Financial Accounting: Foundations

Professor Oktay Urcan

Module 1: Introduction to Financial Accounting

Table of Contents
Module 1: Introduction to Financial Accounting ...................................................................... 1
Lesson 1-1: Introduction ................................................................................................................... 2
Lesson 1-1.1: Introduction to Financial Accounting ............................................................................................. 2
Lesson 1-1.2: What Is Accounting? ...................................................................................................................... 3
Lesson 1-1.3: Financial Accounting Information .................................................................................................. 7

Lesson 1-2: Balance Sheets ............................................................................................................. 12

Lesson 1-2.1: Balance Sheet Overview .............................................................................................................. 12
Lesson 1-2.2: Balance Sheet: Assets .................................................................................................................. 15
Lesson 1-2.3: Balance Sheet: Liabilities.............................................................................................................. 22
Lesson 1-2.4: Balance Sheet: Shareholders’ Equity ........................................................................................... 28

Lesson 1-3: Income Statement ....................................................................................................... 34

Lesson 1-3.1: Income Statement........................................................................................................................ 34

Lesson 1-4: Cash Flow Statement ................................................................................................... 40

Lesson 1-4.1: Cash Flow Statement ................................................................................................................... 40

Lesson 1-5: Module 1 Case Video ................................................................................................... 45

Lesson 1-5.1: Module 1 Case Video ................................................................................................................... 45

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Lesson 1-1: Introduction

Lesson 1-1.1: Introduction to Financial Accounting

Hello. Welcome to the first class of financial accounting foundations here at the
University of Illinois. Here is a very brief overview of what we are going to do today.
First, we are going to define what accounting is, and then we will go through what
financial accounting is. And finally, we will discuss in detail three main financial
statements. These are balance sheet, income statement and cash flow statement. If
you're ready. Let's get started.

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Lesson 1-1.2: What Is Accounting?

What is accounting? If you go to Wikipedia, accounting is defined as the measurement,

processing, and communication of financial information about economic entities.

Accounting information is useful for many different parties. Shareholders and investors
can use accounting information to predict future cash flows of a firm. Creditors can use
accounting information to understand liquidity, risk, and profitability of a firm. Employees

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can use accounting information to judge a firm’s financial stability as well as in
negotiating their employment contracts.

Customers can use accounting information to understand if the firm is strong enough to
cover its warranty. Finally, managers can use accounting information in their decision-
making process, and in negotiating their own compensation contracts.

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Now, it's a good time to differentiate between financial accounting and management
accounting. Financial accounting deals with measurement and communication of
financial information for external users. These external users include shareholders,
investors, creditors, governmental authorities or auditors.

On the other hand, management accounting deals with measurement and

communication of information for internal users. These internal users include managers
and employees.

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In summary, financial and management accounting deal with the measurement and
communication of the same economic reality in different forms for different users.

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Lesson 1-1.3: Financial Accounting Information

What is accounting information and how we can obtain this information. Let me start
with the second question. There are many resources you can use to obtain accounting
information. One very useful resource you can always use is firm's websites. If you go to
the website of any public firm, you are likely to see a link for investor relations. If you
click on the link, you will get a lot of financial accounting information about the firm.

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For example, here is the investor relations website of Walmart. In this website, you have
access to information about recent significant events, stock prices, governance, and
ESG activities of Walmart. What we are interested in is accounting information. You can
obtain accounting information of Walmart by clicking on First financials and then Annual
reports links. Annual reports provide accounting information for a particular year. On the
other hand, under SEC filings, you will have access to both quarterly and annual
accounting information for Walmart.

In today's class, our focus will be on 2023 annual report of Walmart. Can you please
download this file from Walmart's Investor Relations website?

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Now, let me answer my first question I ask in this lesson, what exactly is accounting
information? Accounting information consists of major financial statements and notes to
the major financial statements. The major financial statements are balance sheet,
income statement, and cashflow statements. For 2023, annual report of Walmart,
balance sheet is on page 56, income statement is on page 54, and casual statement is
on page 58, and the notes to the financial statements are on pages between 59 and 80.
Now, let's discuss briefly what information we can obtain from these financial
statements.

