accounting information system

An Accounting information system collects and processes transaction date and then disseminates the financial information to interested parties. accounting information systems vary widely form one business to another.
Various factors shape these systems:
- the nature of the businesses and the transactions in which it engages.
- the size of the firm the volume of data to be handled, and
- the information demands that management and other require.
accounting information system helps management answer such question as:
. how mush and what kind of debt is outstanding?
. were sales higher this period than last?
. what assets do we have?
. what were our cash inflows and outflows?
. did we make a profit last period?

users of financial information

information that is going out side of the company must be in compliance with the established accounting guidelines because outside users will be relying on this information to make a variety of decisions. these rules and standard are in place for the purpose of protecting outside users by ensuring that everyone understand the information and that it is accurate and useful.
we will look later at the characteristics of useful information , but we will start by looking first at the outside users of the financial information reported by a company.
Outside users are classified by various distinctions:
a- Direct VS. Indirect users : Direct users, or individual who are directly affected by the results of company, include investors and potential investor , employees, management , suppliers and creditors. these are individuals who stand to lose money financially if the company has financial problems.
Indirect users Ara basically those people or groups who represent direct users . they include financial analysts and advisors,stock markets and regulatory exchanges.
b- Internal vs. External- this distinction is rather obvious in that internal users are making decisions within the firm whereas external users are making decisions from outside of the firm about whether or not to continue, start or change their relationship to the firm.
because there are so many people who are using the financial information and using it for so many diverse reasons, there are a lot of different types of required information. some of the key reasons that people need this information are to:
1- make investment decisions
2- extent credit or not
3- assess areas of strength and weakness within the company
4- evaluate performance of management
5- determine if the company is in compliance with necessary regulatory rules.

accounting for issuing common stock

when common shares are issued for cash, the standard journal entry for the issuance of common or preferred shares is :
Dr cash......... cash received
Cr common shares ........par value of shares issued
Cr Additional paid-in capital-common shares.... balancing amount
this will be the basic journal entry for all our share transactions,including preferred shares. In the case of preferred shares, we simply change the "common shares" account to 'preferred shares'. it does not matter if the shares are sold at a price above or below the current market price for shares. we will debit cash for the amount of cash received and divide this amount between common shares and APIC. the only amount that will ever go into the common shares account is the par value of te stock. Again, it does not matter if the sales price is above or below the fair market value of the shares. issuance of shares for something other than cash

accounting for changes in accounting principles

An accounting change for the purposes of income statement is a change from one GAAP accepted method to another GAAP accepted method. Therefore, a change in accounting policy only occurs in area where there is more than one acceptable method. The most common examples are: inventory, fixed assets depreciation and long-term contract.
A change from a non-GAAP method to a GAAP method (for example, from not depreciating fixed assets to the straight-line method) is not a change in accounting policy. Rather, it is the correction of an error.
An entity shall report a change in accounting principle trough retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so. Retrospective application requires the following:
- the cumulative effect of the change to new accounting principle on periods prior to those presented shall be reflected in the carrying amounts of assets and liabilities as of the beginning of the first period presented.
- An offsetting adjustment, if any, shall be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that period.
- Financial statements for each individual prior period presented shall be adjusted to reflect the period-specific effects of applying the new accounting principle.

recording long-term contracts on the balance sheet

Even if no profit has been recognized, the long-term contract itself must be recognized on the balance sheet to extent that it represents a net asset or liability. In these journal entries, the asset is the CIP account and the liability is the BCA.BCA is the liability because by sending an invoice to the customer, the contractor is promising to deliver something in the future to the customer. The difference between the construction in progress (CIP) AND the billings on construction account (BCA) Accounts is reported on the balance sheet as either an asset or liability.
If CIP > BCA, the difference is reported as a current asset (inventory)
If CIP < BCA the amount is reported as a current liability.

