Basic Accounting: Concepts, Techniques , and Revenues are increases in ownership claims arising

Conventions from the delivery of goods or services.

The Need for Accounting Recognize revenue by formally recording it in the
 Accounting information can be used to assess accounting records during the current period only
past financial performance of a company and after it meets two tests:
help predict its future performance. All kinds of 1. The company must earn the revenues. That is, it
organizations—government agencies, nonprofit must deliver the goods or render the services to
organizations, and others —rely on accounting to customers.
gauge their progress. The accounting process
2. The revenue must be realized or realizable.
begins with a transaction. A transaction is any
Expenses are decreases in ownership claims
event that affects the financial position of an
(stockholders’ equity) arising from delivering goods
organization and requires recording.
or services or using up assets.
 Many concepts, conventions, and rules
Income (also called net income, profits, or
determine what events a company records as
earnings), is the excess of revenues over expenses.
accounting transactions and how accountants
It increases stockholders’ equity.
measure the financial impact of each transaction.
An income statement summarizes revenues and
Financial statements are used to summarize the
expenses. It measures an organization’s performance
recorded accounting transactions.
by matching its revenue and its expenses for a span of
 Managers, investors, and other internal groups time, often a month, a quarter, or a year.
want the answers to two important questions: The Analytical Power of the Balance Sheet Equation
How well did the organization perform? The balance sheet equation can highlight the link
Where does the organization stand? between the income statement and balance sheet.
 Accountants answer these questions with three Assets (A) = Liabilities (L) + Stockholders’ equity (SE)
major financial statements: A = L + Paid-in capital + Retained income
 Balance sheet (statement of financial position) is a A = L + Paid-in capital + Revenue – Expenses
snapshot of the financial status of an organization
Accrual Basis and Cash Basis
at a point in time.
The balance sheet has two sections: The accrual basis of accounting recognizes revenues
(1) Assets
and expenses when they occur regardless of when
(2) Liabilities plus owners’ (stockholders’) equity.
Assets = Liabilities + Owners’ equity cash is received or disbursed.
 Assets are economic resources that are expected The cash basis of accounting recognizes revenue and
to benefit future activities of the organization. expense when cash is received and disbursed.
 Liabilities are the entity’s economic obligations to
The major deficiency of the cash basis of accounting is
non-owners.
 Owners’ equity is the excess of the assets over that it is incomplete.
the liabilities. It fails to match efforts and accomplishments in a
 The owners’ equity of a corporation is called manner that properly measures economic
stockholders’ equity. performance and financial position.
Stockholders’ equity Nonprofit Organizations
Paid-in capital Retained earnings Nonprofit organizations, such as government
agencies and charitable organizations, also use
balance sheets and income statements.
For years, most nonprofit organizations used cash-
Revenues and Expenses
basis rather than accrual accounting. As these
organizations face more pressure to develop accurate
 measures of performance, they are increasingly using expect to become expenses in future accounting
accrual accounting. periods.
The basic concepts of assets, liabilities, revenues,
Depreciation
and expenses apply to all organizations, whatever
To account for long-lived assets, assets that will provide
their goals and wherever they are located. However,
services for more than one year:
organizations that do not seek profits do not measure
(1) predict the length of the asset’s useful life
income. Further, because they have no owners, there
(2) predict the residual value
is no owners’ equity.
(3) allocate the cost of the equipment to the years of its
Balance sheets of nonprofit organizations show a
useful life in a systematic way.
category of “net assets” instead of “owners’ equity”
To measure the difference between assets and 2. Recognition (earning) of unearned revenues
liabilities. Instead of an income statement, nonprofit Unearned Revenue (deferred revenue) is . . .
organizations have a “statement of activities” that A liability recorded when a company receive collections
reports changes in net assets. from customers before it earns the revenue
Adjustments to the Accounts Because customers have already paid in advance for
Under the accrual basis of accounting, record: merchandise or services . . .
1. Explicit transactions-day-to-day routine events An obligation exists to deliver merchandise or service
2. Implicit transactions - events that day-to-day or refund the customers’ deposits if the goods or
recording procedures temporarily ignore, such as services are not delivered
expiration of prepaid rent or accrual of interest due to 3. Accrual of unrecorded expenses
the passage of time. Accrue means to accumulate a receivable or payable
Explicit transactions are easy to identify because they during a given period, even though no explicit
are supported by source documents. Implicit transaction occurs.
transactions are recorded at the end of each Interest expense
accounting period by using adjusting entries. Employee wages
Principal Adjustments 4. Accrual of unrecorded revenues
Four types of principal adjustments: The recognition of revenues that a company has
1. Expiration of unexpired costs -Assets other than earned but has not yet recorded in its accounts is. . .
cash and receivables are viewed as economic services the mirror image of the accrual of unrecorded
awaiting future use—prepaid or stored costs, and expenses. Interest Revenue
they are carried forward to future periods. The values
Dividends and Retained Earnings
of assets frequently decline (and eventually
Dividends are distributions of assets to stockholders
disappear) because of the passage of time. When a
that reduce retained earnings. Cash dividends are
company uses services represented by a particular
distributions of cash rather than some other asset.
cost, the cost expires. An unexpired cost is any asset
that managers expect to become an expense in future The distribution reduces both assets and owners’
periods. Rather than immediately charge these costs equity and is made possible by profitable operations.
as expenses, they are charged as expenses in future Dividends reduce retained earnings, But they are not
periods when the services are used. expenses.
 Assets frequently expire because of the passage of Companies do not deduct dividends from revenues
time. when measuring income because they do not help
 Assets other than cash and receivables are viewed as
generate sales or conduct operations.
economic services awaiting future use.

