Course Objectives:
Terminology and definitions used in the accounting language.
Identify why accounting is a necessary skill.
Summarize the history of accounting.
Identify and describe assets, liabilities and owners' equity.
Demonstrate the effects of business transactions on the accounting equation
Recognize and compare the major financial reports.
Describe and create a company's Income Statement.
Compare and contrast a company's revenue, expenses, income, and retained earnings.
Identify the key elements of a Balance Sheet.
Balance the accounting equation and properly chart debits and credits.
Describe the accounting cycle.
Define key terms: inventory, FIFO, LIFO, Cost of Goods Sold.
Summarize cash flow, identify fixed assets, and describe depreciation.
Know what to expect in an audit.
8. History of Accounting ) "Double-entry bookkeeping is one of the most beautiful discoveries of the human spirit… “ ( Johann Wolfgang Von Goethe 1796)
12. Money as a Unit of Account But if everybody charges in the same item, that is money, it becomes very clear who has the lowest price. What if one supplier wants to be paid in babysitting, another one in computer help and another in petsitting and so on… “ Standard unit of measurement” = “Language of business”
16. Why do we need accounting? It´s all about people…
17. Why do we need accounting? Unlimited Wants vs. Limited Resources Unlimited Wants: Only perfect beings want nothing… Limited Resources: Time, Energy, Money…
18. Why do we need accounting? Choices must be made…
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21. The Price Mechanism How to distribute resources rationally in the economy? Capitalist solution is the Price Mechanism Those who are willing to pay the price will get the goods and services
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23. Equilibrium Price Subjective preference rankings interact to yield objective money prices Equilibrium occurs when quantity supplied equals quantity demanded Market price will be stable, that is it won’t tend to change, when you reach the point at which willingness to buy coincides with willingness to sell in the market
24. Equilibrium Price Subjective preference rankings interact to yield objective money prices At 3 dollars every seller can find a willing buyer…
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26. Equilibrium Price - Shortage Subjective preference rankings interact to yield objective money prices Buyers start to compete to get the available units
27. Equilibrium Price Subjective preference rankings interact to yield objective money prices Price goes up and consequently quantity demanded drops and quantity supplied rises until we get to equilibrium again
28. Equilibrium Price Subjective preference rankings interact to yield objective money prices What about a higher price, like 5 dollars?
29. Equilibrium Price - Surplus Subjective preference rankings interact to yield objective money prices When the quantity demanded is less than the quantity supplied we have a surplus and the price will drop. At 5 dollars sellers are happy providing 5 units but buyers are unhappy, they only want one unit. 3 Dollars = “MARKET CLEARING PRICE” (clears the market of all surpluses and shortages)
31. Disadvantages of the Price Mechanism In our market economy it´s the market that determines price and price serves as the rationing mechanism to determine who gets the scarce product or service and who does not.
34. Price Mechanism – Rationing, Price Ceilings What would happen if you force a price that is not the equilibrium price? Example: Government imposes price ceiling on gasoline At the imposed price of 2,50 the quantity demanded is greater than quantity supplied. This means that not everyone is going to get the gasoline that they want, because there is a shortage. WHAT WILL HAPPEN?
39. “ The Invisible Hand” – Adam Smith Adam Smith was the first economist who investigated how this process of social coordination works. Rational, self-interested behaviour does not produce chaos, but usually produces social coordination
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41. Division of Labour Coordination through money prices Supply, demand, and prices in input and output markets determine the allocation of resources and the ultimate combinations of things produced. EXAMPLES OF “CREATIVE DESTRUCTION”: Polaroid Cameras, Typewriter, SteamTrains.... CONSUMER LABOUR – LAND - CAPITAL
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54. Users of accounting information Shareholders / Investors ANALYST COVERAGE: Financial Analyst: A financial professional who studies various industries and companies, providing research and valuation reports, and making buy, sell, and hold recommendations.
