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Introduction to Accounting

Introduction

to

Accounting

Accounting An Information Process Users of Accounting Information GAAP The Accounting Equation Double Entry System

Accounting...
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is the language of business.

Accounting..
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is an information system that...

measures business activities,

processes information, and... communicates financial information.

Accounting The Language of Business

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Accounting is the information system that...

measures business activities,

processes data into reports, and communicates results to decision makers.

Accounting

- a process of identifying, recording, summarizing, and reporting economic information to decision makers in the form of financial statements.

Definitions of Accounting
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The process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by users of the information.
American Accounting Association (AAA)

A service activity whose function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.
American Institute of Certified Public Accountants (AICPA)

Features of Accounting
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Identifying the business transaction to be recorded in the books of account Measuring (value in terms of money) Recording Classifying Summarising (effects of business transaction through various financial statements) Analysis and interpretation (drawing meaningful conclusion about profit, financial position & future prospects) Communicating ( results to end users)

Primary Functions of Accounting

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Recording data about business transactionsSummarizing results of business activity into useful reportProviding assurances that the business is operating as intended

Purpose of Accounting
Purpose of Accounting i. Planning how you are going to use your money ii. Recording accounting data. iii. Keeping specific records of information in specific manual. iv. Enabling circulating information. v. Use accounting data to make decision.

Advantages of Accounting
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Maintenance of permanent records of business. Ascertainment of profit or loss Ascertainment of progress of the business Ascertainment of financial position Ascertainment of amounts due to/from the business. Maintaining documentary evidence Prevention of errors and frauds Control over activities Helpful to management Provides information to external users Satisfaction of legal requirement

Accounting as an Aid to Decision Making

Accounting helps in decision making by showing where and when money has been spent, by evaluating performance, and by showing the implications of choosing one plan instead of another. Fundamental relationships in the decisionmaking process:
Event Accountants analysis and recording

Financial statements

Users

Accounting An Information Process

Identification of Users

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Accounting An Information Process

Identification of Users

User Information Needs

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Accounting An Information Process

Identification of Users

User Information Needs

Accounting System

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Accounting An Information Process

Identification of Users

User Information Needs

Economic Data and Activities

Accounting System

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Accounting An Information Process

Identification of Users

User Information Needs

Economic Data and Activities

Accounting System

Reports

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Accounting An Information Process

Identification of Users

User Information Needs

Economic Data and Activities

Accounting System

Reports

User Decisions

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The Flow of Accounting Information

1. Business transactions occur

2. Businesses prepare reports to Show the results of their operations

3. People make decisions.

The Flow of Accounting Information

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Accounting systems are designed to meet the needs of the decision makers who use the financial information. Every business maintains some type of accounting system.
These

accounting systems may be very complex or very simple, but the real value of any accounting system lies in the information that the system provides.

Users of Accounting Information

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Individuals

Government regulatory agencies

Businesses Investors and creditors

Taxing authorities Nonprofit organizations

Users of Accounting Information

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Financial Accounting
EXTERNAL USERS

investors investors creditors creditors regulators regulators customers customers competitors

competitor s

Users of Accounting Information

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Financial Accounting
EXTERNAL USERS

investors creditors regulators customers competitors

Financial Accounting
INTERNAL USERS

owners managers employees

owners

managers

employees

Users of Accounting Information Users of Accounting Information

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External users make decisions about the entity.

Internal users make decisions for the entity.

Financial Accounting
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Its focus is on reporting to external parties. It measures and records business transactions.

It provides financial statements based on generally accepted accounting principles.

Management Accounting
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It measures and reports financial and nonfinancial information that helps managers make decisions to fulfill the goals of an organization.

Cost Accounting
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It provides information for both management accounting and financial accounting. It measures and reports financial and nonfinancial data.

