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Introduction to Accounting
Chapter 1
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Learning objectives
1. Explain the role of accounting information
2. Identify the users of accounting information
3. Distinguish between financial accounting and
management accounting
4. Explain the role of the regulatory bodies in
developing generally accepted accounting
principles
5. Explain five of the general principles that underlie
accounting standards
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Learning objectives
6. Describe the key features of four business
structures
7. Define the accounting equation and its
components
8. Analyze transactions using the accounting
equation
9. Describe the features of financial statements and
explain how they interrelate
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Learning objective 1
Explain the role of
accounting information
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Role of accounting information
▪ Accounting is an information system that
– identifies information
– records information
– communicates information
▪ Aim of accounting is to provide sufficient information
for users to make informed business decisions
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Role of accounting information
▪ Identifying information
– Recognizing transactions and events
▪ Recording information
– Measuring, classifying, documenting
▪ Communicating information
– Organizing, analyzing, interpreting, publishing
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Learning objective 2
Identify the users of
accounting information
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Users of accounting information
▪ Investors
▪ Lenders
▪ Suppliers
▪ Employees
▪ Customers
▪ Government and regulatory agencies
▪ General public
▪ Managers
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Learning objective 3
Distinguish between
financial accounting and
management accounting
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Financial and management accounting
Financial
accounting
External
Regulated
Management
accounting
Internal
No regulation
Past
Future
Users
Reporting
requirements
Detail
General reports
Detailed reports
Frequency
Annual or half-yearly As required
Focus
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Learning objective 4
Explain the role of the
regulatory bodies in developing
generally accepted accounting
principles
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Role of regulatory bodies
GAAP:
▪ Generally accepted accounting principles
– Rules that govern financial accounting practice
FASB:
▪ The Financial Accounting Standards Board
– Issues the Accounting standards codification, the single
authoritative source of U.S. GAAP
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Role of regulatory bodies
SEC:
▪ The Securities and Exchange Commission
– Authorizes the reporting requirements for companies who
issue stock to the general public
IASB:
▪ International Accounting Standards Board
– Issues IFRS, the International Financial Reporting
Standards
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Learning objective 5
Explain five of the
general principles that underlie
accounting standards
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General principles of accounting
1. Historical cost principle
▪ items are recorded at exchange value
2. Monetary unit principle
▪ items are recorded in dollars
3. Going-concern principle
▪ assumes the business will remain in operation
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General principles of accounting
4. Business entity principle
▪ business records kept separate from owners
5. Materiality principle
▪ information is material if its omission or
misstatement could change or influence the
judgment of a user relying on that information
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Learning objective 6
Describe the key features of
four business structures
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Business structures
▪ Sole proprietorships
▪ Partnerships
▪ Corporations
▪ Limited Liability Company (LLC)
▪ Each has advantages and disadvantages
▪ Important to choose business structure because of
legal and taxation implications
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Sole proprietorships
▪ A business that only has one owner
▪ Separate business entity
▪ NOT a separate legal entity
▪ Unlimited liability
▪ Earnings taxed in the owner’s personal tax return
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Partnerships
▪ Two or more people that have an agreement to form
a business
▪ Agreement includes how the income or losses of
the partnership are to be shared
▪ Separate business entity
▪ NOT a separate legal entity
▪ Unlimited liability
▪ Earnings distributed among the partners and taxed
in the partners’ personal tax return
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Corporations
▪ Separate legal entity
– Own rights and responsibilities, similar to that of a natural
person
– Corporation responsible for its actions
▪ Limited liability
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Corporations
▪ Ownership divided into units called shares,
collectively known as stock
▪ Owners are stockholders
▪ Double taxation
– Corporations pay tax on earnings, AND dividends
distributed to stockholders are also taxed in the owner’s
individual tax return
– Double taxation does not apply if business elects to be
treated as an S corporation provided it is eligible to do so
