(1) introduction & conceptual framework 2014

INTRODUCTION TO FINANCIAL

ACCOUNTING Mahfuzul Hoque Ph. D

What is Accounting?

Accounting is an Information System. The purpose of accounting is to identify, record, classify and summarize and finally communicate the economic events of an organization to interested users.

Wednesday, May 3, 2023 2DMH - DU

Management

There are two broad groups of users of

financial information: internal users and

external users.

Human Resources

TAX

Labor Unions

SEC

Marketing

Finance

Investors

Creditors

Who Uses Accounting Data?

Customers

Internal Users

External Users


Common Questions Asked User

1. Can we afford to give our employees a pay raise? Human Resources

2. Did the company earn a satisfactory income?

3. Do we need to borrow in the near future?

4. Is cash sufficient to pay dividends to the stockholders?

5. What price for our product will maximize net income?

Who Uses Accounting Data?

6. Will the company be able to pay its short-term debts?

Investors

Management

Finance

Marketing

Creditors


The Building Blocks of AccountingEthics In Financial Reporting

Standards of conduct by which one’s actions are judged as right or wrong, honest or dishonest, fair or not fair, are Ethics.

Effective financial reporting depends on sound ethical behavior.


Various users need financial information

The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced.

Financial StatementsBalance SheetIncome StatementStatement of Owner’s EquityStatement of Cash FlowsNote Disclosure

Generally Accepted Accounting Principles (GAAP)

The Building Blocks of Accounting


Proprietorship Partnership Corporation

Owned by two or more persons.

Often retail and service-type businesses

Generally unlimited personal liability

Partnership agreement

Ownership divided into shares of stock

Separate legal entity organized under state corporation law

Limited liability

Forms of Business Ownership

Generally owned by one person.

Often small service-type businesses

Owner receives any profits, suffers any losses, and is personally liable for all debts.


Assets LiabilitiesOwner’s Equity

= +

Provides the underlying framework for recording and summarizing economic events.

Assets are claimed by either creditors or owners.Claims of creditors must be paid before ownership claims.

The Basic Accounting Equation


= +



Resources a business owns.

Provide future services or benefits.

Cash, Supplies, Equipment, etc.

Assets


= +



Claims against assets (debts and obligations).

Creditors - party to whom money is owed.

Accounts payable, Notes payable, etc.

Liabilities


= +



Ownership claim on total assets.

Referred to as residual equity.

Capital, Drawings, etc. (Proprietorship or Partnership).

Owner’s Equity

Owner’s Equity

Revenues result from business activities entered into for the purpose of earning income.

Common sources of revenue are: sales, fees, services, commissions, interest, dividends, royalties, and rent.


Expenses are the cost of assets consumed or services used in the process of earning revenue.

Common expenses are: salaries expense, rent expense, utilities expense, tax expense, etc.

Owner’s Equity

Using The Basic Accounting

Transactions are a business’s economic events recorded by accountants.

May be external or internal.Not all activities represent transactions.Each transaction has a dual effect on the accounting equation.


Q1-15: Are the following events recorded in the accounting records?

EventSupplies are purchased on account.

Criterion Is the financial position (assets, liabilities, or owner’s equity) of the company changed?

An employee is hired.

Owner withdraws cash for personal use.

Record/ Don’t Record

Transactions (Question?)


Discussion Question

Q1-18. In February 2010, Paula King invested an

additional $10,000 in her business, King’s Pharmacy,

which is organized as a proprietorship. King’s accountant,

Lance Jones, recorded this receipt as an increase in cash

and revenues. Is this treatment appropriate? Why or why

not?

Transactions


P1-1A: Barone’s Repair Shop was started on May 1 by Nancy Barone. Prepare a tabular analysis of the following transactions for the month of May.

Transactions (Problem)

1. Invested $10,000 cash to start the repair shop.

Revenues

+10,0001. +10,000

CashAccounts Receivable Equipment

Accounts Payable

Barone, Capital= +

Assets Liabilities Owners’ Equity

- Expenses

= +

Barone, Drawing ++ + -


Transactions (Problem)2. Purchased equipment for $5,000 cash.

Revenues

+10,0001. +10,000


Accounts Payable

Barone, Capital= +


- Expenses

= +


-5,0002. +5,000

3.

4.

5.

7.

8.

9.

10.

6.

Transactions (Problem)3. Paid $400 cash for May office rent.

Revenues

+10,0001. +10,000


Accounts Payable

Barone, Capital= +


- Expenses

= +


-5,0002. +5,000

3.

4.

5.

7.

8.

9.

10.

6.

