Accounting What the Numbers Mean - Professor …professorahmed.com/Download/BUSN5600_Week-1.pdf · The Financial Accounting Foundation (FAF) was created and established the Financial

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1- 1Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.


Marshall,McManus,andViele11thEdition

AccountingWhattheNumbersMean

CHAPTER1:AccountingPresentandPast


LearningObjectivesAfter studying this chapter you should understand and be able to:LO 1-1: Explain the definition of accounting.LO 1-2: Identify who the users of accounting information are and explain why they find

accounting information useful.LO 1-3: Identify the variety of professional services that accountants provide.LO 1-4: Summarize the development of accounting from a broad historical perspective.LO 1-5: Explain the role that the Financial Accounting Standards Board (FASB) plays in the

development of financial accounting standards.LO 1-6: Generalize about how financial reporting standards evolve.LO 1-7: Identify the key elements of ethical behavior for a professional accountant. LO 1-8: Summarize the reasons for the FASB’s Conceptual Framework project.LO 1-9: Summarize the objective of general purpose financial reporting.LO 1-10: Describe the plan of the book.


WhatisAccounting?

Accounting is the process of:

Learning Objective 1-1: Explain the definition of accounting.


UsersandUsesofAccountingInformation

UserDecision/Informed Judgment

MadeManagement Planning, directing, and controllingInvestors/Shareholders Assessing amounts, timing, and

uncertainty of future cash returns on their investment

Creditors/Suppliers Assessing probability of collection and the risk of late (or non-) payment

Employees Planning for retirement and future job prospects

Securities and Exchange Commission

Reviewing for compliance of all required information

Learning Objective 1-2: Identify who the users of accounting information are and explain why they find accounting information useful.1- 6

Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

FinancialAccountingFinancial accounting generally refers to

the process that results in the preparation and reporting of financial statements for

an entity.

Financial accounting is primarily externally oriented and concerned with

the historical results of an entity’s performance.

Professional services that accountants provide include:

Learning Objective 1-2: Identify who the users of accounting information are and explain why they find accounting information useful.

1-2


ManagerialAccounting/CostAccounting

Managerial accounting is concerned with the use of economic and financial information to plan and control many of the activities of the

entity and to support the management decision-making process.

Cost accounting relates to the determination and accumulation of product, process, or

service costs.


Learning Objective 1-3: Identify the variety of professional services that accountants provide.1- 8


Auditing—PublicAccountingPublic accounting firms and individual Certified

Public Accountants (CPAs) provide auditing services and issue an independent

auditor’s report.

An independent auditor’s report usually contains four brief paragraphs and states whether the financial

statements are prepared in conformity with generallyaccepted accounting principles. An auditor’s report can

be unqualified (a “clean opinion) or qualified.


Learning Objective 1-3: Identify the variety of professional services that accountants provide.


InternalAuditingInternal auditors are

professional accountants who

perform functions much like those of an external

auditor. However, internal auditors are employed in industry

rather than public accounting.




GovernmentalandNot-for-ProfitAccounting

Governmental units (e.g., municipal, state, and

federal agencies) and not-for-profit entities (e.g.,

universities, hospitals, and religious organizations)

require the same accounting functions to be

performed as do other accounting entities.


Learning Objective 1-3: Identify the variety of professional services that accountants provide.


IncomeTaxAccounting

Tax practitioners often develop specialties in

the taxation of individuals,

partnerships, corporations, trusts

and estates, or international tax law

issues.




HowHasAccountingDeveloped?

Mesopotamians record tax receipts

on clay tablets.

3000 B.C.

Learning Objective 1-4: Summarize the development of accounting from a broad historical perspective.

1-3


Luca Pacioli published the first textbook describing a comprehensive double-

entry bookkeeping system.


3000 B.C. 1494

Learning Objective 1-4: Summarize the development of accounting from a broad historical perspective.1- 14


The industrial revolution of the 19th century generated the need for large amounts of capital to finance the

enterprises that supplanted individual craftsmen.

This need resulted in the corporate form of organization and the need to provide investors with reports showing the

financial position and the results of operations.