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The first and the probably most important financial statement is the balance sheet.
Balance sheet communicates information about assets, liabilities, and shareholders’
equity of a firm. In other words, balance sheets help outsiders assess the resources of a
firm to create value and how these resources are financed. Income statement provides
information about revenues and expenses of a firm for a certain period of time. The
certain period of time can be a quarter or a year. Cashflow statement describes in detail
how cash changes for a firm for a certain period of time. In particular, by looking at cash
flow statement, we can learn the cash generated from operations, cash generated from
investment activities, and cash generated by financing activities. One thing we have to
always remember about financial statements is that they are highly summarized and
they do not provide much details.

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If we want to learn details on how financial statement numbers are calculated, we need
to look at notes for financial statements.

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Lesson 1-2: Balance Sheets

Lesson 1-2.1: Balance Sheet Overview

Balance sheet communicates information about financial position of a firm at a particular

point in time. By looking at balance sheet, we can learn information about assets,
liabilities and shareholders’ equity of a firm. In other words, balance sheet
communicates information about the resources of the firm and how those resources are
financed. The name balance sheet comes from the fact that assets = liabilities +
shareholders' equity. In other words, total resources of a firm is equal to total financing.
This equation is called fundamental accounting equation. We will frequently use this
equation throughout this course. Now let’s go through a small exercise about balance
sheet.

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Here is the asset side of the balance sheet of Walmart at the end of year 2023. Our task
is to check whether fundamental accounting equation holds for Walmart. In particular,
we need to check whether total assets are equal to total liabilities plus shareholders
equity for year 2023. According to Slide on the screen, Walmart's total assets in 2023 is
243,197. Please pay particular attention to the fact that all numbers in one month's
balance sheet are in millions as indicated at the top left corner.

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Under fundamental accounting equation, total assets should be equal to total liabilities
plus shareholders equity. As you can see in this slide, total liabilities plus redeemable
noncontrolling interest plus equity is 243,197. So, fundamental accounting equation
holds for Walmart.

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Lesson 1-2.2: Balance Sheet: Assets

Balance sheet consists of three important parts, the first part of a balance sheet is
assets. Assets section of a balance sheet provides information about resources of a firm
to create value. Resources have three important features. Resources should be
controlled by a firm. They should have probable economic benefits, and we should have
sufficient reliability to estimate these future economic benefits. So what are some
examples of assets? Cash is an asset, cash can be used to create value. Inventories,
these are items Walmart sells in its stores or assets. Another example for assets is
production machines, machines can be used by firms to create value. We will talk about
cash, inventories, and machines in detail later in the course.

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In general, we have two groups of assets. These are current assets and long-term
assets. Current assets are the ones that we have relatively short life, one year or less.
Some examples of current assets are cash, inventories, and account receivable.
Account receivables are the amounts that firms expect to collect in the future from
customers in return for a service they provide or goods they sell. Account receivables
are collected from customers generally within a year, therefore, they are classified as
current assets. The second important group of assets is long-term assets. Long-term
assets have a life more than one year. Some examples of long-term assets are
buildings and equipment. Firms use buildings and equipment to generate value more
than one year.

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Here is an exercise about assets. The question asks to identify the values of the
following accounts on Walmart's 2023 balance sheet. The balance sheet is located on
page 56 of Walmart's 2023 Annual Report. The accounts for which we will identify
amounts are cash and cash equivalents, receivables, net, inventories, and property and
equipment, net.

Here is the asset section of Walmart's 2023 Annual Report. Please note that we have
both 2022 and 2023 asset information on this slide.

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Our focus will be on the first column to identify 2023 amounts.

