introduction to accounting concepts and practice

Chapter 1-1

Introduction to Introduction to Accounting Accounting

Concepts and Concepts and PracticePractice

Introduction to Introduction to Accounting Accounting

Concepts and Concepts and PracticePractice

BAC1614 Fundamentals of Financial AccountingBAC1614 Fundamentals of Financial Accounting

Topic Topic 11Topic Topic 11

Chapter 1-2

1.1. Explain what accounting is.Explain what accounting is.

2.2. Identify the users and uses of accounting.Identify the users and uses of accounting.

3.3. Understand why ethics is a fundamental Understand why ethics is a fundamental business concept.business concept.

4.4. Explain generally accepted accounting Explain generally accepted accounting principles and the cost principle.principles and the cost principle.

5.5. Explain the monetary unit assumption and the Explain the monetary unit assumption and the economic entity assumption.economic entity assumption.

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Chapter 1-3

6.6. State the accounting equation, and define State the accounting equation, and define assets, liabilities, and stockholders’ equity.assets, liabilities, and stockholders’ equity.

7.7. Analyze the effects of business transactions on Analyze the effects of business transactions on the accounting equation.the accounting equation.

8.8. Understand the four financial statements and Understand the four financial statements and how they are prepared.how they are prepared.

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Chapter 1-4

Accounting in ActionAccounting in ActionAccounting in ActionAccounting in Action

Ethics in Ethics in financial financial reportingreporting

Generally Generally accepted accepted accounting accounting principlesprinciples

AssumptionsAssumptions

ConstraintsConstraints

What is What is

Accounting?Accounting?What is What is

Accounting?Accounting?

Building Building

Blocks of Blocks of

AccountingAccounting

Building Building

Blocks of Blocks of


The Basic The Basic

Accounting Accounting

EquationEquation

The Basic The Basic

Accounting Accounting

EquationEquation

Using the Using the Basic Basic

Accounting Accounting EquationEquation

Using the Using the Basic Basic

Accounting Accounting EquationEquation

Financial Financial

StatementsStatementsFinancial Financial

StatementsStatements

Three Three activitiesactivities

Who uses Who uses accounting accounting datadata

AssetsAssets

LiabilitiesLiabilities

Stockholders' Stockholders' equityequity

Transaction Transaction analysisanalysis

Summary of Summary of transactionstransactions

Income Income statementstatement

Statement of Statement of retained retained earningsearnings

Balance Balance sheetsheet

Statement of Statement of cash flowscash flows

Chapter 1-5

What is Accounting?What is Accounting?What is Accounting?What is Accounting?

► Importance of Accounting — Importance of Accounting — we live in the we live in the information age, where information, and its reliability, information age, where information, and its reliability, impacts the financial well-being of us allimpacts the financial well-being of us all

► IdentifyIdentify economic events, a company selects economic events, a company selects economic events relevant to its business.economic events relevant to its business.

► Once company identifies economic events, it Once company identifies economic events, it recordsrecords those events in order to provide a history of the those events in order to provide a history of the organization’s financial activities. organization’s financial activities.

► Recording consists of keeping a systematic, Recording consists of keeping a systematic, chronological diary of events, chronological diary of events, measuredmeasured in in dollarsdollars and and cents.cents.

Chapter 1-6


► CommunicatesCommunicates the collected information to the collected information to interested users by means of accounting reports interested users by means of accounting reports which are called which are called financial statementsfinancial statements..

► A vital element in communicating economic events is A vital element in communicating economic events is the accountant’s ability to the accountant’s ability to analyzeanalyze and and interpretinterpret the the reported information. reported information.

► Interpretation involves explaining the uses, meaning, Interpretation involves explaining the uses, meaning, and limitations of reported data.and limitations of reported data.

► Bookkeeping usually involves only the recording of Bookkeeping usually involves only the recording of economic events and is just one part of the economic events and is just one part of the accounting process. accounting process.

Chapter 1-7

IdentifyingSelect transactions and events

IdentifyingSelect transactions and events

RecordingInput, measure and classify

RecordingInput, measure and classify

CommunicatingPrepare, analyze and interpret

CommunicatingPrepare, analyze and interpret



An information and An information and measurement measurement system system

Relevant, reliable, and comparable information Relevant, reliable, and comparable information about an organizationabout an organization’’s business activities. s business activities.

Chapter 1-8


IdentifyingIdentifying business activities requires selecting business activities requires selecting transactions and events relevant to an organization.transactions and events relevant to an organization.

RecordingRecording business activities requires keeping a business activities requires keeping a chronological log of transactions and events chronological log of transactions and events measured in dollars and classified and summarized measured in dollars and classified and summarized in a useful format. in a useful format.

CommunicatingCommunicating business activities requires business activities requires preparing accounting reports such as financial preparing accounting reports such as financial statements. It also requires statements. It also requires analyzinganalyzing and and interpretinginterpreting such reports. such reports.

Chapter 1-9


Purpose of accounting is to:Purpose of accounting is to:

(1)(1) identify, recordidentify, record, and , and communicatecommunicate the economic the economic events of anevents of an

(2)(2) organization toorganization to

(3)(3) interested users.interested users.

Chapter 1-10

Three Activities


Accounting process

Accounting process includes the bookkeeping function.

Chapter 1-11

Management

Common Questions

Human Resources

Inland Revenue

Labor Unions

Securities Exchange

Commission

Marketing

Finance

Investors

Creditors

Users of Accounting Data?Users of Accounting Data?Users of Accounting Data?Users of Accounting Data?

Customers

Internal Users

External Users

Chapter 1-12


Accountants prepare reports for both external and Accountants prepare reports for both external and internal users. internal users.

External usersExternal users of accounting information are of accounting information are not not directlydirectly involved in running the organization. involved in running the organization.

► Examples: lenders, shareholders (investors), Examples: lenders, shareholders (investors), governments, consumer groups, customers, and the governments, consumer groups, customers, and the external auditors. external auditors.

Internal usersInternal users of accounting information are those of accounting information are those directly involved directly involved in managing and operating an in managing and operating an organization. organization.

Chapter 1-13


Information are used to help improve the Information are used to help improve the efficiency and effectiveness of an organization.efficiency and effectiveness of an organization.

► Examples of internal users are managers, Examples of internal users are managers, officers/directors, internal auditors, sales staff, officers/directors, internal auditors, sales staff, budget officers and controllers.budget officers and controllers.

Chapter 1-14

Internal Users External Users

► Internal users of Internal users of accounting accounting information are those information are those individuals inside a individuals inside a company who plan, company who plan, organize, and run a organize, and run a business. business.

