Financial Accounting: Key Concepts and Principles
Financial Accounting Fundamentals
Key Accounting Concepts
- Assets: Resources controlled by a company as a result of past events and from which future economic benefits are expected to flow to the entity.
- Liabilities: Present obligations of an entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
- Equity: The residual interest in the assets of the entity after deducting all its liabilities.
Understanding Liabilities
Types of Liabilities
- Current Liabilities: Obligations due within one year or the operating cycle, whichever is longer.
- Long-Term Liabilities: Obligations due beyond one year or the operating cycle.
- Contingent Liabilities: Potential obligations dependent on future events.
Accounting for Liabilities
- Debt-to-Equity Ratio: Total liabilities divided by total stockholders’ equity.
- Times Interest Earned Ratio: Income before interest and taxes divided by interest expense.
Working Capital Management
Cash and Cash Equivalents
- Cash Equivalents: Short-term, highly liquid investments readily convertible to known amounts of cash.
Accounts Receivable and Payables
- Accounts Receivable: Amounts owed to a company by customers for goods or services sold on credit.
- Accounts Payable: Amounts owed to suppliers for goods or services purchased on credit.
Capital Expenditures and Depreciation
Capital Expenditures
- Capital Expenditures: Expenditures that increase the value or useful life of an asset.
Depreciation Methods
- Straight-Line Depreciation: Allocates the cost of an asset evenly over its useful life.
- Double-Declining-Balance Depreciation: An accelerated depreciation method that yields larger depreciation expense in the early years of an asset’s life.
Internal Control Systems
Importance of Internal Controls
Properly designed internal control systems lower a company’s risk of loss and help ensure the reliability of financial reporting.
Principles of Internal Control
- Establishment of Responsibility: Assigning responsibility for each task.
- Segregation of Duties: Separating authorization, recording, and custody of assets.
- Documentation Procedures: Using pre-numbered documents and maintaining adequate records.
- Physical Controls: Safeguarding assets through physical measures.
- Independent Internal Verification: Regularly reviewing and verifying records.
Statement of Cash Flows
Cash Flow Activities
- Operating Activities: Cash flows from the business’s day-to-day operations.
- Investing Activities: Cash flows related to the acquisition and disposal of long-term assets.
- Financing Activities: Cash flows related to obtaining and repaying capital.
Methods of Reporting Cash Flows
- Direct Method: Lists major items of operating cash receipts and payments.
- Indirect Method: Starts with net income and adjusts for items that do not affect cash.
Other Key Topics
- Bonds: A contract pledging title to assets as security for a note or bond.
- Stockholders’ Equity: Paid-in capital and retained earnings.
- Goodwill: The amount by which a company’s value exceeds the value of its individual assets and liabilities.