Financial Accounting

Information for Decisions

John J. Wild
4th Edition
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008
 Chapter 1

Introducing Accounting
in Business

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 Conceptual Chapter Objectives

C1: Explain the purpose and importance of

accounting in the information age
C2: Identify users and uses of accounting
C3: Identify opportunities in accounting and
related fields
C4: Explain why ethics are crucial in
accounting
C5: Explain the meaning of GAAP, and define
and apply several key accounting principles
C6: Appendix 1B: Identify and describe the
three major activities in organizations

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 Analytical Chapter Objectives

A1: Define and interpret the accounting

equation and each of its components
A2: Analyze business transactions using the
accounting equation
A3: Compute and interpret return on assets
A4: Appendix 1A: Explain the relationship
between return and risk

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 Procedural Chapter Objectives

P1: Identify and prepare basic financial

statements and explain how they
interrelate

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 C1

Importance of Accounting
is a
Accounting Identifies
system that

Records

information
Relevant Communicates
that is

Reliable
to help users make
Comparable better decisions.

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 C1

Accounting Activities

 Identifying  Recording
Business Business
Activities Activities

Communicating
Business
Activities

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 C2 Users of Accounting
Information
External Users Internal Users

•Lenders •Consumer Groups •Managers •Sales Staff

•Shareholders •External Auditors •Officers/Directors •Budget Officers

•Governments •Customers •Internal Auditors •Controllers

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 C2 Users of Accounting
Information

External Users Internal Users

Financial accounting provides Managerial accounting provides

external users with financial information needs for internal
statements. decision makers.

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 C3

Opportunities in Accounting
Financial Managerial Taxation
•Preparation •General accounting •Preparation
•Analysis •Cost accounting •Planning
•Auditing •Budgeting •Regulatory
•Regulatory •Internal auditing •Investigations
•Consulting •Consulting •Consulting
•Planning •Controller •Enforcement
•Criminal •Treasurer •Legal services
investigation •Strategy •Estate plans

•Lenders •FBI investigators

•Consultants •Market researchers
•Analysts •Systems designers
Accounting- •Traders •Merger services
•Directors •Business valuation
related •Underwriters •Human services
•Planners •Litigation support
•Appraisers •Entrepreneurs
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 C3

Accounting Jobs by Area

Private
Public accounting
accounting 60%
25%

Government,
not-for-profit,
& education
15%
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 C4

Ethics—A Key Concept

Ethics

Beliefs that
Accepted
distinguish
standards of
right from
good and bad
wrong
behavior

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 C4 Guidelines for Ethical
Decisions
 Identify  Analyze  Make ethical
ethical concerns options decision

Use personal Consider all Choose best

ethics to good and bad option after
recognize ethical consequences. weighing all
concern. consequences.
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 C5
Generally Accepted Accounting
Principles
Financial accounting practice is governed by
concepts and rules known as generally accepted
accounting principles (GAAP).

Relevant Affects the decision of

Information its users.

Reliable Information Is trusted by

users.

Comparable Used in comparisons

Information across years & companies.

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 C5

Setting Accounting Principles

Financial Accounting Standards

Board is the private group that
sets both broad and specific
principles.

The Securities and Exchange Commission is the

government group that establishes reporting
requirements for companies that issue stock to
the public.

The International Accounting Standards Board (IASB) issues inter-

national standards that identify preferred accounting practices
in other countries. The IASB does not have authority to impose
its standards on companies.
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 C5

Principles of Accounting

Objectivity Principle Cost Principle

Accounting information is Accounting information is
supported by independent, based on actual cost.
unbiased evidence.

Now Future
Going-Concern Principle
Reflects assumption that the
business will continue operating
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 C5

Principles of Accounting

Monetary Unit Principle Revenue Recognition Principle

Express transactions and events in 2. Recognize revenue when it is
monetary, or money, units. earned.
3. Proceeds need not be in cash.
4. Measure revenue by cash
received plus cash value of items
received.

Business Entity Principle

A business is accounted for
separately from other business
entities, including its owner.
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 C5

Business Entity Forms

Sole Partnership Corporation

Proprietorship

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 C5

Characteristics of Businesses
Characteristic Proprietorship Partnership Corporation
Business entity yes yes yes
Legal entity no no yes
Limited liability no* no* yes
Unlimited life no no yes
Business taxed no no yes
One owner allowed yes no yes

* Proprietorships and partnerships that are set up as LLC’s

provide limited liability.

