Introduction to Basic Accounting Concept

Chapter

CHAPTER 1

ACCOUNTING IN

ACTION

Chapter

History of Accounting

Ancient history :

o Accountancy is a very old concept. Its inception was

during the age of human agriculture and civilization.

(the Sumerians* in Mesopotamia, and the Egyptian Old

Kingdom) Ancient economic thinking facilitated the

creation of accurate records of the quantities and

relative values of agricultural products, methods that

were formalized in trading and monetary systems by

2000 BC.

* (late 6th millennium BC to 4th millennium BC))

Chapter

Painting of Luca Pacioli (The father of Accounting)

Chapter

Luca Pacioli (1445 - 1517), also known as Friar Luca dal

Borgo, is credited for the "birth" of accounting.

His Summa de arithmetica, geometrica, proportioni et

proportionalita (Summa on arithmetic, geometry,

proportions and proportionality, Venice 1494), was a

textbook for use in the abbaco schools of northern Italy,

where the sons of merchants and craftsmen were

educated.

Chapter

It includes the first printed description of the method of

keeping accounts that merchants used at that time,

known as the double-entry accounting system.

Pacioli actually codified rather than invented this system.

As The system he published included most of the

accounting cycle as we know it today, so he is widely

regarded as the "Father of Accounting".

He described the use of journals and ledgers, and

warned that a person should not go to sleep at night until

the debits equal the credits!

Chapter

Study Objectives

1. Explain what accounting is.

2. Identify the users and uses of accounting.

3. Understand why ethics is a fundamental business concept.

4. Explain generally accepted accounting principles and the cost principle.

5. Explain the monetary unit assumption and the economic entity assumption.

6. State the accounting equation, and define assets, liabilities, and owner’s equity.

7. Analyze the effects of business transactions on the accounting equation.

8. Understand the four financial statements and how they are prepared.

Chapter

Accounting in Action

Ethics in

financial

reporting

Generally

accepted

accounting

principles

Assumptions

What is

Accounting?

The Building

Blocks of

Accounting

The Basic

Accounting

Equation

Using the

Accounting

Equation

Financial

Statements

activities

Who uses

accounting

Assets

Liabilities

Owner’s

equity

Transaction

analysis

Summary of

transactions

Income

statement

Owner’s

equity

statement

Balance

Statement of

cash flows

Chapter

Three Activities

What is Accounting?

LO 1 Explain what accounting is.

Illustration 1-1Accounting process

The accounting process includesthe bookkeeping function.

Chapter

There are two broad groups of users of financial information: internal users and external users.

Who Uses Accounting Data?

LO 2 Identify the users and uses of accounting.

Internal Users

External Users

Management

Human Resources

Labor Unions

Marketing

Finance

Investors

Creditors

Customers

Chapter

Who Uses Accounting Data?

Common Questions Asked User

1. Can we afford to give our employees a pay raise?

Human Resources

2. Did the company earn a satisfactory income?

3. Do we need to borrow in the near future?

4. Is cash sufficient to pay dividends to the stockholders?

5. What price for our product will maximize net income?

LO 2 Identify the users and uses of accounting.

6. Will the company be able to pay its short-term debts?

Investors

Management

Finance

Marketing

Creditors

Chapter

The Building Blocks of Accounting

Ethics In Financial Reporting

LO 3 Understand why ethics is a fundamental business concept.

Standards of conduct by which one’s actions are judged as right or

wrong, honest or dishonest, fair or not fair, are Ethics.

Recent financial scandals include: Enron, WorldCom,

HealthSouth, AIG, and others.

Effective financial reporting depends on sound ethical behavior.

Chapter

The common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP are a combination of authoritative standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting information. Source: [http://www.investopedia.com/terms/g/gaap.asp]

Chapter

Organizations Involved in Standard Setting:

Securities and Exchange Commission (SEC)

Financial Accounting Standards Board (FASB)

International Accounting Standards Board

(IASB)

LO 4 Explain generally accepted accounting principles and the cost principle.

http://www.fasb.org/

http://www.sec.gov/

http://www.iasb.org/

Chapter

Since 1973 the FASB has been the organization designated to establish authoritative financial accounting and reporting standards (Statements of Financial Accounting Standards, SFAS) for business and other private-sector entities. Its mission is to be responsive to the entire economic community and to operate in full view of the entire community through a due-process system.

Chapter

Formed in January 2001. IASB is structured similarly to the FASB. It is currently the focus of the IASB, in collaboration with the FASB and other accounting focused organizations, to "meet" standards and develop a single, universally accepted set of biding international accounting standards. The IASC, and now IASB, issue a series of standards known as International Financial Reporting Standards (IFRS), formerly called International Accounting Standards (IAS).

