Introduction to Accounting

Introduction to Accounting

Agenda • Fundamental concepts • The Accounting Cycle • Financial statements • Comprehensive example Introduction to Accounting

Fundamental concepts What is accounting? • The language of business. • A means to communicate financial information. • A way to convey information about a business to users. Introduction to Accounting

Fundamental concepts Who uses accounting information? • Owners • Managers • Investors (including potential) • Analysts on their behalf • Creditors (including potential) • Government (tax assessment) • Regulators • Customers Introduction to Accounting

Fundamental concepts Accounting has two main divisions: • Financial accounting • Primarily prepared for users external to the company. • Revenues, earnings, assets, etc. • Management accounting • Primarily for internal purposes • Costing, budgeting, net present value, etc. • This lecture will focus only on financial accounting. Introduction to Accounting

Fundamental concepts There are several ways that cash gets into a company: • Investment by owners • Investment by creditors (loans) • Payments from customers. • Repayment of amounts loaned to other entities. • Return on investments (interest and dividend) • Proceeds from selling assets. Introduction to Accounting

Fundamental concepts These can be organized into three categories: Operations • Payments from customers • Refunds from suppliers Financing • Investment by owners • Investment by creditors (loans) Investing • Return on investments (interest and dividend) • Proceeds from selling assets • Repayment of amounts loaned to other entities Introduction to Accounting

Fundamental concepts Similarly, money going out of an entity can be categorized: Operations • Payments to suppliers • Refunds to customers Financing • Payment of dividends or capital to owners • Repayment of creditors Investing • Purchase of assets • Amounts invested in other entities (debt or equity) Introduction to Accounting

Fundamental concepts Financial accounting categorizes all transactions and events based on their substance. • It is very important that the substance of a transaction be accurately reflected by financial accounting because the users of the information are using it with the assumption that these categorizations are being made accurately. • If money invested by owners was reported as revenue, this would be counter to the fundamental definition of revenue (i.e. that it results from the operations of the company). • The separation of income and capital is a fundamental concept of financial accounting. Introduction to Accounting

The Accounting Cycle • Transaction or event occurs • Could simply be the passage of time. • Recorded in the Journal using a Journal Entry. • event is translated into accounting language. • Journal is posted to Ledger • the information from all the journal entries in the period is aggregated. • Ledger accounts are totalled. • Financial statements are prepared. Introduction to Accounting

The Accounting Cycle • Transaction or event occurs • Recorded in the Journal using a Journal Entry. • Journal is posted to Ledger • Ledger accounts are totalled. • Financial statements are prepared. • It is important to note that the decision-making of accounting occurs at step 2 – Journal entry. • Steps 3 – 5 are mechanical exercises. • Therefore, the decisions made when making the journal entry (i.e. translating to accounting language) are very important as they determine what will ultimately be presented on the financial statements. cont’d on next slide… Introduction to Accounting

Accounting Equation • Fundamental Accounting Equation: Assets = Liabilities + Owners’ Equity • This equation is always in balance • In order for this equation to remain in balance, double-entry bookkeeping is employed. • That is, the recording of every transaction or event must have at least two parts • Either an equal impact (increase or decrease) to both sides of the equation or equal and opposite impact to one side. • The recording of every transaction must keep this equation in balance Introduction to Accounting

Journal Entries All journal entries have two “sides”: • Debit and Credit • For every journal entry, the total debits must equal the total credits • This ensures that the fundamental accounting equation (A = L + OE) is always in balance. The basic journal entry: Debit Account name1 $amount Credit Account name2 $amount To record… Introduction to Accounting

Journal Entries • “Debit” and “Credit” are just accounting-speak for “increase” and “decrease” • “Debit” means “increase” for some elements and “decrease” for other elements. Likewise for “credit”. • For example, a company pays its $500 utility bill: • In English: the company has incurred an expense (the amount of expense has increased) and the amount of cash in the company has decreased. • An expense (Utilities) has increased • An asset (Cash) has decreased • In Journal entry: Debit Utility expense $500 Credit Cash $500 To record the payment of utility bill Introduction to Accounting

Journal Entries • How do we know whether to debit or credit? • Convention exists based on what element is being increased or decreased. • Each element “lives in” either debit or credit. If we want to increase something that “lives in” debit, we will debit it. • The convention works such that the fundamental equation (A = L + OE) is always kept in balance. Introduction to Accounting

Journal Entries • The Basic Accounting Elements: Introduction to Accounting

Journal Entries The Basic Accounting Elements: Asset • Has future benefit to the entity Liability • Obligation to transfer assets in the future Owners’ Equity • Owners’ interest in the company Revenue • Increase in economic resources resulting from normal operations of the company Expense • Decrease in economic resources resulting from normal operations of the company Introduction to Accounting

