Accounting: Balance Sheet Basics

Chapter 1

• Balance Sheet = "Financial Position" of a company

• A company's financial position is everything as of a certain point in time

• All the cash you've ever had minus all the money you've ever spent, is how much money you have right now

• Balance Sheet = Assets (Future Benefit) = Liability (Future Sacrifice) + Equity (Residual Interest)

• Balance sheets list an entity's assets, liabilities, and owner's equity as of a specific date

• Work Capital = Current Assets - Current Liabilities

• Working Capital Ratio = Current Assets/Current Liabilities

• Retained Earnings = Beginning retained earnings + Net Income - Dividends Paid

• Net Income = Revenue - Total Expenses

• Net Assets = Equity

• Shareholders' equity = total assets - total liabilities

• Asset: Probable future economic benefit due to past transaction. Example: cash, accounts receivable (money owed to a company by its debtors)

• Liability: Probable future economic sacrifice as a result of a past translation. Examples: account payable (money owed to a company to creditors and suppliers) and accrued expenses (an expense a business has incurred but does not yet pay)

• Equity: Residual interest of owners. Example: retained earnings (revenue that continues after work is finished), common stock (shareholders of a company)

• Income Statement is how a company is doing

• Comparing two companies and their profiting and reporting activities is an important aspect to understanding their financial health.

• Income Statement = Revenue (recorded when they have been earned when a service is completed) - Expenses (recorded when have received the benefit) = Net Income

• Net Income goes into the retained earnings; what comes out is the dividend

• The "bucket" has a certain amount of money in it at one point

• Dividends leaving the "bucket" leaves one with a specific amount of money at a specific time

• Creates a balance sheet to show the amount of money at any specific time

• Revenue affects the equity within a balance sheet

• Recording revenue and subtracting Expenses then creates Net Income, increasing Equity

• GAAP (Generally Accepted Accounting Principles) is a set of accounting rules

• The rules of GAAP are an accountant's main concern when analyzing accounts of cost and spending

• A graduated tax means the more you make, the higher the rate

• Prepaid expenses are assets that have been paid for but for which the benefit has not been received

• A sole proprietor is a business owned by one person

  • Simple to establish
  • Gives you full control
  • Tax advantages

• Partnership; a business owned by two or more people

  • Simple to establish
  • Shared control
  • Broader skills and resourcess
  • Tax advantages

• Corporation; organized by separate legal entities owned by stockholders

  • Easier to transfer ownership
  • Easier to raise funds
  • No personal liability

• Commercial Real Estate Brokers are a type of corporation

• External Users: Taxing Authorities (IRS) want to that the company complies with tax laws

• Customers are interested in that a company's ability to honor product warranties and support product lines

• Labor Unions want to know that the ability of the company to pay increased wages and benefits

• Regulatory Agencies (Securities and Exchange Commission or the Federal Trade Commission) want to know whether the company is operating within prescribed rules

• Data Analytics is where Companies analyze amounts of data to increase efficiency

• The goal is to identify bottlenecks to increase production efficiency

• A financial bottleneck refers to places in a company's financial processes where cash flow or transactions become significantly restricted

• Revenue is reported when it is earned

• Revenue is earned when a service or product is completed or transferred to the buyer

• If you are paid but haven't done the service it would be a liability

• If you completed a service but payment hasn't been received it is revenue earned but not liquid cash

• Expense is reported when it is derived where the expense earned is matched to the period in which the associated revenue is recorded

• Every public company has to file a form 10-K once a year which provides a comprehensive overview of a company's financial performance and business condition

• Every time a company has a significant change they have to file with the SAEC a form 8-K, used to announce major events within companies typically within 4 days of the event/change

• The Sarbanes-Oxley Act is strict legislature that imposes significant costs on all public companies

• Historical cost: what it cost is the historical value and it's the fair value on the day you buy it.

• Cost is very objective; Fair Value is very subjective

• Accrual Accounting records revenue when earned and matches expenses to the period when revenue was recorded

• Record expenses with the expense recognition principle when "incurred", under GAAP

• Incurred means "when the associated benefit has been realized", NOT Webster's Definition of "incurred"

• An expense can't be recorded as an expense

• Revenue is recorded when it's earned, expenses when we receive a benefit

• Net Income will occur in a time period when revenues exceed expenses

• Retained earnings ultimately finds its way to a balance sheet

• Revenue is recorded and without liquid cash you have an account receivable

• If revenue stays retained it becomes retained earnings, if not it becomes dividend

