Since the content of an income statement can vary widely from business to business depending on how they operate and generate revenue, we will examine the generic form of the documents. For example, not all businesses sell goods, so the "cost of goods sold" will not be on all income statements. Also, not all businesses express revenue sources in the same manner. A church would have offerings, but an airline probably would not.

Income statements are generally divided into four pieces. The first piece encountered at the top is the balance forward from the previous period. This represents the money that the company had to begin business at the start of the current period. If the business is healthy, the overall balance forward should be a positive number. There may be times when an account dips into the negative column, but the overall position of the company is black.

In the second part of the statement is the income part of the income statement. All revenue sources will be listed here as well as any negative revenues. A negative revenue would like a refund to an unhappy customer. Again, these negatives would often be offset by positive income and not really be reflected as a negative on the composite report.

All revenues are added together to arrive at a total funds available. This number represents all of the cash available to the company for operations during the period. If all is well for the period, this should be the largest number on the report.

The third part of the income statement will contain the expenses for the period. This portion of the report will include such diverse items as payroll, interest payments, utilities, and insurance costs. Whatever the company spent money for during the period is listed here. Many times items are combined under a more general heading to conserve space. For example all shipping costs whether going out or coming in may simply be called "shipping."

The conclusion of this portion of the income statement will list the total expenses for the period represented. This number will frequently be the second largest number on the form. If it turns out to be the largest number, the income statement will have a loss.

The final piece of the income statement is the profit or loss information. Depending on the complexity of the company business and the income statement, this may require several lines. A gross profit or loss may be listed as the raw total of the income and expenses combined. Other items may be subtracted from this number. If a company pays stock dividends these would change the profit or loss in this area.

When everything has be adjusted, the final number at the bottom of the income statement will be the profit or loss the company had during the period. At times, a note or footnote will be included with an income statement to explain why certain things were included or excluded from a given income statement. The note or notes may also justify larger than expected profits or losses to owners or shareholders. The length of an income statement can range from less than a page to a document that resembles a book.

Assets are the tangible things your company owns. Your inventory for resale is an asset. So is any equipment you have, including computers, copiers, refrigerators and microwaves and office furniture. Even office supplies you have on hand are considered assets, though they are consumable. Any office supplies or other consumables you have on hand are valued at the amount at which they were purchased. So is inventory. Your checking account, petty cash and accounts receivables are also assets valued with no adjustment to your books. Any equipment your company owns is valued at a specific percentage of the purchase price based on age. The adjustment for the loss in value is called depreciation.

There is also a term for things that have no purchase value, but can still increase the value of your company. These things are called intangible assets. Contracts, customer lists, contacts, insider knowledge, and patents are intangible assets. Many of these things are based on the current condition of the market in your niche, and will vary depending on the timing of this calculation. Really anything you can stake a claim to is an asset. The value of these things is not based on anything other than purchase price and time since. If you owe money on something, that part of the calculation for the value of your company is recorded under liabilities.

Liabilities are accounts that show the amount of money your company owes people. Any loans, accounts payable and payroll liabilities are all accounts that indicate money owed and qualify as liabilities. The equity in your company is the difference between your assets and your liabilities. If your liabilities exceed your assets, then your equity will be negative. The report that shows all of this is called a balance sheet. It is a collective value for your company based on the assets, the liabilities and the equity. The assets will always equal the liabilities plus the equity. Subtracting the liabilities and the equity from the assets will always equal zero. That is the balance. The balance sheet is necessary in calculating taxes, but it has nothing at all to do with expenses.

Expenses are a record of how your company spends money. They help you budget, and they help you figure out your net profit and thereby your company taxes, but only figure into the value of your company in the net profit. Your expense accounts should be specific enough to help you keep your records organized, but they do not need to be individualized to each vendor. Common expense accounts are, among others, freight, office supplies, advertising, telephone, rent, utilities, insurance, licenses and fees, travel and entertainment, and taxes. Many companies also utilize a miscellaneous expense account for random expenses incurred which do not fall under any of the other categories, particularly if the purchase is a one-time thing. Donuts for a breakfast meeting might fall under this category.