3000 B.C. 1494 1800’s



Accounting professionals in this country organized themselves in the early 1900’s and worked hard to establish certification laws, standardized audit procedures, and other

attributes of a profession.


3000 B.C. 1494 1800’s 1900’s



The Securities Act of 1933 and the Securities Exchange Act of 1934gave the Securities and Exchange Commission (SEC) the authority to establish accounting principles for companies whose securities had

to be registered with the SEC.

Between 1932 and 1934, the American Institute of Accountants and the New York Stock Exchange agreed

on five broad principles of accounting.


3000 B.C. 1494 1800’s 1900’s 1932to

1934

1933&

1934



The Committee on Accounting Procedure of the American Institute of Accountants issued 51 Accounting Research

Bulletins that dealt with accounting principles.

Although the SEC has the authority to establish accounting principles, the standard-setting process has

been delegated to other organizations over the years.


3000 B.C. 1494 1800’s 1900’s 1932to

1934

1933&

1934

1939to

1959




3000 B.C. 1494 1800’s 1900’s 1932to

1934

1933&

1934

1939to

1959

The Financial Accounting Foundation (FAF) was created and established the Financial Accounting Standards

Board (FASB) as the authoritative standard-setting body within the accounting profession.

The FASB has issued 168 Statements of Financial Accounting Standards that have established standards of

accounting and reporting for particular issues.

1973

Learning Objective 1-5: Explain the role that the Financial Accounting Standards Board (FASB) plays in the development of financial accounting standards.

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1939to

1959The Sarbanes-Oxley Act of 2002 created the five-member

Public Company Accounting Oversight Board (PCAOB), which has the authority to set and enforce auditing, attestation,

quality control, and ethics standards for public companies.

3000 B.C. 1494 1800’s 1900’s 1932to

1934

1933&

1934

1973 2002

Learning Objective 1-5: Explain the role that the Financial Accounting Standards Board (FASB) plays in the development of financial accounting standards. 1- 20Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.


Effective July, 2009, however, all FASB standards were superseded by the FASB Accounting Standards

Codification (FASB Codification). Essentially, the FASB Codification reorganized divergent sources of U.S.

GAAP in a more accessible and researchable format. The FASB Codification now represents a single source

of U.S. GAAP.

Learning Objective 1-5: Explain the role that the Financial Accounting Standards Board (FASB) plays in the development of financial accounting standards.


StandardsforOtherTypesofAccounting:

Managerial/Cost Accounting

Cost Accounting Standards Board (CASB) for government contracts

Auditing/Public Accounting

Auditing Standards Board (part of AICPA)

State and Local Governments

Governmental Accounting Standards

Board (GASB)

How do financial reporting standards evolve?

Learning Objective 1-6: Generalize about how financial reporting standards evolve.1- 22


InternationalAccountingStandardsThe goal of the International Accounting

Standards Board (IASB) is to develop a single set of high-quality, understandable, enforceable

and globally accepted financial reporting standards based upon clearly articulated

principles.

The IASB has issued 41 IASs and

15 IFRSs.

How do financial reporting standards evolve?

Learning Objective 1-6: Generalize about how financial reporting standards evolve.


EthicsandtheAccountingProfession

ObjectivityIntegrity

Independence Competence

Learning Objective 1-7: Identify the key elements of ethical behavior for a professional accountant. 1- 24


TheConceptualFramework

Statements of Financial Accounting Concepts (SFACs)

describe concepts and relationships that underlie financial

accounting standards.

In the mid-1970’s, the Financial Accounting Standards Board (FASB) began creating the Statements of

Financial Accounting Concepts (SFAC) in an effort to define the underlying concepts of accounting principles

and financial reporting practices.

Learning Objective 1-8: Summarize the reasons for the FASB’s Conceptual Framework project.

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ConceptsStatementNo.8“The Objective of General Purpose

Financial Statements”

Individual firms or entities External Users Historical cost

Timely information

Notes and disclosures

Accrual accounting

Benefits exceed costs

Does not measure value of the firm Evolving

Learning Objective 1-9: Summarize the objectives of financial reporting for business enterprises.1- 26


ThePlanofthisBook:

26

This text is divided into two main parts:Chapters 2 through 11, which compose the first part of the book, are devoted to financial accounting topics.

