Chapter 01
Introduction Accounting
1-1
Conceptual Chapter Objectives
C1: Explain the purpose and importance of
accounting.
C2: Identify users and uses of accounting.
C3: Explain why ethics are crucial to
accounting.
C4: Explain generally accepted accounting
principles and define and apply
several accounting principles.
C5: Appendix 1B – Identify and describe the
three major activities of organizations.
1-2
C1
Importance of Accounting
is a
Accounting
system that
Identifies
Records
information
Relevant
that is
Communicates
Reliable
Comparable
about an
organization’s
business activities.
1-3
C1
Accounting Activities
Identifying
Business
Activities
 Recording
Business
Activities

Communicating
Business
Activities
1-4
Users of Accounting
Information
C2
Internal Users
External Users
•Lenders
•Consumer Groups
•Managers
•Sales Staff
•Shareholders •External Auditors
•Officers
•Budget Officers
•Governments •Customers
•Internal Auditors •Controllers
1-5
C2
Users of Accounting
Information
External Users
Internal Users
Financial accounting provides
external users with financial
statements (shareholders,
lenders, etc.).
Managerial accounting provides
information needs for internal
decision makers (officers,
managers, etc.).
1-6
C2
Opportunities in Accounting
Financial
•Preparation
•Analysis
•Auditing
•Regulatory
•Consulting
•Planning
•Criminal
investigation
Accountingrelated
Managerial
•General accounting
•Cost accounting
•Budgeting
•Internal auditing
•Consulting
•Controller
•Treasurer
•Strategy
•Lenders
•Consultants
•Analysts
•Traders
•Directors
•Underwriters
•Planners
•Appraisers
Taxation
•Preparation
•Planning
•Regulatory
•Investigations
•Consulting
•Enforcement
•Legal services
•Estate plans
•FBI investigators
•Market researchers
•Systems designers
•Merger services
•Business valuation
•Forensic accountant
•Litigation support
•Entrepreneurs
1-7
FIELDS IN ACCOUNTING

PUBLIC ACCOUNTING




Auditing
Management Advisory Services
Tax Services
PRIVATE ACCOUNTING
PRIVATE ACCOUNTING








General Accounting
Cost Accounting
Budgeting
Internal Auditing
Government Accounting
Accounting Education
International Accounting
Social Accounting
DEFINITION OF ACCOUNTING


Accounting as an art. “It is the
language of the business”
Accounting as a science. “There are
accounting principles that serve as a
guide in accomplishing data and
preparing reports”
Accounting

Is an art of recording, classifying,
summarizing in a significant manner in
terms of money, transaction, and events
which are in part at least of financial
character and interpreting the result
thereof.
American Institute of Accountants
BOOKKEEPING DISTINGUISHED
FROM ACCOUNTING
Accounting
1. Includes bookkeeping
2. Also includes much more
Bookkeeping
1. Involves only the recording of
economic events
2. Is just one part of accounting
The Accounting Cycle
1.
2.
3.
4.
Perform transactions.
Analyze and record transactions in a
journal.
Post journal entries to the ledger
Prepare a trial balance
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Copyright © 2015 Pearson Education, Inc.
The Accounting Cycle (cont.)
5.
6.
7.
8.
Make adjusting entries, as needed
Prepare an adjusted trial balance
Prepare financial statements
Close the books for the accounting
period
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Copyright © 2015 Pearson Education, Inc.
C3
Ethics—A Key Concept
Ethics
Beliefs that
distinguish
right from
wrong
Accepted
standards of
good and bad
behavior
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C3
Guidelines for Ethical Decisions
Identify ethical
concerns
 Analyze
options
Use personal Consider all good
ethics to
and bad
recognize an
consequences.
ethical concern.
 Make ethical
decision
Choose best
option after
weighing all
consequences.
1-16
C4
Generally Accepted Accounting
Principles
Financial accounting practice is governed by
concepts and rules known as generally accepted
accounting principles (GAAP).
Relevant
Information
Affects the decision of
its users.
Reliable Information
Is trusted by
users.
Comparable
Information
Used in comparisons
across years & companies.
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C4
Setting Accounting Principles
In the Philippines, the Securities and Exchange
Commission, a government agency, has the legal authority
to establish reporting requirements and set GAAP for
companies that issue stock to the public.
The Financial Accounting
Standards Board is the private
group that sets both broad and
specific principles.
The International Accounting Standards Board (IASB) issues international standards that identify preferred accounting practices
in other countries. More than 100 countries now require or permit
companies to prepare financial reports following IFRS standards.
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C4
Principles and Assumptions
of Accounting
Measurement principle (also called
historical cost principle) means that
accounting information is based on
actual cost.
Revenue recognition principle
provides guidance on when a
company must recognize revenue.
Going-concern assumption means
that accounting information reflects a
presumption the business will
continue operating.
Matching principle (expense
recognition) prescribes that a
company must record its expenses
incurred to generate the revenue.
Time period (periodicity) assumption
presumes that the life of a company
can be divided into time periods, such
as months and years.
Full disclosure principle requires a
company to report the details behind
financial statements that would impact
users’ decisions.
Monetary unit assumption means we
can express transactions in money.
Business entity assumption means
that a business is accounted for
separately from its owner or other
business entities.
1-19
The business entity concept
limits the economic data in
the accounting system to
data related directly to the
activities of the business.
The cost concept is the
basis for entering the
exchange price, or cost
of an acquisition in the
accounting records.
Business Entity Concept /
Economic Entity Principle

