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Introduction to financial accounting

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Introduction to financial accounting Powered By Docstoc
					Chris Benson

INTRODUCTION TO FINANCIAL
ACCOUNTING
AGENDA
 Brief History
 What is Accounting?
 3 Key Financial Statements
 Vocabulary – Balance Sheet
 Balance Sheet Formula
 Balance Sheet
     Example 1
     Example 2
     Example 3
   Depreciation Formula and Example
AGENDA

 Vocabulary - Income Statement
 Income Statement Formula
     Example 1
     Example 2

     Example 3

   Test your knowledge
HISTORY

   Luca Pacioli – father of modern accounting
     Renaissance

     Mathematician  and friar
     Developed the double-entry accounting system

     Your debits must equal your credits!
RECENT HISTORY

 Accounting fraud has been behind many
  financial headlines
 Name that white-collar criminal!
WHAT IS ACCOUNTING?

   Accounting is the art of communicating
    financial information about a business entity to
    users such as shareholders and managers.

   The communication is generally in the form of
    financial statements that show in money terms
    the economic resources under the control of
    management
THREE KEY FINANCIAL STATEMENTS

   Balance Sheet – snap shot of financial health

   Income Statement – communicates periodic
    performance

   Statement of Cash Flows – communicates
    periodic cash usage
VOCABULARY – BALANCE SHEET
   Asset – things of value that can be readily converted
    into cash
       Examples?

   Liability – future obligation of payment for a good or
    service that has been rendered
       Examples?

   Shareholder’s Equity – shareholder’s interest after the
    liabilities have been paid.
       Examples?
       Owners are the last to be paid!
VOCABULARY – BALANCE SHEET
   Accumulated Depreciation - cumulative
    reduction in the value of an asset due to usage,
    passage of time, wear and tear, technological
    outdating or obsolescence, depletion,
    inadequacy, rot, rust, decay or other such
    factors.

   Book value – original cost of asset less the
    accumulated depreciation
BALANCE SHEET FORMULA

   Assets = Liabilities + Shareholder’s Equity

                                   Liabilities
         Assets                 Accounts Payable
          Cash                   Long term debt
  Accounts Receivable
       Inventory
   Property Plant and
      Equipment
Accumulated Depreciation       Shareholder’s Equity
                                 Common Stock
                                Retained Earnings
BALANCE SHEET EXAMPLE #1

   Duke energy borrows $100 million from Bank
    of America. The proceeds are transferred to
    Duke’s bank account as cash.
                               Liabilities
                             Long-term debt
                                +$100
          Assets
           Cash
          +$100

                            Shareholder Equity
                               No Change
BALANCE SHEET EXAMPLE #2

   Duke energy issues 10 million shares with a
    par value of $1 per share. The proceeds are
    transferred to Duke’s bank account as cash.
                                Liabilities
                                No Change
          Assets
           Cash
          +$10
                             Shareholder Equity
                              Common Stock
                                   +$10
BALANCE SHEET EXAMPLE #3

   Duke Energy uses the cash raised in Example
    #2 to purchase coal from WV Mining. The coal
    is stored in inventory until it is used.
                               Liabilities
                               No Change
          Assets
         Cash -$10
      Inventory +$10
                            Shareholder Equity
                             Common Stock
                               No Change
DEPRECIATION FORMULA AND EXAMPLE
VOCABULARY – INCOME STATEMENT
   Revenue – income that a company receives from
    its normal business activities, usually from the
    sale of goods or services to customers
       Examples?

   Expense – an event in which an asset is used up
    or a liability is incurred
       Examples?

   Net Income – profit(loss) remaining after expenses
    are subtracted from revenues
INCOME STATEMENT FORMULA
 Revenue – Expenses = Net Income (Profit)
 Revenue recognition – income is not recognized
  on the income statement until goods are delivered
  or services are rendered.
       Ask yourself, did a good or service cross the fence?
          Yes= revenue
          No = no revenue recognition

   Matching principle – for every good or service sold,
    an asset must have been used or a liability
    incurred
INCOME STATEMENT EXAMPLE #1

   Duke energy delivers         Revenue: $100
    500 kilowatts of energy      Coal usage expense: $30
    for $100                     Labor usage expense:
   The coal burned to            $20
    produce the energy cost      Net Income: $50
    $30
   2 hours of labor were
    used to produce and
    distribute the power
    costing $20
INCOME STATEMENT EXAMPLE #1

   Example #1 demonstrates a form of expense
    called “Costs of Goods Sold”
     This expense is demonstrates the matching
      principle in action
     Revenues realized from the delivery of the power
      were matched with the cost of materials + labor
      used to manufacture and distribute the power
INCOME STATEMENT EXAMPLE #2

   Duke recently employed 2 William & Mary
    students as interns. These students activities
    included fetching coffee and making copies. It
    is impossible to associate their labor to a unit
    of energy that is delivered to a customer by
    Duke – is there an expense that should be
    recognized?
INCOME STATEMENT EXAMPLE #2
   Answer – Yes!

   While it is difficult to match the labor usage to a unit of
    revenue, we know that the interns were functioning in an
    indirect capacity that affects Duke’s day-to-day business
    activities.

   This type of expense is a Selling General and Administrative
    expense.

   The total salary owed to the interns during the period is
    taken as an expense on the income statement
INCOME STATEMENT EXAMPLE #3

 Bank of America (BofA) did not loan Duke the
  money without strings attached. The interest
  payment is not enough. BofA included
  covenants in the contract. One covenant states
  that the interest coverage ratio can not fall
  below 4.0. How do you calculate it?
 EBIT / Interest Expense
    TEST YOUR KNOWLEDGE
   In the 2008 accounting period,

   (1) Duke Energy completes a new plant that costs them $100 million funded the
    investment with a combination of $70 million in long-term debt and $30 million in equity.

   (2) The plant has a useful life of 20 years and depreciation starts in 2008, zero salvage
    value.

   (3) Duke delivers $80 million in energy to customers. The customers paid in cash. Duke
    used $30 million in inventory to produce the energy and $20 million in indirect expenses
    accrued.

   (4) Duke pays the interest on the new debt at the end of the year.

   (5) Duke’s tax rate is 25%.

   Tell me how these transactions impact the balance sheet and income statement. Is
    Bank of America concerned about Duke’s ability to make interest payments?

				
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