Chapter 1
Accounting as a Form of
Communication
Financial Accounting 4e by Porter and Norton
1
Decisions Made with
Financial Information
Invest??
Borrow $$??
Extend credit $$??
Start new business??
Add new
product line??
Build new plant??
Loan $$??
Sell stocks or bonds??
2
What is Accounting?
Identifying
Measuring
Economic
Information
to
various
users
Communicating
3
Internal and External
Users of Accounting Information
Banks
Current
and
Potential
Owners
Creditors
Internal
Users Management
Financial
Analysts
Suppliers
Trade
Organizations
Government
Agencies
4
1-14
The Accounting Equation
Basic Accounting Equation
Assets
= Liabilities + Stockholders’ Equity
Economic
resources =
Sources of financing . . .
Liabilities: from creditors
Equity: from stockholders.
5
The Accounting Equation
Assets =
Liabilities + Owners’ Equity
(or Stockholders' Equity)
Economic
Resources
=
Creditors'
Claims
to Assets
+
Owners'
Claims
to Assets
Examples:
Accounts payable
Cash
Accounts receivable Notes payable
Inventory
Capital stock
Retained earnings
6
1-13
The Balance Sheet
Body of the Statement
– Assets

Economic benefits owned by the business as a result of past
transactions.
– Liabilities


Debts or obligations of the business that result from past transactions.
Stockholders’ Equity

Amount of financing provided by owners of the business and
operations.
7
1. Name of entity
2. Title of statement
3. Specific date
4. Unit of measure
The
Balance
Sheet
reports the
financial
position of
an entity at
a particular
point in
time.
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2014
(in thousands of dollars)
Assets
Cash
Accounts receivable
Inventories
Plant and equipment
Land
Total assets
Liabilities and Stockholders' Equity
Liabilities
Accounts payable
Notes payable
Total liabilities
Stockholders' Equity
Contributed capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
$
$
4,895
5,714
8,517
7,154
981
27,261
$
16,156
$
11,105
27,261
7,156
9,000
2,000
9,105
8
Assets are
economic
resources
owned by the
business as a
result of past
transactions.
Assets are
listed by their
ease of
conversion into
cash.
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2014
(in thousands of dollars)
Assets
Cash
$
4,895
Accounts receivable
5,714
Inventories
8,517
Plant and equipment
7,154
Land
981
Total assets
$
27,261
of cash
in the company’s bank
Liabilities andAmount
Stockholders'
Equity
Cash
Liabilities
accounts.
Accounts
payable
$
7,156
Accounts
Amounts owed by customers
from prior
Notes
payable sales.
9,000
receivable
Total liabilities
Parts and completed but unsold $ 16,156
Inventories
Stockholders' Equity
products.
Contributed capital
$
2,000
Plant and
Retained
earnings
9,105
Factories and production machinery.
equipment
Total stockholders' equity
11,105
Land
on whichequity
factories are built.$ 27,261
TotalLand
liabilities and
stockholders'
9
1-15
Assets are
listed by their
ease of
conversion into
cash.
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2014
(In thousands of dollars)
Assets
Cash
$
4,895
Accounts receivable
5,714
Inventories
8,517
Plant and equipment
7,154
Land
981
Total assets
$
27,261
Amount of cash in the company’s bank
Liabilities
Cash and Stockholders' Equity
account.
Liabilities
Accounts
Amounts owed by customers
from prior
Accounts
payable
$
7,156
receivable
Notes
payable sales.
9,000
Partial and completed but unsold$ 16,156
Total liabilities
Inventories
product.Equity
Stockholders'
Plant andcapital
Contributed
$ machinery.
2,000
Factories and production
equipment
Retained
earnings
9,105
Total stockholders' equity
11,105
Land
Property on which factories are located.10
Total liabilities and stockholders' equity
$
27,261
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2014
(in thousands of dollars)
Assets
Liabilities are
debts or
obligations of
the business
that result from
past
transactions.
Cash
Accounts receivable
Inventories
Plant and equipment
Land
Total assets
Liabilities and Stockholders' Equity
Liabilities
Accounts payable
Notes payable
Total liabilities
Equity
Accounts Amounts owed toStockholders'
suppliers for
prior
Contributed capital
payable purchases.
Retained earnings
Notes
Amounts owed on written debt
Total stockholders' equity
payable contracts.
