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Managers also need other information that is not reported in the three basic financial statements. Accounting Accounting for Businesses borrow money in the form of interest-bearing loans that have to be paid back at a later date, and they buy things on credit that are paid for later. Only the investors in the business and its lenders are entitled to receive the financial reports. Pastel accounting for dummies List of ebooks and manuels about Pastel accounting for dummies.
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Accounting Accounting for Small File type: PDF Book Message from the MD: Steven Cohen. Accounting notes Macarthur Community College. Brunch Workshop Computer Accounting ZT are the time-period dummies , Bookkeeping Introduction Topic A: Types of companies Topic. Financial Statements I devote a good deal of space in this book to discussing financial statements.
In Chapter 2, I explain the fundamental information components of financial statements, and then Part II gets into the nitty-gritty details.
Financial statements are prepared at the end of each accounting period. A period may be one month, one quarter three calendar months , or one year. Financial statements report summary amounts, or totals. Accountants seldom prepare a complete listing of the details of all the activities that took place during a period, or the individual items making up a total amount.
Business managers occasionally need to search through a detailed list of all the specific transactions that make up a total amount. When they want to drill down into the details, they ask the accountant for the more detailed information. But this sort of detailed listing is not a financial statement. Outside investors in a business see only summary-level financial statements. For example, investors see the total amount of sales revenue for the period but not how much was sold to each and every customer.
This is called the statement of financial condition or, more commonly, the balance sheet. The date of preparation is given in the header, or title, above this financial statement.
A balance sheet shows two sides of the business, which I suppose you could think of as the financial yin and yang of the business: On one side of the balance sheet the assets of the business are listed, which are the economic resources owned and being used in the business.
The asset values reported in the balance sheet are the amounts recorded when the assets were originally acquired — although I should mention that an asset is written down below its historical cost when the asset has suffered a loss in value. And to complicate matters, some assets are written up to their current fair values. Some assets have been on the books only a few weeks or a few months, so their reported historical values are current.
The values for other assets, on the other hand, are their costs when they were acquired many years ago. On the other side of the balance sheet is a breakdown of where the assets came from, or their sources. Assets are not like manna from the heavens. Assets come from two basically different sources: First, the creditors: Businesses borrow money in the form of interest-bearing loans that have to be paid back at a later date, and they buy things on credit that are paid for later.
So, part of total assets can be traced to creditors, which are the liabilities of a business. Second are the owners: Every business needs to have owners invest capital usually money in the business. Also, businesses retain part or all of the annual profits they make, and profit increases the total assets of the business.
Otherwise its books would be out of balance, which means there are bookkeeping errors. Owners bear the risk that the business may be unable to make a profit. The financial condition of the business in this example is summarized in the following accounting equation in millions: Double-entry bookkeeping is based on the accounting equation — the fact that the total of assets on the one side is counterbalanced by the total of liabilities, invested capital, and retained profit on the other side.
I discuss double-entry bookkeeping in Chapter 3. Basically, double-entry bookkeeping simply means that both sides of transactions are recorded. This is the economic nature of transactions. Double-entry means two-sided, not that the transactions are recorded twice. Reporting profit and loss, and cash flows Other financial statements are different from the balance sheet in one important respect: They summarize the flows of activities over the period.
An example of a flow number is the total attendance at Colorado Rockies baseball games over its entire 82 home game regular season; the cumulative count of spectators passing through the turnstiles over the season is the flow. Accountants prepare two types of financial flow reports for a business: Deducting expenses from revenue and income leads down to the wellknown bottom line, which is the final net profit or loss for the period and is called net income or net loss or some variation of these terms.
Opening the Books on Accounting Alternative titles for this financial statement are the statement of operations and the statement of earnings. The accounting profession has adopted a three-way classification of cash flows for external financial reporting: Respecting the importance of this trio I explain more about the three primary financial statements balance sheet, income statement, and statement of cash flows in Chapter 2.
These individuals have invested capital in the business, or the business owes them money; therefore, they have a financial interest in how well the business is doing. They are absolutely essential in helping managers control the performance of a business, identify problems as they come up, and plan the future course of a business.
