Lec 2 Basic Financial Statements and Accouting Equation.pptx

Accounting Equation and
BASIC FINANCIAL STATEMENTS
Lec 2: Financial Accouting 1

What is Accounting Equation?
• The accounting equation states that a company's total assets
are equal to the sum of its liabilities and its shareholders'
equity.
• The accounting equation is considered to be the foundation
of the double-entry accounting system.
• The accounting equation shows on a company's balance
sheet that a company's total assets are equal to the sum of
the company's liabilities and shareholders' equity.
• This equation has the following formula:
• Assets = Liabilities + Owner’s equity

Basics of Accounting Equation?
• Assets
• Assets include cash and cash equivalents or liquid assets, which
may include Treasury bills and certificates of deposit.
• Accounts receivable list the amounts of money owed to the
company by its customers for the sale of its products. Inventory is
also considered an asset.
• The major and often largest value assets of most companies are
that company's machinery, buildings, and property. These are fixed
assets that are usually held for many years.
• Assets = Liabilities + Equity

What are personal assets?
• Personal assets are any items a person owns that have some sort of value.
• People use their assets in several ways, such as when applying for a loan at a
bank or other financial institution and determining their net worth.
• You can measure someone’s wealth by adding the value of their assets, including
property and cash.
• Individuals also may itemize and evaluate their assets when they file an insurance
claim or their income taxes.
• Here’s a list of some of the most common personal assets:
• Cash, Checking and savings accounts, Art, Vehicles, Antiques, Jewelry, Personally
owned businesses, Real estate, stocks, Mutual funds, Property or land

What are company assets?
• A company asset is any intangible or tangible item that produces positive value for the
company.
• Tangible assets: They have a physical presence, such as machinery and real estate, are
subject to depreciation and have a life cycle of more than a year.
• Intangible assets: They are harder to evaluate, measure and define because they have no
physical presence. For example, brand identity and intellectual property are intangible
assets.
• A company lists assets it owns and its liabilities on balance sheets, making these an
important part of its financial reporting.
• Every type of asset has three characteristics:
1. Economic value: This is the value of an asset when a company sells or exchanges it.
2. Ownership: The owner of the asset determines when to convert the asset into cash.
3. Resource: Resources, such as cash, fixed assets and equipment the asset uses,
determine their purpose and how it benefits growth.

Types of Assets
• 1. Current assets
• Current assets are ones an owner can convert into cash or cash equivalents
within a year through sale or account payments. (Short Term Holdings)
• Companies can use current assets to pay for daily operations and other short-
term expenses. Current assets include:
• Cash: Cash assets include the cash you have on-site and the total amount of
money in all of your bank accounts, certificates of deposits and prepaid expenses.
• Mutual funds: This account consists of money from various investors and is part
of a portfolio of mixed assets.
• Money market account: This is a low-risk savings account that pays interest. As a
significant part of the world’s financial system, it’s an investment of short-term
debt where shares sell for about $1 each.

Types of Assets
• Marketable securities: These may include equity that you can liquidate,
treasury bills and stocks.
• Accounts receivable: Accounts receivable are payments clients owe you for
products you sold or services you rendered. These are short-term assets
because you can collect the money within a year.
• Goods and products: These can be items you or a business own or your
current inventory of products you haven’t sold. These also are short-term
assets.
• Supplies: Supplies can include office equipment, such as paper products,
and manufacturing supplies, such as wood, textiles and plastic.
• Promissory Notes: This is an official document that’s signed and includes a
written promise to pay back a sum of money to a specific person on a
specific date or demand.

Types of Assets
2. Fixed Assets
• Fixed assets, or capitalized assets, are the tangible assets of a company. (Long Term Holding)
• These help companies produce goods or provide services that result in future income.
• These Assets can’t be convert quickly to cash or use them to cover daily expenses.
• Long-term tangible assets kept for long periods and that often depreciate.
• Fixed assets are only sold if there’s an emergency and they’re more profitable than your current
assets.
• Fixed assets include:
• Buildings and land: This is any property or land a business purchases and owns. These real estate
investments include any permanent structures on the land.
• Machinery: Machines help produce goods that bring in revenue, making them assets.
• Vehicles: Any vehicles, including work trucks and cars, a company provides to its also are fixed
assets.
• IT equipment: This includes computers, servers, routers and other related equipment a company
owns.

