Financial Accounting

1. Based on: Harrison, Horngren & Thomas: Financial Accounting, newest ed.
Financial Accounting
Prof. Dr. Marlies Brunner
The Financial Statements

2. Walt T. Harrison, Charles
T. Horngren, William
Thomas, Wendy M.
Tietz
Financial Accounting,
Global Edition

4. 4
ACCOUNTING - THE BASIS OF DECISION MAKING
• Accounting is the “language of business”
• Accounting is the information system that
– Measures business activities
– Processes that information into reports
– Communicates the results to decision makers

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THE ACCOUNTING SYSTEM:
THE FLOW OF INFORMATION
1. People make decisions
2. Business transactions occur
3. Businesses prepare reports to show the
results of their operations

6. 6
ACCOUNTING VS. BOOKKEEPING
• Bookkeeping is the procedural element of
accounting that processes the accounting
data

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• Individuals
• Businesses
• Investors and Creditors
• Government Regulatory Agencies
• Taxing Authorities
• Nonprofit Organizations
DECISION MAKERS WHO USE ACCOUNTING
INFORMATION

8. 8
• Financial accounting provides information
to managers and people outside the firm
– Financial accounting information must meet
certain standards of relevance and reliability
• Management accounting generates
confidential information for internal
decision makers, e.g.,
– Top executives
– Department heads
FINANCIAL ACCOUNTING AND MANAGEMENT
ACCOUNTING

9. 9
ETHICAL CONSIDERATIONS
• Ethical standards in accounting are designed
to produce accurate information for decision
making
• The result of ethical behavior by accountants
is information that people can rely on for
decision making

10. 10
TYPES OF BUSINESS ORGANIZATIONS
• Proprietorships
– Have a single owner who is generally the manager
– Are business entities, but not legal entities
– Have debt for which the proprietor is personally
liable

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TYPES OF BUSINESS ORGANIZATIONS
• Partnerships
– Join two or more persons together as co-owners
– Are business entities, but not legal entities
– Have debt for which each partner is personally
liable

12. 12
TYPES OF BUSINESS ORGANIZATIONS
• Corporations
– Are owned by stockholders or shareholders
– Are business entities and legal entities
– Are liable for all debts
• Stockholders have no personal obligation for
corporation debts

13. International Financial Reporting
Standards (IFRS and IAS rules)

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ACCOUNTING PRINCIPLES AND
CONCEPTS
• The entity concept
–States that an organization is an economic
entity that keeps its affairs separate from
those of the owner(s)
• The reliability (objective) principle
– States that accounting records and statements are
based on the most reliable data available and
documented by objective evidence

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ACCOUNTING PRINCIPLES AND
CONCEPTS
• Understandability
• Relevance
• Materiality (if issues influence the economic
performance of the business in the future)
• Faithful representation
• Neutrality
• Prudence
• …

16. 16
ACCOUNTING PRINCIPLES AND
CONCEPTS
• …
• Timeliness
• Balance between benefit and cost
• FAIR PRESENTATION
• (out of the IASB Framework for the preparation
and presentation of financial statements)

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ACCOUNTING PRINCIPLES AND
CONCEPTS
• The cost principle versus fair value principle
– States that acquired assets and services should be
recorded at their actual (historical) cost and should
maintain that historical cost for as long as they are
owned (HGB – German Commercial Code) …. or
– Recorded at fair value (IFRS) if revaluation model is
chosen
• The going-concern concept
– States that the entity will remain in operation for the
foreseeable future

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ACCOUNTING PRINCIPLES AND
CONCEPTS
• The stable-monetary-unit concept
– States that each dollar has the same purchasing
power as any other dollar at any other time

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ACCOUNTING PRINCIPLES AND
CONCEPTS
• Accrual basis: transactions are recorded when
they occur and not when they are paid

20. 20
THE ACCOUNTING EQUATION
• The accounting equation presents the
resources of the business and the claims to
those resources
Economic Resources = Claims to Economic Resources
Assets = Liabilities + Owners’ Equity
or

