Financial accounting Day_01

Understanding Accounting Transactions

Day 1(Chapters 1 to 4)

Prof. Jonghwan Kim, Ph.D.Course 20352| Prep for Financial Accounting

Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan

Kim

20352 - FINANCIAL ACCOUNTING PREPARATORY COURSE

forAFC, IM, CLEFIN-FINANCE, and EMIT

Instructor:Jonghwan Kim, Ph.D.

• Department of Accounting, Via Roentgen, 1 – 5th

floor A3-06

• Email: [email protected]

• Consultation hours: by email appointments


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Course Description

Accounting is the language of business, an important means of communication among various business parties. Among others, financial accounting speaks mainly to external information users, such as investors and financial analysts, who make decisions for many different purposes using the accounting information revealed in financial statements. This preparatory course is designed to provide students with a quick understanding of key accounting concepts and principles with which financial statements are prepared. Despite its short span, this course covers most of important accounting topics including:

• the double-entry accounting system,

• accounting for common transactions, and

• financial statement preparation (including income statement, balance sheet, and cash flow statement).


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Objectives

The course aims to prepare students for other graduate-level business courses for which accounting knowledge and skills can help to advance relevant knowledge. Upon completion of the course, students are expected to understand the basics of

• accounting terminology,

• how to generate accounting information and prepare financial statements, and

• how to interpret the accounting information.


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Class Schedule

12 sessions, 6 days

Session Date Time Topics Reference

1 August 27 13:00~14:30 Understanding accounting transactions Double-entry book-keeping Accrual accounting Accounting cycle Income statement and balance sheet

SLL Ch. 1 to 4

2 14:30~16:00

3 16:15~17:45

4 August 28 14:30~16:00 Sales and accounts receivable SLL Ch. 6

5 16:15~17:45 Inventory and cost of goods sold SLL Ch. 7

6 August 29 13:00~14:30 Long-lived assets SLL Ch. 8

7 14:30~16:00 Liabilities and long-term debt SLL Ch. 9

8 September 1 8:45~10:15 Bonds SLL Ch. 10

9 10:30~12:00 Owners’ Equity SLL Ch. 11

10 September 2 10:30~12:00 Investments SLL Ch. 12

11 September 3 14:30~16:00 Cash flow statement SLL Ch. 13

12 16:15~17:45 Comprehensive review Hand-outs

FINANCIAL ACCOUNTING- INTRODUCTION -

Session 1


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“Accounting is the language of business.”

A system that collects and processes financial information about an organization and reports that information to decision makers

What is Accounting?

Collect Process Reportmeasurerecord

analyze

?

!!

Information

Decision-Makers(Information Users)


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Accounting for Different Users

Exhibit 1.1

External Decision Makers Internal Decision Makers


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Objectives of Financial Reporting

To provide useful economic information about a business to help external users of financial statements

External users?

• investors

• creditors

• financial advisors

➥ Interested in a business’s ability to generate cash

• to pay dividends

• to increase the business’s value

• to pay interest and the principal on a loan


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Four Basic Financial Statements

Balance Sheet Income Statement

Statement of Retained Earnings

Statement of Cash Flows

Financial position at a particular point in time:• Assets• Liabilities• Owners’ Equity

Financial performance during an accounting period measured as revenues minus expenses

The change of retained earnings: + net income− dividends

The change of the cash balanceIn/out-flows in three categories:• Operating activities• Investing activities• Financing activities


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Key Elements of Financial Statements

AssetsEconomic resources• Probable future benefits• Owned or controlled• Related to prior transactions

LiabilityEconomic obligation• Probable future sacrifices• Unavoidable• Related to prior transactions

Stockholders’ EquityFinancing provided by owners and operations

Balance Sheet

Inco

me

Sta

tem

ent

• Revenue: increase in assets or settlement of liabilities from ongoing operations• Expense: decrease in assets or increase in liabilities from ongoing operations• Gain: increase in assets or settlement of liabilities from peripheral activities• Loss: decrease in assets or increase in liabilities from peripheral activities

Bal

ance

Sh

eet

= +“Basic Accounting Equation”

“I/S Equation” Revenues – Expenses = Net Income


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Relationships Among the Four Basic Financial Statements

“Basic Accounting Equation” “Income Statement Equation”


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Accounting Standards

Guides and rules that govern accounting practice, regarding how financial statements are prepared and accounting information is presented

• GAAP (Generally Accepted Accounting Principles)

• IFRS (International Financial Reporting Standards)

Prior to 1930’s, each company has self-defined financial reporting practices. Thus, no uniform standard across companies was in practice.

