Introduction to Financial Accounting, Appunti di Contabilità

Scarica Introduction to Financial Accounting e più Appunti in PDF di Contabilità solo su Docsity! 1 Irene Busnelli 2022/2023 01. WHAT IS ACCOUNTING, BASIC FINANCIAL STATEMENTS, ROLE OF ACCOUNTING STANDARDS ➔ ACCOUNTING = is the measurement, processing, and communication of financial and non- financial information about economic entities → accounting consists of 3 basic activities: 1. IDENTIFYING RELEVANT FINANCIAL INFORMATION = based on identifying economic events relevant to the business, also known as transactions (cash in / cash out). 2. COLLECTING AND RECORDING (BOOKKEEPING) = after identifying transactions it is necessary to collect, record and classify them in order to provide a history of financial activities, therefore to keep a systematic chronological diary of events measured in monetary units → this classification has to be coherent and constant, therefore companies need a standardized classification which is reached by accumulating information resulting from similar transactions → finally it is necessary to summarize numbers related to the same classification in order for them to make sense. (ex. classify transaction in food – not classified as coffee, breakfast, bread but under the same group) 3. AGGREGATING, PROCESSING, AND COMMUNICATING INFORMATION = it is necessary to process and to communicate the information obtained to interested users, which is done by preparing and providing accounting reports → moreover, when the accountant is communicating economic events, he must be able to: - analyse information by providing graphs and charts to highlight significant financial trends - and interpret information by explaining the use, meaning and limitations of data. ➔ Therefore, it is possible to identify and classify those who will be interested in the financial accounting of a company, who can be defined as the users of accounting information, and they are: - Shareholders, because they own shares, thus they are interested in being aware of the company’s financial status in order to decide whether to buy, hold or sell. - Government, as the company must fulfil tax obligations. - Competitors, because they want to know the performances of the company. - Employees, since the company is supposed to pay them their salary. - Suppliers, as they have to understand if their relationship with the firm will survive over time and also because they usually sell on credit. - Customers - Investors, that can be classified as: • shareholders • creditors/lenders Both can be either actual investors or potential investors who are considering to hold/buy/sell shares (shareholders) or to lend money (creditors) to the company → therefore they have to take into consideration the financial position of the firm. - Management, which includes the decision-makers, such as the board of directors and divisional /functional management. IN TE R N A L U SE R S EX TE R N A L U SE R S 2 Irene Busnelli 2022/2023 ➔ Moreover, in accounting users are classifies into: ▪ INTERNAL USERS = include management, marketing managers, human resources, and finance directors etc., so those who have access to all the financial information they need. ▪ EXTERNAL USERS = include all the other users, so individuals and organizations outside the company, that get access only to specific information → the main external users are investors and creditors. ➔ Core stakeholders (employees and shareholders), even though they are members of the board of directors – thus they are in management – in accounting are considered as external users → this is due to the fact that the accounting we do is the Anglo-Saxon approach to accounting, whereas the idea of shareholders and employees being core stakeholders is more of an Italian approach → in fact, in the Italian economy there are many small companies in which shareholders are in management, but internationally speaking there are bigger companies in which shareholders have few shares (ex. if you buy a share of Apple you are automatically a shareholder but you are not in management, thus you do not have access to all financial information). ➔ However, if a shareholder owns a great percentage of shares or if a lender provides a great amount of money, then they are no longer external users but internal users, therefore they are in management. ➔ External users get information since companies publish their FINANCIAL STATEMENTS AND REPORTS → in particular, there is standardization on the information a company must publish, which is defined by ACCOUNTING STANDARDS set of accounting rules companies must follow when they provide financial information, which define what specific information the firm has to provide and that protect external users. ➔ In some countries accounting standards are stated by laws (ex. in Europe), while in Anglo- Saxon countries the association of accountants define accounting standards that become generally accepted (because