The remaining chapters, Chapters12 through 16, provide an in-depth look at managerial accounting.

Learning Objective 1-10: The Plan of the Book


EndofChapter1



Marshall,McManus,andViele11thEdition

AccountingWhattheNumbersMean

CHAPTER2:FinancialStatementsandAccountingConcepts/Principles


LearningObjectivesAfter studying this chapter you should understand and be able to:LO 2-1: Explain what transactions are. LO 2-2: Identify and explain the kind of information reported in each financial statement

and describe how financial statements are related to each other.LO 2-3: Explain the meaning and usefulness of the accounting equation.LO 2-4: Explain the meaning of each of the captions on the financial statements illustrated

in this chapter.LO 2-5: Identify and explain the broad, generally accepted concepts and principles that

apply to the accounting process.LO 2-6: Discuss why investors must carefully consider cash flow information in

conjunction with accrual accounting results.LO 2-7: Identify and explain several limitations of financial statements.LO 2-8: Describe what a corporation’s annual report is and why it is issued.

1-6


FinancialStatementsTransactionsareeconomic

interchangesbetweenentitiesthatareaccountedforandreflectedinfinancial

statements.

Learning Objective 2-1: Explain what transactions are. 1- 32


An entity’s financial statements are the end product of a process that starts with transactions between the entity and other organizations and individuals.

Transactions

Financial Statements

FinancialStatements

• Procedures for sorting, classifying, and presenting (bookkeeping)

• Selection of alternative methods of reflecting the effects of certain transactions (accounting)

Learning Objective 2-1: Explain what transactions are.


Account balances are then used in the preparation of

financial statements.

Cash Account

Accounts Receivable

Account

Accounts Payable Account

Transactions are summarized in accounts.

Accounts are used to organize like-kind

transactions.

Accounts

Learning Objective 2-1: Explain what transactions are. 1- 34


In addition to the financial statements, the annual report will probably include several accompanying notes or

explanations of the accounting policies used and detailed information about many of the amounts and captions shown

in the financial statements.

Required Disclosure Financial Statement that Satisfies Requirement

Financial position at the end of the period Balance Sheet

Earnings for the period Income Statement Cash flows during the period Statement of Cash Flows

Investments by and distributions to owners during the period

Statement of Changes in Owners' Equity

FinancialStatements

Learning Objective 2-2: Identify and explain the kind of information reported in each financial statement and describe how financial statements are related to each other.


BalanceSheet—ElementsLiabilities are

amounts owed to other entities.

Assets represent the amount of resources owned by the entity.

Equity is the ownership right

of the owner(s) of the entity in the

assets that remain after

deducting the liabilities.

Learning Objective 2-3: Explain the meaning and usefulness of the accounting equation.1- 36


BalanceSheetPresents the balances in an entity's accounts at a given point in time

Liabilities EquityAssets = +

Learning Objective 2-3: Explain the meaning and usefulness of the accounting equation.

1-7


Current assets are those assets that are likely to be converted into cash or used to benefit the entity within

one year.

BalanceSheet

Plant and equipment

includes long-term assets

that will benefit the entity over several years.

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter.1- 38


BalanceSheetLong-term liabilities are those liabilities that will not be

repaid within one year of the balance sheet date.

Current liabilities are thoseliabilities that are to be paid within one year.

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter.


IncomeStatementThe income statement shows the net income (or net

loss) for the period of time under consideration.Revenues result from the entity’s operating activities (e.g., selling

merchandise).

Costs and expenses are incurred in generating revenues and

operating the entity.

Notice that the statement starts

with net sales and that the various expenses are

subtracted to arrive at net income



IncomeStatementIncome taxes are shown after all the other income statement

items have been reported.

Earnings per share of common stock outstanding is reported as a separate item at the bottom of the income statement because of its

significance in evaluating the market value of a share of common stock.



StatementofChangesinStockholders'Equity

This financial statement shows the detail of stockholders' equity and explains the changes that occurred in the components of stockholders'

equity during the year.

