Approved Learning Partner

in Egypt and Middle East

 F P A C Certification

1 Accounting Concepts & Standards

Chapter 3
2 Accounting & External Financial Reporting

Financial 3 Income Statement

accounting
& reporting 4 Balance Sheet

5 Statement of Cash Flows

6 Interactions among current Financial Statements

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1. Accounting Concepts &
Standards
 F P A C Certification

Objective: Assess an organization

Accounting Financial Performance & Position

Concepts &
Accounting Standards: Allow
Standards financial statements to be compared
apples to apples.

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Accounting
Concepts and • Asset • Debit/Credit
Standards • Liability • Expenses
• Capitalize • Revenues
• Amortization • Impairment
• Journal entry • Capital asset
• Depreciation • Intangible asset
• Equity • Period
• General ledger • Trial balance

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Global Accounting Standards

Basic IFRS Concepts:

• Usefulness of financial information
• Recognition principle
• Measurement principle

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U.S. Accounting Standards

Basic GAAP Principles:

• Historical cost
• Full disclosure
• Conservative
• Revenue recognition
• Matching

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Conceptual Differences Between GAAP and IFRS

US. GAAP IFRS

• Uses the matching principle • Does not use matching
principle. Recognizes items
• Uses the conservative principle when definitions are met.
• Accurate representation
• Provides information for use by
includes neutrality and non-bias
investors, creditors and
management • Provides information for use by
investors and creditors only

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Differences Between GAAP and IFRS Standards

US. GAAP IFRS

• Allows LIFO inventory costing • Does not permit LIFO inventory
costing
• Two-step method for write-
downs • Single-step method for write-
downs
• R&D costs expensed when
incurred • R&D costs capitalized
• Some operating leases not • All probable liabilities reported
reported

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Applying the Matching Principle

Accruals Prepayments
(accrued revenue or accrued expenses) (prepaid expenses or unearned revenue)

• Revenue must be accrued when • Expenses are prepaid and must be

they are earned but not yet accrued when cash has been paid
received as cash. for goods or services prior to their
receipt.
• Expenses must be accrued when
they are incurred but not yet paid. • Unearned revenue must be
accrued when cash has been
received from customers as
prepayment for goods or services.

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Accounting Concepts & Standards

Global Accounting Standards:
• They are determined by the International Accounting Standards Board (IASB), based in
London. IASB’s mission is to develop a single set of global accounting standards called:
IFRS. About 120 countries require the use of IFRS, with the exception of China,
Indonesia, Thailand, Egypt & US.

US Accounting Standards:
• The United States requires GAAP to be used for publicly traded companies & are
determined by the Financial Accounting Standard Board (FASB).

• While the FASB develops the U.S. accounting principles, authority for enforcing
accounting principles is the responsibility of the SEC. All publicly traded companies must
file audited financial statements with the SEC annually using Form 10-K and quarterly
using SEC Form 10-Q.

Key differences between US GAAP and IFRS have been shrinking, IFRS is more high level , looking
at overall patterns “Principles based” vs. US GAAP is more detailed and is “Rule based”.

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Conceptual Differences IFRS vs. GAAP

U.S. GAAP IFRS

• Recognizes items when definitions are satisfied and according
• Follows the matching principle
to recognition criteria but not using the matching principle

• Accurate representation includes the concept of neutrality or

• Follows the conservative principle
freedom from bias
• Allows LIFO method of inventory costing • Does not permit LIFO
• Uses a two-step method for writing down impaired assets, • Uses a single step method for writing down impaired assets,
making write-downs less likely allows reversal of write down
• Generally, requires R&D costs to be expensed when incurred,
• Requires the capitalization of (R&D) costs once certain
with the exception of certain development costs related to
qualifying criteria are met
computer software
• Some liabilities related to operating leases and sales of
• All liabilities that are probable and can be reliably measured
receivables are not required to be reported on the balance
are reported on the balance sheet
sheet

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2. Accounting & External
Financial Reporting
 F P A C Certification

Accounting Methods

1 2 3

Cash Basis Modified Cash Basis Accrual Basis

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Accounting
Cycle
[Link]
a/[Link]

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Accounting Cycle

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Accounting Cycle

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Accounting Cycle

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Accounting Cycle

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Discussion Question
Will a debit increase or decrease each account type?

Answer:
Assets
Debit
Expenses
Account
Increases Dividends

Liabilities
Debit
Revenues
Account
Decreases Capital stock

Retained earnings

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Discussion Question

Will a credit increase or decrease each account

type?
Answer:
Assets
Debit Credit
Expenses Account
Account
Increases Decreases
Dividends

Liabilities
Debit Credit
Account Revenues
Account
Decreases Capital stock Increases

Retained earnings

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Accounting & External Financial Reporting

• Accounting Cycle / Journal entry: Business transactions are
recorded in journals then transferred to general ledger at the
end of the accounting period.