they use the common law) ➔ Furthermore, of course for internal users there are no accounting standards. ➔ Moreover, there are two main accounting systems: 1. FINANCIAL ACCOUNTING = provides economic and financial information to external decision makers such as creditors, investors, suppliers, and customers → those who are in charge of writing financial accounting reports must take into consideration the information that external users need and provide it to them. 2. MANAGERIAL ACCOUNTING = provides internal reports to internal decision makers → management accounting is more frequent, in fact while financial accounting statements for external users are published yearly, on the other hand statements for internal users are more frequent and dispose of more detailed information → managerial accounting statement also provide information about specific segments/divisions of the firm and include non-financial data. 5 Irene Busnelli 2022/2023 sometimes they are paid with other assets or services (ex. airline companies pay the debt with customers by providing a service) → liabilities are, just like assets, classified as: • Current liabilities (are meant to be paid within a year) • Non-current liabilities (they are meant to be paid beyond the year, therefore in the balance sheet only the amount left to pay will appear) → financial resources are provided by creditors through: • Commercial debt (suppliers allow the firm to purchase on credit) • Financial debt (cash lent by suppliers)  Accounts payable  Notes payable  Taxes payable - EQUITY: difference between assets and liabilities (A = L + E) → it is also the financing contributed by shareholder, either with: • Share capital (money invested by shareholders) → explicitly invested • Retained capital (capital generated by not distributing profits to shareholder in the form of dividends) → implicitly invested 4. STATEMENT OF CASH FLOW ➔ statement that shows inflows and outflows of cash (that is a specific kind of asset) and covers the same given period of time as that of the income statement. ➔ The statement of cash flow classifies inflows and outflows into: • Initial cash (as reported in the previous year’s balance sheet) • Cash flows from operating activities (cash from activities that are directly related to earning income, so day-to-day activities, such as purchasing raw materials, paying salaries etc.) • Cash flows from investing activities (cash generated from the acquisition (+) or sale (-) of assets → they are reported in this statement only when the firm pays for them, not when it just owns it) • Cash flows from financing activities (cash borrowed (+) or repaid (-).) 5. COMPREHENSIVE INCOME STATEMENT ➔ presents other comprehensive income items that are not included in the determination of net income ➔ furthermore, it is necessary to define 3 main concepts related to financial statements: - HISTORICAL COST CONVENTION = establishes how accountants attach a price/value to assets; the historical cost is the price at which the asset has bee bought, the value is the actual value of the asset in a specific moment. - SUBJECTIVITY IN FINANCIAL STATEMENTS = not all values in a financial statement are objective; as a matter of fact, the purchase price is objective, but on the other hand the value after usage is based on assumptions (because consumption is not constant over time, so the usage of assets is not constant). 6 Irene Busnelli 2022/2023 - DEPRECIATION = it is the spreading out of the original cost over the estimated life of the asset → as a result, depreciation is not objective, as the usage of an asset, as previously stated, is based on assumptions → the values resulting from depreciation are presented in financial statements in the following ways: ➢ Gross book value = value of the asset at the moment of acquiring it (not necessarily buying it). ➢ Depreciation expense = usage of the asset in the relevant year (in monetary value) → reported in the income statement. ➢ Accumulated depreciation = used up portion (sum of the values of usage of each year). ➢ Net book value = it is the value still left and it equals to the difference between the gross book value and the accumulated depreciation → reported in the balance sheet. ➔ As previously stated, additionally to the 5 financial statements, in the financial report there will also be: 1- MANAGEMENT DISCUSSION AND ANALYSIS = descriptive statement in which managers describe and discuss the financial position and performance, in fact it is usually the very first statement the reader sees → it must cover at least the company’s ability to cover short-term obligations, the ability to fund operations and expansion, and results of operations (amount of profit and factors that determined the profit) → it must also provide some background of the firm, such as difficulties, favourable or unfavourable trends and uncertainties that affect these 3 factors. 