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Principles of Accounting, Volume 1: Financial Accounting

Summary

Principles of Accounting, Volume 1: Financial AccountingSummary

Summary

2.1 Describe the Income Statement, Statement of Owner’s Equity, Balance Sheet, and Statement of Cash Flows, and How They Interrelate

  • Financial statements provide financial information to stakeholders to help them in making decisions.
  • There are four financial statements: income statement, statement of owner’s equity, balance sheet, and statement of cash flows.
  • The income statement measures the financial performance of the organization for a period of time. The income statement lists revenues, expenses, gains, and losses, which make up net income (or net loss).
  • The statement of owner’s equity shows how the net worth of the organization changes for a period of time. In addition to showing net income or net loss, the statement of owner’s equity shows the investments by and distributions to owners.
  • The balance sheet shows the organization’s financial position on a given date. The balance sheet lists assets, liabilities, and owners’ equity.
  • The statement of cash flows shows the organization’s cash inflows and cash outflows for a given period of time. The statement of cash flows is necessary because financial statements are usually prepared using accrual accounting, which records transactions when they occur rather than waiting until cash is exchanged.

2.2 Define, Explain, and Provide Examples of Current and Noncurrent Assets, Current and Noncurrent Liabilities, Equity, Revenues, and Expenses

  • Assets and liabilities are categorized into current and noncurrent, based on when the item will be settled. Assets and liabilities that will be settled in one year or less are classified as current; otherwise, the items are classified as noncurrent.
  • Assets are also categorized based on whether or not the asset has physical substance. Assets with physical substance are considered tangible assets, while intangible assets lack physical substance.
  • The distinction between current and noncurrent assets and liabilities is important because it helps financial statement users assess the timing of the transactions.
  • Three broad categories of legal business structures are sole proprietorship, partnership, and corporation, with each structure having advantages and disadvantages.
  • The accounting equation is Assets = Liabilities + Owner’s Equity. It is important to the study of accounting because it shows what the organization owns and the sources of (or claims against) those resources.
  • Owners’ equity can also be thought of as the net worth or value of the business. There are many factors that influence equity, including net income or net loss, investments by and distributions to owners, revenues, gains, losses, expenses, and comprehensive income.

2.3 Prepare an Income Statement, Statement of Owner’s Equity, and Balance Sheet

  • There are ten financial statement elements: revenues, expenses, gains, losses, assets, liabilities, equity, investments by owners, distributions to owners, and comprehensive income.
  • There are standard conventions for the order of preparing financial statements (income statement, statement of owner’s equity, balance sheet, and statement of cash flows) and for the format (three-line heading and columnar structure).
  • Financial ratios, which are calculated using financial statement information, are often beneficial to aid in financial decision-making. Ratios allow for comparisons between businesses and determining trends between periods within the same business.
  • Liquidity ratios assess the firm’s ability to convert assets into cash.
  • Working Capital (Current Assets – Current Liabilities) is a liquidity ratio that measures a firm’s ability to meet current obligations.
  • The Current Ratio (Current Assets/Current Liabilities) is similar to Working Capital but allows for comparisons between firms by determining the proportion of current assets to current liabilities.
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