ACCOUNTING - CLUTCH CH. 1 - INTRODUCTION TO ACCOUNTING.

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2 CONCEPT: TYPES OF ACCOUNTING Financial Accounting creates information to report to users Examples of users: Laws/Standard Setting: USA follows Standards set by Generally Accepted Accounting Principles Financial Accounting Standards Board International follows Standards set by International Financial Reporting Standards International Accounting Standards Board Managerial Accounting creates information to report to users Examples of users: Laws/Standard Setting: Page 2

3 CONCEPT: BUSINESS ORGANIZATION The income of a Sole Proprietorship completely to the owner The owner of the business has liability for the business debt A Partnership is generally the same as a, only there are multiple owners. The owners of the business generally have liability for the business debt A Corporation is a entity from the owners of the business Characteristics of a corporation: - Unlimited life - Easy transferability of ownership - Owners have liability for the business debt Hybrid Business Organizations, such as the, have special rules for owner liability. Example: Doctors who formed an LLP are not liable for another doctor s malpractice Page 3

4 CONCEPT: USEFUL INFORMATION For information to be useful to the user, it must have these two qualitative characteristics: Relevance the information makes a difference in the user s - Predictive Value enables users to future outcomes - Confirmatory Value enables users to previous predictions Faithful Representation the information is - Completeness means the company is providing relevant information to users - Neutrality means that the information is - Freedom from material error means that there are no errors in the information The establishes their accounting standards based on its conceptual framework. Useful information should also have the following four characteristics: Comparability information is across companies and with prior periods Verifiability information can be for accuracy, completeness, and reliability Timeliness information is in time to make meaningful decisions Understandability the language is Page 4

5 There are also four underlying in financial accounting: Monetary Unit the currency of the accounting information is expected to stay Economic Entity the company can be separately from other companies and individuals - Example: The personal residence of Elon Musk is not included in Tesla s accounting records Periodicity the economic life of a company is divided into time periods ( of reporting) Going Concern the business will indefinitely Finally, there are the of financial accounting: GAAP identifies two measurement principles: - Historical Cost Principle Companies should record their assets (i.e. what they own) at their cost. Purchase Land for $50,000 After a year, land increases in value to $60,000 - Fair Value Principle Companies should report their assets at their current market value Purchase Apple Stock for $50,000 After a year, stock increases in value to $60,000 Full disclosure principle a company must all events that would impact user s decision making - This helps fulfill the requirement of useful information - Cost constraint Some information may be too to gather. Must weigh benefits against costs Page 5

6 CONCEPT: FUNDAMENTAL ACCOUNTING EQUATION This equation is the foundation of the financial accounting system: Assets = Liabilities + Equity Assets Anything tangible or intangible by the company Current Assets Cash or any asset convertible to cash in less than Long-term (Fixed) Assets Assets expected to be used for more than (i.e. land or machinery) Liabilities Money that the company to others Current Liabilities must be paid in under (i.e. accounts payable or short-term debt) Long-term Liabilities Payable in over (i.e. bonds payable) Equity has two main components: The money that stockholders paid into the company when the company raised capital The accumulated and over the course of the company s lifespan - Paid-in Capital the amount that stockholders have in the corporation - Retained Earnings income from that has not been distributed as dividends - Revenues of resources (generally cash) from delivering goods or services to customers - Expenses of resources from receiving goods or services from outsiders - Dividends payments to shareholders that are taken from DIVIDENDS ARE AN EXPENSE! - Income/Loss the net amount of revenue minus expenses will result in income or loss. Income and Profit are synonymous; Revenue is not the same as Income! EXAMPLE: Equity when purchasing a home The home costs $150,000 and you make a $30,000 down payment. The remainder is a mortgage from the bank. You pay back $20,000 of the principal on the mortgage. Page 6

7 PRACTICE: A company has assets totaling $50,000 and equity of $20,000. What are their liabilities? a) $0 b) $20,000 c) $30,000 d) $70,000 PRACTICE: A company has liabilities of $25,000 and assets of $35,000. What is the company s equity? a) $10,000 b) $20,000 c) $30,000 d) $60,000 PRACTICE: If a company has liabilities of $65,000 and equity of $25,000, what are the company s assets worth? a) $25,000 b) $40,000 c) $60,000 d) $90,000 Page 7

8 CONCEPT: THE FINANCIAL STATEMENTS There are main financial statements that are required by and reported by companies: Balance Sheet shows and how they are financed at a = + Income Statement shows the firm s and over a - = Statement of Cash Flows shows how the firm s changed over a Statement of Stockholder s Equity shows how the firm s changed over a Some small companies might just show a Statement of Retained Earnings The financial statements follow a flow when being assembled: Income Statement Statement of Stockholder's Equity Balance Sheet Statement of Cash Flows Accounts are going to fall into one of broad categories, it is important to be able to classify an account by its title Assets Cash and cash equivalents Accounts Receivable Inventory Investments Prepaid Expenses Buildings Land Machinery Long-term Investments Equipment Patents Liabilities Accounts Payable Accrued Expenses Income Taxes Payable Notes Payable Bonds Payable Current Portion of LT Debt Equity Common Stock Additional Paid-in Captial Retained Earnings Preferred Stock Treasury Stock Revenue Sales Revenue Fees Earned Expenses Expense Page 8

9 PRACTICE: Label the following accounts as either Asset, Liability, Equity, Revenue, or Expense Accounts Receivable Accrued Expenses Notes Payable Land Common Stock Retained Earnings Prepaid Expenses Bonds Payable Accounts Payable Marketable Securities Additional Paid-in Capital Unearned Revenue Machinery Inventory Supplies Customer Deposits Cash Investment in Apple Common Stock Treasury Stock Preferred Stock Restricted Cash Page 9

10 CONCEPT: SAMPLE FINANCIAL STATEMENTS COCA COLA Page 10

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