financial accounting course

financial accounting course

The Fundamentals of Financial Accounting: A Comprehensive Guide

1. Introduction to Financial Accounting

What to Expect This chapter will introduce you to the basic foundation of financial accounting. You should gain an understanding of the following after reading and working through this chapter: 1. Account-keeping convention, strategies, economic events, entity, generalization, materiality, reliability, consistency, and audit. 2. Account-keeping mechanisms and general structures—functional elements of accounts, income statement, and balance sheet: a. Functioning elemental structures b. Income statement c. Balance sheet

Introduction Financial accounting is the area of accounting that prepares financial statements concerning the performance, position, and budget of a commercial company. Company accounts are statutory and must comply with relevant financial legislation. This chapter seeks to give an introduction into the two main areas of company accounting: accounting conventions and structures, and general concepts of company accounts. It also outlines the main functional elemental structures of financial accounting and statements, particularly the income statement and the balance sheet. As a basic primer, the chapter gives a very broad overview of the indicators and technical accounting procedures of each of the two main account-keeping domains. These will be made more meaningful in subsequent chapters.

2. Key Concepts and Principles

Different owners make investments in a business in order to achieve certain specific financial objectives. Because of this common objective, the economic life of the business is usually divided into specific time periods, and its activities are summarized in periodic reports to the owners. Financial accounting is mainly concerned with producing financial reports that are intended primarily for external use by investors, lenders, and other outside parties. These reports are called general-purpose financial statements and include the income statement, the balance sheet, the statement of cash flows, and the statement of stockholder’s equity.

The basic principle of accounting is the entity concept. To the accountant, the business is in some way separate or distinct from the owner or owners. In accounting, the business unit is usually considered as a separate or independent entity. This is what accountants mean when they refer to things as belonging to a business or a company. Property, goods, and money that belong to the business are defined as assets. Property, goods, and money that belong to others are defined as liabilities. The leftover part of the total property, goods, and money (assets minus liabilities) that belongs to the owners of the business is called the owner’s equity. It’s the owners’ stake or claim in the company.

3. Financial Statements and Analysis

The minimum requirement is to distinguish total assets and total liabilities from unappropriated retained earnings, share capital, and amounts recognized in the statement of financial position as cumulative and translated differences and as equity in a separate statement of financial position. However, the purpose of the statement of financial position is to facilitate comparison with the similar statements of other entities and its statements in a different reporting period; to portray the company’s financial health so that potential investors, creditors, or purchasers can understand its financial standing and to portray the financial condition of the business on the going concern. The decision to sell your stock or to invest in the company or to grant a loan to the company is all made on the basis of the financial statements presented to potential stakeholders.

By classifying these as current assets, current liabilities, etc., decision-makers are able to assess how the company is doing in its ability to meet its current obligations. Wouldn’t you want to know if a company is able to pay its bills as they come due and how well it operates from day to day, week to week? It is safe to assume that the ability to do so today helps determine the success of a company down the road. A review of comparative statements for more than two years would depict the change and stability of a company from year to year within the categories. It helps horizontal analysis. Data needed for a vertical analysis is found on the financial statements. The statement of financial position presents the number of assets, liabilities, and shareholders’ equity disclosed either on the face of the statement of financial position or in the notes.

The statement of financial position (often referred to as the balance sheet) reflects a company’s financial condition as of a given moment, usually the ‘as of’ date of the financial statements. The statement of financial position lists the company’s financial condition (its assets, liabilities, and shareholders’ equity) in a classified format. The more liquid short-term assets (those assets the company expects to consume or convert into cash within a year) are first listed, with the less liquid long-term assets (those assets the company expects to consume or convert into cash if and when they are no longer needed) listed next. Short-term liabilities (those obligations due within a year) are listed first, with the longer-term liabilities listed next. The company’s equity (the book value reported for the owner’s claim to the company’s assets) is listed next.

Statement of Financial Position

4. Accounting for Assets and Liabilities

As before, we take the balance sheet equation as our focus. The accounting profession has developed methods for measuring and reporting the composition and value of the assets and liabilities that populate the balance sheet. The most commonly encountered balance sheet items include: current assets (including primarily cash, accounts and other receivables, and inventories); long-term investment assets (including primarily investments in the securities of other firms); property, plant, and equipment; and intangible assets with finite lives. The total of these balance sheet items is called total assets. In turn, the liabilities side of the balance sheet is commonly divided into two groups: current liabilities (primarily accounts payable, notes payable, current maturities of long-term debt, and accrued expenses); and long-term debt (including primarily bonds and term loans). Given any business enterprise, the balance sheet equation is guaranteed to be in balance, with assets possessing a value equal to that of the liabilities plus the owners’ claim on the enterprise. The owners’ claim is found in the stockholders’ equity portion of the balance sheet. This section deals with the issues of how the individual components of the balance sheet are measured and reported.

A crucial issue in accounting concerns the manner in which the assets and liabilities of a business are measured and reported. The balance sheet quantities must be meaningful to managers, investors, creditors, and others who use accounting information. How to arrive at appropriate measures is not always obvious. Some of the measurement problems are difficult, particularly if precision is demanded; yet, in many cases, estimates, determined on a consistent basis, can add significantly to our understanding of the enterprise. In this section, the most widely accepted methods for measuring the assets and liabilities of a business are presented. Occasionally, we will observe measurement inconsistencies. The reconciliation, or balancing, of the balance sheet example that follows provides a check on the consistency of the methods used. As before, time is ignored, and recognition of interest, taxes, and other income tax considerations are sidestepped.

5. Advanced Topics in Financial Accounting

The central thrust of financial accounting is disclosure. This is in direct contrast to taxation accounting, where the primary focus is the calculation of tax payable. To balance the interests of “mature” financial statement users, like investors, with those of “new” or “naive” financial statement users, like potential employees, lenders, and customers, financial accounting employs a complex mix of full disclosure, recognition, and measurement concepts (the “framework”). However, many complex recognition and measurement concepts associated with advanced topics known as “securitization,” “consolidation,” and “investment accounting” appear in processed annual reports and on financial statements issued by the corporate entities under the US GAAP or IFRS. The objective of this chapter is to describe the recognition and measurement concepts normally associated with these advanced related corporate financial reporting and disclosure topics.

Chapter 1 describes the process of financial accounting and the use of the accounting equation and the T-accounts to record and analyze transactions. The following chapters introduce the accrual basis of accounting, under which revenue is recognized in the accounting records at the time of sale, regardless of when the cash is collected. A corresponding expense is recognized at the time of purchase, regardless of when the cash is paid. As a result, the net income reported at various points in time does not necessarily coincide with the inflow or outflow of cash. In the final analysis, net income reported on the income statement of a company like Google represents the earnings (as normally understood by non-accountants) of the company.