The first asset for which we need to identify the amount is cash and cash equivalents.
For 2023, the amount of cash and cash equivalents is 8,625. Let me please emphasize
that all numbers on Walmart's balance sheet are in millions. Although the exercise didn't
ask this, it is interesting to note that Walmart's cash and cash equivalents decreased
from 14,760 in 2022 to 8,625 in 2023, a net decrease of about $6 billion.

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The second group of assets that we need to identify on Walmart's 2023 balance sheet is
receivables, net. At the end of year 2023, the amount of receivables net for Walmart is
7,933. Just to remind you, receivables are sales made by Walmart, but not collected
from customers yet. Since receivables nets are classified as current assets, Walmart
expects to collect from customers 7,933 by the end of next year, which is 2024.

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The third group of assets that we need to identify on Walmart's 2023 balance sheet is
inventories. The total amount of inventories for Walmart at the end of 2023 is 56,576.
This suggests that Walmart has 56,576 worth of goods in its stores and warehouses
waiting to be sold in next year, which is 2024.

The last group of assets that we need to identify on Walmart's 2023 balance sheet is
property and equipment, net. The total amount of property and equipment, net for
Walmart is 100,760. We will cover property and equipment in detail later in the course,
but they are basically Walmart Superstores, warehouses, fixtures and fittings, as well as
delivery trucks. I would like to highlight at this point that Walmart's most important
assets are property and equipment and inventories. Given the nature of the business for
Walmart, I believe this makes sense.

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Lesson 1-2.3: Balance Sheet: Liabilities

The second important category of a balance sheet is liabilities. Liabilities section

provides information about obligations of a firm. Obligations have three first, these
obligations should be about transferring economic benefits in the future. Second,
obligations have to be measurable, and finally, the benefits which create these
obligations have already been received by the firm. What are some examples of
liabilities? Probably the most important and common example of liabilities is accounts
payable. We will talk about accounts payable in detail later in the course. Accounts
payable represents the value of goods and services received from suppliers but not paid
yet. One important characteristic about accounts payable is that they are interest-free.
In other words, customer firms do not pay interest to their suppliers for paying later.
Another example of liabilities is wage payable, which represents the amount firms owe
to their employees for work employees have performed. And finally, debt is a very
classical example of a liability. Debt represents, for example, the money owed to a
bank.

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In general, we have three types of liabilities. These are current liabilities, long-term
liabilities, and provisions. In current liabilities, we are talking about obligations that are
supposed to be paid within a year. Accounts payable and wage payable are some
common examples of liabilities that firms are supposed to pay within a year. On the
other hand, long-term liabilities are obligations that are supposed to be paid in a time
period more than one year. For example, if a firm borrows money from a bank to be
payable over the next 15 years, we have a long-term liability. The third group of
liabilities is provisions. Provisions represent amounts where there is at least a
reasonable certainty that an obligation will be incurred at some future date. Let me
please give you an example. Suppose that a firm is going through a lawsuit due to an
environmental hazard. It is possible that the firm can lose the lawsuit and therefore will
need to pay a huge penalty. If there is a reasonable certainty that the firm might lose the
lawsuits, the firm needs to create a provision for the future possible penalty. We will
discuss provisions in detail later in the course.

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Now let's go through an exercise about liabilities. The question asks us to identify the
values of the following liability accounts on Walmart’s 2023 balance sheet. Walmart’s
2023 balance sheet is on page 56 of 23 Walmart Annual Report. The liabilities we will
focus on are accounts payable, long-term debt due within one year, and long-term debt.

Here is the liabilities section of Walmart's 23 annual report. Just a small note here. Just
like the asset section of the balance sheet, the first column represents year 2023
values, and the second column represents year 2022 values.

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The first group of liabilities we need to identify is accounts payable. At the end of year
2023, the total amount of accounts payable for Walmart is 53,742. This suggests that
Walmart receives goods and services from its suppliers worth more than 53 billion and
will pay this amount sometime over the next year.