• Stock Issuance: the process of selling shares of stock to investors to raise capital (financial and physical assets and funds)

1.2 Types of Financial Activity

• Financing involves raising money from outside sources
  • Primarily, borrowing money (debt financing) and selling shares of stock in exchange for cash (equity financing)
• The company's Net Income goes into Equity; all earnings are retained
• Amounts owed to creditors is a liability
• Debt securities that must be paid back at particular date some years in the future are bonds payable
• Corporations obtain funds by selling shares of stock to investors
• Common stock describes the total amount paid in by stockholders for shares purchased
• Creditors loan money to a company; You are then owed the money, which you can require payback at a time of your choosing
• A company can be legally forced to sell a property to pay a debt
• Companies regularly pay stockholders with sufficient cash in the form of dividends
• Investing activities involve purchasing resources a company needs in order to operate
• Resources owned by a business are assets like property, plant, and equipment, which are sometimes called fixed assets
• Companies with excess cash think about investing it in the securities (stocks or bonds) of other corporations, referred to as a type of asset
• Cost of goods sold (COGS) is an expense because it is a cost of doing business
• Companies purchase longer-lived assets
• Operating activities, day to day actions by a company to produce and sell a product, or provide a service
• Amounts earned by selling products is revenue
• Revenue increases assets or decreases liabilities from selling goods or performing services in the normal course of business
• Revenue names depend on the nature of the business, examples are sales revenues or service and interest revenue
• Companies buy short-lived assets through operating activities
• Supplies are for day-to-day operations, not sold to customers
• Good available for future sales=inventory
• The right to receive payment in future= account receivable
• This is especially so when a company gives goods/services on credit
• Types of costs: salaries, utilities, rent, cost of goods sold, the cost of salespersons salary (selling expenses), marketing expenses such as advertising, income tax expenses (corporate taxes paid to the government)
• Account payable: companies obligated to pay for goods on credit from suppliers, a liability
• Interest payable on outstanding amounts owed to the bank
• Notes payable are written agreements where one party agrees to pay the other a certain amount of cash can be a liability

Retained Earnings

• Companies want to look better than they are to appeal to customers; an audit of financial statements that shows everything looks good = third party recommendation
• If everything looks good, others are less likely to look into how it is made/functions, especially if costly
• SOX governs all public companies
• In order to audit public accounting firms you have to register with the SOX police
• PCOB, a nonprofit started by SOX, oversees the auditing firms
  • If penalties are found they collect fees and are supposed to be put into a scholarship fund
  • No one gets to audit the PCOB
  • Public Accounting Firms are generally low liability partnerships
• Sales invoice: created by retailer or service provider as proof of a sale
• Purchase invoice: created by business owner or accountant to request to purchase items from a retailer or wholesaler

1.3 The Four Financial Statements

• Income Statement reports a company's revenues and expenses and resulting net income or loss for a period of time
• Investors interested in a company's past net income because it indicates future income
• Buy and stock based on beliefs about a company's future performance
• Creditors use the income statement to predict future earnings
• When a bank loans money to a company, it expects it to be repaid
• Receiving amounts from issuing stock is not revenue and paying dividends is not expense
• Amounts not listed on income statement
• Retained Earnings is the net income retained in the corporation
• A retained earning statement shows the amounts and causes of changes in retained earnings for a specific time period - the time period is the time covered by the income statement
• If a company is profitable at the end of each period it must decide the portion of profits to pay to shareholders in dividends
• The beginning retained earnings amount appears on the first line of the statement
• To determine the retained earnings, the company adds net income and deducts dividends. For a net loss, they deduct that lost amount
• Dividend payments are cash or other property distributions made by a company to its shareholders/investors
• Balance Sheet - beginning of notes explain it
• Stockholders' equity is common stock + retained earnings
• Common stock is when the company sells shares of stock
• Retained earnings is the net income retained in the corporation
• Liabilities are also referred to as debt
• Creditors analyze a company's balance sheet to determine the likelihood of them being repaid
• Analyze the company's assets and liabilities
• Used to measure cash on hand for immediate cash needs
• Used to evaluate the relationship between debt and stockholders' equity to determine if there is a satisfactory proportion of debt and common stock financing
• Statement of Cash Flows provides financial information about the cash receipts and cash payments of a business for a specific period of time in the form of operating, investing, and financing activities
• To prepare financial statements, must understand the sequence of determination and how each statement impacts the next (Interrelationships of Statements)

