What Is Accounting?: Definition 1 (Inst. Certified Pub. Accountants)

Introduction to Accounting
Definitions of Accounting
Definitions of Accounting
What is Accounting?
Definition 1 (Inst. Certified Pub. Accountants ):
Accounting is the art of recording, classifying, and summarizing
in a significant manner and in terms of money, transactions and
events which are, in part at least, of a financial character, and
interpreting the results thereof.
Therefore, accounting is a link between business activities and

decision makers.
Decision Makers
Action
Information
Needs
Definition 2 (A broader perspective): Accounting

Business
Activities
is the process of identifying, measuring, and communicating

economic information to permit informed judgements and
decisions by users of the information.
Definition 3: wrt. Quantitative information
Accounting is a service activity. Its function is to provide
quantitative information, primarily financial in nature about
economic entities that is intended to be useful in making
economic decisions, in making resolved choices among
Dr.Serhan Duran (METU)
Industrial Engineering Dept.
alternative
courses of action.EM 501 Week 1
Information
Data
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Measurement
Processing
Communication
Recording data
Storing data
Reporting
EM 501 Week 1
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Distinctions from Bookkeeping
Users of Accounting
What is the Difference between Accounting and Bookkeeping?

Bookkeeping
Mundane function of
The Parties that Use the Accounting?

1-Internal usage: Management Accounting
Creating reports for
Collecting
Recording
Reporting operating & financial info of firm
controlling costs
measuring performance
planning the future
Vital but
Clerical of accounting
The data and reports must be

accurate
timely
objective and flexible
Accounting
Includes design of information systems that meets users
needs
Its main goals are:
Cost controlling function is known as Cost Accounting.
Analysis of data
Interpretation of data
Using these for problem solving
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Users of Accounting
Users of Accounting
Accounting Function
2-External usage: Stewardship Accounting
Stewardship Accounting
Measure and report information about how the business

performed
- external usage
-report for public usage
regular
accurate
verifiable
standardized
Income Tax Accounting

-special income reports
-tax forms
Financial Accounting
Accounting for
Regulatory Agecies
-reports that meets

standards
Users of these reports are

ex: selection of
depreciation rule
investors
creditors
shareholders
government regulatory agencies
ex: inventory
value
Cost Accounting
Management Accounting
Major accounting system in a manufacturing firm
EM 501 Week 1
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internal usage
coordination
planning and control
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Types of Business Organization
Financial Position - What the company owns and owes
Three types of business

1
Economic resources that belong to a company and the claims against

those resources at a point in time
Proprietorship
owned by a single person
Legally, the proprietorship is the same as the individual
individual receives all profit or losses
A company can be viewed as

Economic resources = Claims
Partnership
owned by more than one person
Legally, the Partnership is again the same as the individuals
receive all profit or losses
Financial Position and the Accounting Equation
Two types of Claims, creditors and owners claims

Economic resources = creditors claims + owners claims
In accounting terminology, economic resources are called Assets,
creditors claims is called Liabilities and owners claims is called as
Equity.
Corporation
separate from its owners (stockholders)
ownership divided into transferable shares of stock
owners do not control the operations directly
the stockholders enjoy limited liability
Accounting Equation
Assets = Liabilities + Equity
From Accounting Perspective - Economic Entity Assumption

This equation tells us that the assets owned by the company are
subject to the rights of debt holders and owners.
Activities of organization kept separate from the activities of owners

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Assets
Economic resources owned by a business that are expected to benefit
future operations.
converted to cash within one year are current
Cash
Accounts Receivable (money owed to the business)
Supplies
Inventory
Liabilities
Obligations in form of money to be paid or services to be rendered by
the company to the outsiders
payable within one year are current
Notes Payable
Account Payable and
Taxes payable
having a life exceeding one year are noncurrent.
payable in more than a year are noncurrent.
Land
Equipment
Buildings
Machinery
Bonds Payable
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Owners/Stockholders Equity
The residual interest in the assets of an entity that remains after
deducting its liabilities or the equity interest of the owner(s).
In a Proprietorship, Owners Equity has only one Capital Account
(owners).
In a Partnership, Owners Equity is composed of Capital Accounts
for each owner.
In a Corporation, equity represents the Stockholders Equity
Shares of Stock
Authorized Shares
1
Issued Shares
Treasury Stock owned by company
Outstanding Shares
Dividends based on them
Common Stock has voting rights
Preferred Stock has priority in dividend distribution
Share capital - ordinary

