You are on page 1of 50

Financial Accounting

Information for Decisions

John J. Wild and Winston Kwok


McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

Chapter 1
Introducing Accounting
in Business

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

Conceptual Chapter Objectives


C1: Explain the purpose and importance of
accounting in the information age
C2: Identify users and uses of accounting
C3: Identify opportunities in accounting and
related fields
C4: Explain why ethics are crucial in
accounting
C5: Explain the meaning of GAAP, and define
and apply several key accounting
principles
C6: Appendix 1B: Identify and describe the
three major activities in organizations
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

Analytical Chapter Objectives


A1: Define and interpret the accounting
equation and each of its components
A2: Analyze business transactions using the
accounting equation
A3: Compute and interpret return on assets
A4: Appendix 1A: Explain the relationship
between return and risk

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

Procedural Chapter Objectives


P1: Identify and prepare basic financial

statements and explain how they


interrelate

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

C1

Importance of Accounting
Accounting
Accounting

is a
system that

Identifies
Identifies
Records
Records

Relevant
Relevant

information
that is

Communicates
Communicates

Reliable
Reliable
Comparable
Comparable
McGraw-Hill/Irwin

to
tohelp
helpusers
usersmake
make
better
betterdecisions.
decisions.
The McGraw-Hill Companies, Inc., 2010

C1

Accounting Activities

Identifying
Business
Activities

McGraw-Hill/Irwin

Recording
Business
Activities

Communicating
Business
Activities

The McGraw-Hill Companies, Inc., 2010

Users of Accounting
Information

C2

External Users

Lenders

Consumer Groups

Internal Users

Managers

Sales Staff

Shareholders External Auditors

Officers/Directors Budget Officers

Governments Customers

Internal Auditors

McGraw-Hill/Irwin

Controllers

The McGraw-Hill Companies, Inc., 2010

Users of Accounting
Information

C2

External Users

Internal Users

Financial accounting provides


external users with financial
statements.

Managerial accounting provides


information needs for internal
decision makers.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

C3

Opportunities in Accounting
Financial
Financial

Preparation
Preparation
Analysis
Analysis
Auditing
Auditing
Regulatory
Regulatory
Consulting
Consulting
Planning
Planning
Criminal
Criminal
investigation
investigation

AccountingAccountingrelated
related
McGraw-Hill/Irwin

Managerial
Managerial
General
Generalaccounting
accounting
Cost
accounting
Cost accounting
Budgeting
Budgeting
Internal
Internalauditing
auditing
Consulting
Consulting
Controller
Controller
Treasurer
Treasurer
Strategy
Strategy
Lenders
Lenders
Consultants
Consultants
Analysts
Analysts
Traders
Traders
Directors
Directors
Underwriters
Underwriters
Planners
Planners
Appraisers
Appraisers

Taxation
Taxation
Preparation
Preparation
Planning
Planning
Regulatory
Regulatory
Investigations
Investigations
Consulting
Consulting
Enforcement
Enforcement
Legal
Legalservices
services
Estate
Estateplans
plans
FBI
FBIinvestigators
investigators
Market
Marketresearchers
researchers
Systems
Systemsdesigners
designers
Merger
Mergerservices
services
Business
Businessvaluation
valuation
Human
services
Human services
Litigation
Litigationsupport
support
Entrepreneurs
Entrepreneurs

The McGraw-Hill Companies, Inc., 2010

C4

EthicsA Key Concept


Ethics
Beliefs that
distinguish
right from
wrong

McGraw-Hill/Irwin

Accepted
standards of
good and bad
behavior

The McGraw-Hill Companies, Inc., 2010

C4

Guidelines for Ethical


Decisions

Identify
ethical concerns

Analyze
options

Use personal
Consider all
ethics to
good and bad
recognize ethical consequences.
concern.
McGraw-Hill/Irwin

Make ethical
decision

Choose best
option after
weighing all
consequences.
The McGraw-Hill Companies, Inc., 2010

Generally Accepted Accounting


Principles

C5

Financial
Financial accounting
accountingpractice
practice is
isgoverned
governedby
by
concepts
conceptsand
andrules
rules known
knownas
as generally
generallyaccepted
accepted
accounting
accountingprinciples
principles (GAAP).
(GAAP).
Relevant
Relevant
Information
Information
Reliable
Reliable Information
Information

Comparable
Comparable
Information
Information
McGraw-Hill/Irwin

Affects
Affectsthe
thedecision
decisionof
of
its
itsusers.
users.
Is
Istrusted
trustedby
by
users.
users.
Used
Usedin
incomparisons
comparisons
across
acrossyears
years&&companies.
companies.
The McGraw-Hill Companies, Inc., 2010

C5

Setting Accounting Principles


International

The International
Accounting Standards
Board (IASB) issues
International Financial
Reporting Standards (IFRS)
that identify preferred
accounting practices.
If IFRS are adopted
worldwide, a company can
potentially use a single set
of financial statements in all
financial markets.

McGraw-Hill/Irwin

U.S.

Financial Accounting
Standards Board is the
private group that sets both
broad and specific
principles.
The Securities and
Exchange Commission is
the government group that
establishes reporting
requirements for
companies that issue
shares or stock to the
public.
The McGraw-Hill Companies, Inc., 2010

C5

IFRS

More than 100 countries and more than 40% of Global


Fortune 500 companies are already using IFRS.

Blue areas: countries that require or permit IFRS.


