LEGAL ACCOUNTING
PROFESSOR CHAPMAN
SPRING 2012
A. THREE PILLARS IN ACCOUNTING
1. Introduction to GAAP:
a. The SEC is charged with promulgating financial accounting principles. It has delegated that authority to the financial accounting standard board (FASB).
i. SOX made it so the FASB is funded from fees paid by publicly traded companies.
b. The Codification is what the SEC recognizes as the law of financial accounting.
i. These are Generally accepted accounting principles (GAAP).
c. The AICPA developed Generally accepted auditing standards (GAAS). When an audit is performed, the point is to express an opinion that the financial accounting is in accordance with GAAP.
d. International Accounting Standards Board (IASB): Issues statements that are international financial reporting statements (IFRPS). In many countries IFRS are GAAP.
2. Components of Financial Statements: (each statement leads to the next)
a. Income statement (Statement of Profit and Loss (P&L)).
i. Revenues
ii. Expenses
iii. Revenues – Expenses = Net income
b. Statement of Owner’s Equity (Statement of retained earnings)
i. Retained Earnings
c. Balance Sheet (Statement of Financial Position).
i. Assets = Liability + Equity
ii. Assets go on here. They are things that the company owns.
d. Statement of Cash Flow
i. What is actually going on with the company’s cash.
3. These are articulated statements, meaning that each statement leads to the next one. Ex: You need to know what the net income is on the income statement to calculate the statement of owner’s equity.
a. These statements have footnotes with important information.
4. Problem 1 (page 4):
1. The $50k in training is an expense. It goes on the income statement, not the balance sheet (no asset is obtained).
2. This money is an asset. An asset is when you buy something that will give you a long term benefit (ownership in something). This goes on the balance sheet.
i. In GAAP you use historical cost, it would be recorded as $150k in assets. In IFRS you use FMV and record it as a $180k asset.
3. Interest is a cash asset. It increases revenue on income statement (interest revenue) it also increases owner’s equity (individual stock is worth more) and increase assets on the balance sheet.
B. THE FUNDAMENTAL EQUATION
1. Balance Sheet: Reflects the financial condition of an entity as of that specific date. Lists entity’s assets as of a specified date and the entity’s liabilities as of that date and the difference between these totals.
2. Definitions:
a. Assets:
i. Probable future economic benefits obtained or controlled by an entity resulting from past transactions or events.
ii. Properties, resources, and claims owned/controlled by an equity
iii. Listed on balance sheet in order of liquidity, starting with cash
iv. Current assets – reasonable expected to be realized in cash or otherwise sold or consumed within a reasonably short period of time, usually one year.
v. Long-term assets – not expected to be turned into cash within that time.
b. Liabilities:
i. Probable future sacrifices of economic benefits arising from present obligations to transfer assets or render services in the future.
ii. Amounts owed by an entity to others, in the form of debts, accounts payable, and other obligations.
iii. Listed on balance sheet beginning with obligations having the shortest due date (like accounts payable) and ending with long-term debts (like long-term bonds).
c. Equity:
i. The residual interest in assets of an entity after subtracting its liabilities
ii. The net ownership interest in the entity, and often called “owner’s equity”.
iii. Represents both the initial investments made by the entity’s owners as well as the entity’s increases in income that it reinvests in the business.
iv. Net income increases equity and this is called retained earnings. This is income that has not yet been paid to SH in the form of dividends.
v. Total assets minus total liabilities.
3. The Fundamental Equation:
a. Assets=Liabilities + Owners’ Equity
i. Everything on left side (assets) increases with Dr and decreases with Cr.
ii. Everything on right side (liability and equity) increases with Cr and decreases with Dr.
b. The rights and claims an entity holds against others must equal the rights and claims others hold against it and the owners as residual claimants with respect to the equity.
c. Debits (left-side) always equal credits (right-side)
i. These terms as used in Assets
aa. Debit Increases Assets
bb. Credit decreases Assets.
cc. Debits always equal credits for every transaction
ii. These terms as used in Liabilities (other side of the equation.
aa. Debit Decreases Liabilities
bb. Credit Increases Liabilities
cc. Debits always equal credits for every transaction.
iii. Ex. in the T-account:
(1) Borrow $100 from the bank
of all the other T-accounts and put them in as either a Dr or a Cr depending on what they ended as. It should balance out.
4. Income Statement: Reflects the financial performance of the entity during that period of time. Lists the total revenues generated by the entity during the period and the total expenses incurred by the entity during that period and then shows the difference between those totals. Subtract Expenses from revenue and you get the net income.
a. What makes up the Income statement:
i. Revenues
aa. Increases in equity resulting from asset increases and/or liability decreases from delivering goods or services or other activities that constitute the entity’s ongoing major or central operations.
bb. Cover sales of merchandise, rendering of services, sales of securities by a securities dealer, sales of buildings and land by a real estate developer, rentals of sales of building and land by a real estate developer, rentals of commercial buildings and land by real property owners, ad dividends and interest earned by financial institutions – all of which represent the entity’s major or central operations.
ii. Expenses
aa. Decreases in equity from asset decreases and/or liability increases from delivering goods or services, or carrying out any activities that constitute the entity’s ongoing major or central operations.
iii. Net income/earnings
aa. The difference between revenues and expenses during each reporting period.
bb. A measure of the entity’s financial performance during that period.
cc. Equals the amount of increase in owners’ equity calculated in the balance sheet.
