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Chapter 1
A Framework for Financial Accounting
INSTRUCTOR’S MANUAL
Learning Objectives
 LO1-1 Describe the two primary functions of financial accounting.
 LO1-2 Understand the business activities that financial accounting measures.
 LO1-3 Determine how financial accounting information is communicated through financial
statements.
 LO1-4 Describe the role that financial accounting plays in the decision-making process.
 LO1-5 Explain the term generally accepted accounting principles (GAAP) and describe the
role of GAAP in financial accounting.
 LO1-6 Identify career opportunities in accounting.
Appendix
 LO1-7 Explain the nature of the conceptual framework used to develop generally accepted
accounting principles.
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Teaching Suggestions
This chapter introduces students to the concept that accounting is not a math course; it’s the
language of business. For Part A, emphasis should be placed on the two functions of accounting:
measurement and communication of business activities. These concepts are reinforced by
describing the business activities of a start-up company, and then discussing the measurements
that various decision makers need. Financial statements are presented for a fictitious company
that will be used in Chapters 1 to 4. The importance of accounting to decision makers, and its
importance to our society, is discussed. This emphasis is used to help students better understand
the role of accounting and motivate their interest in the course.
In Part B, the background of accounting standards and the historical perspective is provided.
The role of the auditor in adding credibility to financial information naturally leads to a
discussion of the ethical issues surrounding financial reporting.
Part C ends the main text with a discussion of careers in accounting. Again, this is used to be
both informative and motivational. This section emphasizes the broad range of job opportunities
available to those earning a degree in accounting, perhaps dispelling the traditional view of
accountants. It also discusses the strong demand for accounting majors.
For those interested, the conceptual framework is discussed in the appendix. The instructor
can cover the conceptual framework in this chapter and then refer back to it as topics in
subsequent chapters are covered. Alternatively, the instructor may wish to cover the conceptual
framework in conjunction with another chapter, such as Chapter 12, Financial Statement
Analysis.
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Assignment Charts
1
2
3
4
5
6
7
8
9
10
11
Learning
Objective(s)
LO1-1
LO1-1
LO1-1
LO1-1
LO1-2
LO1-2
LO1-2
LO1-2
LO1-2
LO1-2
LO1-2
12
13
14
15
16
17
LO1-3
LO1-3
LO1-3
LO1-3
LO1-3
LO1-3
18
19
LO1-3
LO1-3
20
21
22
23
24
25
26
27
28
29
LO1-4
LO1-5
LO1-5
LO1-5
LO1-5
LO1-5
LO1-5
LO1-6
LO1-7
LO1-7
30
31
LO1-7
LO1-7
Questions
Topic
Define accounting
Identify decision makers
Define financial accounting
Determine the functions of accounting
Classify business activities
Determine financing activities
Determine investing activities
Determine operating activities
Distinguish legal forms of business
Define account types
Name advantages and disadvantages of the legal
forms of business
Describe basic financial statements
Understand financial reporting period
Identify revenues and expenses
Understand the accounting equation
Identify assets and liabilities
Understand the link between the income statement
and balance sheet
Identify cash flows
Explain other forms of financial accounting
information
Explain the role of accounting in society
Define GAAP
Describe the role of the FASB
Compare U.S. GAAP and IFRS
Under the historical role of the securities acts
Describe the role of the auditor
List the three objectives of financial reporting
Understand benefits of an accounting degree
Discuss relevance and faithful representation
Identify the components of relevance and faithful
representation
Describe cost effectiveness
Define the four basic assumption underlying GAAP
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Time
(Min.)