All business entities should be accounted for
separately. In other words, businesses, related
businesses, and the owners should be accounted
for separately. Even though the tax law looks at a
sole proprietorship and the owner as one
entity, GAAP disagrees. The owner and the
business are two separate entities and should be
accounted for separately. The same goes for
partnership and corporations. The partners and
shareholders' activities should be kept separate
from the partnership and corporate transactions
because they are separate economic entities.
The objectivity concept
requires that the accounting
records and reports be based
upon objective evidence.
The unit-of-measure
concept requires that
economic data be
recorded in peso.
Cost Benefit Principle

The cost of providing financial
information in the financial statements
must not outweigh the benefit of that
information to the users. In other
words, financial information is not free.
Companies spend millions of dollars
every year gathering and organizing
financial information to assemble into
financial statements.
Cost Benefit Principle

Paul's Retail, LLC discovered that an
employee was stealing from its cash
register. The amount is suspected to be
over $1,000, but Paul is not sure. It's
estimated that Paul would pay his
accountant and attorney $5,000 to dig
through his records and discover the exact
amount of the theft. In this case, it would not
be beneficial for Paul to do further research
and sue his former employee.
Materiality Concept

also called the materiality constraint,
states that financial information is
material to the financial statements if it
would change the opinion or view of a
reasonable person. In other words, all
important financial information that
would sway the opinion of a financial
statement user should be included in
the financial statements.
Industry Practices Constraint

The nature of certain industries and their
practices can require the departure of
traditional accounting theory. In other words,
some industries have practices unlike any
other that require specialized accounting or
reporting. The industry practices constraint
allows these industries to go outside of
traditional accounting principles as long as it
is infrequent and justifiable.
Industry Practices Constraint

The agriculture industry reports its
crops at their fair market value on the
balance sheet instead of the traditional
historical cost or production cost. This
is common because calculating the
actual cost per crop is too difficult and
costly. Its easier for farmers to value
and report their crops at the current
market price.
Conservatism Principle

Gives guidance on how to record
uncertain events and estimates. The
principle of conservatism states that
you should always error on the most
conservative side of any transaction.
Most of the time this means minimizing
profits by recording uncertain losses or
expenses and not recording uncertain
or estimated gains.
Objectivity Principle

Accounting information and financial
reporting should be independent and
supported with unbiased evidence.
This means that accounting
information must be based on
research and facts, not merely a
preparer's opinion. The objectivity
principle is aimed at making financial
statements more relevant and reliable.
Objectivity Principle

Accounting information and financial
reporting should be independent and
supported with unbiased evidence.
This means that accounting
information must be based on
research and facts, not merely a
preparer's opinion. The objectivity
principle is aimed at making financial
statements more relevant and reliable.
Consistency Principle

Companies should use the same accounting
treatment for similar events and transactions
over time. In other words, companies
shouldn't use one accounting method today,
use another tomorrow, and switch back the
day after that. Similar transactions should be
accounted for using the same accounting
method over time. This creates consistency
in the financial information given to creditors
and investors.
There are three types of
business organizations
 Proprietorship
 Partnership
 Corporation
C4
Business Entity Forms
Sole
Proprietorship
Partnership
Corporation
1-33
A sole
proprietorship is
owned by one
individual.
Joe’s
Advantages
• Ease in organizing
• Low cost of
organizing
Disadvantage
• Limited source of
financial resources
• Unlimited liability
A partnership is
owned by two or
more individuals.
Joe and Marty’s
Advantages
• More financial
resources than a
proprietorship.
• Additional
management skills.
Disadvantage
• Unlimited liability.
A corporation is
organized under state
or federal statutes as a
separate legal entity.
J & M, Inc.
Advantage
• The ability to obtain
large amounts of
resources by issuing
stocks.
Disadvantage
• Double taxation.
Types of Businesses
Manufacturing Business
Product
General Motors
Intel
Boeing
Nike
Coca-Cola
Sony
Cars, trucks, vans
Computer chips
Jet aircraft
Athletic shoes and apparel
Beverages
Stereos and television
Types of Businesses
Merchandising Business
Product
Wal-Mart
Toys “R” Us
Circuit City
Lands’ End
Amazon.com
General merchandise
Toys
Consumer electronics
Apparel
Internet books, music, video
retailer
Types of Businesses
Service Business
Product
Disney
Delta Air Lines
Marriott Hotels
Merrill Lynch
Sprint
Entertainment
Transportation
Hospitality and lodging
Financial advice
Telecommunication
Accounting Equation
ASSETS=EQUITY
A1
Assets
ASSETS
=
Liabilities
= LIABILITIES
Assets
+
Owner’s
Equity
+CAPITAL+REVENUE+EXPENSES
Liabilities
+ Equity
1-40
Assignment 1
Define Account Title terms as many as you can
under the following accounts:
ASSETS
Cash –
LIABILITIES
Accounts Payable –
OWNER’S EQUITY

