Principles of Accounting

2002e
Belverd E. Needles, Jr.
Marian Powers
Susan Crosson
-----------
Multimedia Slides by:
Harry Hooper
Santa Fe Community College

Copyright © by Houghton Mifflin Company. All rights reserved. 1

 Chapter 1
Uses of Accounting
Information and
the Financial
Statements
Copyright © by Houghton Mifflin Company. All rights reserved. 2
 LEARNING OBJECTIVES
1. Define accounting, identify business goals
and activities, and describe the role of
accounting in making informed decisions.
2. Identify the many users of accounting
information in society.
3. Explain the importance of business
transactions, money measure, and separate
entity to accounting measurement.
4. Identify the three basic forms of business
organization.
Copyright © by Houghton Mifflin Company. All rights reserved. 3
 LEARNING OBJECTIVES
(continued)
5. Define financial position, state the accounting
equation, and show how they are affected by
simple transactions.
6. Identify the four financial statements.
7. State the relationship of generally accepted
accounting principles (GAAP) to financial
statements and the independent CPA’s report,
and identify the organizations that influence the
GAAP.
8. Define ethics and describe the ethical
responsibilities of accountants.
Copyright © by Houghton Mifflin Company. All rights reserved. 4
Accounting as an Information System

OBJECTIVE 1
Define accounting, identify business
goals and activities, and describe
the role of accounting in making
informed decisions.

Copyright © by Houghton Mifflin Company. All rights reserved. 5

 Today’s accountant focuses on the
ultimate needs of decision makers who
use accounting information, whether
those decision makers are inside or
outside the business.

 Accounting “is not an end in itself,” but is

an information system that measures,
processes, and communicates financial
information about an identifiable
economic entity.

Copyright © by Houghton Mifflin Company. All rights reserved. 6

 Accounting provides a vital service by
supplying the information that decision
makers need to make reasoned choices
among alternative uses of scarce
resources in the conduct of business
and economic activities.

Copyright © by Houghton Mifflin Company. All rights reserved. 7

Accounting is a link between
business activities and decision
makers.
 Accounting measures business activities by
recording data about them for future use.
 The data are stored until needed and then
processed to become useful information.
 The information is communicated, through
reports, to decision makers.

Copyright © by Houghton Mifflin Company. All rights reserved. 8

Data about business activities are the
input to the accounting system.

Useful information for decision makers

is the output.

Copyright © by Houghton Mifflin Company. All rights reserved. 9

Accounting as an Information System

Copyright © by Houghton Mifflin Company. All rights reserved. 10

Business Goals, Activities, and
Performance Measures
 A business is an economic unit that aims to
sell goods and services to customers at
prices that will provide an adequate return
to its owners.

 Businesses, though diverse, have similar

goals and engage in similar activities.

Copyright © by Houghton Mifflin Company. All rights reserved. 11

 Business Goals

Profitability
A business must take in enough money
to pay all the costs of doing business, with
enough left over as profit for the owners
to want to stay in the business.

Liquidity
A business must have enough cash available to pay
debts when they are due.

Copyright © by Houghton Mifflin Company. All rights reserved. 12

Business Goals and Activities

Copyright © by Houghton Mifflin Company. All rights reserved. 13

 Business Activities

Financing Activities.
Obtaining capital from owners and creditors.
Repaying creditors and paying a return to
owners.
Investing Activities.
Spending the capital it receives in ways that are
productive and will help the business achieve
its objectives.
Buying and selling assets to be used in the
business.

Copyright © by Houghton Mifflin Company. All rights reserved. 14

 Business Activities (continued)

Operating Activities.
 Selling goods and services to

customers.
 Employing managers and workers.

 Buying and producing goods and

services.
 Paying taxes.

Copyright © by Houghton Mifflin Company. All rights reserved. 15

 Performance Measures

Indicate whether managers are achieving

their business goals and if they are
managing business activities well.

Copyright © by Houghton Mifflin Company. All rights reserved. 16

 Performance Measures
Performance measures must align with business goals:

Performance Measure Goal

Earned income. Profitability.
Cash flow. Liquidity.
Ratio of expenses to revenues. Operating
performance level.
Ratio of money owed to total Financing
resources controlled. performance level.

Managers should understand and be motivated by

these measures.

Copyright © by Houghton Mifflin Company. All rights reserved. 17

Financial and Management Accounting

Accounting’s role of assisting decision

makers by measuring, processing, and
communicating information is usually
divided into two categories:

1. Management accounting.
2. Financial accounting.

The two may be distinguished by the

principal users of their information.
Copyright © by Houghton Mifflin Company. All rights reserved. 18
 Management Accounting

 Is oriented toward the needs of

internal decision makers.

 Provides managers and employees

with information regarding how they
have done in the past and what they
can expect in the future.

Copyright © by Houghton Mifflin Company. All rights reserved. 19

 Financial Accounting
 Is oriented toward the needs of external
decision makers.
 Provides information in the form of
financial statements to evaluate how well
the business has achieved its goals.
 Financial statements report directly on
the goals of profitability and liquidity.
 Financial statements are used extensively
both inside and outside a business to
evaluate the business’s success.

