ACCT 201 (Parker) Chapter 1

ACCOUNTING 201 WINTER 2025

Instructor

Brandon R. Parker, CPA, Louisiana Tech University

Chapter 1: An Introduction to Accounting

Definition of Accounting

Accounting is defined as an information system that identifies, records, and communicates relevant, reliable, and comparable financial information about organizations to various stakeholders. It functions as the language of business, enabling entities to track their financial performance and serve as a scorecard for businesses, providing insights that inform decision-making and strategic planning.

Careers in Accounting

Accounting offers diverse career paths, which can generally be categorized into two major fields:

1. Public Accounting

   • Certified Public Accountant (CPA): Licensed accountants who provide services to the public.

   • Audit Services: Examination of financial statements to ensure accuracy and compliance with regulations.

   • Tax Services: Assistance in tax preparation and filing, ensuring clients comply with tax laws while maximizing deductions.

   • Consulting Services: Advising businesses on financial strategies, management, and risk assessment.

2. Private Accounting

   • Certified Management Accountant (CMA): Focused on financial management and strategy within corporations.

   • Certified Internal Auditor (CIA): Specializes in evaluating a company's internal controls, risk management, and governance processes.

Role of Accounting in Society

Accounting plays a crucial role in society by providing useful information for resource allocation decisions, influencing investment choices, measuring performance, and facilitating trust among stakeholders.

Types of Accounting Information

1. Financial Accounting

   • Focused primarily on the needs of external users, such as investors, creditors, and regulatory agencies.

   • Example Question: Should I invest in Apple or Walmart stock?

2. Managerial Accounting

   • Concentrates on the needs of internal users, such as management and department heads.

   • Example Question: Does my store location have too many employees?

Focus of Course: This course will primarily cover Financial Accounting principles and practices.

Accounting as an Information Provider

Accounting provides vital information that supports decision-making across different sectors:

• Financial Accounting: Supplies information to external entities like investors, creditors, employees, and regulatory bodies.

• Managerial Accounting: Delivers insights and data to internal management for operational planning and control.

• Nonprofit Accounting: Ensures transparency and accountability to benefactors and beneficiaries regarding how resources are utilized.

Measurement Rules

The Financial Accounting Standards Board (FASB) establishes measurement and reporting rules known collectively as Generally Accepted Accounting Principles (GAAP).The Securities and Exchange Commission (SEC) imposes reporting requirements for publicly traded companies to ensure consistency and transparency in financial reporting.

Reporting Entities Concept

In accounting, reporting entities are treated as separate reporting units, distinguishing between the entity's financial affairs and those of its owners or other stakeholders. Example: A business, its owner, and a banking institution are treated as distinct entities for financial reporting purposes.

The Accounting Cycle: Basic Steps

The accounting cycle involves a series of steps that help ensure accurate financial reporting, including:

1. Identify financial transactions.

2. Record transactions in the Journal (via Journal Entries).

3. Post Journal Entries to the General Ledger.

4. Prepare Trial Balance to ensure debits equal credits.

5. Prepare Financial Statements:

   • Income Statement: Shows revenues and expenses over a period.

   • Statement of Changes in Equity: Reports changes in equity during the period.

   • Balance Sheet: Snapshot of assets, liabilities, and equity at a point in time.

   • Statement of Cash Flow: Summarizes cash inflows and outflows over a period.

Elements of Financial Statements

Understanding the elements of financial statements is essential:

• Assets: Resources owned that have economic value.

• Liabilities: Obligations that the entity owes to external parties.

• Equity: Residual interest in the assets after deducting liabilities.

• Contributed Capital: Money invested in the business by its owners.

• Revenue: Inflows from normal business operations.

• Expenses: Costs incurred in generating revenue.

• Distributions: Payments made to investors, typically in the form of dividends.

• Net Income: The difference between revenue and expenses, indicating profitability.

• Gains: Earnings from non-core business activities.