► Include marketing Include marketing managers, finance managers, finance directors, and directors, and company officers.company officers.

External users are individuals/ External users are individuals/ organizations outside the company who organizations outside the company who are either:are either:

a.a.InvestorsInvestors use accounting information use accounting information to make decisions to buy, hold, or sell to make decisions to buy, hold, or sell stock. stock. CreditorsCreditors (suppliers and bankers) (suppliers and bankers) use accounting information to evaluate use accounting information to evaluate the risks of granting credit or lending the risks of granting credit or lending money.money.b.b.Other external usersOther external users:: Tax authorities Tax authorities (Inland Revenue Dept), Regulatory (Inland Revenue Dept), Regulatory agencies (Securities Commission), agencies (Securities Commission), customers and labor unions.customers and labor unions.


Chapter 1-15

Common Questions Asked User

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

2. 2. Did the company earn a Did the company earn a satisfactory incomesatisfactory income??

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

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

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


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

Investors

Management

Finance

Marketing

Creditors

Chapter 1-16

Discussion QuestionDiscussion QuestionQ1. Q1. “Accounting is ingrained in our society and it is “Accounting is ingrained in our society and it is vital to our economic system.” Do you agree? Explain.vital to our economic system.” Do you agree? Explain.

Who Uses Accounting Data?Who Uses Accounting Data?Who Uses Accounting Data?Who Uses Accounting Data?

Yes, this is correct. Virtually every organization and Yes, this is correct. Virtually every organization and person in our society uses accounting information. person in our society uses accounting information. Businesses, investors, creditors, government Businesses, investors, creditors, government agencies, and not-for-profit organizations must use agencies, and not-for-profit organizations must use accounting information to operate effectively.accounting information to operate effectively.

Chapter 1-17

Building Blocks of AccountingBuilding Blocks of AccountingBuilding Blocks of AccountingBuilding Blocks of Accounting

Regulators and lawmakers were very concerned that the economy would suffer if investors lost confidence in corporate accounting because of unethical financial reporting.

Recent financial scandals include: Barclays Bank Recent financial scandals include: Barclays Bank

(LIBOR rate-fixing scandal), Maddoff investment scam, (LIBOR rate-fixing scandal), Maddoff investment scam,

Enron, World.com Enron, World.com

Malaysia Malaysia (Sime Darby’s E & O deals – insider (Sime Darby’s E & O deals – insider

trading allegation, PKFZ cost overruns, National trading allegation, PKFZ cost overruns, National

Feedlot Corp – CBT misappropriating of funds)Feedlot Corp – CBT misappropriating of funds)

Chapter 1-18


“Imagine if you are trying to carry on a business or invest money if you could not depend on the financial statement to be honestly prepared”

Information would have no credibility.

Economy will not function well & sound as it depends on accurate and dependable financial reporting.

Economy would suffers if investors lost confidence in corporate accounting because of unethical financial reporting.

Chapter 1-19


Sarbanes-Oxley Act 2002Sarbanes-Oxley Act 2002

Passed by Congress in 2002, in response to a Passed by Congress in 2002, in response to a

series of corporate scandals.series of corporate scandals.

Requires principal executive and financial officers Requires principal executive and financial officers

to certify a number of statements regarding the to certify a number of statements regarding the

financials.financials.

Places additional responsibilities on management Places additional responsibilities on management

to ensure that adequate internal controls are in to ensure that adequate internal controls are in

place.place.

Chapter 1-20


Sarbanes-Oxley Act 2002

To reduce unethical financial reporting. Top management to certify accuracy of financial information

Reduce the likelihood of future corporate scandals.

Increased the independence of outside auditors who review the accuracy of corporate financial statements, and increased the oversight role of boards of directors

Chapter 1-21


Fundamentals of Accounting Fundamentals of Accounting — — accounting is guided accounting is guided

by principles, standards, concepts, and assumptions.by principles, standards, concepts, and assumptions.

►Goal of accounting is to provide useful information for Goal of accounting is to provide useful information for

decisions.decisions.

►For information to be useful, it must be trusted.For information to be useful, it must be trusted.

►Demand Demand ethics ethics in accountingin accounting

Chapter 1-22

Beliefs that Beliefs that distinguish right distinguish right

from wrongfrom wrong

Accepted standards Accepted standards of good and bad of good and bad

behaviorbehavior


Ethics – A key Concept Ethics – A key Concept

Chapter 1-23


Standards of conduct by which one’s actions are judged Standards of conduct by which one’s actions are judged

as right or wrong, honest or dishonest, fair or not fair, are as right or wrong, honest or dishonest, fair or not fair, are

called called EthicsEthics..

Ethical behavior is the cornerstone of the accounting Ethical behavior is the cornerstone of the accounting

profession. profession.

Effective financial reporting depends on sound Effective financial reporting depends on sound

ethical behavior.ethical behavior.


Chapter 1-24



Identifying the ethical path is sometimes difficult. Preferred path is a course of action that avoids casting doubt on one’s decisions.

Example: Accounting users are less likely to trust an auditor’s report if the auditor’s pay depends on the success of the client’s business.

To avoid such concerns, ethics rules are often set. Example: Auditors are banned from direct investment in their client and cannot accept pay that depends on figures in the client’s reports.

Chapter 1-25



Guidelines for making ethical decisions.Guidelines for making ethical decisions.

Chapter 1-26

In the process of analyzing and solving ethical In the process of analyzing and solving ethical dilemmas, the following steps should be applied:dilemmas, the following steps should be applied:

a.a.Recognize an ethical situation and ethical issues Recognize an ethical situation and ethical issues involved – involved – code of ethics for guidancecode of ethics for guidance..

b.b.Identify and analyze the principal elements in the Identify and analyze the principal elements in the situation - situation - identify the stakeholders identify the stakeholders – persons or – persons or groups who may be harmed or benefited .groups who may be harmed or benefited .

c.c.Identify the alternatives and weigh the impact of each Identify the alternatives and weigh the impact of each alternative on various stakeholders – alternative on various stakeholders – select the most select the most ethical alternativesethical alternatives

Ethics in Financial ReportingEthics in Financial ReportingEthics in Financial ReportingEthics in Financial Reporting

Chapter 1-27

Ethics are the standards of conduct by which one's Ethics are the standards of conduct by which one's actions are judged as: actions are judged as:

a.a. right or wrong. right or wrong.

b.b. honest or dishonest. honest or dishonest.

c.c. fair or not fair. fair or not fair.

d.d. all of these options.all of these options.

