Financial Accounting, Chapter 2 Intro

Hello. My name is Joe Hoyle and I’m
speaking to you from the University of Richmond where it’s a rainy day today. So
therefore, it’s a good day to learn about financial accounting. I’m the co-author
of your financial accounting textbook and this is the introduction to Chapter
2. And to get ready for this video, I went back and I reread Chapter 2 again
and I was amazed by how many important things are covered in Chapter 2. If
you’re going to do well in financial accounting, you need to form a good solid
foundation here in the early chapters. And there’s much to be learned in
Chapter 2 that will help you as you go through the rest of this book. So let’s
make sure to read the material well and to pick out those things that are going
to help you do well. Now, we go back at the beginning of this chapter and we
talked to you about the idea that financial accounting paints a portrait
of an organization so that outside users can make decisions. That’s a very basic
idea behind financial accounting. In this chapter, we introduce financial
statements. Financial statements are the form by which most companies present
financial information. They don’t simply send out financial information randomly.
They put it into the form of financial statements and those financial
statements are sent to outside parties. So we’re going to talk more about that
in Chapter 3, but we set that foundation up here in Chapter 2. Now, one of the things that I want to
make sure you understand right here at the very beginning of the course is that
most financial information is not exact. Financial accounting has a bad
reputation for being a very, very exact discipline. That’s not true.
Financial accounting is attempting to paint a portrait. It’s attempting to
create a likeness of an organization and that likeness does not have to be, and
very much could not be, very exact. Now, that sometimes surprises students.
Why is financial accounting not more exact? Well the first thing is that users
simply don’t need exact information. You’re trying to make decisions about a
company and you can certainly do that without the numbers being exact down to
the penny. In addition, because many businesses and many other organizations
are dealing with huge numbers, it would be almost impossible to get numbers that
were exactly correct down to the penny. So users don’t need exact information
and frequently it would be very difficult to get that type of
information. And finally, and this is something that will you’ll see
throughout the remainder of this book, financial accounting deals a lot with
uncertainty. There is uncertainty in virtually every aspect of financial
information. You make a sale on an account. Will you be able to collect the money?
That’s an uncertainty. You’re sued by someone who thinks you have done them
wrong, will you lose that lawsuit? And if so, how much will you lose? That’s an
uncertainty. You sell a product with a warranty. How much will it cost you to
fix that product if the product breaks? There are uncertainties all the way
through a set of financial statements. And if you think about it, how do you
come up with exact numbers for something where there’s uncertainty? Well if you’re going to produce
information, and it doesn’t have to be exact,
how close is it really when you pick up a set of financial statements? When you
look at financial information how exact should you expect it to be? Well in
financial accounting we use the term “presents fairly.” We are
attempting to present information fairly. That means that we want the information
to present a likeness that is close enough that a decision-maker can make
good decisions with it. If it’s presented fairly then that’s as good as we
probably need for it to be. Now, if I am a student in this course my next question
is gonna be: What do you mean by presents fairly? What we normally say is that
presents fairly means that the information that we are sending out
contains no material misstatements. So if you pick up a set of financial
statements, or pick up a set of financial information, and you look at it, there are
no material misstatements in those financial statements. That’s what the
financial accountant is saying. What does the word “material” mean? What does the
word “misstatement” mean? Let’s do this misstatement first. A misstatement is
simply something that’s wrong. There is no material misstatements nothing
materially wrong. Misstatements are broken into two categories: you have
errors. which are unintentional mistakes you did it by accident. You didn’t mean
to make the mistake. And you have fraud. Fraud is where there’s something wrong
and you did it on purpose. For example, you stole something—that would be fraud.
Or you reported something incorrectly knowing that it was incorrect—that would
be fraud. So when we talk about misstatements, we’re talking about both
errors and fraud. But that leaves the term “material.” Material is anything of a size or a type that would change a decision maker’s decision. So
when we say that information is presented fairly, then it contains no
material misstatements. What we’re saying is that there is no errors and no fraud
there would be large enough to change your decision. And since there’s nothing
that would change your decision, you can feel safe in using the information that
you have received. We close out this chapter by talking
about accounting as a language. Now we talked in Chapter 1 about how accounting
was the conveyance of information, so it could be understood by outside parties.
That’s exactly what happens with any language, whether it’s English or
Japanese or Russian or Spanish or whatever language. They convey
information that would be understood. Now ask yourself, how does a language manage
to work well? It works because there is a structure, a grammar, a syntax, a
punctuation and there is set terminology. If you have rules and you have
terminology you can convey information. Financial accounting works the same way.
It has a structure and it has terminology. The structure here in this
book is presented or created by U.S. Generally Accepted Accounting Principles,
which are well known as U.S. GAAP. You often hear people talk about financial
accounting and refer to U.S. GAAP. That’s the rules that create the structure for
financial accounting, and in many ways, this entire course is a study of U.S. GAAP.
Who produces U.S. GAAP? It’s produced by an organization known as the Financial
Accounting Standards Board, which we often refer to as a FASB. In
addition, there is a terminology, set terminology. And learning that
terminology will help you to come to understand the information being
presented. I close out Chapter 2 with four vital terms. Those terms are: asset, liability, revenues,
and expenses. You need to know those four words. You can go very far in this course
with those four words. Assets: anything you own our control that has future
economic benefit—land, buildings, inventory, patents. Those are all assets
because they have future economic benefit. Liabilities: your debts. Anything
that you owe. If you owe an employee, you have a salary payable. That’s a liability.
If you owe the bank, it’s probably a note payable. That’s a liability. Assets, what
you own of value. Liabilities, what you owe. We often take the assets, subtract
the liabilities, to get a number that we call the “net assets.” Revenues is any
inflow or increase in a company’s net assets by selling goods or services.
That’s what you’re there to do. If you’re a bookstore, you’re selling books. If
you’re a car company, you’re selling cars. Then revenue is the increase, or the
inflow, of net assets because you’re able to sell a good or a service. Expenses are
a type of reverse of revenues. It’s an outflow, or using up, of your net assets, in order to generate revenue. You pay an employee, it’s a salary expense. You pay for rent, it’s a rent expense. It’s using up your
net assets in order to generate revenues. Accounting is a language that has a
structure and terminology. Those four terms are probably as important as any
terms that you have in financial accounting. Read Chapter 2, there’s much
to be learned. There’s much that’s going to help you become a good decision maker once you leave this course. Read it, take good notes, let’s make it happen.

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