Retained Earnings-Accumulated earnings minus dividends
Five types of transactions affect owners equity

1
2
3
4
5
Unissued Shares
Owners investments increases owners/Stockholders equity

Owners withdrawals decreases owners equity
Revenues increases owners/Stockholders equity
Expenses decreases owners/Stockholders equity
Dividends decreases Stockholders equity
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Effects of Business Transactions on Accounting Equation
Business Transactions
are economic events that affect the financial position of a business
entity. These transactions are the raw material of accounting reports. It
can be:
1
An Exchange of Value between two or more parties
A purchase
A sale
A collection
A loan
2
It maintains the equivalence of assets and claims on it

Every business transaction has dual effect
Debit
Credit
A business transaction affects either:

Both sides of the equation by the same amount
One side of the equation only, by both increasing and decreasing it
by identical amounts, netting to zero
A Nonexchange Transaction
Accumulation of Interest
Physical wear and tear on machinery and equipment
Losses from flood, fire, theft
Double-Entry Accounting
EM 501 Week 1
Now Lets Analyze the Effects of some Business Transactions on

Accounting Equation
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EM 501 Week 1
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Transaction 1: Aras starts a business by depositing $50,000 in a bank

in the name of Luxury Homes Realty.
Transaction 2: After starting his business, Aras finds a good location
for his office,and purchases with cash a lot for $10,000 and a small
building on the that lot for $25,000.
Owners Investments
Assets
Cash
$50,000
Owners Equity
Type of OE
Transaction
Purchase of Assets with Cash
Owners investment
Cash
Land
Building
bal. $50,000
-$35,000
+$10,000
+$25,000
bal. $15,000
$10,000
$25,000
Aras,
Capital
$50,000
Assets
Accounts
The labels Cash, Aras, Capital are accounts
Owners Equity
Aras,
Capital
Type of OE
Transaction
$50,000
Owners investment
$50,000
Accounts are used by accountants to accumulate amounts

produced from like transactions
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Transaction 3: Aras buys office supplies for $500 on credit. This

transaction will increase both sides of the accounting equation.
Transaction 4: Let us see how the balance equation changes when

Aras pays $200 of the $500 owned for the supplies he has purchased
before.
Buying on Credit
On agreement to pay for the asset or service later.
Payment of a Liability
Purchase of Assets by Incurring a Liability

Assets
Cash
Supplies
bal. $15,000
=
Land
Building
$10,000
$25,000
+$500
bal. $15,000
$500
Liabilities
Accounts
Payable
Assets
+
Type of OE
Transaction
$50,000
Owners Equity
Supplies
Land
Building
Accounts
Payable
Aras,
Capital
bal. $15,000
$-200
$500
$10,000
$25,000
$500
$-200
$50,000
bal. $14,800
$500
$10,000
$25,000
$300
$50,000
Owners Equity
Aras,
Capital
Liabilities
Cash
Type of OE
Transaction
+$500
$10,000
$25,000
EM 501 Week 1
$500
$50,000
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Transaction 5: Lets assume that Luxury Homes Realty sells a house

and gets $1,500 commissions in cash.
Transaction 6: Now, let see how the transaction of $2,000 of an earned
commission that will be paid later will affect the equation.
Cash Revenue
Assets
Cash
Supplies
bal. $14,800
$+1,500
$500
bal. $16,300
$500
=
Land
$10,000
$10,000
Building
$25,000
$25,000
Liabilities
Owners Equity
Revenue to be Collected
Accounts
Payable
Aras,
Capital
Transaction
$300
$50,000
+1,500
Commission
$300
Assets
Cash
$51,500
Accounts
Receivable
bal. $16,300
Liabilities +
Land
Building
Accounts
Payable
Aras,
Capital
$500
$10,000
$25,000
$300
$51,500
+$2,000
$500
$10,000
$25,000
$300
$53,500
+2,000
bal. $16,300
$2,000
Owners Equity
Supplies
Timing of Recording the Revenues