Some Definitions to remember:

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Inventory - goods held by a firm for resale to customers Account payable - a liability that results from the purchase of goods or services on account Compound entry - a transaction that affects more than two accounts Creditor - one to whom money is owed Debtor - one who owes money

Assets
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What is an asset? It is something a company owns which future economic value. land building equipment goodwill

has

Liability
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What is a liability? It is something a company owes. money service product

Revenues
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What are revenues? They are amounts received or to be received from customers for sales of products or services. sales performance of services rent interest

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What are Expenses? They are amounts that have been paid or will be paid later for costs that have been incurred to earn revenue. salaries and wages utilities supplies used advertising

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Cash basis accounting v/s accrual basis accounting

Owners Equity
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What is owners equity? It is whats left of the assets after liabilities have been deducted. the same as net assets the owners claim on the entitys assets

Transactions that Affect Owners Equity

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OWNERS EQUITY INCREASES

OWNERS EQUITY DECREASES Owner Withdrawals from the Business Owners Equity

Owner Investments in the Business

Revenues

Expenses

Effects of Transactions on Owners Equity

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OWNERS EQUITY

Effects of Transactions on Owners Equity

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OWNERS EQUITY decreased by

Effects of Transactions on Owners Equity

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OWNERS EQUITY decreased by

Owners withdrawals

Expenses

Effects of Transactions on Owners Equity

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OWNERS EQUITY increased by

Effects of Transactions on Owners Equity

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OWNERS EQUITY increased by

Owners investments Revenues

Effects of Transactions on Owners Equity

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OWNERS EQUITY decreased by increased by

Owners withdrawals

Owners investments Revenues

Expenses

Financial and Management Accounting

Accountants answer these primary questions with three major financial statements. Balance Sheet - financial picture on a given day Income Statement - performance over a given period Statement of Cash Flows - performance over a given period

The Balance Sheet

Sections of the balance sheet: Assets - resources of the firm that are expected to increase or cause future cash flows (everything the firm owns) Liabilities - obligations of the firm to outsiders or claims against its assets by outsiders (debts of the firm) Owners Equity - the residual interest in, or remaining claims against, the firms assets after deducting liabilities (rights of the owners)

The Balance Sheet

The balance sheet equation:

Assets = Liabilities + Owners Equity or Owners Equity = Assets - Liabilities

The Balance Sheet

Assets Current assets: Cash $ 9,800 Accounts receivable 2,040 3,765 Total current assets $ 6,565 $13,565 Plant assets: Land $ 9,755 Equipment 6,500 Total plant assets 16,255 9,255
Total assets $22,820 HAMILTON COMPANY Balance Sheet December 31, 1997 Liabilities Current liabilities: $ 4,525 Accounts payable Wages payable Total liabilities

Owners Equity Hamilton, capital

Total liabilities and Owners equity

Balance Sheet Transactions

The balance sheet is affected by every transaction that an entity encounters. Each transaction has counterbalancing entries that keep total assets equal to total liabilities and owners equity, i.e., the balance sheet equation must always be balanced.

Balance Sheet Transactions

Just as the balance sheet equation must always balance, the balance sheet must also always balance. A balance sheet could be prepared after every transaction, but this practice would be awkward and unnecessary.
Therefore,

balance sheets are usually prepared monthly or on some other periodic schedule.

Transaction Analysis

Transactions are recorded in accounts, which are summary records of the changes in particular assets, liabilities, or owners equity. The account balance is the total of all entries to the account.

Transaction Analysis

For each transaction, the accountant must determine:

which

specific accounts are affected whether the account balances are increased or decreased the amount of the change in each account

The Accounting Equation

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The Accounting Equation

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Assets

Liabilities + Owners Equity

Economic Resources

Claims to Economic Resources

The Accounting Equation

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Resources

What are an organizations resources called?

The Accounting Equation

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Resources

Sources

Assets

Resources used in the business

What are the sources of the assets?

The Accounting Equation

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Resources

Sources

Liabilities Assets Owners Equity

Resources supplied by creditors and owners

Resources used in the business

The Basic Accounting Equation

Accounting data is represented by the following relationship among the assets, liabilities and owners equity of a business: Assets = Liabilities + Owners Equity The equation must be in balance after every recorded transaction in the system.

Business Transactions
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a. Sachin deposits RS 25,000 in a bank account for ABC Ltd

ASSETS LIABILITIES

OWNERS EQUITY

Business Transactions
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a. Sachin deposits RS 25,000 in a bank account for ABC Ltd.

ASSETS LIABILITIES

Cash 25,000

OWNERS EQUITY

Business Transactions
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a. Sachin deposits RS 25,000 in a bank account for ABC Ltd.

ASSETS LIABILITIES

Cash 25,000

OWNERS EQUITY

Sachin, Capital 25,000

Business Transactions
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b. ABC Ltd. buys land for Rs 20,000.