Managers also need other information that is not reported in the three basic financial statements. The president and chief executive officer of a business plus other top-level officers are responsible for seeing that the financial statements are prepared according to applicable financial reporting standards and according to established accounting principles and methods. For this reason, business managers should understand their responsibility for the financial statements and the accounting methods used to prepare the statements.
This situation is a little scary; a manager who Chapter 1: Business managers at all levels need to understand financial statements and the accounting methods used to prepare them.
Also, lenders to a business, investors in a business, business lawyers, government regulators of business, entrepreneurs, anyone thinking of becoming an entrepreneur and starting a business, and, yes, even economists should know the basics of financial statement accounting. The bottom line is found in the income statement, not the balance sheet!
They work for businesses, government agencies, nonprofit organizations, and other organizations and associations. Accountants take these snide references in stride and with good humor. Actually, accountants rank among the most respected professionals in many polls. Certified public accountant CPA In the accounting profession, the mark of distinction is to be a CPA, which stands for certified public accountant.
The term public means that the person has had some practical experience working for a CPA firm; it does not indicate whether that person is presently in public practice as an individual CPA or as an employee or partner in a CPA firm that offers services to the public at large rather than working for one organization.
Opening the Books on Accounting To become a CPA, you go to college, graduate with an accounting major in a five-year program in most states , and pass the national, computer-based CPA exam. You also must satisfy professional employment experience; this requirement varies from state to state but generally is one or two years. After satisfying the education, exam, and experience requirements, you get a CPA certificate to hang on your wall. More important, you get a permit from your state to practice as a CPA and offer your services to the public.
States require continuing education hours to maintain an active CPA permit. The controller: The chief accountant in an organization The top-level accounting officer in a business organization is usually called the controller.
The controller designs the entire accounting system of the business and keeps it up-to-date with changes in the tax laws and changes in the accounting rules that govern reporting financial statements to outside lenders and owners. Controllers are responsible for hiring, training, evaluating, promoting, and sometimes firing the persons who hold the various bookkeeping and accounting positions in an organization — which range from payroll functions to the several different types of tax returns that have to be filed on time with different government agencies.
The controller is the lead person in the financial planning and budgeting process of the business organization. Furthermore, the controller designs the accounting reports that all the managers in the organization receive — from the sales and marketing managers to the purchasing and procurement managers. All the tough accounting questions and problems get referred to the controller.
Smaller businesses may employ only one accountant. Smaller businesses often call in a CPA for advice and help. The Language of Business, Investing, Finance, and Taxes State incorporation laws typically require that someone in the business be designated the treasurer, who has fiduciary responsibilities. Also, these laws usually require that someone be designated the secretary. The organizational charts of larger businesses usually put their controller under their vice president for finance, or chief financial officer CFO.
The accounting functions in a business are integrated with and work in close coordination with its financial, treasury, and secretary functions. A springboard to other careers Many CPAs move on to other careers.
A recent article in the Journal of Accountancy featured former CPAs who moved on to other interesting careers. After a few years in public accounting, I went back to school, got my Ph. These days, the starting salaries for new assistant professors of accounting are well into six digits! In this chapter, you get some juicy details. Then, in Part II, you really get the goods. Think back to when you learned to ride a bicycle. Chapter 1 is like getting on the bike and learning to keep your balance.
In this chapter, you put on your training wheels and start riding. The financial effects of making profit are not as simple as you may think. Profitmaking activities cause changes in the financial condition of a business — but maybe not the changes you suppose.
Making profit leaves many footprints on the financial condition of a business. Also in this chapter, I briefly discuss financial accounting and reporting standards. Businesses comply with established rules for recording revenue, income, expenses, and losses; for putting values on assets and liabilities; and for presenting and disclosing information in their financial reports.
The basic idea is that all businesses should follow uniform methods for measuring and reporting profit performance, and reporting financial condition and cash flows. Consistency in accounting from business to business is the goal. I explain who makes the rules, and I discuss two important recent developments: Opening the Books on Accounting Introducing the Information Content of Financial Statements This chapter focuses on the basic information components of each financial statement reported by a business.
In this first step, I do not address the classification, or grouping, of these information packets within each financial statement. The first step is to get a good idea of the information content reported in financial statements.
