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ACCT 111: Financial Accounting
Foundations of Financial Reporting
1. What the Heck is accounting? (The Basics)
The Big Picture: Accounting is basically a company's information system. We Identify stuff that matters (like a sale), Record it (in the books), and Communicate it (in reports/statements). The Nickname: "Language of Business." Why? Because if you can read the reports (like the Balance Sheet), you know if the company is rich, broke, or making money. The Goal: Help people make smart decisions (Should I invest? Should I loan them money? Should I raise prices?).
2. Who Cares About the Financials? (Users/Stakeholders)
This is an easy test question—just remember the two groups and their why. Who They Are Why They Care What They Use Accounting For Internal Users (Managers, CEOs, Sales Teams) Running the show. They use data to plan, budget, and check if things are working. Deciding if they need more staff, if they should buy a new truck, etc. ( Managerial Accounting is their jam). External Users (Investors, Banks, IRS) Making big decisions about the company from the outside. Investors: Should I buy stock? Banks: Should I lend them money? IRS: Are they paying enough tax? ( Financial Accounting is focused on these guys).
3. Business Structures: Liability Matters!
The structure determines how Equity is reported and how much risk the owner takes.
- Sole Proprietorship: o One owner. Super easy to start. o BAD PART: Unlimited Liability. If the business goes broke, they can take your personal house/car. o Equity Name: Owner's Capital.
- Partnership: o Two or more owners. o BAD PART: Still usually unlimited liability for the partners. o Equity Name: Partner Capital Accounts.
- Corporation: o Owned by shareholders (investors). The most complicated to set up. o GOOD PART: Limited Liability. You only lose the money you invested, not your house. o Equity Name: Stockholders' Equity (Retained Earnings + Common Stock).
4. The Three Activities of Any Business
Every transaction fits into one of these buckets.
- Financing: Getting or repaying money from outside the business. o Examples: Borrowing money (getting a Note Payable ), Issuing stock to owners, Paying Dividends.
- Investing: Buying or selling the long-term assets the business needs to operate. o Examples: Buying a building, buying equipment, buying a huge software system.
- Operating: The day-to-day stuff that makes the company money. o Examples: Selling a product (Revenue), Paying salaries, paying rent, Paying utilities (Expenses).
5. Conceptual Framework: The Golden Rules (Assumptions & Principles)
These rules are non-negotiable! They stop us from cheating or making inconsistent reports.
The 4 Assumptions (It's just how we assume things are):
- Economic Entity: Keep the owner's stuff separate from the business's stuff. Period.
- Monetary Unit: Everything has to be measured in dollars ($$). We ignore stuff we can't put a price tag on (like employee happiness).
- Buy supplies on credit Supplies go up (Asset), Accounts Payable goes up (Liability) Supplies (A) = Accounts Payable (L)
- Customer pays us for service we did last month Cash goes up (Asset), Accounts Receivable goes down (Asset) Cash (A) and A/R (A) Key Idea: Every single transaction has at least two effects to keep the equation balanced!
(Unit II: The Cycle)
7. The Recording Process (Putting DEAD CLER to Work)
Refresher: The Double-Entry System means for every transaction, Total Debits MUST equal Total Credits. The Golden Rule: DEAD CLER (Debit increases: E xpenses, A ssets, D ividends / Credit increases: L iabilities, E quity, R evenues ).
A. Step 1: Journalize (The Chronological Log)
What it is: The General Journal is the first place we write down a transaction. It’s a date-by- date log. How to do it (Format is HUGE):
- Date.
- The Debit account always goes first , flush left.
- The Credit account always goes second , indented right.
- A short, specific explanation (the memo) goes below. Example: Paid $500 for office rent. Date Account Titles and Explanation Ref Debit Credit July 5 Rent Expense $ Cash $ (To record payment of July office rent)
B. Step 2: Post to the Ledger
What it is: The General Ledger is the collection of all T-Accounts. Posting: We take the numbers from the Journal and dump them into the relevant T-Accounts. o Why we do this: We need to know the running balance of every account (e.g., how much cash do we actually have right now?).