Chapter

Various users need financial information

The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced.

Financial StatementsBalance SheetIncome StatementStatement of Owner’s EquityStatement of Cash FlowsNote Disclosure

Generally Accepted Accounting Principles (GAAP)

Chapter

Cost Principle (Historical) – dictates that companies record

assets at their cost.

Issues:

Reported at cost when purchased and also over the time the asset is held.

Cost easily verified, whereas market value is often subjective.

e.g. XYZ corp. purchased a car for $200,000 in the year of 2006. But, the car’s

current market price is $150,000. Still, the historic cost principle says that

the book value (recorded value) of the asset should portray the historic

cost meaning $200,000 for the car.

Chapter

Monetary Unit Assumption – include in the accounting

records only transaction data that can be expressed in terms of money.

Economic Entity Assumption – requires that activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities.

Proprietorship.

Partnership.

Corporation.

Assumptions

LO 5 Explain the monetary unit assumption and the economic entity assumption.

Forms of Business Ownership

Chapter

Proprietorship Partnership Corporation

Owned by two or more persons.

Often retail and service-type businesses

Generally unlimited personal liability

Partnership agreement

Ownership divided into shares of stock

Separate legal entity organized under state corporation law

Limited liability

Forms of Business Ownership

Generally owned by one person.

Often small service-type businesses

Owner receives any profits, suffers any losses, and is personally liable for all debts.

LO 5 Explain the monetary unit assumption and the economic entity assumption.

Chapter

Assets LiabilitiesOwner’s Equity

Provides the underlying framework for recording and summarizing economic events.

Assets are claimed by either creditors or owners.

Claims of creditors must be paid before ownership claims.

The Basic Accounting Equation

LO 6 State the accounting equation, and define assets, liabilities, and owner’s equity.

Chapter

Resources a business owns.

Provide future services or benefits.

Cash, Supplies, Equipment, inventory, Car, trucks, machines, etc.

Assets

Chapter

Claims against assets (debts and obligations).

Creditors - party to whom money is owed.

Accounts payable, Notes payable, etc.

Liabilities

Chapter

Ownership claim on total assets.

Referred to as residual equity.

Capital, Drawings, etc. (Proprietorship or Partnership).

Owner’s Equity

Chapter

Owners’ Equity

Revenues result from business activities entered into for the purpose of

earning income.

Common sources of revenue are: sales, fees, services, commissions, interest,

dividends, royalties, and rent.

Illustration 1-6

Chapter

Owners’ Equity

Expenses are the cost of assets consumed or services used in the process of

earning revenue.

Common expenses are: salaries expense, rent expense, utilities expense, tax

expense, etc.

Illustration 1-6

Chapter

Using The Basic Accounting Equation

Transactions are a business’s economic events recorded by

accountants.

May be external or internal.

Not all activities represent transactions.

Each transaction has a dual effect on the accounting equation.

LO 7 Analyze the effects of business transactions on the accounting equation.

Chapter

Q1-15: Are the following events recorded in the accounting records?

EventSupplies are purchased for cash.

Criterion Is the financial position (assets, liabilities, or owner’s equity) of the company changed?

An employee is hired.

Owner withdraws cash for personal use.

Record/ Don’t Record

Transactions (Question?)

Chapter

Accrual Basis Accounting – An intro

Accrual Basis accounting is one of the most important accounting concept that is being followed by most of the organizations. As per the “Matching principle” it is binding that the revenues and the expenses of any specific period must be reported in that period. So, sometimes this very criterion pushes the firms to follow the accrual basis accounting.

Chapter

Accounts Payable

To run the business sometimes it is required to purchase

several products or to receive services on credit. This is

an obligation that the company needs to pay and these

obligations are called as Accounts Payables.

In a similar manner if any company borrows any amount

of money with formal instruments as proof of debt, then it

is an obligation that is needed to be paid. Then it is

called Notes Payable.

All these PAYABLES are LIABILITIES.

Chapter

Discussion Question

Q18. In February 2008, Paula King invested an

additional $10,000 in her business, King’s

Pharmacy, which is organized as a proprietorship.

King’s accountant, Lance Jones, recorded this

receipt as an increase in cash and revenues. Is

this treatment appropriate? Why or why not?

Transactions

Chapter

Answer

Question 18 (Chapter 1) No, this treatment is not proper. While the transactions does involve a receipt of cash, it does not represent revenues. Revenues are the gross increase in owner’s equity resulting from business activities entered into for the purpose of earning income. This transactions is simply an additional investment made by the owner in the business.

