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8/3/2019 Chap01 Premium

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Chapter 1Principles of

Accounting

Uses of Accounting

Information and theFinancial Statements


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Copyright Houghton Mifflin Company. All rights reserved. 1 | 2

CVS: How Is Success Measured?

Learn more about the company at

CVS.com

More than 5,000 stores

Quality products

Holds #1 or #2 marketshare in 73% of the top100 markets in which itserves

Large selection

Good service

Strong management

Royalty Free Digital Vision/ Getty Images


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Accounting as an Information System

LO1

Define accounting, and

describe its role in

making informed

decisions, identify

business goals and

activities, and explain

the importance of ethicsin accounting.

Royalty Free PhotoDisc Blue/ Getty Images


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What Is Accounting?

Accounting is an

information system

that measures,

processes, and

communicatesfinancial information

about an economic

entity

Supplies information for reasoned choices among

alternative uses of scarce resources in business and

economic activities

Royalty-Free/Corbis


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Economic Entity: Business

Economic

unit that aims

to sell goods

and servicesto customers

Provides adequate return to owners

Examples:Wal-Mart, Best Buy,Wendys

Royalty-Free/Corbis


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Why Is AccountingImportant to Business?

To achieve

business goals

Profitability

Liquidity

To carry on

business activities

Operating

Investing

Financing


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Meeting Business Goals

Profitability

Is the business

earning enough

income to attract

and hold

investment

capital?

Liquidity

Does the

business have

enough cash to

pay debts when

they are due?

Royalty Free C Squared Studios/ Getty Images


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Conducting Business Activities

Operating

Activities

Investing

Activities

Financing

Activities

Buying land,buildings, and

equipment Purchasing other

resourcesnecessary tooperate thebusiness

Selling theseresources when nolonger needed

Obtaining capitalfrom creditors

Gathering fundsfrom owners

Repaying creditors

Paying returns toowners

Selling goods and

services to

customers

Employing

managers and

workers

Buying and

producing goodsand services

Paying taxes


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Performance Measures

Indicate whethermanagers areachievingbusiness goals

and whetherbusinessactivities are wellmanaged

Should be crafted in a way that motivates managers to

act in the best interests of the owners of the business

Royalty Free PhotoDisc Collection/ Getty Images


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Performance Measures: Ratios

Used to compare a companys financialperformance from one year to the next

Helpful when making comparisons among

companies

Examples:

Total Liabilities / Total Assets

Total Expenses / Total Revenues


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Who Needs Accounting Information?

Internal Users External Users

Management Accounting

Information about past

performance and what canbe expected in the future

Financial Accounting

Financial statements

report on profitability andliquidity to evaluate the

success of a business

Employees

Managers

Creditors

Government regulators

Owners (or stockholders)


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Components of Accounting

AccountingRecord Transactions:

Bookkeeping

System

Design

Analyze & Interpret

Information

Communicate

Information

Processing can be

done:

Manually, By computer, or

Using a

management

information system



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Importance ofEthics

in Financial Reporting Users of reports depend on

the good faith of those who

prepared the reports

Users rely on the accuracy ofthe reports and the disclosureof all relevant facts

Investors make decisions

based on the reliability of

the reports



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Sarbanes-Oxley Act

Chief executives and chief financial officers ofall publicly traded U.S. companies must attestto the accuracy and completeness of their

quarterly statements and annual reports filedwith the SEC

On theWeb

Violations can result in criminal penalties

Want to learn more about the legislation?

Sarbanes-Oxley.com


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Management Responsibility

What assurance does management give that a companysreports are not false or misleading?

Research: Find the current years annual report forCVS

on the companys website and locate ManagementsReport.What language is used?

CVSs SEC Filings

W

e are responsible for establishing and maintaining effective internalcontrol over financial reporting. . . . the unauthorized acquisition, use or

disposition of assets are prevented or timely detected and that transactions

are authorized, recorded and reported properly to permit the preparation of

financial statements in accordance with GAAP and receipt and expenditures

are duly authorized.

On theWeb


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Stop & Review

Q.What is accounting and what business goals

does it help managers achieve?

A. Accounting measures, processes, andcommunicates financial information about

an economic entity. It helps managers

achieve the goals of profitability andliquidity.


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Stop & Review

Q.What is the difference between management

accounting and financial accounting?

A. Management accounting provides internalusers like managers and employees with

information to make operating decisions.

Financial accounting provides financialstatements to external users like creditors

and owners.


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Decision Makers:

The Users of Accounting Information

LO2Identify

the users of

accounting

information.

Royalty-Free/Corbis


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Who Uses

Accounting Information?

ThoseWith Direct

Financial Interests

Management ThoseWith Indirect

Financial Interests Finance

Investment

Operations &Production

Marketing

Human

Resources

Accounting

TaxAuthorities

Regulators Labor Unions

Customers

Economic

Planners

Owners

Creditors

Banks



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If You Were a Manager

Making good financial decisions requiresreliable accounting information.

Does my company have enough cash?

Which products are most profitable?

Is the rate of return to owners adequate?