The second group of liabilities we need to focus on is long-term debt due within one
year. This account represents the amount of long-term debt that should be paid within a

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year. In other words, it is the short-term component of the long-term debt at the end of
year 2023. The total amount of long-term debt due within one year for Walmart is 4191.

The last group of liabilities we need to identify is long-term debt. Walmart has a long-
term debt balance of 34,649 at the end of year 2023, which needs to be paid over a
time period in more than one year. Taken together, it seems that the most important
group of liabilities for Walmart is accounts payable, which is the amount Walmart owes
its suppliers.

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As we have discussed before, accounts payable is a form of interest-free borrowing.

This suggests that Walmart finances a substantial part of its operations through interest
free financing. When we are discussing income statement, we will talk about why
Walmart needs interest-free financing.

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Lesson 1-2.4: Balance Sheet: Shareholders’ Equity

The third section of a balance it is shareholders' equity. Under shareholders' equity, we

have information about investment of shareholders. Shareholders are the owners of a
firm. According to the fundamental accounting equation, assets are equal to liabilities
plus shareholders' equity. Therefore, another way of defining shareholders equity is the
difference between assets and liabilities. Assets are resources used by firms to create
value. Some of these assets are financed by liabilities, and the rest are financed by
shareholders' equity.

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There are three major accounts in shareholders' equity. These are common stock,
additional paid-in capital, and retained earnings. What is a common stock? When
investors buy shares of a firm, they receive share certificates. Share certificates have a
small value on them. These values are called nominal value or par value of a share. Par
value is a legal concept, and it doesn't represent actual market value of a share. It is
generally random, small number, such as $0.10. You can view par value as the paper
value of a share certificate. Common stock account represents total par value of all
printed shares and is calculated as par value per share times number of shares issued.
The second important section of shareholders' equity is additional paid-in capital.
Additional paid-in capital represents the amount shareholders pay, or an above par
value to purchase shares of a firm. The third important section of shareholders' equities
retained earnings. Conceptually, firms generate profits for their shareholders and may
distribute these profits to their shareholders as dividends. The amount of profits that
firms do not distribute to their shareholders is called retained earnings. Retained
earnings is an important form of indirect financing for firms where, shareholders let firms
not to distribute profits, but keep profits in the business to invest in future growth. Let me
please highlight that retained earnings is an interest free form of financing. In other
words, shareholders do not demand interest from firms for profits kept in the firm.

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Now, let's go through an exercise about shareholders' equity. The question asks us to
identify the values of the following shareholders equity accounts on Walmart's 2023
balance sheet. Walmart's 2023 balance sheet is on page 56 of Walmart's annual report.
The equity accounts we will focus on are common stock, capital in excess of par value,
in other words, additional paid-in capital and retained earnings.

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Here is the shareholders' equity section of Walmart's 2023 annual report. Again, a small
reminder, just like as a section of the balance sheet, the first column represents year
2023 values, and the second column represents year 2022 values.

The first shareholders' equity account we need to identify as common stock. At the end
of year 2023, the total amount of common stock for Walmart is 269.

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The second shareholders' equity account we will discuss is capital in excess of par
value, in other words, additional paid-in capital. At the end of year 2023, the total
amount of capital in excess of par values, 4,969. In other words, Walmart shareholders
paid 4,969 to purchase Walmart shares over and above par value.

The last shareholder equity account we will focus on is retained earnings. At the end of
year 2023, the total amount of retained earnings is 83,135. It seems that the important
shareholders' equity account for Walmart is retained earnings in 2023.

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Let me please also remind you that accounts payable was the most important group of
liabilities for Walmart in 2023. Walmart's operations are mainly financed by accounts
payable and retained earnings. The common denominator of these two accounts, is
that, they are both interest free, and they do not cost Walmart to use them to finance
operations.

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Lesson 1-3: Income Statement

Lesson 1-3.1: Income Statement

The second major finance statement we will discuss is income statement. Income
statement summarizes financial performance of a firm over a certain period of time.
Publicly traded firms prepare quarterly and annual income statements. Income
statement includes information about firm's revenues, expenses, gains, and losses
within a certain period of time.

