Financial Accounting Day - 01

Understanding
Accounting Transactions
Day 1
(Chapters 1 to 4)
Prof. Jonghwan Kim, Ph.D.

Course 20352| Prep for Financial Accounting
20352 - FINANCIAL ACCOUNTING

PREPARATORY COURSE
for
AFC, IM, CLEFIN-FINANCE, and EMIT
Department of Accounting, Via Roentgen, 1 5th

floor A3-06
Email: jonghwan.kim@unibocconi.it
Consultation hours: by email appointments
FinancialAccountingPrep.20352|AY20142015|Prof.JonghwanKim
Instructor:
Jonghwan Kim, Ph.D.
Accounting is the language of business, an important means of

communication among various business parties. Among others,
financial accounting speaks mainly to external information users,
such as investors and financial analysts, who make decisions for
many different purposes using the accounting information
revealed in financial statements. This preparatory course is
designed to provide students with a quick understanding of key
accounting concepts and principles with which financial
statements are prepared. Despite its short span, this course
covers most of important accounting topics including:
the double-entry accounting system,
accounting for common transactions, and
financial statement preparation (including income statement,
balance sheet, and cash flow statement).
Course Description
Objectives
The course aims to prepare students for other graduate-level
business courses for which accounting knowledge and skills
can help to advance relevant knowledge. Upon completion of
the course, students are expected to understand the basics
of
accounting terminology,
how to interpret the accounting information.
how to generate accounting information and prepare

financial statements, and
Class Schedule
12 sessions, 6 days
Date
Time
1
2
3
August 27
13:00~14:30
14:30~16:00
16:15~17:45
Understanding accounting transactions SLL Ch. 1 to 4

Double-entry book-keeping
Accrual accounting
Accounting cycle
Income statement and balance sheet
4
5
6
7
8
9
10
11
12
August 28
14:30~16:00
16:15~17:45
13:00~14:30
14:30~16:00
8:45~10:15
10:30~12:00
10:30~12:00
14:30~16:00
16:15~17:45
Sales and accounts receivable

Inventory and cost of goods sold
Long-lived assets
Liabilities and long-term debt
Bonds
Owners Equity
Investments
Cash flow statement
Comprehensive review
August 29
September 1
September 2
September 3
Topics
Session 1
FINANCIAL ACCOUNTING
- INTRODUCTION -
Reference
SLL Ch. 6
SLL Ch. 7
SLL Ch. 8
SLL Ch. 9
SLL Ch. 10
SLL Ch. 11
SLL Ch. 12
SLL Ch. 13
Hand-outs
Session
What is Accounting?
Accounting is the language of business.
measure
record
analyze
!
Information
Decision-Makers
(Information Users)
A system that collects and processes financial information

about an organization and reports that information to
decision makers
Collect Process Report
Accounting for Different Users

Exhibit 1.1
Internal Decision Makers

External Decision Makers
Objectives of Financial Reporting

To provide useful economic information about a business to
help external users of financial statements
External users?
investors
creditors
Interested in a businesss ability to generate cash

to pay dividends
to increase the businesss value
to pay interest and the principal on a loan
financial advisors
Four Basic Financial Statements
Financial position at a particular point

in time:
Assets
Liabilities
Owners Equity
Income Statement
Financial performance during
an accounting period measured
as revenues minus expenses
Statement of
Cash Flows
Statement of
Retained Earnings
The change of the cash balance

In/out-flows in three categories:
Operating activities
Investing activities
Financing activities
The change of retained earnings:

+ net income
dividends
Balance Sheet
Assets
Economic resources
Probable future benefits
Owned or controlled
Related to prior transactions
Liability
Economic obligation
Probable future sacrifices
Unavoidable
Related to prior transactions
Stockholders Equity
Financing provided
by owners and operations
Revenue: increase in assets or settlement of liabilities from ongoing operations

