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CHAPTER 1
ACCOUNTING IN BUSINESS
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DEFINITION OF ACCOUNTING
Recording
Classifying
Accounting is the
art (science) of
Summarizing
(in a significant manner)
in Monetary terms
Ai
of _________
(subject matter)
and Interpreting the
Results thereof
Analogy to sports! Think of a game.
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USERS OF ACCOUNTING
INFORMATION
Temporal
External Users
Financial accounting
provides external users
with financial statements.
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Spatial
Internal Users
Managerial accounting
provides information needs
for internal decision-makers.
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OPPORTUNITIES IN ACCOUNTING
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ETHICS - A KEY CONCEPT
Ethics
Beliefs that
distinguish right
from wrong
Accepted standards
of good and bad
behavior
This is the cornerstone of the accounting profession.
Eg., auditors: 1) no investment in client firms.
2) pay is independent of audit report.
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INTERNATIONAL STANDARDS
The International Accounting Standards Board (IASB), an
independent group (consisting of 16 individuals from many
countries), issues International Financial Reporting Standards
(IFRS) that identify preferred accounting practices.
Demand for
international
borrowing
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IASB
FASB & harmonization
(no convergence)
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GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES
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PRINCIPLES OF ACCOUNTING
Revenue Recognition Principle
1. 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.
Expense Recognition or
Matching Principle
A company must record its expenses
incurred to generate the revenue reported.
Cost Principle
Accounting information is based on
actual cost. Actual cost is
considered objective.
Full Disclosure Principle
A company is required to report the
details behind financial statements
that would impact users’ decisions.
Notes serve this purpose!
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ACCOUNTING ASSUMPTIONS
(FACTS)
Now
Future
Going-Concern Assumption
Reflects assumption that the business
will continue operating instead of
being closed or sold.
Business Entity Assumption
A business is accounted for
separately from other business
entities, including its owner.
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Monetary Unit Assumption
Express transactions and events in
monetary, or money, units.
Time Period Assumption
Presumes that the life of a company can
be divided into time periods, such as
months and years.
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FORMS OF BUSINESS ENTITIES
Sole
Proprietorship
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Partnership
Corporation
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CORPORATION
Owners of a corporation or company are called
shareholders (or stockholders). Shareholders are
not personally liable for corporate acts. When a
corporation issues only one class of shares, we
call it ordinary shares (or common stock).
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IASB CONCEPTUAL FRAMEWORK
FOR FINANCIAL REPORTING
Deals with: 1) Objective of financial reporting.
2) Qualitative characteristics of useful information.
3) Definition, recognition, and measurement of
elements contained in financial statements.
4) Concepts of capital and capital maintenance.
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CONCEPTUAL FRAMEWORK
2 Fundamental
Qualitative
Characteristics
4 Enhancing
Qualitative
Characteristics
Cost-benefit constraint: The cost of providing the information
must be weighed against the benefits that can be derived from
using it.
Materiality:
Information is material if omitting it or
misstating it could influence decisions.
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TRANSACTION ANALYSIS AND THE
ACCOUNTING EQUATION
Accounting Equation
Assets
= Liabilities + Equity
This is an identity equation:
Resources = Claims (creditors &
shareholders)
Note: We will not use Dr and Cr in Chapter 1!
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ASSETS
Cash
Accounts
Receivable
Vehicles
Store
Supplies
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Resources
owned or
controlled by a
company
expected to
yield future
benefits.
Notes
Receivable
Land
Buildings
Equipment
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LIABILITIES
Accounts
Payable
Notes
Payable
Creditors’
claims on
assets
Taxes
Payable
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Wages
Payable
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EQUITY
Owner’s
Claims on
Assets
Equity = Contributed Capital +
Retained Earnings
Equity is also called net assets, residual equity, or net worth.
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TRANSACTION ANALYSIS
Business activities can be transactions and events.
 Record those that affect the accounting equation and can
be reliably measured.
 Example of transactions:
 Selling of products and services (external transactions).
 The business used its supplies, which are reported as
expenses (internal transactions).
 Examples of events:

 Changes in the market value of certain assets and liabilities and
natural events such as floods and fires that destroy assets and
create losses.
Alternative View: Exchange Analysis (Received/Given)
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TRANSACTION ANALYSIS
The accounting equation MUST remain in
balance after each transaction (exchange).
