Introduction to Financial Accounting
Professor Alexander Sannella
Lecture 3
Learning Objective 3
The Accounting Equation (A=L+OE) 0:21
Equity 1:33
Contributed or Paid in Capital 2:27
Retained Earnings 7:05
(+revenues-expenses-dividends)
Owner Transactions 11:32
Revenues 12:45
Gains 13:40
Expenses vs. Losses 16:19
Dividends 17:58
Summary (Equity) 21:10
Income 22:56
Questions and Explanations
Question 1 23:56
Question 2 28:50
Question 3 32:59
Learning Objective 4
How to Analyze a transaction 36:14
Transactions Analysis (Double Entry) 37:22
Examples 39:32
Questions and Explanations
Question 1 57:014
Question 2 59:52
Question 3 1:03:47
Learning Objective 5
Financial Statements 1:08:58
Income Statement 1:10:10
The accounting equation is: Assets = Liabilities + Equity. Equity is the owner's residual claim against the assets of the company. It includes contributed capital, retained earnings, and accumulated other comprehensive income. It is known as Stockholder's Equity in a corporation. Stockholder's equity consists of three major components: contributed or paid in capital, accumulated other comprehensive income, and retained earnings. The owner's claim on the resources increase and decrease as the company engages in operating activities.
Contributed or paid in capital includes the common stock sold by the entity at face or par value and amounts received above par value called additional paid-in capital or paid-in capital in excess of par (denoted APIC).
Retained earnings represent the historical record of earnings (losses) that have not been paid out or distributed as dividends to shareholders. Retained earnings consist of three items: revenues, expenses, and dividends.
As the company earns revenue, assets increase and the shareholder claims against the assets of the company will increase. Conversely, as the company incurs expenses, shareholders claims against the assets of the company will decrease. The other events that can change the company's claim against the assets of the company is the amount of resources that shareholders invest in the company (via common stock) and the amount of resources that the owners take out of the company
Revenues are economic resources that have been earned by delivering products or services to external customers. Revenues are the gross increase in stockholders' equity resulting from business activities entered into for the purpose of earning income. Revenues are asset inflows, or reduction of liabilities, resulting from the normal operations of the business. Gains, on the other hand, while they are asset inflows, or reduction of liabilities, they are from peripheral or nonoperating activities.
Expenses are the costs associated with selling goods or services to external customers. Expenses are the cost of assets consumed or services used in the process of earning revenue. Expenses are asset outflows, or increases of liabilities, resulting from the normal operations of the business. Losses are asset outflows, or increases of liabilities, resulting from peripheral or nonoperating activities.
Dividends are distributions of cash or other assets to stockholders; dividends reduce retained earnings. Dividends are NOT expenses in the determination of net income but are distributions of net income. The amount of the annual withdrawals (dividends) is usually limited by the business to prevent an owner from taking out more resources in a given period than the company can sustain.
A transaction is a special kind of historical event. A transaction must involve the exchange of economic resources, and we must be able to measure the economic impact in monetary units. Buying a copying machine for the office would be considered a transaction, whilst simply meeting with a potential customer would not qualify as a transaction.
Each transaction must have a dual effect on the accounting equation so that the equality of the equation is preserved. This is commonly known as double entry bookkeeping or the double entry system. For example, if an individual asset is increased, there must be a corresponding decrease in another asset, an increase in a specific liability, or an increase in stockholder's equity.
There are four financial statements. They are the Income Statement, Statement of Retained Earnings, Balance Sheet, and Statement of Cash Flows. They are used by all companies as the primary means of communicating to external stakeholders.
The income statement includes temporary accounts reflecting completed accounting cycles. The model of the income statement is simply revenues (gains, asset inflows, reduction in liabilities / obligations) minus expenses (losses, asset outflows, or an increase in liabilities / obligations) equals net income (listed on the bottom of the statement).