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
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Brief
Exercises
BE1-1
BE1-2
BE1-3
Learning
Objective(s)
LO1-1
LO1-2
LO1-2
BE1-4
BE1-5
BE1-6
BE1-7
BE1-8
LO1-2
LO1-2
LO1-2
LO1-3
LO1-3
BE1-9
LO1-5
BE1-10
BE1-11
BE1-12
BE1-13
LO1-5
LO1-6
LO1-7
LO1-7
E1-1
E1-2
Learning
Objective(s)
LO1-2
LO1-2
E1-3
LO1-2
E1-4
E1-5
E1-6
E1-7
E1-8
E1-9
E1-10
LO1-2
LO1-2
LO1-3
LO1-3
LO1-3
LO1-3
LO1-3
E1-11
LO1-3
E1-12
LO1-3
E1-13
E1-14
E1-15
LO1-3
LO1-3
LO1-3
Exercises
Topic
Define accounting
Identify the different types of business activities
Identify the different forms of business
organizations
Recognize the different account classifications
Assign account classifications
Assign account classifications
Describe each financial statement
Determine the location of items in financial
statements
Identify different groups engaged in providing highquality financial reporting
Identify the objectives of financial accounting
Identify careers for accounting majors
Identify the components/aspects of relevance
Identify the components/aspects of faithful
representation
Topic
Identify the different types of business activities
Identify account classifications and business
activities
Identify account classifications and business
activities
Calculate net income and stockholders’ equity
Calculate net loss and stockholders’ equity
Prepare an income statement
Prepare a statement of stockholders’ equity
Prepare a balance sheet
Prepare a statement of cash flows
Link the income statement to the statement of
stockholders’ equity
Link the statement of stockholders’ equity to the
balance sheet
Link the balance sheet to the statement of cash
flows
Compute missing amounts from financial statements
Calculate the balance of retained earnings
Calculate amounts related to the balance of retained
earnings.
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Time
(Min.)
5
5
5
5
5
5
5
5
5
5
5
5
5
Time
(Min.)
5
5
5
10
10
5
10
5
10
15
15
15
10
5
10
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E1-16
LO1-3
E1-17
LO1-3
E1-18
E1-19
E1-20
LO1-5
LO1-7
LO1-7
Use the accounting equation to calculate amounts
related to the balance sheet
Calculate missing amounts related to the statement
of cash flows
Understand the role of the auditor
Identify the purpose of qualitative characteristics
Identify business assumptions underlying GAAP
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10
10
10
5
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P1-1A
P1-2A
P1-3A
P1-4A
Learning
Objective(s)
LO1-2
LO1-2
LO1-3
LO1-3
P1-5A
P1-6A
P1-7A
LO1-3
LO1-7
LO1-7
P1-1B
P1-2B
LO1-2
LO1-2
P1-3B
P1-4B
LO1-3
LO1-3
P1-5B
P1-6B
P1-7B
LO1-3
LO1-7
LO1-7
Problems
Additional
Perspectives
AP1-1
AP1-2
AP1-3
AP1-4
AP1-5
AP1-6
AP1-7
Topic
Classify business activities
Assign account classifications
Prepare financial statements
Understand the format of financial statements and
the link among them
Prepare financial statements
Identify underlying assumptions of GAAP
Understand the components of the FASB’s
conceptual framework
Classify accounts
Assign business transactions to account
classifications
Prepare financial statements
Understand the format of financial statements and
the link among them
Prepare financial statements
Identify underlying assumptions of GAAP
Understand the components of the FASB’s
conceptual framework
Topic
Continuing Problem: Great Adventures
Financial Analysis: American Eagle Outfitters, Inc.
Financial Analysis: The Buckle, Inc.
Comparative Analysis: American Eagle Outfitters, Inc., vs. The
Buckle, Inc.
Ethics
Internet Research
Written Communication
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Time
(Min.)
10
10
20
25
20
15
10
10
10
20
25
20
15
10
Time
(Min.)
20
15
15
20
20
30
25
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Chapter Quiz Questions
The following multiple-choice questions are 10 unique quiz questions that correspond to the 10
questions at the end of each chapter. Each question covers the same learning objective but with a
little different twist. The correct answer is highlighted in bold for each item.
LO1-1
1. Which of the following best describes financial accounting?
a. Artistic presentation.
b. Information measurement/communication process.
c. Mathematical procedure.
d. Behavioral psychology.
LO1-2
2. Which definition best describes financial accounting?
a. Process of measuring income taxes owed to the government.
b. System of maintaining communication with a company’s customers and suppliers.
c. Procedures designed to enhance the company’s image to potential investors.
d. Measuring a company’s business activities and communicating those measurements to
external parties.
LO1-2
3. Which of the following is a financing activity?
a. Paying utilities for the month.
b. Issuing common stock to investors.
c. Selling equipment for cash.
d. Purchasing office supplies.
LO1-2
4. Which of the following is an investing activity?
a. Purchasing land.
b. Paying dividends to stockholders.
c. Repaying amounts borrowed from the bank.
d. Purchasing advertising on a local radio station.
