Financial accounting provides financial information to external parties such as creditors, investors and governmental agencies. It reports on the financial position and performance of a firm through financial statements. The key elements of financial accounting are assets, liabilities and shareholders' equity. Assets are items owned by a company, liabilities are amounts owed, and shareholders' equity represents the owners' claim on assets. The accounting equation states that assets must always equal liabilities plus shareholders' equity. Financial accounting uses double-entry bookkeeping to record transactions, ensuring the accounting equation stays in balance.

1. MBA Orientation
Southern States University

2. What is Financial
Accounting?
Introduction,
Definitions and
Purpose
2

3.  Language of businessLanguage of business
 Provides information to…Provides information to…
• ManagersManagers
• OwnersOwners
• InvestorsInvestors
• Governmental agenciesGovernmental agencies
3

4.  The reporting of the financial position and
performance of a firm through financial statements
issued to external parties such as creditors, investors,
and tax-collecting (ex. IRS) or governmental (ex: SEC)
bodies.
 Financial accounting is aimed at providing information
to parties outside the organization.
 Managerial accounting information is aimed at helping
managers within an organization make decisions.
4

5. Analyze Record Classify
Summarize
Communicate
Interpret Report
5

6. Relevant:
 Significant enough to influence business
decisions
 Timely
 Useful in predicting the future
Accounting information must be useful.
To be useful, information must be. . .
6

7. Reliable:
 Representational
 True and verifiable
 Unbiased
Comparable:
 From year to year for one company
 Between similar companies
 To industry averages
7

8.  In the US, Financial Accounting Standards
Board (FASB)(FASB) -independent agency responsible
for compiling and amending US GAAP, the
Generally Accepted Accounting Principles.
 US GAAPGAAP - widely accepted set of rules,
conventions, standards, and procedures for
reporting financial information, which guide
business entities in financial reporting.
 UK GAAP, Swiss GAAP, International
Accounting Standards - similar in rules and
conventions
8

9.  The mission of the U.S. Securities and Exchange
Commission is to protect investors, maintain fair,
orderly, and efficient markets, and facilitate capital
formation. (www.sec.gov)
 Securities Act of 1933
• Often referred to as the "truth in securities" law - two basic objectives:
 require that investors receive financial and other significant
information concerning securities being offered for public sale; and
 prohibit deceit, misrepresentations, and other fraud in the sale of
securities.
 Registration
• primary means of accomplishing these goals is the disclosure of
important financial information through the registration of securities.
This information enables investors, not the government, to make
informed judgments about whether to purchase a company's
securities.
9

10.  Financial accounting and reporting are based
on a fundamental concept, the accounting
equation.The accounting equation is simply
stated as:
Assets = Liabilities + Shareholders’ Equity
In financial accounting,the Assets of a company must equal the
Liabilities of a company plus the Shareholders’ Equity.
10

11.  In general, Assets are items owned by the company.
Assets are categorized as current (short–term) and
long-term. Current assets are assets that are
expected to be sold or used with the next year.
 Primary examples of CURRENT ASSETS include:
• Cash and Cash Equivalents
• Accounts Receivable
• Inventory
 LONG-TERM ASSETS are assets that are expected to
be in service for over one year and include:
• Property, Plant, and Equipment
• Land
• Investment Property
• Intangible Assets (Goodwill,Trademarks, Patents, etc.)
11

12.  Liabilities, on the other hand, are money or
services owed to another entity.
• Result in increasing the financial rights or
claims of creditors to assets.
 Liabilities, like assets are also categorized as
current (due within one year) and long-term.
 Examples of liabilities include:
• Accounts Payable
• Loans and Promissory Notes
• Tax Liabilities
12

13.  Shareholders’ Equity, Owner's Equity or Net
Worth, owner’s net investment in a company
• Does not always mean cash
• Includes any assets the owner has put into the
business
• is the difference between what the company owns
(Assets), and what the company owes (Liabilities).
 This is the inherent value of the company.
• Common Stock
• Preferred Stock
• Retained Earnings (Revenues and Expenses)
13

14.  The accounting equation, is the basis of
financial accounting.
 Assets = Liabilities + Shareholders’ Equity
 In financial accounting, the Assets of a company
must equal the Liabilities of a company plus the
Shareholders’ Equity.
14

15. Assets = Equities
Properties (resources)
of value owned by a firm
Financial items owed to
others +
owner’s net investment
income
15

