Financial Accounting For Decision Making Accounting 201

Accounting 201 is the first accounting course offered at UTM. One must have Sophomore standing and passed Math 140 (College Algebra) prior to entering Accounting 201. It serves as a major prerequisite for all other accounting courses. It is an introductory course in Financial Accounting. 

 

Course Syllabus

 

Purpose of this Web Page

It is the intent of this Web Page to provide help to Introductory Accounting students in Accounting 201. Even though the discussion is oriented toward accounting students, anyone   is welcome to visit this page. I hope you will find it helpful. Your comments are appreciated and will be considered in the design of future pages.

Many of my beginning students over the past years have complained of their inability to see the total picture from illustrations and discussions in the classroom. Accordingly, this page will be devoted to a "birds eye" depiction of accounting as a complete system rather than detailed studies of parts of the system.

Key Points : Financial Accounting

  • Primary users are external
  • Financial Statements are the basic forms of presentation
  • Subject to Generally Accepted Accounting Principles (GAAP)
  • Organizations instrumental in the development of GAAP--
    • American Institute of Certified Public Accountants (AICPA)
    • American Accounting Association (AAA)
    • Securities and Exchange Commission (SEC)
    • Financial Accounting Standards Board (FASB) The "current" authority
  • The financial statements are articulated (One or more items from one statement link to other financial statements)
  • The accounting equation is the backbone to financial statement presentation
  • The accounting equation is: Assets = Liabilities + Owners' Equity
  • Double- Entry Accounting is used to reflect the changes in the accounting equation for every business transaction that affects the financial statements
  • Following the financial statement effect via the accounting equation is as easy as 3, 2, 1


 Summary of Financial Statements
 

Balance Sheet  

Assets = Liabilities + Owners' Equity

Income Statement 

<-----(Revenues and Gains) - (Expenses and Losses)

Statement of Cash Flows 

Cash Inflows: 

From -Operations; Investing, and Financing 

+ Beginning Cash Balance 

= Ending Cash Balance

Owners' Equity Statement 

Paid-In Capital: Permanent Capital 

Retained Earnings: Net Income - Dividends

Effect of Financial Transactions on the Accounting Equation

                                       Assets = Liabilities + Owners' Equity

Beginning Balance                                   3    =            2         +            1

Owners Invest in business                     +1 assets                              +1 owners' equity

Result                                                       4    =             2         +            2

Borrow Money                                       +1 assets     +1 liabilities

Result                                                       5    =             3         +            2

Revenue                                                 +2 assets                               +2 owners' equity

Result                                                       7    =              3         +           4

Expenses                                                 -1 assets                                -1 owners' equity

Result                                                       6   =                3        +            3

Repay Loan                                            -1 assets         -1 liabilities

Result                                                       5   =                2                  + 3

Owners Disinvest                                   -1 assets                               -1 owners' equity

Result                                                       4   =                2                 + 2

Dividend Paid                                         -1 assets                               -1 owners' equity

Result                                                      3   =                 2                 + 1

The preceding is a simplified example of typical business transactions and how transactions affect the accounting equation. The owners' equity transactions may be further broken down in the accounts into Revenue and Expenses (Income Statement) and to Paid-In Capital and Dividends (Owners' Equity Statement.) An expanded accounting equation may be illustrated accordingly.

  • Assets = Liabilities + Owners' Equity - Dividends + Revenue - Expenses

Thus, Assets + Expenses + Dividends = Liabilities + Owners' Equity + Revenue

Thus the beginning balances (3 = 2 + 1) are equal to the ending balances, but upon analysis, we note that these identical balances were obtained by a combination of events which are reflected in the respective financial statements.  Revenue (2) - Expenses (1) = Net Income +1, increases owners' equity by 1. But we declare dividends of 1 (all of the net income) which reduces owners' equity by that amount. All of the other transactions affected the original accounting equation directly.

One can see that the four generally accepted financial statements can be pulled from data maintained in the accounting equation format. The systematic method that accountants use to record the business transactions is known as the double-entry system. One transaction means recording two entries in opposite directions so that each side of the accounting equation remains in balance after each transaction is recorded. Accounting thought has identified transactions that increase the left side of the equation as debits and those that increase the right side as credits.

So, if we borrow $1 as we did in the preceding example, the effect on the accounting equation is to increase our cash balance by $1 and also increase our liabilities by $1. As an asset, cash is on the left side of the = sign in the equation, so it would require a debit. Our liabilities are on the right side, so an account such as "notes payable" is credited. The accounting equation remains in balance.

Financial Statement Definintions (Condensed)

Balance Sheet

Assets: Items having future value owned or controlled by the organization
Liabilities: Debts owed by the organization
Owners' Equity: The difference between assets owned or controlled and liabilities owed by the organization (Also known as net assets)

  • Owners' Equity consists of permanent capital (remains in the corporation) and retained earnings (may remain in the corporation or be returned to the owners as dividends)

Income Statement

Revenues: Organization earnings from sales of products or provision of services (results in increases in assets or decreases in liabilities)
Expenses: Costs incurred in earning revenue (decreases assets or increases liabilities)
Gains: Increases in assets and decreases in liabilities due to non-operating items
Losses: Decreases assets or increases liabilities due to non-operating items

Important notes on Financial Accounting

  • Is concerned primarily with reporting financial activities to external parties such as investors, creditors, and government through the issuance of financial statements according to generally accepted accounting principles (GAAP)
  • Financial statements are grounded around the basic accounting equation--Assets = Liabilities + Owners' Equity (Balance Sheet)
  • The Income Statement and Retained Earnings Statement expands the basic accounting equation to incorporate a summary of Revenues and Expenses and Gains and Losses for a specific period of time (Month, Quarter, Year)
  • Revenues and Gains increase Retained Earnings and Expenses and Losses decrease Retained Earnings (Thus, Net Income increases and Net Loss decreases)
  • Dividends declared also decrease Retained Earnings but are not expenses so dividends declared appears on the Retained Earnings Statement
  • The Cash Flow Statement summarizes cash inflows and outflows for a specific period of time into three categories; operating activities, investing activities, and financing activities 

Keeping the Books by double-entry format

  • Accounts (brief titles that correspond to financial statement items) are arranged around the basic and expanded accounting equation; so, Assets = Liabilities + Owners' Equity + Revenue - Expenses - Dividends
  • We can transfer the negatives on each side of the = sign to make each element of the financial statements positive
  • Thus, Assets + Expenses + Dividends = Liabilities + Owners' Equity + Revenue
  • Each Journal entry requires equal debit and credit amounts for financial transactions that occur
  • A very critical determination at this point is the increase side determination of each account affected by a transaction.  Rule: Increases on the left side of the = sign require debits; Increases on the right side of the = sign require credits
  • Thus, if a company borrows $10,000 cash from the local bank the journal entry would require a debit to Cash (an asset) for $10,000 and a credit to Notes payable (a liability) for $10,000

The Accounting Cycle

1. The financial transaction is analyzed 
2. The financial transaction is journalized
3. Periodically the journal is posted or updated to classified account lists (Ledger)
4. Trial balance is prepared to check the equality of debit and credit balances
5. Certain account balances are updated (adjusted)
6. Financial statements are prepared from adjusted trial balance
7. Adjusting and closing entries are journalized and posted
8. A post-closing trial balance is prepared and the books are ready for the new period

Last Updated December 6, 2004 by Robert L. Putman