AccountingFundamentalsCourseNotes 1497312155070

Course Notes
Accounting Fundamentals
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Session Objectives
Format balance sheet

Format income statement
Record transactions

The Three Key Financial Statements
Balance Sheet
A statement of financial position
Assets, liabilities, equity
LIABILITIES
(What a business owes)
ASSETS
(What a business owns)
EQUITY
(What a business is worth)

Income Statement
Profitability
Revenue, expenses, profit and loss
EXPENSES
REVENUE
PROFIT OR LOSS

Cash flow statement

Classifies all the different cash flows
Cash flow from operations, financing and investing
CFO
TOTAL CASH FLOWS CFF
CFI

The Balance Sheet: Asset
Assets are required for business
1. Current Asset: assets that are quickly liquidated

2. Non-current asset:
Long term intangible assets
Property, plant and equipment
Financial assets

The Balance Sheet: Liabilities
Obligations owed by the company
1. Current Liabilities: obligations to be paid in under a year

2. Non-current liabilities: long term debt

The Balance Sheet: Equity
Equity begins as initial investments

Equity increases with retained earnings, which increases with
positive income and decreases with losses and dividends

Balancing the Balance Sheet
Assets = Liability + Equity

This formula must always be true

Balancing the Balance Sheet
Double entry journal keeping holds that:

Transactions have an equal effect in one or more accounts
on the other side of the balance sheet; or,
Transactions have an positive effect and equal negative
effect in one or more accounts on the same side of the
balance sheet.

Recording Transactions
Company undergoes the following transactions:
Issue shares for 100 in cash

Four year bank loan of 50
Buys equipment for 80
Buys inventory for 60
Sells the inventory for 90
Pays salaries of 20
Pays interest of 3

Recording Transactions: Shares for 100 in cash
Cash of 100 falls under current assets

Offsetting effect in equity as 100 to common shares
Assets equals liabilities and equity
Dr. Cash 100

Cr. Common Shares 100

Recording Transactions: Bank Loan
Company owes 50 to the bank

This is a non-current liability
Dr. Cash 50
Cr. Loans 50

Recording Transactions: Property Purchase
Property cost 80 in cash, in exchange for a non-current asset worth 80
Dr. Property, Plant and Equipment 80

Cr. Cash 80
Assets (+80)
Assets (-80)

Recording Transactions: Buying Inventory
Purchase of inventory for 60 in cash
Dr. Inventory 60
Cr. Cash 60

Recording Transactions: Selling Inventory
Selling inventory worth 60 for 90 in revenue

We lose 60 in inventory, but receive 100 in cash
Dr. Cash 90
Dr. Cost of Goods Sold (Expense) 60
Cr. Sales Revenue 90
Cr. Inventory 60

Recording Transactions: Selling Inventory
Alternatively:
Dr. Cash 90
Cr. Inventory 60
Cr. Retained Earnings 30

Recording Transactions: Salaries
Salaries are paid out in cash or bank deposits

Salaries are paid in 20 of cash
Dr. Salaries Payable 20

Cr. Cash 20

Recording Transactions: Payment of Interest
Paying interest expense of 3

Interest expense reduces profits by 3
Dr. Interest Payable 3

Cr. Interest Expense 3

Account Receivable and Account Payable
In the previous examples, the company only operated with cash

However, accrual accounting result in buying and selling on credit
Two terms are important in this regard,

Account receivable: Amount owed by customer to the company
Account payable: Amount owed by the company to suppliers
So, if the inventory transaction was on credit, how the balance sheet would
look like?
Buying or Selling on Credit
Inventory sold on credit creates an accounts receivable balance

Instead of debiting cash, debit accounts receivables
When the customer pays the balance, accounts receivables is reduced
and cash is increased
Inventory purchased on credit creates an accounts payables balance

Instead of crediting cash, credit accounts payables
When the company pays the balance, accounts payables is reduced
and cash is reduced
Exercise
Follow the video for the exercise:
Vadero Inc.
Check your work against the Vadero Inc. Solution

The Income Statement
Statement of operations
Profit and loss
Income statement transactions are a flow in time

Balance sheet transactions were a snapshot of a point in time

The Income Statement: Gross Profit
Revenue cost of goods sold
Revenue is sales net of returns and allowances
Cost of goods sold are direct costs for generating that revenue

The Income Statement: Operating Income
There are other expenses that should be deducted.
Indirect operating expenses

Selling, general and administrative expenses
Interest expense
Tax expense

Creating a Full Income Statement
From the previous balance sheet transactions, the income statement values
are:
- Gross profit is 30
- Operating Income is 10
- Net Income is 7

Recording Income and Expenses
Income statement record the revenues and expenses during a year
Some transactions must be prorated
For example:
Company buys insurance worth 12,000 at the 12th month of the financial
year.
Only 1000 would be included in this years income statement.