income statement Definition

the income statement is a summary of all of a company's transactions during a period of time that involves income, expenses,gains or losses.
the income statement is prepared using the concept of accruals accounting. this means that income can be recognized before the actual receipt of cash, and expenses can be recognized before the actual expenditure of cash. item on the income statement will be recorded as they occur,not when cash is transacted.
the income statement gives the results of operations for a period of time. when people talk about net income, they usually mean the period of time of one year, but income statements are also prepared on a quarterly or monthly basis as well as annually.
the accounts that are used to record revenues,expenses,gains and losses throughout the year are temporary accounts. this means that means that they are closed to a permanent account (retained earnings)at the end of each period. After they are closed, temporary accounts have a zero balance and therefore are not shown individually on the balance sheet. the retained earnings account, which is presented on the balance sheet as part of owner's equity , represents the profit of the company.

limitations of financial statement analysis

Although financial statement analysis is highly useful tool, it has two limitations that we must mention before proceeding any further. These two limitations involve the comparability of financial data between companies and the need to look beyond ratios.
Comparison of financial data
Comparisons of one company with another can provide valuable clues about the financial health of an organization. Unfortunately, differences in accounting methods between companies sometimes make it difficult to compare the companies' financial data. For example, if one company values its inventories by the LIFO method and another company by the average cost method, then direct comparisons of financial data such as inventory valuations and cost of goods sold between the two companies may be misleading. Sometimes enough data is presented in footnotes to the financial statements to restate data to a comparable basis. Otherwise, the analyst should keep in mind the lack of comparability of the data before drawing any definite conclusions. Nevertheless, even with this limitation in mind, comparisons of key ratios with other companies and with industry averages often suggest avenues for further investigation.
The need to look beyond ratios
An inexperienced analyst may assume that ratios are sufficient in themselves as a basis for judgments about the future. Nothing could be further from the truth. Conclusions based on ratio analysis must be regarded as tentative. Ratios should not be viewed as an end, but rather they should be viewed as a starting point, as indicators of what to pursue in greater depth. They raise many questions, but they rarely answer any questions by themselves.
In addition to ratios, other sources of data should be analyzed in order to make judgments about the future of an organization. The analyst should look, for example, at industry trends, technological changes, changes in consumer tastes, changes in broad economic factors, and changes within the company itself. A recent change in a key management position for example, might provide a basis for optimism about the future, even though the past performance of the company (as shown by its ratios) may have been mediocre.

cost classifications of financial statements

The financial statements prepared by a manufacturing company are more complex than the statement prepared by a merchandising company because a manufacturing company must produce its goods as well as market them. The production process involves many costs that do not exist in a merchandising company, and somehow these costs must be accounted for on the manufacturing company's financial statement. In the section, we focus our attention on how this accounting is carried out in the balance sheet .
The balance sheet
The balance sheet or statement of financial position, of a manufacturing company is similar to that of a merchandising company. However, the inventory accounts differ between the two types of companies. A merchandising company has only class of inventory- goods purchased from suppliers that are a waiting resale to customers. In contrast, manufacturing companies have three classes of inventories- raw materials, work in process, and finished goods. Raw materials, as we have noted, are the materials that are used to make a product. Work in process consists of units of product that are only partially complete and will require further work before they are ready for sale to a customer. Finished goods consist of units of product that have been completed but have not yet been sold to customers. The overall inventory figure is usually broken down into these three classes of inventories in a footnote to the financial statements

Calculation of depreciation

There are four methods of calculating deprecation expense. Each of these four methods is looked at in detail below, but some general information is needed before depreciation can be calculated under any of the methods. These terms and their definitions are below.
1- estimated useful life; this is how long we expect the asset to be useful and it is the period of time recognizes deprecation expense. At the end of its useful life the assets should have a book value equal to the expected salvage value. (This may also be called service life.).
2- Estimated salvage value; this is the value we expected the asset to have at the end of its value useful life. The book value of the asset may not be depreciation below the salvage value. Some companies have an accounting policy that the salvage value always equal to $0. (This may also be called residual value.)
3- Deprecation amount; this is the amount that must depreciate over the useful life of the asset. It is equal to the capitalized amount (this is the cost of the asset) minus the salvage value of the asset.