Why do we need accounting standards?


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Conceptual FrameworkQualities of Financial Information

Primary Characteristics

• Relevancy: predictive value, confirmatory (feedback) value, and timeliness.

• Faithful Representation (Reliability): verifiability, neutrality, and completeness

Secondary Characteristics

• Comparability: across companies.

• Consistency: over time.


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Conceptual FrameworkAssumptions and Principles for Measuring and Reporting Information

Assumptions:

• Separate-Entity

• Unit-of-Measure

• Continuity (Going-concern)

• Time Period

Principles:

• Historical Cost

• Revenue Recognition

• Matching

• Full Disclosure

ACCOUNTING TRANSACTIONS,ACCOUNTING EQUATION, AND

DOUBLE-ENTRY BOOKKEEPING

Session 1 (Continued)


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Accounting Transactions

Economic events that impact the financial standing of a business

• External Events:exchanges of assets, goods, or services with one or more external parties

• Internal Events:not an exchange between the business and other parties, but have a direct effect on the accounting entity


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Accounts

An organized format used by companies to accumulate the dollar effects of transactions


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Typical Account Titles

Balance Sheet Accounts

AssetsCashShort-Term InvestmentAccounts ReceivableNotes ReceivableInventory (to be sold)SuppliesPrepaid ExpensesLong-Term InvestmentsEquipmentBuildingsLandIntangibles

LiabilitiesAccounts PayableAccrued ExpensesNotes PayableTaxes PayableUnearned Revenue Bonds Payable

Stockholders’ EquityContributed CapitalRetained Earnings


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Typical Account Titles

Income Statement Accounts

RevenuesSales RevenueFee RevenueInterest RevenueRent Revenue

ExpensesCost of Goods SoldWages ExpenseRent ExpenseInterest ExpenseDepreciation ExpenseAdvertising ExpenseInsurance ExpenseRepair ExpenseIncome Tax Expense


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Transaction Analysis

“How do transactions affect accounts?”

Principles of Transaction Analysis

• Duality:Every transaction affects at least two accounts

• Accounting Equation:Assets = Liabilities + Stockholers’ Equity


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Balancing the Accounting Equation

Step 1: Accounts and effects

• Identify the accounts affected and classify them by type of account (A, L, SE).

• Determine the direction of the effect (increase or decrease) on each account.

Step 2: Balancing

• Verify that the accounting equation (A = L + SE) remains in balance.


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Example:

a. Papa John’s issues $2,000 of additional common stock to new investors for cash.

b. The company borrows $6,000 from the local bank, signing a three-year note.

c. Papa John’s purchases $10,000 of new equipment, paying $2,000 in cash and signing a two-year note payable for the rest.

d. Papa John’s lends $3,000 cash to new franchises who sign notes agreeing to repay the loans in five years.

e. Papa John’s purchases the stock of other companies as a long-term investment, paying $1,000 in cash.

f. Papa John’s board of directors declares and pays $3,000 in dividends to shareholders.

1. Identify and classify the accounts.

2. Determine the direction of effects.

3. Verify the equation holds.


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Double-Entry Bookkeeping

http://en.wikipedia.org/wiki/History_of_accounting#mediaviewer/File:Pacioli.jpg

Luca Pacioli, Italian monk and mathematician, the writer of “Summa de Arithmetica, Geometria, Proportioni et Proportionalità"

(early Italian: "Review of Arithmetic, Geometry, Ratio and Proportion")


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Keeping Track of Account Balances

“Double-entry” bookkeeping

• Debit (dr.) and Credit (cr.)

T-Account

Account Title

Debit(Dr.)

Credit(Cr.)


