Chapter 1 ACCOUNTING IN BUSINESS

A Importance of Accounting B Accounting Equation C Transaction Analysis

Examples

D Financial Statements
Income statement, Statement of owners equity, Balance sheet, Statement of cash flow

McGraw-Hill

ACCT2020 Spring 2012

A. Importance of Accounting
is a Accounting Accounting system that Identifies Identifies Records Records information Relevant Relevant Reliable Reliable Comparable Comparable
McGraw-Hill ACCT2020 Spring 2012

that is

Communicates Communicates

to help users make to help users make better decisions. better decisions.
2

Accounting Activities
Identifying Business Activities Recording Business Activities Communicating Business Activities

McGraw-Hill

ACCT2020 Spring 2012

Accounting as the language of business

It is a necessary feature in all organizations to communicate data to help people make better decisions! Accounting information system serves many kinds of users

McGraw-Hill

ACCT2020 Spring 2012

Users of Accounting Information

External Users Internal Users

Lenders Consumer Groups Shareholders External Auditors Governments Customers

Managers Sales Staff Officers/Directors Budget Officers Internal Auditors Controllers

5

McGraw-Hill

ACCT2020 Spring 2012

Users of Accounting Information

Internal Users

External Users

Financial accounting provides external users with financial statements.

Managerial accounting provides information needs for internal decision makers.

ACCT2020 Spring 2012 6

McGraw-Hill

Generally Accepted Accounting Principles

Financial accounting practice is governed by Financial accounting practice is governed by concepts and rules known as generally accepted concepts and rules known as generally accepted accounting principles (GAAP). accounting principles (GAAP).
Relevant Relevant Information Information Reliable Reliable Information Information Comparable Comparable Information Information
McGraw-Hill

Affects the decision of Affects the decision of its users. its users. Is trusted by Is trusted by users. users. Is helpful in contrasting Is helpful in contrasting organizations. organizations.
ACCT2020 Spring 2012 7

Setting Accounting Principles

US
Financial Accounting Standards Board (FASB) and Securities and Exchange Commission (SEC)

Hong Kong:
Hong Kong Institute of Certified Public Accountants (HKICPA)

China
Ministry of Finance Peoples Republic of China

International Accounting Standard Board (IASB)

International Financial Reporting Standards (IFRS)

McGraw-Hill

ACCT2020 Spring 2012

Principles and Assumptions of Accounting

Revenue Recognition Principle

1. Recognize revenue when it is earned. 2. Proceeds need not be in cash. 3. Measure revenue by cash received plus cash value of items received.

Cost Principle
Accounting information is based on actual cost. Actual cost is considered objective.

Matching Principle
A company must record its expenses incurred to generate the revenue reported.
McGraw-Hill

Full Disclosure Principle

A company is required to report the details behind financial statements that would impact users decisions.
9

ACCT2020 Spring 2012

Principles and Assumptions of Accounting

Now

Future

Going-Concern Assumption
Reflects assumption that the business will continue operating instead of being closed or sold.

Monetary Unit Assumption

Express transactions and events in monetary, or money, units.

Business Entity Assumption

A business is accounted for separately from other business entities, including its owner.
McGraw-Hill

Time Period Assumption

Presumes that the life of a company can be divided into time periods, such as months and years.
ACCT2020 Spring 2012 10

B. Accounting Equation
Assets

Liabilities

Equity

Assets

Liabilities & Equity

McGraw-Hill

ACCT2020 Spring 2012

11

Accounting Equation
Forms of funds = Sources of funds A firm acquires assets by funds. Liabilities and equity are the sources of funds to acquire those assets. Basis for understanding the double-entry system of accounting If a business has assets of $500,000 and liabilities of $200,000; then its equity has to be $300,000

McGraw-Hill

ACCT2020 Spring 2012

12

Accounting Equation
Assets (LHS) are economic resources.
An asset has the ability or potential to provide future benefits (cash flow) to a firm

Liabilities (RHS) are creditors claims on the assets of a firm.

Creditors has provided funds to the firm The firm must pay a specified amount on a specified date Creditors claim has higher priority

Equity (RHS) is the owners claim on the assets of a firm.

