Introduction to Financial Accounting

Accounting 1: Introduction to Financial Accounting Page 1 I. Introduction to Accounting Accounting defined: The process of identifying, measuring, recording, and communicating financial information about an entity's economic activities. Role of accounting: Helps businesses make informed decisions, monitor performance, attract investors, and comply with legal requirements. Users of financial information: Internal (managers) and external (investors, creditors, regulators) stakeholders. II. Financial Statements Income Statement: Reports revenues and expenses over a specific period (e.g., a month, quarter, year). Net Income (or net loss) = Revenues - Expenses. Contributes to assessing profitability and performance. Balance Sheet (Statement of Financial Position): Presents a snapshot of a company's financial position at a specific point in time. Assets = Liabilities + Owner's Equity. Assets: Current (cash, inventory) and non-current (property, equipment). Liabilities: Current (short-term debts) and long-term (loans). Owner's Equity: Investments by owners and retained earnings. Statement of Cash Flows: Summarizes cash inflows and outflows from operating, investing, and financing activities. Helps analyze a company's cash generation and usage. III. Double-Entry Accounting Each transaction affects at least two accounts: debit and credit. Debit: Left side; increases assets, decreases liabilities and equity. Credit: Right side; increases liabilities and equity, decreases assets. The accounting equation (Assets = Liabilities + Equity) remains balanced. IV. Recording Transactions Journal Entries: Chronological records of transactions. Debit and credit accounts are noted, maintaining the accounting equation balance. Ledger: A collection of all accounts used by a business. Posting journal entries to the appropriate accounts in the ledger. Page 2 V. Adjusting Entries Made at the end of an accounting period to ensure that accounts accurately reflect revenues earned and expenses incurred. Two main types: prepaid expenses and accrued revenues/expenses. VI. Closing Process Transferring temporary account balances (revenues, expenses) to the Income Summary account. Income Summary account's balance is then transferred to the Retained Earnings account. Resets temporary accounts for the next accounting period. VII. Merchandising Transactions Inventory Systems: Perpetual: Constantly updated records of inventory levels. Periodic: Physical counts periodically to adjust inventory records. Sales Transactions: Record sales revenue and related cost of goods sold (COGS). Calculate gross profit: Gross Profit = Sales - COGS. VIII. Accounting for Receivables Accounts Receivable: Amounts owed to a company by customers. Bad Debts: Accounts that are unlikely to be collected. Allowance for Doubtful Accounts: Contra-asset account to reflect estimated uncollectible accounts. IX. Accounting for Long-Term Assets Depreciation: Allocating the cost of a long-term asset over its useful life. Accumulated Depreciation: Contra-asset account showing total depreciation to date. Amortization: Similar to depreciation, but for intangible assets (patents, copyrights). Accumulated Amortization account tracks amortized amount. Page 3 X. Accounting for Equity Common Stock and Preferred Stock: Represents ownership in the company. Par value vs. market value. Retained Earnings: Accumulated net income not distributed as dividends. Impacted by net income/loss, dividends, and prior period adjustments. XI. Financial Ratios and Analysis Liquidity Ratios: Measure a company's short-term ability to pay its debts. Examples: Current Ratio (Current Assets / Current Liabilities), Quick Ratio. Profitability Ratios: Assess a company's ability to generate profits relative to various metrics. Examples: Gross Profit Margin, Net Profit Margin, Return on Equity. Solvency Ratios: Evaluate a company's long-term financial health and ability to meet its obligations. Examples: Debt-to-Equity Ratio, Interest Coverage Ratio. XII. Fraud and Internal Control Fraud: Deliberate misrepresentation to gain an unfair advantage. Internal Control: Procedures to safeguard assets, enhance accuracy, and ensure compliance. Segregation of duties, physical safeguards, and independent verification are key aspects. XIII. Ethical Considerations in Accounting Integrity, objectivity, confidentiality, and professional competence are ethical principles. Adhering to ethical standards enhances credibility and trust in financial reporting.