Basics of Accounting (The Language of Finance)

Business & Accounting

Accounting is the universal language of Business and

Finance. More CEOs from fortune 500 companies have come up through the ranks of accounting than from any other area in business. Currently: 54% Small businesses usually fail because of poor accounting & finance understanding. Marriages usually fail because of poor financial management (80% of divorces are money related.) If you want to get ahead in business & marriage determine that you are going to understand accounting basics.

What do Accountants Account For?

Everything of value!

Terms
Assets:

Tangible and Non-tangible resources of a business that have future value. Usually sub-classified as follows:
Current Assets (Turn into cash/use annually) Fixed Assets (Depreciated over several yrs.) Buildings, Equipment, Natural Resources Land (Fixed, but never depreciated) Intangible Assets: Patents, Trademarks, Copyrights

What are your Assets?

Bank Account & Money in your pocket

Car
Clothes Books Stocks/Bonds/CDs Prepaid rent Computers & Electronic Equip. Knowledge? Abilities?

Accounting Term:Liabilities
Other peoples claims against your assets!
What you owe!! Debts! Classified as: Current Liabilities (one year debt) Credit Card Debt, Accounts Payable Long Term Liabilities Car, Mortgage, Note Payable Unearned revenues Bonds (usually super long term)

What are your liabilities?

School Loan

Car Loan
Credit Card Balance House loan

Capital or Owners Equity

The portion of your assets that you can legally claim. (Net Assets)

What you really own legally. Assets (minus) Liabilities = Owners Equity (or Capital) Example (purchased a building for Rs.500,000 with a 10% down payment (Rs.50,000) Cost of a building (sales price = Asset amount) Rs.500,000 Less: What you still owe on the building (Liability) Rs.450,000 Equals: Your equity in the building (Capital) or your net worth in the building. Rs.50,000 Formula universally used in all financial and personal financial institutions: Assets = Liability + Owners Equity (Balance Sheet Equation) (Resources you have) =(What you owe on them) + (the principle you have paid on them.)

 If assets equal Rs. 195000 and liabilities equal Rs.40000, then

owners capital/ equity equals_____. If assets equal Rs. 65000 and owners equity equals_____. If current assets equal Rs. 25000, liabilities equal Rs.40000 and owners equity equals Rs.55000, then fixed assets equal ____. If assets equal Rs.225000 and owners claim equals Rs.105000 then liabilities equal __________.

Entity concept There are three basic structures that a company can have : 1. Sole proprietorship 2. Partnership 3. Corporation A sole proprietorship is not a legal entity separate from its owner A partnership is not a legal entity separate from its owners These are both sub-components of their owners/partners for legal purposes A corporation is a separate legal entity

Owners Equity Account Titles

Single Proprietorship:
Capital

Corporation:
Common Stock (what owners paid in) Preferred Stock (what owners paid in) Retained Earnings (profits that the business

keeps in the business)

What is your net worth?

What you have minus what you owe. What format do we use in business and in personal

finance to show our net worth? A Balance Sheet Financial Statement List of Assets (classified by type in accounts) Compared or balanced with: List of Liabilities and Owners Equity (classified by type and in accounts)

Example (Simplified) An Example of Business or Personal Records

Balance Sheet September 10, 2010

Assets: Current: Cash at Home Cash Deposits in Bank Fixed: Wardrobe Equipment Car Total Assets: Liabilities: Current: Credit Card Payable Long Term: Note Payable (on Car) Total Liabilities Capital, J D Total Liabilities & Owners Equity:

Rs.100 500
2000 1000 5000 Rs.8,600

Rs.500

Rs.2000 Rs.2,500 6,100 Rs.8,600

Other Terms
Temporary Accounts are used in addition to balance

sheet accounts to record changes in owners equity each reporting period. Expenses Decrease in owners equity during the period by using up an asset or a portion of an asset. (or creating additional liabilities) Revenue Increase in owners equity during the period by performing a service or selling an asset. Drawing or Dividends Decrease in owners equity due to personal withdrawals by the owner(s).

Income Statement Report

Used to determine the net income or net loss of an

individual or business for a defined period of time. Used for marking progress by comparing months and years Used by financial institutions for determining the progress and status of a company or individuals financial health. Used by the IT Dept. for determining taxes

Income Statement What does it contain?

Matches Expenses with Revenues for a specific

period of time. (Only the temporary type of accounts are on the income statement.) No Assets/Liabilities Income Statement accounts are closed out at the end of the reporting period and started over again the next period.so comparisons can be made.

Income Statement Example

Name of Individual or business Income Statement For period of time (Month of Sept. 2010) Revenue: Income from Job Income from XGrant Total Revenue: Expenses: Clothes Expense Rent Expense Food Expense Tuition Expense Misc. Expense Total Expenses: Net Income for September:

Rs.500 2000 Rs.2500 Rs.300 200 50 1200 250 Rs.2000 Rs.500

Quiz
Which financial report is a snapshot of the financial

status of a business or a family..and is given a specific date? Which financial report is a moving picture of the business/enterprise for a period of time? What does a balance sheet balance? What are the two kinds of accounts found on an Income Statement? On what financial report(s) is the cash account found? What are the three subtitles of a income statement. (name them in the order they are given on the report)

 If the bank wanted to know your Net Worth what

report would they ask for? Capital in a corporation is entitled ? Two ways to increase the capital account are? Two ways to decrease the capital account are? If the bank wanted to know your Net Worth what report would they ask for?