LO1-3
5. Which financial statement reports a company’s assets and liabilities?
a. Income statement.
b. Statement of cash flows.
c. Balance sheet.
d. Statement of stockholders’ equity.
LO1-3
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6. Which financial statement shows a company’s revenues and expenses?
a. Income statement.
b. Statement of stockholders’ equity.
c. Balance sheet.
d. Statement of cash flows.
LO1-4
7. Which of the following best describes an important function of financial accounting?
a. To increase the number of customers for a company.
b. To support the efficient distribution of society’s resources.
c. To provide managers with useful information related to human resources.
d. To support government initiatives through taxation of company profits.
LO1-5
8. Which body has the primary responsibility for the establishment of Generally Accepted
Accounting Principles?
a. American Institute of Certified Public Accountants (AICPA).
b. International Accounting Standards Board (IASB).
c. Securities and Exchange Commission (SEC).
d. Financial Accounting Standards Board (FASB).
LO1-5
9. Traditional careers in public accounting include:
a. Auditors.
b. Tax preparers/planners.
c. Business consultants.
d. All of the above.
LO1-7
10. A component/aspect of relevant accounting information includes:
a. Faithful representation.
b. Comparability.
c. Predictive value.
d. Consistency.
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Alternate Let’s Review
On December 31, Wortham Services reports the following year-end amounts.
Assets:
Cash
Accts. rec.
Buildings
$11,000
19,000
32,000
Revenues: Service
Expenses:
Liabilities: Salaries payable
Notes payable
5,000
20,000
$85,000
Advertising
Insurance
Salaries
12,000
18,000
44,000
Additional information:
a. The balance of retained earnings at the beginning of the year is $6,000.
b. The company pays dividends of $5,000 on December 31.
c. Common stock is $20,000 at the beginning of the year, and $5,000 of additional shares are
issued during the year.
Required:
Prepare the (1) income statement, (2) statement of stockholders’ equity, and (3) balance sheet.
Solution:
Wortham Services
Income Statement
Year ended Dec. 31
Service revenue
Less:
Adv. expense
Ins. expense
Salaries expense
Net Income
$85,000
(12,000)
(18,000)
(44,000)
$ 11,000
Wortham Services
Statement of Stockholders’ Equity
Year ended Dec. 31
Common Retained
Stock
Earnings
Beginning
$20,000
$ 6,000
New issuances
5,000
Net income
11,000
Less: Dividends
(5,000)
Ending
$25,000
$12,000
Wortham Services
Balance Sheet
December 31
Assets
Cash
Accts. rec.
Buildings
$11,000
19,000
32,000
Total assets
$62,000
Liabilities
Salaries payable
$ 5,000
Notes payable
20,000
Stockholders’ Equity
Common stock
25,000
Retained earnings
12,000
Total liabilities and equity
$62,000
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Key Points by Learning Objective
LO1-1 Describe the two primary functions of financial accounting.
The functions of financial accounting are to measure business activities of a company and to
communicate information about those activities to investors and creditors and other outside users
for decision-making purposes.
LO1-2 Understand the business activities that financial accounting measures.
The measurement role of accounting is to create a record of the activities of a company. To make
this possible, a company must maintain an accurate record of its assets, liabilities, stockholders’
equity, revenues, expenses, and dividends.
LO1-3 Determine how financial accounting information is communicated through financial
statements.
The income statement compares revenues and expenses for the current period to assess the
company’s ability to earn a profit from running its operations.
The statement of stockholders’ equity reports information related to changes in common stock
and retained earnings each period. The change in retained earnings equals net income less
dividends for the period.
The balance sheet demonstrates that the company’s resources (assets) equal creditors’ claims
(liabilities) plus owners’ claims (stockholders’ equity) to those resources on a particular date.
The statement of cash flows reports cash transactions from operating, investing, and financing
activities for the period.
All transactions that affect revenues or expenses reported in the income statement ultimately
affect the balance sheet through the balance in retained earnings.
LO1-4 Describe the role that financial accounting plays in the decision-making process.
Financial accounting serves an important role by providing information useful in investment and
lending decisions.
No single piece of company information better explains a company’s stock price performance
than financial accounting net income. A company’s debt level is an important indicator of
management’s ability to respond to business situations and the possibility of bankruptcy.
