1

- 1
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 Accounting
What the Numbers Mean
CHAPTER 1: Accounting
Present and Past

Marshall, McManus, and Viele

11th Edition

1 - 2
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 Learning Objectives
After studying this chapter you should understand and be able to:
LO 1-1: Explain the definition of accounting.
LO 1-2: Identify who the users of accounting information are and explain why they find
accounting information useful.
LO 1-3: Identify the variety of professional services that accountants provide.
LO 1-4: Summarize the development of accounting from a broad historical perspective.
LO 1-5: Explain the role that the Financial Accounting Standards Board (FASB) plays in the
development of financial accounting standards.
LO 1-6: Generalize about how financial reporting standards evolve.
LO 1-7: Identify the key elements of ethical behavior for a professional accountant.
LO 1-8: Summarize the reasons for the FASBs Conceptual Framework project.
LO 1-9: Summarize the objective of general purpose financial reporting.
LO 1-10: Describe the plan of the book.
1 - 3
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 What is Accounting?

Accounting is the process of:

Learning Objective 1-1: Explain the definition of accounting. 1 - 4

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 Users and Uses of Accounting
Information
Decision/Informed Judgment
User Made
Management Planning, directing, and controlling
Investors/Shareholders Assessing amounts, timing, and
uncertainty of future cash returns on
their investment
Creditors/Suppliers Assessing probability of collection and
the risk of late (or non-) payment
Employees Planning for retirement and future job
prospects
Securities and Reviewing for compliance of all
Exchange Commission required information

Learning Objective 1-2: Identify who the users of accounting information are and explain why they find accounting information useful. 1 - 5
Copyright 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 Professional services that accountants provide include:

Financial Accounting
Financial accounting generally refers to
the process that results in the preparation
and reporting of financial statements for
an entity.

Financial accounting is primarily

externally oriented and concerned with
the historical results of an entitys
performance.
Learning Objective 1-2: Identify who the users of accounting information are and explain why they find accounting information useful. 1 - 6
Copyright 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 Professional services that accountants provide include:

Managerial Accounting/ Cost

Accounting
Managerial accounting is concerned with the
use of economic and financial information to
plan and control many of the activities of the
entity and to support the management decision-
making process.

Cost accounting relates to the determination

and accumulation of product, process, or
service costs.
Learning Objective 1-3: Identify the variety of professional services that accountants provide. 1 - 7
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 Professional services that accountants provide include:

AuditingPublic Accounting
Public accounting firms
and individual Certified
Public Accountants (CPAs)
provide auditing services
and issue an independent
auditors report.

An independent auditors report usually contains four

brief paragraphs and states whether the financial
statements are prepared in conformity with generally
accepted accounting principles. An auditors report can
be unqualified (a clean opinion) or qualified.
Learning Objective 1-3: Identify the variety of professional services that accountants provide. 1 - 8
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 Professional services that accountants provide include:

Internal Auditing
Internal auditors are
professional
accountants who
perform functions much
like those of an external
auditor. However,
internal auditors are
employed in industry
rather than public
accounting.
Learning Objective 1-3: Identify the variety of professional services that accountants provide. 1 - 9
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 Professional services that accountants provide include:

Governmental and Not-for-Profit

Accounting
Governmental units (e.g.,
municipal, state, and
federal agencies) and not-
for-profit entities (e.g.,
universities, hospitals, and
religious organizations)
require the same
accounting functions to be
performed as do other
accounting entities.

Learning Objective 1-3: Identify the variety of professional services that accountants provide. 1 - 10
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 Professional services that accountants provide include:

Income Tax Accounting

Tax practitioners often
develop specialties in
the taxation of
individuals,
partnerships,
corporations, trusts
and estates, or
international tax law
issues.

Learning Objective 1-3: Identify the variety of professional services that accountants provide. 1 - 11
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 How Has Accounting Developed?

Mesopotamians
record tax receipts
on clay tablets.

3000 B.C.

Learning Objective 1-4: Summarize the development of accounting from a broad historical perspective. 1 - 12
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 How Has Accounting Developed?
Luca Pacioli published the first textbook
describing a comprehensive double-
entry bookkeeping system.

3000 B.C. 1494

Learning Objective 1-4: Summarize the development of accounting from a broad historical perspective. 1 - 13
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 How Has Accounting Developed?
The industrial revolution of the 19th century generated the
need for large amounts of capital to finance the
enterprises that supplanted individual craftsmen.

3000 B.C. 1494 1800s

This need resulted in the corporate form of organization

and the need to provide investors with reports showing the
financial position and the results of operations.