Expense: decrease in assets or increase in liabilities from ongoing operations
Gain: increase in assets or settlement of liabilities from peripheral activities
Loss: decrease in assets or increase in liabilities from peripheral activities
I/S Equation Revenues Expenses = Net Income
Balance Sheet
Basic Accounting Equation
Relationships
Among the Four Basic Financial Statements
Basic Accounting Equation
Income Statement Equation
Income Statement
Balance Sheet
Key Elements of Financial Statements
Accounting Standards
Guides and rules that govern accounting practice,
regarding how financial statements are prepared and
accounting information is presented
GAAP (Generally Accepted Accounting Principles)
Prior to 1930s, each company has self-defined financial

reporting practices. Thus, no uniform standard across
companies was in practice.
Why do we need accounting standards?
IFRS (International Financial Reporting Standards)
Conceptual Framework
Qualities of Financial Information
Primary Characteristics
Relevancy:
predictive value, confirmatory (feedback) value, and
timeliness.
Secondary Characteristics
Comparability: across companies.
Consistency: over time.
Faithful Representation (Reliability):

verifiability, neutrality, and completeness
Assumptions and Principles for Measuring and Reporting Information
Assumptions:
Separate-Entity
Unit-of-Measure
Continuity (Going-concern)
Principles:
Historical Cost
Revenue Recognition
Matching
Full Disclosure
Session 1 (Continued)
ACCOUNTING TRANSACTIONS,
ACCOUNTING EQUATION, AND
DOUBLE-ENTRY BOOKKEEPING
Time Period
Accounting Transactions
Economic events that impact the financial standing of a
business
Internal Events:
not an exchange between the business and other
parties, but have a direct effect on the accounting entity
External Events:
exchanges of assets, goods, or services with one or
more external parties
Accounts
An organized format used by companies to accumulate

the dollar effects of transactions
Typical Account Titles
Assets
Cash
Short-Term Investment
Accounts Receivable
Notes Receivable
Inventory (to be sold)
Supplies
Prepaid Expenses
Long-Term Investments
Equipment
Buildings
Land
Intangibles
Liabilities
Accounts Payable
Accrued Expenses
Notes Payable
Taxes Payable
Unearned Revenue
Bonds Payable
Stockholders Equity
Contributed Capital
Retained Earnings
Balance Sheet Accounts
Typical Account Titles

Income Statement Accounts
Expenses
Cost of Goods Sold
Wages Expense
Rent Expense
Interest Expense
Depreciation Expense
Advertising Expense
Insurance Expense
Repair Expense
Income Tax Expense
Revenues
Sales Revenue
Fee Revenue
Interest Revenue
Rent Revenue
Transaction Analysis
How do transactions affect accounts?
Principles of Transaction Analysis
Accounting Equation:
Assets = Liabilities + Stockholers Equity
Duality:
Every transaction affects at least two accounts
Balancing the Accounting Equation
Step 1: Accounts and effects
Identify the accounts affected and classify them by
type of account (A, L, SE).
Step 2: Balancing
Verify that the accounting equation (A = L + SE)
remains in balance.
Determine the direction of the effect (increase or

decrease) on each account.
Example:
a. Papa Johns issues $2,000 of additional common stock to new investors
for cash.
b. The company borrows $6,000 from the local bank, signing a three-year
note.
c. Papa Johns purchases $10,000 of new equipment, paying $2,000 in
cash and signing a two-year note payable for the rest.
e. Papa Johns purchases the stock of other companies as a long-term

investment, paying $1,000 in cash.
f. Papa Johns board of directors declares and pays $3,000 in dividends to
shareholders.
1. Identify and classify the accounts.

