Financial Accounting
Needles, Powers & Crosson
Financial & Managerial
Accounting
2002e
Presented by:
Gayle M. Richardson
CPA, Professor
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1-1
Chapter 1
Uses of Accounting Information and
the Financial Statements
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1-2
LEARNING OBJECTIVES
1. Define accounting, identify business goals and
activities, and describe the role of accounting in
making informed decisions.
2. Identify the many users of accounting information in
society.
3. Explain the importance of business transactions,
money measure, and separate entity to accounting
measurement.
4. Describe the corporate form of business organization.
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1-3
LEARNING OBJECTIVES
(continued)
5. Define financial position, state the accounting equation,
and show how they are affected by simple transactions.
6. Identify the four basic financial statements.
7. State the relationship of generally accepted accounting
principles (GAAP) to financial statements and the
independent CPA’s report, and identify the organizations
that influence GAAP.
8. Define ethics and describe the ethical responsibilities of
accountants.
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1-4
Accounting as an Information System
OBJECTIVE 1
Define accounting, identify business goals
and activities, and describe the role of
accounting in making informed decisions.
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1-5
 Today’s
accountant focuses on the ultimate
needs of decision makers who use accounting
information, whether those decision makers
are inside or outside the business.
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1-6
 Today’s
accountant focuses on the ultimate
needs of decision makers who use accounting
information, whether those decision makers
are inside or outside the business.
 Accounting “is not an end in itself,” but is an
information system that measures, processes,
and communicates financial information about
an identifiable economic entity.
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1-7
Accounting
provides a vital service by
supplying the information decision
makers need to make reasoned choices
among alternative uses of scarce
resources in the conduct of business and
economic activities.
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Accounting
is a link between business
activities and decision makers.
 Accounting
measures business activities by
recording data about them for future use.
 The data are stored until needed and then
processed to become useful information.
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 The
information is
communicated, through
reports, to decision
makers.
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 The
information is
communicated, through
reports, to decision
makers.
 Data about business
activities are the input to
the accounting system
and useful information
for decision makers is the
output.
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1-11
Accounting as an Information System
1 -1
B U S IN E S S
A C T IV IT IE S
D E C IS IO N
M AKERS
D a ta
In f o r m a t io n
A C C O U N T IN G
M EASUREM ENT
A c c o m p lis h e d
b y r e c o r d in g o f
d a ta
P R O C E S S IN G
A c c o m p lis h e d
b y s to ra g e a n d
p r e p a r a tio n o f
d a ta
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C o m m u n ic a tio n
A c c o m p lis h e d
b y r e p o r t in g
1-12
Accounting as an Information System
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1-13
Business Goals, Activities, and
Performance Measures
 A business
is an economic unit that aims to sell
goods and services to customers at prices that
will provide an adequate return to its owners.
 Businesses, though diverse, have similar goals
and engage in similar activities.
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Business Goals
1. Profitability.
A business must take in enough money
to pay all the costs of doing business, with
enough left over as profit for the owners
to want to stay in business.
2. Liquidity.
A business must have enough funds
available to pay debts when they are due.
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Business Goals and Activities
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Business Activities
1. Financing Activities.
Obtaining capital from owners and creditors.
Repaying creditors and a return to owners.
2. Investing Activities.
Spending the capital it receives in ways that are
productive and will help the business achieve its
objectives.
Buying and selling assets to be used in the business.




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Business Activities (continued)
3. Operating Activities.
Selling of goods and services to customers.
Employing managers and workers, buying and
producing goods and services, and paying taxes.


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Performance Measures
 Indicate
whether or not managers are achieving the
business goals and if they are managing business
activities well.
 Performance measures include:
Earned income.
 Cash flow.
 Ratio of expenses to revenues.
 Ratio of money owed to total resources controlled.

