Financial management

Business
An organization in which basic resources (inputs) such as materials and labour, are
assembled and processed to provide goods or services (outputs) to customers.
- Objective of businesses: earn profit

Profit
The difference between the amounts received from customers for goods or services
and the amounts paid for the inputs used to provide the goods of services.

Types of businesses
- Service business (provides services rather than products to customers)
- Merchandising business (sell products they purchase from other businesses to
customers)
- Manufacturing business (change basic inputs into products that are sold to
customers)

Role of accounting in business

- Accounting provides information for managers to use in operating the business
- Accounting provides information to other users in assessing the economic
performance and condition of the business

Accounting
An information system that provides reports to users about the economic activities
and condition of a business.
Objective: providing relevant and timely information for user decision making.
- Accountants must behave in an ethical manner so that the information they
provide will be trustworthy and useful for decision making.

Managerial accounting/ management accounting

The area of accounting that provides internal users with information.
Objective: providing relevant and timely information for managers’ and employees’
decision-making needs.

Financial accounting
The area of accounting that provides external users with information.
Objective: providing relevant and timely information for the decision-making needs of
users outside of the business.
- Financial reports must possess relevance and faithful representation.

Relevance
Relevant information has the potential to impact decision making,

Faithful representation
The given information accurately reflects an entity’s economic activity/condition.

Ethics
Moral principles that guide the conduct of individuals.
Private accounting
Accountants employed by companies, government and not-for-profit entities.

Public accounting
Accountants employed individually or within a public accounting firm in audit, tax or
management advisory services.
- People who provide services on a fee basis
- These people may practice as an individual or as a member of a public
accounting firm.

Generally accepted accounting principles (GAAP)

A collection of accounting standards, principles and assumptions that define how
financial information will be reported.

Accounting standards
Rules that determine the accounting for individual business transactions.

Accounting principles/assumptions
Provide the framework upon which accounting standards are constructed.

Monetary unit assumption

Requires that financial reports be expressed in a single money unit or currency.
- Normally determined by the country in which the company operates.

Time period assumption

Allows a company to report its economic activities on a regular basis for a specific
period of time.

Business entity assumption

Limits the economic data in financial reports that are directly related to the activities
of the business.

Measurement principle
Determines the amount that will be recorded and reported.
- Requires that amounts be objective (based upon independent, unbiased
evidence) and verifiable (can be confirmed by a third party).

Arms-length transactions
Transactions between two independent parties.

Historical principle/cost principle

Recording an item at its initial transaction price
- Amounts do not normally change until another transaction occurs.

Revenue
The amount earned for selling goods or services to customers.
- Rent, interest
Revenue recognition principle
Determines when revenue is recorded in the accounting records:
- normally when services have been performed or goods have been delivered.

Expenses
Amounts to generate revenue.

Expense recognition principle/ matching principle

Requires expenses to be recorded in the same period as the related revenue.

Accounting equation
Assets = liabilities + (stockholders) equity

Assets
An item of property owned by a person or company, regarded as having value and
available to meet debts, commitments, or legacies.
- cash, land, supplies

Liabilities
A thing for which someone is responsible, especially an amount of money owed.
- accounts payable, common stock

Equity
The value of the shares issued by a company.
- fees earned (providing services), wages expense, rent, utilities

Business transaction
An economic event or condition that directly changes an entity’s financial condition or
its results of operations.

Common stock
Shares entitling their holder to dividends that vary in amount and may even be
missed, depending on the fortunes of the company; ordinary shares.
- Shares of ownership distributed to investors of a corporation.
- Represents the portion of stockholders’ equity contributed by investors.

Account payable
The liability created by a purchase on account.

Account receivable
A claim against the customer

Expenses
Assets used in the process of earning revenue.

Prepaid expenses (assets)

Items that will be used in a business in the future
- like supplies
Dividends
Distributions of earnings to stockholders.

Retained earnings
The stockholders’ equity created from business operations through revenue and
expense transactions.

Financial statements
The accounting reports providing users recorded and summarized transactions.

Income statement
A summary of the revenue and expenses for a specific period of time.
- Month, year

Retained earnings statement

A summary of the changes in the retained earnings that have occurred during a
specific period of time.

Balance sheet
A list of the assets, liabilities and stockholders’ equity as of a specific date.
- Usually at the close of the last day of a month or year.

Statement cash flows

A summary of the cash receipts and cash payments for a specific period of time.

Net income/net profit/ earnings

The excess of the revenue over the expenses.
- If the expenses exceed the revenue, the excess is called a net loss.

Cash flows from operating activities

This section reports a summary of cash receipts and cash payments from operations.

Cash flows from investing activities

This section reports the cash transactions for the acquisition and sale of relatively
permanent assets.

Cash flows from financing activities

This section reports the cash transactions related to cash investments by
stockholders, borrowings and dividends.

Chapter two
A debit is an accounting entry that either increases an asset or expense account, or
decreases a liability or equity account. It is positioned to the left in an accounting
entry.

A credit is an accounting entry that either increases a liability or equity account, or

decreases an asset or expense account.
Account
A system designed to show increases and decreases in each accounting equation
element as a separate record.
- Amounts entered on the left side of an account are debits, and amounts entered on
the right side of the account are credits.

Debit
Increases in assets
- Left side of an account

Credit
Decreases in assets
- Right side of an account

The balance of the account

The excess of the debits of an asset account over its credits.