2. Determine the direction of effects.
3. Verify the equation holds.
d. Papa Johns lends $3,000 cash to new franchises who sign notes
agreeing to repay the loans in five years.
Luca Pacioli, Italian monk and mathematician,

the writer of Summa de Arithmetica, Geometria, Proportioni et Proportionalit"
(early Italian: "Review of Arithmetic, Geometry, Ratio and Proportion")
http://en.wikipedia.org/wiki/History_of_accounting#mediaviewer/File:Pacioli.jpg
Double-Entry Bookkeeping
Keeping Track of Account Balances

Double-entry bookkeeping
Debit (dr.) and Credit (cr.)
T-Account
Debit
(Dr.)
Account Title
Credit
(Cr.)
Basic Transaction Analysis Model
Any Asset Account

[increase] [decrease]
$ 10
6
??
11 ??
5
$ 16
Any Liab./ SE Account

[decrease] [increase]
$ 20
12
?? 7
??
25
$ 32
T-account & Accounting Equation
Making Journal Entries

Journal Entry
To record transactions in chronological order in a

general journal
Posting to General Ledger

Posting
To transfer (record) transactions into respective

accounts in a general ledger
Journal Entries and T-Accounts
Example:
a. Papa Johns issues $2,000 of additional common stock to new investors
for cash.
b. The company borrows $6,000 from the local bank, signing a three-year
note.
c. Papa Johns purchases $10,000 of new equipment, paying $2,000 in
cash and signing a two-year note payable for the rest.
e. Papa Johns purchases the stock of other companies as a long-term

investment, paying $1,000 in cash.
f. Papa Johns board of directors declares and pays $3,000 in dividends to
shareholders.
Session 2
ACCRUAL ACCOUNTING AND

INCOME STATEMENTS
d. Papa Johns lends $3,000 cash to new franchises who sign notes
agreeing to repay the loans in five years.
Operating Cycle
The time it takes for a company to pay cash to suppliers, sell
goods and services to customers, and collect cash from
customers.
Receive
cash from
customers
Pay cash to
suppliers
Sell goods
or services
to
customers
Purchase
Operating Cycle
Time Period: The long life of a company can be reported

over a series of shorter time periods.
Recognition Issues : When should the effects of operating

activities be recognized (recorded)?
Measurement Issues: What amounts should be

recognized?
The operating cycle repeats continuously until a company

goes out of the business.
Increase in assets
or
Settlement of liabilities
Decrease in assets
or
Increase of liabilities
from ongoing operations

/ primary businesses
Revenue
Expenses
from peripheral
transactions
Gains
Losses
Elements of the Income Statement
Papa Johns Income Statement
Exhibit 3.1
Accrual vs. Cash Accounting

Accrual Basis Accounting
Records accounting transactions when they occur
revenues are recognized when earned,
expenses when incurred
Cash Basis Accounting

Records transactions whenever they involve cash
receipt or distribution.
Regardless of the timing of receipts or payments of

cash.
for Measuring and Reporting Information
Under Accrual Basis Accounting,
Recognize revenues when...

Delivery has occurred or services have been rendered.
There is persuasive evidence of an arrangement for
customer payment.
The price is fixed or determinable.
Collection is reasonably assured.
Matching Principle
Resources consumed to earn revenues in an accounting
period should be recorded in that period, regardless of when
cash is paid.
Revenue Principle
Revenue Principle
Journal entries for situations:

1. Cash received in advance
2. Cash received at the time of sale
3. Cash received after a sale
Exhibit 3.2
Matching Principle
Journal entries for situations:

1. Cash paid before the expense is incurred
2. Cash paid when ...
3. Cash paid after ...
Exhibit 3.3
Extended Transaction Analysis Model
Balancing the Accounting Equation
Step 1: Accounts and effects
Identify the accounts affected and classify them by
type of account (A, L, SE).
Step 2: Balancing
Verify that the accounting equation (A = L + SE)
remains in balance.
Determine the direction of the effect (increase or