Elements of an Annual Report

• The annual report includes:
  • Financial statements
  • Management discussion and analysis section
  • Notes to financial statements
  • Independent auditor's report
• Management views on the company: Management must highlight favorable or unfavorable trends and identify significant events and uncertainties that affect the ability to pay near-term, to fund operations and expansion, and their results of operations
• Notes to the financial clarify and provide detail such as descriptions of the significant accounting policies and methods.
• This can be explanations of uncertainties and contingencies and various statistics and details too voluminous to include in statements
• Auditor's Report: prepared by an independent outside auditor, and they must state the auditor's opinion, that the presentation of the financial position and results of operations and their conformance with generally accepted accounting principles are fair
• An auditor is an accounting professional who conducts an independent examination of a company's financial statements
• In the annual report an opinion presented regarding the fairness of the presentation of the financial position and results of operations is the auditor's opinion

Chapter 2

2.1 The Classified Balance Sheet

• The Classified Balance Sheet groups together similar assets and similar liabilities, using standard classifications/sections
• Financial statement readers can determine things like if a company has enough assets to pay debts and the claims of short- and long-term creditors on the company's total assets.
• Current Assets are assets a company expects to convert to cash or use up within one year
• The cutoff for classifying an asset as current is one year from the balance sheet due date
• A company's operating cycle is average time to produce revenue (purchase inventory, selling it, and then collecting cash from customers)
• Companies list current assets in order of liquidity (how fast they convert into liquid cash) in the following order:
  • Cash
  • Investments such as short-term U.S. government securities
  • Receivables (accounts receivable, notes receivable, and interest receivable)
  • Inventories
  • Prepaid Expenses such as insurance and supplies
• To calculate a companies current assets add cash and accounts receivable, which can convert to cash within a year

Current Assests

• Current Assets = Cash + Accounts Receivable + Inventory + Other Liquid Assets
• Long-term assets are stocks and bonds of other corporations that are held for more than one year
• Land or building assets not in operating activities belong to this cattegory
• A long-term note receivable is a written agreement that a business records on its balance sheet to represent debt owed by a customer
• Property, Plant, and Equipment are assets w/ long useful lives currently used in operating including land, buildings, equipment, delivery vehicles, and furniture
• Depreciation is the systematic distribution of the total cost of an asset to expense over a number of years, rather than the full purchase price in the purchase year
• The accumulated depreciation account shows the total amount of depreciation of that the company has expensed so far in the asset's life
• Accumulated depreciation an offset of property, plant, and equipment
• Intangible assets are assets without physical substance but have value
• Goodwill is a common intangible asset
• Other intangibles include patents, copyrights, and trademarks that give the company exclusive right of use for a specified period of time
• Goodwill is buying a company for more than their products are worth (meaning overpaying for whatever you can identify you are receiving)
• Current liabilities are obligations that the company plans to pay within the next year
• Common examples of current liabilies include accounts payable, salaries, wages, and notes and interest payable, and income taxes payable
• Current maturities of long-term obligations; payments to be made within a year of the balance sheet
• Long-Term Liabilities is debt a company expects to pay after one year
  • Liabilities include bonds or mortgages payable, long-term notes payable, lease liabilities, and pension liabilities.
• Many companies report long-term debt maturing after one year as a single amount on the balance sheet but the details are in notes
• Stockholders' Equity consists of two parts: common stock and retained earnings
• Common stock is investments made when acquiring assets into the business by the stockholders
• As income retained when in record as retained earnings for use
• Combined total makes stockholders' equity on the balance sheet

2.2 Analyzing the Financial Statements Using Ratios

• Ratio Analysis: expresses the relationship among selected items of financial statement data

• express the math between one quantity and another.

• analysis of financial you have: -- Profitability ratios -- Liquidity ratios -- Solvency ratios.

• Probability measures the income success success company in given time

• Liquidity measures debt paying short term ability with cash

• Solvency measures ability the company survive the long period of time.

• Compare all rates: -- Intracompany two years -- Industry-average all particular industries. -- Intercomparasion competitors.

• The income statement reveals how well the company profit from sales

• • the income statement earned during the period

• -how was made during the time

• Cash Flow Statement - GAAP uses accrual accounting, this statement spend all cash on income statement

• • generate an spend.

• Statement of Stockholders – Show retained based on the the year

• Earning per Share - measures the on each own or plan buy earn Share the for income Stockholders.

• Approach calculating is divide income stock holders Shares weighted year what the the is is calculate income divided EPS = (Net Income - Preferred Dividends) / Weighted Average Common Shares

• comparing single can evaluate its on a per Share to note comparing across mean wide number stock out outstanding.