lessee Accounting for capital leases

If the leasee is a capital lease, the lessee will account for this transaction in two parts. The first is the purchase of fixed asset and the second in the obtaining and repayment of a loan.
This means that the asset itself will be recorded on the books of the lessee (and the lessee will remove the asset from their books). The first calculation that needs to be made is the amount at which the asset will be recorded on their books. The lessee then must depreciate the asset and this will be done in the same way as other similar assets owned by the lessee.
The lessee also must account for the loan (or financing) part of this transaction. this is done as if the lessee is financing the purchase for the lessor. The lessee records a payable and each period will make a payment on this amount. Part of each payment made by the lessee will be recorded as interested expense, while
the remainder will be the reduction of the lease payable itself. (This is very similar to the accounting approach for bonds payable.)
This means that the lessee will:
1-Recorded a fixed asset on their books.
2-Depreciate that asset
3- recorded a payable representing their future lease payment, and because they have received a loan to purchase this asset from the lessor, the lessee will also need to recognize interest expense as the part of the lease payment each period.
Like the case with bonds, the amount of interest that is expensed on the income statement will be calculated from the amount of the loan that is still outstanding each period. This means that each period when a payment is made, part of the it is payment of interest and part of it is the reduction of the lease payable itself.
The lessor will need to do the following:
1- Remove the fixed assets from their books.
2- recognize revenue from the sale of the assets.
3- recognize a gain or a loss on the sale.
4- recoded a receivable, and recorded interest revenue each time a payment is received from the lessee

Lessee accounting for operating leases

If the lease is classified as an operating lease. The accounting for the lease is very simple as we are going to treat the lease payments as rent expense. The payments will be only rent expense for the lessee and rent revenue for the lessee and there is no interest in operating lease.
Each period there is an entry that is as follows:
Dr Rent expenses …………………………………X
Cr cash ………………………………………….. …….Y
Where X = the monthly (or yearly) expense calculated as outlined below.
Y= the amount cash that is paid.
For the lessor the entry is the opposite with rent revenue rather than expense.

the accounting criteria for capitalizing leases by the lessee

To record a lease as capital lease one or more of four criteria must be met:
1- transfers ownership to the lessee.
2- contains a bargain purchase option.
3- lease term is equal to or greater than 75 percent of the estimated economic life of the leased property.
4- the present value of the minimum lease payments, equals or exceeds 90 percent of the fair value of the leased property.

The two type of leases

There are actually two different ways to account for a lease depending upon the specific details of the lease agreement. The first (and easiest) method is to account for the lease as if the transaction were simply a rental agreement. This is called an operating lease and is essentially a sort-term lease.
The second method is to account for the lease as if the transaction were essentially a purchase of the asset by the lessee that is being financed by the lessor. This is called capital lease and this is what was described above.
The lessee (buyer) and the lessor (seller) separately determine whether the lease is accounted for as an operating or capital lease.

accounting for Unearned Revenue

Unearned Revenue is actually not revenue and is therefore not reported on the income statement. Unearned revenue occurs when the seller receive the cash from the sale of the good or service before the company has to provide the good or service. When this occurs, the seller must set up an unearned revenue account (or deferred revenue) to record the liability rather than recognize the cash received as revenue. The liability is recognized because the company now has the liability of providing the good or services that the customer paid for.
This unearned revenue account is set up as follows:
Dr Cash xxx
Cr unearned revenue xxx
When the revenue is then later earned, the deferred revenue account is closed to revenue (this being the account on the income statement).
Dr unearned revenue xxx
Cr revenue xxx
Alternatively, theses entries can be done in the reserve order and the amount collected can be initially credited to revenue account. Then, at the end of the period, the amount of this unearned revenue must be reversed out of "revenue" into "deferred revenue". Either method will provide the same amount of unearned revenue on the balance sheet and revenue on the income statements.

Registered Bonds Vs. Coupon bonds

Registered bonds are bonds where the owner of the bond is registered with the issuing company and the owner receive the interest each period directly from the issuer. Most corporate bonds are registered bonds.
if bond is not a registered bond, it is a coupon bond (or bearer bond). in order to receive the interest from a coupon bond, the bond owner must send a coupon to the issuing company. in a coupon bond, the issuing company does not know who owns the bonds, but pays the interest to whoever submits the coupon.