Review Question

Ethics in Financial ReportingEthics in Financial ReportingEthics in Financial ReportingEthics in Financial Reporting

Chapter 1-28

Various users need financial information

Various users need financial information

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

Financial StatementsBalance SheetIncome StatementRetained Earnings StatementStatement of Cash FlowsNote Disclosure

Financial StatementsBalance SheetIncome StatementRetained Earnings StatementStatement of Cash FlowsNote Disclosure

Generally Accepted Generally Accepted Accounting Accounting

Principles (GAAP)Principles (GAAP)

Generally Accepted Generally Accepted Accounting Accounting

Principles (GAAP)Principles (GAAP)

Generally Accepted Accounting PrinciplesGenerally Accepted Accounting PrinciplesGenerally Accepted Accounting PrinciplesGenerally Accepted Accounting Principles

Chapter 1-29

Financial accounting practice is governed by concepts and rules known as Generally accepted accounting

principles (GAAP).

Financial accounting practice is governed by concepts and rules known as Generally accepted accounting

principles (GAAP).

Relevant InformationRelevant Information Affects the decision of its users.Affects the decision of its users.

Reliable InformationReliable Information Is trusted by users.Is trusted by users.

Comparable Information

Comparable Information

Is helpful in contrasting organizations.

Is helpful in contrasting organizations.


Chapter 1-30


Financial accounting is governed by a set of rules Financial accounting is governed by a set of rules we call we call Generally Accepted Accounting Generally Accepted Accounting PrinciplesPrinciples, or , or GAAPGAAP. .

Generally accepted accounting principles identify Generally accepted accounting principles identify three major characteristics of information. three major characteristics of information.

► Information must be relevantInformation must be relevant. Relevant . Relevant information impacts the decision of the informed information impacts the decision of the informed user for financial information. user for financial information.

► Information must be reliableInformation must be reliable. .

► Information must be comparableInformation must be comparable..Comparability helps us evaluate financial information Comparability helps us evaluate financial information

from one period with that of the next period.from one period with that of the next period.

Chapter 1-31

Standard-setting bodies in consultation with accounting profession and business community determine these standards.

In U.S. major rule-setting bodies are the Securities Securities and Exchange Commission (SEC)and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB). Financial Accounting Standards Board (FASB).

SEC delegated authority to set U.S. GAAP to the FASB.

Generally Accepted Accounting PrinciplesGenerally Accepted Accounting Principles

Setting Accounting PrinciplesSetting Accounting Principles

Chapter 1-32

a.a.Securities and Exchange Commission (SEC) Securities and Exchange Commission (SEC) is a is a governmental agency that requires publicly traded governmental agency that requires publicly traded companies to file financial reports in accordance with companies to file financial reports in accordance with GAAP.GAAP.

►To develop and standardised financial information presented to stakeholders.

► Administer SEC Act 1934 and has broad powers to prescribe the accounting practices and standards to be employed by companies fall within its jurisdiction.


Chapter 1-33

b.b. Financial Accounting Standards Board (FASB) Financial Accounting Standards Board (FASB) is a private organization responsible for the is a private organization responsible for the promulgation of GAAP for financial statement or a promulgation of GAAP for financial statement or a body that establishes common standards of how to body that establishes common standards of how to report economic events.report economic events.

► TTo establish & improve standards of financial accounting and reporting for guidance and education of the public, include issuers, auditors and users of financial information.


Chapter 1-34

c.c. International Accounting Standards Board International Accounting Standards Board (IASB) (IASB) issues standards (International Financial issues standards (International Financial Reporting Standards or IFRS) that identify Reporting Standards or IFRS) that identify preferred accounting practices in the global preferred accounting practices in the global economy. IASB hopes to create harmony among economy. IASB hopes to create harmony among accounting practices in different countries.accounting practices in different countries.

d.d. Differences between U.S. GAAP and IFRS are Differences between U.S. GAAP and IFRS are fading as the FASB and IASB pursue convergence.fading as the FASB and IASB pursue convergence.


Chapter 1-35

Organizations Involved in Standard Setting:

Securities and Exchange Commission (SEC)

Financial Accounting Standards Board (FASB)

International Accounting Standards Board (IASB)


http://www.fasb.org/

http://www.sec.gov/

http://www.iasb.org/

Chapter 1-36


FASB is recognized as the group in the private FASB is recognized as the group in the private sector that makes specific accounting principles. If sector that makes specific accounting principles. If an accountant departs from the principles an accountant departs from the principles established by the FASB, proper disclosure of the established by the FASB, proper disclosure of the departure must be made.departure must be made.

In the public sector, the SEC has the authority to In the public sector, the SEC has the authority to establish accounting principles for companies establish accounting principles for companies reporting to the agency. Currently, the SEC has reporting to the agency. Currently, the SEC has accepted all pronouncements of the FASB for use accepted all pronouncements of the FASB for use by public reporting companies.by public reporting companies.


Chapter 1-37


IASB issues International Financial Reporting IASB issues International Financial Reporting Standards (IFRS) that identify preferred accounting Standards (IFRS) that identify preferred accounting practices to create harmony among accounting practices to create harmony among accounting practices of different countries.practices of different countries.


Chapter 1-38

IASB, an independent group (consisting of 16 IASB, an independent group (consisting of 16 individuals from many countries), issues International individuals from many countries), issues International Financial Reporting Standards (IFRS) that identify Financial Reporting Standards (IFRS) that identify preferred accounting practices.preferred accounting practices.

IASBIASB


Chapter 1-39


Setting Accounting PrinciplesSetting Accounting Principles In today’s global economy, there is increased In today’s global economy, there is increased

demand by external users for comparability in demand by external users for comparability in accounting reports. This demand often arises when accounting reports. This demand often arises when companies wish to raise money from lenders and companies wish to raise money from lenders and investors in different countries.investors in different countries.

If standards are harmonized, one company can If standards are harmonized, one company can potentially use a single set of financial statements in potentially use a single set of financial statements in all financial markets. Differences between U.S. all financial markets. Differences between U.S. GAAP and IFRS are slowly fading as the FASB and GAAP and IFRS are slowly fading as the FASB and IASB pursue a convergence process aimed to IASB pursue a convergence process aimed to achieve a single set of accounting standards for achieve a single set of accounting standards for global use.global use.