2- NOTES TO FINANCIAL STATEMENTS = descriptions of the accounting rules applied in the financial statements, which provide additional detail (ex. revenues from different market, comparisons with previous years etc.), non-monetary information and explain specific choices taken by the firm. 3- AUDITOR’S REPORTS = when a firm publishes its financial reports it must comply with accounting standards, and auditors are the body that has the responsibility to verify that the data in the financial statements are correct. ➔ The whole financial report is based on an equation, which is known as the BASIC ACCOUNING EQUATION ( A = L + E ) → however, it is also possible to make explicit an EXTENDED ACCOUNTING EQUATION, as all financial statements are interconnected, and each transaction has to be recorded in a way that keeps the equation balanced: ➔ The values defined in the extended accounting equation are present in different financial statements: → equity is made of share capital and retained earnings → retained earnings are beginning retained earnings + net income – dividends → net income is the difference between revenues and expenses 7 Irene Busnelli 2022/2023 ➔ EXAMPLE OF FINANCIAL REPORT: SANDWICHES 2001 BALANCE SHEET AS AT 2001/01/01 OWN (ASSETS) OWE (LIABILITIES) Cash 10.00 0.00 Equity (A-L) 10.00 BALANCE SHEET AS AT 2001/12/31 OWN (ASSETS) OWE (LIABILITIES) Equipment (ham slicer) 18.00 To mother 18.00 Supplies/inventory (leftover ham) 1.50 To suppliers (for ham slicer) 20.00 Cash 28.80 Total owned 48.30 Total owed 38.00 Equity (A-L) 10.30 ➔ The balance sheet shows what a company owns and what it owes to third parties. ➔ The second one is also a balance sheet but as of December 31st - the value of the ham slicer is 18.00 because it is possible to define a double value of an item: ➢ HISTORICAL COST = determines the value of an asset, the price at which the asset was bought (in this case 20.00) → this cost is objective. ➢ VALUE = the actual value of the item in a specific moment, not related to current market priced but to its lifespan and the usage (in this case 18.00 because 10% of its lifespan has already been exploited) → the value over time is not objective. - The value of ham owned is 1.50 because only the 15% of the ham was left → this number is not objective. INCOME STATEMENT RESOURCES USED (EXPENSES) PRODUCED AND SOLD (REVENUES) Bread 1.20 Sandwiches 12.00 Ham 8.50 Mother’s money 0.00 Ham slicer 2.00 Labour 0.00 10 Irene Busnelli 2022/2023 CAPITAL INVESTED SHARE CAPITAL RETAINED CAPITAL Cash from shareholders 10.00 Net income 2001 0.30 Additional share capital 4.00 Net income 2002 6.60 Total invested 20.90 11 Irene Busnelli 2022/2023 03. Transactions, accounting equation, & accounting cycle ➔ As previously said, accounting consists of 3 basic activities → among them, the second one consists in collecting, recording, classifying transactions: this second step has 2 sections: 1. First, it is necessary to record transactions during the financial year by using the accounting equation, but also: o Identifying transactions through “accounts” and “transactions analysis”. o Formalizing transactions through journalising and posting. o Aggregating such impacts in an unadjusted trial balance. 2. However, at the end of the financial year, in order to produce the financial statement, it is necessary to adjust it. ➔ As a matter of fact, there are 9 main steps required in the accounting cycle: 1 ANALYSING TRANSACTIONS 2 JOURNALIZE THE TRANSACTIONS 3 POST TO LEDGER ACCOUNTS 4 PREPARE AN UNADJUSTED TRIAL BALANCE (at the end of the year) 5 JOURNALIZE AND POST-ADJUSTING ENTRIES: DEFERRALS/ACCRUALS 6 PREPARE AND ADJUSTED TRIAL BALANCE 7 PREPARE FINANCIAL STATEMENTS 8 JOURNALIZE AND POST-CLOSING ENTRIES 9 PREPARE A POST-CLOSING TRIAL BALANCE 1. Transaction analysis ➔ TRANSACTIONS = economic events that require recording in the financial statement, since they affect assets, liabilities, and/or equity, so they have an effect on the entity → there are 2 main types of transactions: - EXTERNAL TRANSACTIONS = the large majority of external transactions are exchanges, where the business entity buys and sells, so where it gives something up and receives something in return (ex. purchase of a machine from supplier, borrow cash from a bank) → however, when shareholders invest cash in a company, the action is considered an external transaction but not really an exchange, because there is no third party involved. - INTERNAL TRANSACTIONS = they are not exchanges, but they are transactions as they have a direct and measurable effect on the firm, even though they happen inside a company (ex. depreciation). ➔ As a result, it is possible to say that transactions, in order to be considered as such, must affect the firm, and: • They must affect at least 2 ACCOUNTS → accounts are classifications of assets/liabilities/revenues etc., they specify the category to which each transaction belongs (ex. cash, equipment, investments, notes payable …) → account titles are organized into a chart of accounts. • The basic accounting equation must remain in balance after each transaction. 