Introduction to Accounting

Introduction to Accounting

  • General Overview

    • Accounting as an information system

    • Reports on the economic activities and financial condition of a business or other organization.

    • Applicable to non-profit organizations.

    • Accounting year vs calendar year: may not always align.

How to Prepare Financial Statements

  • Types of Financial Statements:

    1. Income Statement

    • Reports profit or loss over a maximum period of one year.

    1. Statement of Change in Owners’ Equity / Statement of Retained Earnings

    2. Balance Sheet / Statement of Financial Position

    3. Statement of Cash Flows

Role of Accounting in Society

  • Provides information to assist in investment decisions for societal benefit.

Market-Based Allocations

  • Definition of Market:

    • A group of people or entities organized to exchange items of value.

  • Common Terms for Added Value Creation in Transformation Process:

    • Profit

    • Income

    • Earnings (as of January 12, 2026, 7:50 AM)

Financial Resources

  • Necessity for Businesses:

    • Financial resources (money) are needed to start and operate businesses.

    • Sources of Financial Resources:

    • Investors:

      • Funding comes from owners.

    • Creditors:

      • Money loaned that must be repaid; can include banks, loan companies, and private loans.

  • Financing:

    • Involves interest rates paid back on loans.

    • Example:

    • $10,000 needed to start a business:

      • $6,000 from investors, $4,000 from creditors.

Market Trilogy in Resource Allocation

  • Physical Resources:

    • Natural resources that high-earning business owners seek to sell at higher prices.

  • Labour Resources:

    • Consists of intellectual and physical labor.

    • Workers prefer high-income potential businesses offering better wages and job security.

Accounting Provides Information

  • Stakeholders:

    • Numerous users of accounting information are referred to as stakeholders (not stockholders).

    • Stakeholders encompass resource providers, financial analysts, brokers, attorneys, government regulators, and news reporters.

Types of Accounting Information

  1. Financial Accounting:

    • Focused on external users' needs.

  2. Managerial Accounting:

    • Focused on internal users' needs.

  • External Users:

    • Shareholders and various other stakeholders.

  • Internal Users:

    • Managers within the organization.

Nonbusiness Resource Usage

  • Resources may be allocated not solely based on profitability.

  • Examples of Nonprofit Allocations:

    • Governments allocate resources for national defense, wealth reallocation, and environmental protection.

    • Foundations and religious groups prioritize humanitarian concerns over profitability.

  • Nonprofit Entities:

    • Organizations not driven by profit motives.

Accounting as Resource Provider

  • Improvement of Communication:

    • Accountants standardize rules for measurement and reporting to enhance communication within businesses.

  • Generally Accepted Accounting Principles (GAAP):

    • A set of standards for financial accounting.

  • Focus on International Issues:

    • Each country previously had its GAAP, posing challenges for global companies.

    • The International Accounting Standards Board (IASB) issues International Financial Reporting Standards (IFRS), increasing global support.

Reporting Entities

  • Financial accounting reports show the financial activities of specific reporting entities, classified as separate reporting units (e.g., businesses, individuals, organizations).

The Accounting Equation

  • Elements of the Accounting Equation:

    • Assets

    • Liabilities

    • Stockholders’ Equity

    • Stockholders’ equity includes common stock and retained earnings.

  • Relevance of Assets:

    • Resources utilized by businesses to generate money are termed assets.

  • Examples of Assets:

    • Receivables, investments, buildings, furniture.

  • Formulation of Accounting Equation:

    • Assets = Claims

    • Assets = Liabilities + Stockholders’ Equity

    • Claims = Liabilities + Stockholders’ Equity

    • Assets = Liabilities + Common Stock + Retained Earnings

    • Stockholders’ Equity = Common Stock + Retained Earnings

  • Sources of Claims on Assets:

    • Creditors (liabilities)

    • Investors (stockholders’ equity)

    • Operations (profits increasing assets)

  • Retained Earnings:

    • Represents increases to stockholders' equity derived from earnings.

  • Dividends:

    • Distribution of assets generated through earnings.

Using Accounts to Gather Information

  • Types of Accounts:

    • Assets: cash, equipment, buildings, land.

