Understanding Accounting Transactions
Day 1(Chapters 1 to 4)
Prof. Jonghwan Kim, Ph.D.Course 20352| Prep for Financial Accounting
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
20352 - FINANCIAL ACCOUNTING PREPARATORY COURSE
forAFC, IM, CLEFIN-FINANCE, and EMIT
Instructor:Jonghwan Kim, Ph.D.
• Department of Accounting, Via Roentgen, 1 – 5th
floor A3-06
• Email: [email protected]
• Consultation hours: by email appointments
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Course Description
Accounting is the language of business, an important means of communication among various business parties. Among others, financial accounting speaks mainly to external information users, such as investors and financial analysts, who make decisions for many different purposes using the accounting information revealed in financial statements. This preparatory course is designed to provide students with a quick understanding of key accounting concepts and principles with which financial statements are prepared. Despite its short span, this course covers most of important accounting topics including:
• the double-entry accounting system,
• accounting for common transactions, and
• financial statement preparation (including income statement, balance sheet, and cash flow statement).
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Objectives
The course aims to prepare students for other graduate-level business courses for which accounting knowledge and skills can help to advance relevant knowledge. Upon completion of the course, students are expected to understand the basics of
• accounting terminology,
• how to generate accounting information and prepare financial statements, and
• how to interpret the accounting information.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Class Schedule
12 sessions, 6 days
Session Date Time Topics Reference
1 August 27 13:00~14:30 Understanding accounting transactions Double-entry book-keeping Accrual accounting Accounting cycle Income statement and balance sheet
SLL Ch. 1 to 4
2 14:30~16:00
3 16:15~17:45
4 August 28 14:30~16:00 Sales and accounts receivable SLL Ch. 6
5 16:15~17:45 Inventory and cost of goods sold SLL Ch. 7
6 August 29 13:00~14:30 Long-lived assets SLL Ch. 8
7 14:30~16:00 Liabilities and long-term debt SLL Ch. 9
8 September 1 8:45~10:15 Bonds SLL Ch. 10
9 10:30~12:00 Owners’ Equity SLL Ch. 11
10 September 2 10:30~12:00 Investments SLL Ch. 12
11 September 3 14:30~16:00 Cash flow statement SLL Ch. 13
12 16:15~17:45 Comprehensive review Hand-outs
FINANCIAL ACCOUNTING- INTRODUCTION -
Session 1
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
“Accounting is the language of business.”
A system that collects and processes financial information about an organization and reports that information to decision makers
What is Accounting?
Collect Process Reportmeasurerecord
analyze
?
!!
Information
Decision-Makers(Information Users)
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Accounting for Different Users
Exhibit 1.1
External Decision Makers Internal Decision Makers
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Objectives of Financial Reporting
To provide useful economic information about a business to help external users of financial statements
External users?
• investors
• creditors
• financial advisors
➥ Interested in a business’s ability to generate cash
• to pay dividends
• to increase the business’s value
• to pay interest and the principal on a loan
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Four Basic Financial Statements
Balance Sheet Income Statement
Statement of Retained Earnings
Statement of Cash Flows
Financial position at a particular point in time:• Assets• Liabilities• Owners’ Equity
Financial performance during an accounting period measured as revenues minus expenses
The change of retained earnings: + net income− dividends
The change of the cash balanceIn/out-flows in three categories:• Operating activities• Investing activities• Financing activities
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Key Elements of Financial Statements
AssetsEconomic resources• Probable future benefits• Owned or controlled• Related to prior transactions
LiabilityEconomic obligation• Probable future sacrifices• Unavoidable• Related to prior transactions
Stockholders’ EquityFinancing provided by owners and operations
Balance Sheet
Inco
me
Sta
tem
ent
• Revenue: increase in assets or settlement of liabilities from ongoing operations• Expense: decrease in assets or increase in liabilities from ongoing operations• Gain: increase in assets or settlement of liabilities from peripheral activities• Loss: decrease in assets or increase in liabilities from peripheral activities
Bal
ance
Sh
eet
= +“Basic Accounting Equation”
“I/S Equation” Revenues – Expenses = Net Income
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Relationships Among the Four Basic Financial Statements
“Basic Accounting Equation” “Income Statement Equation”
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Accounting Standards
Guides and rules that govern accounting practice, regarding how financial statements are prepared and accounting information is presented
• GAAP (Generally Accepted Accounting Principles)
• IFRS (International Financial Reporting Standards)
Prior to 1930’s, each company has self-defined financial reporting practices. Thus, no uniform standard across companies was in practice.