REVENUE
EXPENSES
Assets
A1
Cash
Accounts
Receivable
Vehicles
Store
Supplies
Resources
owned or
controlled
by a
company
Notes
Receivable
Land
Buildings
Equipment
1-42
A1
Liabilities
Accounts
Payable
Notes
Payable
Creditors’
claims on
assets
Taxes
Payable
Wages
Payable
1-43
A1
Equity
Retained
Earnings
Contributed
Capital
Owner’s
claim on
assets
Dividends
1-44
A1
Expanded Accounting Equation
Assets
Assets
Contributed
Capital
=
=
_
Liabilities
Liabilities
Dividends
+
+
+
Revenues
Equity
Equity
_ Expenses
Retained Earnings
1-45
P1
Transaction Analysis
Business activities can be described in terms of
transactions and events. External transactions
are exchanges of value between two entities,
which yield changes in the accounting equation.
Internal transactions are exchanges within any
entity; they can also affect the accounting
equation. Events refer to happenings that affect
an entity’s accounting equation and can be
reliably measured. Transaction analysis is
defined as the process used to analyze
transactions and events.
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P1
Transaction Analysis
J. Scott invests $20,000 cash to start the
business in return for stock.
Assets
=
Cash
Supplies Equipment
(1) $ 20,000
$ 20,000 $
-
$ 20,000
$
-
Liabilities
Accounts
Notes
Payable Payable
$
=
-
$
-
$
20,000
+
Equity
Common
Stock
$ 20,000
$ 20,000
1-47
P1
Transaction Analysis
Purchased supplies paying $1,000 cash.
Assets
=
Cash
Supplies Equipment
(1) $ 20,000
(2)
(1,000) $ 1,000
$ 19,000 $ 1,000 $
$ 20,000
-
Liabilities
Accounts
Notes
Payable Payable
$
=
-
$
-
$
20,000
+
Equity
Common
Stock
$ 20,000
$ 20,000
1-48
P1
Transaction Analysis
Purchased equipment for $15,000 cash.
Assets
=
Cash
Supplies Equipment
(1) $ 20,000
(2)
(1,000) $ 1,000
(3)
(15,000)
$ 15,000
$
4,000 $ 1,000 $
$ 20,000
15,000
Liabilities
Accounts
Notes
Payable Payable
$
=
-
$
-
$
20,000
+
Equity
Common
Stock
$ 20,000
$ 20,000
1-49
P1
Transaction Analysis
Purchased Supplies of $200 and
Equipment of $1,000 on account.
Assets
=
Cash
Supplies Equipment
(1) $ 20,000
(2)
(1,000) $ 1,000
(3)
(15,000)
$ 15,000
(4)
200
1,000
$
4,000 $ 1,200 $
$ 21,200
Liabilities
Accounts
Notes
Payable Payable
+
Equity
Common
Stock
$ 20,000
$ 1,200
16,000
$ 1,200 $
=
$
-
$ 20,000
21,200
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P1
Transaction Analysis
Borrowed $4,000 from 1st American Bank.
Assets
=
Cash
Supplies Equipment
(1) $ 20,000
(2)
(1,000) $ 1,000
(3)
(15,000)
$ 15,000
(4)
200
1,000
(5)
4,000
$ 8,000 $ 1,200 $ 16,000
$ 25,200
Liabilities
Accounts
Notes
Payable Payable
+
Equity
Common
Stock
$ 20,000
$ 1,200
=
$
$ 1,200 $
4,000
4,000
$
25,200
$ 20,000
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P1
Transaction Analysis
The balances so far appear below. Note that the
Balance Sheet Equation is still in balance.
Assets
=
Cash
Supplies Equipment
Bal. $ 8,000 $ 1,200 $ 16,000
$ 8,000 $
1,200 $
$ 25,200
16,000
=
Liabilities
+
Equity
Accounts Notes
Payable Payable
$ 1,200 $ 4,000
Common
Stock
$ 20,000
$
$ 20,000
1,200 $
4,000
$ 25,200
1-52
P1
Transaction Analysis
Now, let’s look at transactions
involving revenue, expenses and
dividends.
1-53
P1
Transaction Analysis
Provided consulting services receiving
$3,000 cash.
Assets
=
Cash
Supplies Equipment
Bal. $ 8,000 $ 1,200 $ 16,000
(6)
3,000
$ 11,000 $
1,200 $
$ 28,200
16,000
=
Liabilities
+
Equity
Accounts Notes
Payable Payable
$ 1,200 $ 4,000
Common
Stock
Revenue
$ 20,000
$ 3,000
$ 1,200 $ 4,000
$ 20,000 $ 3,000
$ 28,200
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P1
Transaction Analysis
