Financial Accounting

FINANCIAL ACCOUNTING

CHAPTER 1: FINANCIAL STATEMENTS AND BUSINESS DECISIONS

sole proprietorship: single owner, unlimited liability, managers and owners are not separated

Partnership: partners, unlimited liability, managers and owners are not separated

LLC (Limited Liability Company): members, limited liability, managers and owners might be separated

Corporation: shareholders, limited liability, managers and owners are separated

Corporations can have many structures but the most typical one consist of:

• Board of directors
• Managers
• Employees
• Shareholders or owners/investors

A corporation can be financed:

1. EQUITY: given by the shareholders using the shares or stocks, and can give back the dividend
2. DEBT: is given by the creditors, like banks, bonds or notes, and can give back an interest.

BUSINESS OPERATIONS

1. purchase parts and labor
2. manufacture product
3. sell products to customers
4. collect cash from customers and pay creditors

The accounting system is the process that identify, record and summarized the economic informations; an information system that measures transactions and transforms information to output called FINANCIAL STATEMENTS.

It can be summarized as:

ACCOUNTING SYSTEM

• FINANCIAL REPORTS

  • periodic financial statements and related disclosures
  • EXTERNAL DECISION MAKERS
  • evaluate the company

• MANAGERIAL REPORTS

  • detailed plans and continuous performance reports
  • INTERNAL DECISION MAKERS
  • run the company

To aid a decision making there are a few step to follow:

1. Event: that is recorded and analyzed
2. Accountant's analysis and recording: that need to be summarized
3. Financial statements: that need to be communicated to the users

FINANCIAL STATEMENTS

• BALANCE SHEET: reports the amount of assets, liabilities, stockholders equity of an accounting entity at a point in time.
• INCOME STATEMENT: reports the revenues less the expenses of the accounting period.
• STATEMENT OF SHAREHOLDERS EQUITY: reports the way that net income and distribution of dividends affected the financial position of the company during the accounting period.
• STATEMENT OF CASH FLOWS: reports inflows and outflows of cash during the accounting period in the categories of operating, investing and financing.

To calculate the economic resources, the assets, we need to sum the liabilities and the stockholders equity, that are the sources of financing the economic resources; the liabilities are form the creditors and the stockholders equity is from the stockholders.

A = L + SE

BALANCE SHEET

The recording process start with the source documents, the journal entry, the ledger t-accounts, the trial balance and the financial statements.

• journal entry: process of entering transaction, for each transaction this analysis identifies the accounts to be debited or credited.
  • Debit: entry on left side of any account
  • Credit: entry in the right side of any account
• Ledger t-accounts: contains the records for a group of related accounts, a book with one page for each account
• Trial balance: simple periodical listing of the accounts form general ledger with their balances

ACCOUNTING CYCLE

During the period:

1. Analyse transactions
2. Record journal entries in the general journal
3. Post amounts to the general ledger

At the end of the period:

1. Prepare a trial balance to determine if debits equal credits
2. Adjust revenues and expenses and related balance sheet accounts, record in journal and post to ledger
3. Prepare a complete set of financial statements and disseminate it to users
4. Close revenues, gains, expenses and losses to retained earnings, record in journal and post to ledger.

In a classified balance sheet assets and liabilities are classified into two categories:

• Current
  • current asset: those to be used or turned into cash within the upcoming year
  • current liabilities: those obligations to be paid or settled within the next 12 months with current assets
• Non current
  • non current asset: those that will last longer than one year

Chapter 4: Adjustment, Financial Statements and the Quality of Earnings

Management is responsible for preparing financial statements that must be high quality. Relevance + Reliability to be useful to investors and creditors.

Accounting cycle

During the period:

1. Analyze transactions
2. Record journal entries in the general journal
3. Post amounts to the general ledger

At the end of the period:

4. Prepare a trial balance to determine if debits equal credits
5. Adjust revenues and expenses and related balance sheet account, record in journal and post to ledger
6. Prepare a complete set of financial statements and disseminate it to users
7. Close revenues, gains, expense and losses to retained earnings, record in journal and post to ledger.

Unadjusted trial balance: a listing of individual accounts, usually in financial statement order; ending debit or credit balances are listed in two separated columns. Total debit account should equal total credit account balances.

Purpose of adjustments:

• Revenues are recorded when earned
• Expenses are recorded when incurred

Matching principle: because transactions occur over time, adjustments are required at the end of each fiscal period to get the revenues and expenses into the right period.

Daily application of the revenue realisation principle and the matching principle, adopting accrual accounting basis, does not ensure that all the revenue and expenses has been recorded in the proper accounting period. End-of-period adjustments are intended to compensate such effects and avoid inaccurate representations of the firm's financial situation.

Four types of adjustments

Adjusting entries that increase revenues

Adjusting entries that increase expenses