Chapter 1-40

In Malaysia, organizations involved in Standard Setting:


Malaysian Institute of Accountant (MIA)

Malaysian Institute of Certified Public Accountant (MICPA)

Malaysian Accounting Standard Board – Malaysian Financial Reporting Standard (MFRS))

SecuritiesCommission

BNM

Chapter 1-41


Conceptual framework of Financial Reporting Conceptual framework of Financial Reporting

Conceptual Framework and Convergence — The FASB and IASB are attempting to converge and enhance the conceptual framework that guides standard setting. Framework consists of:

a.a. ObjectivesObjectives — to provide information useful to investors, creditors, and others.

b. Qualitative Characteristics . Qualitative Characteristics — to require information that is relevant, reliable comparable.

Chapter 1-42


Conceptual framework of Financial Reporting

Framework consists of:

c.c. Elements Elements — to define items that financial statements can contain.

d. Recognition and Measurement d. Recognition and Measurement — to set criteria that an item must meet for it to be recognized as an element; and how

Chapter 1-43

Concepts of recognitionrecognition and measurementmeasurement..

Concepts explain whichwhich, whenwhen and howhow financial elements and events should be recognizedrecognized, measuredmeasured and reportedreported by accounting system.

FASB Statement of Financial Accounting Concepts No.5 ““Recognition and Measurement in Financial Statements Recognition and Measurement in Financial Statements of Business Enterprise” of Business Enterprise” stated - to be recognised, an item (event or transaction) must meet the definition of an “element of financial statement” “element of financial statement” and must be measurable.measurable.



Chapter 1-44

Accounting profession has identify the concepts as basic principles of accounting, basic assumptions and constraints.

GAAP generally uses one of two measurement principles ,

► Revenue Recognition principleRevenue Recognition principle► Matching principleMatching principle► Cost principleCost principle► Full Disclosure principleFull Disclosure principle► Fair Value principleFair Value principle



Chapter 1-45

Cost PrincipleAccounting information is based on

actual cost. Actual cost is considered objective.

Revenue Recognition Principle1. Recognize revenue when it is earned.2. Proceeds need not be in cash.3. Measure revenue by cash received plus

cash value of items received.

Matching PrincipleA company must record its expenses

incurred to generate the revenue reported.

Full Disclosure PrincipleA company is required to report the details

behind financial statements that would impact users’ decisions.

Principles of AccountingPrinciples of AccountingPrinciples of AccountingPrinciples of Accounting

Chapter 1-46

Revenue Recognition PrincipleRevenue Recognition Principle..

Revenue Recognition PrinciplesRevenue Recognition PrinciplesRevenue Recognition PrinciplesRevenue Recognition Principles

Revenue recognition principle states that revenue is Revenue recognition principle states that revenue is to recognized when it is earned, to recognized when it is earned,

Revenue need not be in the form of cash and Revenue need not be in the form of cash and

Measure revenue by the cash received plus cash Measure revenue by the cash received plus cash value of other items received. value of other items received.

Chapter 1-47

Expenses Recognition PrincipleExpenses Recognition Principle..

Expenses Recognition PrinciplesExpenses Recognition PrinciplesExpenses Recognition PrinciplesExpenses Recognition Principles

Also called Also called matching Principlematching Principle

prescribes that a company records expenses prescribes that a company records expenses incurred to generate revenues it reported. incurred to generate revenues it reported.

Matching principle dictates that expenses incurred Matching principle dictates that expenses incurred by a company must be matched against revenue by a company must be matched against revenue generated as a result of those expenses. generated as a result of those expenses.

Chapter 1-48

Measurement principle also called Cost Principle Measurement principle also called Cost Principle (Historical) (Historical) – dictates that companies record assets at – dictates that companies record assets at cost.cost.

Issues:Issues:

Financial statements are based on actual costs (with a Financial statements are based on actual costs (with a potential for subsequent adjustments to market) potential for subsequent adjustments to market) incurred in business transactions. incurred in business transactions.

Cost is measured on a cash or equal-to-cash basis.Cost is measured on a cash or equal-to-cash basis.

Principle emphasizes reliability and verifiability, and Principle emphasizes reliability and verifiability, and information based on cost considered objective.information based on cost considered objective.

Cost PrinciplesCost PrinciplesCost PrinciplesCost Principles

Chapter 1-49

Measurement principle also called Cost Principle Measurement principle also called Cost Principle (Historical)(Historical)

Issues:Issues:

Objectivity means information is supported by Objectivity means information is supported by unbiased evidence: more than someone's opinionunbiased evidence: more than someone's opinion. .

Reported at cost when purchased and also over Reported at cost when purchased and also over the time the asset is held.the time the asset is held.

Cost easily verified, whereas market value is often Cost easily verified, whereas market value is often subjective. subjective.

Fair value information may be more useful.Fair value information may be more useful.

Cost PrinciplesCost PrinciplesCost PrinciplesCost Principles

Chapter 1-50

Full Disclosure Principle - - requires that requires that companies disclose all circumstances and events that companies disclose all circumstances and events that would make a difference to financial statement users. would make a difference to financial statement users.

Issues:Issues:

prescribes reporting the details prescribes reporting the details behind the financial behind the financial statements that would impacts users’ decisions.statements that would impacts users’ decisions.

If an important item cannot reasonably be If an important item cannot reasonably be reported directly in one of four types of financial reported directly in one of four types of financial statement, then it should be disclose in the notes statement, then it should be disclose in the notes that accompany the statements.that accompany the statements.

Full Disclosure PrinciplesFull Disclosure PrinciplesFull Disclosure PrinciplesFull Disclosure Principles

Chapter 1-51

Fair Value Principle Fair Value Principle – indicates that assets and – indicates that assets and liabilities should be reported at fair value (the price liabilities should be reported at fair value (the price received to sell an asset or settle a liability).received to sell an asset or settle a liability).

Issues:Issues:

Fair value information may be more useful than Fair value information may be more useful than historical cost for certain types of assets & historical cost for certain types of assets & liabilities.liabilities.

Example: Investment in securities (debts, stock) Example: Investment in securities (debts, stock) are reported at fair value because market price are reported at fair value because market price information is often readily available for these type information is often readily available for these type of assets. of assets.

Fair Value PrinciplesFair Value PrinciplesFair Value PrinciplesFair Value Principles

Chapter 1-52

Fair Value PrincipleFair Value Principle

Issues:Issues:

Choosing between cost and fair value, FASB Choosing between cost and fair value, FASB uses two qualities that make a accounting uses two qualities that make a accounting information useful for decision making – information useful for decision making – relevance of fair value relevance of fair value ((if it would make a if it would make a difference in business decisions)difference in business decisions) andand faithful faithful representationrepresentation ( (information accurately depicts information accurately depicts what really happened)what really happened)

FASB indicates that most assets must follow the FASB indicates that most assets must follow the cost principle because market values may not be cost principle because market values may not be representationally faithful.representationally faithful.