ASSETS

LIABILITIES

OWNERS EQUITY

Business Transactions
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b. ABC Ltd. buys land for Rs 20,000.

ASSETS

LIABILITIES

Cash (20,000)

OWNERS EQUITY

Business Transactions
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b. ABC Ltd buys land for RS 20,000.

ASSETS

LIABILITIES

Cash (20,000) Land 20,000

OWNERS EQUITY

Business Transactions
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c. ABC Ltd buys goods for RS1,350, agreeing to pay the supplier in the near future.
ASSETS LIABILITIES

OWNERS EQUITY

Business Transactions
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c. ABC Ltd buys goods for RS1,350, agreeing to pay the supplier in the near future.
ASSETS LIABILITIES

Purchases 1,350

Accounts Payable 1,350

OWNERS EQUITY

Business Transactions
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e. ABC Ltd paid: wages Rs 2,125; rent, Rs 800; utilities, Rs 450; and miscellaneous, Rs 275.
ASSETS LIABILITIES

OWNERS EQUITY

Business Transactions
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e. ABC Ltd paid: wages Rs 2,125; rent, Rs 800; utilities, Rs 450; and miscellaneous, Rs 275.
ASSETS LIABILITIES

Cash (3,650)

OWNERS EQUITY

Business Transactions
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e. ABC Ltd paid: wages Rs 2,125; rent, Rs 800; utilities, Rs 450; and miscellaneous, Rs 275.
ASSETS LIABILITIES

Cash (3,650)

OWNERS EQUITY

Expenses (3,650)

Business Transactions
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f. ABC Ltd pays Rs 950 to creditors on account.

ASSETS

LIABILITIES

OWNERS EQUITY

Business Transactions
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f. ABC Ltd pays Rs 950 to creditors on account.

ASSETS

LIABILITIES

Cash (950)

OWNERS EQUITY

Business Transactions
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f. ABC Ltd pays Rs 950 to creditors on account.

ASSETS

LIABILITIES

Accounts Payable (950) Cash (950)

OWNERS EQUITY

Business Transactions
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h. Sachin withdraws Rs 2,000 in cash.

ASSETS LIABILITIES

OWNERS EQUITY

Business Transactions
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h. Sachin withdraws Rs 2,000 in cash.

ASSETS LIABILITIES

Cash (2,000)

OWNERS EQUITY

Business Transactions
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h. Sachin withdraws Rs 2,000 in cash.

ASSETS LIABILITIES

Cash (2,000)

OWNERS EQUITY

Sachins, Drawing (2,000)

Transaction Summary
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ASSETS

LIABILITIES

Cash Purchases Land

6,700 550 20,000

OWNERS EQUITY

Transaction Summary
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ASSETS

LIABILITIES Accts. Payable 400

Cash Purchases Land

6,700 550 20,000

OWNERS EQUITY

Transaction Summary
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ASSETS

LIABILITIES Accts. Payable 400

Cash Purchases Land

6,700 550 20,000

OWNERS EQUITY Sachin, Capital Sachin, Drawing Fees Earned Wages Expense Rent Expense Commission Misc. Expense 25,000 (2,000) 7,500 (2,125) (800) (450) (275)

Role of Accounting
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Good managers plan for the future. They develop a budget. A budget is a formal plan stated in monetary terms.

Role of Accounting
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Accounting helps banks decide to whom they will lend money.

Accounting provides information that helps investors pick stocks.

Role of Accounting
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Budgeting Information systems design

Cost accounting
Internal auditing

Role of Accounting
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Consulting

Assurance services including auditing

Tax accounting

Accounting as an Aid to Decision Making

Accounting information is useful to anyone who makes decisions that have economic results.

Owners want to know which employees are productive. investors want to know if a company is a good investment. Legislators want to know how a proposed law will affect budgets. Managers want to know if a new product will be profitable. Creditors want to know if they should extend credit, how much to extend, and for how long.

ABUSIVE ACCOUNTING PRACTICES

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CREATIVE ACCOUNTING PRACTICES

ENRON DEBTS

NOT REPORTED RECOGNITION OF LOSSES WAS POSTPONED REPORT INCOME BEFORE BEING EARNED

Basis of accounting
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Two types Cash basis: The cash method accounts for revenue only when the money is received and for expenses only when the money is paid out. Accrual basis: the accrual method accounts for revenue when it is earned and expenses goods and services when they are incurred. The revenue is recorded even if cash has not been received or if expenses have been incurred but no cash has been paid.

