Principles of Accounting I
1. Introduction to Accounting
and Business
Objectives
1. Explain what accounting is.
2. Identify the users and uses of accounting.
3. Understand why ethics is a fundamental business concept.
4. Explain accounting standards and the measurement principles.
5. Explain the monetary unit assumption and the economic entity
assumption.
6. State the accounting equation, and define its components.
7. Analyze the effects of business transactions on the accounting
equation.
8. Understand the four financial statements and how they are
prepared.
Accounting in Action
The Building The Basic Using the
What is Financial
Blocks of Accounting Accounting
Accounting? Equation Statements
Accounting Equation
Three Accounting Assets Transaction Income
activities standards Liabilities analysis statement
Who uses Principles Equity Summary of Retained
accounting and transactions earnings
data? Assumptions statement
Statement of
financial
position
Statement of
cash flows
What is Accounting?
The purpose of accounting:
(1) to identify, record, and communicate the economic
events of an
(2) organization to
(3) interested users.
What is Accounting?
Illustration 1-1
The activities of the
Three Activities accounting process
The accounting process includes
the bookkeeping function.
What is Accounting?
Who Uses Accounting Data
External
Internal Users
Human Taxing
Users
Resources Authorities
Labor
Unions
Finance
Management Customers
Creditors
Marketing Regulatory
Agencies
Investors
What is Accounting?
Common Questions Asked User
1. Can we afford to give our
employees a pay raise? Human Resources
2. Did the company earn a
satisfactory income? Investors
3. Should any product lines be
eliminated? Management
4. Is cash sufficient to pay
dividends to shareholders? Finance
5. What price for our product will
maximize net income? Marketing
6. Will the company be able to
pay its debts? Creditors
The Building Blocks of Accounting
Accounting Standards
International Accounting Standards Board (IASB)
[Link]
International Financial Reporting Standards (IFRS)
Financial Accounting Standards Board (FASB)
[Link]
Generally Accepted Accounting Principles (GAAP)
The Building Blocks of Accounting
Measurement Principles
Cost Principle (Historical) – dictates that companies record
assets at their cost.
Issues:
Reported at cost when purchased and also over the time the
asset is held.
Cost easily verified, market value is often subjective.
Fair value information may be more useful.
The Building Blocks of Accounting
Measurement Principles
Fair Value Principle – indicates that assets and liabilities should
be reported at fair value.
In determining which measurement principle to use, companies
weigh the factual nature of cost figures versus the relevance of
fair value.
Only in situations where assets are actively traded, such as
investment securities, is the fair value principle applied.
The Building Blocks of Accounting
Assumptions
Monetary Unit Assumption – include in the accounting records
only transaction data that can be expressed in terms of money.
Economic Entity Assumption – requires that activities of the
entity be kept separate and distinct from the activities of its
owner and all other economic entities.
Proprietorship.
Forms of Business
Partnership. Ownership
Corporation.
The Building Blocks of Accounting
Proprietorship Partnership Corporation
Generally owned Owned by two or Ownership divided
by one person. more persons. into shares
Often small Often retail and Separate legal
service-type service-type entity organized
businesses businesses under state
Owner receives corporation law
Generally unlimited
any profits, suffers personal liability Limited liability
any losses, and is
Partnership
personally liable for
agreement
all debts.
The Basic Accounting Equation
Assets = Liabilities + Equity
Provides the underlying framework for recording and
summarizing economic events.
Applies to all economic entities regardless of size.
The Basic Accounting Equation
Assets = Liabilities + Equity
Provides the underlying framework for recording and
summarizing economic events.
Assets
Resources a business owns.
Provide future services or benefits.
Cash, Inventory, Equipment, etc.
The Basic Accounting Equation
Assets = Liabilities + Equity
Provides the underlying framework for recording and
summarizing economic events.
Liabilities
Claims against assets (debts and obligations).
Creditors - party to whom money is owed.
Accounts payable, Notes payable, etc.
The Basic Accounting Equation
Assets = Liabilities + Equity
Provides the underlying framework for recording and
summarizing economic events.
Equity
Ownership claim on total assets.
Referred to as residual equity.
Share capital and retained earnings.