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Income statements have several components. Most income statements start with sales
information, which is the total value of sold items or provided services. Sales can also
be called as revenues or turnover. The second, cost of sales represents original
purchase price from a supplier of a sold item. For example, if Walmart purchases a
gallon of milk for four dollars and sells it for five dollars, in this example, four is the cost
of sales, and five is the sales information. Third, operating expenses include expenses a
firm incurs to run a business. For example, wages, electricity, insurance, and rent are
operating expenses for Walmart. Fourth, other income represents income or expense
from activities which has nothing to do with a firm's main core operations. For example,
interest income Walmart makes from keeping its cash in a bank account is another
income. Fifth, income taxes represent amount a firm owes to the government. Finally,
some income statements include information about extraordinary gains or losses, which
represent very rare gains or losses. For example, financial loss due to a fire is an
extraordinary loss. Extraordinary gains and losses are reported separately in an income
statement because we don't want rare events to distort a firm's income statement.

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Let's go to an exercise about income statement. The question asks us to identify the
values of the following items on Walmart's 2023 income statement. 2023 income
statement is on page 54 of Walmart's Annual Report. The accounts we will focus on are
total revenues, cost of sales, and consolidated net income.

This is what Walmart's income statement looks like for years 2023, 2022, and 2021.

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The first income statement account we need to identify is total revenues. At the end of
Year 2023, the amount of total revenues for Walmart is 611,289. It is also worth noting
that Walmart's total revenues steadily increased between 2021 and 2023.

The second income statement account we need to identify is cost of sales. At the end of
Year 2023, the total amount of cost of sales for Walmart is 463,721.

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The last income statement account we need to identify is consolidated net income.
Consolidation is a term related to mergers and acquisitions, therefore, please, do not
worry about the word consolidated. At the end of Year 2023, the total amount of
consolidated net income for Walmart is 11,292. It is interesting to note that compared to
the total revenues, Walmart doesn't make a huge amount of net income. To see this, we
can calculate profit margin, which is equal to net income divided by total revenues. If we
divide net income of 11,292 by total revenues of 611,289, we will get 1.8%.

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This suggests that for every $100 of sales Walmart records, it earns net after paying all
expenses $1.8. This is a quite small amount. If you remember our discussion of
Walmart's liabilities and shareholders' equity, we mentioned that Walmart finances its
operations mainly through accounts payable and retained earnings. The common
characteristic of these accounts was that they are interest-free form of financing.
Walmart earns a small profit margin from its operations despite it finances its operations
with almost free form of financing. If Walmart would finance its operations with, for
example, bank debt, the profit margin will be much smaller than 1.8%. How does
Walmart make profit? Walmart doesn't make profit by charging high profit margins.
Walmart makes profit from the volume of the sales it makes.

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Lesson 1-4: Cash Flow Statement

Lesson 1-4.1: Cash Flow Statement

The third major finance statement we will discuss is cash flow statement. Cash flow
statement provides information on cash inflows and cash outflows of a firm over a
certain period of time. Therefore, cash flow statement is very useful to summarize how
cash changes over a certain time period. Cash flow statement has three major cash
flows from operations, cash flow from investing activities and cash flows from financing
activities.

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2023 Walmart Annual report has cash flow statement on page 58. Here is how
Walmart's cash flow statement looks like in years 2023, 2022 and 2021. We said that
cash flow statement summarizes how cash changes for a public firm over a particular
period of time.

If we zoom in the last section of Walmart's 2023 cash flow statement, we learned that
cash decreased by $5,993 in 2023. Please note that in accounting we indicate negative

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numbers in parentheses. This explains how cash balance decreased from $14,834 at
the beginning of year 2023 to $8,841 at the end of year 2023.

