Accounting Principles

Prepared by:
TEJ SINGH
 CHAPTER

ACCOUNTING IN ACTION
 ILLUSTRATION 1-1
THE ACCOUNTING PROCESS
Communication
Identification Recording Accounti
ng
Reports
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7 M ald Tr
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Prepare
accounting reports
SOFTBYTE
Select economic events Record, classify, Annual Report

(transactions) and summarize

Analyse and interpret

for users
 ILLUSTRATION 1-2
QUESTIONS ASKED BY INTERNAL USERS

What is the cost of manufacturing each unit of

Is cash sufficient to pay bills? product?

Can we afford to give employees pay raises Which product line is the most profitable?
this year?
 ILLUSTRATION 1-3
QUESTIONS ASKED BY EXTERNAL USERS

How does the company compare in size and

Is the company earning profitability with its competitors?
satisfactory income?

What do we
do if they
catch us?

Will the company be able to pay its debts as they come due?
 BOOKKEEPING DISTINGUISHED
FROM ACCOUNTING
Accounting
1. Includes bookkeeping
2. Also includes much more
Bookkeeping
1. Involves only the recording of economic
events
2. Is just one part of accounting
 THE ACCOUNTING PROFESSION

 Public accountants offer their expertise to the general public

through the services they perform.
 Private accountants are employees of individual companies
and are involved in a number of activities, including cost and
tax accounting, systems, and internal auditing.
 Not-for-profit accounting includes reporting and control for
government units, foundations, hospitals, labour unions,
colleges/universities, and charities.
 ILLUSTRATION 1-4
ETHICS

Ethics To Solve Ethical Dilemma

1. Recognize situation
 Standards of conduct and ethical issues
involved
2. Identify and analyse
elements
3. Identify alternatives
and weigh effects on
stakeholders
 GAAP
Generally Accepted Accounting Principles
 Primarily established by the Canadian Institute of
Chartered Accountants
Cost Principle
 The cost principle dictates that assets are recorded
at their cost.
 Cost is the value exchanged at the time something
is acquired.
 Cost is used because it is both relevant and reliable.
 ASSUMPTIONS

1. Going Concern - assumes organization will

continue into foreseeable future.
2. Monetary Unit - only transaction data that can
be expressed in terms of money is included in the
accounting records.
3. Economic Entity - includes any organization or
unit in society.
 BUSINESS ENTERPRISES
 A business owned by one person is generally a
proprietorship (owner’s equity).
 A business owned by two or more persons associated as
partners is a partnership (partners’ equity).
 A business organized as a separate legal entity under
corporation law and having ownership divided into
transferable shares is called a corporation (shareholders’
equity).
 ILLUSTRATION 1-5
BASIC ACCOUNTING EQUATION

The Basic Accounting Equation

Assets = Liabilities + Owner’s Equity

 ASSETS AS A BUILDING BLOCK

 Assets are resources owned by a business.

 They are things of value used in carrying
out such activities as production and
exchange.
LIABILITIES AS A BUILDING BLOCK

 Liabilities are claims against assets.

 They are existing debts and obligations.
 OWNER’S EQUITY AS
A BUILDING BLOCK
 Owner’s Equity is equal to total assets minus
total liabilities.
 Owner’s Equity represents the ownership claim
on total assets.
 Subdivisions of Owner’s Equity:
1. Capital
2. Drawings
3. Revenues
4. Expenses
 INVESTMENTS BY OWNERS
AS A BUILDING BLOCK

 Investments by owner are the assets put into

the business by the owner.
 These investments in the business increase
owner’s equity.
 DRAWINGS AS A
BUILDING BLOCK

 Drawings are withdrawals of cash or other

assets by the owner for personal use.
 Drawings decrease total owner’s equity.
 REVENUES AS A
BUILDING BLOCK
 Revenues are the gross increases in owner’s equity
resulting from business activities entered into for
the purpose of earning income.
 Revenues may result from sale of merchandise,
performance of services, rental of property, or
lending of money.
 Revenues usually result in an increase in an asset.
 EXPENSES AS A
BUILDING BLOCK

 Expenses are the decreases in owner’s equity that

result from operating the business.
 Expenses are the cost of assets consumed or
services used in the process of earning revenue.
 Examples of expenses include utility expense, rent
expense, and supplies expense.
 TIME
TIME PERIOD
PERIOD ASSUMPTION
ASSUMPTION

 The time period assumption assumes that the economic

life of a business can be divided into artificial time periods
— generally a month, a quarter, or a year.

 Periods of less than one year are called interim periods.

 The accounting time period of one year in length is

usually known as a fiscal year.
 REVENUE RECOGNITION
PRINCIPLE
 The revenue recognition principle states that
revenue should be recognized in the accounting
period in which it is earned.
 In a service business, revenue is usually considered
to be earned at the time the service is performed.
 In a merchandising business, revenue is usually
earned at the time the goods are delivered.
 THE MATCHING PRINCIPLE

 The practice of expense recognition is referred

to as the matching principle.
 The matching principle dictates that efforts
(expenses) be matched with accomplishments
(revenues).