 Managers
should understand these measures.
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Performance Measures
Performance measures must align with business goals:
Performance Measure
Earned income.
Goal
Profitability.
Cash flow.
Liquidity.
Ratio of expenses to revenues.
Operating performance
level.
Financing performance
level.
Ratio of money owed to total resources
controlled.
Managers should understand and be motivated by these
measures.
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1-20
Financial and Management
Accounting
 Accounting’s
role of assisting decision makers by
measuring, processing, and communicating
information is usually divided into two categories:
1. Management accounting.
2. Financial accounting.
 The two may be distinguished by the principal users
of their information.
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Management Accounting
 Is
oriented toward the needs of internal
decision makers.
 Provides managers and employees with
information regarding how they have
done in the past and what they can expect
in the future.
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Financial Accounting
 Is
oriented toward the needs of external decision
makers.
 Provides information in the form of financial
statements so that external decision makers can
evaluate how well the business has achieved its
goals.
 Financial statements report directly on the goals of
profitability and liquidity.

Financial statements are used extensively both inside and
outside a business to evaluate the business’s success.
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Processing Accounting Information

Accounting versus bookkeeping
 Bookkeeping is the mechanical and repetitive
process of recording financial transactions and
keeping financial records.
 Bookkeeping is a small part of accounting.
 Accounting includes the design of an information
system that meets user’s needs.
 Accounting goals are the analysis, interpretation,
and use of information.
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 Computers
are used extensively in accounting as a
tool for the accountant.
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 Computers
are used extensively in accounting as a
tool for the accountant.
 A business’s many information needs are organized
into a Management Information System (MIS).
 An MIS consists of various interconnected
subsystems.
 The Accounting Information System (AIS) is the
most important subsystem.
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1-26
Discussion
Q.
What is the difference between profitability
and liquidity?
A.
 Profitability
means earning enough income to attract
and hold investment capital.
 Liquidity means being able to pay debts when they fall
due.
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1-27
Decision Makers: The Users of
Accounting Information
OBJECTIVE 2
Identify the many users of accounting
information in society.
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1-28
The Users of Accounting Information
The Users of Accounting Information
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Decision Makers
 The
people who use accounting information to
make decisions fall into three categories.
1. Management.
2. Outside users with a direct financial interest.
3. People, organizations, and agencies with an
indirect financial interest.
 These
categories apply both to profit-oriented
ventures as well as government and not-for-profit
organizations.
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Management
 Requires
financial information to carry out its
basic functions.
1. Financing the business.
2. Investing the resources of the business.
3. Producing goods and services.
4. Marketing goods and services.
5. Managing employees.
6. Providing information to decision makers.
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Outside Users with
a Direct Financial Interest
Investors
Creditors
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People, Organizations, and Agencies with
an Indirect Financial Interest
Tax Authorities.
 Regulatory Agencies.
 Labor Unions.
 Customers &
Consumer Groups.
 Investment Advisors
 The Financial Media


Economic Planners.
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1-33
Discussion
Q. Which decision makers use accounting
information?
A. Three groups of decision makers use
accounting information.
1. Those who manage a business.
2. Those outside a business enterprise who have a
direct financial interest in the business.
3. Those people, organizations, and agencies that
have an indirect financial interest in the business.
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1-34
Accounting Measurement
OBJECTIVE 3
Explain the importance of business
transactions, money measure, and
separate entity to accounting
measurement.
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1-35
Four Basic Questions
1.What is measured?
2.When should the measurement be
made?
3.What value should be placed on what is
measured?
4.How should what is measured be
classified?
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1-36
What Is Measured?
 Business
transactions as the object of measurement.
 Business transactions are economic events that effect
the financial position of a business entity.
Transactions are the raw material of accounting reports.
 Transactions must relate directly to a business entity.

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 Money
Measure.
Money is the only factor common to all business
transactions.
 The monetary unit a business uses depends on the
country in which the business resides.
 Exchange rates translate one currency to another.

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1-38
 Money
Measure.
Money is the only factor common to all business
transactions.
 The monetary unit a business uses depends on the
country in which the business resides.
 Exchange rates translate one currency to another.