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Limited liability company (LLC)
▪ Combines characteristics of both corporations and
partnerships
▪ Separate legal entity (corporation)
▪ Limited liability (corporation)
▪ Taxation (partnership)
– May elect to be taxed as a corporation, partnership or sole
proprietorship, depending on specific structure
▪ Owners are members who hold a membership
interest
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Learning objective 7
Define the
accounting equation and its
components
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Accounting equation
Assets = Liabilities + Equity
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Assets
▪ Resources owned or controlled by an entity that are
expected to provide benefits to the business in the
future
Examples:
–
–
–
–
–
–
–
Cash
Accounts Receivable
Office Supplies
Equipment
Machinery
Vehicles
Land
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Liabilities
▪ Probable future sacrifices of economic benefits
where the entity has an obligation to transfer assets
to another entity outside the organization, or to
provide them with a service
Examples:
– Accounts Payable
– Bank Loan
– Loan Payable
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Equity
▪ The residual interest, held by the owners of the
entity, in the assets of the entity after all liabilities
have been deducted
▪ Also known as net assets
Examples:
– Owner's Equity
– Capital
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Equity
▪ Equity can be subdivided into
– Capital
– Withdrawals
– Revenues
– Expenses
▪ This creates the expanded accounting equation…
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Expanded accounting equation
A=L+C–W+R–E
Where:
A = Assets
L = Liabilities
C = Capital
W = Withdrawals
R = Revenues
E = Expenses
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Capital
▪ Represents the value of the contributions the
owners have invested in the business
▪ Capital increases equity
▪ Another name for Owner's Equity
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Withdrawals
▪ Represents the amount the owners have withdrawn
from a sole proprietorship or partnership
▪ Withdrawals decrease equity
▪ Also known as Distributions
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Revenues
▪ Inflows or enhancements of assets or settlements of
liabilities (or both) that result from activities that
make up the ongoing central operations of the entity
▪ Revenues increase equity
Examples:
– Sales
– Sales Revenues
• amounts earned by a firm by providing goods to customers
– Service Revenues
• amounts earned by a firm by providing services to customers
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Expenses
▪ Outflows or other using up of assets or incurrences
of liabilities (or both) that result from activities that
make up the ongoing central operations of the
entity.
▪ Expenses decrease equity
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Expenses
Examples:
– Electricity Expense
– Gas Expense
– Telephone Expense
– Utilities Expenses
– Rent Expense
– Wages Expense
• Employees paid on an hourly
basis
– Salary Expense
• employees paid a set amount,
regardless of hours worked
– Advertising Expenses
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Learning objective 8
Analyze transactions using the
accounting equation
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Transaction analysis
▪ Transactions and events are recorded in the
accounting system
▪ A business transaction is an event in which entities
exchange something of value
▪ Transactions are recorded as increases or
decreases in the elements of the accounting
equation
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Transaction analysis
▪ Each transaction has at least two entries that affect
the accounting equation
▪ The accounting equation must remain in balance
after each and every transaction
Assets = Liabilities + Equity
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Steps in transaction analysis
1. Decide if the event is to be recorded in the
accounting system
2. Determine the changes in the elements of the
accounting equation
– Identify the names of the items affected
– Classify each item as an element of the expanded
accounting equation
– Determine whether each item has increased or decreased
– Calculate the value of the increase or decrease of each
item
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Steps in transaction analysis
3. Record the transaction and check that the
accounting equation remains in balance
– If the accounting equation is not balanced, an error has
been made
– This error needs to be identified and fixed up before the
next transaction is recorded
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A. Cash investment by owner
Transaction
Owner invests $2,000 cash into the business
Transaction
analysis
Item
Classification
Change
Value
Cash
Asset
Increase
$2,000
Capital
Equity
Increase
$2,000
Accounting
equation
analysis
(A)
Assets
=
Cash
=
+2,000
Liabilities
+
Equity
Capital
+2,000
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B. Purchased an asset with cash
Transaction
Purchased supplies for $700 cash
Transaction
analysis
Item
Classification
Change
Value
Supplies
Asset
Increase
$700
Cash
Asset
Decrease
$700
Accounting
equation
analysis
Assets
(B)
=
Cash
+ Supplies =
-700
+700
Liabilities
+
Equity
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C. Purchased an asset on credit
Transaction
Purchased a computer on credit for $2,400
Transaction
analysis
Item
Classification
Change
Value
Equipment
Asset
Increase