Paid salaries of $800 to employees.
Assets
=
Cash
Supplies Equipment
Bal. $ 8,000 $ 1,200 $ 16,000
(6)
3,000
(7)
(800)
$ 10,200 $
1,200 $
$ 27,400
16,000
=
Liabilities
+
Equity
Accounts Notes
Payable Payable
$ 1,200 $ 4,000
Common
Stock
Revenue Expenses
$ 20,000
$ 3,000
$
(800)
$ 1,200 $
$ 20,000 $ 3,000 $
4,000
(800)
$ 27,400
Remember that expenses decrease equity.
1-55
P1
Transaction Analysis
Dividends of $500 are paid to shareholders.
Assets
=
Accounts Notes
Payable Payable
$ 1,200 $ 4,000
Cash
Supplies Equipment
Bal. $ 8,000 $ 1,200 $ 16,000
(6)
3,000
(7)
(800)
(8)
(500)
$ 9,700 $ 1,200 $ 16,000
$ 26,900
Liabilities
$ 1,200 $
=
4,000
+
Equity
Common
Stock
Dividends Revenue Expenses
$ 20,000
$ 3,000
$
(800)
$
(500)
$ 20,000 $
(500) $ 3,000 $
(800)
$ 26,900
Remember that dividends decrease equity.
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P2
Financial Statements
Let’s prepare the Financial Statements
reflecting the transactions we have
recorded.
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows
1-57
P2
Income Statement
Scott Company
Income Statement
For Month Ended December 31, 2011
Revenues:
Consulting revenue
Expenses:
Salaries expense
Net income
$
3,000
$
800
2,200
Net income is the
difference
between
Revenues and
Expenses.
The income statement describes a
company’s revenues and expenses along
with the resulting net income or loss over a
period of time due to earnings activities.
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P2
Statement of Retained Earnings
Scott Company
Income Statement
For Month Ended December 31, 2011
Revenues:
Consulting revenue
Expenses:
Salaries expense
Net income
$
3,000
$
800
2,200
The net income of
$2,200 increases
Retained Earnings by
$2,200.
Scott Company
Statement of Retained Earnings
For Month Ended December 31, 2011
Retained Earnings, Dec. 1, 2011 $
Plus: Net income
Less: Dividends
Retained Earnings, Dec. 31, 2011 $
2,200
500
1,700
1-59
P2
Balance Sheet
The Balance Sheet describes
a company’s financial position
at a point in time.
Scott Company
Balance Sheet
December 31, 2011
Assets
$
Cash
Supplies
Equipment
Total assets
$
9,700
1,200
16,000
26,900
Scott Company
Statement of Retained Earnings
For Month Ended December 31, 2011
Retained Earnings, Dec. 1, 2011
Plus: Net income
Less: Dividends
Retained Earnings, Dec. 31, 2011
Liabilities
Accounts payable
Notes payable
Total liabilities
Equity
Common stock
Retained earnings
Total liabilities and equity
$
$
$
2,200
500
1,700
1,200
4,000
5,200
20,000
1,700
$
26,900
1-60
P2
Statement of Cash Flows
Scott Company
Statement of Cash Flows
For Month Ended December 31, 2011
Cash flows from operating activities:
Cash received from clients
$ 3,000
Purchase of supplies
(1,000)
Cash paid to employees
(800)
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of equipment
(15,000)
Net cash used in investing activities
Cash flows from financing activities:
Investment by Shareholders
20,000
Borrowed at bank
4,000
Dividends Paid
(500)
Net cash provided by financing activities
Net increase in cash
Cash balance, December 1, 2011
Cash balance, December 31, 2011
$
1,200
(15,000)
$
$
23,500
9,700
9,700
1-61
A2
Return on Assets (ROA)
Return
on
assets
Net income
=
Average total assets
ROA is a profitability
measure.
1-62
STORYTELLING


Group Activity
Apply the concepts learned in a story
(any language).




Need for Accounting
Why study accounting
Definition of accounting
Cycle of Accounting
Present the story after 30 minutes.
End of Chapter 01
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