumption
info. prepared and reported periodically (quarterly,
annually, etc.)
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Accounting Principles
• Historical Cost
Transactions are recoded at their historical costs.
• Revenue Recognition
The recognition of revenues when:
(1) reasonable assurance of collection; (2) substantial completion of
the transaction.
• Matching
All expenses & revenues must be recognized for/during the same
period.
•Full disclosure principle
Major information about the business is disclosed in a clear and
understandable way.
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Accrual Basis of Accounting
• Accrual Basis • Cash Basis
Records revenues and Records revenues when
expenses in the periods cash is received, and
when they are earned or expenses when cash is paid.
incurred.

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The Annual Report

• Corporations that have shareholders must prepare an

Annual Report and make it available to the corporation's
shareholders.

• The basic purpose of the Annual Report is to let the

shareholder's know how the company is doing. The Annual
Report contains information such as basic financial
statements, management's opinion of the past year's
operations, and the corporation's future prospects.

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The Audit report

• A report issued by an independent (external) Auditor that

expresses an opinion about whether the financial
statements present fairly a company's financial position,
operating results, and cash flows in accordance with
generally accepted accounting principles.

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The Income Statement

• Financial document showing a company's income /

revenues and expenses over a given period (like one fiscal
year).

• Also known as the Earnings Statement or Statement of

Operations.

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Revenues & Expenses (Basic Definitions)

Revenues/Sales: what is charged to customers

for good or services.

Costs & Expenses what the company pays in

order to generate the sales.

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Income Statement (Basic Format)
Item Description
Total Sales
Less: Cost of Goods Sold
Gross Profit

Less: Selling, General & Administrative Expenses

Operating Profit

Plus: Other Sundry Income

Less: Other Sundry expense
Earnings Before Interest & Tax (EBIT)
Less: Interest Expenses

Earnings Before Tax (EBT)

Less: Tax

Net Profit After Taxes

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Income Statement (Example)

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The Balance Sheet

• A balance sheet is a snapshot of a business’ financial

condition at a specific moment in time, usually at the close
of an accounting period.

• A balance sheet comprises assets, liabilities, and owners’

or stockholders’ equity.

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The Balance Sheet Equation

Liabilities
Assets

Owners’
Equity

Assets = Liabilities + Owners’ Equity

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Assets

Assets are the resources that the firm controls.

These Assets benefit the business now and in the future

Investments
Cash Land
Intangible
Accounts receivable Buildings
assets:
Inventory Equipment,
- Patents
Notes receivable furniture,
- Copyrights
Prepaid expenses and fixtures
- Licenses
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Liabilities

Liabilities are the debts of the company.

Notes payable
Accounts payable
Loans
Accrued liabilities
bonds
(expenses incurred
but not paid)

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Shareholders’ Equity

Stockholders’ (owners’) equity is the

owners’ claims to the assets of a corporation.

Capital Reserves Retained Earnings

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Balance Sheet (Example)

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Balance Sheet (Example)

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Example: Statement of Retained Earnings

Month Ended April 30, 200x

Retained earnings, April 1, 200x 0

Add: Net income for the month 5,800
5,800
Less: Dividends (2,100)
Retained earnings, April 30, 200x 3,700

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 Example: Balance Sheet
As of April 30, 200x

Assets Liabilities
Cash LE 33,300 Accounts Payable LE 100
Accounts receivable 2,000 Stockholders’ Equity
Office supplies 500 Common stock LE 50,000
Land 18,000 Retained earnings 3,700
Total stockholders’
Equity LE 53,700
Total liabilities and
Total assets LE 53,800 stockholders’ equity LE53,800

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 The Cash Flow Statement
Provides
Provides information
information about
about the
the cash
cash receipts
receipts and
and
cash
cash payments
payments ofof aa business
business entity
entity during
during the
the
..accounting
accounting period
period
Helps
Helps investors
investors with
with questions
questions about
about the
the company’s
company’s
•• Ability
Ability to
to generate
generate positive
positive cash
cash flows.
flows.
•• Ability
Ability to
to meet
meet its
its obligations
obligations and
and to to pay
pay dividends.
dividends.
•• Need
Need for
for external
external financing.
financing.
•• Investing
Investing andand financing
financing transactions
transactions for for the
the period.
period.
•• Provide
Provide information
information on on the
the “utilization”
“utilization” of
of cash.
cash.
•• Reports
Reports the the cash
cash inflows
inflows and
and out
out flows
flows generated
generated from:
from:
1-
1- Operating
Operating activities.
activities.
2-
2- Investments.
Investments.
3-
3- Financing.
Financing.
 Classification of Cash Flows
The
The Statement
Statement of of Cash
Cash Flows
Flows must
must include
include
::the
the following
following three
three sections
sections
Cash
CashFlows
Flowsfrom Operating Activities ••
fromOperatingActivities
Cash
CashFlows
Flowsfrom Activities ••
Investing Activities
fromInvesting
Cash
CashFlows
Flowsfrom Financing Activities ••
fromFinancingActivities
 Operating Activities
Inflows
Inflows from:
from:
•• Interest
Interest and
and dividends
dividends received.
received.
•• Sales
Sales to
to customers.
customers.
+ Cash
Flows
Outflows
Outflows to:
to: from
•• Suppliers
Suppliers of
of merchandise
merchandise and
and services.
•• Employees.
Employees.
services.
Operating
•• Lenders
Lenders for
for interest.
interest. _ Activities
•• Governments
Governments for for taxes.
taxes.
 Operating
Operating Activities
Activities

General rule:
Any transactions that enter into the
determination of net income are classified
as operating activities.
 Investing Activities
::Inflowsfrom
Inflows from
Selling investments
Selling investments andand
..plant
plant assets
assets
Collecting
Collecting ofof principal on ••
principal on + Cash
Cash
..loans
loans
Flows
Flows
from
from
::Outflowsto
Outflows to
Investing
Investing
Purchase
Purchase of investments ••
of investments
..and
and plant
plant assets
assets _ Activities
Activities
Purchase
Purchase debt
debt or equity ••
or equity
..investments
investments
..Make loans ••
Make loans
 Investing
Investing Activities
Activities

:General rule
Any transactions that involved in the
acquisitions or disposition of non-current
. assets
 Financing Activities
Inflows
Inflows from:
from:
• Short-term
Short-term and
and long-term
long-term
borrowing.
borrowing. +
• Owners
Owners (for
(for example,
example, from
from
Cash
issuing
issuing stock).
stock). Flows
from
Outflows
Outflows to:
to: Financing
• Make
Make payments
payments on on _ Activities
borrowed
borrowed funds.
funds.
• Owners
Owners for
for dividends.
dividends.
• Purchase
Purchase treasury
treasury stock.
stock.
 Financing
Financing Activities
Activities

:General rule
Any transactions involving borrowing
from creditors, and any transactions
involving the owners of a company
Questions
&
Discussion