Why do we need accounting standards?
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Conceptual FrameworkQualities of Financial Information
Primary Characteristics
• Relevancy: predictive value, confirmatory (feedback) value, and timeliness.
• Faithful Representation (Reliability): verifiability, neutrality, and completeness
Secondary Characteristics
• Comparability: across companies.
• Consistency: over time.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Conceptual FrameworkAssumptions and Principles for Measuring and Reporting Information
Assumptions:
• Separate-Entity
• Unit-of-Measure
• Continuity (Going-concern)
• Time Period
Principles:
• Historical Cost
• Revenue Recognition
• Matching
• Full Disclosure
ACCOUNTING TRANSACTIONS,ACCOUNTING EQUATION, AND
DOUBLE-ENTRY BOOKKEEPING
Session 1 (Continued)
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Accounting Transactions
Economic events that impact the financial standing of a business
• External Events:exchanges of assets, goods, or services with one or more external parties
• Internal Events:not an exchange between the business and other parties, but have a direct effect on the accounting entity
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Accounts
An organized format used by companies to accumulate the dollar effects of transactions
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Typical Account Titles
Balance Sheet Accounts
AssetsCashShort-Term InvestmentAccounts ReceivableNotes ReceivableInventory (to be sold)SuppliesPrepaid ExpensesLong-Term InvestmentsEquipmentBuildingsLandIntangibles
LiabilitiesAccounts PayableAccrued ExpensesNotes PayableTaxes PayableUnearned Revenue Bonds Payable
Stockholders’ EquityContributed CapitalRetained Earnings
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Typical Account Titles
Income Statement Accounts
RevenuesSales RevenueFee RevenueInterest RevenueRent Revenue
ExpensesCost of Goods SoldWages ExpenseRent ExpenseInterest ExpenseDepreciation ExpenseAdvertising ExpenseInsurance ExpenseRepair ExpenseIncome Tax Expense
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Transaction Analysis
“How do transactions affect accounts?”
Principles of Transaction Analysis
• Duality:Every transaction affects at least two accounts
• Accounting Equation:Assets = Liabilities + Stockholers’ Equity
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Transaction Analysis
Balancing the Accounting Equation
Step 1: Accounts and effects
• Identify the accounts affected and classify them by type of account (A, L, SE).
• Determine the direction of the effect (increase or decrease) on each account.
Step 2: Balancing
• Verify that the accounting equation (A = L + SE) remains in balance.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Transaction Analysis
Example:
a. Papa John’s issues $2,000 of additional common stock to new investors for cash.
b. The company borrows $6,000 from the local bank, signing a three-year note.
c. Papa John’s purchases $10,000 of new equipment, paying $2,000 in cash and signing a two-year note payable for the rest.
d. Papa John’s lends $3,000 cash to new franchises who sign notes agreeing to repay the loans in five years.
e. Papa John’s purchases the stock of other companies as a long-term investment, paying $1,000 in cash.
f. Papa John’s board of directors declares and pays $3,000 in dividends to shareholders.
1. Identify and classify the accounts.
2. Determine the direction of effects.
3. Verify the equation holds.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Double-Entry Bookkeeping
http://en.wikipedia.org/wiki/History_of_accounting#mediaviewer/File:Pacioli.jpg
Luca Pacioli, Italian monk and mathematician, the writer of “Summa de Arithmetica, Geometria, Proportioni et Proportionalità"
(early Italian: "Review of Arithmetic, Geometry, Ratio and Proportion")
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Keeping Track of Account Balances
“Double-entry” bookkeeping
• Debit (dr.) and Credit (cr.)
T-Account
Account Title
Debit(Dr.)
Credit(Cr.)
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Basic Transaction Analysis Model
T-account & Accounting Equation
Any Asset Account
[increase]$ 10
6
[decrease]
$ 16
Any Liab./ SE Account
[decrease] [increase]$ 20
12
$ 32$ 5 $ 25
?? ??11 ?? ??7
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Making Journal Entries
Journal Entry
• To record transactions in “chronological” order in a general journal
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Posting to General Ledger
Posting
• To transfer (record) transactions into respective accounts in a general ledger
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Transaction AnalysisJournal Entries and T-Accounts
Example:
a. Papa John’s issues $2,000 of additional common stock to new investors for cash.
b. The company borrows $6,000 from the local bank, signing a three-year note.
c. Papa John’s purchases $10,000 of new equipment, paying $2,000 in cash and signing a two-year note payable for the rest.
d. Papa John’s lends $3,000 cash to new franchises who sign notes agreeing to repay the loans in five years.
e. Papa John’s purchases the stock of other companies as a long-term investment, paying $1,000 in cash.
f. Papa John’s board of directors declares and pays $3,000 in dividends to shareholders.