 The

Concept of Separate Entity.
A business is a separate entity, distinct from its creditors
and customers and from its owner or owners.
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1-39
Discussion
Q. Tell whether each of the following words or phrases
relates most closely to a: (a) business transaction, (b)
separate entity, or (c) money measure.
1. Partnership
2. U.S. dollar
3. Payment of an expense
4. Corporation
5. Sale of an asset
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1-40
A.
1. Partnership: (b)
2. U.S. dollar: (c)
KEY
(a) business
transaction
(b) separate
entity
(c) money
measure
3. Payment of an expense: (a)
4. Corporation: (b)
5. Sale of an asset: (a)
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1-41
OBJECTIVE 4
Describe the corporate form of business
organization.
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Types of Business Organization
Sole
Proprietorship.
Partnership.
Corporation.
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Sole Proprietorships
• Owned by one person.
• Records should be kept separate from
owner’s personal interests.
• Legally same economic unit as owner.
• Unlimited liability.
• Ends when owner wants it to, or owner
dies.
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1-44
Partnerships
•
•
•
•
•
More than one owner.
Unincorporated association, not
legally separate from owners.
Unlimited liability.
Mutual agency, any partner can bind
all partners to a contract .
Ends when ownership changes, e.g
partner leaves or dies.
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1-45
Corporations
•
•
•
•
•
One or more owners (stockholders.)
Legally separate entity from owners.
Owners can be separate from managers.
Limited liability.
Unlimited life.
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1-46
Number and Receipts of U.S. Proprietorships, Partnerships,
and Corporations, 1997
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The Corporate Form of Business
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Organization of a Corporation
• To form a corporation, articles of incorporation
must be filed with and approved by the state.
Stockholders are the owners of the corporation.
The Board of Directors is elected by the stockholders
to set policies and choose officers.
Management consists of operating officers who carry
out the policies and run day-to-day operations.
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1-49
Discussion
Q. How do sole proprietorships, partnerships, and
corporations differ?
A.



