Financial Accounting For Dummies

Maire Loughran, CPA, is a university professor who teaches both undergraduate and graduate accounting classes. She is the author of Auditing For Dummies as well as the previous edition of Financial Accounting For Dummies.

Introduction 1

About This Book 2

Foolish Assumptions 2

Icons Used in This Book 3

Beyond the Book 3

Where to Go from Here 4

Part 1: Getting a Financial Accounting Initiation 5

Chapter 1: Seeing the Big Picture of Financial Accounting 7

Knowing the Purposes of Financial Accounting 8

Preparing financial statements 8

Showing historic performance 10

Providing results for the annual report 10

Getting to Know Financial Accounting Users 11

Identifying the most likely users 11

Recognizing their needs 11

Providing information for decision-making 12

Respecting the Key Characteristics of Financial Accounting Information 13

Relevance 13

Reliability 14

Comparability 14

Consistency 15

Accepting Financial Accounting Constraints 17

Considering Your Ethical Responsibilities 18

Following the accountant’s code of conduct 18

Having integrity 19

Maintaining objectivity 19

Achieving independence 20

Introducing the Conceptual Framework of Financial Accounting 21

Chapter 2: Introducing the Big Three Financial Statements 23

Gauging the Health of a Business through Its Financials 24

Reporting Assets and Claims: The Balance Sheet 25

Realizing why the balance sheet is “classified” 26

Studying the balance sheet components 26

Seeing an example of a classified balance sheet 29

Posting Profit or Loss: The Income Statement 30

Keeping a scorecard for business activity 30

Studying the income statement components 31

Seeing an example of an income statement 33

Showing the Money: The Statement of Cash Flows 33

Tracking sources and uses of cash 34

Studying sections of the cash flow statement 34

Seeing a short statement of cash flows 35

Chapter 3: Running the Numbers for Success 37

Identifying Accounting Issues and Solutions 38

Selecting a Business Entity 38

Advantages of the sole proprietorship 39

Owners’ capital 39

Limiting liability with the S Corporation 40

Learning about recognition options 41

Reporting for Small Businesses 42

Preparing reports 42

Analyzing reporting 45

Identifying cost issues 46

Managing Cash 48

Identifying cost issues 48

Improving cash flow 53

Chapter 4: Acronym Alert! Setting the Standards for Financial Accounting 55

Walking through the Origins of Number Crunching 56

Knowing the Role of the American Institute of Certified Public Accountants (AICPA) 58