Learning Objective 1-4: Summarize the development of accounting from a broad historical perspective.
1 - 14
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 How Has Accounting Developed?

3000 B.C. 1494 1800s 1900s

Accounting professionals in this country

organized themselves in the early 1900s and
worked hard to establish certification laws,
standardized audit procedures, and other
attributes of a profession.
Learning Objective 1-4: Summarize the development of accounting from a broad historical perspective. 1 - 15
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 How Has Accounting Developed?
Between 1932 and 1934, the American Institute of
Accountants and the New York Stock Exchange agreed
on five broad principles of accounting.

3000 B.C. 1494 1800s 1900s 1932 1933

to &
1934 1934
The Securities Act of 1933 and the Securities Exchange Act of 1934
gave the Securities and Exchange Commission (SEC) the authority to
establish accounting principles for companies whose securities had
to be registered with the SEC.
Learning Objective 1-4: Summarize the development of accounting from a broad historical perspective. 1 - 16
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 How Has Accounting Developed?
Although the SEC has the authority to establish
accounting principles, the standard-setting process has
been delegated to other organizations over the years.

3000 B.C. 1494 1800s 1900s 1932 1933 1939

to & to
1934 1934 1959
The Committee on Accounting Procedure of the American
Institute of Accountants issued 51 Accounting Research
Bulletins that dealt with accounting principles.
Learning Objective 1-4: Summarize the development of accounting from a broad historical perspective. 1 - 17
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 How Has Accounting Developed?
The Financial Accounting Foundation (FAF) was created
and established the Financial Accounting Standards
Board (FASB) as the authoritative standard-setting body
within the accounting profession.

3000 B.C. 1494 1800s 1900s 1932 1933 1939 1973

to & to
1934 1934 1959

The FASB has issued 168 Statements of Financial

Accounting Standards that have established standards of
accounting and reporting for particular issues.
Learning Objective 1-5: Explain the role that the Financial Accounting Standards Board (FASB) plays in the development of financial accounting standards. 1 - 18
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 How Has Accounting Developed?

3000 B.C. 1494 1939 1973

1800s 1900s 2002 1932 1933
to to &
1959 1934 1934
The Sarbanes-Oxley Act of 2002 created the five-member
Public Company Accounting Oversight Board (PCAOB), which
has the authority to set and enforce auditing, attestation,
quality control, and ethics standards for public companies.
Learning Objective 1-5: Explain the role that the Financial Accounting Standards Board (FASB) plays in the development of financial accounting standards. 1 - 19
Copyright 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 How Has Accounting Developed?

Effective July, 2009, however, all FASB standards were

superseded by the FASB Accounting Standards
Codification (FASB Codification). Essentially, the
FASB Codification reorganized divergent sources of U.S.
GAAP in a more accessible and researchable format.
The FASB Codification now represents a single source
of U.S. GAAP.

Learning Objective 1-5: Explain the role that the Financial Accounting Standards Board (FASB) plays in the development of financial accounting standards. 1 - 20
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 How do financial reporting standards evolve?
Standards for Other Types of Accounting:

Cost Accounting
Managerial/Cost
Standards Board (CASB)
Accounting
for government contracts

Auditing/Public Auditing Standards

Accounting Board (part of AICPA)

Governmental
State and Local
Accounting Standards
Governments
Board (GASB)
Learning Objective 1-6: Generalize about how financial reporting standards evolve. 1 - 21
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 How do financial reporting standards evolve?

International Accounting Standards

The goal of the International Accounting
Standards Board (IASB) is to develop a single
set of high-quality, understandable, enforceable
and globally accepted financial reporting
standards based upon clearly articulated
principles.

The IASB has

issued 41 IASs and
15 IFRSs.
Learning Objective 1-6: Generalize about how financial reporting standards evolve. 1 - 22
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 Ethics and the Accounting
Profession
Integrity Objectivity

Independence Competence

Learning Objective 1-7: Identify the key elements of ethical behavior for a professional accountant. 1 - 23
Copyright 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 The Conceptual Framework
In the mid-1970s, the Financial Accounting Standards
Board (FASB) began creating the Statements of
Financial Accounting Concepts (SFAC) in an effort to
define the underlying concepts of accounting principles
and financial reporting practices.

Statements of Financial
Accounting Concepts (SFACs)
describe concepts and
relationships that underlie financial
accounting standards.