• Double entry system:

• Debit:
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.

• Credit:
Entry that either increases a liability or equity account or
decreases an asset or expense account.

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Journal Entries
How a given financial transaction show up in Firm General Ledger System?

Answer:
Assets
Account
Debit
Credit Account
Expenses
Increases Decreases
Dividends

Liabilities

Account
Debit Revenues Credit Account
Decreases Increases
Capital stock

Retained earnings

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Areas of Financial Reporting Supported by FP&A

• Accounting cycle
• Looking at Journal entries
• Financial Reporting & analysis
• Critical Financial Issues & potential transactions: impact on firm
• Profitability Reporting

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Discussion Question

How does the FP&A professional contribute

to the accounting close?
Answer:
• Providing oversight to ensure proper recording of transactions on which they
previously provided analysis
• Providing input on earnings management
• Providing input on accruals and reserves
• Ensuring consistent treatment of extraordinary items
• Completing post-close analysis and summaries

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Example:
Suppose a Company pays $25,000 for a delivery van
A= L+E
• Cash (an asset account ) is decreased → Credit to cash for $25,000.
• Delivery Van (an asset account) is increased → Debit to long term asset for $25,000.
• Net effect: the asset ‘Delivery Vehicle’ was increased with a debit and the asset ‘Cash’ was decreased with a
credit. The accounting equation (A=L+OE) remains in balance because one asset increased by $25,000 and one
asset decreased by $25,000.
Suppose a Company pays $800 for the next month’s rent
• Cash (an asset account ) is decreased → Credit to cash for $800.
• Prepaid rent (an asset account) is increased → Debit to prepaid rent got $800.
• Net effect: assets decreasing by the reduction in cash and increasing by the increase of prepaid rent.
Suppose a $250 payment received on account from a customer
• Cash (an asset account ) is increased → Debit to cash for $250.
• Accounts Receivable (an asset account) is decreased → Credit to AR for $250
• Net effect: Since we deposited funds in the amount of $250, we increased the balance in the cash account with a
debit of $250. Since customer paid the bill, we decreased AR by $250.
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Example:
Suppose a Company borrows $ 1,000 from a line of credit at the bank on Apr. 1st.
• Cash (an asset account ) is increased → Debit to cash for $1,000.
• Notes payable (a liability account) is increased → Credit to notes payable for $1,000.
• Net effect: both sides of the Balance sheet are increased. (Double Entry accounting system)

Suppose On Apr. 15th, business repays $500of this loan to the bank.

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Example:
A business has two owners and one owner wants to invest an additional $50,000 in the
business.
• Cash (an asset account ) is increased → Debit to cash for $50,000.
• Common Stock is increased → Credit to common stock for $50,000.
• Net effect: both sides of the Balance sheet are increased. (Double Entry accounting system)

A company purchases $750 in office supplies using cash.

• Cash (an asset account ) is decreased → Credit to cash for $750.
• Office supplies (an expense account) is increased → Debit to assets for $750.

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3. Income Statement
 F P A C Certification

This is your business…

A fruit bearing tree

03
An apple tree

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Like a tree, your business produces

an annual yield, that gets reset
every year

03 The Income Statement starts at the

beginning of every year and
measures the annual yield

The Income Statement measures

the fruits of your business efforts.

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A tree cannot bear fruit without the

support of a strong trunk.

03 The Balance Sheet is a picture in time.

It measures the cumulative result of your

business efforts.

A business cannot produce annual Net

Income without a solid Balance Sheet.

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At the end of each year,

03 Net Earnings (or Net Income) is added to

Retained Earnings on the Balance Sheet.

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Without water, no tree can survive for

long.

03 No business can survive without Cash

The Cash Flow Statement shows

where the water went in your business

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The Income Statement

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Definition:
It measures an organization’s operating
Income Statement performance—its earnings and
profitability—for a specified time span.
It shows revenues earned, expenses
incurred, and gains and losses arising
from conversions of assets and liabilities.

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Income Statement

Operating
income

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The Income Statement

Revenue – Cost of Goods Sold = Gross Profit

Amounts earned from The expense associated Measures the

the sale of products or with providing the profitability of the end
services to customers. goods or services product considering
whose sale is only the direct costs
recognized as revenue. associated with
creating the product.