What explains the cash balance decrease of $5,993 in 2023? Net cash provided by
operating activities is $28,841. This suggests that Walmart’s core operations, which is
buying and selling groceries, provided net cash inflow of $28,841. Net cash used in
investing activities is $17,722, this suggests that Walmart spent $17,722 to invest. If we
briefly examine the investing section, we will notice that the majority of money spent in
investing section is for payments of property and equipment. Net cash used in financing
activities is $17,039. If we examine the details of the financing section, we will notice
that Walmart spent $9,920 in repurchasing its own shares and spent $6,114 in
payments of dividends.

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If we sum net cash provided by operating activities, net cash used by investing
activities, and net cash used by financing activities, we will get a net cash balance
decrease of $5,993 in 2023.

This concludes our first module. In this module, we learned about the definition and
users of financial accounting information. We also went through in detail main financial
statements. In the next module, we are going to learn how to record financial

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transactions in accounting language and we will learn how to prepare basic financial
statements.

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Lesson 1-5: Module 1 Case Video

Lesson 1-5.1: Module 1 Case Video

In this video, we will use case studies to apply what we learned in this module. Before
you watch the solutions of the case studies, I strongly recommend you download the
case questions and spend some time to solve them. This will help you to get the
maximum benefit out of the case questions. The case questions have already been
uploaded on Coursera. Our first case is about General Mills Annual Report, please
download the 2023 General Mills Annual Report from the link given in the case
question. Alternatively, you can Google for 2023 General Mills Annual Report and
download the report.

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The first question asks where we can find some important items in General Mills Annual
Report. We have company overview on page 4. This section provides a brief summary
of the business and the markets it operates. Management's discussion and analysis of
financial condition and results of operations is on page 15 and 16. In this section,
managers of a firm summarize the firm's financial performance over the last year. I
would like to highlight that this section is not formal accounting. It is just the opinion of
the managers on how the firm did last year. Therefore, it is generally positively biased.
Financial statements and supplementary data section is on pages between 39 and 88.
This section provides the main financial statements such as balance sheet, income
statement, and cash flow statement, as well as financial statement footnotes to explain
the details of the amounts on main financial statements.

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Question 2 asks about General Mills' three largest assets in 2023. We need to look at
the balance sheet of General Mills on page 44 to answer this question.

The largest asset of General Mills in 2023 is goodwill. Its amount is 14,511 at the end of
2023. Goodwill is a topic we cover in mergers and acquisitions accounting. You can
simply view goodwill as the amount of excess payment in mergers and acquisitions. I
would like to highlight that goodwill amount constitutes almost half of the value of total

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assets. The second largest asset in 2023 is other intangible assets. Its amount is 6,967.
The third largest asset in 2023 is land, buildings, and equipment. Its value is 3,636.

Third question asks whether it makes sense for General Mills to have these assets.
General Mills manufactures and sells branded, processed consumer goods, such as
cereals, yogurt, pizza, ice cream, and snacks. It is not surprising that goodwill is the
largest asset because General Mills purchase many other food brands since it was
created in 1928. It is also not surprising that land, buildings, and equipment is large
asset since General Mills is a food manufacturer.

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How about intangible assets? The balance sheet doesn't provide much detail about
intangible assets. We need to look at Footnote 6 on page 53 to have the details of
intangible assets. Intangible assets mainly consist of brands purchased and customer
relationships. These items are related to mergers and acquisitions, and therefore, we
expect General Mills to have these intangible assets.

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Question 4 asks about two largest liabilities at the end of 2023. We need to look at the
balance sheet of General Mills on page 44 to answer this question.

The largest liability of General Mills in 2023 is long-term debt. Its amount is 9,965. The
second largest liability is accounts payable with an amount of 4,194.

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Question 5 asks the types of obligations represented by these liabilities. In other words,
this question asks the details of these liabilities. Accounts payable is a common type of
liability for many firms, and it represents the amounts firms owe to their suppliers.