Learning Objective 1-8: Summarize the reasons for the FASBs Conceptual Framework project. 1 - 24
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 Concepts Statement No. 8
The Objective of General Purpose
Financial Statements
Individual firms
External Users Historical cost
or entities

Benefits exceed Timely Notes and

costs information disclosures

Accrual Does not measure

Evolving
accounting value of the firm
Learning Objective 1-9: Summarize the objectives of financial reporting for business enterprises. 1 - 25
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 The Plan of this Book:

This text is divided into two main parts:

Chapters 2 through 11, which compose the
first part of the book, are devoted to
financial accounting topics.

The remaining chapters, Chapters

12 through 16, provide an in-depth look
at managerial accounting.

Learning Objective 1-10: The Plan of the Book 26 1 - 26

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 End of Chapter 1

1 - 27
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 1 - 28
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 Accounting
What the Numbers Mean
CHAPTER 2: Financial Statements and
Accounting Concepts/Principles

Marshall, McManus, and Viele

11th Edition

1 - 29
Copyright 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 Learning Objectives
After studying this chapter you should understand and be able to:
LO 2-1: Explain what transactions are.
LO 2-2: Identify and explain the kind of information reported in each financial statement
and describe how financial statements are related to each other.
LO 2-3: Explain the meaning and usefulness of the accounting equation.
LO 2-4: Explain the meaning of each of the captions on the financial statements illustrated
in this chapter.
LO 2-5: Identify and explain the broad, generally accepted concepts and principles that
apply to the accounting process.
LO 2-6: Discuss why investors must carefully consider cash flow information in
conjunction with accrual accounting results.
LO 2-7: Identify and explain several limitations of financial statements.
LO 2-8: Describe what a corporations annual report is and why it is issued.

1 - 30
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 Financial Statements
Transactions are economic
interchanges between entities that are
accounted for and reflected in financial
statements.

Learning Objective 2-1: Explain what transactions are. 1 - 31

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 Financial Statements
Transactions
Procedures for sorting, classifying,
and presenting (bookkeeping)
Selection of alternative methods of
reflecting the effects of certain
transactions (accounting)

Financial
An entitys financial statements are the Statements
end product of a process that starts
with transactions between the entity
and other organizations and individuals.
Learning Objective 2-1: Explain what transactions are. 1 - 32
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 Accounts
Transactions are
summarized in accounts.
Cash Account

Accounts are used to

Accounts organize like-kind
Receivable
Account transactions.

Accounts Account balances are then

Payable used in the preparation of
Account
financial statements.

Learning Objective 2-1: Explain what transactions are. 1 - 33

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 Financial Statements
Financial Statement that
Required Disclosure
Satisfies Requirement
Financial position at the
Balance Sheet
end of the period
Earnings for the period Income Statement
Cash flows during the
Statement of Cash Flows
period
Investments by and
Statement of Changes in
distributions to owners
Owners' Equity
during the period

In addition to the financial statements, the annual report will

probably include several accompanying notes or
explanations of the accounting policies used and detailed
information about many of the amounts and captions shown
in the financial statements.
Learning Objective 2-2: Identify and explain the kind of information reported in each financial statement and describe how financial statements are
related to each other. 1 - 34
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 Balance SheetElements
Assets represent the amount of resources
owned by the entity. Liabilities are
amounts owed
to other entities.

Equity is the
ownership right
of the owner(s) of
the entity in the
assets that
remain after
deducting the
liabilities.

Learning Objective 2-3: Explain the meaning and usefulness of the accounting equation. 1 - 35
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 Balance Sheet
Presents the balances in an entity's accounts at a given point in time

Assets = Liabilities + Equity

Learning Objective 2-3: Explain the meaning and usefulness of the accounting equation. 1 - 36
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 Balance Sheet
Current assets are those assets that are likely to be
converted into cash or used to benefit the entity within
one year.

Plant and
equipment
includes long-
term assets
that will benefit
the entity over
several years.

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 37
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 Balance Sheet
Long-term liabilities are those liabilities that will not be
repaid within one year of the balance sheet date.

Current
liabilities
are those
liabilities
that are
to be paid
within
one year.

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 38
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 Income Statement
The income statement shows the net income (or net
loss) for the period of time under consideration.
Revenues result from the entitys Costs and expenses
operating activities (e.g., selling are incurred in generating revenues and
merchandise). operating the entity.

Notice that the

statement starts
with net sales and
that the various
expenses are
subtracted to arrive
at net income

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 39
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 Income Statement
Earnings per share of common
Income taxes are shown after stock outstanding is reported as a
separate item at the bottom of the
all the other income statement income statement because of its
items have been reported. significance in evaluating the market
value of a share of common stock.