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Basic Transaction Analysis Model

T-account & Accounting Equation

Any Asset Account

[increase]$ 10

6

[decrease]

$ 16

Any Liab./ SE Account

[decrease] [increase]$ 20

12

$ 32$ 5 $ 25

?? ??11 ?? ??7


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Making Journal Entries

Journal Entry

• To record transactions in “chronological” order in a general journal


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Posting to General Ledger

Posting

• To transfer (record) transactions into respective accounts in a general ledger


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Transaction AnalysisJournal Entries and T-Accounts

Example:

a. Papa John’s issues $2,000 of additional common stock to new investors for cash.

b. The company borrows $6,000 from the local bank, signing a three-year note.

c. Papa John’s purchases $10,000 of new equipment, paying $2,000 in cash and signing a two-year note payable for the rest.

d. Papa John’s lends $3,000 cash to new franchises who sign notes agreeing to repay the loans in five years.

e. Papa John’s purchases the stock of other companies as a long-term investment, paying $1,000 in cash.

f. Papa John’s board of directors declares and pays $3,000 in dividends to shareholders.

ACCRUAL ACCOUNTING ANDINCOME STATEMENTS

Session 2


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Operating Cycle

The time it takes for a company to pay cash to suppliers, sell goods and services to customers, and collect cash from customers.

Purchase

Pay cash to suppliers

Sell goods or services

to customers

Receive cash from customers


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Operating Cycle

The operating cycle repeats “continuously” until a company goes out of the business.

• Time Period: The long life of a company can be reported over a series of shorter time periods.

• Recognition Issues : When should the effects of operating activities be recognized (recorded)?

• Measurement Issues: What amounts should be recognized?


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Elements of the Income Statement

Increase in assetsor

Settlement of liabilities

Decrease in assetsor

Increase of liabilities

from ongoing operations / primary businesses Revenue Expenses

from peripheraltransactions Gains Losses


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Papa John’s Income Statement

Exhibit 3.1


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Accrual vs. Cash Accounting

Accrual Basis Accounting

• Records accounting transactions when they occurrevenues are recognized when earned,expenses when incurred

• Regardless of the timing of receipts or payments of cash.

Cash Basis Accounting

• Records transactions whenever they involve cash receipt or distribution.


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Conceptual Frameworkfor Measuring and Reporting Information

Under Accrual Basis Accounting,

Revenue Principle

Recognize revenues when...• Delivery has occurred or services have been rendered.• There is persuasive evidence of an arrangement for

customer payment. • The price is fixed or determinable.• Collection is reasonably assured.

Matching Principle

Resources consumed to earn revenues in an accounting period should be recorded in that period, regardless of when cash is paid.


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Revenue Principle

Exhibit 3.2

Journal entries for situations:

1. Cash received in advance

2. Cash received at the time of sale

3. Cash received after a sale


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Matching Principle

Exhibit 3.3

Journal entries for situations:

1. Cash paid before the expense is incurred

2. Cash paid when ...

3. Cash paid after ...


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Extended Transaction Analysis Model


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Balancing the Accounting Equation

•Step 1: Accounts and effects

• Identify the accounts affected and classify them by type of account (A, L, SE).

• Determine the direction of the effect (increase or decrease) on each account.

•Step 2: Balancing

• Verify that the accounting equation (A = L + SE) remains in balance.


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Example:

a. Papa John’s restaurants sold pizza to customers for $36,000 cash and sold $30,000 in supplies to franchised restaurants, receiving $21,000 cash with the rest due on account.

b. The cost of the dough, sauce, cheese, and other supplies for the restaurant sales in (a) was $30,000.

c. Papa John’s sold new franchises for $400 cash, earning $100 immediately by performing services for franchisees; the rest will be earned over the next several months.

d. In January, Papa John’s paid $7,000 for utilities, repairs, and fuel for delivery vehicles, all considered general and administrative expenses incurred during the month.

e. Papa John’s commissaries ordered and received $29,000 in supplies, paying $9,000 in cash and owing the rest on account to suppliers.

f. Papa John’s paid $14,000 cash to employees for their work in January.


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Example:

g. At the beginning of January, Papa John’s paid the following, all of which are considered prepaid expenses when paid (any adjustments will be made in Chapter 4):• $2,000 for insurance (covering the next four months beginning January 1),• $6,000 for renting space in shopping centers (over the next three months beginning January 1), and • $1,000 for advertising (to be run in February).

h. Papa John’s sold land with an historical cost of $1,000 for $4,000 cash.

i. Papa John’s received $15,500 in franchisee fees based on their weekly sales; $12,800 of the amount was due from franchisees’ sales recorded as accounts receivable in December and the rest is from January sales.

j. Papa John’s paid $10,000 on accounts owed to suppliers.

k. Papa John’s received $1,000 in cash for interest earned on investments.