C. Step 3: Unadjusted Trial Balance (The Checkpoint)
What it is: A list of every account (Assets, Liabilities, Equity, Revenue, Expense) and its balance before we make end-of-period adjustments. The Check: We prove that Total Debits = Total Credits. If they don't, we stop and find the typo! Warning: A balanced Trial Balance just means you did Debits = Credits. It doesn't mean you recorded the right accounts or the right amount!
8. Accrual Accounting and Adjustments (The Hard Part!)
A. Cash vs. Accrual Basis (The Philosophy)
Cash Basis (The Lazy Way): You record revenue only when CASH is received and expenses only when CASH is paid.
Goal: Total Debits still MUST equal Total Credits. This is the final, clean data set used to make the actual financial statements.
9. Financial Statement Preparation (The Output!)
We prepare the statements in a specific order because they feed into each other : Income Retained Earnings Balance Sheet.
A. Step 5: The Income Statement (Performance)
Shows: Revenue and Expenses over a period of time (e.g., month, year). Formula: Revenues - Expenses = Net Income (Loss) Multi-Step Format (For Merchandising): Gross Profit Net Sales - Cost of Goods Sold Income from Operations Gross Profit - Operating Expenses Net Income (Final Result)
B. Step 6: Statement of Retained Earnings (Owner Change)
Shows: How Net Income/Loss and Dividends changed the Retained Earnings account over the period. Formula: Beginning RE + Net Income - Dividends = Ending RE Crucial: This "Ending RE" number immediately moves to the Balance Sheet!
C. Step 7: The Balance Sheet (Snapshot)
Shows: Assets, Liabilities, and Equity at a specific point in time (like a photo). Goal: It MUST satisfy the equation: Assets = Liabilities + Equity Classified Format: We categorize accounts to make it useful: o Assets: Current Assets (convert to cash in $<1$ year) vs. Non-Current Assets. o Liabilities: Current Liabilities (due in $<1$ year) vs. Long-Term Liabilities. o Equity: Common Stock and that shiny new Ending Retained Earnings balance.
D. Statement of Cash Flows (Introduction)
Shows: Where the company's CASH came from and where it went. Breaks cash flow into the 3 activities: Operating, Investing, and Financing. Note: This is often covered briefly or saved for the next course, but know the 3 sections!
10. Completion of the Cycle (Cleaning Up)
A. Step 8: Closing Entries (Zeroing Out) Temporary Accounts: R evenues, E xpenses, and D ividends ( RED ). They only track one period, so they must be reset to zero at year-end. Permanent Accounts: A ssets, L iabilities, and E quity (Stock/RE). These balances carry forward to the next year. The Closing Process (4 Steps):
- Close all Revenue accounts (Debit Revenue, Credit Income Summary).
- Close all Expense accounts (Debit Income Summary, Credit Expense).
- Close Income Summary (which now holds Net Income) to Retained Earnings.
- Close Dividends to Retained Earnings. Result: All RED accounts are zero, and Retained Earnings is updated for the New Year.
B. Step 9: Post-Closing Trial Balance (Final Check)
What it is: The final list of accounts. The Check: Only Permanent Accounts (A, L, E) should have balances. All the temporary accounts (R, E, D) must be zero. If this balances, you are 100% ready for the next accounting period!
The Problem: Your Cash account balance (Books) almost never matches the Bank Statement balance. This is OK—it's just a timing difference! The Solution: We prepare a Bank Reconciliation to find the true cash balance. Crucial Rule: Only items we find on the Book Side require a Journal Entry (JE). Why? Because the bank has already fixed their side, but our ledger is wrong! Item Type Side to Adjust Increase/Decrease Requires JE? Study Tip Deposits in Transit (DIT) Bank + Increase No You recorded the cash, but the bank hasn't yet. Outstanding Checks (OC) Bank - Decrease No You recorded the check payment, but the bank hasn't cashed it. Bank Service Charges (SC) Book - Decrease YES You didn't know about this expense yet. NSF Checks (Not Sufficient Funds) Book - Decrease^ YES A customer check bounced! They owe you again. EFT Collections / Interest Book + Increase YES The bank collected money for you that you didn't know about. JE Example (Book Side Fix): If the bank charged you a $20 service fee: o Debit: Bank Charges Expense (Expense , DEAD) - $ o Credit: Cash (Asset , CLER) - $
12. Receivables and Valuation (Money Owed to Us)
A. Types of Receivables
Accounts Receivable (A/R): Money owed by customers from selling goods/services on credit. (Informal, short-term, no interest).