A sole proprietorship is a business owned by one individual.
A partnership is similar in most respects to a proprietorship except
that more than one owner is involved.
A corporation is an economic unit that is legally separate from its
owners.
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1-50
Financial Position and the
Accounting Equation
OBJECTIVE 5
Define financial position,
state the accounting equation, and
show how they are affected by
simple transactions.
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1-51
Financial Position
Assets = Liabilities + Owner’s Equity
A =
L + OE
THE ACCOUNTING EQUATION!!
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1-52
Assets
 Assets
are economic resources owned by a
business that are expected to benefit future
operations.
 Monetary items.
 Nonmonetary physical things.
 Nonphysical items
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1-53
Liabilities
 Liabilities
are the present obligations of a
business to pay cash, transfer assets, or provide
services to other entities in the future.
 Liabilities are debts recognized by law.
Creditors must be paid before stockholders.
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1-54
Owner’s Equity
 Owner’s
equity represents the claims by the owners of
a business to the assets of the business.
 Owner’s equity is the residual equity that remains
after deducting liabilities from assets.
 OE = Assets - Liabilities.
 Assets = Liabilities + OE
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Contributed Capital
• The amount invested in the
business by stockholders
• Typically, it comprises par value
stock and additional paid-in-capital
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Retained Earnings
• Equity generated from the income-producing
activities and kept for use in the business.
Revenues and Expenses
• Increases and decreases in equity that result
from operating a business
Dividends
• Distributions to stockholders of assets
(usually cash) generated by past earnings.
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1-57
Three Types of Transactions That
Affect Retained Earnings
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1-58
Net Income / Loss
Revenues > Expenses
Net Income
Revenues < Expenses
Net Loss
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Some Illustrative Transactions
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The owner invests $50,000
ASSETS
Cash
Beg. Bal.
T1.
End. Bal.
OE
Capital
$
0
50,000
$50,000
$
0
50,000
$50,000
Assets = $50,000; L+OE = $50,000
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1-61
T2 - Purchases land and Building
for $35,000
Beg. Bal.
T2.
End. Bal.
Cash
$50,000
-35,000
$15,000
ASSETS
Land
$
0
+10,000
$10,000
Bldg.
$
0
+25,000
$25,000
Assets = $50,000; L+OE = $50,000
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1-62
T3. Purchase of Supplies on account
Beg. Bal.
T3.
End. Bal.
ASSETS
Supplies
$ 0
+500
$500
LIABILITIES
A/P
$ 0
+500
$500
Assets = $50,500; L+OE= $50,500
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1-63
T4. Payment of a Liability
with Cash
Beg. Bal.
T4.
End. Bal.
ASSETS LIABILITIES
Cash
A/P
$15,000
$500
200
-200
$14,800
$300
Assets = $50,300; L+OE = $50,300
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1-64
T5. Revenues Earned - Commission That
Was Paid in Cash
Beg. Bal
T5.
End. Bal.
ASSETS
Cash
$14,800
+ 1,500
$16,300
SE
R/E
$
0
+1,500
$1,500
Assets = $51,800; L+OE = $51,800
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1-65
T6. Revenues Earned -Commission with
Deferred Receipt
Beg. Bal
T6.
End. Bal.
ASSETS
A/R
$
0
+2,000
$2,000
OE
$1,500
+2,000
$3,500
Assets = $53,800; L+SE = $53,800
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1-66
T7. Collection of Accounts
Receivable
Beg. Bal.
T7.
End. Bal.
ASSETS
Cash
A/R
$16,300
$2,000
+ 1,000
- 1,000
$17,300
$1,000
Assets = $53,800; L+SE = $53,800
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1-67
T8. Paid Equipment Rental Expense
T9. Paid Wages Expense with Cash
Beg. Bal
T8.
T9.
End. Bal.
ASSETS
Cash
$ 17,300
- 1,000
400
$15,900
OE
$3,500
-1,000
- 400
$2,100
Assets = $52,400; L+SE = $52,400
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1-68
T10. Paid Utility Expense Incurring a
Current Liability
Beg. Bal.
T10.
End. Bal.
A/P
$300
+300
$600
O/E
$2,100
- 300
$1,800
Assets = $52,400; L+OE = $52,400
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1-69
T11. Paid Dividends with Cash
Beg. Bal
T11.
End. Bal.
ASSETS
Cash
$15,900
- 600
$15,300
OE
$1,800
- 600
$1,200
Assets = $51,800; L+OE = $51,800
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1-70
Discussion
Q. Define financial position.
A. Financial position refers to the economic
resources that belong to a company and the
claims against those resources at a point in
time.
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1-71
Communication Through Financial
Statements
OBJECTIVE 6
Identify the four financial statements.
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1-72
The Importance of
Financial Statements
Financial statements are the primary means of
communicating important accounting
information to users.
 Financial statements represent models of the
business enterprise because they show the
business in financial terms.
 Financial statements are not perfect pictures of
the real thing.

