Key Accounting Principles and Financial Reporting
Fundamental Accounting Principles and Financial Reporting
Types of Businesses
- Service Businesses: Provide services to customers, relying on human knowledge or talent. They do not sell tangible goods.
- Merchandising Businesses: Buy finished goods and sell them to customers (e.g., Walmart, Target).
- Manufacturing Businesses: Make the products they sell (e.g., Ford, Microsoft, Apple).
Financial Resources
Businesses need capital to establish and operate. This capital comes from:
- Investors: Provide capital in hopes of receiving a return on their investment.
- Creditors: Loan money with a contractual obligation for repayment plus interest.
Physical Resources
These are tangible natural resources like timber, oil, and gas.
Financial Accounting
This branch of accounting focuses on the information needs of external users such as investors, creditors, customers, and the government. It ensures uniformity across companies for comparison.
Managerial Accounting
This branch focuses on the information needs of managers and others working within the business.
Regulatory Bodies
- FASB (Financial Accounting Standards Board): A privately funded organization that establishes accounting standards/rules in the U.S.
- GAAP (Generally Accepted Accounting Principles): The rules established by the FASB.
- IASB (International Accounting Standards Board): Sets broad global accounting standards.
- IFRS (International Financial Reporting Standards): Global standards reflecting interdependent economies, permissible by the SEC for multinational companies trading in the USA.
Key Financial Statements
Income Statement
Provides a summary of the company’s expenses and revenue for a specific period.
Statement of Shareholder Equity
Shows changes in common stock and retained earnings for a period.
- Common Stock: Represents specific commitments made to investors and amounts given by investors in exchange for ownership.
- Retained Earnings: Profits retained in the business since its inception.
Balance Sheet
Shows the company’s financial position at a specific point in time, detailing assets, liabilities, and equity.
Statement of Cash Flows
Details the cash inflows and outflows related to:
- Financing Activities (FA): Cash obtained from or paid to investors and creditors.
- Investing Activities (IA): Cash used to purchase or sell long-term assets.
- Operating Activities (OA): Cash from revenue and expenses.
Assets, Liabilities, and Equity
- Equity = Assets – Liabilities
- Assets: Resources used by a business to earn money (e.g., cars, buildings, equipment, cash, inventory).
- Liabilities: Amounts a company owes to its creditors (e.g., notes payable, wages payable, taxes payable).
- Shareholder Equity: The owner’s claim to the company’s assets after deducting liabilities.
Assets come from creditors (liabilities), investors (common stock), and operations (retained earnings). Revenue increases retained earnings, while expenses and dividends decrease it.
Chapter 2: Accrual Accounting and Adjustments
US GAAP and Accrual Accounting
- Accrual: Only amounts earned by the company are reported, regardless of when cash is received.
- Expense Recognition: Only report costs incurred in the period to generate or support revenue production, regardless of when cash is paid.
The income statement reflects accrual accounting.
- Accrual: Revenue or expense recognized before cash is exchanged.
- Deferral: Revenue or expense recognized after cash is exchanged.
Accounts Receivable
Amounts owed by customers who did not pay cash at purchase (on account). Revenue is recorded before cash is received. Accounts are adjusted at the end of an accounting period to reflect all revenue earned and all expenses incurred.
Temporary vs. Permanent Accounts
- Temporary Accounts: Track financial results for a limited period.
- Permanent Accounts: Track financial results from year to year.
Chapter 3: Product Costs, Selling/Admin Costs, and Inventory
Product Costs
All costs incurred to acquire merchandise and ready it for sale. These costs are included in inventory on the balance sheet (e.g., shipping costs, transit insurance, storage costs).
Selling and Administrative Costs (Period Costs)
Costs that are not included in inventory and are expensed immediately (e.g., advertising, administrative salaries, sales commissions, interest).
Income Statements
- Single-Step: Lists revenues and expenses.
- Multiple-Step:
- Gross Margin: Company profits before deducting operating expenses (Revenue – COGS = Gross Margin).
- Total Operating Expenses: Expenses from normal operations (Selling + General & Administrative Expenses).
- Income/Loss from Operations: Income or loss from primary business activities.
- Non-Operating Items: Activities not included in normal/primary business activities (e.g., interest income/expense, gains and losses).
- Net Income: Income from operations +/- non-operating items.
Perpetual Inventory System
The inventory account is adjusted continually throughout the accounting period. It increases for each item purchased and decreases for each item sold.
Purchase Discounts
Reduce the buyer’s cost of inventory. For example, 2/10 net 30 means a 2% discount is offered if payment is made within 10 days; otherwise, the full payment is due within 30 days.
FOB (Free on Board)
- FOB Shipping Point (SP): The buyer owns the goods during transit and pays the shipping costs, increasing the buyer’s inventory.
- FOB Destination (D): The seller owns the goods in transit and pays the shipping costs, increasing the seller’s delivery expense.
Gross Margin (Gross Profit)
The difference between sales revenue and the cost of goods sold (COGS).
Gross Losses
Profit that results from peripheral or incidental transactions.