-400 -400

Transactions (Problem)4. Incurred $250 of advertising costs, on account.

Revenues

+10,0001. +10,000


Accounts Payable

Barone, Capital= +


- Expenses

= +


-5,0002. +5,000

3.

4.

5.

7.

8.

9.

10.

6.

-400 -400

+250 -250

Transactions (Problem)5. Received $5,100 from customers for repair service.

Revenues

+10,0001. +10,000


Accounts Payable

Barone, Capital= +


- Expenses

= +


-5,0002. +5,000

3.

4.

5.

7.

8.

9.

10.

6.

-400 -400

+250 -250

+5,100 +5,100

Transactions (Problem)6. Withdrew $1,000 cash for personal use.

Revenues

+10,0001. +10,000


Accounts Payable

Barone, Capital= +


- Expenses

= +


-5,0002. +5,000

3.

4.

5.

7.

8.

9.

10.

6.

-400 -400

+250 -250

+5,100 +5,100

-1,000 -1,000

Transactions (Problem)7. Paid part-time employee salaries of $2,000.

Revenues

+10,0001. +10,000


Accounts Payable

Barone, Capital= +


- Expenses

= +


-5,0002. +5,000

3.

4.

5.

7.

8.

9.

10.

6.

-400 -400

+250 -250

+5,100 +5,100

-1,000 -1,000

-2,000 -2,000

Transactions (Problem)8. Paid utility bills $140.

Revenues

+10,0001. +10,000


Accounts Payable

Barone, Capital= +


- Expenses

= +


-5,0002. +5,000

3.

4.

5.

7.

8.

9.

10.

6.

-400 -400

+250 -250

+5,100 +5,100

-1,000 -1,000

-2,000 -2,000

-140 -140

Transactions (Problem)9. Provided $750 of repair services on account.

Revenues

+10,0001. +10,000


Accounts Payable

Barone, Capital= +


- Expenses

= +


-5,0002. +5,000

3.

4.

5.

7.

8.

9.

10.

6.

-400 -400

+250 -250

+5,100 +5,100

-1,000 -1,000

-2,000 -2,000

-140 -140

+750 +750

Revenues


+10,0001. +10,000


Accounts Payable

Barone, Capital+ + = +

10. Collected $120 cash for services previously billed.Assets Liabilities Owners’ Equity

- - Expenses

= +

-5,0002. +5,000

-4003. -400

+2504. -250

+5,1005. +5,100

-2,0007. -2,000

-1408. -140

+7509. +750

+12010. -120

Barone, Drawing +

-1,0006. -1,000

Revenues


+10,0001. +10,000


Accounts Payable

Barone, Capital+ + = +

10. Collected $120 cash for services previously billed.Assets Liabilities Owners’ Equity

- - Expenses

= +

-5,0002. +5,000

-4003. -400

+2504. -250

+5,1005. +5,100

-2,0007. -2,000

-1408. -140

+7509. +750

+12010. -120

+6,680 +630 +5,000 +250 +10,000 +5,850 -2,790=

$12,310 $12,310

Barone, Drawing +

-1,0006. -1,000

-1,000

Companies prepare four financial statements from the summarized accounting data:

Balance Sheet

Income Statement

Statement of Cash Flows

Owner’s Equity

Statement

Financial Statements


Income Statement


Reports the revenues and expenses for a specific period of time.

Net income – revenues exceed expenses.

Net loss – expenses exceed revenues.

Revenues:Service revenue 5,850$

Expenses:Salary expense 2,000 Rent expense 400 Utility expense 140 Advertising expense 250

Total expenses 2,790 Net income 3,060$

Barone’s Repair Shop

Income Statement

For the Month Ended May 31, 2010


Income Statement


Barone's, Capital May 1 -$ Add: Investment 10,000 Net income 3,060

13,060 Less: Drawings 1,000 Barone's, Capital May 31 12,060$


Owner's Equity Statement


Owner’s Equity Statement

Net income is needed to determine the ending balance in owner’s equity.

Revenues:Service revenue 5,850$

Expenses:Salary expense 2,000 Rent expense 400 Utility expense 140 Advertising expense 250

Total expenses 2,790 Net income 3,060$


Income Statement




Statement indicates the reasons why owner’s equity has increased or decreased during the period. Barone's, Capital May 1 -$

Add: Investment 10,000 Net income 3,060

13,060 Less: Drawings 1,000 Barone's, Capital May 31 12,060$


Owner's Equity Statement





AssetsCash 6,680$ Accounts receivable 630 Equipment 5,000

Total assets 12,310$ Liabilities

Accounts payable 250$ Owner's Equity

Barone's, capital 12,060 Total liab. & equity 12,310$

Balance Sheet


May 31, 2010

The ending balance in owner’s equity is needed in preparing the balance sheet

Balance Sheet

Barone's, Capital May 1 -$ Add: Investment 10,000 Net income 3,060

13,060 Less: Drawings 1,000.00 Barone's, Capital May 31 12,060$

Barone’s Repair Shop Owner's Equity Statement





Reports the assets, liabilities, and owner’s equity at a specific date.