After all creditor claims are satisfied, the owners, or stockholders, have a claim on those assets. Note: shareholders equity, stockholders equity and owners equity are used interchangeably in ACCT102
McGraw-Hill ACCT2020 Spring 2012 13

Assets
Cash Cash Accounts Accounts Receivable Receivable Notes Notes Receivable Receivable

Vehicles Vehicles

Resources Resources owned or owned or controlled controlled by a by a company company

Land Land

Store Store Supplies Supplies

Buildings Buildings Equipment Equipment

ACCT2020 Spring 2012 14

McGraw-Hill

Liabilities
Accounts Accounts Payable Payable Notes Notes Payable Payable

Creditors Creditors claims on claims on assets assets

Taxes Taxes Payable Payable
McGraw-Hill ACCT2020 Spring 2012

Wages Wages Payable Payable

15

Expanded Accounting Equation

Assets Assets

=
_

Liabilities Liabilities

+
Revenues Revenues

Equity Equity

Owner Owner Capital Capital

Owner Owner Withdrawals Withdrawals

Expenses Expenses

Owner's Equity
McGraw-Hill ACCT2020 Spring 2012 16

Expanded Accounting Equation

Revenues: gross increase in equity from a companys earnings activities. Expenses: the cost of assets or services used to earn revenue. Expenses decrease owners equity. Owner investments: the assets an owner puts into the company. Owner withdrawals: the assets take away from the company for personal use.
McGraw-Hill ACCT2020 Spring 2012 17

C. Transaction Analysis
Business activities can be described in terms of transactions and events. Transactions: exchanges of economic consideration between two parties.
External Transactions occur between the organization and an outside party. Internal Transactions occur within the organization.

Events refer to those happenings that affect an entitys accounting equation and can be reliably measured.

McGraw-Hill

ACCT2020 Spring 2012

18

Transaction Analysis Equation

The accounting equation MUST remain in balance after each transaction.

Assets Assets

Liabilities Liabilities

Equity Equity

McGraw-Hill

ACCT2020 Spring 2012

19

Transaction Analysis Example

J. Scott invests $20,000 cash to start the business.
The accounts involved are: (1) Cash (asset) (2) Owner Capital (equity)

McGraw-Hill

ACCT2020 Spring 2012

20

Transaction Analysis Example

J. Scott invests $20,000 cash to start the business.
Assets Cash Supplies Equipment (1) $ 20,000 = Liabilities Accounts Notes Payable Payable + Equity Owner Capital $ 20,000

$ 20,000 $

$ $

20,000

$ 20,000

$ 20,000
McGraw-Hill

ACCT2020 Spring 2012

21

Transaction Analysis Example

Purchased supplies paying $1,000 cash. The accounts involved are:

McGraw-Hill

ACCT2020 Spring 2012

22

Transaction Analysis Example

Purchased supplies paying $1,000 cash.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 = Liabilities Accounts Notes Payable Payable + Equity Owner Capital $ 20,000

$ 19,000 $

1,000 $

$ $

20,000

$ 20,000

$ 20,000
McGraw-Hill

ACCT2020 Spring 2012

23

Transaction Analysis Example

Purchased equipment for $15,000 cash. The accounts involved are:

McGraw-Hill

ACCT2020 Spring 2012

24

Transaction Analysis Example

Purchased equipment for $15,000 cash.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 = Liabilities Accounts Notes Payable Payable + Equity Owner Capital $ 20,000

4,000 $ 1,000 $ $ 20,000

15,000 =

$ $

20,000

$ 20,000

McGraw-Hill

ACCT2020 Spring 2012

25

Transaction Analysis Example

Purchased Supplies of $200 and Equipment of $1,000 on account. The accounts involved are:

McGraw-Hill

ACCT2020 Spring 2012

26

Transaction Analysis Example

Purchased Supplies of $200 and Equipment of $1,000 on account.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 (4) 200 1,000 $ 4,000 $ 1,200 $ $ 21,200
McGraw-Hill

Liabilities Accounts Notes Payable Payable

Equity Owner Capital $ 20,000

$ 1,200 $ 1,200 $ = $ 21,200

27

16,000

$ 20,000

ACCT2020 Spring 2012

Transaction Analysis Example

Borrowed $4,000 from 1st American Bank. The accounts involved are:

McGraw-Hill

ACCT2020 Spring 2012

28

Transaction Analysis Example

Borrowed $4,000 from 1st American Bank.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 (4) 200 1,000 (5) 4,000 $ 8,000 $ 1,200 $ 16,000 $ 25,200
McGraw-Hill