Setting up the business example To better illustrate the three primary financial statements, I need a realistic business example. The information content of its financial statements depends on the line of business a company is in — in other words, which types of products and services it sells. The financial statements of a movie theater chain are different from those of a bank, which are different from those of an airline, which are different from an automobile manufacturer.
Here, I use a fairly common type of business example. Here are the particulars of the business I use for the example: Chapter 2: Dollar amounts in the three financials are rounded off to the nearest thousand, which is not uncommon.
Dollar amounts can be reported out to the last dollar, or even the last penny for that matter. But too many digits in a dollar amount are hard to absorb, so many businesses round off the dollar amounts in their financial statements.
These financial statements are stepping-stone illustrations that are concerned mainly with the basic information components in each statement. Full-blown, classified financial statements are presented in Part II of the book. The financial statements in this chapter do not include all the information you see in actual financial statements. Also, I use descriptive labels for each item rather than the terse and technical titles you see in actual financial statements.
And I strip out subtotals that you see in actual financial statements because they are not necessary at this point. Oops, I forgot to mention a couple of things about financial statements.
I should give you quick heads-up on these points. Financial statements are rather stiff and formal. Financial statements would get a G in the movies rating system. Seldom do you see any graphics or artwork in a financial statement itself, although you do see a fair amount of photos and graphics elsewhere in the financial reports of public companies. However, I might mention that in his annual letter to the stockholders of Berkshire Hathaway, Warren Buffett includes some wonderful humor to make his points.
The income statement The income statement is the all-important financial statement that summarizes the profit-making activities of a business over a period of time. Figure shows the basic information content for an external income statement: The income statement in Figure shows six lines of information: Virtually all income statements disclose at least the four expenses shown in Figure The first two expenses cost of goods sold and selling, general, and administrative expenses take a big bite out of sales revenue.
The other two expenses interest and income tax are relatively small as a percent of annual sales revenue but important enough in their own right to be reported separately. Opening the Books on Accounting Figure Basic information components of the income statement. For example, a business could disclose separate expenses for advertising and sales promotion, depreciation, salaries and wages, research and development, and delivery and shipping — though reporting these expenses is not common.
Businesses do not disclose the compensation of top management in their external financial reports although this information can be found in the proxy statements of public companies that are filed with the Securities and Exchange Commission.
These internal profit performance reports to the managers of a business include a good deal more detailed information about expenses, and about sales revenue also. Reporting just four expenses to managers as shown in Figure would not do. Sales revenue is from the sales of products and services to customers.
Income refers to amounts earned by a business from sources other than sales; for example, a real estate rental business receives rental income from its tenants. In the example, the business has only sales revenue. As I mention above, businesses report the expenses shown in Figure — cost of goods sold expense, selling and general expenses, interest expense, and income tax expense. Further breakdown of expenses is at the discretion of the business.
Net income, being the bottom line of the income statement after deducting all expenses from sales revenue and income, if any , is called, not surprisingly, the bottom line. It is also called net earnings. A few companies call it profit or net profit, but such terminology is not common.
The income statement gets the most attention from business managers, lenders, and investors not that they ignore the other two financial statements. The very abbreviated versions of income statements that you see in the financial press, such as in The Wall Street Journal, report the top line sales revenue and income and the bottom line net income and not much more.
Refer to Chapter 4 for much more information on income statements. Financial Statements and Accounting Standards The balance sheet Figure shows the building blocks basic information components of a typical balance sheet. One reason the balance sheet is called by this name is that its two sides balance, or are equal in total amounts. Generally speaking, five or more assets are reported in a typical balance sheet, starting with cash, and then receivables, and then cost of products held for sale, and so on down the line.
Generally five or more liabilities are disclosed, starting with trade credit liabilities from buying on credit , and then unpaid expenses, and then proceeding through the interest-bearing debts of the business.
Basic information components of the balance sheet. Opening the Books on Accounting Most businesses need a variety of assets. You have cash, which every business needs, of course. Businesses that sell products carry an inventory of products awaiting sale to customers. Businesses need long-term resources that are generally called property, plant, and equipment; this group includes buildings, vehicles, tools, machines, and other resources needed in their operations. I include just four basic assets in Figure These are the hardcore assets that a business selling products on credit would have.