12 Irene Busnelli 2022/2023 ➔ The technique employed when analysing transactions can be described as: 1. Identify the events that can be defined as transactions. 2. Identify the accounts (by title) affected and make sure at least two accounts change 3. Classify such accounts by type. Was each account an asset (A), a liability (L), or a stockholders’ equity (SE)? 4. Determine the direction of the effect. Did the account increase (+) or decrease (-)? → it is useful to identify what “comes in” (+) and what “goes out” (-), keeping in mind that one of the two flows (in or out) will often be cash or a promise to pay. 5. Verify that the accounting equation remains in balance ➔ EXAMPLE 1 LIABILITIES SC BRE EXP DIV independent situations cash equipment construction in progress intangibles land investments A) New co is formed & sells 100 shares @ $12 ea 1200 1200 B) Co. Purchases for $ 18,000 a new delivery truck that has a list price of 21,000 -18000 18000 C) Co. Orders 30 new display stands for $300 ea for future delivery D) Co. Orders & receives 10 pc's for which it signs a $ 25,000 note 25000 25000 E) Co. Signs contract with construction co to build a $500,000 warehouse. It then writes a $50,000 check, receiving construction in progress -50000 50000 F) Publishing Co. Purchases copyright for $40,000 cash -40000 40000 G) Co. Pays shareholders a $100,000 cash dividend -100000 -100000 H) Co. Purchases land for $50,000 cash. An appraiser values it at $52,500 -50000 50000 I) Co. Acquires patent, paying $500,000 cash & signing a $400,000 note payable -500000 900000 400000 J) Co's owner buys a car for $10000 with his own money for his personal use K) Co. Purchases shares in another co. for $5,000 cash -5000 5000 L) Co. Borrows $1,000 from bank & signs 6-month note 1000 1000 M) Co. Pays $1,500 principal on its note payable -1500 -1500 ASSETS = NOT A TRANSACTION NOT A TRANSACTION THAT CONCERNS THE FIRM ENTITY CONCEPT = clarifies that the firm is one thing, and the owner of the firm is another ➔ EXAMPLE 2: LIABILITIES SC REV EXP DIV transactions cash account receivable supplies equipment accounts payable 1 15000 15000 2 -7000 7000 3 1600 1600 4 1200 1200 5 250 250 6 1500 2000 3500 7 -1700 1700 8 -250 -250 9 600 -600 10 -1300 1300 ASSETS = 15 Irene Busnelli 2022/2023 3. Journalizing transactions ➔ In addition to posting, companies also journalize transactions (usually before posting) to display the impact of transactions → the JOURNAL includes • the date of the transaction • the account involved in the transaction • debit or credit (according to the direction of the transaction) ➔ Moreover, accounts are written with and INDENT, in order to highlight which account goes debit and which one goes credit debit or credit → in the journal debits are reported first, and then credits are reported with the indent (this implies that debit and credit must always balance). ➔ EXAMPLE OF JOURNAL ➔ As a result, it is possible to affirm that: - The rows of the spreadsheet correspond to the JOURNAL - The columns of the spreadsheet correspond to the T-ACCOUNT ➔ Moreover, for both the journal and the T-account, balance can be either debit or credit: ▪ If debits are greater than credits, the account will have a DEBIT BALANCE ▪ If credits are greater than debits, the account will have a CREDIT BALANCE ➔ The type of balance usually depends on the type of account taken into consideration, and different accounts have a different NORMAL BALANCE, in fact: - The normal balance of assets, expenses, and dividends (left-hand side of the rearranged equation) is the DEBIT BALANCE - The normal balance of liabilities, shared capital, revenues, and beginning retained earning (right-hand side of the rearranged equation) is the CREDIT BALANCE. (ex. the normal balance for cash is debit, the normal balance for shared capital is credit). DATE ACCOUNT TITLE AND EXPLANATION DEBIT CREDIT 1) Oct 1 Cash Shared capital 10000 10000 2) Oct 1 Cash Notes payable 5000 5000 3) Oct 2 Equipment Cash 5000 5000 4) Oct 2 Cash Unearned service revenue 1200 1200 5) Oct 3 Cash Service revenue 10000 10000 6) Oct 3 Rent expense Cash 900 900 7) Oct 4 Prepaid insurance Cash 600 600 8) Oct 5 Supplies Accounts payable 2500 2500 10- Oct 20 Dividend Cash 500 500 11- Oct 26 Salaries expenses Cash 4000 4000 16 Irene Busnelli 2022/2023 4. TRIAL BALANCE ➔ TRIAL BALANCE = list of accounts and their balances at a given time (ex. total for cash, total for equipment) → the balance of these accounts can be either debit or credit, and the purpose of the trial balance is to prove that debits equal credits → the trial balance is produced after recording transactions in the T-Account, and it lists accounts and their balance in the order in which they appear in the ledger: - Assets - Liabilities - Equity - Revenues - Expenses ➔ There are 3 different types of trial balance: the unadjusted trial