MAIN STREET STORE, INC.Statement of Changes in Stockholders’ Equity

For the Year Ended August 31, 2017Paid-In Capital:Beginning balance $ –0–

1.Common stock, par value, $10; 50,000 shares authorized, 10,000 shares issued and outstanding 100,000Additional paid-in capital 90,000

Balance, August 31, 2017 $190,000Retained Earnings:Beginning balance $ –0–Net income for the year 18,000Less: Cash dividends of $.50 per share (5,000)

Balance, August 31, 2017 $ 13,000Total stockholders’ equity $203,000



StatementofCashFlowsThe purpose of this financial statement is to identify the

sources and uses of cash during the year.MAIN STREET STORE, INC.

Statement of Cash FlowsFor the Year Ended August 31, 2017

Cash Flows from Operating Activities:

Net income $ 18,000

Add (deduct) items not affecting cash:

Depreciation expense 4,000

Increase in accounts receivable (80,000)

Increase in merchandise inventory (170,000)

Increase in current liabilities 67,000

Net cash used by operating activities $(161,000)

Cash Flows from Investing Activities:

Cash paid for equipment $ (40,000)

Cash Flows from Financing Activities:

Cash received from issue of long-term debt $ 50,000

Cash received from sale of common stock 190,000

Payment of cash dividend on common stock (5,000)

Net cash provided by financing activities $ 235,000

Net increase in cash for the year $ 34,000


1-8


Time-LineModel



FinancialStatementRelationships

The arrow indicates that net income affects retained earnings, which is a component of stockholders' equity.






FinancialStatementRelationshipsIf assets equal $300,000 and liabilities equal $125,000,

what is stockholders' equity?

Assets = Liabilities + Stockholders'

Equity 320,000 = 117,000 + ?

Balance Sheet



If assets equal $320,000 and liabilities equal $117,000, what is stockholders' equity?


Equity 320,000 = 117,000 + 203,000

Balance Sheet

Stockholders' equity equals $203,000

($320,000 - $117,000)




Now, suppose that total assets increase $10,000 during the year and total liabilities decrease $3,000 during the year.

What is stockholders' equity at the end of the year?



Equity 320,000 117,000 203,000

10,000 (3,000) ?330,000 114,000 ?

Balance Sheet


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Stockholders' equity must have increased by $13,000. Since stockholders' equity was $203,000 at the beginning

of the year, it must be $216,000 at the end of the year.



Equity 320,000 117,000 203,000

10,000 (3,000) 13,000 330,000 114,000 216,000

Balance Sheet



BalanceSheetAccount Definition

Cash Cash on hand and in the bankAccounts receivable Amounts due from customersMerchandise inventory Cost of merchandise acquired and not yet soldEquipment Cost of equipment purchased and used in businessAccumulated depreciation

Portion of the cost of equipment that is estimated to have been used up in the process of operating the business

Short-term debt Amounts borrowed that will be repaid within one year of the balance sheet date

Accounts payable Amounts due to suppliersOther accrued liabilities Amounts owed to various creditorsLong-term debt Amounts borrowed from banks or other creditors that will

not be repaid within one year from the balance sheet date

Residual claim of owners, computed as "assets minus liabilities"

Stockholders' equity



IncomeStatementCaptions Explanation

Net sales Amount of sales of merchandise to customers, less the amount of customer returns of merchandise

Cost of goods sold Represents the total cost of merchandise removed from inventory and delivered to customers as a result of sales

Gross profit Difference between net sales and cost of goods sold; Represents the seller's maximum amount of "cushion" from which all other expenses of the business must be deducted before it is possible to have net income

Selling, general, and administrative expenses

Represents the operating expenses of the entity

Income from operations Represents one of the most important measures of the firm's activities

Interest expense Represents the cost of using borrowed fundsIncome taxes Shown after all of the other income statement items have

been reported because income taxes are a function of the firm's income before taxes

Net income per share of common stock outstanding

A significant item in evaluating the market value of a share of common stock; Often referred to as "earnings per share" or EPS



StatementofChangesinStockholders'Equity

Captions ExplanationPaid-in capital Represents the total amount invested in the entity by

the ownersCommon stock Reflects the number of shares authorized by the

corporation's charter, the number of shares issued to stockholders, and the number of shares still held by the stockholders

