ACCOUNTING FOR LAWYERS
TOPIC 1 CONCEPTS
MECHANICS OF ACCOUNTING
•Financial Accounting: the process by which we prepare financial reports to be issued to external parties. (contrast with cost accounting which is used internally)
•4 Statements
1. Income Statement
2. Balance Sheet
3. Statement of shareholders equity
4. Statements of Cash Flows
Other informations besides financial statements found in the annual report
-footnotes
-MD&A
Each financial statement is comprised of a number of different “line items” which are also referred to as “accounts”.
Balance Sheet: snapshot of the company at a particular point in time
Income Statement: shows income made/lost for a period of time
Balance Sheet Componenets
Assets- what you own
Liabilities- what you owe
Equity- whats left over (a concept, not a thing)
Accounting Equation: ASSETS = LIABILITIES + STOCKHOLDERS EQUITY
(this equality always holds true, even if there are accounting errors)
How do accounts work? They prepare financial statements periodically, and keep
“T Accounts” in the meantime.
Each T account has two columns; one to report increases in that account and one to report decreases in that account. Ie. the cash account has its own T-Account and every time the cash account is effected, the T account gets either an increase or decrease on the relevant side depending on the type of trasnaction.
ASSETS: are on the left hand side of the equation, and show increases on the left and decreases on the right.
LIABILITIES & SE: are on the right hand side of the equation, and show increases on the right and decrease
ets and Liabilities)
CREDITS: increase right hand side accounts (Lia & SE); and decrease left hand side accounts (Assets)
Simple Example
On 1/1/07, I form a business and complete the following transactions:
Transaction # Description
1 Issue common stock for 900k
2 Buy inventory for 600k
3 Borrow 400k
Asset accounts:
cash inventory
900 600
600
400
Liabilities & equity accounts:
debt common stock
400 900
Now, after all of these transactions, what is my new accounting equation?
assets = liab + equity
cash + inventory = debt + equity
700k + 600k = 400k + 900k
For each transaction you can also make a JOURNAL ENTRY
Finally, note that all of these T-account entries:
1. (DR) cash for 900k
(CR) common stock for 900k
2. (DR) inventory for 600k
(CR) cash for 600k
3. (DR) cash for 400k
(CR) debt for 400k
These particular transactions only effect the balance sheet; many transactions also effect the Income Statement, eg.
Recall my 30k trailer home.
assets = liabilities + equity
30k = 25k + 5k
Now assume:
– my trailer home goes DOWN in value by 2k
– I don’t make any principal payments on my home loan
My new accounting equation would be:
assets = liabilities + equity
28k = 25k + 3k