ASB audit and attestation standards 59

AICPA Code of Professional Conduct 60

Following Regulatory Issues 61

The U.S Securities and Exchange Commission (SEC) 62

The Sarbanes-Oxley Act of 2002 (SOX) 63

The Public Company Accounting Oversight Board (PCAOB) 64

Getting to Know the Financial Accounting Standards Board (FASB) 65

Understanding generally accepted accounting principles (GAAP) 66

Looking online for the FASB’s standards 67

Part 2: Reviewing Some Accounting Basics 69

Chapter 5: Booking It: The Process Behind Financial Accounting 71

Shedding Some Light on Bookkeeping 72

Analyzing the Effect of Business Transactions 73

Working the fundamental accounting equation 73

Getting familiar with accounts 74

Defining debits and credits 76

Learning about the transaction methodology 77

Defining Journals 78

Using journals to record cash transactions 78

Recording accrual transactions 82

Learning about other journals 84

Seeing examples of common journal entries 86

Bringing It All Together in the Ledger 88

Realizing what a ledger is 88

Posting to the ledgers 89

Viewing an example of a general ledger 89

Recognizing the purpose of the trial balance 91

Chapter 6: Focusing on Accounting Methods and Concepts 93

Distinguishing between Key Accounting Methods 94

The cash basis 94

The accrual basis 95

Sorting through Standards for Other Types of Accounting 96

Managerial accounting 96

Not-for-profit accounting 97

Governmental accounting 98

International accounting 98

Considering the Conceptual Framework of Financial Accounting 99

The objective of financial reporting 100

Characteristics of accounting information 101

Elements of the financial statements 101

Financial statement measurements 102

Part 3: Spending Quality Time with the Balance Sheet 103

Chapter 7: Assessing the Balance Sheet’s Asset Section 105

Homing in on Historic Cost 106

Learning What Makes an Asset Current 106

Cash 107

Short-term investments 108

Accounts receivable 110

Notes receivable 111

Inventory 112

Prepaid expenses 113

Keeping Track of Noncurrent (Long-Term) Assets 114

Meeting the tangibles: Property, plant, and equipment (PP&E) 114

Investigating intangible assets 116

Studying the Asset Section of the Balance Sheet 118

Chapter 8: Digging for Debt in the Liabilities Section 121

Seeing How Businesses Account for Liabilities 122

Keeping Current Liabilities under Control 123

Accounts payable 124

Payroll and taxes 125

Unearned revenue 127

Other short-term liabilities 128

Planning for Long-Term Obligations 130

Managing long-term debt 131

Anticipating contingent liabilities 132

Accounting for Bond Issuances 133

Understanding bond basics 133

Accounting for bonds sold at face value 134

Addressing interest payments 134

Getting and amortizing a premium 134

Reporting a bond discount 135

Retiring and converting bonds 136

Chapter 9: Letting Owners Know Where They Stand: The Equity Section 137

Distinguishing Different Types of Business Entities 138

Sole proprietorship 138

Partnership 139

Corporate 140

Defining Paid-in Capital 141

Recording Retained Earnings 143

Spotting Reductions to Stockholders’ Equity 143

Paying dividends 144

Buying treasury stock 146

Learning about Stock Splits 146

Accounting for Accumulated Other Comprehensive Income 147

Seeing a Sample Equity Section of the Balance Sheet 148

Part 4: Investigating Income and Cash Flow 149

Chapter 10: Searching for Profit or Loss on the Income Statement 151

Presenting the Income Statement in One of Two Ways 152

Recognizing the single-step format 152

Breaking it out with the multiple-step format 153

Defining Different Types of Businesses 154

Providing a service 154

Merchandising to the public 154

Manufacturing a product 155

Examining Income Statement Sections 155

Two types of revenue 156

Contra revenue accounts 157

Cost of goods sold 159

Gross profit 162

Operating expenses 162

Heading toward the bottom line 163

Earnings per share 165

Watching Out for Unusual Income Statement Items 166

Discontinued operations 167

Noncontrolling subsidiary interests 168

Arriving at the Final Product 168

Chapter 11: Following the Money by Studying Cash Flow 171

Understanding the Difference between Cash and Profit 172

Seeing how noncash transactions affect profit 172

Distinguishing costs from expenses 173

Realizing the Purpose of the Statement of Cash Flows 173

Walking through the Cash Flow Sections 175

Figuring cash operating results 175

Showing cash investing transactions 178

Accounting for financing activities 180

Recognizing Methods for Preparing the Statement of Cash Flows 181

Using the direct method 181

Starting indirectly with net income 182

Interpreting the Statement of Cash Flows 183

Looking at Two Sample Statements of Cash Flows 183

Chapter 12: Examining Depreciation Cost Flow Assumptions 187

Discovering How Depreciation Affects All Financial Statements 188

Mastering Costs 189

Defining costs and expenses in the business world 190

Satisfying the matching principle 190

Identifying product and period costs 191

Learning which costs are depreciated 191

Distinguishing among Depreciation Methods 194

Walking through the straight-line method 196

Accelerating by using declining balance 196

Calculating sum-of-the-years’-digits 197

Using the units-of-production method 198

Seeing how the methods compare 198

Figuring partial year depreciation 199

Preparing a Depreciation Schedule 200

Chapter 13: Learning about Inventory Cost Flow Assumptions 203

Discovering How Inventory Valuation Affects the Financial Statements 204

Do Service Companies Have Inventory? 205

Classifying Inventory Types 206

Accounting for merchandising company inventory 206

Accounting for manufacturing company inventory 208

Getting to Know Inventory Valuation Methods 210

Specific identification 211

Weighted average 211

First-in, first out (FIFO) 211

Last-in, first-out (LIFO) 212

Comparing inventory cost-flow assumptions 212

Preparing an Inventory Worksheet 216

Part 5: Analyzing the Financial Statements 217

Chapter 14: Using Ratios and Other Tools 219

Learning about Liquidity Measurements 220

Figuring the current ratio 221

Putting the acid test to work 222

Working with working capital 223

Measuring Profitability 224

Explaining trend analysis 224

Focusing on return on investment 225

Homing in on return on equity 227

Exploring Activity Measures 227

Accounts receivable turnover 228

Inventory turnover 228

Number of days’ sales in accounts receivable 229

Analyzing Financial Statements 230

Using horizontal analysis 230

Comparing with vertical analysis 231

Using Common Size Financial Statements 232

Chapter 15: Got Your Dictionary Ready? Reading Explanatory Notes and Disclosures 235

