Unlike majority of the vastly superior European upper-secondary schools, students in 🇨🇦 have to enrol in pointless electives to get their dispensable certificate of achievement. As part of the university’s scheme to increase revenue, they use this tactic to tack on an extra year of useless schooling, crank out more tuition, and complete the capitalist fetish.

Sometimes I wanna shatter an improvised incendiary grenade at the unoccupied office of the Secretary of Education.

Nevertheless, Financial Accounting is an elective I’ve enrolled in as something completely unrelated to my program of programming. As part of my motivation of getting through this shithole, I wrote this post summarizing why everyone should learn the basics of accounting, despite being rather self-explanatory: counting things.

Financial accounting is understanding businesses through accounting, unlike regular accounting which can focus on personal finances.

Why is it important to understand a business? Let’s say you’re like me and don’t want to become an accountant; instead, you wanna invest in a business.

If you want to invest in Tesla because you like Tesla, that’s a poor way to invest. Instead, how about you read their quarterly balance sheet, income statement, and cash flow statement?

They answer questions like:

• How much debt is Tesla in?
• How much assets can they liquidate in order to pay off their debt in case of a crisis?
• How much profit are they making?
• What do they do with excess cash? (does it go to you, the shareholder, or is it reinvested?)
• How much cash flows in and out of their business?
• What is their net profit margin over the last 10 years? Are they consistently profitable?
• How much of their net earnings is due to operational expenses, rather than lawsuits and acquisitions?
• How much of their assets are financed by your equity and how much is financed by creditors like a bank?

There’s much more, but you get the gist of why reading the financial statements above is useful. We also learn about a “Statement of Changes in Equity”, which I can’t see as being useful to anyone but the accountants who close the books at the end of a reporting period.

You don’t need to know what that means, but if you do (you masochist), just CMD/Ctrl + F: “closing entries” on this page

Anyway, that’s about it. You can read on if you want, but honestly, this is all useless as an external investor since the common financial advice I hear nowadays is this:

👶 If you’re young, buy the S&P 500 ETF

🧑 If you’re older, mix that ETF with a bond ETF

🧓 If you’re old, buy gold or something for your grandkids like a bond

🏩 If you’re kinky, get a robo-investor to do essentially the same thing, and pay them a fee for some reason

🤫 If you’re really kinky, commit some insider trading on your own company (then join go to jail where they feed you for free)

WLU Intro to Financial Accounting - BU127

Index

Formulas

1: 📰 Financial Statements

Note: the statements can come with notes which aren’t necessary but do provide supplementary knowledge for interpretation

For the balance sheet:

• Current assets can be converted into cash within 1 year and current liabilities will be paid off within 1 year
  • Non-current assets/liabilities are therefore self-explanatory
• The order of assets listed are sorted by descending orders of liquidity, or how readily the assets can be converted into cash

These powerpuff girls are used by internal/external investors to judge companies using some set of ratios.

Here are the relationships, bitch:

2: 💱 Investing and the Accounting System

Useful Information for Investors

Useful information is considered:

• Relevant
• Faithful
• Verifiable
• Timely
• Understandable

Financial Info Assumptions

1. Seperate Entity: transactions of the shareholders are not confused with transactions from the business
2. Monetary Unit: information is reported without taking inflation into account
3. Continuity/Going Concern: the business is expected to operate (so there is a point to analyzing the information)

Recording Transactions

1. A journal entry is a transaction with more than 2 accounts being credited or debited.

2. A T-account summarizes journal entries over a period a time for 1 account.

3. A Trial Balance summarizes the ending balances of multiple t-accounts over a period of time.

The general rule for all three of these: Debits are on the left, and Credits are on the right.

🏭️ 3: Operating Decisions

Ratios

• The current ratio is useful because it measures a company’s liquidity, or how much of its debt can be paid off with assets if need be
• The Total Asset Turnover Ratio is useful because it measures the sales/revenue generated from the use of assets, and thus, the efficiency of the assets
• The ROA Ratio is useful because it measures how much profit was earned by using assets
• The NPM Ratio is useful because it measures the percentage of profit earned per revenue. If NPM goes up, we know revenues and expenses are being managed efficiently.

Accrual Basis Accounting

Cash basis accounting isn’t used according to GAAP, since it drastically fluctuates statements where cash is received before or after delivery of goods.

Instead, we use accrual basis accounting which uses the RRP and ERP to recognize revenues and expenses.

• The RRP says that we recognize revenues when goods are delivered, not when they’re paid for
• The ERP says that we incur expenses when generating revenue

📪️ 4: Adjustments/Closing Entries

Adjusting Journal Entries

To correct any errors and measure earnings properly throughout the accounting period, we use 4 types of adjusting entries:

Closing the Books

Temporary accounts like revenue/gains and expenses/losses, or those seen on the income statement, must be closed to a zero balance at the end of the accounting period.

The accumulation of these temporary accounts are moved into the permanent Retained Earnings account.

