Financial Accounting

Fundamentals

John J. Wild
Third Edition
McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 01

Introducing Financial
Accounting

1-2
 Conceptual Chapter Objectives

C1: Explain the purpose and importance of

accounting.
C2: Identify users and uses of accounting.
C3: Explain why ethics are crucial to
accounting.
C4: Explain generally accepted accounting
principles and define and apply
several accounting principles.
C5: Appendix 1B Identify and describe the
three major activities of organizations.

1-3
 Analytical Chapter Objectives

A1: Define and interpret the accounting

equation and each of its components.
A2: Compute and interpret return on assets.
A3: Appendix 1A Explain the relation
between return and risk.

1-4
 Procedural Chapter Objectives

P1: Analyze business transactions using

the accounting equation.
P2: Identify and prepare basic financial
statements and explain how they
interrelate.

1-5
C1

Importance of Accounting
is a
Accounting
Accounting Identifies
Identifies
system that

Records
Records

information
Relevant
Relevant Communicates
Communicates
that is

Reliable
Reliable
about
aboutan
an
organizations
organizations
Comparable
Comparable business
businessactivities.
activities.
1-6
C1

Accounting Activities

Identifying Recording
Business Business
Activities Activities

Communicating
Business
Activities

1-7
C2 Users of Accounting
Information
Internal Users
External Users

Lenders Consumer Groups Managers Sales Staff

Shareholders External Auditors Officers Budget Officers
Governments Customers Internal Auditors Controllers
1-8
C2 Users of Accounting
Information

External Users Internal Users

Financial accounting provides Managerial accounting provides

external users with financial information needs for internal
statements (shareholders, decision makers (officers,
lenders, etc.). managers, etc.).
1-9
C2

Opportunities in Accounting
Managerial
Managerial Taxation
Financial
Financial Taxation
General
Generalaccounting
accounting Preparation
Preparation Preparation
Preparation Cost
Costaccounting
accounting Planning
Analysis Planning
Analysis Budgeting
Budgeting Regulatory
Auditing Regulatory
Auditing Internal
Internalauditing
auditing Investigations
Regulatory Investigations
Regulatory Consulting
Consulting Consulting
Consulting Consulting
Consulting Controller
Controller Enforcement
Planning Enforcement
Planning Treasurer Legal
Criminal
Treasurer Legalservices
services
Criminal Strategy Estate
investigation
Strategy Estateplans
plans
investigation
Lenders
Lenders FBI
FBIinvestigators
investigators
Consultants
Consultants Market
Marketresearchers
researchers
Analysts
Analysts Systems
Systemsdesigners
designers
Accounting-
Accounting- Traders
Traders Merger services
Merger services
Directors Business
Businessvaluation
related
related Directors
Underwriters Forensic
valuation
Underwriters Forensicaccountant
accountant
Planners
Planners Litigation
Litigationsupport
support
Appraisers
Appraisers Entrepreneurs
Entrepreneurs
1-10
C2

Accounting Jobs by Area

1-11
C3

EthicsA Key Concept

Ethics

Beliefs that
Accepted
distinguish
standards of
right from
good and bad
wrong
behavior

1-12
C3

Guidelines for Ethical Decisions

Identify Analyze Make ethical
ethical concerns options decision

Use personal Consider all Choose best

ethics to good and bad option after
recognize an consequences. weighing all
ethical concern. consequences.

1-13
C4
Generally Accepted Accounting
Principles
Financial
Financial accounting
accountingpractice
practice is
isgoverned
governedbyby
concepts
conceptsandandrules
rules known
knownas as generally
generallyaccepted
accepted
accounting
accountingprinciples
principles (GAAP).
(GAAP).

Relevant
Relevant Affects
Affectsthethedecision
decisionof
of
Information
Information its
itsusers.
users.

Reliable
Reliable Information
Information Is
Istrusted
trustedby
by
users.
users.

Comparable
Comparable Used
Usedin
incomparisons
comparisons
Information across
acrossyears
years&&companies.
companies.
Information
1-14
C4

Setting Accounting Principles

In
Inthe
theUnited
UnitedStates,
States,the
theSecurities
Securitiesand
andExchange
Exchange
Commission,
Commission,aagovernment
governmentagency,
agency,has
hasthe
thelegal
legalauthority
authority
to
toestablish
establishreporting
reportingrequirements
requirementsandandset
setGAAP
GAAPforfor
companies
companiesthat
thatissue
issuestock
stockto
tothe
thepublic.
public.