16. Assets = Liabilities + Owner’s Equity
Rights of creditors Rights of owner
16

17. Liabilities
Cash +
Accounts
Rec. +
Computer
Equip. =
Accounts
Payable +
B. Bell,
Capital -
B. Bell,
W/D + Revenue - Expense
Assets Owner's Equity
• The expanded accounting equation lists the
individual accounts that fall under each classification.
• All assets are added together.
• Liabilities + Owner’s Equity is expanded to Liabilities
+ Capital – Withdrawals + Revenue - Expenses
17

18. Indicates that the make-up of assets
has changed, but the total of assets
remains the same.
Example: If a company buys a piece
of equipment with cash for $600,
value of total asset equipment would
increase and cash would decrease
but the total value of assets would
not change.
18

19. Assets = Liabilities + Owner’s Equity
a. = +
b. +
+$120,000
+ $600
+$120,000
- $600
Equipment
Cash
19

20. Owner Investment,
Revenue, Expenses,
and Withdrawals
20

21. Liabilities
Cash +
Accounts
Rec. +
Computer
Equip. =
Accounts
Payable +
B. Bell,
Capital -
B. Bell,
W/D + Revenue - Expense
Assets Owner's Equity
$60,000 $60,000
$7,000b.
a.
$7,000$60,000 $60,000
Assets = $67,000 L + S = $67,000
a) Owner invests $60,000 as casha) Owner invests $60,000 as cash
b) Buys new computer for $7,000 on creditb) Buys new computer for $7,000 on credit
21

22.  Amount earned by performing
services for customers or selling
goods to customers
 Increases owner’s equity
22

23.  Cost incurred in running a business
by consuming goods or services in
producing revenue
 Decreases owner’s equity
 Recorded when incurred
23

24. Liabilities
Cash +
Accounts
Rec. +
Computer
Equip. =
Accounts
Payable +
B. Bell,
Capital - B. Bell, W/D + Revenue - Expense
Assets Owner's Equity
-
200
- 200
$59,800d.
c.
$14,000
$60,000 $60,000$7,000 $7,000
Assets = $66,800 L + S = $66,800
+14,000 $60,000$7,000 $7,000
Assets = $80,800 L + S = $80,800
c) Pays electricity bill of $200 in cashc) Pays electricity bill of $200 in cash
d) Earns $14,000 in sales (as cash)d) Earns $14,000 in sales (as cash)
C:
D:
24
- 200

25. Liabilities
Cash +
Accounts
Rec. +
Computer
Equip. =
Accounts
Payable +
B. Bell,
Capital - B. Bell, W/D + Revenue - Expense
Assets Owner'sEquity
30,000
$73,800f.
e.
- 200
$73,800 $60,000$7,000 $7,000
Assets = $110,800 L + S = $110,800
-4,000 $60,000$7,000$7,000 -$4,000$44,000
Assets = $106,800 L + S = $106,800
$14,000 - $200
$30,000
$30,000
E:
F:
e) Earns $30,000 in sales (on credit)e) Earns $30,000 in sales (on credit)
f) Pays $4,000 in wages (as cash)f) Pays $4,000 in wages (as cash)
25

26.  Money or other assets an owner
withdraws from a business for
personal use
 Decreases owner’s equity
 Not an expense
26

27.  Let’s assume the owner withdraws
$100 in cash for personal use.
Liabilities
Cash +
Accounts
Rec. +
Computer
Equip. =
Accounts
Payable +
B. Bell,
Capital -
B. Bell,
W/D + Revenue - Expense
Assets Owner's Equity
69,800 $60,000$7,000 $7,000 - $4,200$30,000 $44,000
- 100 -100
= 69,700 -$100 -$4,200$44,000$60,000$7,000$7,000$30,000
27

28.  Financial Accounting - based on a double
entry system
• a transaction or exchange between two accounts
• each account has two columns, a debit and credit
side
• each transaction is recorded in two accounts.
28

29.  Each transaction must have at least two
entries, one in a debit account, and one
in a credit account to keep the
accounting equation in balance at all
times.
 In the double entry system, each type of
account, such as Cash, Accounts
Receivable, Accounts Payable, Retained
Earnings, etc. has its own t-account, with
the debits on the left side and the credits
on the right side.
29

30. T-Account
Title of Account
Left side Right side
Debit Credit
30

31. Assets dominate the left-hand side
of the Accounting Equation.
Assets
Debit + Credit -
31

32. Liabilities and Equity dominate the
right-hand side of the Accounting
Equation.
Liabilities and Equity
Debit - Credit +
32