Example
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Let's say you own a business that sells machinery. If you sell $5,000 worth of machinery, under the cash method, that amount is not recorded in the books until the customer hands you the money or you receive the check. Under the accrual method, the $5000 is recorded as revenue immediately when the sale is made, even if you receive the money a few days or weeks later. The same thing occurs for expenses. If you get an electric bill for $1700, under the cash method, the amount is not added to the books until you actually pay the bill. However, under the accrual method, the $1700 is recorded as an expense the day you get the bill.

Form of Business

Sole Proprietor/Sole Trader Partnership Co-operative

Sole Proprietor or Sole Trader

Business ownership is a single business carried on by individuals and owned by individual full. Business owner have a power to control the business operations. Owners and business is referred to as one of the same entity. No separation between them. Owners will received all the profits and bear for all losses from business. Unlimited liabilities

Advantages

Easy to set up. The owner has absolute power to control the business. Fast decision make by the owner of the business. Individual Tax. No need the complex financial reports.

Disadvantages

Difficult to grow because of the limited capacity of capital Difficult to get capital financing from the financial institution because they need a strong assurance from the business. Liability is unlimited. Business will disband itself if the owner died.

Partnerships
A partnership is defined as the relationship that exist between person carrying on business. These person agree to combine some or all their property, labor and skill. This relationship is based on contract. Business owned by minimum of two persons and maximum of 20 persons. Professional service partnerships consist of maximum 50 persons. There are two types of partnerships: -Active partner -Sleeping partner

Partnerships

Strictly follow the Partnerships Act 1961 and partnerships contract of agreement for profit and loss distribution. Liability for partnerships is unlimited except for the limited partnerships. General partners have unlimited liability for partnerships debts, and the partnerships terminates when a general partner wishes to sell out or dies.

Advantages

Partnerships allow for a greater amount of money, skill and other resources to be pooled. They are relatively easy to organize. They are subject to limited government regulations and do not face high tax rates.

Disadvantages

Partnerships have a limited life. Each partner is subject to unlimited liability. This means that if the company fails, creditors can take action against both the partnership and the persons who are in it. Partners have mutual agency. This means that one partner can make decisions without consulting to other(s).

Co-operative

It is a business organization owned and operated by a group of individuals for their mutual benefits. A community based business Eg: Bank Rakyat, Koperasi Angkatan Tentera Malaysia and Angkasa.

Corporation
A business created as a distinct legal entity composed of one or more individuals or entities. In Malaysia, corporations are follow strictly under Company Act 1965. Corporation are divide into two -Private Limited -Public Limited

Corporation

Private limited can be held by minimum of 2 and maximum of 50 shareholders. There is no maximum shareholders for Public limited company. Shareholders will received their profit in the form of dividend. Corporation managed by Board of Director that appointed by shareholders in AGM. Liability of shareholders is limited base on the paid up capital. Tax is paid, base on company profit. Eg: Tenaga Nasional Berhad, Safeguard Securicor Sdn Bhd.

Types of Ownership
Corporation

An artificial entity created under state laws Corporations have limited liability - corporate creditors have claims against corporate assets only.
Individual

investors are at risk only up to the amount they have invested in the corporation. Creditors cannot hold investors liable for the corporations debts.

Types of Ownership
Corporation

Owners are called shareholders or stockholders. Publicly owned vs. privately owned corporations
Public

- Shares in the ownership are sold to the public on a stock exchange; the corporation can have many thousands of shareholders. Private - Shares in the ownership are owned by families, small groups of shareholders, and shares are not sold to the public.

Advantages and Disadvantages of Forms of Ownership

Corporations

Advantages
limited

liability easy transfer of ownership - shares of stock can be bought and sold easily (stock exchanges) ease of raising ownership capital - many potential stockholders continuity of existence - life of the corporation continues even if its ownership changes

Advantages and Disadvantages of Forms of Ownership

Corporations

Disadvantages
possibility

of double taxation - corporation pays tax at the entity level and its owners pay taxes on distributions of earnings to them