• • obligations the become due the the operating . (easily turn cash) close the relationship to liabilities
• • is the current liabilities, capital is When this, is a greater the the will

• is , to short- the might forced into

• • The the is a more indicator the working
• • companies the amount of the have different

• weakness ratio is it take account the

• • A current ratio disclose the current up slow moving of the matters a of is more to the is a
• • A that has more current assets can increase the ratio current assets to current liabilities by using cash to pay off some current liabilities

Solvency

• Long-term and are in a ability pay to to repay the a being at back

##Solvency

• are the company long time the to is one the is by dividing total to

• (both current and long-term) It the the by creditors

2.3 Financial Reporting Concepts

• (SEC): the agency the oversees markets standards bodies.

• • The (FASB): the primary standards
• • The Company Board (PCAOB): auditing and the auditing firms

• -The Standards Board (IASB) standards (IFRS), many to stock to that with .10

• • (Reporting Standards) but require the financial rather balance

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is methods obtain CPA's perform an verify

• For to must be to be before it its SEC large public within

• have the so that users can its.

• An is called a fiscal year.

Assumptions in Financial Reporting

Monetary Unit - requires that only those things that can be expressed in money are included in the accounting records.

• Certain important data needed by users, this relies on remaining relatively stable Economic Entity -economic entity states entity can .blur company with Economic events can be .

• Periodic -that the a artificial and thatful covering be prepared for the income other for all each

• Going -that the for foreseeable Conceptual for Report

• Assumption

• Economic-accountability

• Going-the longits (you the its$100)

• Monetary unit-in

• Materiality -principle in Important

• Conservatism - guidelines is accountants should

• Losses but profits

• should be reported at as but contigent you (it rainy

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• Recognition record Stuff can the service

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Qualitative characteristcs

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• Reliability(obtain simililar results,favor interest )
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• Comparability -reported same way can compared Contradictory is use same accounting and methods different time. Difference Accrual you

• basis than is the you.

• When you Deposit is the asset (benefit)

• The Intangible, if nike for shirt fair value of Chapter 3

3.1 Accounting Equation to Analyze Transactions

• Accounting Information System : collecting transaction informing to

• Accounting Transactions:events the in

• equity to a result of something occur

• *When a company performs services for cash the effect basic equity assets and stockholders equity

• *If cash an the the will,the "unearned "the will

• Each has for if an the or or

• Recalled consist of common and earning

• common is is are cash -earning are recognizes earning pays divided

• companies services " " That is they services

  • however when services Therefore, would when services although not been is receiving the account Account the to a later

Summary Transactions

Each is analyzed in terms of its effect on ,equity to The will

• the cause should be

3.2 Debits,

• An is an accounting record a specific equity revenue or expenses item.

• In the form, account

• debit side to is

• The the left an,account the right side.

• the

  • total debit if the debit the credits If the the credits the debits Debit: asset and expense the liability revenue and Credit:asset and revenue the liability revenue and Credit increase Contra -Account, amount , direction

revenues are expenses are Assets = L Debit Credit with to Debit and Credit

• Each balance to Debits equal credits The debit the doublesystem

• the the doublesided transaction in system Provides method recording transaction

• Earnings Earnings is income that is in the business. Earnings the of stockholders equity to been the profitable operation of the company.

• Earnings is by credits income and by for example, a lost

Dividends A is a by a to its stockholder. The common to is

• Revenues and a company recognizes equity is Revenue is - Thus, expense debits and by

*International Note

Rules for sometimes across For European rely fair than

• Despite basicaccounting

Share Holders Equity Relations

Companies report the of share equity in various in the financial states

• Common ,retained in holders section the sheet
• Dividends earnings revenue and Dividends are at the end the period As result ,change any one affect share holders equity..

3.3 Using Journals

-Though possible enter the data directly the business business these recording process (an integral part -the recording -to its in

• the Ledger 1 .comes in the form a document a a bill .or a

2. This the the the effect of the the 3 Finally the the designed in

the makes three contributions to the recording process

• It in the complete It the
• It helps to errors the debit and credit amounts entry canCompared -and its

3.4 The Ledger and Posting

• Ledger accounts a company ledger

• track the of the accounts and the journal

• ledgers ledger liability expenses

• Charts chart for Depending size account

• and Posting

• journalledger is journalised the each

• the purpose transaction is is to determine whethere debit or credit to of is

3.5 The Trial Balance

• the trial balance accounts list at given the

• usually prepares for period

• Alisted which is

• the and the