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The Income Statement

Gross Profit – SG&A Expenses= EBITDA

Includes:
• Payroll costs
• Marketing and advertising
• Promotion costs
• R&D All costs (other than interest and
• Some taxes income taxes) not directly connected
• Office expenses and supplies to producing the goods or services
• Shipping and distribution expenses the organization sells.
• Rent, utilities, maintenance and
insurance

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The Income Statement

EBITDA – Depreciation and Amortization = EBIT

Examples:
• Buildings
• Machinery
• Vehicles
• Furniture Assets that provide value over more
• Technology items than the operating cycle.

Cost – Residual Value Considered capital expenses.

________________ = period Depreciation
Useful Life

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Discussion Question

What three values must be known to calculate

depreciation and how is it calculated?

Answer:
• Historical cost
• Useful life
• Residual value

Cost – Residual Value = Period

Useful Life Depreciation

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Discussion Question
Match each to the appropriate type of lease.
Answer:
B May purchase at end of lease

B Appears on the balance sheet

A Operating Lease
A Does not appear on the balance sheet
B Capital Lease Only rights to the use of the property/equipment
A

B Can claim depreciation on the asset and deduct

interest expense on the lease payment

A Returned at end of the lease

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The Income Statement

EBIT – Interest Expense = Net Income Before Taxes

The interest an organization This is a subtotal line.

pays to bondholders, banks
and private lenders, including It is used to calculate the effective tax
revolving bank debt (plus rate for the initial estimation of the
interest on capital leases). provision for income taxes.

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The Income Statement

𝐈𝐧𝐜𝐨𝐦𝐞 𝐓𝐚𝐱
𝐄𝐓𝐑 =
𝐈𝐧𝐜𝐨𝐦𝐞 𝐁𝐞𝐟𝐨𝐫𝐞 𝐓𝐚𝐱

Income Before Taxes – Income Tax Expense

+ or – Extraordinary Items = Net Income

Events or transactions that are both highly abnormal

for the particular operations, type of business, The “Bottom Line”
industry or geographic region and infrequent; they
are not expected to occur often, given the particular
environment.

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Earnings Per Share (EPS)

A widely used measure of profitability and must be reported on
the income statement if the company is publicly traded.

Net income – Preferred Dividends

Basic EPS = ____________________________
weighted average outstanding shares

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Measures of Income, Profitability and Taxation

Gross profit
Gross margin
Cost of goods sold
EBITDA
EBITDA margin
EBIT (operating income)
Income before tax
Effective tax rate
Net income

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Income Statement

• IS shows growth, profitability & overall company position

• IS based on accrual accounting and not on cash basis (Revenue is counted when earned regardless of when cash is
received)

• Operating Margin (OI / Sales) is a famous measure to check profitability ratio (EBIT)

• Operating lease is treated as an Operating expense, while capital lease incures dep. / interest expense and is a BS
item (asset (FKL), liability (PV of min lease pmts).

• Net income must be reported on a per share basis (EPS)

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Income Statement
• International and GAAP standards require both a diluted and Basic EPS to be reported on the income statement for
publicly listed companies.
• Benefits of share repurchases: increasing EPS [Link]
[Link]

• Diluted EPS: calculates a company’s earnings per share if all convertible securities were converted. It is less than Basic
EPS and more conservative.

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[Link] Sheet
 F P A C Certification

The Balance Sheet

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Definition:

Balance Sheet Snapshot of an organization’s financial

condition including assets, liabilities and
stockholders’ equity. It expresses what the
organization owns and what it owes—on
a specified date

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Balance Sheet: What Co. owes and owns

A = L + E
Assets (Expected to generate benefit) Liabilities (Debt Obligations)
Cash: Cash / Marketable Securities
Current Liabilities:
Current Assets: Accounts Payable
Accounts Receivable Accrued Expense
Inventory
Long Term Liabilities
Prepaid Expenses Long Term Debt
Deferred income tax
Long-Term Assets:
PP&E Stockholders’ Equity (amount by which co is financed)
Goodwill & other Intangibles Common Stock (money originally invested + additional inv)
Retained Earnings

• BS shows liquidity, solvency, sources of financing and overall business strength

• If the ratio of your business's assets to liabilities is less than 1 to 1, company is in danger of going bankrupt.
• Working capital: CA/CL indicates whether a company has enough short term assets to cover its short term
debt
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Balance Sheet

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Liabilities

Current Liabilities Noncurrent Liabilities

Accounts payable (A/P) • Long-term debt
Deferred revenue • Deferred income taxes
Accrued liabilities • Other noncurrent liabilities (pension
Income taxes payable obligations, health care, long-term
compensation, other operating and
Short-term debt administrative activities)
Current maturities of long-term debt

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Difference between Debt & Liabilities

• Liabilities are amounts owed regardless of

from
• Debt refers only to obligations that require
interest payments
• Debt is a subset of liabilities
• Different is explicit interest rate associated

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5. Statement of Cash Flows
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Statement of Cash Flows

CFO: How do we do from

an operations perspective
/ working capital.