In this example, the business owns these so-called fixed assets. They are fixed because they are held for use in the operations of the business and are not for sale, and their usefulness lasts several years or longer. So, where does a business get the money to buy its assets? Most businesses borrow money on the basis of interest-bearing notes or other credit instruments for part of the total capital they need for their assets.
Also, businesses buy many things on credit and at the balance sheet date owe money to their suppliers, which will be paid in the future. These operating liabilities are never grouped with interest-bearing debt in the balance sheet. The accountant would be tied to the stake for doing such a thing. Note that liabilities are not intermingled among assets — this is a definite no-no in financial reporting.
You cannot subtract certain liabilities from certain assets and only report the net balance. You would be given 20 lashes for doing so. Well, not likely — unless the business has been losing money hand over fist. In the vast majority of cases a business has more total assets than total liabilities. For two reasons: Sometimes this amount is referred to as net worth, because it equals total assets minus total liabilities. However, net worth is not a good term because it implies that the business is worth the Chapter 2: The market value of a business, when it needs to be known, depends on many factors.
A balance sheet could be whipped up anytime you want, say at the end of every day. In fact, some businesses such as banks and other financial institutions need daily balance sheets, but most businesses do not prepare balance sheets that often. In external financial reports those released outside the business to its lenders and investors , a balance sheet is required at the close of business on the last day of the income statement period.
If its annual or quarterly income statement ends, say, September 30; then the business reports its balance sheet at the close of business on September Its more formal name is the statement of financial condition. Just a reminder: The profit for the most recent period is found in the income statement; periodic profit is not reported in the balance sheet. The profit reported in the income statement is before any distributions from profit to owners.
By the way, notice that the balance sheet in Figure is presented in a top and bottom format, instead of a left and right side format. Either the vertical or horizontal mode of display is acceptable. You see both the portrait and the landscape layouts in financial reports. The statement of cash flows To survive and thrive, business managers confront three financial imperatives: Opening the Books on Accounting The income statement reports whether the business made a profit.
The balance sheet reports the financial condition of the business. Smart business managers hardly get the word net income or profit out of their mouths before mentioning cash flow. Business is a two-headed dragon in this respect. Ignoring cash flow can pull the rug out from under a successful profit formula.
Still, some managers are preoccupied with making profit and overlook cash flow. For external financial reporting, the cash flows of a business are divided into three categories, which are shown in Figure The actual cash inflows from revenues and outflows for expenses run on a different timetable than when the sales revenue and expenses are recorded for determining profit.
I give a more comprehensive explanation of the differences between cash flows and sales revenue and expenses in Chapter 6.
The second part of the statement of cash flows sums up the long-term investments made by the business during the year, such as constructing a new production plant or replacing machinery and equipment. If the business sold any of its long-term assets, it reports the cash inflows from these divestments in this section of the statement of cash flows. The cash flows of other investment activities if any are reported in this part of the statement as well. The third part of the statement sums up the dealings between the business and its sources of capital during the period — borrowing money from lenders and raising new capital from its owners.
Cash outflows to pay debt are reported in this section, as well as cash distributions from profit paid to the owners of the business.
As you can see in part 3 of the statement of cash Chapter 2: By the way, in this example the business did not make cash distributions from profit to its owners. I should make one point clear here: I could tell you that the statement of cash flows is relatively straightforward and easy to understand, but that would be a lie.
The statements of cash flows reported by most businesses are frustratingly difficult to read. More about this issue in Chapter 6.
Figure presents the statement of cash flows for the business example as simply as I can possibly make it. Actual cash flow statements are much more complicated than the brief introduction to this financial statement that you see in Figure Basic information components in the statement of cash flows.
Opening the Books on Accounting Imagine you have a highlighter pen in your hand, and the three basic financial statements of a business are in front of you.
What are the most important numbers to mark? Financial statements do not have any numbers highlighted; they do not come with headlines like newspapers.
You have to find your own headlines. Bottom-line profit net income in the income statement is one number you would mark for sure. Another key number is cash flow from operating activities in the statement of cash flows.