Notes Receivable: A formal written promise to pay, often with a maturity date and an official interest rate. (Used for large amounts or longer terms).
B. The Allowance Method (Bad Debts)
The Reality: Not every customer pays! This is called Bad Debt. GAAP Requirement (Matching Principle): We must estimate bad debt losses in the same period we recorded the sales revenue. The Key Account: Allowance for Doubtful Accounts (AFDA). o This is a Contra-Asset account. It reduces the total A/R on the Balance Sheet to show the Net Realizable Value (NRV).
1. Estimation Entry (The Guess) We estimate the loss at the end of the period (e.g., based on 1% of sales or by "aging" the accounts). Journal Entry (Estimation): o Debit: Bad Debts Expense (Expense DEAD) o Credit: Allowance for Doubtful Accounts (Contra-Asset CLER) o Effect: Expense, Net Income, Net Realizable Value. 2. Write-Off Entry (The Reality) When we are 100% sure a specific customer won't pay (e.g., they filed bankruptcy). Journal Entry (Write-Off): o Debit: Allowance for Doubtful Accounts (Contra-Asset , DEAD) o Credit: Accounts Receivable (Asset CLER) o BIG NOTE: This write-off DOES NOT affect Bad Debts Expense or Net Income, because the loss was already estimated and recorded in the AFDA account in the prior period!
13. Merchandise Inventory (The Stuff We Sell)
A. Inventory Systems
1. Perpetual System (The Modern Way):
IV. Long-Term Stuff: The Big Boys of the Balance Sheet
A. Property, Plant, and Equipment (PP&E) - The "Big Ticket" Items Initial Cost: "All-In" Pricing Rule of Thumb: The cost is everything you spent to get the asset ready for use. It's like the "sticker price + all the fees." Includes: Purchase price, sales tax, shipping /freight (FOB Shipping Point), installation costs, legal fees, and any cost to get it working (like tuning up a new machine). Excludes: Damages after purchase, accidental fire loss, vandalism. Land Improvements (like paving a parking lot) are separate from the Land itself. Land is NEVER depreciated. Depreciation - The Art of Spreading the Cost What it is: Allocating an asset's cost to expense over its useful life. It is a cost allocation process, NOT asset valuation. The book value is NOT what you could sell it for. Three Amigos of Depreciation:
- Straight-Line (SL): The easy, fair one. Formula: (Cost - Salvage Value) / Useful Life Pro: Same expense every year. Easy for exams. Mnemonic: Straight Line is Simple & Logical.
- Declining-Balance (DB): The aggressive, front-loaded one. Formula: (Book Value at Beginning of Year) * (DB Rate)
CRITICAL: DO NOT subtract salvage value in the calculation. It's built-in because you stop when Book Value = Salvage Value. Common Rate: Double the SL rate (Double-Declining-Balance or DDB). If SL rate is 10%, DDB rate is 20%. Mnemonic: Declining Balance is Doubly Brutal in the early years.
