Introduction

Accounting Essentials

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Zoologic™ Learning Solutions

Course: Accounting Essentials

Lesson 1 : Introduction

Welcome to Accounting Essentials! If you're a little nervous about studying financial accounting, relax - you've got lots of company. In this course, you'll get lots of help. Let's start with some context. If you haven't already explored the animation above.

Accounting Essentials is based upon the content and close collaboration of Professor Robert P. Magee, the Associate Dean for Academic Affairs: Faculty and Research, and the Keith I. DeLashmutt Distinguished Professor of Accounting Information and Management at the Kellogg Graduate School of Management at Northwestern University. At Kellogg, Professor Magee received the Levy Teaching Award in 1996 and the Chairs' Core Teaching Award in 1998 and 2001. Accounting Essentials combines Professor Magee's content expertise and instructional skill with an effective learn-by-doing instructional design to provide a highly interactive simulation that will guide you through the essential concepts and methods of financial accounting.

Why aren't we starting this course by first looking at a real company's financial statements?

Two reasons. First, it's easier to start with simple examples. Second, looking at real financial statements is most informative if you know something about the company. So, it's a great idea for you to check out financial statements at companies' web sites. Start with a company you know because you've worked for them or invested in them.

Why are we starting this course by identifying these parties?

Financial reports are designed to answer questions about the company and knowing these parties will give us a context for analyzing financial statements. For instance, a potential supplier is interested in different aspects of the financial performance of a company than a potential investor.

What kinds of companies do investors like?

In general, investors like investments with high returns (increasing future consumption) and low risk. That is, an investor will look for a company that can take his or her resources and turn them into a larger quantity of resources. Of course, all investors (and other companies) are looking for these situations, so competition will limit the return that an investor can expect.

Many parties are interested in a company's profits, the company's overall financial condition, (specifically how much cash the company has on hand), and how much the company owes to lenders and creditors. Mouse-over each of the interested parties above to find out who is interested and why. When you do, you'll see why we're focused on financial accounting (as opposed to tax accounting or managerial accounting), with an emphasis on the investors' perspective.

accounting The "language of business"; numerically describes a business entity's transactions and events to describe companies consistently, clearly and fairly. Why would a customer or a supplier care about the company's profits and other financial details? Suppliers care because they want to get paid for the goods and services that they have delivered to the company. In addition, both suppliers and commercial customers make investments (e.g., in product design) that would be lost if the company were to fail. If management and investors both focus on the company's profits, why does management need separate accounting reports?

Management reports must have more detail to manage individual products and services and to assess the performance of business units. In addition, management can use more subjective information that is difficult for an outsider to verify (and therefore difficult to report in public financial statements).

What role does the Securities and Exchange Commission (SEC) and the outside auditor play vis-à-vis investors?

The SEC is charged with maintaining the effectiveness of the securities markets. A key aspect of that job is keeping a regular flow of reliable financial information coming to investors, potential investors, and the parties who participate in the market. Auditors provide a review of the company's financial systems and financial reports to increase (though not to guarantee) the reliability of the information.

In this course, you'll learn about financial accounting experientially. That means you'll learn via a simulation that, while simplified, is based upon a real-world situation. If you haven't explored the images already, mouse-over each to meet the investor and the company of this simulation.

Who are these investors and why do they forego consumption to invest?

Most of us work to manage our lifetime consumption patterns. As young adults, we often spend more than our income to invest in education, a house, a car, and so on. At some point, most people's income exceeds their consumption, and they repay previous borrowing and invest for retirement. After retirement, consumption again exceeds income. Unless our income always matches our consumption desires, we need to borrow and invest at different times to smooth out the difference.

What is a "private equity" investor and what do they do?

When you think about a company and who owns it, you might envision the stock market and related news reports about the Dow Jones Industrial Average, or the S&P 500, or the NASDAQ index, and so on. And you'd be right; those terms are associated with the activities in which many investors own and trade shares of company stock (i.e., "equity securities") that are owned and traded in public markets.

But it turns out that most companies' shares are not owned publicly; they're owned privately, usually by a small number of investors. (Think of a family-owned company, for example.) A private equity investor is a special kind of private investor. Usually a private equity investor is not an individual; it's a company whose business is to invest money by buying stock in private company (in this case Orphan Brands) and, thereafter, by contributing management expertise (and perhaps more money later on) to help the company expand and produce very favorable financial results. Private equity investors do this with a view to sell their investments to other investors (e.g., to public investors via an "Initial Public Offering") who are more comfortable investing in companies whose track records of strong financial performance are well established.

Why would management want to buy a company, and why would they need the private equity investor?

Many people would like to run their own business, where they reap the benefits of their efforts and good decisions. However, they often lack the resources needed to set up the business and get it running, and that's where the investor comes in. The investor will take a share of the company's returns, but should leave the management with a larger share than they would have received while working for a big company like CPX.

Is this going to be hard?

Accounting is a language, so it's going to be about as hard as learning a few simple phrases in French or German or Japanese.

How can I practice skills that I don't have?

We'll give you a quick introduction to get you started in the right direction. After that, you'll learn by doing, with feedback as we go. In fact, you'll probably end up learning more if you make a few mistakes along the way!

Why can't I just leave all of this to the accountants?

You can leave the preparation of the financial statements to the accountants (though they sometimes don't do it properly, as occasional articles in the popular press attest). However, you will need to know how to read the financial statements and where to look to find the answers to questions in finance, strategy, marketing and so on. When you do, there's no substitute for an understanding of the methods used to construct the statements.

Does what I'm about to learn apply to companies in industries different from Orphan Brands'?

The accounting process is exactly the same, although the common transactions and events will differ depending on the type of business the company engages in. Different industries often have different sets of transactions to worry about. For instance, a service business would have no inventory. But the basic structure of the financial reports is the same. The Balance Sheet provides a snapshot of a company's resources and claims on those resources at a point in time, and the Income Statement provides a summary of the flows of resources (actually, resources net of liabilities) from operations over a period of time.

Of the three financial statements, which one do I really have to know well?

Which control does an automobile driver need to know really well - the accelerator, the brake or the steering wheel? Companies are usually complex organizations, with many facets that we want to explore. It's unrealistic to think that we could distill all that complexity down to a few lines of type. An effective user becomes familiar with all components of the financial statements.

However, we're just getting started, and for this online program, you can focus your attention on two statements - the Balance Sheet and the Income Statement - and the relation between them.

What are the Balance Sheet, the Income Statement and the Statement of Cash Flows?

They are financial statements that present a firm's financial position and performance. Companies use financial statements to report financial information to investors, bankers, and other third parties. The Income Statement reports the company's profit or loss, a summary of all the firm's sales and related expense activity from the beginning to the end of a period of time. The Balance Sheet reports the amount of a company's assets, liabilities, and owner's equity. It represents a snapshot of the firm's financial situation at a specific moment in time. And the Statement of Cash Flows reports why the company's cash balance changed over a given period of time.