Chapter

P1-1A: Barone’s Repair Shop was started on May 1 by Nancy. Prepare a tabular analysis of the following transactions for the month of May.

Transactions (Problem)

+10,0001. +10,000

CashAccounts Receivable Equipment

Accounts Payable

Barone, Capital

+ + = +

1. Invested $10,000 cash to start the repair shop.

Investment

Assets Liabilities Equity

Chapter

+10,0001. +10,000

Accounts Payable

Barone, Capital

2. Purchased equipment for $5,000 cash.

-5,0002. +5,000

+ + = +

Investment

Chapter

+10,0001. +10,000

Accounts Payable

3. Paid $400 cash for May office rent.

-5,0002. +5,000

+ + = +

-4003. -400 Expense

Barone, Capital

Investment

Chapter

+10,0001. +10,000

Accounts Payable

4. Received $5,100 from customers for repair service.

-5,0002. +5,000

+ + = +

-4003. -400 Expense

+5,1004. +5,100 Revenue

Barone, Capital

Investment

Chapter

+10,0001. +10,000

Accounts Payable

5. Withdrew $1,000 cash for personal use.

-5,0002. +5,000

+ + = +

-4003. -400 Expense

+5,1004. +5,100 Revenue

-1,0005. -1,000 Drawings

Barone, Capital

Investment

Chapter

+10,0001. +10,000

Accounts Payable

6. Paid part-time employee salaries of $2,000.

-5,0002. +5,000

+ + = +

-4003. -400 Expense

+5,1004. +5,100 Revenue

-1,0005. -1,000 Drawings

-2,0006. -2,000 Expense

Barone, Capital

Investment

Chapter

+10,0001. +10,000

Accounts Payable

7. Incurred $250 of advertising costs, on account.

-5,0002. +5,000

+ + = +

-4003. -400 Expense

+5,1004. +5,100 Revenue

-1,0005. -1,000 Drawings

-2,0006. -2,000 Expense

+2507. -250 Expense

Barone, Capital

Investment

Chapter

Receivables

The term receivables refers to amount due from

individuals and other companies. Receivables are

claims that are expected to be collected in cash.

Examples can be 1) Accounts receivables, 2) Notes

Receivables , etc.

1) Accounts receivables: Amount owed by customers

on account. They result from sale of goods and

services. Companies generally expects to collect these

receivables within 30 to 60 days.

2) Notes receivables: Claims for which formal instrument

of credit are issued as proof of debt. It requires the

debtor to pay interest.

All these Receivables are ASSETS.

Chapter

+10,0001. +10,000

Accounts Payable

8. Provided $750 of repair services on account.

-5,0002. +5,000

+ + = +

-4003. -400 Expense

+5,1004. +5,100 Revenue

-1,0005. -1,000 Drawings

-2,0006. -2,000 Expense

+2507. -250 Expense

+7508. +750 Revenue

Barone, Capital

Investment

Chapter

+10,0001. +10,000

Accounts Payable

9. Collected $120 cash for services previously billed.

-5,0002. +5,000

+ + = +

-4003. -400 Expense

+5,1004. +5,100 Revenue

-1,0005. -1,000 Drawings

-2,0006. -2,000 Expense

+2507. -250 Expense

+7508. +750 Revenue

+1209. -120

Barone, Capital

Investment

6,820 + 630 + 5,000 = 250 + 12,200

Chapter

1. Marie Collins invested $100,000 of her own money into her new pet shop on December 01, 2005. The store will be named “Love thy Pet.”

2. On January 1, 2006, Marie paid $1,350 rent on the pet shop which is the rent of December.

3. For January 2, 2006, Marie borrowed $50,000 by signing a 4-month, 10% note payable.

4. For January 5, 2006, Marie purchased pet store equipment for $7,500 in cash.

5. For January 6, 2006, Marie hired two salespeople to begin work on the 9th of January in the store for a bi-weekly wage of $800 each.

6. For January 8, 2006, Marie receives a cash advance of $1,200 from a customer for an Irish sheep dog that will not arrive from the breeder until March 7, 2006.

.List of Transactions for the months of December 2005 &

January 2006

Chapter

List of Transactions for the months of December 2005 & January 2006

7. For January 10, 2006, Marie received $5,500 in cash for two bulldogs sold to a customer.

8. For January 14, 2006, Marie purchased 2-months of pet supplies on account at a cost of $500 from Morrison pet supply store.

9. For January 15, 2006, Marie declared and paid a dividend to stockholders of $400.

10. For January 31, 2006 Marie purchased a 2-year insurance policy costing $2,400 that will expire on January 31 of 2008.

