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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