Financial Accounting

1. Reference slides

Accounting concepts

Concepts used in Balance Sheet:
Concepts used in Income Statement:


Types of assets based on Liquidity:
Types of assets based on Tangibility:


Example: Loans, Mortgages, Revenue, Expenses

Types of Liabilities:


Money returned to shareholders if all our assets were turned into cash and all our debts were payed off

Financial reports

Financial reports are used to make business decisions. Three major financial reports are:

Balance Sheet

Snapshot of financial health of business at a point in time.

Format of balance sheet: (src: Wikipedia)
Balance Sheet

Balance sheet based ratios:
1. Current ratio = Current Assets / Current Liabilities
2. Total Debt to Equity = Total Debt / Total Equity

Income Statement

A. Sample Income Statement

B. Format of income statement
C. Retaied Earnings
This net income is used to update Retained Earnings in Balance Sheet as follows:
Retained Earnings Formula
Here, Dividends are not an expense but distribution of equity capital to investors.

D. Making a sale
E. Expenses:
+ Depreciation: Cost from using a tangible non-current asset. No depreciation for land.
+ Amortiztion: Intangible long lived asset. Amortization expense directly reduces value of asset. Eg: Franchise License Amortization

F. Income Statement based ratios:
1. Gross Margin % = GM / Sales * 100
2. Return on Sales = Net Income / Sales * 100

Accounting Records

A. Double-Entry Accounting : Both sides of each transaction are recorded, and at least two accounts are affected.

B. Journal Chronological Record of all entities transaction. After analysing a transaction, a journal entry is prepared using the rule that debits indicate increases in assets and in expenses and credits indicate increases in liabilities, owners' equity and sales.

C. Debits and Credits: Youtube Tutorial
Debits and Credits

Debit and Credit Practice Questions & Solutions

D. Sample Journal Entry [TBD]

E. Ledger: Journal entries are posted into a ledger of T-accounts where 'debit' means left side of the T-account and 'credit' means right side of the T-account.

F. Sample Ledger and T-accounts [TBD]

G. Adjusting Entries Adjusting entries do not involve any economic exchange with a third party. Once all transactions with outside entities are recorded for the period, adjusting entries are made to particular accounts- Eg. Prepaid expenses, warehouse building, store fixtures, franchise fee and taxes payable.

H. Closing Entries : Close out each temporary or income statement account and reset it to a zero balance, in preparation for the next accounting period. A closing entry is made to close or reset all sales and expense accounts to zero.

I. Preparing financial reports : Finally, the balance sheet and income statement are prepared.

Cash flow statement

How much money came in / went out in a time period

A. Classifies and organises information about the cash flows during an accounting period
There are two formats for the statement of cash flows: the direct method and the indirect method. They differ in their presentation of operating cash flows.
B. Direct Method: Under the direct method, in the operating section, are included a number of line items, each of which is a cash inflow to the reporting entity or a cash. The direct method statement of operating cash flows can be prepared directly from the entries in the cash T-account during the accounting period. [TBD: Add Sample Format]

C. Indirect Method: Operating section starts with the net income and make a series of de-accrual adjustments to it in order to derive the net cash from operations. The indirect method statement of operating cash flows is prepared from the period's income statement accounts and the period's beginning and ending balance sheets. [TBD: Add sample format]

D. Interpretation

Revenue and Receivables

A. Deferred Revenue : Deferred revenue is future revenue that has already been collected but has yet to be earned. Eg. Unredeemed gift certificate, Coupon, Advanced Payment of Magazine Subscription. We donot use this for tax calculations.

B. Bad Debts : Setting up 'allowance for bad debt/doubtful accounts' contra-account and 'bad debt expense' account (Income statement)

C. Refunds :

D. Prompt Payment Discounts :

E. Allowances are adjusted at month's end

F. Bad Debt Ratio : A company with a low bad debt ratio believes it is more likely to receive payment of more of its receivables outstanding than a company with a high bad debt ratio. High/Low bad debt ratio indicates company is failing to properly screen potential clients before offering them credit. It might also mean that the company is pursuing less credit-worthy customers in an attempt to generate sales.
G. Day's receivable ratio : Indicates the average number of days necessary for the company to collect its outstanding accounts receivable. Analysts compare a company's days receivables with its industry peers. The slowing of a company's days receivables or a high days receivables compared to its competitors has a negative impact on the firm's liquidity. An increasing days receivable ratio might also be an indication that more of the receivables will become bad debts.
Last Updated: 16-14,11-9, 3 Jun 2021