Financial Accounting

Fundamentals

John J. Wild
2009 Edition
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 1

Introducing Financial
Accounting
 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 to
accounting.
C5: Explain GAAP, and define and apply
several key accounting principles.
C6: 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: Analyze business transactions using the
accounting equation.
A3: Compute and interpret return on assets.
A4: Appendix 1A: Explain the relationship
between return and risk.

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 Procedural Chapter Objectives

P1: 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
to
tohelp
helpusers
usersmake
make
Comparable better
betterdecisions.
decisions.
Comparable
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. decision makers.

1-9
C3

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
C3

Accounting Jobs by Area

Private
Public accounting
accounting 60%
25%

Government,
not-for-profit,
& education
15%
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C4

Ethics—A Key Concept

Ethics

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

1-12
C4

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 ethical consequences. weighing all
concern. consequences.

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C5
Generally Accepted Accounting
Principles
Financial
Financial accounting
accountingpractice
practice is
isgoverned
governedbyby
concepts
conceptsandandrules
rulesknown
known asas 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
C5

Setting Accounting Principles

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
TheSecurities
Securitiesand
andExchange
ExchangeCommission
Commissionis isthe
the
government
governmentgroup
groupthat
thatestablishes
establishesreporting
reporting
requirements
requirementsfor
forcompanies
companiesthat
thatissue
issuestock
stockto to
the
thepublic.
public.
The International Accounting Standards Board (IASB) issues inter-
national standards that identify preferred accounting practices
in other countries. The IASB does not have authority to impose
its standards on companies.
1-15
C5
Principles of Accounting
Cost principle means that
accounting information is based
on actual cost.
Going-concern means that
accounting information reflects a
presumption the business will
continue operating.
Monetary unit means we can
express transactions in money.
Full disclosure principle requires a company to report the details behind
financial statements that would impact users’ decisions.
Revenue recognition principle
provides guidance on when a
company must recognize
revenue.
Business entity means that a
business is accounted for
separately from its owner or other
business entities.
Matching Principle prescribes that
a company must record its
expenses incurred to generate the
revenue.
1-16
C5

Business Entity Forms

Sole
Sole Partnership
Partnership Corporation
Corporation
Proprietorship
Proprietorship

1-17
A1

Accounting Equation

Assets
Assets = Liabilities
Liabilities + Equity
Equity

Liabilities
Assets & Equity

1-18
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
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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

1-20
A1

Equity

Contributed
Contributed Retained
Retained
Capital
Capital Earnings
Earnings

Owner’s
Owner’s
claim
claim on
on
assets
assets

Dividends
Dividends
1-21
A1

Expanded Accounting Equation

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

Common
Common _ Dividends _ Expenses
Stock
Stock
Dividends
+ Revenues
Revenues Expenses

Retained Earnings

1-22
A2

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

1-23
A2

Transaction Analysis

Purchased supplies paying $1,000 cash.

1-24
A2

Transaction Analysis

Purchased equipment for $15,000 cash.

1-25
 Transaction Analysis
A2

Purchased Supplies of $200 and

Equipment of $1,000 on account.

1-26
A2

Transaction Analysis

Borrowed $4,000 from 1st American Bank.

1-27
A2

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

1-28
A2

Transaction Analysis

Now, let’s look at transactions

involving revenue, expenses and
dividends.

1-29
A2

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

1-30
A2

Transaction Analysis

Paid salaries of $800 to employees.

Remember that expenses decrease equity.

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A2

Transaction Analysis
Dividends of $500 are paid to shareholders.

Remember that dividends decrease equity.

1-32
P1

Financial Statements
Let’s 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

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P1

Income Statement

Net income is the

difference
between
Revenues and
Expenses.

The income statement describes a

company’s revenues and expenses along
with the resulting net income or loss over a
period of time due to earnings activities.
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P1
Statement of Retained Earnings

The net income of

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

1-35
P1

Balance Sheet

The
TheBalance
BalanceSheet
Sheetdescribes
describes
aacompany’s
company’sfinancial
financialposition
position
at
ataapoint
pointin
intime.
time.

1-36
P1
Statement of Cash Flows

1-37
A3

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.

1-38
End of Chapter 1

1-39