Assets listed at the top, followed by liabilities and owner’s equity.

Total assets must equal total liabilities and owner’s equity.


Total assets 12,310$ Liabilities

Accounts payable 250$ Owner's Equity

Barone's, capital 12,060 Total liab. & equity 12,310$

Balance Sheet


May 31, 2010

Balance Sheet



Cash flow from operating activitiesCash receipts f rom revenues 5,220$ Cash paid f or expenses (2,540) Cash provided by operations 2,680

Cash flow from investing activititesPurchase of equipment (5,000)

Cash flow from financing activitiesI nvestment by owners 10,000 Drawing by owner (1,000) Cash provided by financing 9,000

Net increase in cash 6,680 Cash balance, May 1 - Cash balance, May 31 6,680$

Statement of Cash FlowsBarone’s Repair Shop




Total assets 12,310$ LiabilitiesAccounts payable 250$

Owner's EquityBarone's, capital 12,060

Total liab. & equity 12,310$

Balance SheetBarone’s Repair Shop

May 31, 2010

Balance Sheet


Financial StatementsInformation for a specific period of time.

Answers the following:

1. Where did cash come from?

2. What was cash used for?

3. What was the change in the cash balance?


Cash flow from operating activitiesCash receipts from revenues 5,220$ Cash paid for expenses (2,540) Cash provided by operations 2,680

Cash flow from investing activititesPurchase of equipment (5,000)

Cash flow from financing activitiesInvestment by owners 10,000 Drawing by owner (1,000) Cash provided by financing 9,000

Net increase in cash 6,680 Cash balance, May 1 - Cash balance, May 31 6,680$

Statement of Cash FlowsBarone’s Repair Shop



Which of the following financial statements is prepared as of a specific date?

a. Balance sheet.

b. Income statement.

c. Owner's equity statement.

d. Statement of cash flows.

Financial StatementsReview Question

Discussion Question

Q1-19. “A company’s net income appears directly on the

income statement and the owner’s equity statement, and

it is included indirectly in the company’s balance sheet.”

Do you agree? Explain.



CONCEPTUAL FRAMEWORK OF

ACCOUNTINGMahfuzul Hoque Ph. D

Wednesday, May 3, 2023 DMH - DU 38

CONCEPTUAL FRAMEWORK OF ACCOUNTING

Generally accepted accounting principles are a set of standards & rules that are recognized as a general guide for financial reporting.

Generally accepted means that these principles must have substantial authoritative support.

This support usually comes from the Financial Accounting Standards Board (FASB) & Securities & Exchange Commission (SEC).

The FASB has the responsibility for developing accounting principles in the United States.


CONCEPTUAL FRAMEWORK

The conceptual framework is developed for resolving Accounting & reporting problems.

The conceptual framework consists of:1. objectives of financial reporting;2. qualitative characteristics of accounting

information;3. elements of financial statements; &4. Operating guidelines (assumptions,

principles, & constraints).


OBJECTIVES OF FINANCIAL REPORTING

It is concluded that the objectives of financial reporting are to provide information that:1. Is useful to those making investment & credit

decisions.2. Is helpful in assessing future cash flows.3. Identifies the economic resources (assets),

the claims to those resources (liabilities), & the changes in those resources & claims.


QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION

The FASB concluded that the overriding criterion for accounting choices is decision usefulness.

To be useful, information should possess the following qualitative characteristics:1. relevance2. reliability3. comparability4. consistency


RELEVANCEAccounting information has relevance if it

makes a difference in a decision.Relevant information helps users forecast

future events (predictive value), or it confirms or corrects prior expectations (feedback value).

Information must be available to decision makers before it loses its capacity to influence their decisions (timeliness).


RELIABILITY Reliability of information means that the

information is free of error & bias. In short, it can be depended on.

To be reliable, accounting information must be verifiable – we must be able to prove that it is free of error & bias.

The information must be a faithful representation of what it purports to be – it must be factual.


COMPARABILITY AND CONSISTENCY

Comparability means that the information should be comparable with accounting information about other enterprises.

Consistency means that the same accounting principles & methods should be used from year to year within a company.