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1-73
The Income Statement
 Summarizes
revenues earned expenses
incurred over a period of time.
 Is considered by many to be the most
important financial report because it shows
whether or not a business achieved its
profitability goal of earning an acceptable
income.
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1-74
[Entity] Shannon Realty
[Title] Income Statement
[Period] For the Month Ended December 31, 19xx
Revenues
Commissions Earned
Expenses
Equipment Rental
$1,000
Wages
400
Utilities
300
Total Expenses
Trace to Statement of
Net Income
Compare with page 25 in Owner’s Equity
text - this is for a
proprietorship
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$3,500
$1,700
$1,800
1-75
The Statement of Owner’s Equity
Shows
the changes in owner’s
equity over a period of time.
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1-76
Shannon Realty
Statement of Owner’s Equity
For the Month Ended December 31, 19xx
Owner’s Equity, Beginning
Net Income for the Month
Subtotal
Less Withdrawals
Owner’s Equity, Ending
$
0
1,800
$ 1,800
600
$ 1,200
Trace to Owners’ Equity
Section of Balance Sheet
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The Balance Sheet
 Shows
financial position at a point in time.
 Is often called the statement of financial position.
 Presents a view of the business as the holder of
resources, or assets, that are equal to the claims
against those assets.
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1-78
Shannon Realty
Balance Sheet
As of December 31, 19xx
ASSETS
Cash
A/R
Supplies
Land
Building
Total Assets
$15,300
1,000
500
10,000
25,000
$51,800
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1-79
Shannon Realty
Balance Sheet
As of December 31, 19xx
LIABILITIES
A/P
$ 600
OWNER’S EQUITY
Capital, Shannon
$51,200
Total OE
Total Liabilities and SE
51,200
$51,800
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1-80
The Statement of Cash Flows
 Focuses
on a company’s liquidity goal.
 Shows cash produced by operating a business as
well as important financing and investing
transactions that take place during an accounting
period.
 Is derived from the income statement and balance
sheet.
 Is directly related to the other three statements.
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1-81
Shannon Realty
Statement of Cash Flows
For the Month Ended December 31, 19xx
Cash Flows from Operating Activities
Net Income
Noncash Expenses and Revenues
Included in Income
Increase in A/R
$(1,000)
Increase in Supplies
(500)
Increase in A/P
600
Net Cash Flows from
Operating Activities
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$1,800
(900)
$900
1-82
Shannon Realty
Statement of Cash Flows
For the Month Ended December 31, 19xx
Cash Flows from Investing Activities
Purchase of Land
($10,000)
Purchase of Building
(25,000)
Net Cash Flows from Investing
Activities
(35,000)
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1-83
Shannon Realty
Statement of Cash Flows
For the Month Ended December 31, 19xx
Cash Flows from Financing Activities
Investments by Owner
$50,000
Withdrawals by Owner
(600)
Net Cash Flows from
Financing Activities
Net Increase (Decrease) in Cash
Cash at Beginning of Month
Cash at End of Month
49,400
$15,300
0
$15,300
Trace to Balance Sheet
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1-84
Contributed Capital
• The amount invested in the
business by stockholders
• Typically, it comprises par value
stock and additional paid-in-capital
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Retained Earnings
• Equity generated from the income-producing
activities and kept for use in the business.
Revenues and Expenses
• Increases and decreases in equity that result
from operating a business
Dividends
• Distributions to stockholders of assets
(usually cash) generated by past earnings.
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Three Types of Transactions That
Affect Retained Earnings
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Net Income / Loss
Revenues > Expenses
Net Income
Revenues < Expenses
Net Loss
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If Shannon Realty had been a
corporation
the following slides show the
financial statements. See if you can
notice the differences
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The name includes Inc.
which is an abbreviation
Shannon Realty, Inc.
for Incorporated
Income Statement
For the Month Ended December 31, 20xx
Revenues
Commissions Earned
Expenses
Equipment Rental Expense
Wages Expense
Utilities Expense
Total Expenses
Net Income
$3,500
$1,000
400
300
$1,700
$1,800
There is no difference. However, if there had
been income taxes it would have been shown
on this statement. A corporation pays taxes
a proprietorship does not, the income is included
with all other income of the proprietor.
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The Statement of Retained Earnings
• Shows the change in the owners’
capital over a period of time.
A proprietorship does
not have this statement.
The Statement of
Owner’s Equity serves
the same purpose.
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Shannon Realty, Inc.
Statement of Retained Earnings
For the Month Ended December 31, 20xx
Retained Earnings, 12/1/xx
Net Income for the Month
Subtotal
Less Dividends
Retained Earnings, 12/31/xx
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$
$
$
0
1,800
1,800
600
1,200
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Shannon Realty, Inc.
Balance Sheet
December 31, 20xx
Assets
Cash
Accounts Receivable
Supplies
Land
Building
Total Assets
$15,300
1,000
500
10,000
25,000
$51,800
The Stockholders are the owners The
Common Stock account represents
