Lecture 1 FA.pdf
- 1. Financial Accounting: Financial accounting is a specific branch of accounting involving a process of recording, summarizing, and reporting the myriad of transactions resulting from business operations over a period of time. These transactions are summarized in the preparation of financial statements, including the balance sheet, income statement and cash flow statement, that record the company's operating performance over a specified period. Transaction: A transaction is a completed agreement between a buyer and a seller to exchange goods, services, or financial assets in return for money. The term is also commonly used in corporate accounting. In business bookkeeping, this plain definition can get tricky. A transaction may be recorded by a company earlier or later depending on whether it uses accrual accounting or cash accounting. Cash: Cash is bills, coins, bank balances, money orders, and checks. Cash is used to acquire goods and services or to eliminate obligations. Items that do not fall within the definition of cash are post-dated checks and notes receivable. Most forms of cash are electronic, rather than bills and coins, since cash balances can be stated in the computer records for investment accounts. Cash is listed first in the balance sheet, since the reporting sequence is in order by liquidity, and cash is the most liquid of all assets. A related accounting term is cash equivalents, which refers to assets that can be readily converted into cash. A business is more likely to retain a large amount of cash on hand if it routinely deals with cash transactions (such as a pawn shop), and is less likely to retain much cash if it has an excellent cash forecasting system and can therefore invest in more illiquid but higher yielding investments with confidence. Credit: In accounting, a credit is an entry that records a decrease in assets or an increase in liability as well as a decrease in expenses or an increase in revenue (as opposed to a debit that does the opposite). So a credit
- 2. increases net income on the company's income statement, while a debit reduces net income. Assets: An asset is a resource with a monetary value that a person, business, or country owns or manages with the hope that it will bring benefits in the future. Assets are listed on a company's balance sheet and are bought or built to make the company more valuable or to help it run better. An asset can bring in money, cut costs, or boost sales in the future. This could be a piece of manufacturing equipment or a patent. Asset Classification Current Assets "Current assets" are assets that are expected to be turned into cash within a year. Current assets include cash and other things that can be used as cash, accounts receivable, inventories, and prepaid expenses. Accountants look at inventory and money owed to the business regularly. On the other hand, it's easy to figure out how much cash is worth. If there are signs that accounts receivable might not be paid, they will be written down. Or, a company may eliminate an asset that is no longer useful. Fixed Assets Fixed assets are things like plants, equipment, and buildings that will last long. Charges made regularly are used to change how old fixed assets are. Depreciation is the name for these costs, which may or may not show that a fixed asset makes less money. Generally accepted accounting standards let you figure out depreciation in two main ways (GAAP). The straight-line method says that the value of a fixed asset decreases throughout its useful life. On the other hand, the accelerated method says that the value of the asset decreases more quickly in its first few years of use. Financial Assets Financial assets consist of investments in the assets and securities of other institutions. Financial assets consist of stocks, bonds issued by the government and corporations, preferred stock, and other hybrid securities. The valuation of financial assets depends on the classification and motivation of the investment. Intangible Assets Intangible assets are valuable things that you can't see or touch. Patents, trademarks, copyrights, and goodwill are all part of this. Intangible assets
- 3. can be amortized or tested for impairment every year, depending on the type of asset. Sole Proprietorship? A sole proprietorship—also referred to as a sole trader or a proprietorship—is an unincorporated business that has just one owner who pays personal income tax on profits earned from the business. Many sole proprietors do business under their own names because creating a separate business or trade name isn’t necessary. A sole proprietorship is the easiest type of business to establish or take apart, due to a lack of government regulation. As such, these types of businesses are very popular among sole owners of businesses, individual self-contractors, and consultants. Most small businesses start as sole proprietor-ships and either stay that way or expand and transition to a limited liability entity or corporation. Partnership A partnership is a form of business where two or more people share ownership, as well as the responsibility for managing the company and the income or losses the business generates. That income is paid to partners, who then claim it on their personal tax returns – the business is not taxed separately, as corporations are, on its profits or losses. Corporation A corporation is a business entity that is owned by its shareholder(s), who elect a board of directors to oversee the organization’s activities. The corporation is liable for the actions and finances of the business – the shareholders are not. Corporations can be for-profit, as businesses are, or not-for-profit, as charitable organizations typically are. Debit Debit means an entry recorded for a payment made or owed. A debit entry is usually made on the left side of a ledger account. So, when a transaction occurs in a double entry system, one account is debited while another account is credited. An account is debited either to increase the asset balance or to decrease the liability balance. Usually