Realizing How Corporations Should Govern Themselves 236

Identifying Corporate Characteristics 236

Reviewing Common Explanatory Notes 239

Leveling the playing field among financial statements 239

Explaining significant accounting policies 240

Looking for important event disclosures 244

Putting the Onus on the Preparer 249

Chapter 16: Studying the Report to the Shareholders 251

Why Private and Public Companies Treat Annual Reports Differently 252

Fulfilling Three Purposes 253

Serving a marketing and PR function 253

Stating financial performance and goals 253

Meeting regulatory requirements 254

Reading the Annual Report to Shareholders 254

Meeting the chair of the board of directors 255

Highlighting key financial data 255

Touting company achievements 257

Looking into the future 257

Getting to know key management and board members 258

Walking through the Form 10-K 259

Facing page: Identifying the affected company 259

Part I: Learning more about the registrant 260

Part II: Revealing the company’s financial performance 260

Part III: Identifying management and corporate governance 264

Part IV: Exhibits, financial statement schedules, and signature 264

Part 6: Feeling Brave? Tackling More Advanced Financial Accounting Topics 265

Chapter 17: Accounting for Emerging Issues 267

Reviewing Different Technological Effects on Financial Accounting 268

Working in a digital world 268

Discussing transitional recording 272

Introducing the Pharmaceutical Industry 273

Booking pharmaceutical transactions 274

Crediting Research and Development Costs 279

Walking through the background of research and development (R&D) 280

Explaining the effect on relevant industries 281

Realizing constraints for costs and expenses 281

Reporting in the books 282

Recognizing Losses 282

Different types of business interruptions 282

Properly expensing or accruing costs 284

Chapter 18: Accounting for Income Taxes 285

Identifying Financial Income versus Taxable Income 286

Figuring out financial income 287

Taking a look at taxable income 287

Explaining why the two incomes differ 289

Taking Advantage of Net Operating Losses 292

Identifying loss carrybacks 292

Understanding loss carryforwards 293

Presenting a Side-by-Side Comparison of Book and Tax Calculations 294

Taking Deferred Tax Liabilities or Assets to the Balance Sheet 295

Chapter 19: Accounting for Leases 297

Reviewing Lease Basics 298

Identifying leasing advantages 298

Introducing the lessor and lessee 299

Accounting for the Lessee 300

Looking at operating leases 300

Walking through finance leases 302

Presenting a finance lease on the financial statements 304

Accounting for the Lessor 305

Operating leases 305

Direct financing leases 306

Sales-type leases 307

Chapter 20: Reporting Changes in Methods and the Correction of Errors 309

Coping with Accounting Changes 310

Reporting changes in accounting principles 310

Changing a company’s estimates 316

Understanding changes in reporting entities 318

Dealing with Errors 319

Reviewing common types of errors 319

Letting counterbalancing errors lie 320

Restating the financial statements 321

Part 7: The Part of Tens 323

Chapter 21: Ten Financial Accounting Shenanigans 325

Reporting Revenue in the Wrong Period 325

Reporting Fictitious Income 326

Increasing Income with Misleading Events 327

Shifting Expenses Between Periods 327

Misclassifying Cash 328

Failing to Record Liabilities 329

Reporting Liabilities in the Wrong Period 329

Not Disclosing Related-Party Transactions 330

Capitalizing Normal Operating Expenses 331

Deleting Transactions 331

Chapter 22: Ten Accounting Career Opportunities 333

Certified Public Accountant 334

Consultant 335

Corporate Accountant 335

Forensic Accountant 336

Government Accountant 337

Information Technology Auditor 338

Income Tax Accountant 338

International Accountant 339

Non-Accounting Accountant 339

Not-for-Profit Accountant 340

Index 341