• Losses: Losses stemming from non-operational activities.

Detailed Elements of Financial Statements

Assets include:

• Cash

• Accounts Receivable

• Equipment

• Buildings

• Land

Liabilities include:

• Bank Loans

• Bills Due (Accounts Payable)

Accounting Equation

The fundamental equation of accounting states:Assets = Liabilities + Equity

Understanding Assets

Resources owned or controlled by a business include:

• Cash: Liquid funds available for use.

• Accounts Receivable: Amounts owed by customers for goods sold or services rendered.

• Inventory: Goods available for sale.

• Trucks: Vehicles used for business operations.

• Land: Property owned by the business.

Understanding Liabilities

Liabilities consist of obligations a business owes, including:

• Accounts Payable: Money owed to suppliers.

• Notes Payable: Loans or promissory notes payable to creditors.

• Unearned Revenue: Payments received before services are rendered or goods are delivered.

Owner’s Equity

Changes to Owner’s Equity can occur due to: Increases:

• Investments made by owners.

• Revenue generated by operations.

Decreases:

• Withdrawals of assets by owners (dividends).

• Expenses incurred during operations.

Recording Business Events

Accounting events lead to transactions categorized as:

• Asset Sources: Transactions that increase assets.

• Asset Uses: Transactions that decrease assets.

• Asset Exchanges: Transactions that involve trading one asset for another.

Asset Source Transactions

Businesses can obtain assets from:

• Owners/Investors contributing capital.

• Creditors providing loans or credit.

• Profitable Operations generating earnings.

Example Transactions

1. Event 1: Formation of RCSRCS formed by acquiring $120,000 in cash from issuing common stock.

2. Event 2: Borrowing FundsRCS borrowed $400,000 in cash from a creditor for operational expansion.

3. Event 3: Purchasing LandRCS spent $500,000 cash to purchase land for future development.

4. Event 4: Earning RevenueRCS leased campsites for $85,000 cash, generating income from operations.

5. Event 5: Paying ExpensesRCS incurred $50,000 in operating expenses for the period.

6. Event 6: Paying DividendsRCS paid out $4,000 in cash dividends to shareholders.

Quick Quiz

Should RCS report the land's new appraised value of $575,000?Historical Cost Concept: Generally, most assets are reported at their historical cost, regardless of any increases in market value. The reliability of financial information is paramount, hence it must be verifiable by independent sources.

Financial Statements: Summary of Transactions

Transactions Overview:

• RCS issued common stock, acquiring $120,000 cash.

• RCS borrowed $400,000 cash from a creditor.

• RCS paid $500,000 cash for land.

• RCS earned $85,000 in revenue from campsite leases.

• RCS paid $50,000 in expenses related to operations.

• RCS paid dividends of $4,000 cash to owners.

Financial Statements Preparation

1. Income StatementThe income statement reflects that revenue exceeds expenses, leading to a net income of $35,000, derived from rental revenue of $85,000 minus operating expenses of $50,000.

2. Statement of Changes in Stockholders' EquityThis statement details required net income calculations and illustrates how RCS’s net income adds to retained earnings after deducting paid dividends.

3. Balance SheetPresents a snapshot where assets are arranged by liquidity; total assets will equal total liabilities plus stockholders' equity, confirming the accounting equation.

4. Statement of Cash FlowProvides insights into cash inflows and outflows, indicating the liquidity and cash flow management within RCS.

The Closing Process

The closing process is essential as it:

• Transfers net income (or loss) to retained earnings, reflecting overall business performance.

• Establishes zero balances in temporary accounts (revenue, expense, and dividend accounts) in preparation for the new accounting period.

Temporary vs Permanent Accounts

1. Temporary Accounts

   • Track performance for a limited period (e.g., revenues, expenses, dividends).

2. Permanent Accounts

   • Track ongoing financial activity over multiple periods (e.g., assets, liabilities, equity).