- 4. an expense or any asset addition or a reduce in the revenue, or liabilities are termed as debits. For example, a small business owner purchases refrigerator for his business. To record the transaction, she debits the Asset account to increase the asset balance and credits the Cash account to decrease the cash balance. Account Payable: When a company purchases goods on credit which needs to be paid back in a short period of time, it is known as Accounts Payable. It is treated as a liability and comes under the head ‘current liabilities’. Accounts Payable is a short-term debt payment which needs to be paid to avoid default. Accounts Receivable (AR ) is the proceeds or payment which the company will receive from its customers who have purchased its goods & services on credit. Usually the credit period is short ranging from few days to months or in some cases maybe a year. Notes payable Notes payable are long-term liabilities that indicate the money a company owes its financiers—banks and other financial institutions as well as other sources of funds such as friends and family. They are long- term because they are payable beyond 12 months, though usually within five years.: Notes receivable are a balance sheet item that records the value of promissory notes that a business is owed and should receive payment for. A written promissory note gives the holder, or bearer, the right to receive the amount outlined in the legal agreement. Promissory notes are a written promise to pay cash to another party on or before a specified future date. If the note receivable is due within a year, then it is treated as a current asset on the balance sheet. If it is not due until a date that is more than one year in the future, then it is treated as a non-current asset on the balance sheet.
- 5. Often, a business will allow customers to convert their overdue accounts (the business’ accounts receivable) into notes receivable. By doing so, the debtor typically benefits by having more time to pay. Owner's Equity/ Capital: Owner's equity is one of the three main sections of a sole proprietorship's balance sheet and one of the components of the accounting equation: Assets = Liabilities + Owner's Equity. Owner's equity represents the owner's investment in the business minus the owner's draws or withdrawals from the business plus the net income (or minus the net loss) since the business began. Owner's equity is viewed as a residual claim on the business assets because liabilities have a higher claim. Owner's equity can also be viewed (along with liabilities) as a source of the business assets. Example of Owner's Equity If a sole proprietorship's accounting records indicate assets of $100,000 and liabilities of $70,000, the amount of owner's equity is $30,000. Due to the cost principle (and other accounting principles) the amount of owner's equity should not be considered to be the fair market value of the business. Income Statement An income statement is one of the three important financial statements used for reporting a company’s financial performance over a specific accounting period. The other two key statements are the balance sheet and the cash flow statement. Also known as the profit and loss (P&L) statement or the statement of revenue and expense, the income statement primarily focuses on the company’s revenue and expenses during a particular period. The best way to analyze a company and decide whether you should invest is to know how to dissect its income statement.
- 6. Balance Sheet The term balance sheet refers to a financial statement that reports a company's assets, liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis for computing rates of return for investors and evaluating a company's capital structure. In short, the balance sheet is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders. Balance sheets can be used with other important financial statements to conduct fundamental analysis or calculate financial ratios. Revenue The revenue number is the income a company generates before any expenses are taken out. Therefore, when a company has "top-line growth," the company is experiencing an increase in gross sales or revenue. Both revenue and net income are useful in determining the financial strength of a company, but they are not interchangeable. Revenue only indicates how effective a company is at generating sales and revenue and does not take into consideration operating efficiencies which could have a dramatic impact on the bottom line. Revenue vs. Income: Revenue is the total amount of income generated by the sale of goods or services related to the company's primary operations. Revenue, also known as gross sales, is often referred to as the "top line" because it sits at the top of the income statement. Income, or net income, is a company's total earnings or profit. When investors and analysts speak of a company's income, they're actually referring to net income or the profit for the company. Journal: journal is a detailed account that records all the financial transactions of a business, to be used for the future reconciling of accounts and the transfer of information to other official accounting records, such as the general ledger.
- 7. ledger A ledger is a book or digital record containing bookkeeping entries. Ledgers may contain detailed transaction information for one account, one type of transaction, or—in the case of a general ledger—summarized information for all of a company’s financial transactions over a period. Ledgers are also known as the second book of entry. Ledgers contain the necessary information to prepare financial statements.