Accounting e book

IntroductiontoAccounting
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Discussion topics
 Introduction to accounting
 Background
 Business Cycle
 Use of Financial Statements
 Income Statement
 Introduction
 Accrual basis of accounting
 Cash basis of accounting
 Revenue recognition principle
 Matching principle of costs
 Balance Sheet
 Introduction
 Accounting Equation
 Debit and Credit
 Assets / Liabilities
 Key Questions
 Cash flow Statement
 Introduction
 Calculating cash flow from operations, investing and finance

Introduction to Accounting

Starting a Business: some background
 Kartik want to start a new business. Kartik sees the need for “Movers and Packers” business
in Mumbai. He has researched this idea and has prepared a business plan that documents the
viability of his new business
 Kartik met his lawyer friend to discuss the form of business he should use. Given his
situation, they concluded that a corporation will be best form. Kartik names his company as
FastTrack Inc?
 What is a corporation?
 What are other form of business types?
 Kartik is a hard worker and a smart man, but admits he is not comfortable with matters of
accounting
 Kartik asks his banker to recommend a professional analyst who is skilled in explaining
business accounting to someone without an accounting background
 Kartik wants to understand financial statements and wants to keep on top of his new
business
 Kartik asks you the following questions
 What is business cycle?
 Why do we use financial statements at all?

What is a Business Cycle?
 Simple Business Cycle for FastTrack Inc
Kartik Infuses
Capital
Uses the money
to purchase
trucks,
inventory, pay
labor and
admin costs
Provides
Service
“Movers and
Packers”
Receives Money
from Clients,
Earns
Profit/Loss
Cash Outflow
Cash Inflow
Shareholder of the
firm
 Kartik receives money from the clients – Profit or Loss
 Kartik has following options
 Kartik can reinvest the profit made in the business to expand his business or
 Can simply keep the money!

Why do we use Financial Statements?
FastTrack Movers & Packers Transactions
 Based on Kartik’s business plan, you now understand that there will likely be thousands of
transactions each year
 Kartik seems puzzled by the term transaction, so you gives him five examples of transactions
that FastTrack Inc will need to record:
 Kartik will start his business by putting some of his own personal money into it. In effect, he is buying
shares of FastTrack Inc common stock
 FastTrack Inc will need to buy a few transport vehicles - truck
 The business will begin earning fees and billing clients for relocating their parcels from one place to
another
 The business will be collecting the fees that were earned
 The business will incur expenses in operating the business, such as a salary for Kartik, labors, expenses
associated with packaging material, delivery vehicle, advertising, etc
 With thousands of such transactions in a given year, Kartik is being advised to make an entry
of these transactions in an accounting software on a daily basis
Why Accounting?
 Understanding of company’s profitability, assets and cash position
 Generate sales invoices and accounting entries
 Prepare statements for customers with no additional work
 Can you now explain Kartik, the content and purpose of the three main financial statements –
Income Statement, Balance Sheet and Cash Flow statement

Income Statement

Income Statement – Jargons introduced!
 The order of deduction of cost is as follows:
 Cost of products sold
 Sales, general and administrative costs
 Interest Expenses
 Tax Expenses
 Lets get back to our FastTrack Inc example
Revenues result from the entity’s
operating activities (selling
merchandise, selling services)
Costs and expenses are incurred in
generating revenues and operating
the entity
The income statement shows the profit for the period of time under consideration
FastTrack Movers & Packers Inc.
Sales $ xxx
Cost of goods sold $ xxx
Gross Profit $ xxx
Selling,general and admin. expenses $ xxx
Income from operations $ xxx
Interest expense $ xxx
Income before taxes $ xxx
Net Income $ xxx
Earnings per share $ xxx
Income Statement, for year ended 31st December, 2007

FastTrack Movers & Packers Revenues
 Even though Kartik’s clients won't be paying FastTrack Inc until January 15, the accrual basis
of accounting requires that the $1,000 be recorded as December revenues, since that is when
the delivery work actually took place
 What is accrual basis of accounting?
 What is cash method of accounting?
 What is revenue recognition principle?
 After expenses are matched with these revenues, the income statement for December will
show just how profitable the company was in delivering parcels in December
Case 1: Revenues
If Kartik delivers 200 parcels in December for $5 per delivery, he has technically earned fees totaling
$1,000 for that month. He sends invoices to his clients for these fees and his terms require that his
clients must pay by January 15