11. For January 31, 2006, Marie paid the salespersons bi-weekly wages.

Chapter

Marie Collins invested $100,000 of her own money into her new pet shop on January 1, 2006. The store will be named “Love thy Pet.”

Chapter

On January 1, 2006, Marie paid $1,350 rent on the pet shop. (For December last year)

Chapter

For January 2, 2006, Marie borrowed $50,000 by signing a 4-month, 10% note payable.

Chapter

For January 5, 2006, Marie purchased pet store equipment for $7,500 in cash.

Chapter

For January 6, 2006, Marie hired two salespeople to begin work on the 9th of January in the shop for

a bi-weekly wage of $800 each.

This was not a transaction; therefore, it requires no journal

entries because assets were not exchanged at the time of

this event.

Chapter

For January 8, 2006, Marie receives a cash advance of $1,200 from a customer for an Irish sheep dog that will not arrive from the breeder until March 7, 2006.

Chapter

For January 10, 2006, Marie received $5,500 in cash for two bulldogs sold to a customer.

Chapter

For January 14, 2006, Marie purchased 2-months of pet supplies on account from Morrison pet supply store for $500.

Chapter

For January 15,2006, Marie declared and paid a dividend to stockholders of $400.

Chapter

For January 31, 2006 Marie purchased a 2-year insurance policy costing $2,400 that will expire on January 31 of 2008.

Chapter

For January 31, 2006, Marie paid the salespeople their bi-weekly wages.

Chapter

Companies prepare four financial statements from the summarized accounting data:

Balance SheetIncome Statement

Statement of Cash Flows

Owner’s Equity Statement

Financial Statements

LO 8 Understand the four financial statements and how they are prepared.

Chapter

Income Statement

Reports the revenues and expenses for a specific period of time.

Net income – revenues exceed expenses.

Net loss – expenses exceed revenues.

Revenues:

Service revenue 5,850$

Expenses:

Salary expense 2,000

Rent expense 400

Advertising expense 250

Total expenses 2,650

Net income 3,200$

Barone’s Repair Shop

Income Statement

For the Month Ended May 31, 2008

Chapter

Revenues:

Service revenue 5,850$

Expenses:

Salary expense 2,000

Rent expense 400

Advertising expense 250

Total expenses 2,650

Net income 3,200$

Income Statement

Barone's, Capital May 1 -$

Add: Investment 10,000

Net income 3,200

13,200

Less: Drawings 1,000

Barone's, Capital May 31 12,200$

Owner's Equity Statement

Net income is needed to determine the ending balance in owner’s equity.

Chapter

Net income 3,200

13,200

Statement indicates the reasons why owner’s equity has increased or decreased during the period.

Chapter

Net income 3,200

13,200

Owners’ Equity Statement

Assets

Cash 6,820$

Accounts receivable 630

Equipment 5,000

Total assets 12,450$

Liabilities

Accounts payable 250$

Owner's Equity

Barone's, capital 12,200

Total liab. & equity 12,450$

Balance Sheet

May 31, 2008

The ending balance in owner’s equity is needed in preparing the balance sheet

Balance Sheet

Chapter

Balance Sheet

Reports the assets, liabilities, and owner’s equity at a specific date.

Assets listed at the top, followed by liabilities and owner’s equity.

Total assets must equal total liabilities and owner’s equity.

Assets

Cash 6,820$

Equipment 5,000

Liabilities

Owner's Equity

Balance Sheet

May 31, 2008

Chapter

Balance Sheet

Assets

Cash 6,820$

Equipment 5,000

Liabilities

Owner's Equity

Balance Sheet

May 31, 2008Cash flow from operating activities

Cash receipts from revenues 5,220$

Cash paid for expenses (2,400)

Cash provided by operations 2,820

Cash flow from investing activitites

Purchase of equipment (5,000)

Cash flow from financing activities

Investment by owners 10,000

Drawings by owners (1,000)

Cash provided by financing 9,000

Net increase in cash 6,820

Cash balance, May 1 -

Cash balance, May 31 6,820$

Chapter

Cash flow from operating activities

Cash receipts from customers 5,220$

Cash paid for expenses (2,400)

Cash provided by operations 2,820

Cash flow from investing activities

Purchase of equipment (5,000)

Cash flow from financing activities

Investment by owners 10,000

Drawings by owners (1,000)

Cash provided by financing 9,000

Net increase in cash 6,820

Cash balance, May 1 -

Cash balance, May 31 6,820$

Statement of Cash FlowsInformation for a specific period of time.

Answers the following:

1. Where did cash come from?

2. What was cash used for?

3. What was the change in the cash balance?

Chapter

End of the Chapter!

Introduction to Basic Accounting Concept

Education

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