balance, the adjusted trial balance, and the closing trial balance. unadjusted trial balance ➔ The trial balance can be defined as “unadjusted” because accounting has 2 main phases: 1. Recording the financial transactions which happen during the financial year 2. Adjusting those numbers. ➔ Moreover, companies prepare unadjusted trial balances in order to determine if any mistakes were made recording financial transactions, in fact, debits and credits not balancing implies that a mistake was made. adjusted trial balance ➔ The main reason why adjustments are needed in the trial balance lies in the fact that the life of an organization is continuous, but it is artificially divided into periods → this artificial division has major consequences in recording transactions: for example, if company A provides a service in February and gets paid in May, and company B provides a service in November but gets paid in January, they will both get paid after 3 months, but company B at the end of the year in the financial statements has to show that they still need to receive money. ➔ Adjusting entries: - Implies ensuring that revenue recognition principle and expense recognition principle are followed. - Is required every time a company prepares financial statements. - Is based the tools used to analyse and record transactions. 17 Irene Busnelli 2022/2023 - Requires additional estimations, assumptions, and judgements → as a matter of fact, the numbers recorder throughout the financial year are objective, whereas the adjustments are always somehow subjective. - Follows the unadjusted trial balance and lead to the adjusted trial balance. - Always includes one INCOME STATEMENT ACCOUNT (revenue or expense) and one BALANCE SHEET ACCOUNT (asset or liability). - NEVER INVOLVES CASH, as movements of cash are recorded as day-to-day transactions (external transactions). ➔ Moreover, accounting focuses on transactions, so on economic events that have an impact on assets, liabilities, or equity → transactions can be either: ➢ EXTERNAL TRANSACTIONS are recorded day by day through the extended accounting equation, the spreadsheet, the journal, or the ledger → the result is the unadjusted trial balance, in which, however, the numbers do not satisfy the revenue recognition and matching principles. ➢ INTERNAL TRANSACTIONS are recorded as end-of-the-year adjustments (ex. depreciation). ➔ In particular, it is necessary to consider 4 different types of adjustments: 1. PREPAID EXPENSES 2. UNEARNED REVENUES 3. ACCRUED REVENUES 4. ACCRUED EXPENSES ➔ Moreover, even though transaction analysis records assets, at the end of the accounting period the firm has to verify if the asset is still unused or if it has been used to any extent (adjustments in the journal are dated in the last day of the accounting period). ➔ It is also important to remember that ADJUSTMENTS NEVER INVOLVE CASH. Company is Rent is due at landlord tenant Beginning of stay During financial year: 2 Cash 90 (debit) Unearned revenues 90 (credit) (This is not consistent with the revenue recognition principle) At dec 31 Unearned revenues 60 (debits) Service revenue 60 (credit) During financial year: 1 Prepaid expense 90 (debit) Cash 90 (credit) (This is not consistent with the expense recognition principle) At dec 31 Prepaid expense 60 (credit) Rent expense 60 (debit) End of stay During financial year: 3 Nothing At dec 31 Service revenue 60 (credit) (Accrued) Accounts receivable 60 (debit) During financial year: 4 Nothing At dec 31 Rent expenses 60 (debit) (accrued) accounts payable 60 (credit) 1. PREPAID (DEFERRED) EXPENSES ➔ If a transaction has been recorded as an ASSET (in particular a prepaid expense) in the unadjusted trial balance, the adjustment determines if it has turned into an EXPENSE by the end of the period. DEFERRALS ACCRUALS 20 Irene Busnelli 2022/2023 5. FINANCIAL STATEMENTs ➔ After identifying adjustments, it is necessary to produce the adjusted trial balance, and afterwards the adjusted trial balance provides the primary basis for the preparation of 3 of the 5 financial statements. ➔ In order to prepare financial statements from the adjusted trial balance, the CLASSIFICATION OF ACCOUNTS is needed → accounts must be classified into assets, contra- assets (inside assets but with minus), liabilities, share capital, revenues, expenses etc. ➔ When producing statements, it is better to follow this order 1- INCOME STATEMENT (A=L+SC+BRE+REV-EXP-DIV) 2- STATEMENT OF RETAINED EARNINGS (A=L+SC+BRE+NI-DIV) 3- BALANCE SHEET (A=L+E) ➔ For what regards the STATEMENT OF CASH FLOWS, there are 2 ways to build it: 1. In real life the technique is based on using the balance sheet, the balance sheet at the end of previous year, the income statement, and additional information. 