Something that many people do not understand is that each and every time you spend money on something it falls under some expense account somewhere. Whether or not that expenditure is a valid expense is a totally different issue. If you spent the money out of your company and not personally, it falls under an expense account. If it is supposed to be personal, I recommend recording it under payroll as a bonus or something so that it is taxed appropriately and in the event of an audit you can avoid a penalty.

I highly recommend that everyone learn the basics of assets, liabilities and expenses. It will make everything you do in your business easier. It can help you calculate the value of your company in the event of a sale or merger, and it will also help you avoid problems with various revenue departments. It does not have to be complicated. It just has to be accurate and correct. Once you know the rules, you can follow them. If you already have someone following the rules in your company, now you can begin to understand them.

Accounting - an information system that measures business activities, processes information and communicates financial information.

Users of Financial Information

• External Users - make decisions about the entity

1. Creditors - before making a loan, creditors determine a businesses ability to meet scheduled payments. This determination is based upon the businesses financial information.
2. Individuals - use accounting information to manage bank affairs, evaluate job prospects and make investments.
3. Investors - evaluate the return on capital they can expect to receive from accounting information.

• Internal Users - make decisions for the entity

1. Business Managers - use accounting information to set goals for their orgs, to evaluate progress towards these goals and to take corrective action if necessary.

Fields of Accounting

• Financial Accounting - Focuses on information for people outside the firm, including creditors, government agencies and the general public.
• Management Accounting - Focuses on information for internal decision makers, including top executives, department heads or university deans.

Standards of Professional Conduct

Standards of Ethical Conduct of Individual Companies In light of the collapses of HIH and One Tel, companies are increasing seeing their responsibilities to stakeholders in a broader ethical context.

• KPMG: “ensuring good ethical conduct reduces corporate risk and enhances corporate reputation.”.
• Key to ethics is honest disclosure
• Ethical standards exist to ensure that accounting information is honest and accurate. Thus, users of accounting information are able to rely on this information for decision-making.

Codes of Professional Conduct - have been established in many large accounting organizations”

• Lists obligations/duties of employees
• Requires employees to conduct themselves in certain ways
• Binding

ICAA and CPPA's Joint “Code of Professional Conduct” contains common prescriptions and places common obligations on the members of both professional bodies

• Purpose is maintaining and enhancing their credibility, professionalism and quality
• Lays down minimum standards of conduct

Types of Business Organizations

Proprietorships

• Single owner who is often the manager
• Each proprietorship is distinct from the proprietor

Advantages

• Total undivided attention
• Low levels of bureaucracy, allowing changes to be made quickly

Disadvantages

• Unlimited liability
• Capital is harder to find

Partnerships

• Joins two or more individuals together as co-owners
• Accounting records treat it as a separate entity, distinct from personal affairs of each partner

Advantages

• Skills and abilities of the partners will strengthen the companies foundation and knowledge
• Significantly broadens access to capital by increasing ability to borrow needed funds

Disadvantages

• Unlimited liability
• Possibility of personality or authority conflicts

Companies

• A business owned by shareholders, people whom own shares of ownership in the business
• A company is a legal, individual entity

Advantages

• Limited liability of shareholders
• Relative ease of ownership transference

Disadvantages

• Separation of ownership and control
• Extensive government regulations

Generally Accepted Accounting Principles

Primary Objective of Financial Reporting - To provide information useful for making investment and lending decisions.

The Entity Concept

• Defines the entity for which accounting data are collected
• An accounting entity is an organization or section of an organization that stands apart from other organizations and individuals as a separate economic unit for the purpose of some decision
• Sharp boundaries are drawn around each entity so as not to confuse its affairs with those of other entities and thus bring info that is not relevant to the decision being made
• Important also because allows a separation to be made between the owners of the business and the business itself

The Time Period Concept

• Defines the unit of time for which accounting data is collected and the financial reports prepared
• In Australia, many businesses prepare their statements for the financial year from July one to June 30 the following year
• As a result of this concept, there is a production of yearly financial reports and the calculation of periodic profit