Liabilities Accounts Notes Payable Payable

Equity Owner Capital $ 20,000

$ 1,200 $ $ 1,200 $ = $ 4,000 4,000 25,200

29

$ 20,000

ACCT2020 Spring 2012

Transaction Analysis Example

The balances so far appear below. Note that the Balance Sheet Equation is still in balance.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity Owner Capital $ 20,000

8,000 $

1,200 $

16,000 =

1,200 $

4,000

$ 20,000

$ 25,200

$ 25,200

McGraw-Hill

ACCT2020 Spring 2012

30

Transaction Analysis Example

Provided consulting services receiving $3,000 cash. The accounts involved are:

McGraw-Hill

ACCT2020 Spring 2012

31

Transaction Analysis Example

Provided consulting services receiving $3,000 cash.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000 = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity Owner Capital Revenue $ 20,000 $ 3,000

$ 11,000 $

1,200 $

16,000 =

$ 1,200 $ 4,000 $ 28,200

20,000 $

3,000

$ 28,200

McGraw-Hill

ACCT2020 Spring 2012

32

Transaction Analysis Example

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.
McGraw-Hill ACCT2020 Spring 2012 33

Transaction Analysis Example

Paid salaries of $800 to employees.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000 (7) (800) $ 10,200 $ $ 1,200 $ 16,000 27,400 = = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity Owner Capital Revenue Expenses $ 20,000 $ 3,000 $ (800) $ 20,000 $ 3,000 $ (800)

$ 1,200 $ 4,000 $ 27,400

Remember that expenses decrease equity.

McGraw-Hill ACCT2020 Spring 2012 34

Transaction Analysis Example

A withdrawal of $500 is made by the owner.
The accounts involved are: (1) Cash (asset) (2) Withdrawals (equity)
Remember that the withdrawal account actually increases. But, total equity decreases because the withdrawal reduces equity.
McGraw-Hill ACCT2020 Spring 2012 35

Transaction Analysis Example

A withdrawal of $500 is made by the owner.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000 (7) (800) (8) (500) $ 9,700 $ 1,200 $ 16,000 $ 26,900 = = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Owner Capital $ 20,000 Equity Owner Withdrawals Revenue $ $ 20,000 $ (500) (500) $ 3,000 $ $ 1,200 $ 4,000 $ 3,000 $ (800) (800) Expenses

$ 26,900

Remember that withdrawals decrease equity.

McGraw-Hill ACCT2020 Spring 2012 36

D. Financial Statements
Lets prepare the Financial Statements reflecting the transactions we have recorded.
1. Income Statement 2. Statement of Owners Equity 3. Balance Sheet 4. Statement of Cash Flows

McGraw-Hill

ACCT2020 Spring 2012

37

Income Statement
Scott Company Income Statement For Month Ended December 31, 2007 Revenues: Consulting revenue Expenses: Salaries expense Net income

3,000 800 2,200

Net income is the difference between Revenues and Expenses.

The income statement describes a companys revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities.
McGraw-Hill ACCT2020 Spring 2012 38

Statement of Owners Equity

Scott Company Scott Company Income Statement Income Statement For Month Ended December 31, 2007 For Month Ended December 31, 2007 Revenues: Revenues: Consulting revenue Consulting revenue Expenses: Expenses: Salaries expense Salaries expense Net income Net income

$ $

3,000 3,000 800 800 2,200 2,200

The net income of $2,200 increases Owner's Equity by $2,200.

$ $

Scott Company Statement of Owner's Equity For Month Ended December 31, 2007 Capital, December 1, 2007 Plus: Investments by Owner Net Income Less: Withdrawals by owner Capital, December 31, 2007
McGraw-Hill ACCT2020 Spring 2012

$ $ 20,000 2,200

22,200 22,200 500 21,700

39

Balance Sheet
The Balance Sheet describes The Balance Sheet describes a companys financial a companys financial position at a point in time. position at a point in time.
Scott Company Balance Sheet December 31, 2007 Assets $ Liabilities & Equity Accounts payable $ Notes payable Total liabilities Owner Capital Total liabilities and equity $

Cash Supplies Equipment

9,700 1,200 16,000

1,200 4,000 5,200 21,700 26,900

Total assets

26,900

McGraw-Hill

ACCT2020 Spring 2012

40