 Unexpired costs are assets that managers

Retained Earnings Audit
Stockholders’ equity represents the claims of owners An audit is an “examination” or in-depth inspection of
arising out of their initial investment (paid-in capital) financial statements and companies’ records that is
and subsequent profitable operations (retained made in accordance with generally accepted auditing
earnings). standards.
Retained earnings and paid-in capital represent a Auditing standards are approved by the Public
general claim against, or undivided interest in, total Company Accounting Oversight Board (PCAOB) which
assets, not a specific claim against any asset. is a part of the Securities and Exchange Commission
Retained earnings and paid-in capital result from (SEC), a government agency that regulates the
profitable operations. Equity is not a pot of cash financial markets in the U.S. including financial
awaiting distribution to stockholders. reporting.
Retained earnings and paid-in capital result from Accounting Standard Setters
profitable operations. Equity is not a pot of cash The Financial Accounting Standards Board (FASB) is
awaiting distribution to stockholders. the primary regulatory body over accounting
Do not confuse retained earnings and cash. Cash can principles and practices in the U.S.
increase while retained earnings decreases, and vice The FASB consists of seven full-time members plus a
versa. There is no direct relationship between staff of nearly 60 members, and it is an independent
retained earnings and available cash. creation of the private sector.
The IASB is a similar independent organization whose
Sole Proprietorships and Partnerships pronouncements, called International Financial
A sole proprietorship is a business entity with a single Reporting Standards (IFRS) define GAAP in more than
owner. A partnership is an organization that joins two 100 other countries.
or more individuals together as co-owners.
Ethics
Comparison of Owners’ Equity Reporting The public sector–private sector relationship:
Unlike corporations, sole proprietorships and Confidence in financial information is important to
partnerships do not distinguish between paid-in the smooth functioning of the world’s capital markets,
capital (i.e., amounts invested by owners) and and confidence in financial statements depends on
retained earnings. Instead, they typically accumulate the competence and integrity of accountants and
a single amount for each owner’s original investment, auditors.
subsequent investments, share of net income, and
withdrawals. A hallmark of the accounting profession has been its
ethics and integrity. Most accountants and auditors
Generally Accepted Accounting Principles (GAAP) are highly ethical and truthfully report their financial
Accounting is more an art than a science. It is results in accordance with GAAP.
commonly misunderstood as being a precise
discipline that produces exact measurements of a Three Measurement Conventions
company’s financial position and performance. U. S. GAAP is based on a conceptual framework that
Accounting is based on a set of principles on which contains three broad measurement or valuation
there is general agreement, not on rules that can be conventions (principles) that underlie accrual
“proved.” accounting:
The principles and procedures that together make up Recognition
accepted accounting practice at any given time are Matching and cost recovery
known as generally accepted accounting principles Stable monetary unit
(GAAP).
 Recognition Principle  Relevance
 The recognition principle specifies when a company  Predictive value
should record revenue in the accounting records.  Confirmatory value
 Generally, companies recognize revenue when it is
both earned and realized or realizable.  Faithful representation
 Comparability
 In some industries revenue recognition is not so  Consistency
straightforward. These judgment issues require  Verifiability
company accountants together with its auditor to  Timeliness
decide when earning and realization are sufficiently  Understandable
complete to recognize the revenue.  Materiality
 Conservatism
 Cost-benefit