2. However, a simplified method classifies the values inside the cash account into cash inflows and outflows from OPERATING, INVESTING, OR FINANCING ACTIVITIES. ➔ After finding the net increase in cash in the statement of cash flows, it is necessary to check if it is equal to the value of cash in the balance sheet → finally, in the statement of cash flows the net increase in cash has to be summed to cash at the beginning of the period in order to determine the value of cash at the end of the period. 21 Irene Busnelli 2022/2023 6. Closing entries ➔ After producing financial statements, the firm needs to organize data for the following year. ➔ This procedure is called CLOSING ENTRIES, and it includes 4 steps (assets, liabilities and share capital are not affected by this procedure, only revenues and expenses are): 1- CLOSE REVENUES TO INCOME SUMMARY = based on moving the balance of revenue accounts to income summary → this is done by debiting the credit of revenues (therefore establishing a zero balance in revenues) and crediting income summary. 2- CLOSE EXPENSES TO INCOME SUMMARY = based on moving the balance of each expense account to income summary → this is done by crediting the debit of expenses (therefore establishing a zero balance in expenses) and debiting income summary ➔ By doing step 1 and 2, the income summary is equal to the income statement (rev-exp) 3- CLOSE INCOME SUMMARY TO RETAINED EARNINGS = done by moving the net income to debit (in order to close the income summary) and credit the retained earnings T- Account. 4- CLOSE DIVIDENDS TO RETAINED EARNINGS = done by crediting dividends (in order to close the T-Account for dividends) and crediting them to the retained earnings T- Account. ➔ By doing step 3 and 4, the T-account for retained earnings will be equal to the statement of retained earnings (ni – div) ➔ At the end of this procedure, the only accounts that will not have a zero-balance are retained earnings, which is a permanent account, but also assets, liabilities, and shared capital, as they are not affected by the procedure of closing entries → as a result, the only accounts that do not have a zero-balance are the balance sheet accounts. ➔ Finally, it is necessary to produce a POST-CLOSING TRIAL BALANCE. 22 Irene Busnelli 2022/2023 04. classified statements ➔ Classifying statements implies that companies group similar assets and similar liabilities together in order to improve the understanding of financial information → this usually works for the balance sheet and the income statement. ➔ In the case of the BALANCE SHEET, transactions are classified into: ➢ assets = they are usually divided into current and non-current assets. • INTANGIBLE ASSETS = include assets which do not have physical substance, such as software, patents, trademarks, copyrights, trademarks, and goodwill → moreover, intangible assets are similar to durable goods, as a matter of fact they usually undergo depreciation. • PROPERTY, PLANT AND EQUIPMENT = include durable goods that are tangible, and which have long, useful lives, such as land, buildings, equipment, vehicles, and furniture. → only assets that are included in core operations belong to this category. → they are asset that get depreciated (however, the only assets belonging to this category which do not get depreciated are land and construction work in progress). • LONG-TERM INVESTMENTS = there are 3 types of long-term investments: 1. Investments in stocks and bonds of other companies that have been held for more than 1 year → as previously seen, if a company holds cash in excess, it can acquire shares of other companies on the stock exchange, or government bonds → these assets must not turn into cash within 1 year, as they are non-current assets. 2. Long-term assets such as land or buildings, that the firm is not currently using in its core operating activities. 3. Long-term notes receivables, so money that the firm has been lending to someone external to the firm for more than 1 year. • CURRENT ASSETS = include assets that the firm expects to either convert into cash or use up within 1 year or within the operating cycle, which is longer since it is the period that starts from purchase of raw materials and ends at the delivery of the final product. → they include prepaid insurance, prepaid rent, supplies and inventory, accounts receivables, notes receivable (if due within 1 year), cash, short-term investments (shares and bonds that the firm expects to sell or redeem within 1 year). ➢ equity = includes • SHARE CAPITAL = investments of assets into the business by shareholders. • RETAINED EARNINGS = income retained for use in the business. ➢ liabilities = include • CURRENT LIABILITIES = include liabilities that are due within 1 year, such as accounts/notes payable, salaries and wages payable, interest payable, and income taxes payable). • NON-CURRENT LIABILITIES = include liabilities that are due beyond the year, such as bonds payable, long-term notes payable, and lease liabilities. → the year is calculated from the day of the balance sheet; it is not calculated from the day the liability was generated. CURRENT ASSETS NON-CURRENT ASSETS