Fair Value PrinciplesFair Value PrinciplesFair Value PrinciplesFair Value Principles

Chapter 1-53

Basic assumptions are foundations of financial Basic assumptions are foundations of financial accounting measurements accounting measurements

Basic assumptions of accounting are:Basic assumptions of accounting are:

Going Concern Going Concern

Business/Economic EntityBusiness/Economic Entity

Monetary Unit Monetary Unit

Time PeriodTime Period

Assumptions of AccountingAssumptions of AccountingAssumptions of AccountingAssumptions of Accounting

Chapter 1-54

Monetary Unit AssumptionExpress transactions and events in

monetary, or money, units.

Business Entity AssumptionA business is accounted for separately from other business entities, including

its owner.

Time Period AssumptionPresumes that the life of a company

can be divided into time periods, such as months and years.

Now Future

Going-Concern AssumptionReflects assumption that the business will

continue operating instead of being closed or sold.


Chapter 1-55

Going Concern –

In the absence of information to the contrary, the In the absence of information to the contrary, the business entity is assumed to continue operations business entity is assumed to continue operations into the foreseeable future. into the foreseeable future.

Life of an economic entity is assumed to be Life of an economic entity is assumed to be indefinite indefinite

Assets, defined as having future economic benefit, Assets, defined as having future economic benefit, require this assumption.require this assumption.

Allocation of costs to future periods is supported Allocation of costs to future periods is supported by the going concern assumption – examples by the going concern assumption – examples depreciation, amortizationdepreciation, amortization


Chapter 1-56

Going Concern –

Business enterprise will have a long life and going Business enterprise will have a long life and going concern assumption applies in most business.concern assumption applies in most business.

MaMany businesses do fail, but in general, it is ny businesses do fail, but in general, it is reasonable to assume that the business will reasonable to assume that the business will continue.continue.

Only where liquidation appears imminent is the Only where liquidation appears imminent is the assumption inapplicable.assumption inapplicable.


Chapter 1-57

Economic Entity –

A company is assumed to be a separate economic A company is assumed to be a separate economic entity that can be identified and measured.entity that can be identified and measured.

Requires that activities of the entity be kept Requires that activities of the entity be kept separate and distinct from the activities of its separate and distinct from the activities of its owner and all other economic entities.owner and all other economic entities.

Every economic entity can be separately identified Every economic entity can be separately identified and accounted for.and accounted for.


Chapter 1-58

Economic Entity –

This concept helps determine the scope of This concept helps determine the scope of financial statements.financial statements.

Must not blur on company transactions with Must not blur on company transactions with personal transactions (especially those of its personal transactions (especially those of its managers) or transactions of other companiesmanagers) or transactions of other companies

Examples: MMU and Telekom, UNITEN and TNBExamples: MMU and Telekom, UNITEN and TNB


Chapter 1-59

Economic Entity –

Proprietorship.Proprietorship.

Partnership. Partnership.

Corporation.Corporation.


Forms of Business Ownership

Sole Proprietorship

Sole Proprietorship

PartnershipPartnership CorporationCorporation

Chapter 1-60

Proprietorship Partnership Corporation

Owned by two or Owned by two or more persons.more persons.

Often retail and Often retail and service-type service-type businessesbusinesses

Generally Generally unlimited unlimited personal liabilitypersonal liability

Partnership Partnership agreementagreement

Ownership Ownership divided into divided into shares of stockshares of stock

Separate legal Separate legal entity organized entity organized under state under state corporation lawcorporation law

Limited liabilityLimited liability

Forms of Business OwnershipForms of Business OwnershipForms of Business OwnershipForms of Business Ownership

Generally owned Generally owned by one person.by one person.

Often small Often small service-type service-type businessesbusinesses

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

Chapter 1-61

Monetary Unit –

Include in the accounting records only transaction Include in the accounting records only transaction data that can be expressed in terms of money. data that can be expressed in terms of money. Examples: MYR, US Dollars Examples: MYR, US Dollars

Value of the monetary unit used to measure an Value of the monetary unit used to measure an economic entity’s performance and position is economic entity’s performance and position is assumed stable.assumed stable.

This assumption enables accounting to quantify This assumption enables accounting to quantify (measure) economic events and to applying the (measure) economic events and to applying the cost principle.cost principle.


Chapter 1-62

Monetary Unit –

Monetary unit must maintain constant purchasing Monetary unit must maintain constant purchasing power.power.

MMonetary unit assumption is vital to applying the onetary unit assumption is vital to applying the cost principle.cost principle.

Certain important information needed by investors, Certain important information needed by investors, creditors, and managers such as customer creditors, and managers such as customer satisfaction is not reported in the financial satisfaction is not reported in the financial statements.statements.


Chapter 1-63

Time Period –

Presumed that the life of an economic entity can Presumed that the life of an economic entity can be broken down into accounting periods such as be broken down into accounting periods such as months and years.months and years.

Useful reports covering those periods can be Useful reports covering those periods can be prepared for business.prepared for business.

The result is a trade-off between objectivity and The result is a trade-off between objectivity and timeliness.timeliness.


Chapter 1-64

Time Period –

Users need to be apprised of performance and Users need to be apprised of performance and economic status on a timely basis so that they can economic status on a timely basis so that they can evaluate and compare firms, and take appropriate evaluate and compare firms, and take appropriate actions.actions.

Information must be reported periodically.Information must be reported periodically.

Alternative accounting periods include the Alternative accounting periods include the calendar or fiscal year.calendar or fiscal year.


Chapter 1-65

Efforts to provide useful information can be costly to a Efforts to provide useful information can be costly to a company. Two (2) overriding constraintscompany. Two (2) overriding constraints must be must be considered to ensure that companies apply accounting considered to ensure that companies apply accounting rules in reasonable manner, from the perspective of the rules in reasonable manner, from the perspective of the company and user.company and user.

Materiality constraintMateriality constraint: : Relates to financial statement Relates to financial statement item’s impact on a company’s overall financial item’s impact on a company’s overall financial conditions / operations.conditions / operations.

►Material when Material when sizessizes is likely to influence the decision of is likely to influence the decision of investors/creditors or the investors/creditors or the amount is significantamount is significant that have an that have an impact on the financial position.impact on the financial position.

Accounting Constraints Accounting Constraints Accounting Constraints Accounting Constraints

Chapter 1-66

Cost/Benefit constraintCost/Benefit constraint: : Relates to the fact that Relates to the fact that providing information is costly.providing information is costly.

► To decide whether the Company should required to provide To decide whether the Company should required to provide certain type of information.certain type of information.