Assets
=
Liabilities
+
Equity
We are going to adopt a spreadsheet approach!
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TRANSACTION 1: ISSUANCE OF SHARES
Chas Taylor receives shares for investing $30,000 cash
to start a consulting business set up as a corporation
called Fastforward. Transactions 1 to 11 are for
Fastforward.
The accounts involved are:
Think about the B/S equation!
(1) Cash (asset)
(2) Share Capital (equity)
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TRANSACTION 2: PURCHASE SUPPLIES
FOR CASH
Purchases supplies paying $2,500 cash.
The accounts involved are:
(1) Cash (asset)
(2) Supplies (asset)
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A substitution – total
assets do not change.
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TRANSACTION 3: PURCHASE
EQUIPMENT FOR CASH
Purchases equipment for $26,000 cash.
The accounts involved are:
(1) Cash (asset)
(2) Equipment (asset)
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Note: Assets could be on the right!
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TRANSACTION 4: PURCHASE SUPPLIES
ON CREDIT
Purchases supplies of $7,100 on account.
The accounts involved are:
(1) Supplies (asset)
(2) Accounts Payable (liability)
Note: Why the BS
does not measure
performance!
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TRANSACTION 5: PROVIDE SERVICES FOR
CASH
Provides consulting services receiving $4,200
cash.
The accounts involved are:
(1) Cash (asset)
(2) Revenue (equity)
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TRANSACTION 6 AND 7: PAYMENT OF
EXPENSES (CONSUMPTION)
Pays $1,000 rent and $700 in salary to the
company’s only employee.
The accounts involved are:
(1) Cash (asset)
(2) Expenses
(equity
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)
By definition, increases in
expenses yield decreases
in equity
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TRANSACTION 8: PROVIDE SERVICES AND
FACILITIES FOR CREDIT
Provides consulting services of $1,600 and rents
out its test facilities for $300, both on account.
The accounts involved are:
(1) Accounts Receivable (asset)
(2) Revenues (equity)
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TRANSACTION 9: RECEIPT OF CASH FROM
ACCOUNTS RECEIVABLE
Receives $1,900 from client of test facilities in
transaction 8.
The accounts involved are:
(1) Cash (asset)
(2) Accounts Receivable (asset)
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TRANSACTION 10: PAYMENT OF ACCOUNTS
PAYABLE
Pays $900 as partial payment for transaction 4
on supplies.
The accounts involved are:
(1) Cash (asset)
(2) Accounts Payable (liability)
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TRANSACTION 11: PAYMENT OF DIVIDEND
Pays $200 dividend.
The accounts involved are:
(1) Cash (asset)
(2) Dividends
(equity
)
By definition, increases in dividends yield decreases in equity
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SUMMARY OF TRANSACTIONS
Try adding: books are still in balance (40,400).
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FINANCIAL STATEMENTS
• Statement of comprehensive
income (income statement)
• Statement of changes in equity
• Statement of financial position
• Statement of cash flows
• Notes, comprising a summary of
significant accounting polices and
other information.
IAS 1 Presentation of Financial Statements
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INCOME STATEMENT
If negative, called Net Loss.
Notice the heading; the
concept of time! Time is
needed for a performance
measure!
to Statement of
Changes in Equity
The income statement describes a company’s revenues and
expenses along with the resulting net profit or loss over a
period of time due to earnings activities.
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STATEMENT OF CHANGES IN EQUITY
Notice the heading; the
concept of time! Time is
needed for a performance
measure!
Notice: There are four items that can change!
Opening Capital cannot change by definition!
from
Income
Statement
to Statement
of Financial
Position
The statement of changes in equity reports information about
how equity changes over the reporting period.
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STATEMENT OF FINANCIAL POSITION
The Statement of Financial Position describes a
company’s financial position at a point in time.
Here, there is no time. Time does not exist at
a point in space!
to Statement of Cash Flows
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from Statement of
Changes in Equity
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STATEMENT OF CASH FLOWS
from Statement of
Financial Position
Notice the heading; the
concept of time! Flows
require time!
Notice: there are
three major sections!
The Statement of Cash Flows describes a company’s cash
flows for operating, investing, and financing activities.
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DECISION ANALYSIS
Return on assets (ROA) is stated in ratio form as
income divided by assets invested.
Return on assets =
Net income
Average total assets
Comparisons across time and across firms.
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End of Material
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