what they paid the corporation for
their stock --- investment by owner.
Retained earnings represents Net
Income (Loss) since incorporating less
all dividends since incorporating.
Liabilities
Accounts Payable
$600
Stockholders’ Equity
Common Stock
Retained Earnings
Total Stockholders’
Equity
Total Liabilities and
Stockholders’ Equity
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$50,000
1,200
51,200
$51,800
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Shannon Realty, Inc.
Statement of Cash Flows
For the Month Ended December 31, 20xx
Cash Flows from Operating Activities
Net Income
Noncash Expenses and Revenues
Included in Income
Increase in Accounts Receivable
Increase in Supplies
Increase in Accounts Payable
Net Cash Flows from
Operating Activities
$1,800
$(1,000)
(500)
600
The Cash Flow Statement
is the same!
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(900)
$900
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Shannon Realty, Inc.
Statement of Cash Flows
For the Month Ended December 31, 20xx
(continued…)
Cash Flows from Investing Activities
Purchase of Land
Purchase of Building
Net Cash Flows from Investing
Activities
($10,000)
(25,000)
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(35,000)
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Shannon Realty, Inc.
Statement of Cash Flows
For the Month Ended December 31, 20xx
(continued…)
Cash Flows from Financing Activities
Investments by
Dividends
Stockholders
$50,000
(600)
Net Cash Flows from
Financing Activities
Net Increase (Decrease) in Cash
Cash at Beginning of Month
Cash at End of Month
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49,400
$15,300
0
$15,300
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Discussion
Q. Why is the balance sheet sometimes called the
statement of financial position?
A. Financial position consists of the economic
resources that belong to a business and the
claims against those resources as of a certain
date. This is the information shown on the
balance sheet.
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Generally Accepted
Accounting Principles
OBJECTIVE 7
State the relationship of generally
accepted accounting principles
(GAAP) to financial statements and
the independent CPA’s report, and
identify the organizations that
influence GAAP.
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Generally Accepted
Accounting Principles (GAAP)
 Focus
on understandability of financial
statements.
 Encompass the conventions, rules, and
procedures necessary to define accepted
accounting practice at a particular time.
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Financial Statements, GAAP, and
the Independent CPA’s Report
 Financial
statements are prepared by management
and may be biased.
 Financial statements are audited by independent
CPAs.
 An audit ascertains that the financial statements
have been prepared in accordance with GAAP.
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Organizations that Influence
Current Practice
FASB.
AICPA.
GASB.
IASC.
IRS.
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Discussion
Q. What are GAAP?
A. GAAP are generally accepted accounting
principles; they are the “conventions, rules,
and procedures necessary to define accepted
accounting practice at a particular time.”
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Discussion
Q. Why are GAAP important to readers of
financial statements?
A. GAAP ensure that the financial statements
will be understandable to their users.
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Professional Ethics and the
Accounting Profession
OBJECTIVE 8
Define ethics and describe the ethical
responsibilities of accountants.
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What Are Professional Ethics?
 A code
of conduct that applies to the practice
of a profession.
 Code of conduct adopted by the AICPA and
each state.
 Responsibility
to the public.
 Integrity.
 Objectivity.
 Independence.
 Due
care.
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The Institute of Management
Accountants (IMA) Code of Professional
Conduct
 Competency.
 Confidentiality.
 Integrity.
 Avoidance
of conflicts of interest.
 Communication of information
objectively and without bias.
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Discussion
Q. Discuss the importance of professional ethics in
the accounting profession.
A. Professional ethics forms a code of conduct that
applies to the practice of a profession. As
members of a profession, accountants have a
responsibility, not only to their employers and
clients but also to society as a whole, to uphold
the highest ethical standards.
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OK, LET’S REVIEW . . .
1. Define accounting, identify business goals and
activities, and describe the role of accounting in
making informed decisions.
2. Identify the many users of accounting information
in society.
3. Explain the importance of business transactions,
money measure, and separate entity to accounting
measurement.
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CONTINUING OUR
REVIEW . . .
4. Identify the three basic forms of business
organization.
5. Define financial position, state the accounting
equation, and show how they are affected by
simple transactions.
6. Identify the four basic financial statements.
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AND FINALLY . . .
7. State the relationship of generally accepted
accounting principles (GAAP) to financial
statements and the independent CPA’s report,
and identify the organizations that influence
GAAP.
8. Define ethics and describe the ethical
responsibilities of accountants.
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