Using Ledger Accounts

Matching and Cost Recovery
Some techniques that accountants use to record
transactions.
 The timing of revenue recognition is important
because it leads to the recording of expenses T-Accounts
through the concept of matching—the linking of Ledger Accounts
revenues with expenses incurred to generate them. Double-Entry System
Accountants apply matching as follows: Debits and Credits
1. Identify the revenue recognized during the period.
2. Record expenses that relate directly to the INTRODUCTION Overview of Managerial
recognized revenue. Accounting
3. Record expenses that are costs of operations during
a specific time period that have no measurable benefit PURPOSES OF MANAGEMENT ACCOUNTING
for a future period and must be linked to the current Provide information to assist management in four
period’s revenues. basic tasks:
 The heart of recognizing expense is the cost 1. Costing out products, services, and other items
recovery concept. Companies carry forward as and activities of interest
assets such items as inventories, prepayments, and 2. Planning and controlling operations
equipment because they expect to recover the costs 3. Evaluating the performances of individual
of these assets in the form of cash inflows (or managers and different operational units
reduced cash outflows) in future periods. 4. Making decisions .

Stable Monetary Unit CONTEMPORARY MANAGEMENT ACCOUNTING

 The monetary unit (for example, the dollar in the INFORMATION SYSTEMS
United States, the yen in Japan, or the euro in the • Increased accuracy in assigning and
European Union) is the principal means for determining costs
measuring assets, liabilities, and stockholders’ • Much greater emphasis on tracking
equity. nonfinancial data and highlighting its
relationship to financial results
Additional Accounting Concepts • Explicitly attempts to measure changes in
Concepts that are prominent parts of the body of performance (improvement) over time
GAAP: • More attuned to providing information for
 Continuity (going concern) employee empowerment
 Time As A Competitive Element
• Time is a crucial element in all phases of the value
Mgt. Acct. Vs. Fin. Acct. chain
Management Acct. Financial Acct. • World-class firms reduce time to market by
• Internally • Externally focused compressing design, implementation, and production
Focused cycles
 Not constrained by • Must follow GAAP • Quick delivery is accomplished by eliminating (or
mandatory rules & other reducing) non-value added activities
external rules • Information on the correlation between cost and
 Provides both  Objective time is also now needed by the firm
financial & non- financial
financial information Management Accountants’ Role
information • Management accountants are generally in staff
• Emphasis on future • Historical positions
Orientation • Their positions are usually supportive and
• Detailed • Information on the
participatory in nature
information on whole firm
individual units • They are not responsible for making operating
decisions, and thus only have indirect
responsibility for achieving the organization’s basic
Factors Bringing About Change in Management
and targeted objectives
Accounting
• They assist marketing, manufacturing, service and
• Customer orientation
financial managers in their decision making
• Cross-functional perspective The Controller
• Chief accounting officer
• Global competition • Supervises all accounting units
• Often viewed as a member of top management
• Total Quality Management team
• Often participates in planning, control and
• Time as a competitive element decision-making activities
• Has responsibilities for both external and internal
• Advances in information technology
accounting requirements
Management Accounting & Ethical Behavior
• Advances in the manufacturing environ.
• Profit maximization should be achieved
through legal and ethical means
• Growth and dereg. in the service industry
• Ethical behavior involves choosing actions
that are “right,” and “proper,” and “just”
• Activity-based management
• Underlying principle is the belief that each
Total Quality Management
member of the group bears some
• Where manufacturers strive to create an
responsibility for the well-being of other
environment that will enable workers to
members
manufacture perfect (zero-defect) products
• Willingness to sacrifice one’s self-interest for
• This approach is replacing the “acceptable
the group is the heart of ethical action
quality” attitudes of the past
• This increased emphasis on quality has
created a need for additional financial and
nonfinancial information about quality
 • Objectivity
– To not allow bias, conflict of interest
or undue influence of others to override
professional or business judgments.
• Professional Competence and Due Care
– To maintain professional knowledge and skill at
the level required to ensure competent
professional services based on current
Ten Core Values Underlying Ethical Behavior developments in practice, legislation and
Principles techniques
