Accounting Chapter 1 9/22/12 8:32 PM

Accounting is a system that identifies, records and communicates information that is

relevant reliable and comparable to help users make better decisions.

Identify economic events

o Economic events are relevant to the business meaning they affect the

money ex. Transactions

Record economic events

o They are done in a systematic chronological diary of events

o Also known as bookkeeping.

Communicate collected info

o Done so through accounting reports

Ex. Financial Statements

o Economic events reported in the aggregate under certain categories

o Important accountants can analyze and interpret the reported

information.

Includes explaining the uses, meaning, and limitations of

reported data.

Accounting Information Users

Internal Users

o Those inside a business who plan organize and run the business

Ex. Finance Marketing, human resources, management

o Managerial Accounting: provides internal reports to help users

External Users

o Those outside a company who want financial information.

Investors use infor to make decisions to buy hold or sell

ownership shares

Creditors (ex. Suppliers and bankers) use accounting

information to evaluate the risks of granting credit or lending

money.

Taxing Authorities (IRS) use it to test for tax law compliance

Regulatory agencies (SEC, FTC) whether company operates in

prescribe rules

Customers, warranty and support issues

Labor Unions to identify whether owners can pay increased

wages and benefits.

o Financial Accounting provides reports that aid external users

Building Blocks of Accounting

Generally accepted accounting principles (GAAP)

o Determined by

SEC, oversees U.S financial markets and accounting standard

setting bodies

Public Company Accounting Oversight Board (PCAOB),

determines auditing standards and reviews auditing firms

Financial Accounting Standards Board (FASB) primary

accounting standard setting body in the US

International Accounting Standards Board (IASB), issues

international financial reporting standards (IFRS) that have been

adopted by many countries outside of the US

Measurement principles

o Chosen between

Relevance, financial info is capable of making a difference

Faithful Representation, it is factual

o Cost Principle

Record assets at cost

o Fair Value Principle, assets and liabilities are reported at fair value

Price received to sell an asset or settle a liability

Assumptions

o Monetary Unit Assumption

Companies include in the accounting records only transaction

data that can be expressed in money terms

o Economic Unit Entity

Activities of the entity be separate and distinct from the activities

of its owner and all other economic entities.

Proprietorship

Owned by one person, liable for all debts

Partnership

Two or more people can be fully liable or limited liability

Corporation

Stockholders have limited liability

Ease of transfer of ownership

Enjoys unlimited life.

Basic Accounting Equation

Assets = Liabilities + Stockholder’s Equity

o Assets

Resources a business own,

Have capacity to provide future services or benefits

o Liabilities

Claims against these assets

Ex. Accounts payable, note payable, wages payable,

sales and real estate taxes payable.

People you owe money to are creditors

Pay them first when you go bankrupt

o Stockholder’s equity or Residual Equity

Common Stock

Total amount stockholder’s pay for the shares they have

Retained Earnings, determined by 3 items.

Revenues

Gross increases resulting from business activities

entered into for the purpose of earning income.

Expenses

Cost of assets consumed or services used in the

process of earning revenue.

Dividends

Distribution of cash or other assets to

stockholders.

Use of Accounting Equation

For ever transaction there is a dual response.

Review Book Examples

Financial Statements

Income statement

o Revenues and expenses and resulting net income

Retained Earnings

o Retained earnings + net income - Dividends

Balance sheet

o Reports assets liabilities and stockholder’s equity of a company at a

specific date

Statement of cash flows

o Receipts (cash inflows) outflows (payments)

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Account or T- Account

Record of increases and decreases in a specific asset, liability or

owner’s equity item.

Debit indicates left

o Debit balance when debit > Credit

o Normal Balance Debit

Assets

Dividend

Expense

Credit indicates right

o Credit balance when Credit > Debit

o Normal Balance Credit

Liabilities

Increase in common stock

Revenue

Normal Balance of an account is on the side where an increase in

the account is recorded.

Steps in Recording Process

Analyze Each Transaction

Enter Transaction Information in a Journal

Transfer Journal Information to appropriate accounts in ledger

Journal

Book of original entry. Recorded in chronological order

o Date, account title, reference number, debit, credit columns

Entering transaction data in is journalizing.

o Simple entries include only two accounts

o Compound entries have more than two

Ledgers are account specific.

*Look at book illustrations

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Timing Issues

Time period assumption

o Accountants divide economic life of a business into artificial

time periods

Interim periods

o When accounting period is a quarter or year

Fiscal Year

o When it is an entire year

Accrual Vs. Cash Basis

Accrual basis accounting

o Record transactions in the period in which the event occurs

o In accordance with GAAP

o Revenue Recognition Principle

Companies recognize revenue in the accounting period

in which it is earned.

o Expense Recognition (Matching Principle)

Expenses follow revenues.

Cash basis accounting.

o Record when the cash moves

Basics of Adjusting Entries

Ensure that revenue recognition and expense recognition are

followed.

Must make every time a financial statement is prepared.

Deferrals

o Companies make adjustments to record portion that

represents expense incurred or revenue earned.

o Prepaid expenses or prepayments

Asset account is debited at first.

Adjusting entry credits the asset account while it debits

the expense account.

o Unearned Revenues

Adjusting entry debits liability and credits revenue.

Unearned revenue is a liability

Accruals

o Accrued Revenues

Adjusting entry is debit Asset and credit Revenue.

o Accrued Expenses.

Adjusting entry, debit expense and credit liability.

o Accrued Interest

Face value * annual interest rate * time in terms of one

year