Grey areas: countries pursuing adoption of IFRS.
ASIA: Adopted or in-process:
Singapore, Malaysia, Taiwan, China, Hong Kong, Australia, India
and South Korea

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

C5

Principles of Accounting

Objectivity Principle
Accounting information is
supported by independent,
unbiased evidence.

Now

McGraw-Hill/Irwin

Cost Principle
Accounting information is
based on actual cost.

Future

Going-Concern Principle
Reflects assumption that the
business will continue operating
instead of being closed or sold.
The McGraw-Hill Companies, Inc., 2010

C5

Principles of Accounting

Monetary Unit Principle


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

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.

Business Entity Principle


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

The McGraw-Hill Companies, Inc., 2010

C5

Business Entity Forms

Sole
Sole
Proprietorship
Proprietorship

McGraw-Hill/Irwin

Partnership
Partnership

Corporation
Corporation

The McGraw-Hill Companies, Inc., 2010

C5

Characteristics of Businesses

**Proprietorships
Proprietorshipsand
andpartnerships
partnershipsthat
thatare
areset
set up
up as
as
limited
limitedliability
liabilitycorporations
corporations(LLC)
(LLC)provide
providelimited
limitedliability.
liability.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

C5

Corporation

Owners of a corporation are called


shareholders (or stockholders).
When a corporation issues only one
class of stock, we call it common stock,
ordinary shares or capital stock.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A1

Accounting Equation
Assets
Assets

Liabilities
Liabilities

Assets

McGraw-Hill/Irwin

Equity
Equity

Liabilities
& Equity

The McGraw-Hill Companies, Inc., 2010

Assets

A1

Cash
Cash
Accounts
Accounts
Receivable
Receivable

Vehicles
Vehicles

Store
Store
Supplies
Supplies
McGraw-Hill/Irwin

Resources
Resources
owned
owned or
or
controlled
controlled
by
by aa
company
company

Notes
Notes
Receivable
Receivable

Land
Land

Buildings
Buildings
Equipment
Equipment
The McGraw-Hill Companies, Inc., 2010

A1

Liabilities
Accounts
Accounts
Payable
Payable

Notes
Notes
Payable
Payable

Creditors
Creditors
claims
claims on
on
assets
assets
Taxes
Taxes
Payable
Payable
McGraw-Hill/Irwin

Wages
Wages
Payable
Payable
The McGraw-Hill Companies, Inc., 2010

A1

Equity
Retained
Retained
Earnings
Earnings

Contributed
Contributed
Capital
Capital

Owners
Owners
claim
claim on
on
assets
assets

Dividends
Dividends
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

Expanded Accounting
Equation

A1

Assets
Assets

Common
Common
Stock
Stock

=
_

Liabilities
Liabilities

Dividends
Dividends

+
Revenues
Revenues

Equity
Equity

Expenses
Expenses

Retained Earnings
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis Equation


The accounting equation MUST remain in
balance after each transaction.

Assets
Assets

McGraw-Hill/Irwin

Liabilities
Liabilities

Equity
Equity

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis
J. Scott invests $20,000 cash to start
the business in exchange for stock.
The accounts involved are:
(1) Cash (asset)
(2) Common Stock (equity)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis

J. Scott invests $20,000 cash to start the


business in return for stock.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis
Purchased supplies paying $1,000 cash.
The accounts involved are:
(1) Cash (asset)
(2) Supplies (asset)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis
Purchased supplies paying $1,000 cash.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis
Purchased equipment for $15,000 cash.
The accounts involved are:
(1) Cash (asset)
(2) Equipment (asset)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis
Purchased equipment for $15,000 cash.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis
Purchased Supplies of $200 and
Equipment of $1,000 on account or on
credit (i.e. will pay cash in the near
future).
The accounts involved are:
(1) Supplies (asset)
(2) Equipment (asset)
(3) Accounts Payable (liability)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

Transaction Analysis

A2

Purchased Supplies of $200 and


Equipment of $1,000 on account.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis

Borrowed $4,000 from 1st American Bank.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis
The balances so far appear below. Note that the
Balance Sheet Equation is still in balance.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis

Now, lets look at transactions


involving revenue, expenses and
dividends.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis

Provided consulting services receiving


$3,000 cash.
The accounts involved are:
(1) Cash (asset)
(2) Revenues (equity)

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis

Provided consulting services receiving


$3,000 cash.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis
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/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis
Paid salaries of $800 to employees.

Remember that expenses decrease equity.


McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis

Dividends of $500 are paid to shareholders.


The accounts involved are:
(1) Cash (asset)
(2) Dividends (equity)
Remember that the Dividend account actually
increases.
But, equity decreases because dividends
reduce equity.
McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

A2

Transaction Analysis

Dividends of $500 are paid to shareholders.

Remember that dividends decrease equity.


McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

P1

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

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

P1

Income Statement
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/Irwin

The McGraw-Hill Companies, Inc., 2010

P1

Statement of Retained Earnings


The net income of $2,200
increases Retained
Earnings by $2,200.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

P1

Balance Sheet
The
TheBalance
BalanceSheet
Sheetdescribes
describes
aacompanys
companysfinancial
financialposition
position
at
ataapoint
pointin
intime.
time.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

P1

McGraw-Hill/Irwin

Statement of Cash Flows

The McGraw-Hill Companies, Inc., 2010

P1

Return on Assets (ROA)


Return on
Net income
=
assets
Average total assets

ROA
ROA is
is viewed
viewed as
as an
an
indicator
indicator of
of operating
operating
efficiency.
efficiency.

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010

End of Chapter 1

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2010