Financial Accounting
Types of Businesses
Manufacturing Business
Product
General Motors Cars, trucks, vans
Intel Computer chips
Boeing Jet aircraft
Nike Athletic shoes and apparel
Coca-Cola Beverages
Sony Stereos and television
Types of Businesses
Merchandising Business
Product
Wal-Mart General merchandise
Toys “R” Us Toys
Circuit City Consumer electronics
Lands’ End Apparel
Amazon.com Internet books, music, video
retailer
Types of Businesses
Service Business
Product
Disney Entertainment
Delta Air Lines Transportation
Marriott Hotels Hospitality and lodging
Merrill Lynch Financial advice
Sprint Telecommunication
There are three types of
business organizations
Proprietorship
Partnership
Corporation
A proprietorship Advantages
is owned by one • Ease in organizing
individual. • Low cost of
organizing
Disadvantage
Joe’s • Limited source of
financial resources
• Unlimited liability
Advantages
A partnership is • More financial
owned by two or resources than a
more individuals. proprietorship.
• Additional
management skills.
Joe and Marty’s Disadvantage
• Unlimited liability.
A corporation is
organized under state Advantage
or federal statutes as a • The ability to obtain
separate legal entity. large amounts of
resources by issuing
stocks.
J & M, Inc. Disadvantage
• Double taxation.
What is Accounting?
Identifying
Economic to
Measuring
Information various
users
Communicating
Internal and External
Users of Accounting Information
Bankers
Current Creditors
and
Potential Internal
Owners Users –
Management Financial
Analysts
Suppliers
Trade
Government
Associations
Agencies
LO1
Decisions Made with Financial
Information
Add new
Invest?? product line??
The resources
owned by a
business
The Accounting Equation
Assets Liabilities
12
THE
FEDERALRESERVENOTE
THEUNITED
UNITED STATES
STATES OF
THI S NOTE I S LEGAL TENDER
OF AMERICA
L70744629F
WASHINGTON, D.C. 12
=
+
A
H 293
L70744629F
12 SERI ES 12
1985
ONE
ONE DOLLAR
DOLLAR
Owners’ Equity
(or Stockholders’ Equity)
Stock
Certificate
On November 1,
2005, Chris
Clark begins a
business that will
be known as
NetSolutions.
a. Chris Clark deposits $25,000 in a bank
account in the name of NetSolutions.
Owner’s
Assets = Liabilities + Equity
Accounts Chris Clark,
Cash + Supplies + Land Payable Capital
Bal. 8,850 1,350 20,000 = 1,350 28,850
f. – 950 – 950
Bal. 7,900 1,350 20,000 400 28,850
g. At the end of the month, the cost
of supplies on hand is $550, so
$800 of supplies were used.
Owner’s
Assets = Liabilities + Equity
Accounts Chris Clark,
Cash + Supplies + Land Payable Capital
Bal. 7,900 1,350 20,000 = 400 28,850
g. – 800 – 800 Supplies
expense
Bal. 7,900 550 20,000 400 28,050
h. At the end of the month, Chris
withdrew $2,000 in cash from the
business for personal use.
Owner’s
Assets = Liabilities + Equity
Accounts Chris Clark,
Cash + Supplies + Land Payable Capital
Bal. 7,900 550 20,000 = 400 28,050
h. –2,000 –2,000 With-
drawal
Bal. 5,900 550 20,000 400 26,050
Accounting reports, called
financial statements,
provide summarized
information to the owner.
Financial Statements
• Income statement—A summary of the revenue
and expenses for a specific period of time.
• Statement of owner’s equity—A summary of
the changes in the owner’s equity that have
occurred during a specific period of time.
• Balance sheet—A list of the assets, liabilities,
and owner’s equity as of a specific date.
• Statement of cash flows—A summary of the
cash receipts and disbursements for a specific
period of time.
Top of the World A = L + SE
Balance Sheet
June 30, 2007
Assets
Current assets: A
Cash $ 200
Accounts receivable 600 800
Non current assets:
Land 4,000
Lodge, lifts and equipment 2,500 6,500
Revenues $$
Less: Expenses ($$)
Net income $$
Top of the World
Income Statement
For the Year Ended June 30, 2007
Revenues – Expenses = Net Income
Revenues:
Lift tickets Revenues $5,800
Equipment rentals 2,200
Total revenues $8,000
Expenses:
Salaries and wages $2,000
Depreciation 100
Water, gas, and electricity Expenses 1,500
Insurance 1,100
Interest 300
Income taxes 1,000
Total expenses 6,000
Economic
Entity Cost
Concept Principle
Time
Period
Assumption
Going Monetary
Concern Unit
LO3
Economic Entity Concept
Each entity has its own books, records,
and financial statements that are
separate from owners
No intermingling of personal and
business assets and liabilities or
income and expenses
Business
Books and
Records
Cost Principle
Assume business
will continue
indefinitely into the
future
Justifies use of
historical cost
Monetary Unit
How we measure amounts in
the financial statements (e.g.,
U.S. dollar, Japanese yen,
Mexican peso, etc.)