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 40
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 Statement of Changes
in Stockholders' Equity
MAIN STREET STORE, INC.
Statement of Changes in Stockholders Equity
For the Year Ended August 31, 2017
Paid-In Capital:
Beginning balance $ 0
1.Common stock, par value, $10; 50,000 shares authorized, 10,000 shares issued
and outstanding 100,000
Additional paid-in capital 90,000
Balance, August 31, 2017 $190,000
Retained Earnings:
Beginning balance $ 0
Net income for the year 18,000
Less: Cash dividends of $.50 per share (5,000)
Balance, August 31, 2017 $ 13,000
Total stockholders equity $203,000

This financial statement shows the detail of stockholders' equity and

explains the changes that occurred in the components of stockholders'
equity during the year.
Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 41
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 Statement of Cash Flows
The purpose of this financial statement is to identify the
sources and uses of cash during the year.
MAIN STREET STORE, INC.
Statement of Cash Flows
For the Year Ended August 31, 2017
Cash Flows from Operating Activities:
Net income $ 18,000
Add (deduct) items not affecting cash:
Depreciation expense 4,000
Increase in accounts receivable (80,000)
Increase in merchandise inventory (170,000)
Increase in current liabilities 67,000
Net cash used by operating activities $(161,000)
Cash Flows from Investing Activities:
Cash paid for equipment $ (40,000)
Cash Flows from Financing Activities:
Cash received from issue of long-term debt $ 50,000
Cash received from sale of common stock 190,000
Payment of cash dividend on common stock (5,000)
Net cash provided by financing activities $ 235,000
Net increase in cash for the year $ 34,000

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 42
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 Time-Line Model

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 43
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 Financial Statement Relationships

The arrow indicates that net income

affects retained earnings, which is a
component of stockholders' equity.

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 44
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 Financial Statement Relationships

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 45
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 Financial Statement Relationships
If assets equal $300,000 and liabilities equal $125,000,
what is stockholders' equity?

Balance Sheet
Stockholders'
Assets = Liabilities + Equity
320,000 = 117,000 + ?

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 46
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 Financial Statement Relationships
If assets equal $320,000 and liabilities equal $117,000,
what is stockholders' equity?
Balance Sheet
Stockholders'
Assets = Liabilities + Equity
320,000 = 117,000 + 203,000

Stockholders' equity equals $203,000

($320,000 - $117,000)

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 47
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 Financial Statement Relationships
Now, suppose that total assets increase $10,000 during the
year and total liabilities decrease $3,000 during the year.
Balance Sheet
Stockholders'
Assets = Liabilities + Equity
320,000 117,000 203,000
10,000 (3,000) ?
330,000 114,000 ?

What is stockholders' equity at the end of the year?

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 48
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 Financial Statement Relationships
Stockholders' equity must have increased by $13,000.
Since stockholders' equity was $203,000 at the beginning
of the year, it must be $216,000 at the end of the year.

Balance Sheet
Stockholders'
Assets = Liabilities + Equity
320,000 117,000 203,000
10,000 (3,000) 13,000
330,000 114,000 216,000

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 49
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 Balance Sheet
Account Definition
Cash Cash on hand and in the bank
Accounts receivable Amounts due from customers
Merchandise inventory Cost of merchandise acquired and not yet sold
Equipment Cost of equipment purchased and used in business
Accumulated Portion of the cost of equipment that is estimated to have
depreciation been used up in the process of operating the business
Short-term debt Amounts borrowed that will be repaid within one year of the
balance sheet date
Accounts payable Amounts due to suppliers
Other accrued liabilities Amounts owed to various creditors
Long-term debt Amounts borrowed from banks or other creditors that will
not be repaid within one year from the balance sheet date
Stockholders' equity Residual claim of owners, computed as "assets minus
liabilities"

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 50
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 Income Statement
Captions Explanation
Net sales Amount of sales of merchandise to customers, less the
amount of customer returns of merchandise
Cost of goods sold Represents the total cost of merchandise removed from
inventory and delivered to customers as a result of sales
Gross profit Difference between net sales and cost of goods sold;
Represents the seller's maximum amount of "cushion"
from which all other expenses of the business must be
deducted before it is possible to have net income
Selling, general, and Represents the operating expenses of the entity
administrative expenses

Income from operations Represents one of the most important measures of the
firm's activities
Interest expense Represents the cost of using borrowed funds
Income taxes Shown after all of the other income statement items have
been reported because income taxes are a function of the
firm's income before taxes
Net income per share of A significant item in evaluating the market value of a share
common stock of common stock; Often referred to as "earnings per
outstanding share" or EPS

