Financial Accounting Overview

Overview of Financial Accounting

● Authors: Earl K. Stice, James D. Stice, W. Steve Albrecht, Monte R. Swain,
Rong-Ruey Duh, Audrey Wenhsin Hsu
● Study Focus: Important financial statements and fundamental accounting
principles.

Financial Statements Overview (LO1)

● Primary Financial Statements:
● Statement of Comprehensive Income
● Statement of Changes in Equity
● Statement of Cash Flows
● Balance Sheet (Statement of Financial Position)

Balance Sheet Components (LO1)

● Assets:
● Resources controlled by the entity due to past events.
● Expected future economic benefits from these resources.
● Liabilities:
● Present obligations from past events expected to lead to an outflow of resources.
● Equity:
● Residual interest in assets after deducting liabilities (Total Assets - Total
Liabilities).
● Increases when owners invest or when the business earns profit.
● Decreases when owners withdraw or when there are losses.

Accounting Equation (LO1)

● Equation: Assets = Liabilities + Equity
● This equation underpins double-entry accounting and reflects the relationship
between these elements.

Statement of Comprehensive Income (LO2)

● Purpose: Measures the overall performance of a company, summarizing
revenues and expenses.
● Formula:
● Net Income = Revenues - Expenses
● Other Comprehensive Income (OCI):
● Includes unrealized gains/losses (not part of normal operations).
● OCI contributes to overall comprehensive income (Comprehensive Income = Net
Income + OCI).
Earnings Per Share (EPS) (LO2)
● Definition: The income attributable to each share of stock.
● Formula: EPS = Net Income / Outstanding Number of Shares of Stock

Statement of Changes in Equity (LO3)

● Tracks: Changes in equity elements over time.
● Retained Earnings: Accumulated earnings not distributed to owners but
reinvested in the business.
● Formula: Ending Retained Earnings = Beginning Retained Earnings + Net
Income - Dividends

Statement of Cash Flows (LO4)

● Purpose: Reports cash inflows and outflows categorized into three activities:
● Operating Activities: Day-to-day business operations.
● Investing Activities: Acquisition and disposal of long-term assets.
● Financing Activities: Debt and equity transactions.

Notes to Financial Statements (LO5)

● Purpose: Provide explanatory information that is integral to understanding the
financial statements.
● Categories:
● Summary of Significant Accounting Policies
● Additional Information about Summary Totals
● Disclosure of Information Not Recognized

The External Audit (LO6)

● Independent CPA Audits: Provides assurance that financial statements comply
with GAAP; not a guarantee of absolute accuracy.
● Economic Incentives: Owners seek favorable results for various interests; CPA
firms rely on reputation and avoid legal consequences.

Fundamental Accounting Concepts and Assumptions (LO7)

● Separate Entity Concept: Distinction between the entity's activities and those of
its owners.
● Time-Period Assumption: Financial performance is reported over standard time
periods (monthly, quarterly, annually).
● Cost Principle: Transactions recorded at historical costs rather than current
market values.
● Fair Value Principle: Some situations allow for measurement of assets and
liabilities at fair value.
 ● Monetary Measurement Concept: Economic activities recorded in monetary
terms for reporting.
● Going Concern Assumption: Assumes an entity will continue operations for the
foreseeable future, impacting asset valuation.

Conclusion
● Understanding these financial concepts and statements is crucial for analyzing a
company's financial health and potential for growth or risk.

Example of the Accounting Equation

Consider a company with the following financial information:

● Total Assets: $50,000

● Total Liabilities: $30,000
Using the accounting equation:
Assets = Liabilities + Equity
We can rearrange to find Equity:
Equity = Assets - Liabilities

Substituting in the values:

Equity = $50,000 - $30,000 = $20,000

Thus, the example shows that if a company has total assets of $50,000 and total
liabilities of $30,000, its equity will be $20,000.

Journal Entries:

● Essential for recording financial transactions.

● Involves identifying accounts, determining increases/decreases, and stating
amounts.
● Examples include expenses, revenue from services, and payments of obligations.
● Accounting Cycle:
● Steps include analyzing transactions, recording in journals, posting to ledgers, and
preparing trial balances.
● Focuses on measurable transactions and maintaining the accounting equation
(Assets = Liabilities + Equity).
● Transactions:
● Various business activities such as investments, borrowing, purchasing supplies, and
providing services.
● Each transaction affects specific accounts and must be recorded accurately.
● Debit-Credit Rule:
● Fundamental principle where debits and credits are used to record transactions.
 ● Temporary accounts (revenues, expenses, dividends) are closed into Retained
Earnings.
● Trial Balance:
● A list of accounts with their respective debit or credit balances.
● Ensures that total debits equal total credits, although errors may still exist.
● T-Accounts:
● Visual representation of accounts used for teaching and learning.
● Helps in understanding how debits and credits affect different types of accounts.
● Impact of Technology:
● Computers streamline the posting of journal entries and summarizing accounts.
● Human judgment remains crucial in the accounting process.
● Examples of Transactions:
● Include acquiring cash, purchasing noncash assets, providing services, and
managing obligations.
● Each example illustrates the impact on various accounts and the corresponding
journal entries.
● Expanded Accounting Equation:
● Incorporates revenues and expenses to show their effect on equity

