introduction to accounting - perdisco · introduction to accounting chapter 1 2. 1. explain the...

Introduction to Accounting

Chapter 1

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1. Explain the role of accounting information2. Identify the users of accounting information3. Distinguish between financial accounting and

management accounting4. Explain the role of the regulatory bodies in

developing generally accepted accounting principles

5. Explain five of the general principles that underlie accounting standards

Learning objectives

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6. Describe the key features of four business structures

7. Define the accounting equation and its components

8. Analyze transactions using the accounting equation

9. Describe the features of financial statements and explain how they interrelate

Learning objectives

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Explain the role ofaccounting information

Learning objective 1

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▪Accounting is an information system that – identifies information– records information– communicates information

▪Aim of accounting is to provide sufficient information for users to make informed business decisions

Role of accounting information

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▪ Identifying information– Recognizing transactions and events

▪Recording information– Measuring, classifying, documenting

▪Communicating information– Organizing, analyzing, interpreting, publishing

Role of accounting information

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Identify the users of accounting information


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▪ Investors▪Lenders▪Suppliers▪Employees▪Customers▪Government and regulatory agencies▪General public▪Managers

Users of accounting information

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Distinguish between financial accounting andmanagement accounting


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Financial accounting

Management accounting

Users External InternalReporting requirements

Regulated No regulation

Detail General reports Detailed reportsFrequency Annual or half-yearly As requiredFocus Past Future

Financial and management accounting

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Explain the role of the regulatory bodies in developinggenerally accepted accounting

principles


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GAAP:▪Generally accepted accounting principles

– Rules that govern financial accounting practice

FASB:▪The Financial Accounting Standards Board

– Issues the Accounting standards codification, the single authoritative source of U.S. GAAP

Role of regulatory bodies

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SEC:▪The Securities and Exchange Commission

– Authorizes the reporting requirements for companies who issue stock to the general public

IASB:▪ International Accounting Standards Board

– Issues IFRS, the International Financial Reporting Standards

Role of regulatory bodies

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Explain five of the general principles that underlie

accounting standards


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1. Historical cost principle▪ items are recorded at exchange value

2. Monetary unit principle▪ items are recorded in dollars

3. Going-concern principle▪assumes the business will remain in operation

General principles of accounting

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4. Business entity principle▪business records kept separate from owners

5. Materiality principle▪ information is material if its omission or misstatement could change or influence the judgment of a user relying on that information

General principles of accounting

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Describe the key features of four business structures


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▪Sole proprietorships▪Partnerships▪Corporations▪Limited Liability Company (LLC)

▪Each has advantages and disadvantages▪ Important to choose business structure because of legal and taxation implications

Business structures

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▪A business that only has one owner▪Separate business entity▪NOT a separate legal entity▪Unlimited liability▪Earnings taxed in the owner’s personal tax return

Sole proprietorships

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▪Two or more people that have an agreement to form a business▪Agreement includes how the income or losses of the partnership are to be shared▪Separate business entity▪NOT a separate legal entity▪Unlimited liability▪Earnings distributed among the partners and taxed in the partners’ personal tax return

Partnerships

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▪Separate legal entity– Own rights and responsibilities, similar to that of a natural

person– Corporation responsible for its actions

▪Limited liability

Corporations

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▪Ownership divided into units called shares, collectively known as stock▪Owners are stockholders▪Double taxation

– Corporations pay tax on earnings, AND dividends distributed to stockholders are also taxed in the owner’s individual tax return

– Double taxation does not apply if business elects to be treated as an S corporation provided it is eligible to do so

Corporations

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▪Combines characteristics of both corporations and partnerships▪Separate legal entity (corporation)▪Limited liability (corporation)▪Taxation (partnership)

– May elect to be taxed as a corporation, partnership or sole proprietorship, depending on specific structure

▪Owners are members who hold a membership interest

Limited liability company (LLC)

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Define the accounting equation and its

components


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Accounting equation

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Assets = Liabilities + Equity

▪Resources owned or controlled by an entity that are expected to provide benefits to the business in the future

Examples:– Cash – Accounts Receivable– Office Supplies– Equipment – Machinery – Vehicles – Land

Assets

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▪Probable future sacrifices of economic benefits where the entity has an obligation to transfer assets to another entity outside the organization, or to provide them with a service

Examples:– Accounts Payable– Bank Loan– Loan Payable

Liabilities

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▪The residual interest, held by the owners of the entity, in the assets of the entity after all liabilities have been deducted▪Also known as net assetsExamples:

– Owner's Equity– Capital

Equity

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▪Equity can be subdivided into– Capital– Withdrawals– Revenues– Expenses

▪This creates the expanded accounting equation…

Equity

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A = L + C – W + R – EWhere:

A = AssetsL = LiabilitiesC = CapitalW = WithdrawalsR = RevenuesE = Expenses

Expanded accounting equation

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▪Represents the value of the contributions the owners have invested in the business▪Capital increases equity▪Another name for Owner's Equity

Capital

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▪Represents the amount the owners have withdrawn from a sole proprietorship or partnership▪Withdrawals decrease equity▪Also known as Distributions

Withdrawals

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▪ Inflows or enhancements of assets or settlements of liabilities (or both) that result from activities that make up the ongoing central operations of the entity▪Revenues increase equityExamples:

– Sales– Sales Revenues

• amounts earned by a firm by providing goods to customers

– Service Revenues • amounts earned by a firm by providing services to customers

Revenues

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▪Outflows or other using up of assets or incurrences of liabilities (or both) that result from activities that make up the ongoing central operations of the entity. ▪Expenses decrease equity

Expenses

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Expenses

Examples:– Electricity Expense– Gas Expense– Telephone Expense– Utilities Expenses– Rent Expense

– Wages Expense• Employees paid on an hourly

basis

– Salary Expense• employees paid a set amount,

regardless of hours worked

– Advertising Expenses

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Analyze transactions using theaccounting equation


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▪Transactions and events are recorded in the accounting system▪A business transaction is an event in which entities exchange something of value▪Transactions are recorded as increases or decreases in the elements of the accounting equation

Transaction analysis

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▪Each transaction has at least two entries that affect the accounting equation ▪The accounting equation must remain in balance after each and every transaction



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1. Decide if the event is to be recorded in the accounting system

2. Determine the changes in the elements of the accounting equation

– Identify the names of the items affected– Classify each item as an element of the expanded

accounting equation – Determine whether each item has increased or decreased– Calculate the value of the increase or decrease of each

item

Steps in transaction analysis

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3. Record the transaction and check that the accounting equation remains in balance

– If the accounting equation is not balanced, an error has been made

– This error needs to be identified and fixed up before the next transaction is recorded

Steps in transaction analysis

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Transaction Owner invests $2,000 cash into the business


Item Classification Change Value

Cash Asset Increase $2,000

Capital Equity Increase $2,000

Accounting equation analysis


Cash = Capital

(A) +2,000 +2,000

A. Cash investment by owner

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Transaction Purchased supplies for $700 cash



Supplies Asset Increase $700

Cash Asset Decrease $700



Cash + Supplies =

(B) -700 +700

B. Purchased an asset with cash

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Transaction Purchased a computer on credit for $2,400



Equipment Asset Increase $2,400

Accounts Payable Liability Increase $2,400



Equipment = Accounts Payable

(C) +2,400 +2,400

C. Purchased an asset on credit

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Transaction Paid $600 cash toward the computer previously purchased on credit



Accounts Payable Liability Decrease $600




Cash = Accounts Payable

(D) -600 -600

D. Paid for an asset purchased on credit

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Transaction Received a loan of $5,000 from the bank




Loan Payable Liability Increase $5,000



Cash = Loan Payable

(E) +5,000 +5,000

E. Received loan

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Transaction Performed tutoring services for $3,300 cash




Revenues Revenue Increase $3,300



Cash = Revenues

(F) +3,300 +3,300

F. Performed services for cash

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Transaction Performed $4,400 worth of tutoring services on credit



Accounts Receivable Asset Increase $4,400

Revenues Revenue Increase $4,400



Accounts Receivable = Revenues

(G) +4,400 +4,400

G. Performed services on credit

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Transaction Received $800 cash from Accounts Receivable



Cash Asset Increase $800

Accounts Receivable Asset Decrease $800



Cash + Accounts Receivable

=

(H) +800 -800

H. Received cash from Accounts Receivable

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Transaction Paid $150 cash for advertising campaign



Advertising Expense Expense Increase ExpenseDecrease Equity

$150




Cash = Advertising Expense

(I) -150 - +150

I. Paid expense with cash

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Transaction Owner withdraws $250 cash from the business



Withdrawals Equity Increase WithdrawalsDecrease Equity

$250




Cash = Withdrawals

(J) -250 - +250

J. Owner withdraws cash from business

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Transaction Signing an employment agreement



- - - -

- - - -


No effect on the accounting equation

K. Non business transaction

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▪Each transaction has at least two entries▪Each transaction can be analyzed according to the increase and/or decrease of the elements of the accounting equation▪Withdrawals and Expenses decrease Equity▪The accounting equation always remains in balance after each transaction


Remember

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Describe the features offinancial statements and explain

how they interrelate


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There are four main financial statements:▪ Income statement ▪Statement of changes in owner's equity▪Balance sheet▪Statement of cash flows

Financial statements

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▪Summarizes the revenues earned and expenses incurred over a period of time

Income statement

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▪ Identifies the movements in equity over a period of time▪These include earnings, contributions and withdrawals of capital by the owners of the business

Statement of changes in owner's equity

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▪Presents the assets, liabilities and equity of the business at a specific point in time

Balance sheet

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▪Explains the inflows (receipts) and outflows (payments) of cash over a period of time

Reports 3 cash flow categories:▪Cash flows from operating activities

– Cash flows that occur in the process of providing goods or services to customers

Statement of cash flows

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▪Cash flows from investing activities– Cash flows that arise from the purchase and sale of

assets that are intended to be used by the business over the long term

▪Cash flows from financing activities– Cash contributions and withdrawals by the owners of the

business, as well as obtaining and repaying long-term loans


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▪Net income (or net loss) from the income statement is an input into the statement of changes in owner's equity▪Ending balance of Capital in the statement of changes in owner's equity is the ending balance of Capital reported in the balance sheet▪Ending balance of Cash in the statement of cash flows is the balance of Cash in the balance sheet.

Relation between the financial statements

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introduction to accounting - perdisco · introduction to accounting chapter 1 2. 1. explain the...

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