What is the cost of manufacturing each

product or service? Royalty Free C Squared Studios/ Getty Images


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Users with Direct Financial Interests


Require financial

information toanalyze the past

success and potential

earnings ofa business

Creditors

Require financial

information toassess whether acompany will havethe cash to repaythe debt beforemaking a loan

Investors

(including Owners)


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Users with Indirect Financial Interests

Labor Unions, ConsumerGroups,Customers, and OtherGroups the financial

performance and prospects ofbusinesses affect the economy,environment, and public policy

Regulatory Agencies publicly traded companies must

report periodically to the SEC

Tax Authorities require special tax returns and

recordkeeping

Royalty-Free/Corbis


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Stop & Review

Q. Who are some users of financial information

with an indirect financial interest?

A. Consumer groups, taxing authorities,

government agencies, the general public, andlabor unions are a few groups with an

indirect financial interest in financial

accounting information.


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Accounting Measurement

LO3

Explain the

importance ofbusiness

transactions,

money measure,

and separate

entity.



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Making an Accounting Measurement

What is measured?Business

transactions

Economic events that affect the financial position of a business

Sale of goods

Loss from theft

Collection of loan

Wear and tear on machinery


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Concept of Money Measure

All business transactions

are recorded in terms of

money.

The monetary unit useddepends on the country

in which the business

resides. An exchange rate is used to translate one

currency to another for international

transactions.


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Concept of Separate Entity

A business is considered distinct from its

creditors and customers as well as its owners

Business

reports &

accounts

Personalreports &

accounts


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Stop & Review

Q. If Ray Coldwell has a bank account that he

uses for his personal transactions as well as

his business transactions, is the concept of

separate entity being employed?

A. No. A business must keep its records and

accounting separate from its owners

personal accounts.


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Stop & Review

Q. Describe at least two business transactionsthat affect the financial position of a

business.

A. The sale of goods or services, collection ofa loan, payment of an invoice, or purchase

of supplies are examples of transactions

that affect the financial position of a

business.


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The Forms of Business Organization

LO4

Identify the

three basic

forms of

business

organization.

Royalty-Free/Corbis


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Forms of Business

Sole Proprietorship Partnership Corporation One owner

Owner takes all

profits and losses

Owner is liable forall business

obligations

Two or more

owners

Partners share in

profits and losses One partner can

obligate the

business to another

party

Must be dissolvedif ownership

changes

Business unit

chartered by the

state with articles

of incorporation;

legally separatefrom owners

(stockholders)

Stockholders enjoy

limited liability

Life of corporation

is unlimited



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Corporation

Stockholders

Elect a board

of directors

and own

shares ofstock

Board of

Directors

Determines

corporate

policy, declares

dividends, and

appointscorporate

officers

Management

Carries out

corporate

policies and

manages thebusiness


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IMCO Recycling Inc.

View this video to

learn what factors

were considered when

IMCO Recycling

chose its form of

business organization.


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Stop & Review

Q. What are the characteristics of a corporation?

A. A corporation is a separate legal entity

owned by its stockholders. The stockholderselect a board of directors to run the

corporation.


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Financial Position

and the AccountingE

quation

LO5Define financial

position, and state the

accounting equation.



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Financial Position

Economic resources (cash,

inventory, buildings) and

the claims against those

resources at a particularpoint in time

Economic Resources = CreditorsEquities + Owners Equity

Royalty Free PhotoDisc Collection/Getty Images


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Building the Accounting Equation

Economic Resources = CreditorsEquities + Owners Equity

In accountingterms

Assets = Liabilities + Owners Equity

The two sides of the equation must always be in balance.


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Assets

Economic resources

expected to benefit

the companys future

operations

Patents, trademarks, copyrights (nonphysical)

Inventory, land,

equipment,

buildings (physical

items)

Cash, accounts receivable (monetary items)

Royalty-Free/Corbis


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Liabilities

Obligations to pay cash, transfer assets, or provide

services to other entities in the future

May take the form of

accounts payable,

taxes payable, loans,

or wages owed to

employees

Liabilities are claims

recognized by law Royalty Free C Squared Studios/ Getty Images


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Owners Equity

Claims of the owners of a company to

the assets of the business

Revenues and investmentsincrease owners equity

Expenses and withdrawals decreaseowners equity


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Stop & Review

Q. State the accounting equation.

A. Assets = Liabilities + Owners Equity


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Stop & Review

Q. Can you name a transaction that would

increase both assets and liabilities?

A. The purchase of a piece of equipment onaccount would increase assets and liabilities.


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Stop & Apply

Q. If Abbott Industries had assets of $40

million and liabilities of $22 million,

what is the amount of owners equity?

A. Owners equity = $40 million

$22 million or$18 million

Assets = Liabilities + OwnersE

quity$40 million = $22 million + $18 million


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Financial Statements

LO6

Identify the fourbasic financial

statements.