33. Statement of Stockholders’ Equity
Stockholders’ Equity
ContributedCapital
Dividends
Revenues
Expenses
Income Statement
33

34. Think of the Owner going for a R I D E
RRevenues
IInvestments
DDividends
EExpenses
Increase Equity
Decrease Equity
34

35. Assets Liabilities Equities
35

36. Assets
Increasewithdebits
DecreasewithCredits
Liabilities
IncreasewithCredits
DecreasewithDebits
Contributed Capital
+withCredits
Retained Earnings
+withRevenues
-WithExpenses
-WithDividends
RIDE!RIDE!
36

37. To summarize…
 Debits are always on the left side
 Credits are always on the right side
 The type of account determines whether a debit or credit
increases or decrease the value.
 Asset and Expense Accounts are increased on the debit side and
decreased on the credit side.
 Liability, Shareholders’ Equity, and Revenue Accounts are
increased on the credit side and decreased on the debit side.
Recall the Accounting Equation:
Assets = Liabilities + Shareholders Equity
Debit Credit Debit Credit Debit Credit
Increase Decrease Decrease Increase Decrease Increase
+ - - + - +
37

38.  For example, let’s say we invested $1000 in the company as
a Shareholder
 The company took a loan for $2500, and then bought
inventory for $350
 Our T-account would look like this:
Assets = Liabilities + Shareholders Equity
Debit Credit Debit Credit Debit Credit
Increase Decrease Decrease Increase Decrease Increase
+ - - + - +
+1000 +1000
+2500 + 2500
+ 350 - 350
3500 = 2500 + 1000
38

39. EXAMPLE
 Blick is a retail art supply store in Little
Italy, San Diego.The following
transactions occurred recently:
1. Owner’s invested $5000 into the company
2. Purchased $3400 of merchandise from suppliers
on credit
3. Sold $300 of merchandise for cash
4. Sold $800 of merchandise on credit
39

40. Assets = Liabilities + Shareholders Equity
Debit Credit Debit Credit Debit Credit
+ - - + - +
5000 5000
3400 3400
300 - 300
800 - 800
9500 - 1100 = 3400 + 5000
8400 = 8400
40

41. 41

42. Assumptions:Assumptions:
 Time-period Assumption
 Separate Entity Assumption
 Monetary Unit Assumption
 Going-Concern Assumption
Principles:Principles:
 Revenue Recognition Principle
 Matching Principle
 Historical Cost Principle
42

43. The life of a business
can be divided into
artificial time periods
for financial reporting
These time periods
are presented at the
top of each financial
statement
43

44. Revenues are
recorded on the
Income Statement
when the work
process is complete
and the amount is
reasonably assured
$6,000 of consulting work was
performed in the month of January
44

45. Expenses are
recorded on the
Income Statement
in the same time
period of the
revenue they
helped generate
$1,420 of expenses were incurred to
generate the $6,000 of revenues
45

46. Assets are recorded
on the Balance Sheet
at cost (cost at the
time they were
purchased)
Cost includes all costs
necessary to get the
asset ready for its
intended purpose (like
installation and
cleaning costs)
$5,000
46

47. Revenues and
Expenses are
recorded on the
Income
Statement at the
time the
economic
activity occurs
regardless of
when the actual
cash flow occurs
$6,000 Revenue = Total work done in January for
Cash and Credit Customers
$1,420 Expense = Total costs incurred in January
whether paid in Cash or with credit
$4,580 Net Income = growth in total asset
base, not necessarily growth in Cash.
47

48. 1.Income Statement
2.Statement of Owner’s Equity
3.Balance Sheet
4.Statement of Cash Flows
48

49. = Capital (end) + Capital (end)
Income Statement Statement of
Owner’s Equity
Balance Sheet
Assets
= Liabilities
Capital (beg.)
- Withdrawals
+ Revenues
- Expenses
= Net Income
+ Net Income
Statement of Cash Flows Sources and Uses
of cash
49

50.  Shows business results
• Revenues
• Expenses
• Net income/loss
 Covers a certain period of time
50

51.  The income statement is more like a video of
the firm’s operations for a specified period of
time.
 You generally report revenues first and then
deduct any expenses for the period
 Matching principle – GAAP says to show
revenue when it accrues and match the
expenses required to generate the revenue
51

