Financial Accounting Statements

• Financial accounting involves preparing financial statements for external users like investors, creditors, and regulators.

Financial Statements

• Financial statements provide a structured representation of a company's financial position and performance.
• The key financial statements are the balance sheet, income statement, and statement of cash flows.
• The balance sheet, also called the statement of financial position, reports a company's assets, liabilities, and equity at a specific point in time.
• Assets are a company's resources, such as cash, accounts receivable, and property, plant, and equipment (PP&E).
• Liabilities are a company's obligations to others, such as accounts payable, salaries payable, and debt.
• Equity represents the owners' stake in the company.
• The accounting equation, Assets = Liabilities + Equity, is the foundation of the balance sheet.
• The income statement, also called the profit and loss (P&L) statement, reports a company's financial performance over a period of time.
• It presents revenues, expenses, and net income or net loss.
• Revenues are inflows from delivering goods or services.
• Expenses are outflows incurred to generate revenue.
• Net income (or net loss) is calculated as Revenues - Expenses.
• The statement of cash flows reports the movement of cash both into and out of a company during a period.
• Cash flows are categorized into operating, investing, and financing activities.
• Operating activities result from the normal day-to-day of business.
• Investing activities include the purchase and sale of long-term assets like property, plant, and equipment (PP&E).
• Financing activities involve transactions with creditors and owners, such as borrowing money and issuing stock.

Journal Entries

• Journal entries are the initial record of financial transactions.
• Each journal entry includes a debit and a credit.
• Debits increase asset, expense, and dividend accounts, while they decrease liability, owner's equity, and revenue accounts.
• Credits increase liability, owner's equity, and revenue accounts, while they decrease asset, expense, and dividend accounts.
• The basic format of a journal entry includes the date, account titles, debit amount, and credit amount, along with a brief description.
• For example, a journal entry to record cash received for services performed involves a debit to the cash account and a credit to the service revenue account.
• A compound journal entry involves more than two accounts.

Ledger Accounts

• Ledger accounts, or T-accounts, are used to summarize the effects of journal entries on individual accounts.
• Each account has its own ledger, which shows all debits and credits made to that account.
• The ending balance is calculated by subtracting the total debits from the total credits (or vice versa, depending on which is greater).
• The chart of accounts is a listing of all accounts used by a company.
• Ledger accounts provide the data for preparing the trial balance and financial statements.

Accounting Principles

• Accounting principles provide a framework for preparing financial statements.
• Generally Accepted Accounting Principles (GAAP) are a common set of accounting rules, standards, and procedures issued by the Financial Accounting Standards Board (FASB).
• The historical cost principle states that assets should be recorded at their original cost.
• The revenue recognition principle determines when revenue should be recorded, which is generally when it is earned and realized.
• The matching principle states expenses should be recognized in the same period as the revenues they helped generate.
• The full disclosure principle requires companies to disclose sufficient information to allow users to make informed decisions.
• The going concern assumption presumes that the company will continue to operate in the foreseeable future.
• The monetary unit assumption assumes that transactions can be expressed in a stable monetary unit.
• The economic entity assumption separates the transactions of a business entity from those of its owners.

Financial Analysis

• Financial analysis involves evaluating financial statements to assess a company's performance and financial position.
• Ratio analysis is a technique used to analyze the relationships between different items in the financial statements.
• Liquidity ratios measure a company's ability to meet its short-term obligations.
• Examples include the current ratio (Current Assets / Current Liabilities).
• Solvency ratios measure a company's ability to meet its long-term obligations.
• Examples include the debt-to-equity ratio (Total Debt / Total Equity).
• Profitability ratios measure a company's ability to generate profits.
• Examples include the profit margin (Net Income / Revenue).
• Activity ratios measure how efficiently a company is using its assets.
• Examples include the inventory turnover ratio (Cost of Goods Sold / Average Inventory).
• Horizontal analysis involves comparing financial data over time, such as comparing this year's sales to last year's sales.
• Vertical analysis involves expressing financial data as a percentage of a base amount, such as expressing each item on the income statement as a percentage of revenue.

Hire Purchase and Installment System

• Hire purchase and installment systems are methods of purchasing assets where payment is made in installments over a period of time.
• In hire purchase, the ownership of the asset is transferred to the buyer only after the last installment is paid.
• Until then, the seller retains ownership and the buyer has the right to use the asset.
• In an installment system, the ownership of the asset is transferred to the buyer immediately, but the seller has a security interest in the asset.
• The cash price is the price at which the asset could be purchased for cash.
• The hire purchase price is the total amount payable by the buyer, including the cash price and interest.
• Interest is the finance charge for deferring payment.
• Depreciation is charged on the asset from the beginning, irrespective of whether the asset is under hire purchase or installment.
• When accounting for hire purchase, the asset is recorded on the buyer's balance sheet at its cash price.
• The difference between the cash price and the total installments is treated as interest expense, which is recognized over the payment period.
• The buyer recognizes both an asset and a liability on its balance sheet under hire purchase.
• Installment systems also involve asset and liability recognition, but ownership transfer is immediate.