ACCRUAL ACCOUNTING ANDINCOME STATEMENTS
Session 2
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Operating Cycle
The time it takes for a company to pay cash to suppliers, sell goods and services to customers, and collect cash from customers.
Purchase
Pay cash to suppliers
Sell goods or services
to customers
Receive cash from customers
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Operating Cycle
The operating cycle repeats “continuously” until a company goes out of the business.
• Time Period: The long life of a company can be reported over a series of shorter time periods.
• Recognition Issues : When should the effects of operating activities be recognized (recorded)?
• Measurement Issues: What amounts should be recognized?
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Elements of the Income Statement
Increase in assetsor
Settlement of liabilities
Decrease in assetsor
Increase of liabilities
from ongoing operations / primary businesses Revenue Expenses
from peripheraltransactions Gains Losses
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Papa John’s Income Statement
Exhibit 3.1
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Accrual vs. Cash Accounting
Accrual Basis Accounting
• Records accounting transactions when they occurrevenues are recognized when earned,expenses when incurred
• Regardless of the timing of receipts or payments of cash.
Cash Basis Accounting
• Records transactions whenever they involve cash receipt or distribution.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Conceptual Frameworkfor Measuring and Reporting Information
Under Accrual Basis Accounting,
Revenue Principle
Recognize revenues when...• Delivery has occurred or services have been rendered.• There is persuasive evidence of an arrangement for
customer payment. • The price is fixed or determinable.• Collection is reasonably assured.
Matching Principle
Resources consumed to earn revenues in an accounting period should be recorded in that period, regardless of when cash is paid.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Revenue Principle
Exhibit 3.2
Journal entries for situations:
1. Cash received in advance
2. Cash received at the time of sale
3. Cash received after a sale
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Matching Principle
Exhibit 3.3
Journal entries for situations:
1. Cash paid before the expense is incurred
2. Cash paid when ...
3. Cash paid after ...
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Extended Transaction Analysis Model
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Transaction Analysis
Balancing the Accounting Equation
•Step 1: Accounts and effects
• Identify the accounts affected and classify them by type of account (A, L, SE).
• Determine the direction of the effect (increase or decrease) on each account.
•Step 2: Balancing
• Verify that the accounting equation (A = L + SE) remains in balance.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Transaction Analysis
Example:
a. Papa John’s restaurants sold pizza to customers for $36,000 cash and sold $30,000 in supplies to franchised restaurants, receiving $21,000 cash with the rest due on account.
b. The cost of the dough, sauce, cheese, and other supplies for the restaurant sales in (a) was $30,000.
c. Papa John’s sold new franchises for $400 cash, earning $100 immediately by performing services for franchisees; the rest will be earned over the next several months.
d. In January, Papa John’s paid $7,000 for utilities, repairs, and fuel for delivery vehicles, all considered general and administrative expenses incurred during the month.
e. Papa John’s commissaries ordered and received $29,000 in supplies, paying $9,000 in cash and owing the rest on account to suppliers.
f. Papa John’s paid $14,000 cash to employees for their work in January.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Transaction Analysis
Example:
g. At the beginning of January, Papa John’s paid the following, all of which are considered prepaid expenses when paid (any adjustments will be made in Chapter 4):• $2,000 for insurance (covering the next four months beginning January 1),• $6,000 for renting space in shopping centers (over the next three months beginning January 1), and • $1,000 for advertising (to be run in February).
h. Papa John’s sold land with an historical cost of $1,000 for $4,000 cash.
i. Papa John’s received $15,500 in franchisee fees based on their weekly sales; $12,800 of the amount was due from franchisees’ sales recorded as accounts receivable in December and the rest is from January sales.
j. Papa John’s paid $10,000 on accounts owed to suppliers.