- Units-of-Production (UOP): The "usage-based" one. Formula: (Cost - Salvage Value) / Total Estimated Units = Depreciation per Unit. Then, Depreciation per Unit Units Produced This Year. Used for: Assets where wear and tear is more about use than time (e.g., delivery trucks, printing presses, mining equipment). Asset Disposal - Saying Goodbye Step 1: Update depreciation to the date of disposal. (This is a classic exam trick!). Step 2: Calculate Gain or Loss. Formula: Cash Received - Book Value at Disposal Date = Gain/Loss. Book Value = Cost - Accumulated Depreciation. If Cash > Book Value → GAIN (Cr. the Gain account) If Cash < Book Value → LOSS (Dr. the Loss account) If you just retire it with no cash → 100% LOSS (the remaining Book Value is the loss). Intangible Assets - The "Invisible" Assets Examples: Patents, Copyrights, Trademarks, Goodwill. Amortization: Just like depreciation, but for intangibles with a finite life. Key Exception: Goodwill is NOT amortized. It's only "tested for impairment" annually. B. Liabilities - What We Owe
Common Stock: The basic ownership. Par value is a legal capital amount, often very small ($0.01). Preferred Stock: "The diva stock." Gets dividends first, but usually non-voting. In liquidation, gets paid back before common stockholders. Retained Earnings: The cumulative total of all net income kept in the company (not paid out as dividends). It's the company's savings account. Stock Issuance & Treasury Stock Issuing Stock: When a company sells its own stock. Cash Dr. Common Stock Cr. for the Par Value. Additional Paid-In Capital (APIC) Cr. for anything above par. This is the "premium" investors pay. Mnemonic: "Par is for the legal minimum, APIC is for the love (or hype)." Treasury Stock: When a company buys back its own stock. It's NOT an asset. Think of it as a contra-equity account (it reduces total equity). When you reissue it later, any difference goes to APIC - Treasury Stock, not to a Gain/Loss. Dividends - Sharing the Wealth Cash Dividends: Three key dates:
- Declaration Date: The promise to pay. This is when the liability is created. (Dr. Retained Earnings, Cr. Dividends Payable)
- Record Date: No journal entry. Just a list of who gets the dividend.
- Payment Date: The payment of the liability. (Dr. Dividends Payable, Cr. Cash) Stock Dividends: A "paper shuffle." Moving numbers from Retained Earnings to Paid-In Capital. No assets are paid, no liability is created. Small Stock Dividend (<20-25%): Record at Market Value.
Large Stock Dividend (≥20-25%): Record at Par Value. Effect: Increases the number of shares outstanding but the pie is the same size, just cut into more, smaller pieces. Your percentage ownership doesn't change.
V. Financial Statement Analysis –
The "Doctor's Visit" for a Business
Formula: Current Assets / Current LiabilitiesInterpretation: Measures ability to pay short-term obligations. A ratio above 1.0 means you have more current assets than current liabilities. Rule of Thumb: Too high might mean inefficient use of assets (e.g., too much cash sitting around). Too low is a major red flag for bankruptcy risk. Memory Trick: It's a "coverage" ratio. "For every $1 I owe this year, I have _$X_ in assets to cover it." Solvency Ratios: "Are We Buried in Debt?" These are long-term stability tests. Can the company survive long-term with its debt load? Debt to Assets Ratio Formula: Total Liabilities / Total Assets Interpretation: Shows the percentage of assets financed by debt (creditors) vs. the owners. What it means: A ratio of 0.60 means 60% of the company is funded by debt. A higher ratio means more leverage and higher risk. Memory Trick: "Who owns more of the company, the bankers or the shareholders?" Profitability Ratios: "Are We Making Money Effectively?" These are the report cards for management's performance. Profit Margin (a.k.a. Net Profit Margin) Formula: Net Income / Net Sales Interpretation: How much profit is generated from each dollar of sales. This is the bottom-line profit percentage. What it means: A 10% profit margin means the company keeps $0.10 of profit from every $1.00 of sales. Memory Trick: "The 'Keep Rate - out of every sales dollar, how much do we get to keep?" Earnings Per Share (EPS) - The King of Ratios Formula (Basic EPS): (Net Income - Preferred Dividends) / Weighted Avg. Common Shares Outstanding Interpretation: This is the single most watched number on Wall Street. It tells the owner of a single share of stock how much of the company's profit belongs to them. Why it's unique: It's the only ratio that often appears directly on the income statement.
Memory Trick: "My slice of the pie." (Net Income is the whole pie, shares are the number of people, EPS is the size of my slice).