LO1-5 Explain the term generally accepted accounting principles (GAAP) and describe the
role of GAAP in financial accounting.
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The rules of financial accounting are called generally accepted accounting principles (GAAP).
The Financial Accounting Standards Board (FASB) is an independent, private body that has
primary responsibility for the establishment of GAAP in the United States.
The primary objective of financial accounting is to provide useful information to investors and
creditors in making decisions.
LO1-6 Identify career opportunities in accounting.
Because of the high demand for accounting graduates, the wide range of job opportunities, and
increasing salaries, this is a great time to obtain a degree in accounting.
Appendix
LO1-7 Explain the nature of the conceptual framework used to develop generally accepted
accounting principles.
The conceptual framework provides an underlying foundation for the development of accounting
standards and interpretation of accounting information.
To be useful for decision making, accounting information should have relevance and faithful
representation.
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Common Mistakes
Common Mistake
Dividends represent the payment of cash but are not considered an expense in
running the business. Students sometimes mistakenly include the amount of
dividends as an expense in the income statement, rather than as a distribution
of net income in the statement of stockholders’ equity.
Decision Points
Question
How can I tell if a
company is
profitable?
Accounting
Information
Income statement
Analysis & Decision
If revenues exceed expenses, a
company has net income and is
profitable.
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Career Corner
Career Corner
Over 20,000 employees join public accounting firms in entry-level jobs each
year, and thousands more go into other areas of accounting. While financial
accountants learn how to measure business transactions and prepare financial
reports, they also learn a great deal about the business itself. Because of this
widespread business knowledge, accountants often play a key role on the
management team. In fact, it should come as no surprise to learn that most
chief financial officers (CFOs) started their careers as accountants.
Accounting, because of its dynamic and professional nature, offers an
attractive career option. You can learn more about a career in accounting
by visiting the website of the American Institute of Certified Public
Accountants (www.aicpa.org). There, you can look under the Career
Development and Workplace Issues link to find current information about job
opportunities, salaries, work life for women, how to write a resume, how to
interview, and other general career advice. For salary and other job-related
information, consult the website of the U.S. Bureau of Labor Statistics
(www.bls.gov/oco/ocos001.htm) or go to careers-in-accounting.com. In
2010, entry-level jobs ranged between $50,000 and $70,000, with $55,000 as
the norm for Big-4 firms. Is an accounting degree right for you?
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Ethical Dilemma
Ethical Dilemma
You have been the manager of a local restaurant for the past five years. Because
of increased competition, you notice you’re getting fewer customers. Despite all
your attempts to attract new customers and cut costs, the restaurant’s
profitability continues to decline. The restaurant owner tells you that if this
year’s profit is lower than last year’s, you’ll lose your job.
When preparing financial statements at the end of the year, you notice that this
year’s profit is lower. You know that by purposely understating certain
expenses, you can falsely report higher profits to the owner for this year. That
will allow you to keep your job for at least one more year and look for a new
job in the meantime.
What should you do? What if you really believe the lower profitability is caused
by factors outside your control? Would this make the false reporting
acceptable?
Key Issues
 Reporting higher profit makes the restaurant’s operations seem more profitable, signaling
better managerial performance.
 Self-preservation (keeping your job) vs. honesty (accurate reporting).
 Managing expectations—justifying why performance is truly declining.
Option 1: Do not understate expenses
 The actions we take depict the type of person we are, not whom we hope to be. You may
believe other causes besides your performance drive the decline in performance, but that
should not be an excuse to lie and manipulate your boss.
 A strong likelihood exists that the understatement of expenses will eventually be detected
(by auditors, owner, employees, etc.).
 If caught, the ability to maintain employment with this restaurant or anywhere else will be
a challenge.
 The best defense of your job is to prepare the financial statements accurately, and present
a thorough analysis to the restaurant owner regarding what you see as the true cause of
the decline in performance. A proactive approach with possible solutions to the problem
would be well received by a competent owner.
Option 2: Understate expenses
 As the decline in performance is not your fault, you may decide that falsifying the
financial statements will allow you time to either explain to the owner why performance
has declined, or to look for another job.
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 It does not seem fair to be punished for things outside your control. You shouldn’t have to
lose your job just because the restaurant is not doing as well as it used to.
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