► Accounting standard - setters must weigh the cost incur to Accounting standard - setters must weigh the cost incur to provide such information against the benefit that can be provide such information against the benefit that can be derived from having the information available.derived from having the information available.

Accounting Constraints Accounting Constraints Accounting Constraints Accounting Constraints

Chapter 1-67

Combining the activities of Kellogg and General Combining the activities of Kellogg and General Mills would violate the Mills would violate the

a.a. cost principle. cost principle.

b.b. economic entity assumption. economic entity assumption.

c.c. monetary unit assumption. monetary unit assumption.

d.d. ethics principle.ethics principle.


Review QuestionReview Question

Chapter 1-68

A business organized as a separate legal entity under state law having ownership divided into shares of stock is a

a. proprietorship.

b. partnership.

c. corporation.

d. sole proprietorship.

Forms of Business OwnershipForms of Business OwnershipForms of Business OwnershipForms of Business Ownership


Chapter 1-69

AssetsAssetsAssetsAssets LiabilitiesLiabilitiesLiabilitiesLiabilitiesStockholders’ Stockholders’

EquityEquityStockholders’ Stockholders’

EquityEquity= +

Provides the Provides the underlying framework underlying framework for recording for recording and summarizing economic events.and summarizing economic events.

During the process of recording business During the process of recording business transactions, it is important that we always keep the transactions, it is important that we always keep the accounting equation in balance. accounting equation in balance.

We canWe can’’t let our books get out of balance.t let our books get out of balance.

Basic Accounting EquationBasic Accounting EquationBasic Accounting EquationBasic Accounting Equation

Chapter 1-70



EquityEquity= +

You have probably heard this saying before, but You have probably heard this saying before, but may not have been sure what we meant by may not have been sure what we meant by keeping the books in balance.keeping the books in balance.

The accounting equation The accounting equation MUSTMUST remain in balance remain in balance after each transaction.after each transaction.


Chapter 1-71



EquityEquity= +


Resources a business owns. Business uses its Resources a business owns. Business uses its assets in carrying out activities such as production assets in carrying out activities such as production and sales.and sales.

These resources are expected to yield future These resources are expected to yield future benefits.benefits.

Service potential or future economic benefits Service potential or future economic benefits eventually result in cash inflows (receipts)eventually result in cash inflows (receipts)..

AssetsAssetsAssetsAssets

Chapter 1-72

LandLand

EquipmentEquipment

BuildingsBuildings

CashCash

VehiclesVehicles

Store Supplies

Store Supplies

Notes Receivable

Notes Receivable

Accounts ReceivableAccounts

Receivable

Resources owned or

controlled by a company

Resources owned or

controlled by a company


Chapter 1-73



EquityEquity= +


LiabilitiesLiabilitiesLiabilitiesLiabilities

Creditors Claims against assets (debts and Creditors Claims against assets (debts and obligations).obligations).

Creditors - party to whom money is owed.Creditors - party to whom money is owed.

These claims reflect company obligations to provide These claims reflect company obligations to provide assets, products or services to others.assets, products or services to others.

Chapter 1-74



EquityEquity= +


LiabilitiesLiabilitiesLiabilitiesLiabilities

The term payable refers to a liability that promises a The term payable refers to a liability that promises a future outflow of resourcesfuture outflow of resources

Examples are wages payable to workers, accounts Examples are wages payable to workers, accounts payable to suppliers, notes payable to banks, and payable to suppliers, notes payable to banks, and taxes payable to the governmenttaxes payable to the government.

Chapter 1-75

Taxes PayableTaxes

PayableWages PayableWages Payable

Notes PayableNotes

PayableAccounts Payable

Accounts Payable

Creditors’ claims on

assets

Creditors’ claims on

assets


Chapter 1-76



EquityEquity= +


Stockholders’Stockholders’equityequity

Stockholders’Stockholders’equityequity

Ownership claim on total assets.

Referred to as residual equity.

Stockholders’ equity section of a corporation’s balance sheet consists of paid-in (contributed) capital and retained earnings.

Chapter 1-77

Owner’s Claims on

Assets

Owner’s Claims on

Assets


Equity is the ownerEquity is the owner’’s claim on assets. Equity is equal to s claim on assets. Equity is equal to assets minus liabilities. This is the reason equity is also called assets minus liabilities. This is the reason equity is also called net assets or residual equity.net assets or residual equity. Net income occurs when Net income occurs when revenues exceed expenses. Net income increases equity. Net revenues exceed expenses. Net income increases equity. Net loss occurs when expenses exceed revenues, which loss occurs when expenses exceed revenues, which decreases equity.decreases equity.

Chapter 1-78


Paid-in capitalPaid-in capital - total amount paid in by stockholders. - total amount paid in by stockholders.

Retained earnings Retained earnings consists of three items: consists of three items: revenues, revenues, expenses expenses andand dividends. dividends.

1.1. RevenuesRevenues - gross increase in stockholders’ equity - gross increase in stockholders’ equity resulting from business activities entered into for the resulting from business activities entered into for the purpose of earning income.purpose of earning income.

2.2. ExpensesExpenses - cost of assets consumed or services used - cost of assets consumed or services used in the process of earning revenue.in the process of earning revenue.

3.3. DividendsDividends - distributions of cash or other assets to - distributions of cash or other assets to stockholders; dividends reduce retained earnings.stockholders; dividends reduce retained earnings.

Stockholders’ equityStockholders’ equityStockholders’ equityStockholders’ equity

Chapter 1-79

Stockholders’ EquityStockholders’ EquityStockholders’ EquityStockholders’ Equity

RevenuesRevenues 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.

Chapter 1-80

Expenses - 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.


Chapter 1-81

Dividends - Dividends - distribution of cash or other assets to stockholders.

Dividends reduce retained earnings, however dividends are not an expense.


Chapter 1-82

Accounting TransactionsAccounting TransactionsAccounting TransactionsAccounting Transactions

TransactionsTransactions - - economic events that require recording in the financial statements or business’s economic r business’s economic

events events recorded recorded by accountants by accountants

Not all activities represent transactionsNot all activities represent transactions

Assets, liabilities, or stockholders’ equity items Assets, liabilities, or stockholders’ equity items

change as a result of some economic event.change as a result of some economic event.

May be external or internal transactions. May be external or internal transactions.

Chapter 1-83


TransactionsTransactions - - economic events that require recording in the financial statements or business’s economic r business’s economic

events events recorded recorded by accountants by accountants

External transactions are economic events between External transactions are economic events between

the company and some outside enterprise.the company and some outside enterprise.