In the extremely brief example above, the company’s net worth dropped by $300.·

📈 5: Revenue, Cash, and Receivables

🔃 In Progress

📦️ 6: Cost of Sales and Inventory

Identifying Inventory and Cost of Goods Sold Amounts

Inventory is a current asset that is either:

1. Held for sale in the normal course of business (like a personal computer)
2. Used to produce goods or services for sale (the hard drives)

There are many types of inventory:

• Merchandise which is finished inventory acquired and held for resale by a retailer

• Raw materials which is unfinished inventory; the parts to be processed into items for sale

• Work in Process inventory which is self explanatory

• Finished goods inventory which is used by merchandisers

The cost of inventory is usually the sum of the costs incurred in bringing an item into a usable or saleable condition and location. Think of manufacturing costs, repair costs, shipping costs, etc.

Example Invoice for the Cost of Merchandise Inventory

In general, companies should not accumulate purchasing costs until either:

• Raw materials are ready for use
• Merchandise inventory is ready to ship

Inventory costs flow from different statements during from acquisition to sale of materials/merchandise:

From the Merchandiser (Reseller) POV

The flow of inventory cost from the merchandiser is rather simple:

From the Manufacturer POV

We can record COGS in a fiscal period using either of the inventory systems:

The Perpetual inventory system: COGS and Inventory are updated as soon as inventory is sold, and detailed records are maintained. Getting and retaining this information is costly, but it allows managers to view it right away.

The Periodic inventory system: COGS and Inventory are updated at the end of the year by multiplying inventory units by the cost of goods. Obviously, this is a much cheaper system to compute.

The 3 Inventory Costing Methods

How do we know the cost of the inventory we’ve sold? Ordinarily, if Walmart purchases 3 shipments of socks at x value, the COGS would be x * units sold.

What if the 3 shipments varied in price? For example:

The Walmart shopper pays the same price no matter the socks bought, but its now difficult for Walmart to determine the value of the goods walking out the door.

1. FIFO

FIFO declares that we sell off inventory as soon as it is received, like fresh fruit. Remember the COGS equation? According to FIFO:

• The oldest units are allocated to cost of goods sold
• The newest units are allocated to ending/remaining inventory

Going along with our Walmart example, the COGS would be $3 because that was the oldest units (or the first to be purchased).

2. LIFO

LIFO declares that we sell off inventory as late as possible, like crude oil.

At Walmart, the COGS would be $1 because that was the newest units (or the last to be purchased).

3. Average Cost

Average cost is where we calculate the ending inventory and COGS as average of the cost of goods available for sale and the amount of units available.

At Walmart, the COGS would be ($3 + $5 + $1) ÷ 3 = $3, or the average of the three purchases.

⚠️ When calculating the ending inventory, COGS, or gross profit using perpetual inventory systems, we must recompute the average cost on every sale of inventory rather than all at the end.

Lower of Cost and Net Realizable Value

But how do we actually value our inventory? Is it worth how much we paid for it, or how much the market values it?

• The cost of the inventory, is how much we paid for it
• The NRV, is the market value of our items

The lower of cost rule says that to avoid overstating the value of our inventory, we must report the lower of cost and NRV.

• If we paid more for our item than we can sell it for, we report how much the market values it
• If the market values it more than its cost, we report how much we paid for it

Who Gives a Fuck?

You’re right! Up until this point, we’ve understood the cost of inventory as how much we paid for it. That’s why, using the lower of cost rule, we must write down the value of devalued units.

In the case of oranges, we will:

(+) Debit cost of goods sold by the valuation amount we’ve written down 300 * ($22 - $17) = $1500 (written down value)

(-) Credit inventory for the same amount, as we’ve lost $1500 in our reported value

Inventory Turnover

Lets say a manager of a clothing store wants to know how many times the store was emptied throughout the year (aka. when did the store sell all of its inventory).

To find the inventory turnover ratio that the manager is looking for, we take the COGS ($120K), beginning inventory ($17.5K), and ending inventory ($22.5K) to calculate the following:

  ($17.5 + $22.5)
/ 2
= $20

  $120
/ $20
= 6 # The inventory turned over 6 times

Now, the manager wants to know how long it takes to sell inventory, or the average days to sell inventory.

  365 days
/ Inventory turnover
= Average days to sell inventory

Following our previous example: 365 / 6 = 60.8 days on average for the inventory to turnover.

🚛 7: Long-Lived Assets

Long lived assets depreciate in value! There are two types of depreciation: 1. Accumulated depreciation which is depreciation over the life of the asset 2. Depreciation expense which is depreciation over the recorded period (whether it be a month, a quarter, a year, etc.)

Any time the depreciation expense goes up, we know the lifetime depreciation has also gone up. To understand how much an asset depreciates, we take into account two factors: 1. Useful life which is an estimate of how long we expect the asset to last 2. Salvageable or Residual Value which is how much the asset will be worth after the end of its useful life

The total amount the asset will depreciate is its original value - residual value.

To determine periodic depreciation, we use three methods:

Disposal before End of Life

If an asset is prematurely disposed of before the end of its estimated useful life, we sell it and take that cash to the bank. Sometimes, we can make gains/losses on the sale of long-lived disposed assets.

💸 8: Current Liabilities

🔃 In Progress

🪙 9: Non-Current Liabilities

🔃 In Progress

🥧 10: Shareholder’s Equity

🔃 In Progress

🌊 11: Statement of Cash Flows

🔃 In Progress

💬 12: Communication and Analysis

🔃 In Progress