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Communicating Financial Information

Four primary financial statements

Balance Sheet

Statement of

Cash Flows

Income Statement

Statement ofOwners Equity

Royalty-Free/Corbis


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Income Statement

Ramirez AgencyIncome Statement

For the Month Ended December 31, 20xx

R

evenuesCommissions earned $7,000

Expenses

Equipment rental ex pense $1,400Wages ex pense 800Utilities ex pense 600

Total ex penses Net income $4,200

Summarizes

revenues and

expenses over an

accounting

period

Shows whether the goal of

profitability was achieved

Oftenconsidered the

most important

financial

statement


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Statement of Owners Equity

Ramirez Agency

Statement ofOwners Equity


R. Ramirez, Capital, December 1, 20xxInvestment by R. Ramirez

$ 0100,000

Net income for the month 4,200

Subtotal $104,200Less withdrawals 1,200

R. Ramirez, Capital, December 31, 20xx $103,000

Shows changes inowners equity over

an accounting

period

Net income figure

from income

statement

Use this figure to

prepare the balance

sheet


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Balance Sheet

Ramirez Agency

Balance Sheet

December 31, 20xx

Assets Liabilities

CashAccounts receivableSupplies

$31,2002,0001,000

Accounts payableTotal liabilities

$1,200$1,200

Land 20,000 Owners EquityBuildings 50,000 R. Ramirez, capital 103,000

Total assets $104,200 Total liabilities and owners equity $104,200

Shows financial

position on a

certain date

Ending balance of owners capital

from statement of owners equity


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Statement ofCash Flows

Ramirez Agency

Statement ofCash Flows


Cash flows from operating activities Net income $4,200Adjustments to reconcile net income to net cash

flows from operating activities

Increase in accounts receivable ($2,000)Increase in supplies (1,000)Increase in accounts payable 1,200 (1,800)

Net cash flows from operating activities $2,400Cash flows from investing activitiesPurchase of land ($20,000)Purchase of building (50,000)

Net cash flows from investing activities (70,000)

Cashflows

from

financing activitiesInvestments by owners $100,000

Withdrawals (1,200)

Net cash flows from financing activities 98,800

Net increase (decrease) in cash $31,200Cash at beginning of month 0

Cash at end of month $31,200

Shows cash inflowsand outflows for an

accounting period

Net income

from income

statement

Matches cash

account on

balance sheet


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Stop & Review

Q. How does the income statement differ from

the balance sheet?

A. The income statement covers an accountingperiod while the balance sheet is a snapshot

of a companys financial position at a

particular date. The income statement

shows whether the company achieved itsprofitability goal.


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Stop & Review

Q. The income statement for MembersPharmacy reported $246,050 in net income.On what other statements would this amount

appear?

A. This amount would appear on the statement

of owners equity and the statement of cash

flows.


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Generally Accepted

Accounting Principles

LO7

Explain how generally

accepted accounting

principles (GAAP)relate to financial

statements and the

independent CPAs

report, and identify the

organizations that

influence GAAP. Royalty-Free/Corbis


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What Are GAAP?

Generally acceptedaccounting principles(GAAP) encompass the

conventions, rules, andprocedures necessary todefine acceptedaccounting practice at a

particular time.

GAAP are constantly growing, changing, and improving



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GAAP and the Audit

Audits are performed by independent CPAs

The CPA renders an opinion about whether the

statements present fairly or conform in all

material respects to GAAP

Audits are performed to determine that

financial statements have been prepared in

accordance with GAAP


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Organizations

That Influence GAAP

GAAP

PublicCompany

Accounting Oversight

Board (PCAOB)

Financial Accounting

Standards Board (FASB)

American Institute of

Certified Public

Accountants (AICPA)

Securities and

Exchange

Commission

(SEC)

GovernmentalAccounting Standards

Board (GASB)

InternationalAccounting Standards

Board (IASB)

Primary source

of GAAP


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Professional Ethics

Key to the accountantsreputation for independence

and competence

The AICPAs code ofprofessional ethics governs

conduct ofCPAs

Is the accountant honest and candid? Does he or sheput aside personal gain in service of the public trust?

Is the accountant impartial and intellectually honest?

Does the accountant avoid all relationships that

impair or appear to impair his or her objectivity?

Integrity

Objectivity

Independence


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Discussion: Ethics on the Job

Carla McDonald is a CPA working on an

audit with Trevor Industries. Teresa Wong,

the staff accountant with Trevor Industries,

invites her and her audit team to dinner at an

expensive restaurant and insists on picking

up the check.

Q. If Carla allows Teresa to pick up the check,

has she violated any ethical standard?Why

or why not?


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Stop & Review

Q. What are GAAP?

A. GAAP are the conventions, rules, and

procedures necessary to define acceptedaccounting practice at a particular time.


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Stop & Review

Q. Which organization is the primary source

of GAAP?

A. The FASB is the most important body fordeveloping rules on accounting practice.


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Chapter Review Problem

Callahan Properties had net income of $52,500 for the year

ended December 31, 20x8. The beginning balance of J.

Callahan, Capital at January 1, 20x8 was $200,000. No

withdrawals were made during the year. Total assets at

December 31, 20x8 were $257,500. Determine total liabilities

at December 31, 20x8.

Solution:

Assets = Liabilities + Owners Equity

$257,500 = X + ($200,000 + $52,500)

$257,500 = X + $252,500

X = $5,000

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