balance analysis

UNIT 1: INTRODUCTION TO

ACCOUNTING

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What is Accounting?

The primary objective of accounting is to provideinformation that is useful for decision-making purposes.From the very start, we emphasize that accounting is notan end, but rather it is a means to an end. The finalproduct of accounting information is the decision that isproduct of accounting information is the decision that isenhanced by the use of that information, whether thedecision is made by owners, management, creditors,governmental regulatory bodies, labor unions, or themany other groups that have an interest in the financialperformance of an enterprise.

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ACCOUNTING - THE BASIS OF

DECISION MAKING

Accounting is the language of business

Accounting is the information system that

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Accounting is the information system that Measures business activities Processes that information into reports Communicates the results to decision makers

What is Accounting?

Classify similar

transactions into useful

Interpret and record business

transactions.

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Summarize and

communicate information to

decision makers.

into useful reports.

THE ACCOUNTING SYSTEM:

THE FLOW OF INFORMATION

1. People make decisions

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2. Business transactions occur

3. Businesses prepare reports to show theresults of their operations

Who uses accounting data?

OwnersCreditorsLabor unionsGovernmental agencies

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SuppliersCustomersTrade associationsGeneral public

Users of accounting information

consumers

regulators Tax officials

lenders

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FIRM

Managers Interaction with External Parties

suppliers

consumers lenders

Financialmarkets

USES OF ACCOUNTING

MANAGERS need INFORMATION: To determine how to operate the business To decide on which investments to make To finance the companys operations

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To finance the companys operations

INVESTORS need INFORMATION: To help them to make better decisions on which

investments to take

Individuals

Who Uses Accounting Information?

Governmentregulatoryagencies

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Businesses

Investors andcreditors

Taxingauthorities

Nonprofitorganizations

HOW THEY USE ACCOUNTING

INFORMATION?

INDIVIDUALS: To make investment decisions To manage a checking account

BUSINESSES (BUSINESS MANAGERS): To set goals, evaluate them and take corrective actions

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To set goals, evaluate them and take corrective actions INVESTORS:

To decide whether to invest or not To evaluate an investment

CREDITORS: To evaluate a borrowers ability to make required payments

HOW THEY USE ACCOUNTING

INFORMATION? (Cont.)

GOVERNMENT REGULATORY AGENCIES: To determine if government regulations have been followed

TAXING AUTHORITIES To determine the amount of tax due

NON-PROFIT ORGANIZATIONS

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NON-PROFIT ORGANIZATIONS Use accounting as a for-profit organization

OTHER POTENTIAL USERS: e.g. employees, labour unions, etc.

Internal Users

Board of directors Chief executive officer (CEO) Chief financial officer (CFO) Vice presidents

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Vice presidents Business unit managers Plant managers Store managers Line supervisors

Financial information and financial markets

The relationship between financial information and securityprices can influence investors direct demand for financialinformation

Evidence shows:

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Evidence shows:

Annual earnings are not timely information and are preempted byalternative, more timely sources

However, significant price reaction was found in the week of theanouncement of annual earnings

Prices act as if earnings anouncements alter investors belief in such away as to alter the price o security

Bookkeeping provides a systematic record ofbusiness events based on accountingpolicies

Bookkeeping refers to the books in which

ACCOUNTING VS.

BOOKKEEPING

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Bookkeeping refers to the books in whichaccountants record transactions. People thinkthat accountants simply count carefully, andkeep records, but accounting transcendscounting.

Accounting process includes thebookkeeping function. However, accountingalso includes much more.

Bookkeeping usually only involves the

ACCOUNTING VS.

BOOKKEEPING

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Bookkeeping usually only involves therecording of economic events.

Accounting involves the entire process ofidentifying, recording and communicatingeconomic events.

The notion of accounting

Accountants: measure, record communicate USERS

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Economic environment

Beliefs &Perceptions

Accounting as communication of financial information:

from income measurement to the informational approach

Management is the steward to whom capitalsuppliers entrust controlover a portion of their

financial resources

Purpose of financialstatements is to provide

a report to capital suppliersto facilitate their evaluation

of managements

Income measurement

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financial resourcesof managements

stewardship

measurement

Financial data have tofacilitate contractingbetween parties suchas management and

investors

Financial data have tofacilitate decisions

makers in selecting thebest action among

available alternatives

Informational approach

Types of Accounting

Financial accounting Information for users outside the firm e.g. investors, creditors, governmentsManagerial Accounting

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Managerial Accounting Information for internal users e.g. managers, other internal decision makers

Internal vs external users

Internal => management accounting More focused and detailed information Feed back possible

Managers can take corrective actionsExternal => financial accounting (annual

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External => financial accounting (annual reports) Global information No influence on the reporting process Relevant for parties not involved in the day-to-day

operations

Regulation

The role of capital markets as fund providers

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Economic consequences of financial information

Managerial incentives to suppress unfavorable information

Need for regulation

ACCOUNTING PRINCIPLES AND CONCEPTS

Generally accepted accounting principles (GAAP) are:

Guidelines that govern how accountants

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Guidelines that govern how accountants

Measure

Process

Communicate

Financial information

Based upon a conceptual framework

Accounting Principles and Concepts

Financial Accounting Standards Board (FASB) establishes US GAAP GAAP Generally Accepted Accounting

Principles

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Principles GAAP is derived from the conceptual framework

Other parties involved in defining how accounting should be practised: SEC: Securities and Exchange Commission AICPA

KEY US ACCOUNTING ORGANIZATIONS

Public SectorLaw creates the SEC to regulate the stock and bond market in the U.S.

