Financial Accounting - Chapter 1: Accounting in Action

Financial Accounting - Chapter 1: Accounting in Action

Chapter Preview

• Good decision-making depends on good information; essential for earning a living, spending money, buying on credit, investing, or paying taxes.

Chapter Outline

Learning Objectives

• LO 1: Identify accounting activities and users.

• LO 2: Explain the building blocks of accounting: ethics, principles, and assumptions.

• LO 3: State the accounting equation and define its components.

• LO 4: Analyze the effects of business transactions on the accounting equation.

• LO 5: Describe the five financial statements and how they are prepared.

Key Topics

• Three activities of accounting

• Users of accounting data

• Ethics in financial reporting

• Accounting standards and measurement principles

• Accounting equation components

• Effects of transactions

• Financial statements: income statement, retained earnings statement, statement of financial position, statement of cash flows, comprehensive income statement

DO IT! Activities

• DO IT! 1: Basic Concepts

• DO IT! 2: Building Blocks of Accounting

• DO IT! 3: Equity Effects

• DO IT! 4: Tabular Analysis

• DO IT! 5: Financial Statement Items

Learning Objective 1: Identify the Activities and Users Associated with Accounting

Accounting Activities

• Three Activities:

  • Identification: Select economic events (transactions).

  • Recording: Record, classify, and summarize.

  • Communication: Prepare accounting reports and analyze & interpret them for users.

Users of Accounting Information

Internal Users

• Examples of questions from internal users:

  • Finance: "Is cash sufficient to pay dividends to shareholders?"

  • Marketing: "What price should be charged for a cell phone to maximize net income?"

  • Human Resources: "Can we afford to give employees pay raises this year?"

  • Management: "Which product line is the most profitable? Should any be eliminated?"

External Users

• Examples of questions from external users:

  • Investors: "Is the company earning satisfactory income?"

  • Creditors: "Will the company be able to pay its debts?"

  • Taxing authorities: "Does the company comply with tax laws?"

  • Regulatory agencies: "Is the company operating within the rules?"

  • Labor unions: "Can the company pay increased wages to members?"

Learning Objective 2: Explain the Building Blocks of Accounting: Ethics, Principles, and Assumptions

Ethics in Financial Reporting

• Ensures high-quality financial reporting.

Accounting Standards

• Primary standard-setting bodies:

  • International Accounting Standards Board (IASB): Establishes IFRS used in 130 countries.

  • Financial Accounting Standards Board (FASB): Establishes GAAP used mostly in the U.S.

Measurement Principles

• Historical Cost Principle: Companies record assets at their cost and maintain this value over time.

• Fair Value Principle: Assets and liabilities are reported at their fair value (the price to sell an asset or settle a liability).

Selection of Measurement Principles

• Relates to trade-offs between relevance and faithful representation.

  • Relevance: Financial information can influence decision-making.

  • Faithful Representation: Information accurately depicts reality; it is factual and complete.

Assumptions

• Monetary Unit Assumption: Includes only transaction data expressible in monetary terms.

• Economic Entity Assumption: Separates the activities of the business from its owner and other entities. Typical entity forms include proprietorships, partnerships, and corporations.

Learning Objective 3: State the Accounting Equation and Define Its Components

The Accounting Equation

• $ext{Assets} = ext{Liabilities} + ext{Equity}$

Components of Equity

• Share Capital - Ordinary: Amounts paid in by shareholders for their shares.

• Revenues: Gross increases in equity from business activities aimed at earning income; usually increase an asset.

• Expenses: Costs of assets or services used to generate revenue; decrease equity.

• Dividends: Distributions of cash/assets to shareholders; do not impact income.

Learning Objective 4: Analyze the Effects of Business Transactions on the Accounting Equation

Accounting Information System

• System for collecting, processing transaction data, and communicating financial information.

Identifying Accounting Transactions

• Criterion: Does it change the financial position (assets, liabilities, equity)? Record if yes.

Transaction Examples:

1. Investment by Shareholders: Ray and Barbara Neal invest €15,000 for shares in Softbyte SA.

   • Equation: Maintains equality; asset increase in cash equals equity in shares.

2. Purchase of Equipment for Cash: €7,000 equipment purchase.

   • Equation: Asset composition changes without overall asset value change.

3. Purchase of Supplies on Credit: €1,600 purchase for headsets; liability increases.

   • Demonstrates changes in assets (supplies) and liabilities (accounts payable).

4. Services Performed for Cash: €1,200 received for app development.

   • Revenue increases, affecting equity positively.

5. Purchase of Advertising on Credit: €250 bill for advertising.

   • Reflects an expense impacting retained earnings.

6. Services Performed on Cash & Credit: Total €3,500 from which €1,500 is cash and €2,000 on account.

   • Increases in equity and assets recorded.

7. Payment of Expenses: Total €1,700 (rent, salary, utilities) paid in cash.

8. Payment of Accounts Payable: €250 bill payment results in liabilities and asset reduction.

9. Receipt of Cash on Account: €600 collection from past services rendered without changing equity.

10. Dividends: €1,300 paid to shareholders; reduces both assets and equity.

Key Points on Transaction Analysis

1. Each transaction affects the accounting equation components.

2. The sides of the equation must balance.

3. Impacts on equity are tracked through share capital and retained earnings.

Learning Objective 5: Describe the Five Financial Statements and How They Are Prepared

Financial Statements Overview

1. Income Statement: Summarizes revenues and expenses resulting in net income/loss for a period.

2. Retained Earnings Statement: Shows changes in retained earnings for a designated period.

3. Statement of Financial Position (Balance Sheet): Reports assets, liabilities, and equity at a specified date.

4. Statement of Cash Flows: Summarizes cash inflows and outflows for a period.

5. Comprehensive Income Statement: Includes comprehensive income items not reported in net income.

Interconnections Between Financial Statements

• Net income calculation is foundational for retained earnings which impact the statement of financial position.

• Cash from the statement of financial position feeds into the statement of cash flows.

Preparation and Structure of Financial Statements

• Income Statement: Lists revenues first, expenses follow, and displays net income/loss.

• Retained Earnings Statement: Starts with beginning retained earnings, adds net income/loss and subtracts dividends.

• Statement of Financial Position: Snapshot; assets first, then equity and liabilities, ensuring totals equal.

• Statement of Cash Flows: Reports cash effects from operations, investing, financing activities, and overall changes in cash.

• Comprehensive Income Statement: Follows the income statement, showing additional income items; IFRS allows a combined statement format.

Career Opportunities in Accounting

• Public Accounting: Provides services such as auditing and tax consulting to the public.

• Private Accounting: Employees in organizations involved in cost accounting, budgeting, and internal audits.

• Governmental Accounting: Positions include roles in tax authorities, regulators, and educators.

• Forensic Accounting: Investigating fraud and theft utilizing accounting skills.

Copyright Information

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