T account
A simple way to illustrate the effects of transactions on accounts and financial
statements.

Ledger
A group of accounts for a business entity.

Chart of accounts
A list of accounts in the ledger.

Assets
Resources owned by the business entity
- Physical items; cash and supplies
- Intangibles that have value; patent rights, copyrights and trademarks.
- Also includes accounts receivable, prepaid expenses (EG. insurance), buildings,
equipment and land.

Liabilities
Debts owned to outsiders (creditors)
- Includes; accounts payable, notes payable and wages payable.
- Includes future service commitments called unearned revenues.
> Examples; subscriptions or tuitions.

Stockholders’ equity
The stockholders’ right to the assets of the business.
- Represented by the balance of common stock and retained earnings accounts.
> A dividends account represents distributions of earnings to stockholders.

Revenues
Increases in assets and stockholders’ equity as a result of selling services or
products to customers.
- Examples; fees earned, fares earned, commissions revenue and rent revenue.
Expenses
The result from using up assets or consuming services in the process of generating
revenues.
- Examples; wages expense, utilities expense, rent expense, supplies expense and
miscellaneous expense.

Chart of account
- Should meet the needs of a company’s managers and other users of its financial
statements.

Double-entry accounting system

A system based on the accounting equation which requires;
- Every business transaction to be recorded in at least two accounts
- The total debits recorded for each transaction to be equal to the total credits
recorded.
The double-entry accounting system also has specific rules of debit and credit for
recording transactions in the accounts.

The normal balance of an account is either a debit or credit depending on whether

increases in the account are recorded as debits or credits.
If you make a deposit at the bank, you are said to credit your account. Likewise,
when you make a withdrawal, you are said to debit your account. Additions to cash
are debits, not credits.

Journal
Transactions which are entered in a record using the rules of debit and credit.
- The journal serves as a record of when transactions occurred and were recorded.

Journalizing
The process of recording a transaction in the journal.

Journal entry
The entry in the journal.

Regardless of the number of accounts, the sum of the debits is always equal to the
sum of the credits in a journal entry.

Posting
The process of transferring the debits and credits from the journal entries to the
accounts.

Unearned revenue
The liability created by receiving the cash in advance of providing the service.
- If the cash received is related to future revenue.

Accounts receivable
A claim against the customer.
- When a business agrees that a customer may pay for services provided at a later
date.
Trial balance
A system used to detect errors that have occurred in posting debits and credits from
the journal to the ledger.

Transposition
An error that occurs when the order of the digits is copied incorrectly.

Slide
In a slide the entire number is copied incorrectly.

Horizontal analysis
When the amount of each item on a current financial statement is compared with the
same item on an earlier statement.
- The increase or decrease in the amount of the item is computed with the percent of
increase or decrease.

Chapter 3
Accrual basis of accounting
Under the accrual basis of accounting, revenues are reported on the income
statement in the period in which a service has been performed or a product has been
delivered.
- The accrual basis of accounting also requires expenses to be recorded when they
are incurred, not necessarily when cash is paid.

The cash basis of accounting

Under the cash basis of accounting, revenues and expenses are reported on the
income statement in the period in which cash is received or paid.
- The net income (or net loss) is the difference between the cash receipts (revenues)
and the cash payments (expenses).

Revenue recognition principle

Under the revenue recognition principle, revenues are recorded when services have
been performed or products have been delivered to customers.
- Revenue is normally measured as the assets received, such as cash or accounts
receivable.
- The process of recognizing revenue is called revenue recognition.

Expense recognition principle

Under the expense recognition principle, the expenses incurred in generating
revenue must be reported in the same period as the related revenue.
> This is also called the matching principle.

Reasons why accounts on the unadjusted trial balance require adjustments;

- Some expenses are not recorded daily
- Some revenues and expenses are incurred as time passes rather than as separate
transactions.
- Some revenues and expenses may be unrecorded at the end of the accounting
period.
Adjusting process
The analysis and updating of accounts at the end of the period before the financial
statements are prepared.

Adjusting entries
The journal entries that bring the accounts up to date at the end of the accounting
period.

Accruals
An accrual occurs when revenue has been earned or an expense has been incurred
but has not been recorded.

Deferrals
A deferral occurs when cash related to a future revenue or expense has been initially
recorded as a liability or an asset.

Prepaid expense
If the cash paid is related to a future expense.

Fixed assets/ plant assets

Physical resources that are owned and used by a business and are permanent or
have a long life.
- Examples include; land, buildings and equipment.

Depreciation
As time passes, the equipment loses its ability to provide useful services.
- Decrease in usefulness.

Depreciation expense
As a fixed asset depreciates, a portion of its cost should be recorded as an expense,
this periodic expense is called depreciation expense.

Contra accounts/ contra asset accounts

Accumulated depreciation accounts.
- Accumulated depreciation accounts are deducted from their related fixed asset
accounts on the balance sheet.

Book value of the asset/ net book value

The difference between the original cost and the accumulated depreciation is the
cost of office equipment that has not yet been depreciated.

Adjusted trial balance

The adjusted trial balance verifies the equality of the total debit and credit balances
before the financial statements are prepared.

Vertical analysis
The comparison of each item on a financial statement with a total amount from the
same statement.
- In vertical analysis of a balance sheet, each asset item is stated as a percent of the
total assets.