57. Users of accounting information Internal: Trade Unions Knowing what a company is making will give them an insight on how much they can demand
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63. Users of accounting information External: Suppliers Suppliers – will look at a company’s balance sheet and profit and loss account to see if and how much credit they are willing to give: METHODS OF PAYMENT IN INTERNATIONAL TRADE: Rule (especially for international trade): NEVER sell on open account to a new customer (only against credit card or advance payment)
97. Balance Sheet ASSETS = LIABILITES + EQUITY Declining order of liquidity For the asset side, the accounts are classified typically from most liquid to least liquid. For the liabilities side, the accounts are organized from short to long-term borrowings and other obligations. Balance sheet of Bakery & Co. Balance sheet as at 1 January 2010 Assets Liabilities & Equity Current Assets Current Liabilities Cash and Cash Equivalents 250 Accounts Payable 350 Inventories 300 Short-term Loan 200 Accounts Receivable 700 Current Tax Liabilities 100 Prepaid Expenses 50 Accrued Liabilities 100 Total Current Assets 1300 Total Current Liabilities 750 Fixed Assets Non-Current Liabilities Property, Plant, and Equipment 1550 Bank Loans 600 Total Fixed Assets 1550 Issued Debt Securities 1100 Deferred Tax Liability 100 Intangible Assets and Goodwill Total Non-Current Liabilities 1800 Intangible Assets 300 Goodwill 0 Total IA and Goodwill 300 Equity Common Stock 400 Other Assets Retained earnings 100 Investments 0 Reserves 50 Total Other Assets 0 Net Income 50 Equity 600 Total Assets 3150 Total Liabilities & Equity 3150
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102. Balance Sheet Balance sheet of Bakery & Co. Balance sheet as at 1 January 2010 Assets Liabilities & Equity Current Assets Current Liabilities Cash and Cash Equivalents 250 Accounts Payable 350 Inventories 300 Short-term Loan 200 Accounts Receivable 700 Current Tax Liabilities 100 Prepaid Expenses 50 Accrued Liabilities 100 Total Current Assets 1300 Total Current Liabilities 750 Fixed Assets Non-Current Liabilities Property, Plant, and Equipment 1550 Bank Loans 600 Total Fixed Assets 1550 Issued Debt Securities 1100 Deferred Tax Liability 100 Intangible Assets and Goodwill Total Non-Current Liabilities 1800 Intangible Assets 300 Goodwill 0 Total IA and Goodwill 300 Equity Common Stock 400 Other Assets Retained earnings 100 Investments 0 Reserves 50 Total Other Assets 0 Net Income 50 Equity 600 Total Assets 3150 Total Liabilities & Equity 3150
117. Did you note regularities? Yes? Because there are… 4 Basic Types of Transactions ASSETS = LIABILITIES + EQUITY Transactions may increase both sides of the equation (left and right side both increase - transaction type (a) , decrease both sides of the equation (left and right side both decrease - transaction type (b) , or increase and decreases on the same side of the equation (increase and decrease on the left side - transaction type (c) or an increase and decrease on the right side transaction (d) , the equation always balances .
118. How Transactions impact the Accounting Equation · · Transactions Assets = Liabilities + Owner's Equity Left Side Right Side Right Side Increase Decrease Decrease Increase Decrease Increase 1. ABC mows a client's yard and receives a check from the customer for $50 for the service provided. 2. ABC purchases $100 worth of office supplies and stores them in their storage room. The office supply store gives them an invoice that allows them to pay for them in 15 days (on account). 3. ABC places an ad in the local newspaper receives the invoice from the supplier and writes a check for $25 to the newspaper. 4. ABC purchases five mowers for $10,000 and finances them with a loan from the local bank. 5. ABC mows another customer's yard and sends the customer a $75 bill (invoice) for the service they performed. They allow their customer ten (10) days to pay them for this service (on account). 6. The owner of ABC needs a little money to pay some personal bills and writes himself a check for $500. 7. ABC pays the office supply company $100 with a check for the office supplies that they charged (promised to pay). 8. ABC receives a check from the customer who they billed (invoiced) $75 for services and allowed 10 days to pay. 9. ABC purchased some mulch for $60 and received an invoice from their supplier who allows them 15 days to pay. The mulch was used on a customer's yard. 10. ABC bills (prepares an invoice) the customer $80 for the mulch and mowing his yard and receives a check for $80 from the customer. Totals $10,380 $700 $100 $10,160 $585 $205 Net Change $9,680 Increase $10,060 Increase $380 Decrease Total Net Changes $9,680 Increase $9,680 Increase
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125. How Transactions impact the Accounting Equation Proper Recording Actually Uses Revenue, Expense & Draws Instead Of Owner's Equity Original Recording Proper Recording Uses Transactions Owner's Equity Revenue Expense Withdrawal Right Side Decrease Increase Revenue Increases Resulting In an Increase to Equity Expenses Increase Resulting In a Decrease to Equity Withdrawals Increase Resulting in a Decrease to Equity 1. ABC mows a client's yard and receives a check from the customer for $50 for the service provided. 50 3. ABC places an ad in the local newspaper receives the invoice from the supplier and writes a check for $25 to the newspaper. 25 5. ABC mows another customer's yard and sends the customer a $75 bill (invoice) for the service they performed. They allow their customer ten (10) days to pay them for this service (on account). 75 6. The owner of ABC needs a little money to pay some personal bills and writes himself a check for $500. 500 9. ABC purchased some mulch for $60 and received an invoice from their supplier who allows them 15 days to pay. The mulch was used on a customer's yard. 60 10. ABC bills (prepares an invoice) the customer $80 for the mulch and mowing his yard and receives a check for $80 from the customer. 80
139. Statement of Retained Earnings (Statement of Equity) The statement of retained earnings reports how net income and dividends affected a company´s financial position during the period. Note that the Income Statement must be prepared before the Statement of Retained Earnings
140. Example: Statement of Equity Many companies provide an expanded statement of stockholders’ equity instead of the required statement of retained earnings. The statement of stockholders’ equity portrays not only the changes in retained earnings, but also changes in other equity accounts. These other equity accounts include capital stock and potentially a lot of other amounts related to topics like par value, preferred stock, treasury stock, and the like…
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143. Statement of Cash Flows … cannot be manipulated with accounting tricks
150. Accounts, debits and credits ACCOUNTS The records that are kept for the individual asset, liability, equity, revenue, expense, and dividend components are known as accounts .