Relevance

1. Predictive value2. Feedback value3. Timely

Reliability

1. Verifiable2. Faithful representation3. Neutral

Comparability

Useful Financial

Information has:

QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION

Wednesday, May 3, 2023 DMH - DU

Consistency

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Assumptions

Monetary unit Economic entity Time period Going concern

Principals

Revenue recognition Matching Full disclosure Cost

Constraints

Materiality Conservatism

THE OPERATING GUIDELINES OF ACCOUNTING

Operating guidelines are classified as assumptions, principles, & constraints.

Assumptions provide a foundation for the accounting process.Principles indicate how transactions & other economic events

should be recorded.Constraints on the accounting process allow for a relaxation of

the principles under certain circumstances.


1. The monetary unit assumption states that only transaction data that can be expressed in terms of money be included in the accounting records.

Example: employee satisfaction & percent of international employees are not transactions that should be included in the financial records.


ASSUMPTIONS

Customer Satisfaction

Percentage of International Employees

Salaries paidShould be includedin accounting records

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ASSUMPTIONS

2. The economic entity assumption states that the activities of the entity be kept separate & distinct from the activities of the owner of all other economic entities.Example: BMW activities can be distinguished from those of other car manufacturers such as Mercedes.


ASSUMPTIONS

3. The time period assumption states that the economic life of a business can be divided into artificial time periods.Example: months, quarters, & years


QTR 1QTR 2QTR 3QTR 4

2000 2001 2002JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC

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GOING CONCERN ASSUMPTION

4. The going concern assumption assumes that the enterprise will continue in operation long enough to carry out its existing objectives.Implications: depreciation & amortization are used, plant assets recorded at cost instead of liquidation value, items are labeled as fixed or long-term.


The revenue recognition principle dictates that revenue should be recognized in the accounting period in which it is earned.

When a sale is involved, revenue is recognized at the point of sale.


PRINCIPLES – REVENUE RECOGNITION

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Expense recognition is traditionally tied to revenue recognition. This practice – referred to as the matching principle – dictates

that expenses be matched with revenues in the period in which efforts are made to generate revenues.

To understand the various approaches for matching expenses & revenues on the income statement, it is necessary to examine the nature of expenses.1. Expired costs are costs that will generate revenues only in

the current period & are therefore reported as operating expenses on the income statement.

2. Unexpired costs are costs that will generate revenues in future accounting periods & are recognized as assets.


PRINCIPLES –MATCHING (EXPENSE RECOGNITION)

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PRINCIPLES –FULL DISCLOSURE

The full disclosure principle requires that circumstances & events that make a difference to financial statement users be disclosed.

Compliance with the full disclosure principle is accomplished through 1. the data in the financial statements & 2 .the notes that accompany the statements.

A summary of significant accounting policies is usually the first note to the financial statements.


PRINCIPLES –COST

The cost principle dictates that assets be recorded at their cost.

Cost is used because it is both relevant & reliable.1. Cost is relevant because it represents a) the price paid, b) the assets sacrificed, or c) the commitment made at the date of acquisition.2. Cost is reliable because it is a) objectively measurable, b) factual, & c) verifiable.


BASIC PRINCIPLES USED IN ACCOUNTING


Revenue Recognition

Duringproduction

At endof production

At point of sale

At timecash received

Revenue should be recognized in the accounting period in which it is earned (generally at point of sale).

Matching

Advertising Utilities

Delivery

Costs Matching Sales Revenue

Materials

Labor

Operating Expenses

Expenses should be matched with revenues

CEMENT

Cost

Assets should be recorded at cost.

Full Disclosure

Circumstances & events that make a difference to financial statement users should be disclosed.

* Financial Statements* Balance Sheet* Income Statement* Retained Earnings Statement* Cash Flow Statement

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CONSTRAINTS IN ACCOUNTING

Constraints permit a company to modify generally accepted accounting principles without reducing the usefulness of the reported information.

The constraints are materiality & conservatism.1 Materiality relates to an item’s impact on a

firm’s overall financial condition & operations.2 The conservatism constraint dictates that when

in doubt, choose the method that will be the least likely to overstate assets & income.


CONSTRAINTS IN ACCOUNTING


Materiality

$$

$$ $

$

$$

$

If dollar amounts of costs are small, GAAP does not have to be followed.

Conservatism

When in doubt, choose the solution that will be least likely to overstate assets & income.

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CONCEPTUAL FRAMEWORK


Objectives of Financial Reporting

Assumptions Principles

Operating Guidelines

Qualitative Characteristics of

Accounting Information

Elements of Financial

Statements

CONSTRAINTS

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