Additional paid-in capital

Difference between the total amount invested by the owners and the par value or stated value of the stock

Retained earnings Represents the cumulative net income of the entity that has been retained for use in the business

Dividends Distributions of earnings to the owners



Captions ExplanationCash flows from operating activities

Shown first; Net income is the starting point for this measure of cash generation

Depreciation expense Added back to net income because it is subtracted to arrive at net income, but does not require the use of cash

Increase in accounts receivable

Deducted because it reflects sales revenues, included in net income, but not yet received in cash

Increase in merchandise inventory

Deducted because cash was spent to acquire the increase in inventory

Increase in current liabilities

Added because cash has not yet been paid for the products and services that have been received during the current fiscal period

Cash flows from investing activities

Shows the cash sources and uses related to long-lived assets

Cash flows from financing activities

Shows the cash sources and uses related to transactions with creditors and stockholders

StatementofCashFlows



AccountingConceptsandPrinciples

Accounting EntityEvery economic entity can be

separately identified and accounted for.

Unit of MeasurementOnly transactions denominated in dollars (currency) are recorded in

the accounting records.

Now FutureGoing Concern Concept

The presumption that the entity will continue to operate in the future—

it’s not being liquidated.

Cost PrincipleTransactions are recorded at their

original cost to the entity as measured in dollars.

Learning Objective 2-5: Identify and explain the broad, generally accepted concepts and principles that apply to the accounting process.

1-10



Matching ConceptAll expenses incurred to generate

that period’s revenues be deducted from the revenues

earned.

Accounting PeriodThe period of time selected for

reporting results of operations and changes in financial position.

ObjectivityThe accountants’ desire to have a given transaction recorded in the same way

in all situations.

Accrual AccountingRecognize revenue at the point of

sale and recognize expenses when incurred, even though the cash

receipt or payment may occur at another time.

Learning Objective 2-5: Identify and explain the broad, generally accepted concepts and principles that apply to the accounting process.1- 56


Full DisclosureCircumstances and events that make a difference to financial statement users

should be disclosed.

ConsistencyProvides meaningful trend

comparisons over several years.

MaterialityThe benefit of increased accuracy

should outweigh the cost of achieving the increased accuracy.

ConservatismWhen in doubt, make judgments and estimates that result in lower profits

and asset valuations.


Learning Objective 2-5: Identify and explain the broad, generally accepted concepts and principles that apply to the accounting process.


AccrualAccountingVs.CashFlows

Revenue Recognition -Timing is the Key

Cash flowrecognizes:

Accrual accountingrecognizes:

Revenuewhen payment is received

for services renderedor products sold.

Revenuewhen revenue is earned,

at the point of sale ofservices or products.

Expenseswhen they are paid.

Expenseswhen they are incurred.

Learning Objective 2-6: Describe why investors must carefully consider cash flow information in conjunction with accrual accounting results.1- 58


LimitationsofFinancialStatements

Financial statements report only quantitative

economic data.

They do not reflect qualitative economic variables, such as the

value of the management team or the

employees’ morale.

How do the terms “quantitative” and “qualitative” differ?

Qualitative economic variables

are usually subjective in value

and cannot be quantified in terms of dollars and cents that can be verified.

Learning Objective 2-7: Identify and describe several limitations of financial statements.


LimitationsofFinancialStatements

Matching Concept

Estimates are acceptable provided there is a basis

for them.

Many estimates are used, such as warranty costs, depreciation, and

pension expense.

Historical Cost Concept

Assets are usually valued at the cost of the Asset

when acquired.

The balance sheet does not report market values

or replacement cost of the assets.

Learning Objective 2-7: Identify and describe several limitations of financial statements.1- 60


TheCorporation’sAnnualReportThe annual report is

distributed to shareholders (and others).

It contains the financial statements, together with the report of the external auditor’s examination of the financial statements.

It also contains Management’s Discussion

and Analysis (MD&A).

Learning Objective 2-8: Describe what a corporation’s annual report is and why it is issued.

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EndofChapter2

Documents

Accounting What the Numbers Mean - Professor …professorahmed.com/Download/BUSN5600_Week-1.pdf · The Financial Accounting Foundation (FAF) was created and established the Financial