Accounting Ch 1 & 2 FHSU

Accounting

An information and measurement system that identifies, records and communicates and organizations business activities

Accounting identifies select transactions and events

Ones that change the financial position of the company

Accounting records

Input measure log

Accounting communicates

Prepare analyze and interpret

Financial accounting

Information provided to external decisions makers like investors , lenders, suppliers, and regulators ( our focus for this class)

Managerial accounting

Information provided to internal decision makers like managers and employees

AI in accounting

Will likely eliminate many of the repetitive tasks in accounting like entering invoice data and recording transactions. accountants needed to develop AI ,analyze reports, communicate results. Accounting jobs are secure

Accounting Ethics

a huge topic in accounting. Knowing right from wrong. Ties to Fraud examination.

FASB (Financial Accounting Standards Board)

oversees creation and governance of
accounting standards (GAAP)

GAAP

governance of
accounting standards

FASB

Financial Accounting Standards Board

SEC

Securities and Exchange Commission

SEC (Securities and Exchange Commission)

oversees US financial markets and other
standard setting bodies (FASB, PCAOB)

IASB

international Accounting Standards Board

IASB (International Accounting Standards Board

oversees creation and governance of
international accounting standards (IFRS)

GAAP (Generally Accepted Accounting Principles)

created by FASB, accounting rulebook.
Primary objective – to provide information useful for decision making
o To be useful, that information must be relevant and faithfully represented.
What do these words mean?
o Relevant (pertaining to the matter)
o Faithful representation (complete, neutral, free from error).

Principle of Measurement (cost)

assets purchased and services rendered should be recorded at their
actual cost (exchange value). Accounting records should continue reporting at historical cost over the useful life (with adjustment).

Principle of Revenue Recognition

requires companies to record revenue when it is earned
(performance obligation is satisfied) at the amount expected to be received

Principle of Expense Recognition (matching)

expenses should be recorded in the same period as the
revenue they were used to generate. Let the expenses follow the revenue

principle of Full Disclosure

company reports all details in the financial statements that would
impact user’s decisions. Often found in the footnotes

Assumptions - Time Period (Periodicity)

the life of a company can be divided up into time periods
(months, quarters, years) to allow us to make timely decisions about a business

Assumptions - Monetary unit assumption

we measure things in dollars (euros, pesos, etc.) not pounds,
barrels or units. We ignore inflation

Assumptions - Going concern assumption

we assume the economic entity will have indefinite life

Assumptions - Economic Entity

a business/organization is a separate economic entity from its owners

Fiscal year
(Time Period)

12-month period a business uses as a reporting period
May or may not align with the calendar year

Sole proprietorship

(Economic Entity)

owned by one person. Separate economic entity, but not a
separate legal entity. Owner taxed on earnings.

Partnership
(Economic Entity)

owned by two or more people. Separate economic entity but not a
separate legal entity. Owners taxed on their share of earnings

LLC (Limited Liability Company)

(Economic Entity)

separate economic entity, owners are only
liable for their own actions. No double taxation. LLC is not taxed, but owners are taxed on their share of earnings.

Corporation

(Economic Entity)

owned by one or more people. Separate economic and legal entity.
Taxed separately (owners taxed on distributions)

Constraints - Cost Benefit

information must have a benefit that outweighs the cost of providing it

Constraints - Materiality

the ability of information to influence a decision

Constraints - Conservatism

when faced with two equally valid choices, chose the one that is least
likely to overstate income and asset

Constraints - Industry Practices

certain industries account for items in prescribed ways

The Accounting Equation

Assets = Liabilities + Owner’s Equity

Assets

resources of a business (things they expect to get future economic benefit from). Things a business owns or controls

Liabilities

resources/debts owed to creditors (future economic sacrifices). Creditors’ claims against assets

Owner’s Equity

resources owed to owners (what is left over after liabilities are paid).
Owner’s claims against assets. Net Assets or Residual Equity

Owner’s capital

what the owner had invested in the business (adds to Equity)

Owner’s withdrawals

what the owner has taken from the business/drawings
(subtracted from Equity)

Revenues

money earned from delivering goods or services (adds to Equity)

Expenses

money expended to earn revenue/cost of selling goods or services
(subtracted from Equity)

Net Income

When revenues are greater than expenses

Net Loss

When revenues are less than expenses

Expanded accounting equation

Assets= Liabilities + Owners Capital - Owners Withdrawls + Revenues - Expenses

owner investments

cause owner equity to increase

revenues do what to equity

increase

Transaction

any event that affects the financial position of a business AND can be measured
with faithful representation (need to be able to be measured in dollar amount that can be reliably
determined).
Transactions can be external (exchanges between two entities) or internal (exchanges within an
entity)
Each transaction affects the accounting equation in two or more ways

Step 1 – Identify the accounts and the account type

Accounts are just descriptors – accountants aren’t that creative
• Account types are Asset, Liability, Equity (Contribution, Withdrawal, Revenue, Expense)

Step 2 – Decide if each account is increasing or decreasing

(from the businesses perspective,
not the owner’s or customer’s perspective)

Step 3 – Determine if the accounting equation is in balance

This is most easily demonstrated through problems. Your book demonstrates one, let’s go
through it.