Revenues can be received immediately as cash, and sometimes the
clients/customers agree to pay the revenue at a later time. In either
case, the revenue is recorded when it is earned.
EM 501 Week 1
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EM 501 Week 1
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Transaction 7: A few days later, Luxury Homes Realty receives $1,000

of $2,000 from his client
Transaction 8: Assume that Aras paid in cash $400 for wages of his aid
and $1,000 for rent of some equipments.
Expenses in Cash
Collection of Accounts Receivable
Assets
Assets
Liabilities +
Accounts
Receivable
Supplies
Land
Building
Accounts
Payable
Aras,
Capital
bal. $16,300
$+1,000
$2,000
$-1,000
$500
$10,000
$25,000
$300
$53,500
bal. $17,300
$1,000
$500
$10,000
$25,000
$300
$53,500
Liabilities +
Owners Equity
Accounts
Receivable
Supplies
Land
Building
Accounts
Payable
Aras,
Capital
bal. $17,300
-$400
-$1,000
$1,000
$500
$10,000
$25,000
$300
$53,500
$-400
$-1,000
bal. $15,900
$1,000
$500
$10,000
$25,000
$300
$52,100
Owners Equity
Cash
Cash
Timing of Recording the Expenses

Expenses are recorded when they are incurred.
EM 501 Week 1
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EM 501 Week 1
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Transaction 9: Lets assume that a bill of $300 for utilities incurred but
not paid yet.
Transaction 10: At the end of the month, Aras withdraws $600 in cash
from Luxury Homes Realty and deposits it into his personal account.
Owners Withdrawal
Expenses to be paid
Assets
Assets
Liabilities +
Liabilities +
Owners Equity
Cash
Accounts
Receivable
Supplies
Land
Building
Accounts
Payable
Aras,
Capital
Owners Equity
Cash
Accounts
Receivable
Supplies
Land
Building
Accounts
Payable
Aras,
Capital
bal. $15,900
$-600
$1,000
$500
$10,000
$25,000
$600
$51,800
-600
bal. $15,900
$1,000
$500
$10,000
$25,000
$300
+$300
$52,100
-$300
bal. $15,300
$1,000
$500
$10,000
$25,000
$600
$51,200
bal. $15,900
$1,000
$500
$10,000
$25,000
$600
$51,800
CAUTION!
Withdrawals are NOT expenses.
EM 501 Week 1
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EM 501 Week 1
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Financial Statements
Accounting Standards
Financial statements
In order to ensure high-quality financial reporting, accountants present
financial statements in conformity with accounting standards that are
issued by standard-setting bodies.
1
International Accounting Standards Board
Financial statements
1
Financial Accounting Standards Board
Summarizes amount of revenues earned and expenses incurred

Shows whether a business earned an acceptable level of income
EM 501 Week 1
Statement of Owners Equity

Changes in the owners capital
Statement of Cash Flows

Changes in cash that result from operating activities, investing
activities and financing activities
2
Standards are called Generally Accepted Accounting Principles

(GAAP)
Followed by US companies
Rules-based
Reflect the activities of the company over a period or time

Income Statement
Standards are called International Financial Reporting Standards

(IFRS)
More than 130 countries follow them
Less detailed
Principle-based
2
Accounting Standards
Indicate the financial position at a point in time

Balance Sheet
Financial position of the firm on a certain date
25 / 30
EM 501 Week 1
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Examples
Luxury Homes Realty

Income Statement
For the Month Ended December 31,2007
Revenues
Commissions Revenues
Expenses
Equipment Rental Expense
Wages Expense
Utility Expense
Total Expenses
Luxury Homes Realty

