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Economics /Management 4 Financial Accounting Fall 2014

Economics /Management 4 Financial Accounting Fall 2014. Introduction. Financial Accounting. A highly-stylized Information System Formulated as a system of Simultaneous Equations Organized around the fundamental Accounting Equation Assets = Liabilities + Equities. Financial Accounting.

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Economics /Management 4 Financial Accounting Fall 2014

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  1. Economics /Management 4Financial AccountingFall 2014 Introduction

  2. Financial Accounting A highly-stylized Information System Formulated as a system of Simultaneous Equations Organized around the fundamental Accounting Equation Assets = Liabilities + Equities

  3. Financial Accounting A highly-stylized Information System Basic Functions (all info systems): Collection of transactions’ data Measurement in dollar $ Classification into 7 Elements Presentation in 3 Reports

  4. Collection Collect the quantitative information from commercial transactions with outsiders. No transaction, no record.

  5. Measurement Transactions are measured in dollars, including trade-in and barter transactions.

  6. Classification into the Elements of Accounting • Asset • Liability • Equity • Revenue • Expense • Gain • Loss

  7. Presentation Into Financial Reports • Balance Sheet • Income Statement • Statement of Cash Flows

  8. The Accounting Process • Transaction amounts are recorded into journals. • One journal per accounts • There must be at least two recordings/journals for each transaction – this is “double-entry” book-keeping – it keeps the fundamental equation [A = L + Eq] in balance.

  9. Terminology is Critical • Earned Revenue v. Unearned Revenue. • Pre-paid Expense v. Expense. • Expense v. Accrued Expense. • Goods Sold v. Inventory on Hand. • Wholesale costs v. Retail prices ADJECTIVES MATTER

  10. Accounting helps keep track of … Accounting for those … Things - that a business owns and owes a. cash b. claimsto or obligationsfor cash (promises) c. resources - tangible and intangible d. sources of financial capital – money invested by others in the business Transactions – inflows & outflows, i.e. changes in the things above.

  11. Designed to provide Useful information to DirectProviders of Financial Capital 1. Owners/Investors (they buy stock) 2. Creditors / Lenders (who buy bonds) IndirectProviders of Financial Capital 3. Suppliers/Vendors 4. Customers 5. Government Tax & Regulatory Agencies

  12. Useful… means what? • Helps creditors & investors to understand firm financial performance (“profits”) • Relevant – for decision-making • Reliable – consistent & comparable • Independent/objective – outside-in • Timely – result of recent activities

  13. Profits ? Profits are a construct, not a fact The “fact” is … a good accountant can make profits anything that he/she wants them to be … Profits = Revenue & Gains less Expenses & Losses Thus, we will look very closely at what is meant by Revenue and Expense.

  14. Cash-basis Rules-oriented method. Only cash receipts or disbursements matter. And there is only one bottom-line. Accrual Principles-based method. GAAP accounting. More useful but opens the way for judgment, thus manipulation. There are many possible bottom-lines. Two Methods of Accounting

  15. the subjective meets the objective • Opinion meets Evidence • Quantitative meets Qualitative • Romance meets Reality • Form competes with Substance

  16. Principle’s-Based Reporting • Accrual concepts. Guidelines. • Useful doesn’t mean accurate! • Fiction is permitted in accounting; it’s just not called fiction, it’s called interpretation. • And, the line between lies and fiction is not a very bright one.

  17. Accounting Assumptions • One Entity. You are separate from your company for accounting purposes. • Record-keeping for a “Period” of time. Fiscal “FY” year comprised of 4 interim quarters of roughly 13 weeks each. • On-going concern. Change accounting methods for bankrupt companies or for discontinued operations w/in a company.

  18. The Accounting Period is a 12 month fiscal year With 4 Interim Periods. Most companiesRetailers 1st Quarter Jan-Mar Feb-Apr 2nd Quarter Apr-June May-July 3rd Quarter Jul-Sep Aug-Oct 4th Quarter Oct-Dec Nov-Jan

  19. Time Matters, i.e. Timing is critical 1st Quarter: January to March Means January 1st to March 31st, not December 31st to March 31st Or January 1st to February 1st

  20. Accounting Principles • Cost • Realization • Matching • Disclosure • Objectivity • Materiality • Comparability • Conservatism

  21. Accounting’s Principles • Cost – keep historical cost on-the-Books • Realization – “earned”. Three basic criteria define earning Revenue Recognition • Matching – outflows, i.e. Expenses w/ related inflows, i.e. revenues in fact or in time. • Disclosure – say it when you can’t measure it. • Objectivity – independence is provided by transactions that are at arm’s length • Comparability – useful in making choices b/w things. • Materiality – level of detail; aggregate the small stuff

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