FastTrack Movers & Packers Revenues
 Receipts of $1,000 will not be considered to be January revenues, since the revenues were
already reported as revenues in December when they were earned
 This $1,000 of receipts will be recorded in January as a reduction in Accounts Receivable (In
December Kartik had made an entry to Accounts Receivable and to Sales) – Don’t worry,
we will explain you this in a bit!
 The actual date of payment of $400 does not matter
 What matters is when the work was done and when the corresponding expense was incurred
 In our case work was done in December and hence, $400 expense is counted as a December
expense even though the money will not be paid out until January 3
 What is matching principle?
Case 2: Revenues
When Kartik receives the $1,000 worth of payment checks from his customers on January 15, he will
make an accounting entry to show the money was received.
Case 3: Expenses
If Kartik hires some labor to help him with December deliveries and Kartik agrees to pay him $300 on
January 3 and another $100 for pakaging and other supporting material; Total expenses of $400
expense for December deliveries

Income Statement - Expenses
 What is the monthly interest expense that is shown for Kartik’s monthly income statement?
Case 4: Expenses
FastTrack Movers and Packers borrowed $20,000 from a bank to start his business on 1st December
and the company agrees to pay 5% in interest, or $1,000. The interest is to be paid in a lump sum on
December 1st of each year.

 FastTrack Income Statement as per the transaction discussed for the month of December,
2007
Sales $1,000
Cost of goods sold $400
Gross Profit $600
Selling,general and admin. Expenses 1
$30
Income from operations $570
Interest expense $83
Income before taxes $487
Income Tax @ 33% $161
Net Income $326
Note 1: SG&A expense is assumed to be $30 in December,2007
Income Statement, for month ended 31st December, 2007
Consolidating the Income Statement
Accrual basis of accounting
Concept of Matching Principle
Concept of Matching Principle

Balance Sheet

Balance Sheet – Jargons reintroduced!
 “Snapshot" of a company's financial position at a given moment
 Reports the amount of a company's
 Assets – Current assets/Long term assets
 Liabilities – Current liabilities/Long term liabilities
 Stockholders' (or owner's) equity – Common stock / Retained earnings
Assets Liabilities & Stockholder's Equity
Current assets Current Liabilities
Cash $ xxx Short-term debt $ xxx
Accounts Receivables $ xxx Accounts Payable $ xxx
Inventory $ xxx Total current liabilities $ xxx
Total current assets $ xxx
Long term Liabilities
Long term assets Long term debt $ xxx
Plant and Equipment $ xxx
Less:Acc depreciation ($ xxx) Stockholder's Equity
Net PPE $ xxx Common Stock $ xxx
Retained Earnings $ xxx
Total Stockholder's Equity $ xxx
Total Assets $ xxx Liabilities & Stockholder's Equity $ xxx
FastTrack Movers & Packers Inc
Balance Sheet, December 31st 2007
Assets Liability Shareholder’s Equity= +

Debits and Credits
 Double Entry
 Double entry is a 500-year-old accounting procedure
 Double entry is a simple yet powerful concept and each and every transactions will result in an amount
recorded into at least two of the accounts in the accounting system
 Debit and Credit
 Double entry system requires that the same dollar amount of the transaction must be entered on both
the left side of one account, and on the right side of another account
 Left means Debit!
 Right means Credit!
 Remember these simple tips:
 Increase in assets – DEBIT
 Decrease in assets – CREDIT
 Increase in Liability & Equity – CREDIT
 Decrease in Liability & Equity - DEBIT

 Shareholder’s Equity
 Common Stock will be increased when the corporation issues shares of stock in exchange for cash (or
some other asset)
 Retained Earnings will increase when the corporation earns a profit and there will be a decrease when the
corporation has a net loss
 Core link between a company's balance sheet and income statement
Balance Sheet
Cash $20,000 Liabilities $0
Stockholder's Equity
Common Stock $20,000
Total Assets $20,000 $20,000
Cash from Kartik’s personal
investment
Increase in its stockholders'
equity account Common Stock
by $20,000
Case 5: Cash and Common Stock
On December 1, 2007 Kartik starts his business FastTrack Movers and Packers. The first transaction that
Kartik will record for his company is his personal investment of $20,000 in exchange for 5,000 shares of
FastTrack Movers & Packers common stock. There are no revenues because no delivery fees were earned
by the company, and there were no expenses.

