Notes

The Benefits of providing accurate accounting information are better access to financial resources (because I obtain more easily equity) and better contractual terms. The Costs of providing accurate accounting information are the so-called preparation costs, which are the cost of obtaining, storing and exploiting data, in addition there are Audit Fees and Proprietary Costs (loss of classified information that can become useful to competitors, it is a reduction in competitive advantage).

The primary objective of external financial reporting is "To provide useful economic information about a business to help external parties make sound financial decisions". The external parties involve Banks, Equityholders, Clients and Suppliers. While the documents are the 4 financial statements.

The Characteristics of Accounting Information, those that will be checked every year by Auditors.

Accounting Information should be:

• Relevant to Decision Makers, it provides feedback and predictive value on a timely basis.
• Reliable, therefore accurate, unbiased and verifiable. When the firms commit an error in their financial statements, they produce an Accounting Restatement. The years following the accounting restatement usually the firm receives lower funds because it's considered unreliable.
• Comparable, across companies. I will choose in which company to invest in after comparing their financial statements, therefore the financial statements have to be comparable with those of other companies.
• Consistent, over time, the same accounting rule on measurement is used from one accounting period to the next. It means that I make account choices that should be the same over time.

Balance Sheet If the first item of the balance sheet is cash expressed in U.S.Dollars, the firm is following GAAP, otherwise if the first item is Property, Plant and Equipment, the firm is following IFRS. As we already said, the Balance Sheet includes all resources (assets) owned and amounts owed (liabilities).

Assets are economic resources with probable future benefits owned or controlled by an entity as a result of past transactions.

They can be:

• Current Assets, resources that company will use or turn into cash within one year, such as Cash, Accounts Receivables and Inventories.
• Non-Current Assets, resources that company will use or turn into cash beyond one year, such as Property, Plant and Equipment.

Liabilities are probable debts or obligations (claims to company's resources) that result from a company's past transactions and will be paid with assets or services.

They can be:

• Current Liabilities, liabilities that the company needs to pay or settle within the coming year, such as Accounts payable, Short-term Borrowings and Current Portion of Long-Term Debt.
• Non-Current Liabilities, liabilities that the company needs to pay or settle beyond the coming year, such as Long-Term Debt.

Stockholders' Equity is the financing provided by the owner and business operations (retained earnings).

Stockholders' Equity = Contributed Capital + Retained Earnings.

Retained Earnings is the part of earnings that it is not distributed through dividends and it is reinvested in the company.

Dividends and Capital Gains represent the return for owners' investment in the firm.

During the accounting period, transactions that result in exchanges between the company and other external parties are analyzed and recorded in the general journal in chronological order, and the related accounts are updated in the general ledger. These formal records are based on two very important tools used by accountants: Journal Entries and T-accounts (created for each accounting item we have in the financial statement). From the standpoint of accounting systems design, these analytical tools are a more efficient way to reflect the effects of transactions, determine account balances, and prepare financial statements. The steps needed to record a transaction are:

• Identify the transaction
• Identify the accounts that are involved
• Determine the effects (increase vs decrease) of the transaction on each account
• Record the effect of the transaction for each account, making sure that the accounting equation is fulfilled.

The Duality of Effects Most transactions with external parties involve an exchange where the business entity gives up something but receives something back. Hence, transactions related with investments and financing affects the balance sheet at least twice.

Account is an organized format used by companies to accumulate the dollar effects of transactions.

To remember which accounts debits increase and which accounts credits increase, recall that a debit (left) increases asset accounts because assets are on the left side of the accounting equation (A = L + SE). Similarly, a credit (right) increases liability and stockholders' equity accounts because they are on the right side of the accounting equation.

The journal entry, then, is an accounting method for expressing the effects of a transaction on accounts. It is written in a debits-equal-credits format. One very useful tool for summarizing the transaction effects and determining the balances for individual accounts is a T-account, a simplified representation of a ledger account.

After Journal entries are prepared, the accountant posts (transfers) the dollar amounts to each account affected by the transaction. For each transaction during the year, Journal Entry and T-Accounts for each account are affected. At the end of the year, all the T-Accounts related to balance sheet are combined in the final balance sheet.