Total liabilities and stockholders' equity
$
$
$
$
4,895
5,714
8,517
7,154
981
27,261
$
16,156
$
11,105
27,261
11
7,156
9,000
2,000
9,105
1-16
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2014
(In thousands of dollars)
Assets
Cash
Accounts AmountsAccounts
owed toreceivable
suppliers for prior
Inventories
payable purchases.
and equipment
Notes
Amounts Plant
owed
on written debt
Land
payable contracts.
Total assets
Liabilities and Stockholders' Equity
Liabilities
Accounts payable
Notes payable
Total liabilities
Stockholders' Equity
Contributed capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
$
$
4,895
5,714
8,517
7,154
981
27,261
$
16,156
$
11,105
27,26112
7,156
9,000
2,000
9,105
Equity is the
amount of
financing
provided by
owners of the
business and
earnings.
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2014
(in thousands of dollars)
Assets
Cash
Accounts receivable
Inventories
Plant and equipment
Land
Total assets
Liabilities and Stockholders' Equity
Contributed Amounts invested in the
business by
Liabilities
capital
stockholders.
Accounts payable
Notesnot
payable
Retained Past earnings
distributed to
Total liabilities
earnings stockholders.
Stockholders' Equity
Contributed capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
$
$
4,895
5,714
8,517
7,154
981
27,261
$
16,156
$
11,105
27,261
13
7,156
9,000
2,000
9,105
1-17
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2014
(In thousands of dollars)
Assets
Cash
Accounts receivable
Inventories
Plant and equipment
Land
Total assets
Liabilities and Stockholders' Equity
Liabilities
Contributed Amounts invested in the
business by
Accounts payable
capital
stockholders.
Notes payable
Retained Past earnings
not distributed to
Total liabilities
earnings stockholders.
Stockholders' Equity
Contributed capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
$
$
4,895
5,714
8,517
7,154
981
27,261
$
16,156
$
11,105
27,261
14
7,156
9,000
2,000
9,105
1-18
Use $ on the
first item in a
group
and on the
group total.
Assets =
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2014
(In thousands of dollars)
Assets
Cash
Accounts receivable
Inventories
Plant and equipment
Land
Total assets
Liabilities and Stockholders' Equity
Liabilities
Accounts payable
$
Notes payable
LiabilitiesTotal
+ liabilities
Stockholders’ Equity
Stockholders' Equity
Contributed capital
$
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
4,895
5,714
8,517
7,154
981
27,261
$
16,156
$
11,105
15
27,261
7,156
9,000
2,000
9,105
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2014
(in thousands of dollars)
Revenues
1. Name
of entity
Sales
revenue
$37,436
2. Title of statement
Expenses
3. Specific date (Unlike the balance sheet, this
Cost
of goods sold
$26,980
statement covers a specified period of time.)
Selling, general and administrative
3,624
4. Unit of measure
Research and development
1,982
Interest expense
450
Total expenses
33,036
Pretax income
$ 4,400
Income tax expense
1,100
Net income
$ 3,300
16
1-20
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2014
(In thousands of dollars)
 Revenues
Sales revenue
 Expenses
Cost of goods sold
Selling, general and administrative
Research and development
Interest expense
Total expenses
Pretax income
Income tax expense
 Net income
$37,436
$26,980
3,624
1,982
450
33,036
$ 4,400
1,100
$ 3,300
17
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2014
(in thousands of dollars)
Revenues
Sales revenue
$37,436
Expenses are earnings from the sale of goods
Revenues
Cost of goods
sold
$26,980
or services
to customers.
Selling, general and administrative
3,624
Revenue
recognized in the period1,982
in which
Research
andisdevelopment
goods
and services are sold, not necessarily
Interest
expense
450
the period in which cash is received.
Total expenses
33,036
Pretax income
$ 4,400
Income tax expense
1,100
Net income
$ 3,300
18
MAXIDRIVE CORP.
Expenses are the Income
dollar amount
of resources used
Statement
up by the
to earn
revenues
during
a period.
Forentity
the Year
Ended
December
31, 2014
(in thousands of dollars)
An expense is recognized in the period in which
goods and services are used, not necessarily
Revenues the period in which cash is paid.
Sales revenue
$37,436
Expenses
Cost of goods sold
$26,980
Selling, general and administrative
3,624
Research and development
1,982
Interest expense
450
Total expenses
33,036
Pretax income
$ 4,400
Income tax expense
1,100
Net income
$ 3,300
19
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2014
(in thousands of dollars)
Revenues
Sales revenue
$37,436
Expenses
Cost of goods sold
$26,980
Selling, general and administrative
3,624
Research and development
1,982
Interest expense
450
Total expenses
33,036
Pretax income
$ 4,400
If expenses exceed revenues,
Income tax expense
1,100
we report net loss.