CFI: buying / selling of

assets (PP&E)

CFO: cash from investors

/ stocks

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Statement of Cash Flows shows how

Statement of Cash changes in Balance Sheet accounts and
Flows income Statement affect cash

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Statement of Cash Flows

Elements of the Statement of Cash Flows

CF from Operating Activities directly related to normal business ops

CF from Investing Activities buying / selling of assets (PP&E)
CF from Financing Activities cash from investors / stocks

• Note that each of the three cash flow sources can be positive (net cash inflow) or negative
(net cash outflow).

• 2 reasons that net income does not correspond to cash earned:

o 1st there are non-cash entries on the income statement, such as depreciation.
o 2nd certain uses of cash, such as the purchase of a building or expenditures on
inventory, are not reported on the income statement.

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Cash Flow basics B/S movements and impacts on Cash Flow – Debit entry

Assets = the ways we USE the money DB

If Assets increase = we “USE” MORE money

Cash Hurt

Inventory
Assets Cash

Trademarks &
Intangibles

PP&E

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Cash Flow basics B/S movements and impacts on Cash Flow – Credit entry

Liabilities = the SOURCE of the money CR

If Liabilities increase = we GET more money (source of funds)

Cash Help

Cash Liabilities
A/P Trade
Supplier A 500 Debt
Supplier B 300
Supplier C 400

Accrued Liab.

i.e. “we’ll pay later”

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Cash Flow basics Indirect calculation

• Start with Net Income Free Cash Flow

• Adjust for Non Cash Items
Operating Cash Flow – Depreciation, Amortization, FADOs, Deferred Tax
• Adjust for Changes in Working Capital
+ •
– Inventories, Receivables & Payables
Adjust for Changes on other B/S operating items

• Capital Expenditures
Investing Cash Flow • Acquisitions and Divestitures

+ • Changes in Debt
– Short Term Investments
– Short Term Debt
– Long Term Debt
Financing Cash Flow
• Changes in Equity
– Dividends
= Total Cash Flow – Stock Issue or Repurchase
– Capital infusions

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Sources and Uses of Funds

Decrease in Assets

Increase in Liabilities

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The Statement of Cash Flows

• Indirect method
• Direct method

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Cash Flow Statement Example

• Cash flow is the true checkbook of the company

• Cash flow can only operate in the present, does not anticipate what
may be withdrawing soon
• IS conversely is beneficial because it shows future transactions
• The 2 together show immediate financial cash solvency & what will
come in the short period

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Cash Flow: Question

Calculate CF from
Operations?

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Cash Flow: Answer

Operating cash
flow. . .

. . . Keeps the business

running

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How to Improve our Cash Flow Question

✓ Grow Earnings

✓ Collect Faster

= ✓ Pay Later

✓ Reduce Inventory

✓ Manage Capital Expenses

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Breaks down the stockholders’ equity

Statement of computed on the balance sheet into the
amount that came from issuing shares
Shareholders (par value plus paid-in capital) versus
Equity retained earnings.

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Shareholders’ Equity

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Statement of Shareholders Equity

Elements of the Statement of Stockholders’ Equity Determines

equity in BS

Common Stock Retained Earnings

Beginning Retained Earnings
+ Net Income
- Dividends
Ending Retained Earnings

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How do P/L & B/S fit together?

Income Statement Balance Sheet
(P/L) shows what happened during the time shows the positions at a key date…
period… It’s like a video… it’s more like a still photo…

Retained Earnings
This account is the link between the balance sheet and the Income Statement.

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Interactions among current
Financial Statements
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Links Between Financial Statements

• A = Net Income
• B = Depreciation and
Amortization

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Links Between Financial Statements

• A = Net income
• C = Change in Working Capital Assets
• D = Change in Working Capital Liabilities
• E = PP&E or CapEx Spend
• F = Change in Long-Term Assets and
Liabilities
• G = Current Portion of Long-Term Debt
• H = Long-Term Debt
• I = Dividends Paid
• J = Beginning Cash (Prior Year Ending
Cash)
• K = Ending Cash

+
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Links Between Financial Statements

• A = Net income
• B = Depreciation and Amortization
• C = Change in Working Capital Assets
• D = Change in Working Capital Liabilities
• E = PP&E or CapEx Spend
• F = Change in Long-Term Assets and
Liabilities
• G = Current Portion of Long-Term Debt
• H = Long-Term Debt
• I = Dividends Paid
• J = Beginning Cash (Prior Year Ending
Cash)
• K = Ending Cash
+

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Interactions among current Financial Statements

P/L B/S

Expenses Revenues Assets Liabilities

Cash
Shareholder Equity
Retained Earnings
Profit

Cash

Inflows Outflows

Cash
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Interpreting the Financial Statements Story

How is the organization financing
growth or reinvesting its earnings?
Is it efficient and effective at
managing its assets and liabilities?
Is it in a position to have strong
growth?