• Honesty – To act diligently in accordance with applicable
• Integrity technical and professional standards.
• Promise keeping • Confidentiality
• Fidelity – To refrain from disclosing confidential
• Fairness information acquired as a result of professional
• Caring for others and business relationships without proper and
• Respect for others specific authority to disclose unless there is a
• Responsible citizenship legal or professional right or duty to disclose.
• Pursuit of excellence – To refrain from using confidential information
• Accountability acquired as a result of professional and
Standards of Ethical Conduct for Management business relationships for personal advantage
Accountants or the advantage of third parties.
• The standards are specified within the following • Professional behavior
categories: – Obligation to comply with relevant laws and
I. Competence regulations and avoid any action that discredits
II. Confidentiality the profession.
III. Integrity Conceptual Framework Approach
IV. Objectivity • Requires active consideration of issues
V. Resolution of Ethical Conflict • Establishes basic principles
Certification of Professional Competence for Mgt. • Can be applied to differing circumstances
Accountants • Responsive to rapid change
• Numerous forms of certification available to • Requires judgment rather than literal
management accountants interpretations encouraged by a pure rules
• These certifications offer evidence that the approach.
holder has achieved a minimum level of Threats
professional competence • Self-interest
• Three major certification programs:
– The CMA (Certified Management Accountant) • Self-review
– The CPA (Certified Public Accountant)
– The CIA (Certified Internal Auditor) • Advocacy
Code of Ethics for Professional Accountants
Fundamental Principles • Familiarity
• Integrity
• Intimidation
– To be straight forward and honest in all
Safeguards
professional and business relationships
 Two categories: • Internal audit services
• Created by the profession, legislation or regulation • IT systems services
• Litigation support services
• In the work environment • Legal services
Prohibitions • Recruiting services
When safeguards are never adequate • Fees
Professional Accountants in Public Practice • Compensation and evaluation policies
• Professional Appointment • Actual or threatened litigation
• Conflicts of Interest • Reports that include a restriction on use or
• Second Opinions distribution
• Fees and Other Types of Remuneration • Corporate finance services
• Marketing Professional Services
• Gifts and Hospitality Independence for Other Assurance Engagements
• Custody of Client Assets • Assurance engagements that are not audit or
• Objectivity – All Services review engagements
• Independence – Audit and Review Engagements • Include related entities when reason to believe
• Independence – Other Assurance Engagements relevant to independence
Independence for Audit and Review Engagements • Include network firms when reason to believe
• Firm includes network firm, except where relevant to independence.
otherwise stated • Assertion-based assurance engagements
• Independence of mind and independence in • Independence required from assurance client
appearance (party responsible for the subject matter
• Public interest entities: additional provisions in information, and which may be responsible for
Section 290 that reflect the extent of public the subject matter)
interest in certain entities • When client not responsible for subject matter
• Documentation: conclusions regarding compliance evaluate the threats firm has reason to believe
with independence requirements, and substance created by interests and relationships with party
of any relevant discussions that support those responsible for subject matter
conclusions. • Direct reporting engagements
• Financial interests • Independence required from assurance client
• Loans and guarantees (party responsible for the subject matter)
• Business relationships • Multiple responsible parties
• Family and personal relationships • Firm may take into account whether interest or
• Employment with an audit client relationship with a particular responsible party
• Temporary staff assignments creates a threat. Consider:
• Recent service with an audit client • Materiality of subject matter information (or
• Serving as a director or officer of an audit client subject matter) for which the particular
• Long association of senior personnel (including responsible party is responsible
partner rotation) with an audit client • Degree of public interest associated with
• Provision of non-assurance services to audit clients engagement.
• Management responsibilities Professional Accountants in Business
• Preparing accounting records and financial • Potential conflicts
statements • Preparation and reporting of information
• Valuation services • Acting with sufficient expertise
• Taxation services • Financial interests
 • Inducements Staff Assistant 0-2 years Performs most of
Effective Date the detailed
• January 1, 2011 audit work.