Assumes economic measure
is relatively stable; no
adjustment for inflation made
in financial statements
Time Period Assumption
Assumes it is possible to break up an
entity’s earnings in discrete time
periods (a month, quarter, year)
Necessary to provide users with
financial results on a timely basis
Requires use of estimates 4 5 6 7
1
8
2
9
3
10
11 12 13 14 15 16 17
18 19 20 21 22 23 24
25 26 27 28 29 30 31
Relationship between the income statement and the
balance sheet
Assets + Profit
= Capital + Liabilities
(–) (Loss)
Sales – Expenses
Assets = Capital + + Liabilities
revenue
Better-Price Stores
Income statement for the year ended 31 October 2007
£
Sales revenue 232,000
Cost of sales 154,000
Gross profit 78,000
Salaries and wages (24,500)
Rent and rates (14,200)
Heat and light (7,500)
Telephone and postage (1,200)
Insurance (1,000)
Motor vehicle running expenses (3,400)
Depreciation – fixtures and fittings (1,000)
Depreciation – motor van (600)
Operating profit 24,600
Interest received from investments 2,000
Loan interest (1,100)
Profit for the year 25,500
Elements of the income
statement
Gross profit
The difference between revenue and cost of sales
Operating profit
Gross profit less expenses (overheads) incurred in
operating the business
Represents the wealth generated from operating
(trading) activities
Profit for the year
Operating profit
+ any non-trading income
- Costs of financing the business
Cost of sales
This represents the cost of goods SOLD by
the business (not cost of goods BOUGHT)
during the accounting period
Part of goods bought during the accounting
period may remain in the business as
inventories
To calculate the cost of goods sold, we need
to know the amount of any opening and
closing inventories, as well as purchases
made
Cost of sales example
1 Jan 2008 Inventory £ 20,000
Purchases during 2008 £140,000
31 Dec 2008 Inventory £ 45,000
Cost of sales £
Opening inventory 20,000
Purchases 140,000
160,000
Less: Closing inventory (45,000)
115,000
Classification of expenses
These are often a matter of judgement
by the company, depending on how
useful the information may be to users
Large items will be shown separately
(concept of materiality)
Finance costs are shown below
operating profit
Limited companies have to follow
Company Law for their classification
Activity: Prepare an Income
Statement
£’000
The adjacent Sales 210
information relates Purchases 109
to Sankey Ltd Inventory: 1.10.07 9
Salaries & Wages 42
Prepare an income Motor expenses 2
Rent 7
statement for the General expenses 3
year ended 30.9.08 Motor vehicles 14
Cash at bank 5
N.B. Not all the Loan interest payable 2
information is Loan 20
Inventory: 30.9.08 11
relevant
Profit measurement and the recognition of revenue
plus plus
equals
(minus)
Current assets
Non-current assets.
Current Assets
Assets that are held for the
short term
Have ANY of the following
characteristics:
Held for sale or
consumption in the normal
course of business
Expected to be sold within
the next year
Held primarily for trading
Cash or near cash
Common examples
Inventories (stock)
Trade receivables (debtors)
Cash
The circulating nature of current assets
Inventories
Cash Receivables
Profit measurement and inventory costing methods
Required:
Calculate the amounts for cost of sales and for
closing inventory for each of FIFO, LIFO and
AVCO
FIFO
Purchase Cost of Balance
cost sales Inventory
1 Oct 1,000@£3.00 £3,000 £3,000
8 Oct (300)@£3.00
(500)@£3.20
(100)@£3.50 £2,850 £ 750
Clg 200 £5,650 £4,950 £ 700
LIFO
Purchase Cost of Balance
cost sales Inventory
1 Oct 1,000@£3.00 £3,000 £3,000
4 Oct (500)@£3.20
(200)@£3.00 £2,200 £2,400
6 Oct 300@£3.50 £1,050 £3,450
8 Oct (300)@£3.50
(600)@£3.00 £2,850 £ 600
Clg 200 £5,650 £5,050 £ 600
AVCO
Purchase Cost of Balance
cost sales Inventory
1 Oct 1,000@£3.00 £3,000 £3,000
@£3.00
3 Oct 500@£3.20 £1,600 £4,600
@£3.07
4 Oct (700)@£3.07 £2,149 £2,451
Then:
Decrease trade receivables by the amount owing
Increase expenses (bad debts) by that amount
Note: we don’t just cancel out the sale
This way more information is given on
Allowances for trade receivables
– general provision
Usually there won’t be specific information
available at the end of the accounting period
However, past experience tells us that a
proportion of trade receivables are never
going to be paid
We therefore make a provision for ‘doubtful
debts’ as follows:
Decrease trade receivables by the required
provision
Increase expenses (allowances for trade
receivables) by that same amount
Example
In the year ended 30.9.07 Callands Ltd has
trade receivables of £90,000.