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 Corporation
C5

Owners of a corporation are called

shareholders (or stockholders).

When a corporation issues only one

class of stock, we call it common stock
(or capital stock).
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 A1

Accounting Equation

Assets = Liabilities + Equity

Liabilities
Assets & Equity

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 A1
Assets

Cash
Accounts Notes
Receivable Receivable
Resources
owned or
Vehicles controlled
by a Land
company

Store Buildings
Supplies
Equipment
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 A1

Liabilities

Accounts Notes
Payable Payable

Creditors’
claims on
assets
Taxes Wages
Payable Payable

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 A1

Equity

Contributed Retained
Capital Earnings

Owner’s
claim on
assets

Dividends
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 Expanded Accounting
A1

Equation

Assets = Liabilities + Equity

Common _ _
Stock
Dividends
+ Revenues Expenses

Retained Earnings

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 A2

Transaction Analysis Equation

The accounting equation MUST remain in
balance after each transaction.

Assets = Liabilities + Equity

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 A2

Transaction Analysis
J. Scott invests $20,000 cash to start
the business in exchange for stock.

The accounts involved are:

(1) Cash (asset)
(2) Common Stock (equity)

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 A2

Transaction Analysis
J. Scott invests $20,000 cash to start the
business in return for stock.

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 A2

Transaction Analysis

Purchased supplies paying $1,000 cash.

The accounts involved are:

(1) Cash (asset)
(2) Supplies (asset)

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 A2

Transaction Analysis

Purchased supplies paying $1,000 cash.

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 A2

Transaction Analysis

Purchased equipment for $15,000 cash.

The accounts involved are:

(1) Cash (asset)
(2) Equipment (asset)

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 A2

Transaction Analysis

Purchased equipment for $15,000 cash.

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 A2

Transaction Analysis

Purchased Supplies of $200 and

Equipment of $1,000 on account.

The accounts involved are:

(1) Supplies (asset)
(2) Equipment (asset)
(3) Accounts Payable (liability)

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 Transaction Analysis
A2

Purchased Supplies of $200 and

Equipment of $1,000 on account.

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 A2

Transaction Analysis

Borrowed $4,000 from 1st American Bank.

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 A2

Transaction Analysis
The balances so far appear below. Note that the
Balance Sheet Equation is still in balance.

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 A2

Transaction Analysis

Now, let’s look at transactions

involving revenue, expenses and
dividends.

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 A2

Transaction Analysis

Provided consulting services receiving

$3,000 cash.

The accounts involved are:

(1) Cash (asset)
(2) Revenues (equity)

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 A2

Transaction Analysis
Provided consulting services receiving
$3,000 cash.

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 A2

Transaction Analysis

Paid salaries of $800 to employees.

The accounts involved are:

(1) Cash (asset)
(2) Salaries expense (equity)
Remember that the balance in the salaries
expense account actually increases.
But, equity decreases because expenses
reduce equity.
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 A2

Transaction Analysis

Paid salaries of $800 to employees.

Remember that expenses decrease equity.

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 A2

Transaction Analysis

Dividends of $500 are paid to shareholders.

The accounts involved are:
(1) Cash (asset)
(2) Dividends (equity)
Remember that the Dividend account actually
increases.
But, equity decreases because dividends
reduce equity.
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 A2

Transaction Analysis
Dividends of $500 are paid to shareholders.

Remember that dividends decrease equity.

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 P1

Financial Statements
Let’s prepare the Financial Statements
reflecting the transactions we have
recorded.
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows

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 P1

Income Statement

Net income is the

difference
between
Revenues and
Expenses.

The income statement describes a

company’s revenues and expenses along
with the resulting net income or loss over a
period of time due to earnings activities.
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 P1
Statement of Retained Earnings
The net income of $2,200
increases Retained
Earnings by $2,200.

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 P1

Balance Sheet

The Balance Sheet describes

a company’s financial position
at a point in time.

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 P1
Statement of Cash Flows

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 P1

Return on Assets (ROA)

Return on Net income

=
assets Average total assets

ROA is viewed as an
indicator of operating
efficiency.

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 End of Chapter 1

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