Senior or in- 2-5 years Responsible for

• Transitional provisions
charge auditor the audit field
work, including
– Public interest entities supervising staff
work.
– Partner rotation
Manager 5-10 years Helps the plan,
– Non-assurance services manages the
audit, reviews
– Fees – relative size work, and works
with the client.
– Compensation and evaluation policies
Partner 10+ years Reviews overall
audit work and is
involved in
A. Organizational Forms with High Personal Liability significant audit
The following forms of firm organization are decisions. Has
unpopular because they provide no owner ultimate
protection against litigation: responsibility for
 Proprietorship – Only firms with one owner the audit
can operate in this form. II. The Regulation of Public Corporations
 General Partnership – Same form as a A. The Public Company Accounting Oversight Board
proprietorship except that there are 2 or (PCAOB)
more owners. 1. A Primary Responsibility of the PCAOB
B. Organizational Forms with Limited Liability -Establishment of standards for auditing,
 General corporation – An owner’s loss in a quality control, ethics, and independence, as
corporation is limited to the amount invested. well as attestation, for registered accounting
However, most states prohibit CPA firms from firms.
organizing in this manner. 2. Meet the Board Members of the PCAOB
 Professional corporation (PC) – Although this -In addition to appointing or removing
form provides some legal liability, the amount members, the SEC, among other things, must
of protection can vary significantly from state approve the Board’s budget and rules,
to state. including auditing standards, and may review
 Limited Liability Company (LLC) – Firm is appeals of adverse Board inspection reports
taxed like a partnership, but the partners and disciplinary actions against registered
have limited liability like a corporation. accounting firms.
Limited Liability Partnership – Partner’s are 3. SEC Oversight Over PCAOB
personally liable for partnership obligations, their -In addition to appointing or removing members,
own acts, and the acts of those under their the SEC, among other things, must approve the
supervision. Not responsible for the acts of other Board’s budget and rules, including auditing
partners or staff not under their supervision. standards, and may review appeals of adverse
C. Staff Levels and Responsibilities Board inspection reports and disciplinary actions
STAFF LEVEL AVERAGE TYPICAL against registered accounting firms.
EXPERIENCE RESPONSIBILITIES
 4. Standard Setting Input from Outside the III. American Institute of Certified Public Accountants
PCAOB The AICPA sets standards and rules that all members
 -Although the Sarbanes-Oxley Act would and other practicing CPAs must follow. This
allow the PCAOB to designate a professional authority extends to the following areas:
group of accountants to propose standards to 1. Auditing Standards
the Board, the Board decided early in 2003 -The Auditing Standards Board (ASB) is responsible for
that it could best protect investors by issuing pronouncements on auditing matters for all
developing standards itself. entities other than publicly traded companies.
 The Board will rely on advice from a standing -The pronouncements are known as Statements on
advisory group, and be involved in soliciting Auditing Standards (SASs)
public comment to obtain the views of 2. Compilation and Review Standards
issuers, accountants, investors, and other =The Accounting and Review Services Committee is
interested parties. responsible for issuing pronouncements of the CPAs
responsibilities when the CPA is associated with
financial statements of non-public companies that are
B. The Securities Acts not audited.
Securities Act of 1933 -The Statements on Standards for Accounting and
Requires most companies planning to issue new Review Services (SSARS), provide guidance for
securities to the public to submit a registration providing compilation (no assurance on financials)
statement to the SEC for approval. and review services (limited assurance on financials).
Securities Exchange Act of 1934 3. Other Attestation Standards
Requires companies to file detailed annual reports -Forms of attestation are often performed for
with the commission in order to have their securities other than historical financial statements.
publicly traded on the stock exchanges. -Examples of other attestation services involve
C. The Role of the SEC prospective financial information in forecasts and
 The SEC has legal power to establish rules for any projections
CPA associated with audited financial statements 4. Consulting Standards
submitted to the commission. -The Management Consulting Services Executive
 The SEC has taken the position that accounting Committee is responsible for issuing
principles and auditing standards should be set by pronouncements on consulting services.
the profession. However, they can override the -Consulting differs from attestation in that the
profession and their opinion is strongly CPA does not report on another party’s assertion.
considered. Rather, the CPA develops findings, conclusions,
D. Specific SEC Forms and recommendations
 Forms S1 to S16 – Completed when new securities 5. Code of Professional Conduct
are to be issued to the public. -The AICPA Committee on Professional Ethics sets
 Form 8K – Filed at the end of any month in which a rules of conduct that CPAs are required to meet.
significant investor event has occurred (i.e., sale of
subsidiary, change of auditor, etc.) A Key Performance Indicator (KPI) is a
 Form 10-K – Filed annually within 90 days of the measurable value that demonstrates how
close of each fiscal year. Includes audited financial effectively a company is achieving key business
statements. objectives. Organizations use key performance
 Form 10-Q – Filed quarterly with financial
indicators at multiple levels to evaluate their
success at reaching targets. High-level KPIs may
statements reviewed by the auditor.
focus on the overall performance of the
enterprise, while low-level KPIs may focus on
processes or employees in departments such as
sales, marketing or a call center.

Smart KPI

Specific
Measurable
Attainable
Relevant
Time-Bound