It recently heard that one of its customers,
Bewsey, has gone bankrupt, owing Callands
£3,000.
After careful checking of its other customers,
Callands considers other trade receivables
totalling £1,800 to be doubtful.
Required: Show the extracts from the
income statement and balance sheet for
y/e 30.9.07
Callands Ltd
Income statement extract £
Bad debts written off
3,000
Allowances for trade receivables
1,800
Current liabilities
Non-current liabilities
Current Liabilities
Amounts due to be paid in the short
term
Have ANY of the following
characteristics:
Expected to be settled in the normal
course of business
Expected to be settled within the next year
Held primarily for trading
Examples
Trade payables (creditors)
Bank overdraft
Non-current Liabilities
Amounts due to be paid after more than
1 year
Examples
Long term loans
Debentures
Activity
Delivery van
Label each item as one Bank loan to be repaid in
of: 2 year’s time
Current asset
Non-current asset Money owed by
Current liability
customers
Non-current liability Cash in the office safe
Capital Electronic parts to be
used in production
process
Bank overdraft
Money the owner put into
the business
Office computer
Unpaid electricity bill
Brie Manufacturing: balance sheet as at 31 December 2006
£000
Non-current assets
Property 45
Plant and equipment 30
Motor vans 19
94
Current assets
Inventories 23
Trade receivables 18
Cash at bank 12
53
Total assets 147
Capital (owner’s equity)
Opening balance 50
Add Profit 14
64
Less Drawings 4
60
Non-current liabilities
Long-term borrowings 50
Current liabilities
Trade payables 37
Total equity and liabilities 147
Purpose of the Statement of Cash
Flows
Explains changes in
cash over a period of
time
Summarizes cash
inflows and outflows
from:
Operating
Activities Investing Financing
Activities Activities
LO1
FEDERALRESERVENOTE
THE
THE UNITED
UNITED STATES
STATES OF
OF AMERICA
AMERICA
THI S NOTE I S LEGAL TENDER
12 WASHINGTON, D.C. 12
A
Cash Equivalents
H 293
L70744629F
12 SERI ES 12
1985
ONE
ONE DOLLAR
DOLLAR
Readily convertible
to cash
4 5 6 7
1
8
2
9
3
10
1 2 3
Little risk of price
11
18
12
19
13
20
14
4
15
5
16
15
4
9
16
5
10
17
6 7
1
8
2
9
3
10
change
Original maturity
25 26 27 2818 2919 30 20 3121 22 23 24
11 12 13 14 15 16 17
25 26 27 28 29
18 30
19 31
20 21 22 23 24
25 26 27 28 29 30 31
to investor of three
months or less
Examples:
Commercial paper
U.S. Treasury bills
Certain money market funds
LO2
Statement of Cash Flows Format
Classified by:
Operating activities
Investing activities =
+Beginning Financing activities
Cash and = Ending
Increase or decrease in Cash and
Cash cash and cash
Equivalents Cash
equivalents Equivalents
LO3
Statement of Cash Flows Format
Cash flows from operating activities:
Inflows $ xxx
Outflows (xxx)
Net cash provided (used) by operating activities $xxx
Cash flows from investing activities:
Inflows $ xxx
Outflows (xxx)
Net cash provided (used) by investing activities xxx
Cash flows from financing activities:
Inflows $ xxx
Outflows (xxx)
Net cash provided (used) by financing activities xxx
Net increase (decrease) in cash and cash equivalents $xxx
Cash and cash equivalents at beginning of year xxx
Cash and cash equivalents at end of year $xxx
from balance sheets
Operating Activities
Payment to suppliers
for inventory
Collection of Cash
customer accounts transactions
concerned with
acquiring and
selling products
and services
THE UNITED
UNITED STATES
STATES OF
THI S NOTE I S LEGAL TENDER
OF AMERICA
L70744629F
12
repayment of
WASHINGTON, D.C.
A
H 293
L70744629F
12 SERI ES 12
1985
ONE
ONE DOLLAR
DOLLAR
funds in the
form of debt
Issuance/retirement and equity
Payment of
of bonds
dividends
Categorizing Cash Flow Activities
Operating Activities Current
assets
and
current
Investing Activities liabilities
Long-term
liabilities
Long-term Financing or
assets Activities stockholders’
equity
£ £
Non Current Assets
Car: Cost 8000
Less Depreciation (2000)
6000
Equipment: 3000
Less Depreciation (500) 2500
8500
Current Assets
Inventories 300
Receivables 275
Prepayments 585
Cash 190 1350
5845