    • Liabilities and Stockholders’ Equity detailed in records termed accounts.

  • Variability in Account Names:

    • Different business entities may not use the same accounts or account names.

Recording Business Events Under an Accounting Equation

  • Accounting Period:

    • Time span over which business activity is reported.

  • Accounting Event:

    • Economic occurrence affecting a business's assets, liabilities, or stockholders’ equity.

  • Transaction:

    • A specific event involving the exchange of value between two entities.

    • Sample Events for Rustic Camp Sites (RCS):

    • Event 1:

      • Acquired $120,000 cash from issuing common stock, increasing cash (asset) and stockholders’ equity (common stock).

    • Event 2:

      • Borrowed $400,000 from a creditor, increasing both cash (asset) and liabilities (notes payable).

    • Event 3:

      • Paid $500,000 cash to purchase land, reducing cash (asset) while increasing land (asset).

Changes in Market Value

  • Historical Cost Concept:

    • Requires that most assets be reported at their purchase price, regardless of market value increases.

Summary of Transactions

  • General Ledger Accounts:

    • Organized under the accounting equation, encompassing the complete collection of a company's accounts.

Left vs. Right Side of the Accounting Equation

  • Left Side:

    • Assets (e.g. cash) not directly correlated to actual cash on hand.

  • Right Side:

    • Reflects sources of company assets rather than their composition.

Cash and Retained Earnings

  • Retained Earnings:

    • Does not equal cash on hand but restricts cash available for dividends.

Business Liquidations from Net Losses

  • Business Liquidation Process:

    • Occurs if a business ceases operations; remaining assets are sold to pay back creditors and investors, with creditors having priority.

  • Mismanagement of Assets:

    • If creditors demand payment and assets are insufficient.

Going Concern Doctrine

  • Assumption:

    • A business will continue operations for the foreseeable future.

  • Accountant's Requirement:

    • Notify creditors and investors if going concern status is uncertain.

Two Views of the Right Side of the Accounting Equation

  1. Sources of Company’s Assets

  2. Obligations to Return Creditor Assets:

    • Stewardship:

    • Duty to protect and manage assets for owners' benefit.

Recap: Types of Transactions

  • Transactions are classified into three categories:

    1. Assets Source

    2. Asset Exchange

    3. Asset Use

Reporting Information

  • Financial Statements for External Users:

    • Income Statement

    • Statement of Changes in Stockholders’ Equity

    • Balance Sheet

Income Statement and the Matching Concept

  • Net Income:

    • Occurs when revenues exceed expenses.

  • Net Loss:

    • Occurs when expenses exceed revenues.

  • Matching Concept:

    • Aligns revenues (benefits) with expenses (sacrifices) incurred for revenue generation.

  • Example:

    • Rental Revenue (asset income) vs Operating Expenses (asset decreases).

Statement of Changes in Stockholders’ Equity

  • Explains transaction effects on stockholders’ equity during the accounting period.

Balance Sheet

  • Derived from the accounting equation, where total assets equal liabilities plus stockholders’ equity.

Financial Statements Interrelationships

  • Articulation:

    • Describes the bonds among financial statements.

  • Key articulation relationships highlighted in RCS’s financial statements.

Statement of Cash Flows

  • Explains cash obtained and used during the accounting period.

Closing Temporary Accounts to Retained Earnings

  • Closing Process:

    • Transfers information from temporary accounts (revenue, expense, dividends) to the Retained Earnings account, a permanent account.

Horizontal Financial Statements Model

  • A visual tool that displays how business events impact financial statements.

Real-World Financial Reports

  • Service Businesses:

    • Examples: Doctors, attorneys, accountants.

  • Merchandising Businesses:

    • Sell goods produced by other entities; examples include retail and wholesale companies.

  • Manufacturing Businesses:

    • Produce goods sold to customers.

Annual Report Components

  • Composed of financial statements, notes, auditor's report, and management's discussion and analysis (MD&A).

  • 10-K Report:

    • A detailed financial document required by the U.S. Securities and Exchange Commission (SEC) for publicly traded corporations.

Special Terms in Real-World Reports

  • Financial statements of real-world companies often include advanced topics beyond introductory accounting textbooks.