How do individuals or businesses keep track for all their assets, liabilities, capital, expenses, revenues. Etc.?
The Accounting Process or otherwise known as the

Accounting Cycle. (also called the Audit Trail of business. Based on universally accepted accounting principles. (Generally accepted accounting principles) Double Entry Bookkeeping Accrual Accounting vs. Cash Accounting Bookkeeping part of accounting.

A few more terms

Goods

Goodwill
Depreciation Goods Capital expenditure v/s revenue expense Insolvent Transaction A supplier of goods is also called _ _ _ _ _ _ . A buyer or purchaser of goods or services is also

called _ _ _ _ _ _ .

 Purchases
Sundry creditors Sales Sundry debtors Revenue Income Gain Loss Drawings

Definition of accounting
The art of recording, classifying, and summarizing monetary transactions and events which are, in part at least, of financial character, and interpreting the results thereof."

Who uses accounting information?

Owners Managers

Investors (including potential)

Analysts on their behalf

Creditors (including potential) Government (tax assessment) Regulators Customers

Branches of accounting
Financial accounting

Cost accounting
Management accounting Tax accounting Social accounting Human resource accounting

Accounting concepts
Accounting

concept refers to the basic assumptions and rules and principles which work as the basis of recording of business transactions and preparing accounts.

Accounting concepts
Business Entity concept Going concern Unit of measure (Money measurement)

Accounting period
Cost Dual aspect concept Revenue recognition Matching Consistency Verifiability Conservatism Full disclosure Materiality

Business Entity concept

The Accounting Entity convention states that the

business is an entity (perceived to have its own existence) separate from its owner. Therefore business records should be separated and kept distinct from the personal records of the business owner(s).

Going concern
Accountants assume, unless there is evidence to

the contrary, that a company is not going broke and will continue its operation for an indefinite period of time or at least into the foreseeable future. This concept also allows businesses to spread (amortize) the cost of fixed asset over its expected useful life.

Unit of measure ( money measurement)

Accountants do not account for items unless they can

be quantified in monetary terms. Which implies that either money was exchanged to acquire it or a market exists that would be prepared to exchange money for it. A business may have other valuable resources like workforce skill, morale, market leadership, brand recognition, quality of management, but these do not get recorded in the financial statements because they cannot be quantified in monetary terms.

Accounting period
This convention allows for the performance evaluation of

a 'going concern' business to be broken-up into specific period of time such as a month, a quarter or a year. This is also known as the accounting period convention. This short time period of assessment allows internal and external users to make adjustments to their strategy in relation to the business. Also using this time period concept, the accountant and other users can compare financial results over a similar period of time. The accounting period generally covers a span of 12 months.

Historical Cost concept

This convention requires that the assets of a business

be recorded in the ledger accounts at the actual price paid to acquire them. Under this concept no account is taken of the changing values of these assets in the market place. Satisfies the criteria of objectivity and verifiability.

Dual aspect concept

According to duality each transaction will affect at least

two items The dual impact of each transaction would be such that Assets = Liabilities + Owners Equity. All transactions recorded in the accounts must keep this equation in balance.

Revenue recognition
Revenue is deemed to be earned at the point of sale

or at the transfer of legal ownership. This may be different from the point when cash actually changes hands. E.g. precollected revenues, accounts receivables, accrued revenue, Two classes of gains possible: a) holding gains; b) trading or operating gains. As per this convention only operating gains will be recorded. Special cases: a) Contract jobs b) Hire purchase agreement

Matching concept
Expenses should be "matched" against revenues that they

enabled and should be recorded in the same period in which the revenue is earned. This approach is supported by the accrual accounting method. Accountants need to prepare accruals at the end of each reporting period to take account of expenses incurred but for which there is no source document.

Consistency
According

this convention, transaction classification and valuation methods should remain unchanged from one period to the next. This allows for a more meaningful comparisons of financial performance between periods by the stakeholders.

to

Verifiability
Transactions must be recorded on the basis of

objective evidence. Accounting records will initiate from a source document to ensure that the information recorded is based on fact and not just on personal opinion.

Conservatism
The rule is to recognize revenue only when it is

reasonably certain of happening and recognize expenses as soon as they are incurred (whether paid or not). Accounting in this manner ensures that financial statements do not overstate the companys financial position.

Full disclosure
This concept requires that financial statements

provide sufficient information to help users of the information make knowledgeable and informed decisions about the business. To meet this requirement, the enterprise must add notes to the financial statements. Does not require to reveal business secrets.

Materiality
Accountants

only record events that are significant enough to justify the usefulness of the information. Only items that are deemed significant for a given size of operation should be recorded. Accountants are guided to ignore insignificant details otherwise the accounts will be burdened down with minute details.