Accountancy

Chapter One: An Introduction to Accounting

McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objective 1: Explain the Role of Accounting in Society

• Accounting's Importance

  • Provides vital information for decision-making related to resource allocation.

  • Example question: "Should I invest money in IBM or General Motors?"

1- Role of Accounting in Society

• Accounting Function

  • Supplies data necessary for assessing resource allocation.

Market-Based Allocations

• Definition: A market consists of groups of people or entities organized to exchange things of value.

1- Market-Based Allocations

• Common Terms:

  • Profit

  • Income

  • Earnings

Financial Resources

• Need for Financial Resources:

  • Conversion agents (businesses) require financial resources to set up and operate.

• Key Stakeholders:

  • Investors

  • Creditors

1- Physical Resources

• Definition: Physical resources are the natural resources in their most basic forms.

  • Ownership

  • Owners of physical resources aim to sell them to profitable businesses capable of paying higher prices and making repeat purchases.

1- Labor Resources

• Definition: Labor resources encompass both intellectual and physical labor.

  • Workers pursue engagements with businesses that exhibit high earnings potential, which equates to the ability to pay higher wages.

Careers in Accounting

• Public Accounting

  • Roles include:

  • Certified Public Accountant

  • Audit services

  • Tax services

  • Consulting services

• Private Accounting

  • Roles include:

  • Certified Management Accountant

  • Certified Internal Auditor

1- Measurement Rules

• Accountants develop measurement and reporting rules, known as Generally Accepted Accounting Principles (GAAP), for businesses to facilitate effective communication.

1- Reporting Entities

• Definition: Financial accounting reports present the financial activities of specific individuals or organizations referred to as reporting entities.

• Principle: Each entity functions as a separate reporting unit.

  • Examples of reporting entities:

  • Business Owner

  • Bank

Learning Objective 2: Construct an Accounting Equation Using Elements of Financial Statements Terminology

1- Elements of Financial Statements

• Categories of Elements:

  • Assets

  • Liabilities

  • Equity

  • Contributed Capital

  • Revenue

  • Expenses

  • Distributions

  • Net Income

  • Gains

  • Losses

• The first eight elements will be discussed in this chapter, while elements nine and ten will be covered later.

1- Elements of Financial Statements (Detailed)

• Assets Examples: Cash, Equipment, Buildings, Land.

• Liabilities & Equity: These categories display the claims against assets.

• Accounts: Sub-classifications of the elements are often referred to as accounts and are reported in financial statements.

Accounting Equation

• Basic Equation: Assets = Claims

  • Claims can originate from two groups:

  • Creditors (Liabilities)

  • Investors or Owners (Equity)

• Expanded Accounting Equation:
  ext{Assets} = ext{Liabilities} + ext{Equity}

Accounting Equation Example

• Example Value Setup:

• ext{Assets} = 500, ext{Liabilities} + ext{Equity}

• Breakdown:

  • 500 = 200 + 300

• Interpretation:

  • Assets minus Liabilities equals Equity:
    500 - 200 = 300

Accounting Equation Breakdown

• Equity Composition:

• ext{Assets} = ext{Liabilities} + ext{Stockholders' Equity}

• Sub-categories of Stockholders' Equity include common stock and retained earnings.

Learning Objective 3: Record Business Events in General Ledger Accounts Organized Under an Accounting Equation

1- Recording Business Events Under the Accounting Equation

• Accounting Event Transaction Stages:

  1. Source

  2. Exchange

  3. Use

1- Asset Source Transactions

• Businesses generate assets from the following sources:

  1. Owners

  2. Creditors

  3. Profitable Operations

1- Business Events — Examples

• Event 1: Rustic Camp Sites (RCS) formed on January 1, 2011, by acquiring $120,000 in cash through issuing common stock.

  • Effect on Accounts:

  • Increases assets (cash).

  • Increases stockholders’ equity (common stock).

  • ** Transaction Type**: Asset Source Transaction

  • Method: Double-Entry Bookkeeping (recorded twice).

• Event 2: RCS acquired an additional $400,000 cash by borrowing from a creditor.

  • Effect on Accounts:

  • Increases assets (cash).

  • Increases liabilities (notes payable).

  • ** Transaction Type**: Asset Source Transaction

• Event 3: RCS paid $500,000 cash to purchase land.

  • Effect on Accounts:

  • Decreases assets (cash).

  • Increases assets (land).

  • Transaction Type: Asset Exchange Transaction

• Event 4: RCS obtained $85,000 cash by leasing campsites to customers.

  • Effect on Accounts:

  • Increases assets (cash).

  • Increases stockholders’ equity (retained earnings).

  • Transaction Type: Asset Source Transaction

• Event 5: RCS paid $50,000 cash for operating expenses (salaries, rent, interest).

  • Effect on Accounts:

  • Decreases assets (cash).

  • Decreases stockholders’ equity (retained earnings).

  • Transaction Type: Asset Use Transaction

• Event 6: RCS paid $4,000 in cash dividends to owners.

  • Effect on Accounts:

  • Decreases assets (cash).

  • Decreases stockholders’ equity (retained earnings).

  • Transaction Type: Asset Use Transaction

• Event 7: The land purchased for $500,000 was appraised at $525,000 on December 31, 2011.

  • Historical Cost Concept: Requires that most assets are recorded at the amount paid (historical cost), regardless of market value fluctuations.

  • Reliability Concept: Information is reliable if verifiable independently.

  • Appraised values can vary and are opinions.

Learning Objective 4: Classify Business Events as Asset Source, Use, or Exchange Transactions

1- Recap: Types of Transactions

• Transaction Classifications:

  • Asset Source: Increased assets and claims on assets.

  • Asset Exchange: One asset increases while another decreases.

  • Asset Use: Decreased assets and claims on assets.

.Summary of Transactions

• Detailed transaction entries described in financial report format include inflows, outflows, and transitions between asset classes.

Learning Objective 6: Record Business Events Using a Horizontal Financial Statements Model

Horizontal Financial Statements Model

• Included Financial Statements: Balance Sheet, Income Statement, Cash Flows.

• Presents transaction events with cumulative figures.

1- Annual Reports Overview

• Contents of Annual Reports:

  • Financial Statements

  • Notes

  • Auditor’s Report

  • Management’s Discussion and Analysis (MD&A)

• Companies traditionally produced elaborate annual reports, but there is a shift towards simpler reports or 10-K filings now.

1- Special Terms in Real-World Reports

• Real-world financial statements often contain complex items not covered in introductory texts.

• Encouragement to engage with annual reports for hands-on learning.

End of Chapter One