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Accounting Fundamentals

Accounting Fundamentals. Dr. Yan Xiong Department of Accountancy CSU Sacramento The lecture notes are primarily based on Reimers (2003). 7/11/03. Chapter 2: Quality of Accounting Info. Agenda Objectives of accounting information Elements of financial statements

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Accounting Fundamentals

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  1. Accounting Fundamentals Dr. Yan Xiong Department of Accountancy CSU Sacramento The lecture notes are primarily based on Reimers (2003). 7/11/03

  2. Chapter 2: Quality of Accounting Info Agenda • Objectives of accounting information • Elements of financial statements • Recognition and measurement in financial statements

  3. Agenda • Objectives of Accounting Information

  4. Who Sets the Rules? • Securities and Exchange Commission has the legal authority to set the accounting rules for companies that are publicly traded. • The SEC has delegated that responsibility to the accounting profession. • Currently, the Financial Accounting Standards Board is the standards-setting body.

  5. GAAP GAAP (not a clothes store) • Generally Accepted Accounting Principles (GAAP) are the rules that most companies follow in preparing their financial reports. • GAAP are not exact rules: professional judgment is needed. • Statements of Financial Accounting Concepts provide the basis and guidance for establishing accounting standards.

  6. Objectives Qualities • To provide useful information for decision-making. • Relevant: • specific to a business entity, • timely, • simplified and condensed, • focus on earnings, • all within a cost-benefit framework.

  7. Objectives Qualities • To provide useful information for decision-making. • Reliable: • representational faithfulness • verifiable • unbiased

  8. Objectives Qualities • To provide useful information for decision-making. • Comparable: • from year to year for one company, • across companies for a single year, • to industry averages, • estimates.

  9. Objectives Qualities • To provide useful information for decision-making. • Consistent: • same rules used each time

  10. Additional Concepts/Constraints • Cost/benefit • Materiality • Full disclosure

  11. Agenda • Elements of Financial Statements

  12. Elements of Financial Statements • Assets • Liabilities • Equity • Revenue • Expenses

  13. Elements of Financial Statements Next to each item, indicate whether it is an Asset, Liability, Equity, Revenue or Expense. _____ Cash _____ Common Stock ($1 par) _____ Depreciation Expense _____ Insurance Expense _____ Interest Receivable _____ Interest Earned _____ Investment in U.S. Bonds

  14. Elements of Financial Statements _____ Cash Asset _____ Common Stock ($1 par) Equity _____ Depreciation Expense Expense _____ Insurance Expense Expense _____ Interest Receivable Asset _____ Interest Earned Revenue _____ Investment in U.S. Bonds Asset

  15. More elements of financial statements _____ Miscellaneous Expense _____ Prepaid Insurance _____ Rent Revenue _____ Retained Earnings _____ Salaries Expense _____ Salaries Payable _____ Service Revenue _____ Supplies Used _____ Unearned Rent

  16. More elements of financial statements _____ Miscellaneous Expense Expense _____ Prepaid Insurance Asset _____ Rent Revenue Revenue _____ Retained Earnings Equity _____ Salaries Expense Expense _____ Salaries Payable Liability _____ Service Revenue Revenue _____ Supplies Used Expense _____ Unearned Rent Liability

  17. Agenda • Recognition and measurement in financial statements

  18. Recognition and Measurement in Financial Statements • Transactions are measured and recorded at COST. • Revenue is recognized--included on the income statement--when it is EARNED. • Expenses are recognized in the period in which the related revenue is recognized: MATCHING CONCEPT. • This is ACCRUAL ACCOUNTING.

  19. ACCRUALS: Action first, dollars later E.g., services are performed, payment to be received later DEFERRALS: Dollars first, action later E.g., payment is made in advance for insurance or rent, the action of using it comes later Accruals and Deferrals Both types of transactions and adjustments are part of ACCRUAL ACCOUNTING.

  20. Tom’s Wear: February 2001 • Let’s look at each of the transactions that took place during February, Tom’s second month of business. • We’ll show how each affects the accounting equations, and then we’ll prepare the four basic financial statements.

  21. Date February 1 Transactions Tom’s Wear purchases 200 T-shirts at $4 each on account. Acquisition of Inventory Assets = Liabilities + CC + RE $800 inventory $800 A/P

  22. Date February 5 Transactions Tom’s Wear hires a company to advertise his business for $150--$100 cash and $50 on account. Acquisition of a Service Assets = Liabilities + CC + RE (100) cash 50 other payables (150) expenses

  23. Date February 14 Transactions Tom’s Wear pays for 3 month’s worth of insurance for $150. Sales and Collection Cycle Assets = Liabilities + CC + RE + 150 prepaid insurance (150) cash

  24. Date February 20 Transactions Tom’s Wear sells 185 T-shirts for $10 each. 170 shirts were cash sales and the other sales were on account. Sales and Collection Cycle Assets = Liabilities + CC + RE +1,700 cash +1,850 sales + 150 A/R

  25. Date February 20 Transactions Tom’s Wear sells 185 T-shirts for $10 each. 170 shirts were cash sales and the other sales were on account. Sales and Collection Cycle Assets = Liabilities + CC + RE +1,700 cash +1,850 sales + 150 A/R (740) inventory (740) cost of goods sold Note: Recall that the cost of shirts was $4 each.

  26. Date February 28 Transactions Tom’s Wear pays dividends of $100. Acquisition/Payment Cycle Assets = Liabilities + CC + RE (100) cash (100) dividends

  27. Date February 28 Prepaid insurance that has been used needs to be recorded as an expense. Only the unused portion remains on the balance sheet as an asset. Adjustment for Year-end Financial Statements Assets = Liabilities + CC + RE (25) prepaid insurance (25) insurance expense

  28. Tom’s Wear, Inc.Income StatementFor the month ended February 28, 2001 Revenue Sales $1,850 Expenses Cost of sales $ 740 Other expenses 175915 Net income $ 935

  29. Tom’s Wear, Inc. Statement of Changes in Shareholder’s Equity For the month ending 2/28/01 Beginning contributed capital $5,000 Contributions during the year -0- Ending contributed capital 5,000 Beginning retained earning $ 385 Net Income for the year 935 Dividends (100) Ending Retained earning $1,220 Total shareholder’s equity $6,220

  30. Tom’s WearBalance SheetAs of 2/28/01 Assets Liabilities + Shareholder’s Equity Cash $6,695 Accounts payable 800 A/R 150 Other Payables 50 Inventory $ 100 Common stock, T. Phillips $5,000 Prepaid Ins 125 Retained earnings 1220 Total assets $ 7,070 Total liabilities + SH’s Equity $ 7,070

  31. Tom’s Wear, Inc.Statement of Cash FlowsFor the month ended 2/28/01 Cash from operating activities Cash from customers $ 1700 Cash paid for advertising (100) Cash paid for insurance (150) Total cash from operations $1450 Cash from investing activities -0- Cash from financing activities Dividends (100) Total Cash from Financing (100) Net Increase in Cash $ 1350 Cash, Beginning Balance 5345 Cash, ending Balance 6,695

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