Balance Sheet
Total Assets $20,000 $20,000
Cash from Kartik’s personal
investment
Increase in its stockholders'
equity account Common Stock
by $20,000
Case 5: Cash and Common Stock
On December 1, 2007 Kartik starts his business FastTrack Movers and Packers. The first transaction that
Kartik will record for his company is his personal investment of $20,000 in exchange for 5,000 shares of
FastTrack Movers & Packers common stock. There are no revenues because no delivery fees were earned
by the company, and there were no expenses.
Common Stock
increases by $20,000
Cash increases by
$20,000

 Kartik also needs to know that the reported amounts on his balance sheet for assets such as
equipment, vehicles, and buildings are routinely reduced by depreciation
 What is Depreciation
 Matching principle?
 Depreciation of land?
 The accountant might match $2,800 ($14,000 5 years) of depreciation expense with each
year's revenues for five years
Balance Sheet
Cash reduces to $6,000 and
vehicle account increases to
$14,000
No change in stockholder’s
position
Vehicle $14,000
Total Assets $20,000 $20,000
Balance Sheet, December 2nd 2007
Case 6: Purchase of Vehicle
On December 2, FastTrack Movers & Packers purchases a truck for $14,000 by writing a check for $14,000.
The two accounts involved are Cash and Vehicles (or Delivery Truck)

 Debit and Credit?
Balance Sheet
Cash reduces to $6,000 and
vehicle account increases to
$14,000
position
Vehicle $14,000
Total Assets $20,000 $20,000
Case 6: Purchase of Vehicle
On December 2, FastTrack Movers & Packers purchases a truck for $14,000 by writing a check for $14,000.
The two accounts involved are Cash and Vehicles (or Delivery Truck)
Cash decreases by
$14,000
Vehicle asset increases
by $14,000

Balance Sheet
 Between Dec 1st & Dec 31st, $100 worth of insurance premium is "used up" or "expires"
 The expired amount will be reported as Insurance Expense on December's income statement
 The remaining portion of unexpired insurance premium is reported as Pre-paid Insurance
 What is the remaining portion of Pre-paid insurance as of Dec 31st , 2007?
Cash reduces further to
$4,800 and Prepaid insurance
account increases to $1,200
position
Prepaid Insurance $1,200
Vehicle $14,000 Common Stock $20,000
Total Assets $20,000 $20,000
Case 7: Prepaid Expenses
On December 2 when Kartik contacts an insurance agent regarding insurance coverage for the Truck just
purchased. The agent informs him that $1,200 will provide insurance protection for the next one year.
Kartik immediately writes a check for $1,200.

Balance Sheet
Cash reduces further to
$4,800 and Prepaid insurance
account increases to $1,200
position
Prepaid Insurance $1,200
Total Assets $20,000 $20,000
Case 7: Prepaid Expenses
On December 2 when Kartik contacts an insurance agent regarding insurance coverage for the Truck just
purchased. The agent informs him that $1,200 will provide insurance protection for the next one year.
Kartik immediately writes a check for $1,200.
Cash decreases by
$1,200
Prepaid insurance
increases by $1,200

Prepaid Insurance $1,200 Long term debt $20,000
Total Assets $40,000 Liabilities & Stockholder's Equity $40,000
Balance Sheet, December 3rd 2007
Balance Sheet
Cash increases by $20,000
(amount of debt raised from
the bank)
Long term debt raised from
the bank
Case 4 Revisited : Raising Debt

Balance Sheet
Cash increases by $20,000
(amount of debt raised from
the bank)
Long term debt raised from
the bank
Case 4 Revisited : Raising Debt
Long term debt
increases by $20,000
Cash increases by
$20,000