Internal transactions are economic events that occur Internal transactions are economic events that occur

entirely within one company.entirely within one company.

Each transaction has a Each transaction has a dual effect dual effect on the accounting on the accounting

equation. equation.

Chapter 1-84

Question:Question: Are the following events recorded in the accounting records?

EventPurchase Purchase computer.computer.

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

Pay rent.Pay rent.

Record/Don’t Record


Discuss guided trip

options with potential

customer.

Chapter 1-85

AssetsAssetsAssetsAssets LiabilitiesLiabilitiesLiabilitiesLiabilitiesStockholdersStockholders

’ Equity’ EquityStockholdersStockholders

’ Equity’ Equity= +

Analyzing TransactionsAnalyzing Transactions


First step in the accounting process is transaction analysis.

The process of identifying specific effects of economic events on the accounting equation.

This process examines relevant, objectively measurable economic events through their effect on the accounting equation:

Chapter 1-86



Expanded Accounting EquationExpanded Accounting Equation

Chapter 1-87

Discussion QuestionQuestionQuestion.. In February 2008, Paula King invested an In February 2008, Paula King invested an additional $10,000 in Hardy Company. Hardy’s additional $10,000 in Hardy Company. Hardy’s accountant, Lance Jones, recorded this receipt as an accountant, Lance Jones, recorded this receipt as an increase in cash and revenues. Is this treatment increase in cash and revenues. Is this treatment appropriate? Why or why not?appropriate? Why or why not?


No, this treatment is not proper. While the transaction does No, this treatment is not proper. While the transaction does involve a receipt of cash, it does not represent revenues. involve a receipt of cash, it does not represent revenues. Revenues are the gross increase in stockholders’ equity Revenues are the gross increase in stockholders’ equity resulting from business activities entered into for the purpose resulting from business activities entered into for the purpose of earning income. This transaction is simply an additional of earning income. This transaction is simply an additional investment made by one of the owners of the business.investment made by one of the owners of the business.

Chapter 1-88

Illustration: 1. On October 1, cash of $10,000 is invested in Sierra Corporation by investors in exchange for $10,000 of common stock.


1. +10,000 +10,000

Analyze the effect of business transactions on the basic accounting equation.

Chapter 1-89

2. On October 1, Sierra borrowed $5,000 from Castle Bank by signing a 3-month, 12%, $5,000 note payable.


1. +10,000 +10,000

2. +5,000 +5,000

Chapter 1-90

3. On October 2, Sierra purchased equipment by paying $5,000 cash to Superior Equipment Sales Co.


3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

Chapter 1-91

4. On October 2, Sierra received a $1,200 cash advance from R. Knox, a client.


4. +1,200 +1,200

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

Chapter 1-92

5. On October 3, Sierra received $10,000 in cash from Copa Company for guide services performed.


4. +1,200 +1,200

5. +10,000 +10,000

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

Chapter 1-93

6. On October 3, Sierra Corporation paid its office rent for the month of October in cash, $900.


4. +1,200 +1,200

5. +10,000 +10,000

6. -900 -900

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

Chapter 1-94

7. On October 4, Sierra paid $600 for a one-year insurance policy that will expire next year on September 30.


4. +1,200 +1,200

5. +10,000 +10,000

6. -900 -900

7. -600 +600

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

Chapter 1-95

8. On October 5, Sierra purchased supplies on account from Aero Supply for $2,500.


4. +1,200 +1,200

5. +10,000 +10,000

6. -900 -900

7. -600 +600

8. +2,500 +2,500

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

Chapter 1-96

10. On October 20, Sierra paid a $500 dividend.


4. +1,200 +1,200

5. +10,000 +10,000

6. -900 -900

7. -600 +600

8. +2,500 +2,500

10. -500 -500

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

Chapter 1-97

11. Employees have worked two weeks, earning $4,000 in salaries, which were paid on October 26.


4. +1,200 +1,200

5. +10,000 +10,000

6. -900 -900

7. -600 +600

8. +2,500 +2,500

10. -500 -500

11. -4,000 -4,000

3. -5,000 +5,000

1. +10,000 +10,000

2. +5,000 +5,000

Chapter 1-98

Each transaction must be analyzed in terms of its effect on the components of basic accounting equation.

Assets = Liabilities + Stockholders EquityAssets = Liabilities + Stockholders Equity

Analysis must identify the specific items affected and the amount of change in each item. Specific items refers to specific accounts specific accounts to the basic accounting transactions.

A tabular summary may be prepared to show the cumulative effect of transactions on the basic accounting equation.



Chapter 1-99

The summary demonstrates that:The summary demonstrates that:

a.a.Each transaction must be analyzed in terms of its effect Each transaction must be analyzed in terms of its effect on (1) the on (1) the three components of the equation three components of the equation (Assets = (Assets = Liabilities + stockholders’ equity) Liabilities + stockholders’ equity) and (2) and (2) specific specific types of itemstypes of items within each component.within each component.

b.b.Two sides of the equation must always be equal.Two sides of the equation must always be equal.

c.c.Common Stock and Retained Earnings column indicate Common Stock and Retained Earnings column indicate the causes of each change in the stockholders’ claim on the causes of each change in the stockholders’ claim on assets.assets.

Stockholders’ equity Stockholders’ equity = = Common stock + Retained Common stock + Retained Earnings (Revenue, Expenses and Dividend)Earnings (Revenue, Expenses and Dividend)


Chapter 1-100

All businesses are involved in three types of activity :

financing,

investing,

operating.

Business ActivitiesBusiness ActivitiesBusiness ActivitiesBusiness Activities

Accounting information system keeps track of the results of each of these business activities.

Chapter 1-101

Provide the means organizations use to pay for Provide the means organizations use to pay for resources such as land, buildings, and equipment resources such as land, buildings, and equipment to carry out plans.to carry out plans.

Two primary sources of outside funds are: Two primary sources of outside funds are:

1.1. Borrowing moneyBorrowing money

2.2. Issuing shares of stock for cash. Issuing shares of stock for cash.


Financing ActivitiesFinancing Activities

Chapter 1-102

1.1. Borrowing moneyBorrowing money

Amounts owed are called liabilities.Amounts owed are called liabilities.

Party to whom amounts are owed are creditors.Party to whom amounts are owed are creditors.

Notes payable and bonds payable are different Notes payable and bonds payable are different type of liabilities.type of liabilities.

2.2. Issuing shares of stock for cash. Issuing shares of stock for cash.

Payments to stockholders are called dividends.Payments to stockholders are called dividends.