The Cost Principle

• Assets and services acquired should be recorded at their actual cost

The Reliability (Objectivity) Principle

• Information must be reasonably accurate
• Information must be free from bias
• Information must report what actually happened
• Individuals would arrive at similar conclusions using the same data

The Matching Principle

• MP relates the inputs and outputs of a business to one another
• The cost of inputs used up to produce outputs are treated as expenses and subtracted from revenues associated with those outputs in calculating profit for their period

The Profit Recognition Principle

• Profit should be recognized when the revenues related to the relevant activity is “earned”
• Revenues are “earned” when goods and services are sold or otherwise disposed of and all the other expenses to be matched with them can be identified
• Therefore you do not wait for cash to be received or paid before recognizing profit

The Conservatism Principle

• Constrains management's natural optimism, as this could find its way into the reported assets and profits
• “Anticipate no profits, but anticipate all losses.”.
• Recognizing expected loss before expected revenues

The Going Concern Principle

• The entity will continue to operate in the future

Australian Accounting Standards

• Standards to govern measurement rules and level of discourse
• Australian Accounting Standards Board is responsible for technical accounting standards
• AU is moving towards the adoption of International Accounting Standards

The Accounting Equation

ASSETS = LIABILITIES + OWNERS EQUITY

Assets - the economic resources of a business that are expected to be of benefit in the future:

• Cash
• Accounts receivable
• Land/building
• Goodwill

Liabilities - are economic obligations/debts, payable to outsiders (creditors) - eg: accounts payables.

Owners Equity - owners claims to the businesses assets. It is what is left of the assets after liabilities have been deducted.

• Owners have a claim before they have invested in the business
• Also called net assets

Revenues - amounts received r to be received from customers for sales of products or services. Generated from:

Sales

• Performance of services
• Rent received
• Interest received

Expenses - amounts that have been paid or will be paid later for costs that have been incurred to earn revenues:

• Salaries and wages
• Services
• Supplies used
• advertising

Transactions that Affect Owners Equity

Increasing Owners Equity

• Revenue increases OE because they increase the businesses assets but not its liabilities. As a result, the owner's share of the businesses assets increases.
• Owner investments also increase OE

Decreasing Owners Equity

• Owner drawings are those amounts removed from the business by the owner
• Expenses are decreases in OE that occur as a result of using assets or increasing liabilities in the course of delivering goods and services to customers

Financial Statements

• The final product of the accounting process
• Tells how the business is performing and where it stands

Statement of Financial Performance (P&L)

• Summary of businesses revenues and expenses for a specific period
• Presents a moving financial picture of business operations during a period
• Shows net profit (revenues - expenses)

Statement of Owners Equity

• Presents a summary of the changes that occurred in the businesses owners' equity during a specific time - e.g. month or year.

Statement of Financial Position (Balance Sheet)

• Lists all the entity's assets, liabilities and OE as of a specific date
• A snap shot of the entity

Statement of Cash Flows

• Reports amount of cash entering and exiting an entity during a period
• Shows net increase or decrease during the period and cash balance at the end of the period

Accounting Terms

The Account - the basic summary device of accounting is the account - the detailed record of the changes that have occurred in a particular asset, liability or owners equity during a period of time. Are grouped in three broad categories, according to the accounting equation.

Ledger - for convenient access to the information, accounts are grouped in a record called the ledger, which usually takes the form of a computer listing.

Classification of Accounts

1. Cash at Bank account - shows the cash effects of a businesses transactions. Cash means money and any medium of exchange that a bank accepts at face value. Cash at bank includes bank account balances, currency, coins and cheques.
2. Bill Receivable - a written pledge that the customer will pay a fixed amount of money by a certain date. It offers more security for collection than a mere account receivable does.
3. Accounts Receivable - a business may sell its goods or services in exchange for an oral, implied or documented promise of future cash receipt. Such sales are made on credit (on account.)
4. Prepaid Expenses - a business often pays certain expenses in advance. It is seen as an asset because the business avoids having to pay cash in the future for the specified expense. The ledger usually holds a separate asset account for each prepaid expense. Prepaid rent and prepaid insurance are two examples.
5. Land - the land account is a record of the cost or value of land a business owns and uses in its operations. Land held for sale is account for separately in an investment account.
6. Buildings - the cost or value of a business's buildings - office, warehouse, garage, etc, appears in the Buildings account. Buildings held for sale are separate assets, accounted for as investments.
7. Equipment- a business has a separate asset account for each type of equipment - office equipment and store equipment, for example.

