KEY ACCOUNTING CONCEPTS

ACTG 6920Session 2Professor Kile

Definition of Accounting

“Accounting is a service activity whose function is to provide quantitative information, primarily financial in nature, about economic entities and is intended to be useful in making reasoned economic choices among alternative actions.”

My Definition of Accounting

Accounting is a measurement system

My Definition of Accounting

Accounting is a system(process) for measuring economic performance.

Accounting has Multiple Uses

1. Taxes2. Financial Reporting3. Internal Control4. Decision Making5. Contracts

Accounting Measures Performance

“Earnings” is the actual performance measurement.

Earnings = Income = Profit

Earnings is a Measurement

“Earnings” is not a physical item;

It is a measurement.

Accounting Measures Performance

Earnings is a “crude” measurement. It is not a perfect measure. Accountingis not precise (“black & white).

How Accounting Measures Costs

A cost to the business can be Either an ASSET (balance sheet= does not affect earnings)or an EXPENSE (income Statement = reduces earnings)

How Accounting Measures Costs

Accounting rules (GAAP) determine whetheror not a cost is an asset or an expense.

If the cost is recorded as an asset, then theprocess is referred to as “CAPITALIZED”

How Accounting Measures Costs

Assets are “expenses waiting to happen”.

Assets generally get converted to expenses at some point.

Take for example, depreciation. Depreciationis simply an accounting process to take an asset and convert it to an expense in bits andpieces over time.

EXPENSES

When expenses are recognized,The expense is offset by either(1) Using up an Asset(2) Incurring a Liability

Output of Financial Accounting

The output of financial Accounting is the FinancialStatements

Output of Financial Accounting

FOUR Financial Statements and aComprehensive set of Footnotes1)Income Statement2)Balance Sheet3)Statement of Cash Flows4)Statement of Retained Earnings5)Footnotes

Link Between Statements

The Income Statement is Linked toThe Balance Sheet through the BalanceSheet account called RETAINED EARNINGS.

Link Between Statements

RETAINED EARNINGS is an EQUITY ACCOUNT.ASSETS – LIABILITIES = EQUITY.

Thus, Earnings increases NET ASSETS.NET ASSETS = EQUITY.

Regulation

U. S. “Public Companies” must register with the Securities & Exchange Commission (SEC). www.sec.gov

Regulation

SEC Registered Companies mustFollow GAAP;Submit to a public audit;Continue to file documents with the SEC.

ASSETS “What we have”

LIABILITIES “What we owe”

EQUITY “The residual value”

REVENUE

EXPENSES

5 Different Type of Accounts

CASH – currencyCASH EQUIVALENTS – investments that can be converted to cash quickly with minimal

riskSHORT-TERM INVESTMENTS (MARKETABLE SECURITIES) – Investments in the stocks or

bonds of other businesses or government entities- to be held one year or lessACCOUNTS RECEIVABLE – amount owed to us by our customers due to previous credit

sales*ALLOWANCE FOR DOUTFUL ACCOUNTS (This is a Contra-Asset account!) – An amount

set aside to represent Accounts Receivables that can not be collectedINVENTORY – Items purchased and held for sale (as part of the company’s line of

business)SUPPLIES – Items of small economic significance held to support operations (not held

for sale).PREPAID RENT, PREPAID INSURANCE, other PREPAID EXPENSES – Future expenses that

are paid in advance

Current Assets

Non-Current Assets = > 1 yr.

PLANT & EQUIPMENT – BUILDINGS and EQUIPMENT. EQUIPMENT would include machinery, furniture and office furnishings and a number of such items.*ACCUMULATED DEPRECIATION – (This is a contra-asset account) The total amount of depreciation that has been taken on buildings and equipmentPROPERTY (LAND) – self explanatoryINTANGIBLE ASSETS –Legal agreements; assets without physical form that give future value to the business. Examples include organizational costs, patents, copyrights*ACCUMULATED AMORTIZATION (This is a contra-asset account) Represents the total amount of depreciation that has been taken on the intangible assets. Amortization is simply depreciation of an intangible item.

Current Liabilities

ACCOUNTS PAYABLE – amounts owed to suppliers.NOTES PAYABLE – amount of money borrowed and owed to a single lender.CURRENT MATURITIES OF LONG-TERM DEBT – portion of the amount borrowed for long-term purposes due in the coming year.

The following may be referred to as “Accrued Liabilities”WAGES PAYABLE- amount owed employeesUTILITIES PAYABLE – amount owed for utilities RENT PAYABLE – amount owed for rentINTEREST PAYABLE – amount owed for interest incurred on borrowing.UNEARNED REVENUE – money collected for work that has not been performed or completed.

Non-Current Liabilities

BONDS PAYABLE and other LONG-TERM DEBT – amount of money borrowed that is not due within the next year.

MORTGAGE PAYABLE – amount of long-term debt secured by real estate.

PENSION LIABILITY – estimated amount owed in future pension costs

EquityRepresent 2 ways to grow value in the company

COMMON STOCK & ADDITIONAL PAID IN CAPITAL – the amount of money received from selling our own company’s stock

RETAINED EARNINGS – The cumulative amount of earnings (minus all dividends paid out) from all prior periods.

Also, Comprehensive Income

Revenue

SALES - Revenue generated from selling inventory to customers.

SERVICE REVENUE AND FEES REVENUE – Revenue generated from performing a service as one of the company’s lines of business.

Operating Expenses

COST OF GOODS SOLD – the cost of inventory that has been soldWAGE EXPENSE – the cost of paying employeesRENT EXPENSE – the cost of paying rentUTILITIES EXPENSE – the cost of paying utilitiesINTEREST EXPENSE – the cost of paying interest on borrowingDEPRECIATION EXPENSE – the amount of depreciation taken on long-term assets this yearAMORTIZATION EXPENSE – the amount of amortization taken on intangible assets this yearSELLING GENERAL AND ADMINSTRATIVE – a host of expense items not related to production activities.

Income Statement Accounts

Other RevenueINTEREST INCOME – revenue earned by lending moneyGAINS ON SALES OF ASSETS – amount cleared over the cost of a sold asset

Other ExpensesLOSSES ON SALES OF ASSETS – amount deficient relative to the cost of a sold asset