Debenture bonds Vs. Guaranteed bonds

A debenture bond does not have any specific asset supporting the bond as collateral. The bondholders of debenture bonds have a standing equal to general creditors in the case of bankruptcy of the bond issuer.
Other types of bonds are guaranteed in that they have some sort of collateral related to the bonds. This way, if the issuer of the bonds fails to pay the bonds upon maturity, the holder of the bonds can obtain the collateral in settlement of the amount owed to them. Some of these types of bonds are;
Collateral bonds have a specific asset up as collateral. if the issuer defaults on the interest payment or the repayment of the principal, the bondholders can pursue legal action to obtain the collateral.
Guaranty bonds are guaranteed by a third party. for example, a parent company guarantees the bonds that are issued by a subsidiary. in the case of the default by the subsidiary, the parent company has guaranteed performance of the bonds.
collateral trust bonds are bonds that are supported by specific securities of the company. Mortgage bonds are backed by a specific asset and this asset is usually a fixed asset. Subordinated bonds (or junior bonds) are bonds that are supported by collateral, but they have a secondary claim on the collateral. So, if the collateral is not large enough to pay those parties with a primary interest in the property, holders of subordinated bonds will not receive anything from the collateral and will become general creditors.

the bond itself

Bonds will have a stated amount (face value), a stated interest rate, a maturity date and information about when interest is paid. The maturity date is the date on which the issuer will "retire' the bond by paying the face amount of the bond to the bondholder. Below is an example of basic bond information.
-face value $1000
-interest rate 8%
-Issue date January 1,2001
-Maturity Date December 31,2001
-Interest is paid annually on December 31
From this information, we can determine all of the amounts that the issuer will pay to the holder of the bond over the life of the bond. We have already mentioned that on the maturity date the issuer will pay the face amount ($1,000 in this case) to the bondholder. The cash that will be paid as interest every December 31st is also determinable from this information. The cash paid as interest is calculated as the face value multiplied by the stated rate of interest.
For interest in this bond example provided above, the issuer of the bond will pay $80 in cash as interest to the purchaser of the bond every December 31st from December 31, 2001, until December 31, 2001.
On December 31, 2011 (the maturity date), not only will the owner of the bond receive the $80 interest payment, but s\he will also receive $1000, which is the face value of the bond on that date.
The accounting for bonds is easier if we understand what happens over the life of the bond. When a company issues a bond it is in a sense simply borrowing money from someone else, and this money will need to be repaid in the future. Whenever a company borrows money, it should recognize a liability for the amount borrowed. Also, each period, it will need to recognize some amount of interest expense related to the amount that it has, in effect, borrowed. The main issues with bonds relate to the calculation of the selling price (or issuance price) of the bond and the calculation of the amount of interest expense that needs to be recognized each period.
However, before looking at the accounting for the bond, we will look again at the cash flows related to the bond itself. This show we the accounting issues that we need to cover. The three main cash flows are the sale of the bond, interest and payment of the face value at maturity.

Bond and finance

One of the main ways that companies raise cash for financing their operations and other business needs is through the issuance of bonds. Bonds are a main source of debt financing by companies, while the other main source is equity financing through the issuance of shares.
Investors purchase bonds because they pay some amount of interest to the purchaser, and additionally, the face amount of the bond will be paid at the bond maturity in the future.
We will look at bonds from both standpoints (the issuer and the investor), but our focus will be largely on the issuer of the bond and their accounting for the bonds. However, before discussing the accounting for bonds, it is important to make certain that we understand what is happening in respect to a bond, and in particular cash flows associated with the bond.

Unearned Revenue

A liability for Unearned Revenue arises when a customer pays in advance upon receipt of an advance payment from a customer, the company debits cash and credits a liability account such as unearned revenue, or customer's deposits . As the services are rendered to the customers, an entry is made debiting the liability account and crediting a revenue account. notice that the liability for unearned revenue normally is "paid" by rendering services to the creditor, rather than by making cash payments.
unearned revenue ordinarily is classified as a current liability, as the activities involved in earning revenue are part of the business's normal operating cycle.

definition of depreciation

A technical definition of depreciation is the systematic and rational allocation of the costs of a fixed asset over its expected useful life.
In Other words. What depreciation does is match the expense (cost) of acquiring the asset with the revenues that it will generate over its useful life by spreading the recognition of expense of acquisition over the time period during which the asset will be useful (provide revenue) to the company. This is concept of matching.
This is purely mathematical process of dividing in some manner the cost of the asset between the period in which it will be used.