Journal Entries • The Basic Accounting Elements: Introduction to Accounting

Journal Entries • To increase an Asset or Expense: Debit • To increase a Liability, Revenue, or Owners’ Equity: Credit • To decrease an Asset or Expense: Credit • To decrease a Liability, Revenue, or Owners’ Equity: Debit Introduction to Accounting

Journal Entries • Going back to the Fundamental Accounting Equation: Assets = Liabilities + Owners’ Equity Debit Credit Credit Introduction to Accounting

Journal Entries • What about the Income Statement elements (Revenue and Expense)? • They don’t appear in the fundamental accounting equation, so how does it stay in balance when they are debited or credited? • e.g. consultant sells services for $300 cash • In English: Cash (asset) increases $300 Revenue increases $300 • In Accounting: Debit Cash (Asset) $300 Credit Consulting Revenue $300 To record payment for consulting services rendered • Assets have increased. Liabilities and Owners’ Equity appear to be unchanged. • Is A = L + OE not true (i.e. out of balance)? Introduction to Accounting

Element structures • Assets • Liabilities • Owners’ equity Introduction to Accounting

Element structures • Assets • Current assets • Cash • Cash on hand • Bank accounts • CIBC • BMO • Accounts receivable • Accounts receivable – customer 1 • Accounts receivable – customer 2 • Inventory • Raw materials • Work in process • Finished goods • Product 1 • Product 2 Introduction to Accounting

Element structures • Assets • Current assets • Long-term assets • Buildings • Ontario buildings • Quebec buildings • Montreal building • Sherbrooke building • Vehicles • Cars • Trucks • Truck 1 • Truck 2 Introduction to Accounting

Element structures • Liabilities • Current liabilities • Accounts payable • Accrued liabilities • Long-term liabilities • Bank loans • Loan from RBC • Loan from Scotiabank • Notes payable • Bonds payable Introduction to Accounting

Element structures • Owners’ equity • Capital stock (direct investment) • Retained earnings (indirect investment) • Revenue • Expenses • (Dividends) • Although revenue and expenses are not sub-pieces of Retained earnings the way Current assets are a sub-piece of Total assets, for the purposes of understanding how they fit in to the equation, this representation is helpful. Introduction to Accounting

Element structures The balance sheet is a permanent statement • Its’ accounts accumulate information from the entity’s beginning. • The amounts presented on the balance sheet are aggregated from the entity’s beginning to the balance sheet date. The income statement is a temporary statement • Its’ accounts are temporary accounts • They accumulate information for a period and then are reset to zero to begin tracking information for the next period. • The amounts presented on the income statement are aggregated from the beginning of the period to the end of the period only. Introduction to Accounting

Element structures The Closing Entry • Whenever financial statements are to be prepared, the temporary (income statement) accounts must be “closed” to zero so that they can begin tracking data for the next period. • The amounts in the accounts at closing are transferred to Retained Earnings (so named because it is the earnings (net income) of the company that is retained in the company and not distributed to the owners). • We will see an example in the comprehensive example. Introduction to Accounting

Element structures The Closing Entry • The result of the closing entry is that all impacts on Revenue and Expenses (the temporary accounts) are indirectly impacts on Retained earnings (a permanent account). • That is how A = L + OE stays in balance. • The temporary accounts are sub-pieces of OE. Introduction to Accounting

Journal Entries • Going back to the Fundamental Accounting Equation: Introduction to Accounting

Financial Statements There are 4 statements in a standard set of financial statements • Balance Sheet • The “what do we have?” statement • Shows what the entity owns and owes (the difference being the owners’ residual interest) • Income Statement • The “what did we do?” statement • Shows the activity the entity undertook in its normal course of operations. • Statement of Retained Earnings • Shows the changes in Retained earnings in the year • Often shown at the bottom of the Income Statement • Statement of Cash Flows • Shows the sources and uses of cash in the year • Information is derived from the B/S and I/S and other Introduction to Accounting

Financial Statements Statement of Cash Flows • Contains information about how cash came into and left the entity in the period. • Does not contain new information • i.e. the SCF is derived from the Balance Sheet and Income Statement (with some supplementary information) • The SCF will not be covered in this lecture. It is covered in ACTG 5100. Introduction to Accounting

Financial Statements Introduction to Accounting

Loblaw Introduction to Accounting

Loblaw Introduction to Accounting To Balance Sheet

Loblaw From Statement of Retained Earnings Introduction to Accounting

Canadian Tire Introduction to Accounting

Canadian Tire To Balance Sheet Introduction to Accounting

Canadian Tire From Statement of Retained Earnings Introduction to Accounting

Research In Motion Introduction to Accounting

Research In Motion To Statement of Shareholders’ Equity Introduction to Accounting

Research In Motion From Income Statement To Balance Sheet Introduction to Accounting

Introduction to Accounting