Chapter 1

Business Decisions and Financial Accounting

Principles of Accounting
Min Kim

12-1
 What is Accounting

Accounting is
• a system of maintaining records of a
company’s operations, and
• communicating that information to
decision makers, namely,
management, investors and creditors.
Two types of accounting information

Managerial accounting: information provided for internal

users

• Managers
• Employees

Financial accounting: information provided for external

users

• Investors
• Creditors
• Suppliers
• Competitors
• Regulators
• Internal Revenue Service (IRS)
Assets, Liabilities, and Stockholder’s Equity
 Assets
Economic resources presently controlled by the
company that have measurable value and are
expected to benefit the company by producing cash
inflows or reducing cash outflows in the future.
Examples:
• Cash.
• Supplies.
• Furniture.
• Equipment.
 Liabilities
Measurable amounts that the company owes to
creditors
Examples:
• Loans from Banks
• Notes Payable.
• Accounts Payable.
 Stockholders’ Equity
Owners’ claims to the business resources.
 Revenues, Expenses, and Net Income

Revenues − Expenses = Net Income

Revenues Expenses
Sales of goods or services The costs of doing business
to customers, measured at necessary to earn revenues,
the amount the business including wages to
charges the customer. employees, advertising,
insurance, utilities, and
supplies used in the office.
 Dividends
Distributions of a company’s earnings to its
stockholders as a return on their investment.

Dividends are not an expense.

 Financial Statements
• Primary financial statements
❑ Balance sheet (Statement of Financial
Position)
❑ Income statement (Statement of

Comprehensive Income)
❑ Statement of cash flows

❑ Statement of stockholders’ equity

(Statement of Changes in Equity)

Fundamental Accounting Equation
To S e t U p B u s i n e s s We N e e d :
Lemons ($50)
Sugar ($20)
Cups ($10)
Water ($10)
Pot ($30)
Table & Chair ($30)
To P u rc h a s e T h e s e A s s et s We N e e d :
Contribution or Capital or Equity
If Contribution Is Insufficient
L o a n s F ro m B a n k
A S S E T S = L I A B I L I T I ES + OW N E RS EQ U I T Y
$150 = $0 + $150 (If we have enough money)
11
$150 = $ 60 (Bank) + $ 90 (If we have only $90)
 Balance Sheet
Assets = Liabilities + Owners Equity
$ 150 $ 60 $ 90

Lemons, sugar,
cups and
water (current Amount owe Initial
asset) to bank – investment in
need to be return for
Table, chair, paid in the share in
pot future profits
(long term
asset)

12
 Income Statement
Revenue Expenses Income or loss
$ 100 $ 60 $ 40
Cost of lemons
used
Cost of cups
Lemonade Cost of water
Sales
Cost of sugar

Depreciation

13
 Net Income
Revenues – Expenses - Dividends

Retained
Earnings Dividends

Adds to Decrease
Owners Owners
Equity Equity
• Income • Dividends
• Losses 14
Expanded Accounting Equation

Liabilities Owners
Assets =
+ Equity
Initial investment
Lemons, sugar,
in return for
cups and water
share in profits –
(current asset)
Amount owe to Common Stock
bank – need to
be paid in the
future Retained Earnings
Table, chair, pot • + Revenues
(long term asset) + Net Income
• - Expenses
• - Dividends

15
Statement of Stockholders’ Equity
Summarizes the changes in stockholders’
equity over an interval of time

= Common
Stockholders’
Stock + Retained
Equity
Earnings
Statement of Cash Flows

Net cash
position =

+Cash
Inflow

- Cash
Outflow

17
 Statement of Cash Flows
Net change in cash balances as a function of:

Operating Cash Flows – regular day to day operations

Investing Cash Flows – purchases and sales of long term assets

Financing Cash Flows – loans and equity transactions

18
Interrelationships among Financial
Statements
 The Balance Sheet
Reports at a point in time:
1. What a business owns
(assets).
2. What it owes to creditors
(liabilities).
3. What is left over for the
owners of the company’s
stock (stockholders’ equity).

Basic Accounting Equation

Assets = Liabilities + Stockholders’ Equity

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 The Income Statement
Reports the
amount of
revenues less
expenses for a
period of time.
The unit of
measure
assumption states
that results of
business activities
should be reported
in an appropriate
monetary unit.
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 The Statement of Stockholders’ Equity

Reports the way that net income and the distribution

of dividends affected the financial position of the
company during the period.

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The Statement of Cash Flows

Summarizes how a
business’s operating,
investing, and
financing activities
caused its cash
balance to change
over a particular
period of time.

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Summary of Business Activities and their
Measurement Category
Activities related to: Measurement Category

Borrowing Liabilities

Stockholders investments Stockholders equity

Distribution to stockholders Dividends

Resources of the Company Assets

Sales to customers Revenues

Costs of selling to customers Expenses

Concept Check 1-1
The resources of a company are referred to
as:
a. Liabilities
b. Revenues
c. Assets
d. Expenses

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Concept Check 1-2
The amounts recorded when the company
sells products or provides services to
customers are referred to as:
a. Liabilities
b. Revenues
c. Assets
d. Expenses

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Concept Check 1-3
Which of the following accounts would
appear in a company’s income statement?
a. Accounts Payable
b. Cash
c. Dividends
d. Rent Expense

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Concept Check 1-4
Which relationship is reflected in the
balance sheet?
a. Revenues − Expenses = Net income
b. Assets = Liabilities + Stockholders’ Equity
c. Assets − Liabilities = Net Income
d. Assets = Revenues + Dividends

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Rules of Financial Accounting

make their decisions

based on
Investors & Financial Accounting
Creditors Information
Should be based
on formal
standards

Generally Accepted Accounting Principles

(GAAP)
Current Standard Setting
United States (GAAP) Global (IFRS)

Financial Accounting International Accounting

Standards Board (FASB) Standards Board (IASB)

Governed by
Securities and Exchange
Commission (SEC)
 Role of Auditors
Trained individuals hired by a company as an
independent party to verify accuracy of that
company’s financial statements

Role of auditors

Help ensure that Help investors and

management has in fact creditors in their decisions
appropriately applied GAAP by adding credibility to the
in preparing the company’s financial statements.
financial statements
International Perspective
Differences in Accounting Methods Acceptable under IFRS
and U.S. GAAP

Many countries have adopted International Financial Reporting

Standards (IFRS) issued by the International Accounting
Standards Board (IASB). IFRS are similar to U.S. GAAP, but there
are several important differences. The FASB and IASB are working
together to eliminate some of these differences.
Difference U.S. GAAP IFRS Chapter
Last-in first-out (LIFO) method for inventory Permitted Prohibited 6
Reversal of inventory write-downs Prohibited Required 6
Basis for property, plant, and equipment Historical cost Fair value or historical cost 7
Development costs Expensed Capitalized 7
Debt to be refinanced Current Noncurrent 8
Recognition of contingent liabilities Probable More likely than not 8
Stockholders’ equity accounts Common stock Share capital 10
Paid-in capital Share premium
Interest received on cash flow statement Operating Operating or investing 11
Interest paid on cash flow statement Operating Operating or financing 11
 External Financial Reporting
Main goal: Provide useful financial information to external
users for decision making.

Useful
•Relevance.
•Faithful Representation.

Timely, Verifiable, Comparable, Understandable