The
The Financial
Financial Accounting
Accounting
Standards
Standards Board
Board is
is the
the private
private
group
group that
that sets
sets both
both broad
broad and
and
specific
specific principles.
principles.
The International Accounting Standards Board (IASB) issues inter-
national standards that identify preferred accounting practices
in other countries. More than 100 countries now require or permit
companies to prepare financial reports following IFRS standards.
1-15
C4 Principles and Assumptions
of Accounting
Measurement principle (also called
cost principle) means that accounting
information is based on actual cost.
Revenue recognition principle provides
guidance on when a company must
recognize revenue.
Matching principle (expense
recognition) prescribes that a company
must record its expenses incurred to
generate the revenue.
Full disclosure principle requires a
company to report the details behind
financial statements that would impact
users decisions.
Going-concern assumption means
that accounting information reflects a
presumption the business will
continue operating.
Monetary unit assumption means we
can express transactions in money.
Time period assumption presumes
that the life of a company can be
divided into time periods, such as
months and years.
Business entity assumption means
that a business is accounted for
separately from its owner or other
business entities.
1-16
C4

Business Entity Forms

Sole
Sole Partnership
Partnership Corporation
Corporation
Proprietorship
Proprietorship

1-17
C4

Sarbanes-Oxley Act

In response to a number of publicized accounting

scandals (Enron, WorldCom, Tyco, ImClone),
Congress passed the Sarbanes-Oxley Act (also
called SOX) in 2002 to help curb financial abuses
at companies that issue their stock to the public.
The act requires that public companies apply
both accounting oversight and stringent internal
controls. The desired results include more
transparency, accountability, and truthfulness in
reporting transactions.

1-18
A1

Accounting Equation

Assets
Assets = Liabilities
Liabilities + Equity
Equity

Liabilities
Assets + Equity

1-19
A1
Assets

Cash
Cash
Accounts
Accounts Notes
Notes
Receivable
Receivable Receivable
Receivable
Resources
Resources
owned
owned oror
Vehicles controlled
controlled
Vehicles Land
by
by aa Land
company
company
Store
Store Buildings
Buildings
Supplies
Supplies Equipment
Equipment
1-20
A1

Liabilities

Accounts
Accounts Notes
Notes
Payable
Payable Payable
Payable

Creditors
Creditors
claims
claims on
on
assets
assets
Taxes
Taxes Wages
Wages
Payable
Payable Payable
Payable

1-21
A1

Equity

Contributed
Contributed Retained
Retained
Capital
Capital Earnings
Earnings

Owners
Owners
claim
claim on
on
assets
assets

Dividends
Dividends
1-22
A1

Expanded Accounting Equation

Assets
Assets
Assets
Assets =
= Liabilities
Liabilities
Liabilities
Liabilities +
+ Equity
Equity
Equity
Equity

Contributed
Contributed _ Dividends _ Expenses
Capital
Capital
Dividends
+ Revenues
Revenues Expenses

Retained Earnings

1-23
P1

Transaction Analysis

Business activities can be described in terms of

transactions and events. External transactions
are exchanges of value between two entities,
which yield changes in the accounting equation.
Internal transactions are exchanges within any
entity; they can also affect the accounting
equation. Events refer to happenings that affect
an entitys accounting equation and can be
reliably measured. Transaction analysis is
defined as the process used to analyze
transactions and events.
1-24
P1

Transaction Analysis
J. Scott invests $20,000 cash to start the
business in return for stock.

1-25
P1

Transaction Analysis

Purchased supplies paying $1,000 cash.

1-26
P1

Transaction Analysis

Purchased equipment for $15,000 cash.

1-27
 Transaction Analysis
P1

Purchased Supplies of $200 and

Equipment of $1,000 on account.

1-28
P1

Transaction Analysis

Borrowed $4,000 from 1st American Bank.

1-29
P1

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

1-30
P1

Transaction Analysis

Now, lets look at transactions

involving revenue, expenses and
dividends.

1-31
P1

Transaction Analysis
Provided consulting services receiving
$3,000 cash.

1-32
P1

Transaction Analysis

Paid salaries of $800 to employees.

Remember that expenses decrease equity.

1-33
P1

Transaction Analysis
Dividends of $500 are paid to shareholders.

Remember that dividends decrease equity.

1-34
P2

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

1-35
P2

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.
1-36
P2
Statement of Retained Earnings

The net income of

$2,200 increases
Retained Earnings by
$2,200.

1-37
P2

Balance Sheet

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

1-38
P2
Statement of Cash Flows

1-39
A2

Return on Assets (ROA)

Return on Net income

=
assets Average total assets

ROA
ROA is
is aa profitability
profitability
measure.
measure.

1-40
End of Chapter 01

1-41