Overview
This course provides a comprehensive introduction to financial accounting concepts, focusing on key terminology, financial statements, journal entries, adjusting entries, inventory methods, depreciation, bonds, shareholders’ equity, cash flows, and financial statement analysis.
Essential Accounting Terminology
- Six crucial terms: assets, liabilities, shareholders' equity, revenues, expenses, and dividends.
- Assets: resources owned/controlled by a company with measurable value (e.g., cash, inventory).
- Liabilities: future obligations a company must repay (e.g., loans, accounts payable).
- Shareholders’ Equity: the owners' claim on assets after liabilities are paid (A = L + SE).
- Revenues: money earned from normal business operations.
- Expenses: costs incurred to earn revenues.
- Dividends: distributions of profits to shareholders.
Financial Statements
- Income Statement: Reports revenues and expenses, showing net income or loss for the period.
- Statement of Changes in Equity: Summarizes changes in common shares and retained earnings.
- Balance Sheet: Lists assets, liabilities, and shareholders’ equity at a point in time (must balance).
- Cash Flow Statement: Shows cash inflows/outflows from operating, investing, and financing activities.
Journal Entries & Double-Entry System
- Every transaction involves at least one debit and one credit; debits must equal credits.
- Assets increase with debits, decrease with credits; liabilities and equity are the opposite.
- Revenues/Equity increase with credits; expenses/dividends increase with debits.
Adjusting Entries
- Five types: prepaids, depreciation, accrued expenses, accrued revenues, unearned revenues.
- Adjustments ensure revenues and expenses are recognized in the correct period.
- Prepaids and depreciation allocate asset costs over time; accruals recognize built-up revenues/expenses.
Inventory & Costing Methods
- Inventory valued using FIFO (first-in, first-out), LIFO (last-in, first-out, US only), and weighted average methods.
- Specific identification used for unique items.
- COGS and ending inventory values depend on chosen method, impacting profit.
Depreciation Methods
- Straight Line: Allocates asset cost evenly over useful life.
- Units of Production: Depreciation based on actual usage.
- Double Declining Balance: Accelerated method, more depreciation early in asset's life.
Bonds & Liabilities
- Bonds can be issued at a discount (below face value) or premium (above face value) depending on market rates.
- Premiums/discounts are amortized over the bond life using the effective interest method.
- Bonds require periodic interest payments and affect cash flow/expense recognition.
Shareholders’ Equity Concepts
- Common shares: Represent ownership with voting rights and residual profits.
- Preferred shares: Typically get priority for dividends and liquidation, sometimes cumulative.
- Stock dividends and splits increase shares outstanding without immediate cash outflow.
Cash Flow Statement Preparation
- Operating section: direct (cash in/out) or indirect (start from net income, adjust for non-cash items).
- Investing: cash from buying/selling long-term assets.
- Financing: cash from debt/equity transactions and dividends.
Financial Statement Analysis
- Horizontal Analysis: Year-over-year changes in financial statement items.
- Vertical Analysis: Express items as a percentage of a base figure (e.g., sales or assets).
- Key Ratios:
- Liquidity (e.g., current ratio, acid-test)
- Efficiency (e.g., inventory & receivables turnover)
- Profitability (e.g., gross profit %, return on assets/equity)
- Debt/solvency (e.g., debt ratio, times interest earned)
- Market (e.g., earnings per share, price/earnings ratio, dividend yield)
Key Terms & Definitions
- Asset — A resource controlled by a company with measurable value.
- Liability — A present obligation to pay a future amount.
- Shareholders' Equity (SE) — Owners’ residual interest in company assets after liabilities.
- Revenue — Money earned from normal business operations.
- Expense — Cost incurred in generating revenues.
- Dividend — Distributions of profit to shareholders.
- Depreciation — Systematic allocation of asset cost over its useful life.
- FIFO/LIFO/Weighted Average — Inventory costing methods.
- Accrual — Recognition of revenue/expense before cash changes hands.
- Bond — Long-term debt instrument issued by companies/governments.
- Operating/Investing/Financing Activities — Sections of the cash flow statement.
Action Items / Next Steps
- Review and internalize the six foundational accounting terms.
- Practice identifying account types and preparing journal and adjusting entries.
- Complete related homework problems and readings (as assigned in your course).
- Practice preparing and analyzing all four main financial statements.
- Memorize key financial ratios and understand their interpretation.