Chapter One FAB
Chapter One FAB
Chapter One
Financial Accounting Basics
Instructor: Habtamu B. Abera [PhD]
Learning Objectives
• After studying this chapter, you should be able to:
– Explain what accounting is and describe its role in making
informed decisions
– Identify the users and uses of accounting
– Identify business goals and activities
– Explain, briefly, the difference between Financial
Accounting and Managerial Accounting
– Define financial position and the accounting equation
– Identify the four basic financial statements
Accounting as an information system
Accounting “links”
Economic decision makers Accounting
or Business with economic
information
activities activities and
with the results of
their decisions.
Actions
Reports
(decisions) Decision Results of
makers Actions
(decisions)
Users and Uses of Accounting Information
Internal Users
Researchers
Management
Human Investors
Resources
There are two broad groups
Labor
of users of financial Unions
Finance information: internal users
and external users.
Creditors
Marketing
Customers AABE
External
Users
Users and Uses of Accounting Information
Primary
Users
Uses and Users of Accounting Information
Common Questions Asked User
Nature of the
reports produced Tend to be specific purpose Tend to be general purpose
Usefulness
Enhanced via
Broader
Explanation than FS
Externally
Reported
Information
Based on
Features
General- Historical
Purpose in Nature
Assumption
Results from
Inexact and
Approximate
Measures
A means
to an End
Measures of
Importance
Efficiency
of
& Effectiveness Timeliness
Features
of MAI
Oriented Identity of
towards the Decision
future maker
Financial Position and the Accounting Equation
• Financial position:
– refers to a company’s economic resources, such as cash,
inventory, and buildings, and the claims against those
resources at a time.
• Claims are also called equities
• Economic Resources = Creditors’ Equities + Owners’ Equities
• Retained Earnings:
– Represent shareholders’ equity that has been generated by the
business’s income producing activities and kept for use in the
business.
Exercises
1. The assets of ABC Co. are Br. 240,000, and the liabilities
are Br. 90,000. What is the amount of the stockholders’
equity?
• Note:
• All four of these conditions must apply. If one of them is
missing, the item will not be treated as an asset for accounting
purposes
Exercise
• Indicate which of the following items could appear as an asset
on the statement of financial position of a business. Explain
your reasoning in each case.
a) Br. 1,000 owed to the business by a customer who is unable
to pay.
b) A patent, bought from an inventor, that gives the business the
right to produce a new product. Production of the new
product is expected to increase profits over the period during
which the patent is held.
c) A new marketing director, whom the business had recently
hired, who is confidently expected to increase profits by over
30 per cent during the next three years.
d) A recently purchased machine that will save the business Br.
10,000 each year. It is already being used by the business but
it has been acquired on credit and is not yet paid for.
Categories of ASSETS
• An entity’s assets can be categorized into two as:
• Long-term assets
• Long-term assets will give long term benefit and which cannot
be converted into cash easily within a year (i.e. more than one
accounting period).
Examples of Current Assets
• Cash — currency, bank deposits, and investments
with an original maturity of 90 days or less (called
cash equivalents);
• Marketable securities—short-term investments that
can be quickly sold to raise cash;
• Accounts receivable, net—amounts due to the
company from customers arising from the sale of
products and services on credit (―net‖ refers to
uncollectible accounts);
• Inventory — goods purchased or produced for sale to
customers;
• Prepaid expenses — costs paid in advance for rent,
insurance, advertising or other services.
The circulating nature of current assets
Inventories
(stock)
Trade receivables
Cash (trade debtors)
Examples of Long-term Assets
• Property, plant and equipment (PPE), net — land,
factory buildings, warehouses, office buildings,
machinery, motor vehicles, office equipment and
other items used in operating activities (―net‖ refers
to subtraction of accumulated depreciation, the
portion of the assets’ cost that has been transferred
from the balance sheet to the income statement);
• Long-term investments — investments that the
company does not intend to sell in the near future;
• Intangible and other assets — assets without
physical substance, including patents, trademarks,
franchise rights, goodwill and other costs the
company incurred that provide future benefits.
Defining Basic Terms of the Balance Sheet
• Liabilities: a liability is as
– a present obligation of an entity arising from past events,
the settlement of which is expected to result in an outflow
from the entity of resources embodying economic
benefits
Current liabilities
Non-current liabilities
Examples of Current Liabilities
• Accounts payable— amounts owed to suppliers for goods
and services purchased on credit.
• Accrued liabilities—obligations for expenses that have
been incurred but not yet paid; examples are accrued wages
payable (wages earned by employees but not yet paid),
accrued interest payable (interest that is owing but has not
been paid), and accrued income taxes (taxes due).
• Unearned revenues—obligations created when the
company accepts payment in advance for goods or services it
will deliver in the future; also called advances from customers,
customer deposits, or deferred revenues.
• Short-term notes payable —short-term debt payable to
banks or other creditors.
• Current maturities of long-term debt—principal portion
of long-term debt that is due to be paid within one year.
Non-current liabilities