Financing ActivitiesFinancing Activities

Chapter 1-103

Investing ActivitiesInvesting Activities

Are the acquiring and disposing of resources (assets) Are the acquiring and disposing of resources (assets)

that an organization uses to acquire and sell its that an organization uses to acquire and sell its

products or services.products or services.

Purchase of resources a company needs to operate.Purchase of resources a company needs to operate.

Computers, delivery trucks, furniture, buildings, etc.Computers, delivery trucks, furniture, buildings, etc.

Resources owned by a business are called assets.Resources owned by a business are called assets.


Chapter 1-104

Operating ActivitiesOperating Activities

Involve using resources to research, develop, and purchase, Involve using resources to research, develop, and purchase,

produce, distribute, and market products and services.produce, distribute, and market products and services.

Once a business has the assets it needs, it can begin its Once a business has the assets it needs, it can begin its

operations.operations.

RevenuesRevenues - Amounts earned from the sale of products Amounts earned from the sale of products

(sales revenue, service revenue, and interest revenue).(sales revenue, service revenue, and interest revenue).

InventoryInventory - Goods available for sale to customersGoods available for sale to customers.

Accounts receivable Accounts receivable - Right to receive money from a Right to receive money from a

customer in the future, as the result of a sale.customer in the future, as the result of a sale.


Chapter 1-105

Operating ActivitiesOperating Activities

Expenses Expenses - cost of assets consumed or services used.

(cost of goods sold, selling, marketing, administrative,

interest, and income taxes expense).

LiabilitiesLiabilities arising from expenses include accounts

payable, interest payable, wages payable, sales taxes

payable, and income taxes payable.

Net incomeNet income – when revenues exceed expenses.

Net loss Net loss – when expenses exceed revenues.


Chapter 1-106

Companies prepare four financial statements from the summarized accounting data:

Companies prepare four financial statements from the summarized accounting data:

Balance Sheet

Income Statement

Statement of Cash Flows

Retained Earnings

Statement

Financial StatementsFinancial StatementsFinancial StatementsFinancial Statements

Chapter 1-107

1.1. Income statement Income statement presents the revenues and presents the revenues and expenses and resulting net income or net loss for a expenses and resulting net income or net loss for a specific period of time.specific period of time.

2.2. Retained earnings statement Retained earnings statement summarizes the summarizes the changes in retained earnings for a specific period of changes in retained earnings for a specific period of time.time.

3.3. Balance sheet Balance sheet reports the assets, liabilities, and reports the assets, liabilities, and stockholders’ equity of a company at a specific date.stockholders’ equity of a company at a specific date.

4.4. A statement of cash flows A statement of cash flows summarizes information summarizes information about the cash inflows (receipts) and outflows about the cash inflows (receipts) and outflows (payments) for a specific period of time.(payments) for a specific period of time.


Chapter 1-108

Financial statements areFinancial statements are interrelatedinterrelated because:because:

a.a.Net income (or net loss) Net income (or net loss) shown on the income shown on the income statement is added (subtracted)statement is added (subtracted) to (from) the beginning to (from) the beginning balance of retained earnings in the retained earnings balance of retained earnings in the retained earnings statement.statement.

b.b.Retained earnings at the end of reporting period Retained earnings at the end of reporting period shown in the retained earnings statement is reported in shown in the retained earnings statement is reported in the balance sheet.the balance sheet.

c.c.Amount of cash shown on the balance sheet is Amount of cash shown on the balance sheet is reported on the statement of cash flows.reported on the statement of cash flows.


Chapter 1-109

Statement ofCash Flows

IncomeStatement

Statement ofStockholders’ Equity

EndingBalance Sheet

Assets (Cash)

=

Liabilities

+

Equity

BeginningBalance Sheet

Assets(Cash)

=

Liabilities

+

Equity

Financial StatementFinancial StatementFinancial StatementFinancial Statement

Relationships Among the Financial StatementsRelationships Among the Financial Statements

Chapter 1-110

In income statement, revenues are listed first, followed by expenses. Then below expenses is the resulting amount of net income (or net loss).

Reports revenues and expenses for a specific period of time.


Income Statement

Chapter 1-111

Net income – revenues exceed expenses.

Net loss – expenses exceed revenues.

Past net income provides information for predicting future net income.


Income Statement

Chapter 1-112


Retained Earnings Statement

Net income is needed to determine the ending balance in retained

earnings.

Income Statement

Chapter 1-113


Statement shows amounts

and causes of changes in

retained earnings during the

period.

Statement shows retained

earnings at beginning of the

period, net income (or net

loss) for the period,

dividends, and retained

earnings at the end of the

period.


Chapter 1-114


Time period is the same as

that covered by the income

statement.

Users can evaluate dividend

payment practices.


Chapter 1-115


Retained Earnings Retained Earnings StatementStatement

Ending balance in retained Ending balance in retained earnings is needed in preparing earnings is needed in preparing

the balance sheet.the balance sheet.

Balance SheetBalance Sheet

Chapter 1-116


Balance SheetBalance Sheet

Reports assets and

claims to assets at a

specific point in time.

Assets = Liabilities +

Stockholders’ Equity.

Lists assets first,

followed by liabilities

and stockholders’

equity.

Chapter 1-117


Balance SheetBalance Sheet Statement of Cash FlowsStatement of Cash Flows

Chapter 1-118

Answers:

Where did cash

come from during

the period?

How was cash

used during the

period?

What was the

change in the cash

balance during the

period?


Statement of Cash FlowsStatement of Cash Flows

SourcesSources

UsesUses

Net increase or Net increase or decrease in decrease in cashcash

Chapter 1-119

Net income will result during a time period when:

a. assets exceed liabilities.

b. assets exceed revenues.

c. expenses exceed revenues.

d. revenues exceed expenses.



Chapter 1-120

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

a) Balance sheet.

b) Income statement.

c) Statement of stockholders’ equity.

d) Statement of cash flows.



Chapter 1-121

Discussion QuestionDiscussion QuestionQuestion. “A company’s net income appears directly on the income statement and the retained earnings statement, and it is included indirectly in the company’s balance sheet.” Do you agree? Explain.


Yes. Net income does appear on the income statement. It is the result of subtracting expenses from revenues. In addition, net income appears in the retained earnings statement. It is shown as an addition to the beginning-of-period retained earnings. Indirectly, the net income of a company is also included in the balance sheet. It is included in the Retained Earnings account which appears in the stockholders’ equity section of the balance sheet.

Chapter 1-122

Copyright © 2008 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

CopyrightCopyrightCopyrightCopyright

introduction to accounting concepts and practice

Documents