This gap between profit and cash flow from operating activities is not unusual. Where is it? Is there some accounting sleight of hand going on? These are good questions, and I will try to answer them as directly as I can without hitting you over the head with a lot of technical details at this point.
Remember that the business sells on credit and its customers take time before actually paying the business. For example, a business that sells products buys or makes the products, and then holds the products in inventory for some time before it sells the items to customers. Cash is paid out before the cost of goods sold expense is recorded.
This is one example of a difference between cash flow connected with an expense and the amount recorded in the income statement for the expense. In Chapter 6, I explain the several factors that cause cash flow and bottom-line profit to diverge. At this point the key idea to hold in mind is that the sales revenue reported in the income statement does not equal cash collections from customers during the year, and expenses do not equal cash payments during the year.
Cash flow almost always is different from net income. Gleaning Key Information from Financial Statements The whole point of reporting financial statements is to provide important information to people who have a financial interest in the business — mainly its outside investors and lenders.
From that information, investors and lenders are able to answer key questions about the financial performance and condition of the business. I discuss some of these key questions in this section. In Chapters 13 and 17, I discuss a longer list of questions and explain financial statement analysis.
Here, I use the data from Figures and the dollar amounts are in thousands: Opening the Books on Accounting Profit looks pretty thin compared with annual sales revenue. The company earns only 5 percent return on sales. In other words, 95 cents out of every sales dollar goes for expenses, and the company keeps only 5 cents for profit.
Many businesses earn 10 percent or higher return on sales. Is there enough cash? Cash is the lubricant of business activity. A business should keep enough cash on hand to keep things running smoothly even when there are interruptions in the normal inflows of cash. A business has to meet its payroll on time, for example. Keeping an adequate balance in the checking account serves as a buffer against unforeseen disruptions in normal cash inflows. This cash balance is available for general business purposes.
If there are restrictions on how it can use its cash balance, the business is obligated to disclose the restrictions. Interestingly, businesses do not have to comment on their cash balance. So, it has enough cash to pay these liabilities. Lenders are more interested in the ability of the business to control its cash flows, so that when the time comes to pay off loans it will be able to do so. They know that the other, non-cash assets of the business will be converted into cash flow.
Receivables will be collected, and products held in inventory will be sold and the sales will generate cash flow. On the other hand, if it turns out that the business is not able to collect its receivables and is not able to sell its products, it would end up in deep doo-doo. In the example, the business has an ending cash balance equal to 35 days of sales, calculated as follows: Can you trust the financial statement numbers?
Whether the financial statements are correct or not depends on the answers to two basic questions: What can I tell you? There are a lot of crooks and dishonest persons in the business world who think nothing of manipulating the accounting numbers and cooking the books. Also, organized crime is involved in many businesses. In short, there is a risk that the financial statements of a business could be incorrect and seriously misleading.
Opening the Books on Accounting To increase the credibility of their financial statements, many businesses hire independent CPA auditors to examine their accounting systems and records and to express opinions on whether the financial statements conform to established standards. In fact, some business lenders insist on an annual audit by an independent CPA firm as a condition of making the loan.
The outside, non-management investors in a privately owned business could vote to have annual CPA audits of the financial statements. Public companies have no choice; under federal securities laws, a public company is required to have annual audits by an independent CPA firm.
Two points: CPA audits are not cheap, and these audits are not always effective in rooting out financial reporting fraud by high-level managers. I discuss these and other points in Chapter Why no cash distribution from profit? In this example the business did not distribute any of its profit for the year to its owners. Distributions from profit by a business corporation are called dividends.
Why not? In most cases, this would be the upper limit on how much cash a business would distribute from profit to its owners. But you got no cash return on your investment in the business. But you did not see any of this increase in your wallet.
Deciding whether to make cash distributions from profit to shareowners is in the hands of the directors of a business corporation. Its shareowners elect the directors, and in theory the directors act in the best interests of the shareowners. Generally the main reason for not making cash distributions from profit is to finance the growth of the business — to use all the cash flow from profit for expanding the assets needed by the business at the higher sales level.
