MGTB05 Chapter 1 Notes

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Financial Accounting
Daga Sandra

MGTB05 Financial Accounting I Chapter 1—Financial Statements and Business Decisions Understanding the Business The Players  an individual is the owner-manager if he/she is the founder or owner of a company and also functions as the manager of the business  creditors lend money for a specific length of time and gain by charging interest in the money they lend  investors are individuals who buy small percentages of large corporations in hope to receive a portion of what the company earns in the form of dividends and hope to sell their shares of the company at a higher price than they paid to acquire it  financing activities: exchanges of money with creditors and owners  investing activities: buying or selling of property The Business Operations  suppliers are the people from whom one purchases supplies to create the good/service whereas customers are the individuals who buy the supplied service/good The Accounting System  accounting is a system that collects and processes (analyzes, measures and records) financial information about an organization and reports that information to decision makers  internal decision makers (managers, etc.) and external decision makers (investors, creditors) use accounting reports but internal decision makers generally require more detailed and frequent updates than external decision makers  managerial or management accounting is the process of developing accounting information for internal decision makers where as financial accounting is the process of providing accounting information for external decision makers The Four Basic Financial Statements: An Overview  four basic financial statements are: statement of financial position, statement of comprehensive income, statement of changes in equity, and statement of cash flows  statements inform investors, creditors and other external decision makers by summarizing the financial activities of the business and are prepared periodically (e.g. quarterly, semi-annually, annually) Statement of Financial Position  purpose: report the financial position (assets, liabilities and shareholders’ equity) of an accounting entity at a particular point in time)  the heading of the statement identifies the name of the entity, the title of the statement, the specific date of the statement (not period but the data it is prepared, a specific point in time) and the unit of measure (the legally required currency)  the accounting entity (business or corporation) is the organization for which the financial data is collected and it is viewed as owning the resources it uses and owing its debt, rather than the business owners  assets are the economic resources legally controlled by the entity, liabilities are the sources of financing and shareholders’ equity are claims again the company’s economic resources Assets = Liabilities + Shareholders’/Owners’ Equity  financial position is the economic resources that the company owns and the sources of financing for those resources  assets are economic resources controlled by the entity as a result of past business events from which future economic benefits can be obtained  every asset on the statement of financial position is initially measured at the cost incurred to acquire it but after acquisition assets are reported on the statement of financial position at values that reflect the benefits the company expects to realize from the assets through use or sale  liabilities are the entity’s legal obligations that result from past business events and arise primarily from the purchase of goods and services on credit and through cash borrowings to finance the business  shareholders’ equity indicates the amount of financing provided by the owners of shares in the business as well as earning over time  it arises from three sources: share capital or the investment of cash and other assets in the business by owners in exchange for shares, retained earnings which are the earnings reinvested in the business and thus not distributed to the shareholders in the form of dividends and other components which reflect the changes the value of assets and liabilities over time  assets provide a basis for judging whether the company has sufficient resources available to operate the business and are important because they could be sold in case of bankruptcy  liabilities are important to see whether a company has enough sources of cash to pay its debt obligations and indicate the control that debts and creditors hold over a company’s assets in case of bankruptcy  net worth is important to creditors because legally creditors claims for repayment of obligation must be settled before those of owners, shareholders provide resources for the company to use in the future without a promise of future repayment  assets are listed in increasing or decreasing order of their convertability to cash (their liquidity), generally the most liquid assets are listed first and the least liquid or hardest to convert to cash assets are listed last  liabilities are listed in order of increasing or decreasing order of maturity (due date) with the most recent maturity date being listed first and the ones that have the longest maturity being listed last  other conventions: monetary sign is places beside the first amount in a group of items, a single underline is placed below the last line in a group or total and a double underline is placed below totals The Statement of Comprehensive Income  purpose: reports the change in shareholders’ equity, during a period, from business activities, excluding exchanges with shareholders (includes all changes in equity during a period except those resulting from investments by owners)  first part is the revenue generated less expenses incurred in the accounting period which is the measure of net profit or net loss—income statement  the second part reports comprehensive income, which accounts for income and expense items that are not recognized in the income statement in accordance with International Financial Reporting Standards (IFRS)  the income statement reports information for a specified period of time, for an accounting period (the time period covered by the financial statements) Revenue – Expenses = Profit/Loss  revenues are generally reported on the income statement when the goods and services are sold to customers whether or not they have been paid for  expenses represent the monetary value of resources the entity used up, or consumed, to earn revenues during the period; for accounting purposes the expense reported in one accounting period may actually be paid for in cash in another accounting period so a company recognizes all expenses (cash and credit) incurred during a specific accounting period regardless of the timing of the cash payment  profit (net earnings, net income) is the excess of total revenues over total expenses incurred to generate revenue during a specific period—it indicates the firm’s ability to sell goods and services for more than they cost to produce and deliver  to a lender profit indicates that a company has the resources to repay loans whereas to investors it helps them decide whether or not to buy a company’s share in hope that the profit will lead to a higher share price  if total expenses exceed total revenues a loss is reported, a loss is noted by using parentheses around the reported figure  when revenues and expenses are equal for the period, the business has operated at breakeven  revenues are not necessarily the same as collections from customers and expenses are not necessarily the same as payments to suppliers, and thus profit does not equal the net cash generated by operations The Statement of Changes in Equity  purpose: reports all changes in shareholders’ equity during the accounting period; and reports the way profit, distribution of profit (dividends) and other changes to shareholders’ equity affected the company’s financial position during the accounting period  the statement of changes in equity covers a specific period of time (the accounting period) similar to the statement of comprehensive income  retained earnings reflect the profits that have been earned since the creation of the company but not distributed to shareholders as dividends  profit earned increases retained earnings whereas the declaration of dividends decreases retained earnings Beginning Retained Earnings + Profit – Dividends = Ending Retained Earnings  creditors monitor a firm’s retained earnings because the firm’s policy on dividend payments to its shareholders affects it ability to repay its debt, and shareholders closer monitor a firm’s retained earnings because the firm’s policy on repayment of debs to creditors affects its ability to pay its shareholders in the form of dividends and for reinvestment purposes which is important for potential investors who want to know if the company is reinvesting a sufficient portion of profit to support future growth The Statement of Cash Flows  purpose: reports cash inflows and outflows that are related to operating, investing and financing activities during the accounting period, describes causes of change in cash reported on the statement of financial position from the end of the last period to the end of the current period  the statement of cash flows like the statement of comprehensive income and statement of changes in equity covers a specific period of time (an accounting period)  revenues do not always equal cash collected from customers because some sales may be on credit  expenses reported on the income st
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