Financial Statements

business documents that are used to communicate information needed to make business decisions.

Financial statement : Income Statement

provides information about a company’s profitability for a period of
time. Revenues – Expenses = Net Income or Net Loss

Financial statement: Statement of Owner’s Equity

shows the changes in owner’s capital for a period of
time. Owner’s Capital, Beginning + Contributions + Net Income (-Net Loss) – Withdrawals = Owner’s Capital, Ending

Financial statement: Balance Sheet

lists balances in assets, liabilities and equity accounts at a point in time.
Financial position of the company. Assets = Liabilities + Owner’s Equity. Assets in order
of liquidity.

Financial statement: Statement of Cash flows

reports on cash receipts and cash payments for a period of
time. Cash flows from Operating Activities, Cash flows from Investing Activities, Cash Flows from Financing Activities (Principles II).

Return on assets

Net Income / Average Total Assets
Net Income / (Beginning Total Assets + Ending Total Assets)/2

Measures how profitably/efficiently a business uses its assets.
Is it good? Compare with self, competitors, industry average. Generally, bigger is better.

Account

detailed record of all increases and decreases that have occurred in an individual asset, liability or component of equity during a specified period

Ledger

A record of all of accounts and their balances

Assets

resources of a business with a future economic benefit to the business

Assets are the following titles

Cash
• Accounts Receivable

• Notes Receivable
• Prepaid Expenses
• Supplies
• Land
• Buildings

equipment

Notes Receivable

– a written promise a customer will pay a fixed amount plus interest
(more formal than accounts receivable)

Prepaid Expenses

a payment of expenses in advance (prepaid rent, prepaid insurance)

Liabilities

debt of the business. Represents a future economic sacrifice

Liabilities are the following titles

Accounts Payable
• Notes Payable –
• Accrued Liability –
• Unearned Revenue

Accounts Receivable

customer’s promise to pay at a future date

Notes Payable

a written promise to pay a fixed amount plus interest (more formal than accounts receivable)

Accrued Liability

an amount owed but not paid (taxes payable, rent payable, salaries payable)

Unearned Revenue

occurs when a company receives payment from a customer for services not yet provided (thus the revenue has not been earned and must be earned in the future

Equity

Owner’s claim to the assets after liabilities are paid (Capital, Withdrawals, Revenues, Expenses)

Equity are the following titles

• Prepaid Rent

• Rent payable

• rent revenue

• rent expense

Prepaid Rent

Rent that was paid in advance. It is an ASSET- a resource, a future economic benefit. You paid September’s rent already, so you won’t have to pay it on September 1st

Rent Payable

rent that is owed, but not paid. It is a LIABILITY – a debt, a future economic sacrifice. Rent is due on the 1st, but not delinquent until the 15th. On the 1st, it becomes a PAYABLE (rent owned). When you pay it, it becomes an expens

Rent Revenue

revenue that is earned by renting out a property or portion of a property.
It is a REVENUE (part of equity) – and inflow, money you have earned. The lease is in your name, but you rent out a room to your friend. The entire amount of rent you pay is a rent expense. The portion that your roommate owes to you is rent revenue

Rent Expense

the cost of renting the property. It is an EXPENSE (part of equity). The amount you must pay to occupy the property.

Chart of accounts

Think table of contents. The way to organize a company’s accounts, varies from business to business

Double entry accounting

what we have been doing. Every transaction recorded into at least two accounts. We record the dual effect of each transaction.

T-Account

shortened form of an account. Looks like a “T” (see what I mean about accountants not being creative). It has a left side (DEBIT) and a right side (CREDIT)

Debit

LEFT. It does NOT mean decrease or subtract. It just means LEFT.

Credit

RIGHT. It does not mean increase or add. It just means RIGHT.

Normal Balance

is the side of the account (debit or credit) where an account increases. It is where we expect the balance to be at the end of a period. Accounts can have a balance on the other, non-normal side, but if they do it represents that the account is over-drawn or over paid.
Follow the AWE LCR rule to determine the normal balance.

Source Documents

provide the evidence of the transaction/economic event. They are what we work from.

Journalizing and Posting Transactions

Instead of the big spreadsheet, this is what we will use. When we journalize, we record the transactions in the date order that they occur. When we post transactions, we transfer the amount we have journalized to the ledger account (we will use T-Accounts)

Step 1:

Identify the accounts and account types for each transaction

Step 2:

Decide whether each account increases or decreases, then apply the rules of debits or credits

Step 3:

Journalize the transaction (write a journal entry) Must have at least one debit and at least one credit. Debits must equal credit

Compound Journal Entry

has multiple debits and/or multiple credits but the same rules apply

Step 4:

Post the amount to the ledger/T-Account

Step 5:

Determine if the accounting equation is still in balance. Use Trial Balance

Trial Balance –

List of all the ledger accounts with their balances at a point in time. Frequently used to prepare the financial statements. We are working with the Unadjusted Trial Balance in this Chapter

Debt Ratio = Total Liabilities/Total Assets

Calculates the portion of assets financed by debt. The higher the Debt Ratio, the greater risk of default. Higher debt means higher financial leverage (assets are leaveraged).