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Relationships Among the Four Basic Financial Statements


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Preparing Financial Statements


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M3-7

ACCOUNTING CYCLE, BOOK CLOSING, AND PREPARING FINANCIAL STATEMENTS

Session 3


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Accounting Cycle

Exhibit 4.1


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1. Unadjusted Trial Balance

A listing of individual accounts

• Usually in financial statement order

• Debits = Credits


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2. Adjustments

Purpose

• 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.➥ Revenue Recognition & Matching Principles

• Revenues are recorded when earned

• Expenses are recorded when incurred

• Assets are reported to represent the “remaining” probable future benefits

• Liabilities are reported to represent the “remaining” future economic sacrifices


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2. Adjustments

Adjustment Process

1. Was revenue earned or an expense incurred that is not yet recorded?

2. Was the related cash received or paid in the past or will it be received or paid in the future?

3. Compute the amount of revenue earned or expense incurred.


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2. Adjustments

Revenue

1. Unearned (or Deferred) 2. Accrued

Expense

3. Deferred 4. Accrued

Period 1 ★ Period 2Period 1 ★ Period 2

at the end of Period 1Revenue Earned

Expense Incurred

Adjusting entriesare required


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2. Adjustments

Example:

1. Unearned Franchise Fees Papa John’s received cash last period and recorded an increase in Cash and an increase in Unearned Franchise Fees, a liability, to recognize the business’s obligation to provide future services to franchisees. During January, Papa John’s performed $1,100 in services for franchisees who had previously paid fees.

2. Accounts ReceivablePapa John’s franchisees owe Papa John’s $830 in royalties for sales the franchisees made in the last week of January.

3. Interest Receivable Papa John’s loaned $3,000 to franchisees on December 31 (one month ago) at 6 percent interest per year with interest to be paid at the end of each year. There was also $8,000 in notes receivable outstanding all month from prior loans. Assume the interest on the other $8,000 in notes receivable is $55.


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2. Adjustments

Example:

4. Prepaid Rent and Insurance The Prepaid Expenses account includes $2,000 paid on January 1 for insurance coverage for four months (January through April) and $6,000 paid on January 1 for the rental of space at shopping centers over three months (January through March).

5. Supplies Supplies include food and paper products. At the end of the month, Papa John’s counted $12,000 in supplies on hand, but the Supplies account indicated a balance of $16,000 (from Exhibit 4.2 ).

6. Property and Equipment The net book value of Papa John’s property and equipment is $199,000 (net of accumulated depreciation of $189,000). Papa John’s estimates depreciation to be $30,000 per year.

7. Accrued Expenses Payable Papa John’s owed (1) its employees salaries for working four days at the end of January at $500 per day, (2) $610 for utilities used in January, and (3) interest on its long-term notes payable borrowed at a 6 percent annual rate.


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Adjusted T/B

Exhibit 4.5


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3. Preparing Financial Statements

The next step in the accounting cycle is to prepare the financial statements. . .


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1. Income Statement


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2. Statement of Stockholders’ Equity


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3. Balance Sheet


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4. Closing the Books

Closing Entries:

• Transfer net income (or loss) to Retained Earnings.

• Establish a zero balance in each of the temporaryaccounts to start the next accounting period.

Temporary accounts with debit balances are credited,with credit balances are debited.


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4. Closing the Books

Post-Closing Trial Balanceswill have zero balances on these temporary accounts.

Dr. Cr.7,590

66,000

4,730

1,070

3,000

30,000

16,000

7,000

4,000

2,000

500

610

2,500

690

3,910

$74,800 $74,800

Closing Entries


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7,59066,000

4,730

1,0703,000

30,00016,000

7,000

4,0002,000

500610

2,500690

3,910

$ 74,800 $ 74,800

127,590

$685,710 $685,710

ClosingEntries

Debit Credit

Post-ClosingTrial Balance


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E4-15

-39,000 +39,000 -39,000-17,000 -17,000 -17,000+3,200 -3,200 +3,200

7,200 153,000 115,800 37,200-2,160 +2,160 -2,1605,040 153,000 117,960 35,040


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E4-18

35

9

a. 4 2

80

c. 8 8

b. 5 5

d. 9 9

73

4

84a,b,c,d

26 58

26 26 188 188

Documents

Financial accounting Day_01