Types of Assets
3. Tangible assets
• Tangible assets are ones you can touch, feel or see. Meaning they’re any
physical or measurable items a company uses for its operations. These
assets often provide a way for a business to operate. Some common
examples of these include:Machinery
• Buildings
• Equipment
• Cash
• Supplies
• Land
• Inventory

Types of Assets
4. Intangible assets
• Intangible assets are nonphysical assets of a company that add to its
value. Because of their nature, these assets can be more difficult to
assign a monetary value to, but they also can be more valuable than
tangible assets. These assets can include:Intellectual property
• Patents
• Copyrights
• Goodwill
• Brand equity
• Intellectual property

Liabilities
• Liabilities are debts that a company owes and costs that it needs to
pay in order to keep the company running.
• Debt is a liability, whether it is a long-term loan or a bill that is due
to be paid.
• Costs include rent, taxes, utilities, salaries, wages, and dividends
payable.
• Liabilities must be reported according to the accepted accounting
principles
• Liabilities = Assets – Equity

Types of Liabilities
• Current vs. non-current liabilities or Long-Term Liabilities
• Current liabilities are those that are due within a year. These primarily occur as
part of regular business operations. Due to the short-term nature of these
financial obligations, they should be managed with consideration of the
company’s liquidity. The most common current liabilities are:
1. Accounts payable: These are the yet-to-be-paid bills to the company’s vendors.
Generally, accounts payable are the largest current liability for most businesses.
2. Interest payable: interest expense that has already been incurred but has not
been paid. Interest payable should not be confused with interest expense,
which is the expense on an income statement.
3. Income taxes payable: the income tax amount owed by a company to the
government. The tax amount owed must generally be payable within one year.
Otherwise, the tax owed would be classified as a long-term liability.

4. Bank account overdrafts: effectively, a type of short-term loan provided
by a bank when a payment is processed with insufficient funds available in
the bank account
5. Accrued expenses: expenses that have been incurred but no supporting
documentation (e.g., invoice) has been received or issued to the company by
the vendor
6. Deferred revenue: (also called unearned revenue). Generated when a
company receives early payment for goods and/or services that have not
been delivered or completed yet.
7. Short-term loans or current portion of long-term debt: loans or other
borrowings with a maturity of one year or less

• Non-current (long-term) liabilities are those that are due after more than
one year. It is important that the non-current liabilities exclude the
amounts that are due in the short-term, such as short-term loans or the
current portion of long-term debt.
• Non-current liabilities can be a source of financing, as well as amounts
arising from business operations.
• Long-term liabilities include:
1. Bonds payable: The amount of outstanding bonds with a maturity of
over one year issued by a company. On a balance sheet, the bonds
payable account indicates the value of the company’s outstanding bonds.
2. Notes payable: The amount of promissory notes with a maturity of over
one year issued by a company. Similar to bonds payable, the notes
payable account on a balance sheet indicates the value of the promissory
notes.

3. Deferred tax liabilities: These arise from the difference between the amount of
tax recognized on the income statement and the actual tax amount due to be paid
to the appropriate tax authorities. As a liability, it essentially means that the
company “underpays” the taxes in the current period and will “overpay” the taxes
at some point in the future.
4. Mortgage payable/long-term debt: If a company takes out a mortgage or a long-
term debt, it records the value of the borrowed principal amount as a non-current
liability on the balance sheet.
5. Leases: Leases are recognized as a liability when a company enters into a long-
term rental agreement for property or equipment. The lease amount is the present
value of the lessee’s obligation.

• Shareholders' Equity
• The shareholders' equity number is a company's total assets minus its
total liabilities.
• It can be defined as the total number of dollars that a company would
have left if it liquidated all of its assets and paid off all of its liabilities.
This would then be distributed to the shareholders.
• Retained earnings are part of shareholders' equity. This number is the
sum of total earnings that were not paid to shareholders as dividends.
• Think of retained earnings as savings, since it represents the total profits
that have been saved and put aside (or "retained") for future use.
• Shareholders’ Equity = Total Assets – Total Liabilities

Balancing the Accounting Equation?
• Assets = ( Liabilities + Owner’s Equity)
• The balance sheet holds the elements that contribute to the
accounting equation:
• Locate the company's total assets on the balance sheet for the period.
• Total all liabilities, which should be a separate listing on the balance
sheet.
• Locate total shareholder's equity and add the number to total
liabilities.
• Total assets will equal the sum of liabilities and total equity.