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MCQs

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Questions 1
1. The generally accepted accounting principles used in the financial statements of U.S corporations are researched and developed by which
organization?
American Accounting Association (AAA) Financial Accounting Standards Board (FASB) Internal Revenue Service (IRS)
2. Which financial statement will allow you to determine the gross margin for a retailer or manufacturer?
Balance Sheet Income Statement Cash Flow Statement
3. Does the heading of a balance sheet indicate a period of time or a point in time?
Period of Time Point in Time
4. A corporation's net income will cause a change in which component of stockholders' equity?
Paid in Capital Retained Earnings Accumulated Other Comprehensive Income
5. Is it true or false that a grocery store’s sale of its old delivery van to one of its employees for $2,000 should be recorded in the general
ledger account Sales?
True False
6. A corporation's working capital is calculated using which amounts?
Total Assets and Total Liabilities Total Assets and Current Liabilities Current Assets and Current Liabilities

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Answers 1

1. FASB
2. IS (rev-COGS / Rev)
3. Point in time
4. RE
5. False
6. CA and CL

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Questions 2
7. The amount spent for capital expenditures will be reported in which section of the statement of cash flows?
Cash Flow from Financing Activities Cash flow in Investing Activities Cash Provided/used In Operating Activities

[Link] of the following will appear as a negative amount on a statement of cash flows that was prepared using the indirect
method?
A Decrease In Inventory An Increase In Accounts Payable An Increase In Accounts Receivable Depreciation Expense
9. Which of the following will appear as a positive amount on a statement of cash flows that was prepared using the indirect
method?
An Increase In Accounts Receivable An Increase In Inventory A Decrease In Accounts Payable Depreciation Expense
[Link] is the annual report to the SEC that contains the financial statements of a publicly-traded corporation?
Form 1040 Form 10-K Form 10-Q Schedule C
11. Important disclosures regarding likely losses that could not be estimated are found where?
General Ledger Accounts Income Statement Notes To The Financial Statements
12. Should the $500 entry to the Cash account be a debit? Yes / No

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Answers 2

[Link]
8. an increase in AR
9. Dep expense
10. 10k
11. Yes, cash is always debited when cash is received

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Questions 3
Use the following information for questions 13 through 16:
A company using the accrual method of accounting performed services on account in August. The services were for $2,000 and
the company gave the customer credit terms that state the amount is to be paid to the company in September.

[Link] that the company prepares monthly income statements, what will be the account debited for $2,000 in August?
Cash Accounts Receivable Service Revenue
14. Which account should the company credit for $2,000 in August?
Cash Accounts Receivable Service Revenue
[Link] September, when the company receives the $2,000 from the customer, which account should the company debit?
Cash Accounts Receivable Service Revenue
16. In September, when the company receives the $2,000 from the customer, which account should the company credit?
Cash Accounts Receivable Service Revenue

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Answers 3

13- AR : The account AR should be debited in August. Accounts Receivable,

an asset, was increased in August.
14- Service revenue: you should credit revenues when they are earned.
15- Cash: we always debit cash when it is received
16- AR: When an asset such as Accounts Receivable is decreased, you
credit the account.

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Questions 4
17. To increase the balance in the following accounts, would you debit the account or would you credit the
account?
a. Accounts Payable Debit Credit
b. Cash Debit Credit
c. Land Debit Credit
d. Notes Payable Debit Credit
e. Supplies Debit Credit
f. Supplies Expense Debit Credit
g. Prepaid Insurance Debit Credit
h. Service Revenue Debit Credit
i. Equipment Debit Credit
j. Unearned Revenue Debit Credit

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Answers 4
[Link] (Liability)
[Link] (Asset)
c. Debit (Asset)
[Link] (Liability)
[Link] (Asset)
f. Debit (Expense)
[Link] (prepaid insurance is an asset)
[Link]: revenue accounts are credited.
i. Debit (equip is asset)
j. Credit (unearned is a liab)

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