Statement of Owners Equity
Aras, Capital, December 1, 2007
Add: Investments by Aras
Net Income for the Month
$3,500
$1,000
$400
$300
$1,700
Net Income
Examples
$0
$50,000
$1,800
$51,800
Subtotal
Less Withdrawals by Aras
$51,800
$600
Aras, Capital December 31, 2007
$51,200
$1,800
EM 501 Week 1
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EM 501 Week 1
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Examples
Luxury Homes Realty

Statement of Cash Flows
Luxury Homes Realty

Balance Sheet
December 31,2007
Assets
Examples
Liabilities
Accounts Payable
Cash Flows from Operating Activities

Net Income
Non Cash Expenses and Revenues Included in Income
Increase in Accounts Receivable
Increase in Supplies
Increase in Accounts Payable
$(1000)
(500)
600
(900)
Cash
Accounts Receivable
Supplies
Land
$15,300
$1,000
$500
$10,000
Building
$25,000
Cash Flows from Financing Activities

Investments by Aras
Withdrawals by Aras
Net Cash Flows from Financing Activities
$51,800
Net Increase (Decrease) in Cash

Cash at Beginning of Month
$15,300
0
Cash at End of Month
$15,300
Total Assets
EM 501 Week 1
$600
$1,800
Net Cash Flows from Operating Activities

Cash Flows from Investing Activities
Purchase of Land
Purchase of Building
Net Cash Flows from Investing Activities
Owners Equity
Aras, Capital $51,200
Total Equities
$51,800
29 / 30
EM 501 Week 1
$900
$(10,000)
(25,000)
(35,000)
$50,000
(600)
49,600
30 / 30

What Is Accounting?: Definition 1 (Inst. Certified Pub. Accountants)

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What Is Accounting?: Definition 1 (Inst. Certified Pub. Accountants)

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Introduction to Accounting

Therefore, accounting is a link between business activities and

Definition 2 (A broader perspective): Accounting

is the process of identifying, measuring, and communicating

Dr.Serhan Duran (METU)

Industrial Engineering Dept.

Distinctions from Bookkeeping

What is the Difference between Accounting and Bookkeeping?

The Parties that Use the Accounting?

The data and reports must be

Cost controlling function is known as Cost Accounting.

Industrial Engineering Dept.

Dr.Serhan Duran (METU)

Industrial Engineering Dept.

Measure and report information about how the business

Income Tax Accounting

-reports that meets

Users of these reports are

Major accounting system in a manufacturing firm

Dr.Serhan Duran (METU)

Industrial Engineering Dept.

Dr.Serhan Duran (METU)

Industrial Engineering Dept.

Types of Business Organization

Financial Position - What the company owns and owes

Three types of business

Economic resources that belong to a company and the claims against

A company can be viewed as

Financial Position and the Accounting Equation

Two types of Claims, creditors and owners claims

From Accounting Perspective - Economic Entity Assumption

Activities of organization kept separate from the activities of owners

Industrial Engineering Dept.

Dr.Serhan Duran (METU)

Industrial Engineering Dept.

Financial Position and the Accounting Equation

having a life exceeding one year are noncurrent.

payable in more than a year are noncurrent.

Dr.Serhan Duran (METU)

Financial Position and the Accounting Equation

Industrial Engineering Dept.

Dr.Serhan Duran (METU)

Industrial Engineering Dept.

Financial Position and the Accounting Equation

Financial Position and the Accounting Equation

Share capital - ordinary

Five types of transactions affect owners equity

Owners investments increases owners/Stockholders equity

Dr.Serhan Duran (METU)

Industrial Engineering Dept.

Dr.Serhan Duran (METU)

Industrial Engineering Dept.

Effects of Business Transactions on Accounting Equation

Effects of Business Transactions on Accounting Equation

It maintains the equivalence of assets and claims on it

A business transaction affects either:

Dr.Serhan Duran (METU)

Industrial Engineering Dept.

Now Lets Analyze the Effects of some Business Transactions on

Dr.Serhan Duran (METU)

Industrial Engineering Dept.

Effects of Business Transactions on Accounting Equation

Effects of Business Transactions on Accounting Equation