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• Assets are the economic resources of a
business that are expected to be of benefit in
the future
• Claims to assets come from
– Liabilities
• Economic obligations - debts payable to outsiders,
called creditors
– Owners’ equity (capital)
• Assets held by the owners of the business
THE ACCOUNTING EQUATION

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• For a corporation, stockholders’ (owners’)
equity consists of two main categories
– Paid-in capital
– Retained earnings
THE ACCOUNTING EQUATION
Assets = Liabilities + Stockholders’ Equity
Assets = Liabilities + Paid-in Capital + Retained Earnings
or

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• Paid-in (contributed) capital is
– The amount invested in the corporation by its
owners
– Comprised basically of common stock
THE ACCOUNTING EQUATION

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• Retained earnings
– Is the amount earned by income-producing
activities and kept for use in the business
– Is affected by
• Revenues - increases in retained earnings from
delivering goods or services
• Expenses - decreases in retained earnings that result
from operations
THE ACCOUNTING EQUATION

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• Net income (net earnings)
– Total revenues exceed total expenses
• Net loss
– Total expenses exceed total revenues
• Dividends
– Distributions to stockholders (usually cash)
generated by net income
THE ACCOUNTING EQUATION

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Beginning Balance
of Retained
Earnings
+
- - =
Net Income (Loss)
for the Period
Dividends for the
Period
Ending Balance of
Retained
Earnings
Revenues for the
Period
Expenses for the
Period
-
=
COMPONENTS OF RETAINED EARNINGS
Start of the
Period
End of the
Period

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• The owners’ equity of proprietorships and
partnerships
– Makes no distinction between paid-in capital and
retained earnings
– Accounts for the equity of each owner under the
single heading of Capital
THE ACCOUNTING EQUATION

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INFORMATION REPORTED ON THE
FINANCIAL STATEMENTS

29. Business Decision Making – 1/4
Question How well did the company perform in the
past?
Answer Revenues
- Expenses
=Net Profit/Net Loss
Financial Statement • Income Statement
• Statement of Earnings
• Comprehensive Statement of Income
• Statement of Profit and Loss

30. Business Decision Making – 2/4
Question Why did the company‘s equity change over
the year?
Answer Equity at the beginning of the period
+ Net Income for the period
- Dividends
- Other changes to equity
(capital contributions)
= Equity at the end of the period
Financial Statement • Statement of Changes in Equity

31. Business Decision Making – 3/4
Question What is the company‘s financial position at
the end of the period?
Answer Assets = Liabilities + Equity
Economic Resources = Claims to Economic
Resources
Financial Statement • Balance Sheet
• Statement of the Financial Position

32. Business Decision Making – 4/4
Question How much cash did the company generate
and spend during the period?
Answer Operating Cash Flow
+/- Investing Cash Flow
+/- Financing Cash Flow
= Change in Cash Flow during the period
Financial Statement • Cash Flow Statement

33. IAS 1.10 calls for …
A complete set of financial statements includes
(a)A statement of financial position as at the end of the period
(b)A statement of profit and loss and other comprehensive income
for the period
(c)A statement of changes in equity
(d)A statement of cash flows
(e)Notes, comprising significant accounting policies and other
explanatory information

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INCOME STATEMENT
• The income statement (statement of
earnings) reports the company’s revenues,
expenses, and net income or net loss for the
period

35. INCOME STATEMENT
Air & Sea Travel Inc.,
Income Statement for the Month Ended April 30, 2022
Revenues
- Service
Revenues 8,500
Expenses
- Salary expense
- Rent expense
- Utitilies
1,200
1,100
400
Total Expenses 2,700
Net Income 5,800

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• Revenues are
– Increases in retained earnings from delivering
goods or services to customers or clients
• Expenses are
– Decreases in retained earnings that result from
operations
INCOME STATEMENT

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• Expenses include
– Cost of goods sold (cost of sales)
• The cost of the goods that a company sold to its
customers
– Operating expenses
• The costs of operating the business
INCOME STATEMENT