 On 10th December, wholesale price of boxes has been risen by 20% & at today's price Kartik’s
could purchase them for $1.20 each. What is the value of inventory shown on balance sheet?
 What is Cost Principle?
 Lets say that since the time Kartik bought inventory, the wholesale price of boxes has been
cut by 40% and at today's price he could purchase them for $0.60 each. What is the value of
inventory shown on the balance sheet in this case?
 What is the principle of Conservatism?
Inventory $1,000 Stockholder's Equity
Vehicle $14,000
Balance Sheet
Cash decreases by $1,000 and
inventory increases by $1,000
No change
Case 8: Inventory
Kartik keeps an inventory of packing boxes not only to use it for his business but also earn additional
revenues by carrying an inventory of packing boxes to sell. Let's say that FastTrack Movers and Packers
purchased 1,000 boxes wholesale for $1.00 each.

Inventory $1,000 Stockholder's Equity
Vehicle $14,000
Balance Sheet
Cash decreases by $1,000 and
inventory increases by $1,000 No change
Case 8: Inventory
Kartik keeps an inventory of packing boxes not only to use it for his business but also earn additional
revenues by carrying an inventory of packing boxes to sell. Let's say that FastTrack Movers and Packers
purchased 1,000 boxes wholesale for $1.00 each.
Cash decreases by
$1,000
Inventory asset
increases by $1,000

 Other liabilities
 For the loan Kartik received from Bank (Notes Payable or Loan Payable), the interest on the loan he owes
to his bank (Interest Payable)
 Amount he owes to the supply store for items purchased on credit (Accounts Payable)
 Wages he owes an employee but hasn't yet paid to him (Wages Payable)
Prepaid Insurance $1,200 Unearned Revenue $600
Inventory $1,000 Long term debt $20,000
Balance Sheet, December 4th 2007
Balance Sheet
Cash increases by $600 Liability increases by $600
Case 9: Unearned Revenues
In addition to 200 parcels delivered by FastTrack Movers and Packers in December, they enters into an
agreement with one of its customers stipulating that the customer prepays $600 in return for the delivery
of 30 parcels every month for 6 months. Assume FastTrack Movers & Packers receives $600 payment on
Dec 1,2007 for deliveries to be made between Dec 1,2007 and May 31,2007

Prepaid Insurance $1,200 Unearned Revenue $600
Inventory $1,000 Long term debt $20,000
Balance Sheet, December 4th 2007
Balance Sheet
Cash increases by $600 Liability increases by $600
Case 9: Unearned Revenues
In addition to 200 parcels delivered by FastTrack Movers and Packers in December, they enters into an
agreement with one of its customers stipulating that the customer prepays $600 in return for the delivery
of 30 parcels every month for 6 months. Assume FastTrack Movers & Packers receives $600 payment on
Dec 1,2007 for deliveries to be made between Dec 1,2007 and May 31,2007
Unearned revenues
increases by $600
Cash increases by $600

Missing links
Accounts Receivables
Accounts Payable
Interest Payable
The arrow indicates that net income affects retained earnings, which is a component of owners’ equity
Assets = Liabilities +
Owners'
Equity Net income = Revenues - Expenses
Balance Sheet Income Statement
Case 1&2: Revenues
If Kartik delivers 200 parcels in December for $5 per delivery, he has technically earned fees totaling
$1,000 for that month. He sends invoices to his clients for these fees and his terms require that his
clients must pay by January 15
Case 3: Expenses
If Kartik hires some labor to help him with December deliveries and Kartik agrees to pay him $300 on
January 3 and another $100 for pakaging and other supporting material; Total expenses of $400
expense for December deliveries
Case 4: Expenses

Sales $1,100
Cost of goods sold $400
Gross Profit $700
Selling,general and admin. Expenses 1
$30
Depreciation Expense $233
Insurance Expense $100
Income from operations $337
Interest expense $83
Income before taxes $254
Income Tax @ 33% $84
Net Income $170
Note 1: SG&A expense is assumed to be $30 in December,2007
Income Statement, for month ended 31st December, 2007
Consolidating all cases in Income Statement
Case 1 (accrual) + Case 9 (earned
revenue for December)
Case 6, monthly depreciation =
$2,800/12 = $233
Case 7, insurance premium worth
$1,200/12 =$100 is utilized per
month