Net income
$ 3,300
20
1-32
MAXIDRIVE CORP.
Statement of Retained Earnings
For the Year Ended December 31, 2014
(In thousands of dollars)
Retained earnings, January 1, 2014
Net income for 2014
Dividends for 2014
Retained earnings, December 31, 2014
$ 6,805
3,300
(1,000)
$ 9,105
21
MAXIDRIVE CORP.
Statement of Retained Earnings
For the Year Ended December 31, 2014
(in thousands of dollars)
Retained earnings, January 1, 2014
$ 6,805
1.
Name
of entity
Net
income
for 2014
3,300
2.
Title of statement
Dividends
for 2014
(1,000)
3. Specific date (Like the income statement, this
Retained earnings, December 31, 2014
$ 9,105
statement covers a specified period of time.)
4. Unit of measure
22
MAXIDRIVE CORP.
Statement of Retained Earnings
For the Year Ended December 31, 2014
(in thousands of dollars)
Retained earnings, January 1, 2014
Net income for 2014
Dividends for 2014
Retained earnings, December 31, 2014
$ 6,805
3,300
(1,000)
$ 9,105
The Statement of Retained Earnings reports the way
that net income and the distribution of dividends affect
the financial position of the company during a period.
23
1-35
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2014
(In thousands of dollars)
Cash flows from operating activities:
Cash collected from customers
Cash paid to suppliers and employees
Cash paid for interest
Cash paid for taxes
Net cash flow from operating activities
Cash flow from investing activities:
Cash paid to purchase equipment
Net cash flow from investing activities
Cash flow from financing activities:
Cash received from bank loan
Cash paid for dividends
Net cash flow from financing activities
Net decrease in cash during the year
Cash at beginning of the year
Cash at end of the year
$
33,563
(30,854)
(450)
(1,190)
$
$
1,069
(1,625)
(1,625)
$
1,400
(1,000)
$
$
400
(156)
5,051
4,895
24
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2014
(in thousands of dollars)
Cash flows from operating activities:
Cash collected from customers
$ 33,563
1.Cash
Name
ofsuppliers
entity and employees
paid to
(30,854)
paid
interest
(450)
2.Cash
Title
offorstatement
paid for taxes
(1,190)
3.Cash
Specific
date
(Like
the
income
statement
and
Net cash flow from operating activities
$
1,069
of retained
Cash statement
flow from investing
activities: earnings, this
Cash
paid to purchase
equipment
$
(1,625)
statement
covers
a specified period
of time.)
cash flow from investing activities
(1,625)
4.NetUnit
of measure
Cash flow from financing activities:
Cash received from bank loan
$
1,400
Cash paid for dividends
(1,000)
Net cash flow from financing activities
400
Net decrease in cash during the year
$
(156)
Cash at beginning of the year
5,051
Cash at end of the year
$
4,895
25
MAXIDRIVE CORP.
The Statement of Cash
Flows reports the inflows
Statement of Cash Flows
and outflows
of cash during the period in the
For the Year Ended December 31, 2014
categories of operating,
investing,
(in thousands
of dollars) and financing.
Cash flows from operating activities:
Cash collected from customers
Cash paid to suppliers and employees
Cash paid for interest
Cash paid for taxes
Net cash flow from operating activities
Cash flow from investing activities:
Cash paid to purchase equipment
Net cash flow from investing activities
Cash flow from financing activities:
Cash received from bank loan
Cash paid for dividends
Net cash flow from financing activities
Net decrease in cash during the year
Cash at beginning of the year
Cash at end of the year
$
33,563
(30,854)
(450)
(1,190)
$
$
1,069
(1,625)
(1,625)
$
1,400
(1,000)
$
$
400
(156)
5,051
4,895
26
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2014
(in thousands of dollars)
Cash flows from operating activities:
Cash collected from customers
Cash paid to suppliers and employees
Cash paid for interest
Cash paid for taxes
Net cash flow from operating activities
Cash flow from investing activities:
Cash paid to purchase equipment
Net cash flow from investing activities
Cash flow from financing activities:
Cash received from bank loan
Cash paid for dividends
Net cash flow from financing activities
Net decrease in cash during the year
Cash at beginning of the year
Cash at end of the year
$
33,563
(30,854)
(450)
(1,190)
$
$
1,069
(1,625)
The statement ends with a
$
1,400
reconciliation of Cash.