Ideally, the directors of the business would explain their decision not to distribute any money from profit to the shareowners. But, generally, no such comments are made in financial reports. Financial Statements and Accounting Standards Is making profit ethical? Many people have the view that making profit is unethical; they think profit is a form of theft — from employees who are not paid enough, from customers who are charged too much, from finding loopholes in the tax laws, and so on.
I must admit that profit critics are sometimes proved right because some businesses make profit by using illegal or unethical means, such as false advertising, selling unsafe products, paying employees lower wages than they are legally entitled to, deliberately under-funding retirement plans for employees, and other immoral tactics.
Of course in making profit a business should comply with all applicable laws, conduct itself in an ethical manner, and play fair with everyone it deals with. In my experience most businesses strive to behave according to high ethical standards, although under pressure they cut corners and take the low road in certain areas.
Keep in mind that businesses provide jobs, pay several kinds of taxes, and are essential cogs in the economic system. Even though they are not perfect angels, where would we be without them? Keeping in Step with Accounting and Financial Reporting Standards The unimpeded flow of capital is absolutely critical in a free market economic system and in the international flow of capital between countries.
To make these decisions, they need the accounting information provided in financial statements of businesses. Imagine the confusion that would result if every business were permitted to invent its own accounting methods for measuring profit and for putting values on assets and liabilities. What if every business adopted its own individual accounting terminology and followed its own style for presenting financial statements?
Such a state of affairs would be a Tower of Babel. Recognizing U. Opening the Books on Accounting complied with GAAP in reporting its cash flows, profit-making activities, and financial condition — unless the business makes very clear that it has prepared its financial statements using some other basis of accounting or has deviated from GAAP in one or more significant respects.
If GAAP are not the basis for preparing its financial statements, a business should make very clear which other basis of accounting is being used and should avoid using titles for its financial statements that are associated with GAAP. For example, if a business uses a simple cash receipts and cash disbursements basis of accounting — which falls way short of GAAP — it should not use the terms income statement and balance sheet.
The general consensus backed up by law is that businesses should use consistent accounting methods and terminology. General Motors and Microsoft should use the same accounting methods; so should Wells Fargo and Apple. Of course, businesses in different industries have different types of transactions, but the same types of transactions should be accounted for in the same way.
That is the goal. There are upwards of 10, public companies in the United States and easily more than a million private-owned businesses. Now, am I telling you that all these businesses should use the same accounting methods, terminology, and presentation styles for their financial statements? Putting it in such a stark manner makes me suck in my breath a little. The correct answer is that all businesses should use the same rulebook of GAAP.
However, the rulebook permits alternative accounting methods for some transactions. Furthermore, accountants have to interpret the rules as they apply GAAP in actual situations. The devil is in the details. In the United States, GAAP constitute the gold standard for preparing financial statements of business entities although the gold is somewhat tarnished, as I discuss in later chapters.
The presumption is that any deviations from GAAP would cause misleading financial statements. If a business honestly thinks it should deviate from GAAP — in order to better reflect the economic reality of its transactions or situation — it should make very clear that it has not complied with GAAP in one or more respects. If deviations from GAAP are not disclosed, the business may have legal exposure to those who relied on the information in its financial report and suffered a loss attributable to the misleading nature of the information.
Financial Statements and Accounting Standards Financial accounting and reporting by government and not-for-profit entities In the grand scheme of things, the world of financial accounting and reporting can be divided into two hemispheres: A large body of authoritative rules and standards called generally accepted accounting principles GAAP have been hammered out over the years to govern accounting methods and financial reporting of business entities in the United States.
Accounting and financial reporting standards have also evolved and been established for government and not-for-profit entities.
This book centers on business accounting methods and financial reporting. Financial reporting by government and not-for-profit entities is a broad and diverse territory, which is beyond the scope of this book. Federal, state, and local government entities issue financial reports that are in the public domain, although few taxpayers are interested in reading them. The members or participants may have an equity interest or ownership share in the organization and, thus, they need financial reports to apprise them of their financial status with the entity.
Government and other not-for profit entities should comply with the established accounting and financial reporting standards that apply to their type of entity. Many not-forprofit entities use accounting methods different than business GAAP — in some cases very different — and the terminology in their financial reports is somewhat different than in the financial reports of business entities.
Getting to know the U.