$2,400
Accounts Payable
Liability
Increase
$2,400
Accounting
equation
analysis
Assets
Equipment
(C)
+2,400
=
Liabilities
+
Equity
= Accounts Payable
+2,400
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D. Paid for an asset purchased on credit
Transaction
Paid $600 cash toward the computer previously purchased on credit
Transaction
analysis
Item
Classification
Change
Value
Accounts Payable
Liability
Decrease
$600
Cash
Asset
Decrease
$600
Accounting
equation
analysis
Assets
Cash
(D)
-600
=
Liabilities
+
Equity
= Accounts Payable
-600
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E. Received loan
Transaction
Received a loan of $5,000 from the bank
Transaction
analysis
Item
Classification
Change
Value
Cash
Asset
Increase
$5,000
Loan Payable
Liability
Increase
$5,000
Accounting
equation
analysis
(E)
Assets
=
Liabilities
Cash
=
Loan Payable
+5,000
+
Equity
+5,000
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F. Performed services for cash
Transaction
Performed tutoring services for $3,300 cash
Transaction
analysis
Item
Classification
Change
Value
Cash
Asset
Increase
$3,300
Revenues
Revenue
Increase
$3,300
Accounting
equation
analysis
(F)
Assets
=
Cash
=
+3,300
Liabilities
+
Equity
Revenues
+3,300
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G. Performed services on credit
Transaction
Performed $4,400 worth of tutoring services on credit
Transaction
analysis
Item
Classification
Change
Value
Accounts Receivable
Asset
Increase
$4,400
Revenues
Revenue
Increase
$4,400
Accounting
equation
analysis
Assets
=
Accounts Receivable =
(G)
+4,400
Liabilities
+
Equity
Revenues
+4,400
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H. Received cash from Accounts Receivable
Transaction
Received $800 cash from Accounts Receivable
Transaction
analysis
Item
Classification
Change
Value
Cash
Asset
Increase
$800
Accounts Receivable
Asset
Decrease
$800
Accounting
equation
analysis
Assets
=
Liabilities
+
Equity
Cash + Accounts =
Receivable
(H)
+800
-800
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I. Paid expense with cash
Transaction
Paid $150 cash for advertising campaign
Transaction
analysis
Item
Classification
Change
Value
Advertising Expense
Expense
Increase Expense
Decrease Equity
$150
Cash
Asset
Decrease
$150
Accounting
equation
analysis
(I)
Assets
=
Cash
=
-150
Liabilities
+
Equity
Advertising
Expense
-
+150
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J. Owner withdraws cash from business
Transaction
Owner withdraws $250 cash from the business
Transaction
analysis
Item
Classification
Change
Withdrawals
Equity
Increase Withdrawals $250
Decrease Equity
Cash
Asset
Decrease
Accounting
equation
analysis
(J)
Assets
=
Cash
=
-250
Liabilities
Value
$250
+
Equity
Withdrawals
-
+250
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K. Non business transaction
Transaction
Signing an employment agreement
Transaction
analysis
Item
Classification
Change
Value
-
-
-
-
-
-
-
-
Accounting
equation
analysis
No effect on the accounting equation
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Remember
▪ Each transaction has at least two entries
▪ Each transaction can be analyzed according to the
increase and/or decrease of the elements of the
accounting equation
▪ Withdrawals and Expenses decrease Equity
▪ The accounting equation always remains in balance
after each transaction
Assets = Liabilities + Equity
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Learning objective 9
Describe the features of
financial statements and explain
how they interrelate
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Financial statements
There are four main financial statements:
▪ Income statement
▪ Statement of changes in owner's equity
▪ Balance sheet
▪ Statement of cash flows
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Income statement
▪ Summarizes the revenues earned and expenses
incurred over a period of time
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Statement of changes in owner's equity
▪ Identifies the movements in equity over a period of
time
▪ These include earnings, contributions and
withdrawals of capital by the owners of the business
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Balance sheet
▪ Presents the assets, liabilities and equity of the
business at a specific point in time
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Statement of cash flows
▪ Explains the inflows (receipts) and outflows
(payments) of cash over a period of time
Reports 3 cash flow categories:
▪ Cash flows from operating activities
– Cash flows that occur in the process of providing goods or
services to customers
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Statement of cash flows
▪ Cash flows from investing activities
– Cash flows that arise from the purchase and sale of
assets that are intended to be used by the business over
the long term
▪ Cash flows from financing activities
– Cash contributions and withdrawals by the owners of the
business, as well as obtaining and repaying long-term
loans
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Statement of cash flows
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Relation between the financial statements
▪ Net income (or net loss) from the income statement
is an input into the statement of changes in owner's
equity
▪ Ending balance of Capital in the statement of
changes in owner's equity is the ending balance of
Capital reported in the balance sheet
▪ Ending balance of Cash in the statement of cash
flows is the balance of Cash in the balance sheet.
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