(1,000)
$
$
(1,625)
400
(156)
5,051
4,895
27
Relationship Among the Financial
Statements
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2014
(in thousands of dollars)
Revenues
Sales revenue
Expenses
Cost of goods sold
Selling, general and administrative
Research and development
Interest expense
Total expenses
Pretax income
Income tax expense
Net income
$37,436
$26,980
3,624
1,982
450
33,036
$ 4,400
1,100
$ 3,300
Net income from the
income statement
increases ending
retained earnings on the
statement of retained
earnings.
MAXIDRIVE CORP.
Statement of Retained Earnings
For the Year Ended December 31, 2014
(in thousands of dollars)
Retained earnings, January 1, 2014
Net income for 2014
Dividends for 2014
Retained earnings, December 31, 2014
$ 6,805
3,300
(1,000)
$ 9,105
28
Relationship Among the Financial
Statements
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2014
(in thousands of dollars)
Assets
Cash
Accounts receivable
Inventories
Plant and equipment
Land
Total assets
Liabilities and Stockholders' Equity
Liabilities
Accounts payable
Notes payable
Total liabilities
Stockholders' Equity
Contributed capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
$
$
4,895
5,714
8,517
7,154
981
27,261
$
16,156
$
11,105
27,261
7,156
9,000
2,000
9,105
Ending retained earnings
from the statement of
retained earnings is one
of the components of
stockholders’ equity on
the balance sheet.
MAXIDRIVE CORP.
Statement of Retained Earnings
For the Year Ended December 31, 2014
(in thousands of dollars)
Retained earnings, January 1, 2014
Net income for 2014
Dividends for 2014
Retained earnings, December 31, 2014
$ 6,805
3,300
(1,000)
$ 9,105
29
Relationship Among the Financial
Statements
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2014
(in thousands of dollars)
Assets
Cash
Accounts receivable
Inventories
Plant and equipment
Land
Total assets
Liabilities and Stockholders' Equity
Liabilities
Accounts payable
Notes payable
Total liabilities
Stockholders' Equity
Contributed capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
$
7,156
9,000
$
$
4,895
5,714
8,517
7,154
981
27,261
16,156
2,000
9,105
$
11,105
27,261
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2014
(in thousands of dollars)
Cash flows from operating activities:
Cash collected from customers
Cash paid to suppliers and employees
Cash paid for interest
Cash paid for taxes
Net cash flow from operating activities
Cash flow from investing activities:
Cash paid to purchase equipment
Net cash flow from investing activities
Cash flow from financing activities:
Cash received from bank loan
Cash paid for dividends
Net cash flow from financing activities
Net decrease in cash during the year
Cash at beginning of the year
Cash at end of the year
$
33,563
(30,854)
(450)
(1,190)
$
$
1,069
(1,625)
(1,625)
$
1,400
(1,000)
$
$
400
(156)
5,051
4,895
The change in cash on the statement of cash flows added to
the beginning of the year balance in cash equals the ending
30
balance in cash on the balance sheet.
The Rules of the Game
 GAAP
The rule makers
 FASB
The rule enforcers
 SEC
The CPA regulators
 AICPA
The
rules
31
Financial Statement Assumptions
Economic
Entity
Cost
Principle
Time
Period
Going
Concern
Monetary
Unit
32
Economic Entity Concept
 Each
entity has its own books, records and
financial statements that are separate from
owners
 No intermingling of personal and business
assets and liabilities or income and expenses
Business
Books &
Records
33
Cost Principle
 Record
assets at cost paid to
acquire them
 Continue
to value assets at
historical cost until sold
 More
objective than market
value
34
Going Concern
 Assume
business will
continue indefinitely
into the foreseeable
future
 Justifies
use of
historical cost
35
Monetary Unit
 How
we measure (e.g. U.S. dollar,
Japanese yen, Mexican peso, etc.)
 Assumes economic measure is
relatively stable; no adjustment
for inflation made in financial
statements
36
Time Period Assumption
 Assumes
it is possible to break up an entity’s
earnings in discrete time periods (a month,
quarter, year)
 Necessary to provide users with financial
results on a timely basis
 Requires use of estimates
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
37
Where Accountants Work
 Private
Business
 Nonprofit
 Public
Organizations
Accounting
–
audit
–
tax
–
management consulting
 Educational
Institutions
38
End of Chapter 1
39