Commit 26e98446 authored by michael lundquist's avatar michael lundquist
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Committing ch4 notes so I can work on PM stuff

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# Ch 4 The Mechanics of Financial Accounting
- This chapter discusses the mechanics of preparing financial statements to report transactions accurately, timely and completely.
- This chapter also discusses reading financial statements using T-account analysis
## Economic Events
- Financial statements must only report relevant and objectively measurable __Economic events__.
### Relevant Events
- __Relevant event__: an economic event large enough to affect a company's financial condition
- ex: elections, wars, changing CEOs...
### Objectivity
- The normal standard for __objectivity__ is when parties with conflicting objectives can agree on the truth
- for example, when buyers (who want a low price) and sellers (who want a high price) agree on an objective price
- objectivity also requires documentation
- If you can't honestly be objective, be conservative
## The Fundamental Accounting Equation
```Accounting
Assets = Liabilities + Shareholders' Equity
```
- All financial statements are based on the fundamental Accounting equation, but the balance sheet explicitly states how everything relates to it.
- The accounting must always balance, but even if it does, there might be accounting errors.
### Assets
- __Assets__: Items and rights obtained through objectively measurable transactions that can be used to generate revenue in the future
- Assets are exchanged for other assets (usually cash or payables)
- ex: cash, securities, receivables, land, buildings, machinery, equipment, and rights
- sources of assets:
- borrow (liabilities)
- owner contributions (Shareholders' Equity)
- operating activities (asset exchanges)
### Liabilities
- __Liabilities__: obligations made on assets
- ex: debts and payables
### Shareholders' Equity
- 2 Components of __shareholders equity__
1. __contributed capital__: the dollar value of assets contributed by shareholders
2. __Retained earnings__: the dollar value of assets generated by operating activities and retained in the business (not paid in dividends)
- Operating activities are transactions directly associated with the acquisition and sale of a company's products or services.
``` Accounting
Assets = Liabilities + (Contributed Capital + Retained Earnings)
```
## Business Transactions, the Accounting Equation, and the Financial Statements
- __Business transactions__: the economic events of exchanging assets and liabilities.
- all business transactions can change the accounting equation, but it will always balance
### Transactions and the Accounting Equation
- This gives some examples of how different transactions affect the accounting equation
### The Accounting Equation and the Financial Statements
- Here they:
- define "account"
- prepare simplified balance sheets, statements of cash flows, income statement and statements of shareholders' equity
#### Accounts and the Accounting Equation
- Accounts subdivide the categories of the accounting equation
- for example assets could have the accounts cash, receivables, land...
- Of a company's account, only a handful of the most informative accounts will appear on financial statements.
- Financial statements should provide meaning to but not overwhelm users.
- US GAAP and IFRS use the same accounting equation
#### The Balance Sheet
- The balance sheet states the accounting equation as of a particular date.
- It's named a "balance sheet" because the equation must balance
- Balance sheets include the accounts associated with each part of the accounting equation.
#### Statement of Cash Flows
- The statement of cash flows is only concerned with the cash account in the assets portion of the accounting equation (and balance sheet)
- The statement of cash flows divides this cash account into 3 sections:
1. Operating
2. Investing
3. Financing
#### Income Statement
- The income statement measures assets generated from operating activities over a period of time.
- *revenues*: asset inflows due to operating activities
- *expenses*: asset outflows required to generate the revenues
- *net income* (or *net loss*) = revenues - expenses
- Operating activities convert assets into the retained earnings account of the shareholders' equity section, hence the equation stays equal.
- The retained earnings section includes these accounts: revenue accounts, expense accounts, and dividend accounts.
- expenses and dividends decrease retained earnings; revenues increase retained earnings.
#### Statement of Shareholders' Equity
- The Statement of Shareholders' Equity just analyzes how the shareholders' equity part of the accounting equation has changed.
- Example accounts in shareholders' equity: contributed capital, retained earnings
- dividends affect shareholder's equity?
## The Journal Entry
- __Journal entries__: A short-hand way to represent which accounts are affected by a transaction and how they are affected.
- __debit__: cash inflows
- on the left side of a journal entry
- __credit__: cash outflows
- on the right side of a journal entry
- __Compound journal entries__ involve more than 2 accountss
### The Double Entry System
-
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