The Basic Accounting Equation
Illustration 1-7
Revenues result from business activities entered into for the purpose
of earning income.
Generally results from selling merchandise, performing services,
renting property, and lending money.
The Basic Accounting Equation
Illustration 1-7
Expenses are the cost of assets consumed or services used in the
process of earning revenue.
Common expenses are salaries expense, rent expense, utilities
expense, tax expense, etc.
The Basic Accounting Equation
Illustration 1-7
Dividends are the distribution of cash or other assets to shareholders.
Reduce retained earnings
Not an expense
Using The Accounting Equation
Transactions are a business’s economic events
recorded by accountants.
May be external or internal.
Not all activities represent transactions.
Each transaction has a dual effect on the accounting
equation.
Using The Accounting Equation
Illustration: Are the following events recorded in the
accounting records? Illustration 1-8
Discuss
Purchase product
Event Pay rent.
computer. design with
customer.
Criterion Is the financial position (assets, liabilities, or
equity) of the company changed?
Record/
Don’t Record
Using The Accounting Equation
Transaction Analysis
Transactions Analysis
Transaction (1). Investment by Shareholders. Ray and
Barbara Neal decides to open a computer programming service
which he names Softbyte. On September 1, 2011, they invest
birr15,000 cash in exchange for capital shares. The effect of this
transaction on the basic equation is:
Transactions Analysis
Transaction (2). Purchase of Equipment for Cash. Softbyte
purchases computer equipment for birr7,000 cash.
Transactions Analysis
Transaction (3). Purchase of Supplies on Credit. Softbyte
purchases for birr1,600 from Acme Supply Company computer
paper and other supplies expected to last several months.
Transactions Analysis
Transaction (4). Services Provided for Cash. Softbyte
receives birr1,200 cash from customers for programming
services it has provided.
Transactions Analysis
Transaction (5). Purchase of Advertising on Credit. Softbyte
receives a bill for birr250 from the Daily News for advertising but
postpones payment until a later date.
Transactions Analysis
Transaction (6). Services Provided for Cash and Credit.
Softbyte provides birr3,500 of programming services for
customers. The company receives cash of birr1,500 from
customers, and it bills the balance of birr2,000 on account.
Transactions Analysis
Transaction (7). Payment of Expenses. Softbyte pays the
following Expenses in cash for September: store rent birr600,
salaries of employees birr900, and utilities birr200.
Transactions Analysis
Transaction (8). Payment of Accounts Payable. Softbyte
pays its birr250 Daily News bill in cash.
Transactions Analysis
Transaction (9). Receipt of Cash on Account. Softbyte
receives birr600 in cash from customers who had been billed for
services [in Transaction (6)].
Transactions Analysis
Transaction (10). Dividends. The corporation pays a dividend
of birr1,300 in cash.
Transactions Analysis
Illustration 1-10
Summary of Transactions Tabular summary of
Softbyte transactions
Financial Statements
Companies prepare four financial statements from the
summarized accounting data:
Retained Statement Statement
Income
Earnings of Financial of Cash
Statement
Statement Position Flows
Financial Statements Income Statement
Reports the revenues and expenses for a specific period of time.
Net income – revenues exceed expenses. Illustration 1-11
Net loss – expenses exceed revenues. Financial statements and
their interrelationships
Net income is needed to determine the
Financial Statements ending balance in retained earnings.
Illustration 1-11
Financial statements and
their interrelationships
Retained Earnings
Financial Statements Statement
Statement indicates the reasons why Illustration 1-11
Financial statements and
retained earnings has increased or their interrelationships
decreased during the period.
Financial
Statements
The ending
balance in
retained
earnings is
needed in
preparing the
statement of
financial position
Illustration 1-11
Financial statements and
their interrelationships
Financial Statements Balance Sheet
Illustration 1-11
Financial statements and
their interrelationships
Financial
Statements
Illustration 1-11
Financial statements and
their interrelationships
Financial Statements
Statement of Cash Flows
Information for a specific period of time.
Answers the following:
1. Where did cash come from?
2. What was cash used for?
3. What was the change in the cash balance?
Financial Statements Statement of Cash Flows
Illustration 1-11
Financial statements and
their interrelationships
End of the Chapter