Prepayments
What will happen with the rest 11000?
Prepaid expense in the balance sheet

An asset
Asset will be used up over the course of the remaining 11 months

Another Example: Accrued Expenses
Company use 2000 worth of office supplies but will pay in the following year.
How much expense should be included in the income statement?
Answer:
The full expense
Record current liability
Company owes supplier within the next year

Depreciation
The equipment purchased was worth 80
Eventually, the equipment will be worth less as it is used up (think used
cars)
This is depreciation

The Impact of Depreciation
Residual value = 30
Useful life = 4 years
Depreciation = (80 30) / 4 = 12.5
Net value = 80 12.5 = 67.5 in the first year
The deducted values will appear in the balance sheet

Conclusion
This module concludes:
Learning how to construct the balance sheet and income statement
Exploring financial terms e.g. account payable, prepayment
Learning how to record the transactions in the statements

Constructing Cash Flow Statement

Overview
This module will explore:
Formatting and constructing cash flow statements
Difference between cash flow and income

Key Financial Statements
How the business uses cash for:
Operating;
Investing; and,
Financing

The Role of Cash Flow Statement
Cash flows can technically be deduced from the balance sheet

But in practice, cash flow statement recorded all the details
Gives insights as to how cash is sourced and used

The Cash Flow Statement: Operating Cash Flow
Operating cash flow includes:

Cash collections from customers
Payment to suppliers and employees
(Possibly) Dividends and interest payments or receipts

The Cash Flow Statement: Cash Before Financing
Investing activities organizes the flows of:
Sale and purchase of PP&E
Sale and purchase of investments

The Cash Flow Statement: Cash Before Financing
Investing activities organizes the flows of:
Sale and purchase of PP&E
Sale and purchase of investments

The Cash Flow Statement: Net Cash Flow
Net cash flow is arrived after accounting for financing activities:
Issuance of shares
Paying dividends
Issuing bonds, and
Repaying loans

Recording Income and Expenses
The accrual concept
Profit =/= Cash
Income Statement records revenue and cost which is

- Incurred or earned
In contrast, cash flow statement records

- Cash received and cash paid

The Idea of Matching Over Time
A five day transit pass costs $40

Paid in cash on Monday
How much is the daily cost on Thursday:

On a cash flow basis?
On a accrual basis?

Matching Over Time Solution
On a cash flow basis the expense on Thursday is $0

Since payment (cash outflow) occurred on Monday

Matching Over Time Solution
On an accrual basis, the expense is $8

Although the payment of $40 occurred on Monday, we used up a days
worth of the weekly pass ($40/5) on Thursday
Which basis better reflects the cost of an individual journey?

Answer: Both can provide valuable information

PP&E and Depreciation Recap
ABC Inc. buys a truck for $45,000 and after 5 years it sells for $15000
What do we record?
Cash flow statement: $45,000
Income statement: $6,000
Balance sheet: $39,000 at year 1, reduced by $6,000 every year

Calculating Operating Cash Flow - Direct Method
Rarely used in practice

Sum of customer receipts + supplier payments + employee payments

Calculating Operating Cash Flow - Indirect Method
Widely used
Begins with net income
Adds back non-cash expenses from the income statement
Adjustment is required in case of:

Sales and purchase on credit
Unsold inventory
Others e.g. depreciation

Deriving the Complete Cash Flow
Complete cash flow statement uses:
Current years balance sheet

Last years balance sheet
Current years income statement

Deriving the Complete Cash Flow
Now let's discuss the method analyst use to forecast:

Future income statement
Balance sheet

Stage One: Compare the Balance Sheet
To complete the entire cash flow statement, compare the balance sheet of:
Current year
Previous year

For every item, the difference between current and previous year is
calculated:
Asset increase Cash outflow (and vice versa)
Liability increase Cash inflow (and vice versa)

The sum of all effects = net change in cash balance

Net change in cash balance should equal the difference between the
current year and prior year cash balances

Dealing with Property, Plant and Equipment
For PP&E, cash and balance sheet differences happens due to

Depreciation
Net capital expenditure (CAPEX)

Dealing with Property, Plant and Equipment
Depreciation is accounted for when added back to net income

under CFO
Any new CapEx is an outflow under CFI

Calculating Net CAPEX
Requires:
Opening net book value of PP&E from balance sheet
Closing net book value of PP&E from balance sheet
Depreciation expense from the income statement

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Course Notes

2017, all rights reserved. https://www.corporatefinanceinstitute.com

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Format balance sheet

2017, all rights reserved. https://www.corporatefinanceinstitute.com

2017, all rights reserved. https://www.corporatefinanceinstitute.com

2017, all rights reserved. https://www.corporatefinanceinstitute.com

Cash flow statement

TOTAL CASH FLOWS CFF

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Assets are required for business

1. Current Asset: assets that are quickly liquidated

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Obligations owed by the company

1. Current Liabilities: obligations to be paid in under a year

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Equity begins as initial investments

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Assets = Liability + Equity

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Double entry journal keeping holds that:

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Company undergoes the following transactions:

Issue shares for 100 in cash

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Cash of 100 falls under current assets

Dr. Cash 100

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Company owes 50 to the bank

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Property cost 80 in cash, in exchange for a non-current asset worth 80

Dr. Property, Plant and Equipment 80

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Purchase of inventory for 60 in cash

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Selling inventory worth 60 for 90 in revenue

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Salaries are paid out in cash or bank deposits

Dr. Salaries Payable 20

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Paying interest expense of 3

Dr. Interest Payable 3

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In the previous examples, the company only operated with cash

Two terms are important in this regard,

Inventory sold on credit creates an accounts receivable balance

Inventory purchased on credit creates an accounts payables balance

Follow the video for the exercise:

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Income statement transactions are a flow in time

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Revenue cost of goods sold

Revenue is sales net of returns and allowances

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There are other expenses that should be deducted.

Indirect operating expenses

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Income statement record the revenues and expenses during a year

Some transactions must be prorated

Only 1000 would be included in this years income statement.

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