160. THE GENERAL LEDGER The journal contains page after page of detailed accounting transactions. In contrast, the general ledger contains a page for each and every account in use by a company.
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162. POSTING To “post” means to copy the entries listed in the journal into their respective ledger accounts.
165. Source Documents A receipt is a written acknowledgement that a specified article or sum of money has been received as an exchange for goods or services. = Source document for expenses
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167. THE TRIAL BALANCE After all transactions have been posted from the journal to the ledger, it is a good practice to prepare a trial balance. A trial balance is simply a listing of the ledger accounts along with their respective debit or credit balances:
168. THE TRIAL BALANCE Since each transaction was journalized in a way that insured that debits equaled credits, one would expect that this equality would be maintained throughout the ledger and trial balance. If the trial balance fails to balance, an error has occurred and must be located.
174. FINANCIAL STATEMENTS FROM THE TRIAL BALANCE So to summarize… The basic process is to transfer amounts from the general ledger to the trial balance, then into the financial statements
213. The adjusting process and related entries A common characteristic of an adjusting entry is that it will involve one income statement account and one balance sheet account. (The purpose of each adjusting entry is to get both the income statement and the balance sheet to be accurate.)
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217. The adjusting process and related entries Example: Prepaid insurance A three-year insurance policy was purchases on January 1, 20x1, for $9,000. The following entry would be needed to record the transaction on January 1:
218. The adjusting process and related entries Example: Prepaid Rent Assume a two-month rent is entered and rent paid in advance on March 1, 20X1, for $3,000. By March 31, 20X1, half of the rental period has lapsed, and financial statements are to be prepared. The following entries would be needed to record the transaction on March 1, and adjust rent expense and prepaid rent on March 31:
223. The adjusting process and related entries Unearned revenue Often, a business will collect monies in advance of providing goods or services. For example, you sell a one-year software licence and collect the full payment at the beginning of the subscription period: EXAMPLES?
229. The adjusting process and related entries ACCRUALS – Accrued revenue Many businesses provide services to clients under an understanding that they will be periodically billed for the hours (or other units) of service provided. As a result, money has been earned during a month, even though it won’t be billed until the following month. Accrual accounting concepts dictate that such revenues be recorded when earned. The following entry would be needed at the end of December to accrue revenue for services rendered to date (even though the physical billing of the client may not occur until January): EXAMPLES?
244. Classified Balance Sheets To facilitate proper analysis, accountants will often divide the balance sheet into categories or classifications. The result is that important groups of accounts can be identified and subtotaled. Such balance sheets are called “classified balance sheets.”
245. Classified Balance Sheets The asset side of the balance sheet may be divided into the following SUB-CATEGORIES: Current assets; Fixed Assets; Intangible assets; Other assets.
246. Classified Balance Sheets Current Assets Current Assets include cash and those assets that will be converted into cash or consumed in a relatively short period of time; specifically, those assets that will be converted into cash or consumed within one year or the operating cycle, whichever is longer.
247. Classified Balance Sheets Current Assets The operating cycle for a particular company is the period of time it takes to convert cash back into cash (i.e., purchase inventory, sell the inventory on account, and collect the receivable); this is usually less than one year. It is determined by adding the number of days inventory is held and the collection period for accounts receivable
253. INVENTORY – Perpetual Inventory System Scanners scan the products and automatically update the sales and inventory records
254. INVENTORY – Perpetual Inventory System PERPETUAL vs. PERIODICAL INVENTORY Which dealer would you rather deal with ? The one who can call it up on their computer and determine immediately if they have any and give you the price or the dealer that puts you on hold and has to look around his store and try to physically locate the item and determine the price? BUT: Also Perpetual Inventory Systems need to have a physical count – WHY? Perpetual Inventory Systems are only as good as the people who maintain it - verify that they actually do have the part…
262. INVENTORY – Cost of Goods sold An inventory count on October 30 showed 500 units in the warehouse. 1) What is the cost of goods sold for October under the FIFO method ? 2) What is the cost of goods sold for October under the LIFO method? 3) What is the cost of goods sold for October under the weighted average method?