k. Papa John’s received $1,000 in cash for interest earned on investments.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Relationships Among the Four Basic Financial Statements
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Preparing Financial Statements
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
M3-7
ACCOUNTING CYCLE, BOOK CLOSING, AND PREPARING FINANCIAL STATEMENTS
Session 3
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Accounting Cycle
Exhibit 4.1
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
1. Unadjusted Trial Balance
A listing of individual accounts
• Usually in financial statement order
• Debits = Credits
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
2. Adjustments
Purpose
• Because transactions occur over time, adjustments are required at the end of each fiscal period to get the revenues and expenses into the “right” period.➥ Revenue Recognition & Matching Principles
• Revenues are recorded when earned
• Expenses are recorded when incurred
• Assets are reported to represent the “remaining” probable future benefits
• Liabilities are reported to represent the “remaining” future economic sacrifices
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
2. Adjustments
Adjustment Process
1. Was revenue earned or an expense incurred that is not yet recorded?
2. Was the related cash received or paid in the past or will it be received or paid in the future?
3. Compute the amount of revenue earned or expense incurred.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
2. Adjustments
Revenue
1. Unearned (or Deferred) 2. Accrued
Expense
3. Deferred 4. Accrued
Period 1 ★ Period 2Period 1 ★ Period 2
at the end of Period 1Revenue Earned
Expense Incurred
Adjusting entriesare required
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
2. Adjustments
Example:
1. Unearned Franchise Fees Papa John’s received cash last period and recorded an increase in Cash and an increase in Unearned Franchise Fees, a liability, to recognize the business’s obligation to provide future services to franchisees. During January, Papa John’s performed $1,100 in services for franchisees who had previously paid fees.
2. Accounts ReceivablePapa John’s franchisees owe Papa John’s $830 in royalties for sales the franchisees made in the last week of January.
3. Interest Receivable Papa John’s loaned $3,000 to franchisees on December 31 (one month ago) at 6 percent interest per year with interest to be paid at the end of each year. There was also $8,000 in notes receivable outstanding all month from prior loans. Assume the interest on the other $8,000 in notes receivable is $55.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
2. Adjustments
Example:
4. Prepaid Rent and Insurance The Prepaid Expenses account includes $2,000 paid on January 1 for insurance coverage for four months (January through April) and $6,000 paid on January 1 for the rental of space at shopping centers over three months (January through March).
5. Supplies Supplies include food and paper products. At the end of the month, Papa John’s counted $12,000 in supplies on hand, but the Supplies account indicated a balance of $16,000 (from Exhibit 4.2 ).
6. Property and Equipment The net book value of Papa John’s property and equipment is $199,000 (net of accumulated depreciation of $189,000). Papa John’s estimates depreciation to be $30,000 per year.
7. Accrued Expenses Payable Papa John’s owed (1) its employees salaries for working four days at the end of January at $500 per day, (2) $610 for utilities used in January, and (3) interest on its long-term notes payable borrowed at a 6 percent annual rate.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
Adjusted T/B
Exhibit 4.5
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
3. Preparing Financial Statements
The next step in the accounting cycle is to prepare the financial statements. . .
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
3. Preparing Financial Statements
1. Income Statement
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
3. Preparing Financial Statements
2. Statement of Stockholders’ Equity
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
3. Preparing Financial Statements
3. Balance Sheet
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
4. Closing the Books
Closing Entries:
• Transfer net income (or loss) to Retained Earnings.
• Establish a zero balance in each of the temporaryaccounts to start the next accounting period.
Temporary accounts with debit balances are credited,with credit balances are debited.
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
4. Closing the Books
Post-Closing Trial Balanceswill have zero balances on these temporary accounts.
Dr. Cr.7,590
66,000
4,730
1,070
3,000
30,000
16,000
7,000
4,000
2,000
500
610
2,500
690
3,910
$74,800 $74,800
Closing Entries
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
7,59066,000
4,730
1,0703,000
30,00016,000
7,000
4,0002,000
500610
2,500690
3,910
$ 74,800 $ 74,800
127,590
$685,710 $685,710
ClosingEntries
Debit Credit
Post-ClosingTrial Balance
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
E4-15
-39,000 +39,000 -39,000-17,000 -17,000 -17,000+3,200 -3,200 +3,200
7,200 153,000 115,800 37,200-2,160 +2,160 -2,1605,040 153,000 117,960 35,040
Financial Accounting Prep. 20352 | AY 2014‐2015 | Prof. Jonghwan
Kim
E4-18
35
9
a. 4 2
80
c. 8 8
b. 5 5
d. 9 9
73
4
84a,b,c,d
26 58
26 26 188 188
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