Revenues expenses
earned are offset incurred in
this month against.... earning the
revenue
 ACCRUAL BASIS OF
ACCOUNTING
 Adheres to the

GAAP
 Revenue recognition principle
 Matching principle
 Revenue recorded when earned, not only
when cash received.
 Expense recorded when services or goods
are used or consumed in the generation of
revenue, not only when cash paid.
 CASH BASIS OF
ACCOUNTING
 Revenue recorded
only when cash

NO
received.

TG
 Expense recorded
only when cash

AA
paid.

P
 ADJUSTING ENTRIES
 Adjusting entries make the revenue
recognition and matching principles

HAPPEN!
 ILLUSTRATION 3-3
TRIAL BALANCE
Pioneer Advertising Agency
Trial Balance
October 31, 2002
Debit Credit
Cash $ 15,200
Advertising Supplies 2,500
Prepaid Insurance The Trial 600
Office Equipment 5,000
Notes Payable
Balance is $ 5,000
Accounts Payable analysed to 2,500
Unearned Revenue determine the 1,200
C.R. Byrd, Capital 10,000
C.R. Byrd, Drawings need for 500
Service Revenue adjusting 10,000
Salaries Expense 4,000
Rent Expense entries. 900
$ 28,700 $ 28,700
 ADJUSTING ENTRIES
 Adjusting entries are required each time financial
statements are prepared.

 Adjusting entries can be classified as

1. prepayments (prepaid expenses or unearned
revenues),
2. accruals (accrued revenues or accrued
expenses), or
3. estimates (amortization).
 TYPES OF ADJUSTING ENTRIES

Prepayments
1. Prepaid Expenses — Expenses paid in cash and
recorded as assets before they are used or
consumed.
2. Unearned Revenues — Revenues received in
cash and recorded as liabilities before they are
earned.
 TYPES OF ADJUSTING ENTRIES

Accruals
1. Accrued Revenues — Revenues earned but not
yet received in cash or recorded.
2. Accrued Expenses — Expenses incurred but not
yet paid in cash or recorded.
 TYPES OF ADJUSTING ENTRIES
Estimates
1. Amortization — Allocation of the cost of capital
assets to expense over their useful lives.
 PREPAYMENTS

 Prepayments are either prepaid expenses or

unearned revenues.
 Adjusting entries for prepayments are
required to record the portion of the
prepayment that represents
1. the expense incurred or,
2. the revenue earned in the current
accounting period.
 PREPAID EXPENSES

 Prepaid expenses are expenses paid in cash

and recorded as assets before they are used
or consumed.
 Prepaid expenses expire with the passage of
time or through use and consumption.
 An asset-expense account relationship exists
with prepaid expenses.
 PREPAID EXPENSES

 Prior to adjustment, assets are overstated and

expenses are understated.
 The adjusting entry results in a debit to an
expense account and a credit to an asset
account.
 Examples of prepaid expenses include supplies,
rent, insurance, and property tax.
 UNEARNED REVENUES

 Unearned revenues are revenues received

and recorded as liabilities before they are
earned.
 Unearned revenues are subsequently earned
by performing a service or providing a good
to a customer.
 A liability-revenue account relationship exists
with unearned revenues.
 UNEARNED REVENUES

 Prior to adjustment, liabilities are overstated

and revenues are understated.
 The adjusting entry results in a debit to a
liability account and a credit to a revenue
account.
 Examples of unearned revenues include rent,
magazine subscriptions, airplane tickets, and
tuition.
ILLUSTRATION 3-4 ADJUSTING
ENTRIES FOR PREPAYMENTS

Adjusting
Entries
Prepaid
Asset Expenses Expen
se
Unadjuste Credit Debit
d Balance Adjusting Adjusting
Entry (-) Entry (+)
Unearned
Liability Revenues Revenu
e
Debit Unadjuste Credit
Adjusting d Balance Adjusting
Entry (-) Entry (+)
 ACCRUALS

 A different type of adjusting entry is accruals.

 Adjusting entries for accruals are required to
record revenues earned and expenses
incurred in the current period.
 The adjusting entry for accruals will increase
both a balance sheet and an income
statement account.
 ACCRUED REVENUES
 Accrued revenues may accumulate with the passing
of time or through services performed but not billed
or collected.
 An asset-revenue account relationship exists with
accrued revenues.
 Prior to adjustment, assets and revenues are
understated.
 The adjusting entry requires a debit to an asset
account and a credit to a revenue account.
 Examples of accrued revenues include accounts
receivable, rent receivable, and interest receivable.
 ACCRUED EXPENSES
 Accrued expenses are expenses incurred but not yet
paid.
 A liability-expense account relationship exists.
 Prior to adjustment, liabilities and expenses are
understated.
 The adjusting entry results in a debit to an expense
account and a credit to a liability account.
 Examples of accrued expenses include accounts
payable, rent payable, salaries payable, and interest
payable.