Introduction to Accounting

Introduction to Accounting

Accounting is the language of business. It is the system of recording, summarizing, and analyzing an economic entity's financial transactions. Effectively communicating this information is key to the success of every business. Those who rely on financial information include internal users, such as a company's managers and employees, and external users, such as banks, investors, governmental agencies, financial analysts, and labor unions. These users depend upon data supplied by accountants to answer the following types of questions:

• Is the company profitable?

• Is there enough cash to meet payroll needs?

• How much debt does the company have?

• How does the company's net income compare to its budget?

• What is the balance owed by customers?

• Has the company consistently paid cash dividends?

• How much income does each division generate?

• Should the company invest money to expand?

Accountants must present an organization's financial information in clear, concise reports that help make questions like these easy to answer. The most common accounting reports are called financial statements.

Understanding Financial Statements

The financial statements shown on the next several pages are for a sole proprietorship, which is a business owned by an individual. Corporate financial statements are slightly different. The four basic financial statements are the income statement, statement of owner's equity, balance sheet, and statement of cash flows. The income statement, statement of owner's equity, and statement of cash flows report activity for a specific period of time, usually a month, quarter, or year. The balance sheet reports balances of certain elements at a specific time. All four statements have a three-line heading in the following format.

Income statement. The income statement, which is sometimes called the statement of earnings or statement of operations, is prepared first. It lists revenues and expenses and calculates the company's net income or net loss for a period of time. Net income means total revenues are greater than total expenses. Net loss means total expenses are greater than total revenues. The specific items that appear in financial statements are explained later.

The Greener Landscape Group Income Statement For the Month Ended April 30, 20X2 Revenues Lawn Cutting Revenue $845 Expenses Wages Expense $280 Depreciation Expense 235 Insurance Expense 100 Interest Expense 79 Advertising Expense 35 Gas Expense 30 Supplies Expense 25 Total Expenses 784 Net Income $ 61

Statement of owner's equity. The statement of owner's equity is prepared after the income statement. It shows the beginning and ending owner's equity balances and the items affecting owner's equity during the period. These items include investments, the net income or loss from the income statement, and withdrawals. Because the specific revenue and expense categories that determine net income or loss appear on the income statement, the statement of owner's equity shows only the total net income or loss. Balances enclosed by parentheses are subtracted from unenclosed balances.

The Greener Landscape Group Statement of Owner's Equity For the Month Ended April 30, 20X2 J. Green, Capital, April 1 $ 0 Additions Investments $15,000 Net Income 61 15,061 Withdrawals (50) J. Green, Capital, April 30 $ 15,011

Balance sheet. The balance sheet shows the balance, at a particular time, of each asset, each liability, and owner's equity. It proves that the accounting equation (Assets = Liabilities + Owner's Equity) is in balance. The ending balance on the statement of owner's equity is used to report owner's equity on the balance sheet.

The Greener Landscape Group Balance Sheet April 30, 20X2 ASSETS Current Assets Cash $ 6,355 Accounts Receivable 200 Supplies 25 Prepaid Insurance 1,100 Total Current Assets 7,680 Property, Plant, and Equipment Equipment $18,000 Less: Accumulated Depreciation (235) 17,765 Total Assets $25,445 LIABILITIES AND OWNER'S EQUITY Current Liabilities Accounts Payable $ 50 Wages Payable 80 Interest Payable 79 Unearned Revenue 225 Total Current Liabilities 434 Long-Term Liabilities Notes Payable 10,000 Total Liabilities 10,434 Owner's Equity J. Green, Capital 15,011 Total Liabilities and Owner's Equity $25,445

Statement of cash flows. The statement of cash flows tracks the movement of cash during a specific accounting period. It assigns all cash exchanges to one of three categories—operating, investing, or financing—to calculate the net change in cash and then reconciles the accounting period's beginning and ending cash balances. As its name implies, the statement of cash flows includes items that affect cash. Although not part of the statement's main body, significant non-cash items must also be disclosed.

According to current accounting standards, operating cash flows may be disclosed using either the direct or the indirect method. The direct method simply lists the net cash flow by type of cash receipt and payment category. For purposes of illustration, the direct method appears below.

The Greener Landscape Group Statement of Cash Flows For the Month Ended April 30, 20X2

Cash Flows from Operating Activities
Cash from Customers	$ 870
Cash to Employees	(200)
Cash to Suppliers	(1,265)
Cash Flow Used by Operating Activities	(595)
Cash Flows from Investing Activities
Purchases of Equipment	(8,000)
Cash Flows from Financing Activities
Investment by Owner	15,000
Withdrawal by Owner	(50)
Cash Flow Provided by Financing Activities	14,950
Net Increase in Cash	6,355
Beginning Cash, April 1	0
Ending Cash, April 30	$6,355