fundamentals of financial accounting pdf

fundamentals of financial accounting pdf

Fundamentals of Financial Accounting: A Comprehensive Guide

1. Introduction to Financial Accounting

A company’s adherence to legal and regulatory financial accounting requirements will increasingly be seen as a foundation of trust and credibility in financial transactions related to the company. Users of financial reports are not only external to the firm, but are often responsible for setting financial accounting policies and procedures. Financial accounting activities incorporate expertise of accounting, financial analysts, tax professionals, and attorneys with corporate, public financial, and accounting perspectives. Managers will derive an understanding of decision usefulness of financial accounting data, as well as overall ethical responsibilities in presenting corporate financial data. Such knowledge will help toward moving beyond legal and ethical responsibilities to develop effective financial accounting reporting and communications strategies, thereby increasing a company’s current and future success and financial stability. Investors need financial accounting skills to compare and choose investment alternatives. They cannot easily conduct a real-time analysis of economic events that impact their investment.

Fundamentals of Financial Accounting: A Comprehensive Guide introduces the reader to key issues in financial accounting theory and practice. Students, professionals, and others can use it alone or as a reference for the fundamental accounting concepts that underlie all aspects of financial statement preparation and discussion. This book is particularly helpful in understanding financial accounting theory and incorporating its concepts into an underlying understanding of accounting theory and its implications for sound business practice. Selecting a financial accounting text is an essential investment in a professional accounting career, business administration background, or introduction to fundamental accounting theory. Development of foundation knowledge in these areas is essential, not only in courses that specialize in accounting theory, but also in general business courses and administration programs. For business owners and others with financial interests in a company, understanding financial accounting concepts is important for gaining the necessary background to place confidence in the company’s financial records.

2. The Accounting Cycle and Financial Statements

Each year, the accountant prepares at least four financial statements as part of the fiscal period report to owners and creditors. They are the income statement, the statement of retained earnings, the balance sheet, and the statement of cash flows. Together, these financial statements provide critical information about the activities of a firm. The income statement tells net income or loss for a particular period. It summarizes the dollar results of this period’s operations. The statement of retained earnings shows additional capital invested by the owner plus net income, minus drawings taken by the owner, or retained. The balance sheet lists things of value, the liabilities that are necessary to provide those things, and the owner’s equity in the business organized under three categories: assets, liabilities, and stockholders’ equity. The statement of cash flows shows how cash is obtained and used during a particular period. It organizes the information contained in the income statement and balance sheet.

The accounting cycle is the series of steps that take place during each fiscal period in a business enterprise to keep its accounting records in order, to prepare the necessary financial statements, and to perform needed accounting tasks. The cycle consists of analyzing and classifying business transactions, journalizing the transactions, posting to the ledger, taking a trial balance, journalizing and posting adjusting entries, preparing an adjusted trial balance, preparing financial statements, journalizing and posting closing entries, and preparing a post-closing trial balance. Once these steps are completed and entered in the accounting records, another accounting cycle begins.

3. Accounting Principles and Concepts

In accounting, principles refer to the theoretical framework foundations of amounts and accounts in accounting. Such concepts are historical cost, matching principle, materiality, revenue recognition principle, consistency, conservatism, full disclosure, and so on. Accounting concepts mean and explain the assumptions and limits of financial accounting. These concepts try to explain various transactions occurring in business, what are their results and financial position? Accounting concepts are set to try to define the entire cycle of the accounting system. The point of setting these concepts is to provide operating guidelines.

Accounting principles and concepts provide the rules and guidelines based on which financial accounting is made. These rules act as the resource or guide for finalizing the financial statements. Any retail business accounting system follows the concepts and conventions settled by financial accounting professionals. Accounting principles are generally established through professional organizations composed of accounting experts. These principles are neither legal requirements nor requirements of any other set of rules. These principles provide a general guideline for the effective running of the business.

4. Analyzing and Interpreting Financial Statements

Drawing Conclusions from Financial Statements Analysts, who are responsible for drawing conclusions about an enterprise’s financial condition and performance, rely on the data and information presented in the company’s financial statements to assist them in this process. They might be equity research analysts, who are employed by investment banks and other brokerage firms; credit analysts, who are employed by rating agencies, private companies, and large lending institutions; or financial statement auditors, who conduct independent audits to enhance the credibility of financial information. Because of the differing motivations, analysts must be cognizant of implicit assumptions within the financial statements and underlying accounting standards when evaluating the company’s performance and financial condition. It is the responsibility of financial reporting standard setters, who promulgate the financial accounting and reporting rules, and external auditors, who evaluate whether accounting treatments comply with these standards, to establish and enforce the principles that produce high-quality financial statements in a technically determined, reliable, objective, and verifiable manner. Indeed, the generality of standard-setting goals is clear, stated succinctly at the beginning of the conceptual framework (a joint project completed by the Financial Accounting Standards Board and the International Accounting Standards Board): The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in decisions about providing resources to the entity.

The purpose of financial statements is to provide decision makers with realistic and predictive insight into the financial condition and performance of an enterprise. Users of financial statements might be interested in learning about the performance and risk characteristics of their investments. Management, which is responsible for the company’s day-to-day operations, often prepares these statements for the benefit of employee and shareholder stakeholders. Lenders, who might have a long-established lender-borrower relationship or even be considering whether to become creditors, make decisions based on the information presented. Taxing authorities might also use financial information for tax planning, estimating, and enforcement purposes.

5. Special Topics in Financial Accounting

Through the broad use of the spreadsheet, we concentrate on teaching and learning to demonstrate the common utility (economic substance and instructional rigor) of financial and managerial accounting.

In this manner, the model helps to tie the student back in to the prior seven chapters, the definitions (earnings, income), and computations of earnings by using only items embedded in previously learned financial accounting concepts and principles. Furthermore, the introduction and use of the spreadsheet showcases the integration of financial accounting and managerial accounting, and illustrates the close connection between the development and use of financial accounting information to external users with the development and use of managerial accounting information by internal users.

The model begins with operating income (earnings), adjusts operating income for non-operating items, adjusts net income for changes in dividends, and adjusts net income for extraordinary items and discontinued operations. The model permits quick and easy computations of earnings in thousands of dollars as well as earnings per share. After a sequence of demonstrations and runs, we switch from historical data to projected data. We compute historical and projected earnings per share for a single future accounting period.

5.1 Financial and Managerial Accounting: In this textbook, while we adhere to the more traditional title of Financial Accounting, we distinguish between financial and managerial accounting by the inclusion of nearly all (about 90%) of the spreadsheet model that we have embedded in our text and collectively have used for over twenty years. The spreadsheet used calculates both historical and projected accounting earnings per share. We have blocked out about 15 to 25 minutes over about seven to ten weeks to demonstrate the model and run the model for a sequence of publicly-held corporations.

Many financial accounting textbooks begin and end with financial statement preparation. Often, there are other topics that are far more relevant to the world of business. We add a variety of special topics to better prepare our students for the business world.