decrease) on each account.
Example:
a. Papa Johns restaurants sold pizza to customers for $36,000 cash and sold
$30,000 in supplies to franchised restaurants, receiving $21,000 cash with the
rest due on account.
b. The cost of the dough, sauce, cheese, and other supplies for the restaurant
sales in (a) was $30,000.
d. In January, Papa Johns paid $7,000 for utilities, repairs, and fuel for delivery
vehicles, all considered general and administrative expenses incurred during
the month.
e. Papa Johns commissaries ordered and received $29,000 in supplies, paying
$9,000 in cash and owing the rest on account to suppliers.
f. Papa Johns paid $14,000 cash to employees for their work in January.
c. Papa Johns sold new franchises for $400 cash, earning $100 immediately by
performing services for franchisees; the rest will be earned over the next
several months.
Example:
g. At the beginning of January, Papa Johns paid the following, all of which are
considered prepaid expenses when paid (any adjustments will be made in
Chapter 4):
$2,000 for insurance (covering the next four months beginning January 1),
$6,000 for renting space in shopping centers (over the next three months
beginning January 1), and
$1,000 for advertising (to be run in February).
i. Papa Johns received $15,500 in franchisee fees based on their weekly sales;
$12,800 of the amount was due from franchisees sales recorded as accounts
receivable in December and the rest is from January sales.
j. Papa Johns paid $10,000 on accounts owed to suppliers.
k. Papa Johns received $1,000 in cash for interest earned on investments.
h. Papa Johns sold land with an historical cost of $1,000 for $4,000 cash.
Relationships
Among the Four Basic Financial Statements
Preparing Financial Statements
M3-7
Session 3
ACCOUNTING CYCLE, BOOK CLOSING, AND

PREPARING FINANCIAL STATEMENTS
Accounting Cycle
Exhibit 4.1
1. Unadjusted Trial Balance

A listing of individual accounts
Usually in financial statement order
Debits = Credits
2. Adjustments
Purpose
Because transactions occur over time, adjustments are
required at the end of each fiscal period to get the
revenues and expenses into the right period.
Revenue Recognition & Matching Principles
Expenses are recorded when incurred

Assets are reported to represent the remaining
probable future benefits
Liabilities are reported to represent the remaining
future economic sacrifices
Revenues are recorded when earned
2. Adjustments
Adjustment Process
1. Was revenue earned or an expense incurred that is not
yet recorded?
3. Compute the amount of revenue earned or expense

incurred.
2. Was the related cash received or paid in the past or will

it be received or paid in the future?
2. Adjustments
Revenue
1. Unearned (or Deferred)
2. Accrued
Adjusting entries
are required
at the end of
Period 1
Period 1
Period 2
Expense Incurred
Expense
3. Deferred
4. Accrued
Revenue Earned
2. Adjustments
Example:
1. Unearned Franchise Fees
Papa Johns received cash last period and recorded an increase in Cash and an increase in
Unearned Franchise Fees, a liability, to recognize the businesss obligation to provide future
services to franchisees. During January, Papa Johns performed $1,100 in services for
franchisees who had previously paid fees.
2. Accounts Receivable
3. Interest Receivable
Papa Johns loaned $3,000 to franchisees on December 31 (one month ago) at 6 percent
interest per year with interest to be paid at the end of each year. There was also $8,000 in
notes receivable outstanding all month from prior loans. Assume the interest on the other
$8,000 in notes receivable is $55.
Papa Johns franchisees owe Papa Johns $830 in royalties for sales the franchisees made
in the last week of January.
2. Adjustments
Example:
4. Prepaid Rent and Insurance
The Prepaid Expenses account includes $2,000 paid on January 1 for insurance coverage
for four months (January through April) and $6,000 paid on January 1 for the rental of space
at shopping centers over three months (January through March).
5. Supplies
6. Property and Equipment

The net book value of Papa Johns property and equipment is $199,000 (net of accumulated
depreciation of $189,000).
Papa Johns estimates depreciation to be $30,000 per year.
7. Accrued Expenses Payable