We need to look at Footnote 9 on page 63 of General Mills Annual Report to learn the
details of long-term debt. It looks like that long-term debt mainly refers to the bonds. We
will discuss details of the bonds later in the course.

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Question 6 asks about the value of shareholders' equity at the end of 2023. We need to
look at the balance sheet of General Mills on page 44 to answer this question.

Shareholders' equity can also be called as stockholders' equity. Total stockholders'

equity of General Mills at the end of 2023 is 10,449.

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Question 7 asks the value of net sales for 2023. Sales information can be obtained from
income statement, which is on page 42 of General Mills 2023 Annual Report.

Net sales for General Mills in 2023 is 20,094.

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Question 8 asks about net income of General Mills in 2023. Net income or net earnings
information can be obtained from income statement, which is on page 42.

Net earnings of General Mills in 2023 is 2,609.

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Question 9 is a conceptual question and asks what net income represents. Net income
conceptual is the financial performance of a firm over a certain time period. It is
calculated as revenues minus all expenses and losses. In the case of General Mills,
revenues include mains sales. Losses and expenses include cost of sales, SG&A
expenses, interest, and tax.

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Question 10 asks about how we can learn about General Mills inventory accounting
methods. Please note that this question is not asking about the amount of inventory.
Instead, the question asks what kind of accounting method General Mills use to account
for inventory? In general, Footnote 1 and sometimes Footnote 2 provide information
about firm's accounting methods.

If we look at summary of significant accounting policies on page 47 of General Mills,

2023 Annual Report, we can learn that all inventories in the United States, other than
grain are valued at the lower of cost using the last in, first out methods. Last in, first out
method can also be called as LIFO methods. We will discuss LIFO method of inventory
valuation later in the course.

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Question 11 asks about the main components of General Mills inventory in 2023. We
need to look at Footnote 18 of General Mills 2023 Annual Report to learn the details of
General Mills inventory.

Footnote 18 provides some supplemental information about certain accounts, and it is

on page 84. It looks like that General Mills has three types of inventory. These are
finished goods, raw materials, and grain. The largest component of inventory is finished

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goods with a balance of 2,066. There's a line about excess of FIFO over LIFO cost. This
is another type of inventory, and we will discuss this in detail later in the course.

Case 2 asks us to classify the following balance sheet accounts as assets, liabilities, or
shareholders' equity. Retained earnings is a shareholders' equity. Income tax receivable
is an asset just like any other receivables. Other long-term debt and leasing obligations
is a liability. Inventories is an asset. Prepaid expenses is an asset. We will talk more
about prepaid expenses later, but briefly, it indicates advanced expense payments,
such as advanced payment of rent or insurance. Accounts payable is a liability.
Additional paid-in capital is a shareholders' equity item. Income tax payable is the
amount a firm owes to the government for taxes, and therefore, it's a liability. Account
receivable is an asset. Common stock is a shareholders' equity item.

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Case 3 provides eight financial scenarios to be classified as an asset, liability or

shareholders' equity for a coffee company. Item A is an agreement to hire a person to
work as a server. Since the firm didn't make any payment and the server didn't provide
any service, there is no financial accounting for this agreement. Item B talks about
roasting machine used to roast coffee beans. Roasting machine is a fixed asset. Item C
is about utilities for the current month payable next month. So, the firm used the utility
but will pay later. Therefore, this is a liability. Since it will be paid within a year, is a
current liability. Item D talks about $4,000 in cash on hand. Cash is a current asset
account. Item E is about 1,000 shares of common stock. Common stock is a
shareholders' equity item. Item F talks about 50,000 kilograms of coffee beans. Coffee
beans for a coffee company is inventory, and most of the inventories are current assets.
Item G is an invoice from a main supplier of coffee beans. In other words, the firm owes
money to a supplier. This is accounts payable and accounts payable is generally a
current liability. Item H talks about a bank note due in three years. This is a bank
borrowing to be paid in three years, and therefore, it's a long-term liability.

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