52. French Realty Company
INCOME STATEMENT
For Month Ended June 30, 2003
Revenue:
Professional fees $2,900
Operating Expenses:
Salaries Expense $500
Utilities Expense 360
Rent Expense 500
Total Operating Expenses _(1,360)_
Net Operating Income: $1,540
Taxes (%) (616)
Net Income $924
52

53.  Reports changes to owner’s equity
for a certain period of time
Beginning capital balance
+Owner investment
+Net Income
-Owner withdrawals
-Net loss .
Ending capital balance
53

54. French Realty Company
STATEMENT OF OWNER’S EQUITY
For Month Ended June 30, 2003
Owner’s Beg. Net Capital, June 1, 2003 $8,000
Net Income for June $924
Owner’s Withdrawals in June (40)
Increase in Capital 884
Owner’s End. Capital, June 30, 2003 $8884
54

55.  Reports financial position of a company as
of a particular date
 Assets are listed in order of decreasing
liquidity
• Ease of conversion to cash
• Without significant loss of value
 Balance Sheet Identity
• Assets = Liabilities + Stockholders’ Equity
• Presents ending balances in assets,
liabilities, and owner’s equity
55

56. French RealtyFrench Realty
BALANCE SHEET
For Month Ended June 30, 2003
AssetsAssets Liabilities & Owners EquityLiabilities & Owners Equity
Cash $2,694Cash $2,694 LiabilitiesLiabilities
Accounts Receivable 1,490 Accounts Payable $2,000Accounts Receivable 1,490 Accounts Payable $2,000
Office Equipment 6,700Office Equipment 6,700 Owner’s EquityOwner’s Equity
End. Capital 8,884End. Capital 8,884
Total Assets $10,884Total Assets $10,884 Total Liabilities &Total Liabilities &
Owner’s Equity $10,884Owner’s Equity $10,884 56

57.  Statement that summarizes the sources and
uses of cash by a company during an
accounting period
 Changes divided into three major
categories
• 1) Operating Activity – includes net income
and changes in most current accounts
• 2) Investment Activity – includes changes in
fixed assets
• 3) Financing Activity – includes changes in
notes payable, long-term debt, and equity
accounts as well as dividends
57

58.  Activities related to conducting the
business for which the enterprise
was established
 Cash inflows
• Cash collected from customers for
goods/services
• Interest/dividends received
 Cash outflows
• Paying for Merchandise Inventory, taxes,
interest
• Paying operating expenses
58

59.  Purchase or sale of plant and
equipment
 Buying stocks and bonds of other
companies
 Selling stocks and bonds of other
companies
 Making loans to others
59

60.  Activities related to raising money
from investors and creditors
• Issuing stock and bonds
• Repurchasing the company’s stock
• Paying cash dividends
• Retiring bonds
60

61. Cash, beginning of year 58 Financing Activity
Operating Activity Decrease in Notes Payable -93
Net Income 689 Decrease in LT Debt -248
Plus: Depreciation 116 Decrease in C/S (minus RE) -94
Decrease in A/R 36 Dividends Paid -206
Decrease in Inventory 60 Net Cash from Financing -641
Increase in A/P 4 Net Increase in Cash 638
Increase in Other CL 309 Cash End of Year 696
Less: Increase in other CA -39
Net Cash from Operations 1,175
Investment Activity
Sale of Fixed Assets 104
Net Cash from Investments 104
*Numbers in millions
61

62. Financial Accounting
in Management Decisions
62

63.  Financial Ratios are not very helpful by
themselves; they need to be compared to
something
 Time-Trend Analysis
• Used to see how the firm’s performance is changing
through time
• Internal and external uses
 Peer Group Analysis
• Compare to similar companies or within industries
63

64.  Internal uses
• Performance evaluation – compensation and
comparison between divisions
• Planning for the future – guide in estimating future
cash flows
 External uses
• Creditors
• Suppliers
• Customers
• Stockholders
64

65.  Common-Size Balance Sheets
• Compute all accounts as a percent of total assets
 Common-Size Income Statements
• Compute all line items as a percent of sales
 Standardized statements make it easier to
compare financial information, particularly as
the company grows
 They are also useful for comparing companies
of different sizes, particularly within the same
industry
65

66.  There is no underlying theory, so there is no way to
know which ratios are most relevant
 Benchmarking is difficult for diversified firms
 Globalization and international competition makes
comparison more difficult because of differences in
accounting regulations
 Varying accounting procedures, i.e. FIFO vs. LIFO
 Different fiscal years
 Extraordinary events
66

67. 67