Papa Johns owed (1) its employees salaries for working four days at the end of January at
$500 per day, (2) $610 for utilities used in January, and (3) interest on its long-term notes
payable borrowed at a 6 percent annual rate.
Supplies include food and paper products. At the end of the month, Papa Johns counted
$12,000 in supplies on hand, but the Supplies account indicated a balance of $16,000 (from
Exhibit 4.2 ).
Adjusted T/B
Exhibit 4.5
3. Preparing Financial Statements
The next step in the accounting cycle is to prepare the

financial statements. . .
1. Income Statement
2. Statement of Stockholders Equity
3. Balance Sheet
4. Closing the Books

Closing Entries:
Transfer net income (or loss) to Retained Earnings.
Establish a zero balance in each of the temporary
accounts to start the next accounting period.
Temporary accounts with debit balances are credited,

with credit balances are debited.
4. Closing the Books

Closing Entries
Dr.
Cr.
7,590
66,000
4,730
1,070
3,000
30,000
16,000
4,000
2,000
500
610
2,500
690
3,910
$74,800
Post-Closing Trial Balances

will have zero balances on these temporary accounts.
$74,800
7,000
Closing
Entries
Credit
7,590
127,590
66,000
4,730
1,070
3,000
30,000
16,000
7,000
4,000
2,000
500
610
2,500
690
3,910
$ 74,800
$ 74,800
$685,710
$685,710
Debit
Post-Closing
Trial Balance
-39,000
-17,000
+3,200
7,200
-2,160
5,040
+39,000
-17,000
153,000
153,000
-3,200
115,800
+2,160
117,960
-39,000
-17,000
+3,200
37,200
-2,160
35,040
E4-15
a. 4
26
c. 8
8
b. 5
5
d. 9
9
a,b,c,d
84
26
58
26
188
188
E4-18
35
9
2
80
73

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Understanding

Prof. Jonghwan Kim, Ph.D.

20352 - FINANCIAL ACCOUNTING

Department of Accounting, Via Roentgen, 1 5th

Accounting is the language of business, an important means of

how to interpret the accounting information.

how to generate accounting information and prepare

Understanding accounting transactions SLL Ch. 1 to 4

Sales and accounts receivable

A system that collects and processes financial information

Collect Process Report

Accounting for Different Users

Internal Decision Makers

External Decision Makers

Objectives of Financial Reporting

Interested in a businesss ability to generate cash

Four Basic Financial Statements

Financial position at a particular point

The change of the cash balance

The change of retained earnings:

Revenue: increase in assets or settlement of liabilities from ongoing operations

I/S Equation Revenues Expenses = Net Income

Basic Accounting Equation

Basic Accounting Equation

Income Statement Equation

Key Elements of Financial Statements

Prior to 1930s, each company has self-defined financial

IFRS (International Financial Reporting Standards)

Faithful Representation (Reliability):

An organized format used by companies to accumulate

Typical Account Titles

Balance Sheet Accounts

Typical Account Titles

Determine the direction of the effect (increase or

e. Papa Johns purchases the stock of other companies as a long-term

1. Identify and classify the accounts.

Luca Pacioli, Italian monk and mathematician,

Keeping Track of Account Balances

Basic Transaction Analysis Model

Any Asset Account

Any Liab./ SE Account

T-account & Accounting Equation

Making Journal Entries

To record transactions in chronological order in a

Posting to General Ledger

To transfer (record) transactions into respective

e. Papa Johns purchases the stock of other companies as a long-term

ACCRUAL ACCOUNTING AND

Time Period: The long life of a company can be reported

Recognition Issues : When should the effects of operating

Measurement Issues: What amounts should be

The operating cycle repeats continuously until a company

from ongoing operations

Elements of the Income Statement

Papa Johns Income Statement

Accrual vs. Cash Accounting

Cash Basis Accounting

Regardless of the timing of receipts or payments of

Under Accrual Basis Accounting,

Recognize revenues when...

Journal entries for situations:

Journal entries for situations:

Extended Transaction Analysis Model