Balancing the Accounting Equation?
• As an example, say the leading retailer XYZ Corporation reported the following on
its balance sheet for its latest full fiscal year:
• Total assets: $170 billion
• Total liabilities: $120 billion
• Total shareholders' equity: $50 billion
• If we calculate the right-hand side of the accounting equation (equity + liabilities),
we arrive at ($50 billion + $120 billion) = $170 billion, which matches the value of
the assets reported by the company.

Introduction to Financial Statements
Companies prepare interim
financial statements and annual
financial statements.
2000
X

Three primary
financial
statements.
Income Statement
Balance Sheet
Statement of Cash Flows
We will use a corporation
to describe these
statements.

Describes
where the
enterprise
stands at a
specific date.
Income Statement
Balance Sheet

Depicts the
revenue and
expenses for a
designated
period of time.
Income Statement
Balance Sheet

Revenues
result in
positive
cash flow.
Expenses
result in
negative
cash flow.
Either in the past, present, or future.

Net income (or
net loss) is
simply the
difference
between
revenues and
expenses.
Income Statement
Balance Sheet

Depicts the
ways cash has
changed during
a designated
period of time.
Balance Sheet
Income Statement

•Balance sheet – provides a snapshot of a firm’s financial
position at one point in time.
•Income statement – summarizes a firm’s revenues and expenses
over a given period of time.
•Statement of retained earnings – shows how much of the firm’s
earnings were retained, rather than paid out as dividends.
•Statement of cash flows – reports the impact of a firm’s activities
on cash flows over a given period of time.
The Annual Report

Vagabond Travel Agency
Balance Sheet
December 31, 2002
Assets
Cash
Notes receivable
Accounts receivable
Supplies
$ 22,500
10,000
60,500
2,000
Liabilities & Owners' Equity
Liabilities:
Notes payable $ 41,000
Accounts payable 36,000
Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
Building 90,000 Owners' Equity:
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
Total $300,000 Total $300,000
A Starting Point: Statement of
Financial Position

A Starting Point: Statement of
Financial Position

Liabilities

Owners’ Equity

The Accounting Equation

Balance Sheet: Assets
2002 2001
Cash 7,282 57,600
A/R 632,160 351,200
Inventories 1,287,360 715,200
Total CA 1,926,802 1,124,000
Gross FA 1,202,950 491,000
Less: Dep. 263,160 146,200
Net FA 939,790 344,800
2,866,592 1,468,800
Total Assets

Balance sheet: Liabilities and Equity
Accts payable
Notes payable
Accruals
Total CL
Long-term debt
Common stock
Retained earnings
Total Equity
Total L & E
2002 2001
524,160 145,600
636,808 200,000
489,600 136,000
1,650,568 481,600
723,432 323,432
460,000 460,000
32,592 203,768
492,592 663,768
2,866,592 1,468,800

Income statement
Sales
COGS
Other expenses
EBITDA
Depr. & Amort.
EBIT
Interest Exp.
EBT
Taxes
Net income
2002
6,034,0
00
5,528,000
519,988
(13,988)
116,960
(130,948)
136,012
(266,960)
(106,784)
(160,176)
2001
3,432,000
2,864,000
358,672
209,328
18,900
190,428
43,828
146,600
58,640
87,960

Other data
No. of shares
EPS
DPS
Stock price
Lease pmts
2002 2001
100,000 100,000
-$1.602 $0.88
$0.11 $0.22
$2.25 $8.50
$40,000 $40,000

Statement of Retained Earnings
(2002)
Balance of retained
earnings, 12/31/01
Add: Net income, 2002
Less: Dividends paid
Balance of retained
earnings, 12/31/02
$203,768
(160,176)
(11,000)
$32,592

Statement of Cash Flows (2002)
OPERATING ACTIVITIES
Net income
Add (Sources of cash):
(160,176)
Depreciation 116,960
Increase in A/P 378,560
Increase in accruals 353,600
Subtract (Uses of cash):
Increase in A/R (280,960)
Increase in inventories (572,160)
Net cash provided by ops. (164,176)

Lec 2 Basic Financial Statements and Accouting Equation.pptx

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