Consolidated Balance Sheet
Current assets Current Liabilities
Cash $24,370 Unearned Revenue $500
Prepaid Insurance $1,100 Accounts Payable $400
Accounts Receivable $1,000 Interest Payable $83
Inventory $1,000 Income Tax Payable $84
Total Current Assets $27,470 Total Current liabilities $1,067
Vehicle $14,000 Long term debt $20,000
Accumulated depreciation $233
Net $13,767 Stockholder's Equity
Retained Earnings $170
Insurance premium worth
$1,200/12 =$100 is utilized for
December
Cash receipt on January 15th,
however, sales has been completed
and booked as Accounts
Receivables
Net Income Flows through the
Income Statement
Revenues worth $100 earned in
December, hence Unearned revenue
of $600 adjusted for the earned
revenues
Unpaid expenses,
classified as
liabilities

Balance Sheet – Key questions?
 Balance sheet shows the company’s assets worth?
 YES?
 NO?
 Balance sheet does not provide us with the fair market value of the company?
 Long-term assets reported at their cost minus amounts already sent to Income Statement as depreciation
expense
 The asset Land is not depreciated, so it will appear at its original cost even if the land is now
worth one hundred times more than its cost
 However, Short-term asset amounts are likely to be close to their market values, since they tend to
"turn over" in relatively short periods of time
 Is reputation cost captured in Balance Sheet – Brand, Logo etc?
 Bill Gates
 Nike
 BMW

Cash Flow Statement
Private and Confidential – Not for Circulation

Cash Flow Statement – Cash is the King!
 Purpose of this cash flow statement is to identify sources & uses of cash during the year
 Cash Flow is divided into three parts
 Cash flow from operations: Include all the transactions and other events related to its earnings process
 Cash flow from Investments: Include all the transactions involving acquiring and selling long-term
investment, property, plant, and equipment
 Cash Flow from Finance: Include all the transactions involved in obtaining and disbursing resources
from and to owners and repaying the amounts borrowed
Net Cash
Cash flow from
Operations
Cash flow from
Investing
Cash flow from
Finance
+ +
Cash Inflows:
 Generation of funds in
normal operations
Cash Outflows:
 Expenditure of funds in
normal operations
Cash Inflows:
 Debt issuance, common
stock, preferred stock and
other securities
Cash Outflows:
 Retirement of debt, common
stock and preferred stock
 Payment of cash dividend
Cash Inflows:
 Sale of plants and
equipments
 Liquidation of long term
investments
Cash Outflows:
 Purchase of plants and
equipments
 Investments in long term
investments

Calculating Cash flows
Cases
Cash Impact
(yes/no)
Cash Amount Classification Comments
Case 1 No $0 Operation Revenues earned but not paid
Case 2 No $0 Operation Revenues earned but not paid
Case 3 No $0 Operation Expenses incurred but not paid
Case 4 No $0 Operation Interest expense incurred but not paid
Case 4 Yes $20,000 Finance FastTrack borrows from the bank
Case 5 Yes $20,000 Finance Kartik infuses capital
Case 6 Yes ($14,000) Investing Purchase of truck
Case 7 Yes ($1,200) Operation Prepaid expenses
Case 8 Yes ($1,000) Operation Purchase of Inventory (boxes)
Case 9 Yes $600 Operation Customer Prepays
Others Yes ($30) Operation SG&A expenses incurred and paid
Cash flows $24,370
Cash flow from operations ($1,630)
Cash flow from investing ($14,000)
Cash flow from financing $40,000
Total Change in cash $24,370
End Cash
Cash at the
beginning
Change in cash during
the period
= +
Flows into the Balance Sheet as “Cash”

Thank You..!!
Private and Confidential – Not for Circulation

For FREE Resources
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Finance News, Articles, Interview Tips etc
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For Online Finance Courses
For any other enquiry / information
Email – support@cbacademy.in
https://www.educoporatebridge.com
https://www.educorporatebridge.com/freebies3.php

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