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 51
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 Statement of Changes
in Stockholders' Equity
Captions Explanation
Paid-in capital Represents the total amount invested in the entity by
the owners
Common stock Reflects the number of shares authorized by the
corporation's charter, the number of shares issued to
stockholders, and the number of shares still held by
the stockholders
Additional paid-in Difference between the total amount invested by the
capital owners and the par value or stated value of the stock
Retained earnings Represents the cumulative net income of the entity
that has been retained for use in the business
Dividends Distributions of earnings to the owners

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 52
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 Statement of Cash Flows
Captions Explanation
Cash flows from Shown first; Net income is the starting point for this
operating activities measure of cash generation
Depreciation expense Added back to net income because it is subtracted to
arrive at net income, but does not require the use of cash
Increase in accounts Deducted because it reflects sales revenues, included in
receivable net income, but not yet received in cash
Increase in Deducted because cash was spent to acquire the
merchandise inventory increase in inventory
Increase in current Added because cash has not yet been paid for the
liabilities products and services that have been received during the
current fiscal period
Cash flows from Shows the cash sources and uses related to long-lived
investing activities assets
Cash flows from Shows the cash sources and uses related to transactions
financing activities with creditors and stockholders

Learning Objective 2-4: Explain the meaning of each of the captions on the financial statements illustrated in this chapter. 1 - 53
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 Accounting Concepts and Principles

Now Future
Accounting Entity Going Concern Concept
Every economic entity can be The presumption that the entity will
separately identified and accounted continue to operate in the future
for. its not being liquidated.

Unit of Measurement Cost Principle

Only transactions denominated in Transactions are recorded at their
dollars (currency) are recorded in original cost to the entity as
the accounting records. measured in dollars.
Learning Objective 2-5: Identify and explain the broad, generally accepted concepts and principles that apply to the accounting process. 1 - 54
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 Accounting Concepts and Principles

Objectivity Accounting Period

The accountants desire to have a given The period of time selected for
transaction recorded in the same way reporting results of operations and
in all situations. changes in financial position.

Accrual Accounting
Matching Concept
All expenses incurred to generate Recognize revenue at the point of
that periods revenues be sale and recognize expenses when
deducted from the revenues incurred, even though the cash
earned. receipt or payment may occur at
another time.
Learning Objective 2-5: Identify and explain the broad, generally accepted concepts and principles that apply to the accounting process. 1 - 55
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 Accounting Concepts and Principles

Full Disclosure
Consistency Circumstances and events that make a
Provides meaningful trend difference to financial statement users
comparisons over several years. should be disclosed.

Materiality Conservatism
The benefit of increased accuracy When in doubt, make judgments and
should outweigh the cost of estimates that result in lower profits
achieving the increased accuracy. and asset valuations.
Learning Objective 2-5: Identify and explain the broad, generally accepted concepts and principles that apply to the accounting process. 1 - 56
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 Accrual Accounting Vs. Cash Flows
Revenue Recognition -Timing is the Key
Accrual accounting Cash flow
recognizes: recognizes:

Revenue Revenue
when revenue is earned, when payment is received
at the point of sale of for services rendered
services or products. or products sold.

Expenses Expenses
when they are incurred. when they are paid.

Learning Objective 2-6: Describe why investors must carefully consider cash flow information in conjunction with accrual accounting results. 1 - 57
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 Limitations of Financial
Statements
Financial statements
report only quantitative
economic data.
They do not reflect
Qualitative
economic variables qualitative economic
are usually variables, such as the
subjective in value value of the
and cannot be
quantified in terms management team or the
of dollars and cents employees morale.
that can be verified.

How do the terms quantitative and qualitative differ?

Learning Objective 2-7: Identify and describe several limitations of financial statements. 1 - 58
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 Limitations of Financial
Statements
Historical Cost Concept Matching Concept
Assets are usually valued Estimates are acceptable
at the cost of the Asset provided there is a basis
when acquired. for them.

The balance sheet does Many estimates are

not report market values used, such as warranty
or replacement cost of the costs, depreciation, and
assets. pension expense.
Learning Objective 2-7: Identify and describe several limitations of financial statements. 1 - 59
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 The Corporations Annual Report
The annual report is
distributed to
shareholders (and others).
It contains the financial
statements, together with
the report of the external
auditors examination of
the financial statements.
It also contains
Managements Discussion
and Analysis (MD&A).

Learning Objective 2-8: Describe what a corporations annual report is and why it is issued. 1 - 60
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 End of Chapter 2

1 - 61
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