Concise Summary
The context addresses the accounting cycle and the importance of adjusting entries. It covers
key concepts such as accrual accounting, revenue recognition principles, applied examples,
and closing accounting books. It reiterates that accrual accounting is critical to complying with
generally accepted accounting principles (GAAP) and that adjusting entries are essential at the
end of each accounting period to reflect the company's true financial situation. Finally, the
process of preparing financial statements is discussed.
Highlights
📅 Accrual Accounting: Revenues and expenses are recorded when incurred, not when cash is
received or paid.
📈 Revenue Recognition: Revenue is recognized when certain criteria are met, regardless of
when the cash is received.
📊 Adjusting Entries: Necessary at the end of each accounting period to adjust account balances
to their correct amount.
🧾 Closing the Books: Involves closing entries and preparing a post-closing trial balance.
📚 Matching Principle: Relates revenue to related expenses in the same accounting period.
🏢 Complete Accounting Cycle: From transaction analysis to financial statement preparation and
book closing.
List of Key Insights
🧮 Cruciality of Accrual Accounting: Critical to financial accuracy and GAAP compliance.
🔄 Requirement for Adjustments: Adjustments ensure that revenue and expenses are correctly
allocated by period.
❌ Difference between Accrual and Cash Accounting: Accrual accounting is more
accurate for measuring economic performance.
📊 Preparation of Financial Statements: Adjusted balances are used to compile the income
statement and balance sheet.
📐 Financial Statement Notes: Provide critical details behind the presented numbers.
✂️Closing Process: Ensures temporary accounts are zeroed out at the end of the period,
transferring their balances to permanent accounts.

Summary

The main information in this document focuses on the internal control structures that companies
develop to ensure the accuracy of financial information. Internal control structures include
policies and procedures aimed at preventing errors, disputes, and fraud. At the same time, laws
such as the Sarbanes-Oxley Act (SOX) impose certain responsibilities on management and
auditors to increase the effectiveness of these controls. The role of auditors is divided into
internal auditors and external auditors and is necessary to ensure the reliability of financial
information. The Securities and Exchange Commission (SEC) is tasked with ensuring that
financial information is reported accurately and that public investors are protected.

Highlights
🔍 Internal Control Structures: Five basic categories are used to ensure the accuracy of financial
information: control environment, risk assessment, control activities, information and
communication, and monitoring.

📜 Sarbanes-Oxley Act: Requires companies to submit a report on internal control over financial
reporting and for management to evaluate the effectiveness of these controls.
🤝 The Role of Auditors: Internal and external auditors play a critical role in ensuring the
reliability of financial statements.

🌐 The Role of the SEC: They audit and regulate companies’ financial reports and require
certain reports to ensure investor safety.

🌍 International Regulatory Responses: Different countries, such as the European Union, Japan,
China, and Taiwan, have adopted regulatory frameworks similar to SOX.

Key Insights

🏢 Management Responsibility: The responsibility for establishing and maintaining the internal
control structure lies with the company’s management.

🔄 Manipulation Risk: Manipulation of income reports can be done to meet internal or external
expectations. This jeopardizes the reliability of the financial statements.

🚨 Fraud Details: Frauds are defined as intentional errors, and effective internal control systems
are critical to preventing such incidents.

🚫 Audit Restrictions: SOX imposes restrictions on certain services to protect the independence
of auditors.
📈 Financial Reporting Requirements: The SEC requires companies to submit certain reports
and statements to ensure the accuracy of financial information

Concise Summary

The context provides detailed guidance on the main financial activities of businesses:
operations, investing, and financing. It also addresses cash management, including internal
controls, purchase discounts, petty cash management, and bank reconciliation.

Highlights
💼 Main Activities: Operating (sales, inventory purchases), Investing (asset purchases), and
Financing (fund acquisition).
💳 Cash Management: Importance of controlling cash flow through internal procedures and bank
reconciliations.
📈 Financing: Methods of raising capital, such as debt and equity issuance.
💸 Purchase Discounts: Potential savings through early payments on purchases.
🏦 Bank Reconciliation: Importance of balancing bank balances by adjusting deposits in transit
and outstanding checks.
Key Insights
🚀 Importance of Cash Management: Controlling cash is essential for a company's financial
stability and efficient operations.
📉 Impact of Delays and Errors: Discrepancies such as outstanding checks or accounting errors
can significantly affect cash flow.
🔄 Efficient Cash Cycle: Performing regular bank reconciliations and maintaining robust internal
controls improves operational efficiency.
Internal Control: Separating functions and conducting regular audits can protect against fraud
and financial errors.
💰 Investment Caution: Understanding the impact of investments in property and equipment on
cash flow is crucial for strategic decision-making.