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• Operating expenses
– Advertising
• The cost to promote the company’s products
– Depreciation
• The expense of using company-owned buildings,
equipment, and furniture
– Other operating expenses
• The costs of salaries, utilities, rent, and supplies
– Interest expense
• The cost of borrowed money
INCOME STATEMENT

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STATEMENT OF
Changes in Equity
• The Statement of Changes in Equity reports
– that portion of net income the company has
retained, or kept for use in the business
– Dividends paid to stockholders
– Any other changes in the capital accounts

40. STATEMENT OF CHANGES IN EQUITY
Air & Sea Travel Inc.,
Statement of Changes in Equity for the Month Ended April 30, 2022
Beginning Equity,
April 1st 2022
50,000
Add:
Net Income for the Period
5,800
Less: Dividends (2,100)
Retained Earnings 3,700
Ending Equity, April 30, 2022 53,700

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BALANCE SHEET
• The balance sheet (statement of financial
position) reports the company’s assets,
liabilities, and owners’ equity

42. BALANCE SHEET
Air & Sea Travel Inc.,
Balance Sheet as of April 30, 2022
Assets Liabilities
Cash
Accounts Receivable
Office Supplies
Land
33,300
2,000
500
18,000
Accounts Payable 100
Stockholders‘ Equity
Common Stock
Retained Earnings
50,000
3,700
Total Assets 53,800 Total Liabilities and
Stockholders‘ Equity
53,800

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ASSETS
• Current assets are
– Those assets which the company expects to
convert to cash, sell, or consume during the next
12 months or within the business's normal
operating cycle if longer than a year
• Current assets include
– Cash
– Accounts receivable
– Merchandise inventory
– Prepaid expenses

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ASSETS
• Long-term assets are
– Those assets which the company expects to
hold longer then the next 12 months or the
business’s normal operating cycle if longer
than one year
• Long-term assets include
– Property
– Equipment

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ASSETS
• Intangible assets are
– Those with no physical form
• Trademarks
• Patents
• Other assets are
– Those with small values which do not fall within
any other standard asset category

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LIABILITIES
• Current liabilities are
– Debts payable within one year or within the
business’s normal operating cycle if longer than a
year
• Current liabilities include
– Notes payable, short term
– Accounts payable
– Accrued expenses payable
– Income taxes payable

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LIABILITIES
• Long-term liabilities are
– Debts not payable within one year or within the
business’s normal operating cycle if longer than a
year
• Long-term liabilities include
– Notes payable, long term
– Bonds payable

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OWNERS’ EQUITY
• Owners’ equity
– Represents the shareholders’ ownership of the
assets of the business
• Owners’ equity of a corporation consists of
– Common stock
– Retained earnings

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STATEMENT OF CASH FLOWS
• The Statement of cash flows reports the
company’s cash inflows and outflows from
operating, investing, and financing activities
for the period

50. STATEMENT OF CASH FLOWS
Air & Sea Travel Inc.,
Statement of Cash Flows for the Month Ended April 30, 2022
Cash flows from operating activities:
Collections from customers
Payments to suppliers and
employees
Net Cash inflow from operating activities
6,500
(-3,100)
3,400
Cash flows from investing activities
Acquisition of land
Sale of land
Net cash outflow from investing activities
(40,000)
22,000
(18,000)
Cash flows from financing activities
Issuance of stock
Payment of dividends
Net cash inflow from financing activities
50,000
(2,100)
47,900
Net Increase in Cash 33,300
Cash Balance, April 1, 2022 0
Cash Balance, April 30, 2022 33,300

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• Operating activities
– Companies operate by buying goods and services,
which are sold to customers
• Investing Activities
– Companies invest in long-term assets that are used
to run the business
• Financing Activities
– Companies finance themselves by issuing stock
and borrowing money
STATEMENT OF CASH FLOWS

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RELATIONSHIPS AMONG THE FINANCIAL
STATEMENTS

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RELATIONSHIPS AMONG THE FINANCIAL
STATEMENTS
Take Income from Income Statement
Include figure for Income into Statement of Equity
Take final figure for Equity and insert into Balance Sheet
Relate the amount of Cash from Balance Sheet
to the Cash Flow Statement

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END OF CHAPTER 1