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Private SectorThe FASB determines

generally acceptedaccounting principlesGAAP governs

accounting information

Private SectorAccountants apply

GAAP throughthe AICPA

KEY SPANISH ORGANIZATIONS(relevant for the Accounting practice)

Ministry of Treasury ICAC

Instituto de Contabilidad y Auditora de Cuentas Bank of Spain

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UE Comission CNMV

Similar to SEC AECA

Asociacin Espaola de Contabilidad y Auditora

Forms of Business Organization

Three major forms of organization These forms differ with respect to

number of owners, degree of liability for debts of the business

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degree of liability for debts of the business Who pays if the company fails to repay its debts?

Status of legal entity

Business Organizations

Types of organizations: Proprietorship Partnership Corporation

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Corporation


Proprietorship Has a single owner Proprietor is personally liable for debts of the

business

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Unlimited liability Owner assumes personal responsibility

Actions can be taken against any of his goods Not a separate legal entity For accounting, the proprietorship is a separate

entity from the proprietor


Partnerships Two or more partners are co-owners Each partner can be liable for all the debts of the

partnership

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Each partner has unlimited liability Not a separate legal entity For accounting, the partnership is a separate

entity from its partners


Corporations May have many owners (stockholders)

Ownership represented by shares Stockholders are not personally liable for debts of the

business They have limited liability

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They have limited liability Is a separate legal entity Stockholders elect a Board of Directors to appoint corporate

officers and set policies It has many of the rights a person is entitled to:

Right to enter into contracts Right to sue and be sued Right to own, buy and sell property

Conceptual Framework

Accounting provides information useful for decision making

To be useful, information must be Relevant able to influence a decision

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Reliable verifiable and free from error Comparable can be compared with different

companies Consistent can be compared from one period to

the next


They are present in the elaboration of all accounting information

They are mainly, five: Entity concept

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Entity concept Reliability principle Cost principle Going-concern concept Stable-monetary-unit concept


The entity concept States that an organization is an economic

unit that keeps its affairs separate from those of the owner(s) or other entities

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those of the owner(s) or other entities Example: the company sells the products,

not the owner.


The reliability (or objectivity) principle States that accounting records and statements

should be based on accurate data. Use the most reliable data available and

documented by objective evidence

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documented by objective evidence Actual cost is usually more reliable than market

value Data is reliable if:

It is verifiable It can be confirmed by an independent observer


The cost principle States that acquired assets and services should be

recorded at their actual (historical) cost and should maintain that historical cost for as long as they are owned

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owned


The going-concern concept

States that the entity will remain in operation for the foreseeable future

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The stable-monetary-unit concept

States that each dollar has the same purchasing power as any other dollar at any other time

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power as any other dollar at any other time It allows accounts to ignore the effect of inflation in

the accounting records

THE ACCOUNTING EQUATION

The accounting equation presents the resources of the business and the claims to those resources

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Economic Resources = Claims to Economic Resources

or

ACCOUNTING EQUATION

Total Assets=

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Total Liabilities

Total Stockholders Equity+

The Accounting Equation

Assets = Liabilities + Owners Equity

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EconomicResources

Claims toEconomicResources

ACCOUNTING EQUATION

IT SHOWS THE EQUALITY BETWEEN THE ASSETS (what the company owns) AND THE CLAIMS TO THEM

FINANCIAL STATEMENTS ARE BASED ON THE ACCOUNTING EQUATION

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ACCOUNTING EQUATION

Assets are the economic resources of a business that are expected to be of benefit in the future


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Claims to assets come from Liabilities Owners equity (capital)

The Accounting Equation

Liabilities are debts payable to outsiders, called creditors

Owners Equity represents the ownership of the owners

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owners It is the owners claim on the entitys assets Also known as Stockholders equity It can be obtained by substracting::

Assets Liabilities = Owners Equity

In a corporation, Owners equity is knows as Stockholders equity

Stockholders equity consists of two main categories:


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categories: Paid-in capital Retained earnings

Assets = Liabilities + Stockholders Equity

Assets = Liabilities + Paid-in Capital + Retained Earningsor

Paid-in (contributed) capital is The amount invested in the corporation by its

owners

Comprised basically of common stock


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Comprised basically of common stock

Retained earnings Is the amount earned by income-producing

activities and kept for use in the business Is affected by


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Is affected by Revenues - increases in retained earnings from

delivering goods or services Expenses - decreases in retained earnings that result

from operations

Revenues for thePeriod

-

COMPONENTS OF RETAINED EARNINGS

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Beginning Balanceof Retained

Earnings+-

- =Net Income (Loss)

for the PeriodDividends for the

PeriodEnding Balance of

RetainedEarnings

Expenses for thePeriod

= Start of the

PeriodEnd of the

Period

Net income (net earnings) Total revenues exceed total expenses

Net loss Total expenses exceed total revenues

OTHER IMPORTANT ACCOUNTING CONCEPTS

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Total expenses exceed total revenues Dividends

Distributions to stockholders (usually cash) generated by net income

OWNERS EQUITY

REVENUESINCREASE NET INCOMERETAINED EARNINGS

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EXPENSESDECREASE NET INCOMERETAINED EARNINGS

DIVIDENDSDECREASE RETAINED EARNINGS

The owners equity of proprietorships and partnerships Makes no distinction between paid-in capital and

retained earnings

OWNERS EQUITY SPECIAL

SITUATIONS

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It does not distinguish what is invested from what is earned

Accounts for the equity of each owner under the single heading of Capital

THE ACCOUNTING CYCLE AND THE FLOW OF INFORMATION

In financial accounting, there are basically nine steps from beginning to end. Although you will be learning all these steps in detail in the next few chapters, it may be a good time the next few chapters, it may be a good time for you to get a sneak preview of what accounting is all about

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THE ACCOUNTING CYCLE AND THE FLOW OF INFORMATION

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balance analysis

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