Classification of Accounts

1. Bills Payable - this account is the opposite of the Bills Receivable account and represents the amounts that the business must pay because it signed bills of exchange to borrow money or to purchase goods or services.
2. Accounts Payable - this account is the opposite of the Accounts Receivable account. The oral, implied or documented promise to pay off debt arising from credit purchases appears in the Accounts Payable account.
3. Accrued Liabilities - a liability for an expense that have been incurred by the business, but not paid for yet. Examples include Taxes Payable, Interest Payable.

Classification of Accounts - Owners Equity

1. Capital - this account shows the owner's claim to the assets of the business. After total liabilities are subtracted from total assets, the remainder is the owner's capital.
2. Drawings - the amounts taken out of the business by its owner appear in a separate account. If drawings were recorded directly in the Capital account, the amount of owner drawings would not be highlighted and decision-making would be difficult. This account shows a decrease in owner's equity.
3. Revenues - the increase in owner's equity created by delivering goods or services to customers are revenue. If a business lends money to an outsider, it will need an interest Revenue account for the interest earned on the loan.
4. Expenses - a business needs a separate account for each type of expense, such as Salary Expenses, Rent Expense and Advertising Expense.

Double - Entry Accounting

• Each transaction affects at least two accounts
• Each transaction is recorded with at least one debit and one credit
• Total debts must = total credits
• For example, by purchasing supplies by cash, this transaction decreases cash at the bank and increases supplies. A purchase on credit increases supplies and increases accounts payable.
• All transactions have at least two effects on the entity

The T - Account

The account format used most widely is called the T account because it takes the form of the capital letter “T”. The vertical line of the T divides the account into its left and right sides. The account title rests on the horizontal line.

Decreases and Increases in the Accounts

• Increases in assets are recorded on the left (debit) side of the account
• Decreases in assets are recorded on the right (credit) side
• Increases in liabilities and owners equity are recorded by credits
• Decreases in liabilities and owners equity are recorded by debits
• Assets are on the opposite side of the equation from liabilities and owner's equity
• Liabilities and owners equity are therefore, on the same side of the equal sign

• The process of creating a new T account in preparation for recording a transaction is called “opening the account.”

Recording Transactions in the Journal

Accountants record transactions in a journal - a list in chronological order of all the transactions for a business. The journalizing process follows four steps:

1. Identify the transaction from source documents, such as sales and sales receipts
2. Specify accounts affected by the transaction and classify it by type (asset, liability or owner's equity)
3. Determine whether each account is increased or decreased by the transaction. Using the rules of debit or credit the account to record its increase or decrease
4. Enter the transaction in the journal, including a brief explanation for the journal entry

The journal entry includes:

1. The date of the transaction
2. The title of the account debited
3. The title of the account credited
4. The dollar amounts of the debt, then credit
5. A short explanation of the transaction
6. Posting from the Journal to the Ledger

Ledger - A collection of all accounts utilized by an entity during an accounting period. Includes:

• Loose leaf pages
• Bounded books
• Computer printouts
• Cards

Posting - copying the amounts from the journal to the accounts in the ledger.

• Each journal entry posted to the ledger is keyed by date or by transaction number
• In this way, any transaction can be traced from the journal to the ledger and back to the journal. This linking allows you to locate any information you may need for decision-making.

The Trial Balance

• A list of all the accounts with their balances - assets first, followed by liabilities and then owner's equity - taken from the ledger
• Before computers, it provided a check on accuracy by showing whether total debits equal total credits

Locating and Correcting Trial Balance Errors

In a trial balance, the total debts and total credits should be equal. If they are not, then accounting errors exist.

1. Search the trial balance for a missing account. Trace each account from the ledger to the trial balance and you will locate the missing account.
2. Divide the difference between total debts and total credits by 2
3. Check journal postings
4. Review accounts for reasonableness