Copyright © by Houghton Mifflin Company. All rights reserved. 20

 Processing Accounting
Information
Accounting versus bookkeeping
 Bookkeeping is the mechanical and repetitive
process of recording financial transactions and
keeping financial records.
 Bookkeeping is a small part of accounting.
 Accounting includes the design of an
information system that meets user’s needs.
 Accounting goals are the analysis,
interpretation, and use of information.

Copyright © by Houghton Mifflin Company. All rights reserved. 21

Computers are used extensively in
accounting as a tool for the accountant.

A business’s information needs are

organized into a Management Information
System (MIS).

 An MIS consists of interconnected

subsystems.
 The Accounting Information System (AIS) is
the most important subsystem.

Copyright © by Houghton Mifflin Company. All rights reserved. 22

 Discussion
Q. What is the difference between
profitability and liquidity?

A.
 Profitability means earning enough
income to attract and hold investment
capital.
 Liquidity means being able to pay debts
when they fall due.

Copyright © by Houghton Mifflin Company. All rights reserved. 23

Decision Makers: The Users of
Accounting Information

OBJECTIVE 2
Identify the many users of
accounting information in society.

Copyright © by Houghton Mifflin Company. All rights reserved. 24

The Users of Accounting Information

Copyright © by Houghton Mifflin Company. All rights reserved. 25

 Decision Makers
The people who use accounting information
to make decisions fall into three categories:
1. Management
2. Outside users with a direct financial
interest.
3. People, organizations, and agencies with an
indirect financial interest.
These categories apply both to profit-
oriented ventures as well as government
and not-for-profit organizations.
Copyright © by Houghton Mifflin Company. All rights reserved. 26
 Management

Requires financial information to carry

out its basic functions.
1. Financing the business.
2. Investing the resources of the business.
3. Producing goods and services.
4. Marketing goods and services.
5. Managing employees.
6. Providing information to decision makers.
Copyright © by Houghton Mifflin Company. All rights reserved. 27
 Outside Users with
a Direct Financial Interest

 Investors

 Creditors

Copyright © by Houghton Mifflin Company. All rights reserved. 28

People, Organizations, and Agencies with
an Indirect Financial Interest
 Tax Authorities.
 Regulatory Agencies.
 Labor Unions.
 Investment Advisors.
 The Financial Press.
 Customers and Consumer
Groups.
 Economic Planners.

Copyright © by Houghton Mifflin Company. All rights reserved. 29

 Discussion
Q. Which decision makers use accounting
information?
A. Three groups of decision makers use accounting
information:
1. Those who manage a business.
2. Those outside a business enterprise who have a
direct financial interest in the business.
3. Those people, organizations, and agencies that
have an indirect financial interest in the
business.

Copyright © by Houghton Mifflin Company. All rights reserved. 30

 Accounting Measurement

OBJECTIVE 3
Explain the importance of business
transactions, money measure, and
separate entity to accounting
measurement.

Copyright © by Houghton Mifflin Company. All rights reserved. 31

 Four Basic Questions

1. What is measured?
2. When should the measurement
be made?
3. What value should be placed on
what is measured?
4. How should what is measured
be classified?

Copyright © by Houghton Mifflin Company. All rights reserved. 32

 What Is Measured?

Business transactions:
 Economic events that affect the
financial position of a business entity.
 Transactions are the raw material of
accounting reports.
 Transactions must relate directly to a

business entity.

Copyright © by Houghton Mifflin Company. All rights reserved. 33

Money Measure.
 Money is the only factor common to all
business transactions.
 The monetary unit a business uses
depends on the country in which the
business resides.
 Exchange rates translate one currency to
another.
The Concept of Separate Entity.
 A business is a separate entity, distinct
from its creditors and customers and from
its owner or owners.
Copyright © by Houghton Mifflin Company. All rights reserved. 34
 Discussion

Q. Tell whether each of the following words or

phrases relates most closely to a:
(a) business transaction,
(b) separate entity, or
(c) money measure.
1. Partnership
2. U.S. dollar
3. Payment of an expense
4. Corporation
5. Sale of an asset
Copyright © by Houghton Mifflin Company. All rights reserved. 35
A.
1. Partnership: (b)
KEY
(a) business 2. U.S. dollar: (c)
transaction
(b) separate 3. Payment of an expense: (a)
entity
(c) money 4. Corporation: (b)
measure
5. Sale of an asset: (a)

Copyright © by Houghton Mifflin Company. All rights reserved. 36

Forms of Business Organization

OBJECTIVE 4
Identify the three basic forms of
business organization.

Copyright © by Houghton Mifflin Company. All rights reserved. 37

Forms of Business Organization

Sole Proprietorship.

Partnership.

Corporation.

Copyright © by Houghton Mifflin Company. All rights reserved. 38

 Sole Proprietorships

 Owned by one person.

 Records should be kept separate from
owner’s personal interests.
 Legally same economic unit as owner.
 Unlimited liability.
 Ends when owner wants it to, or owner dies.

Copyright © by Houghton Mifflin Company. All rights reserved. 39

 Partnerships
 More than one owner.
 Unincorporated association, not legally
separate from owners.
 Unlimited liability.
 Mutual agency.
 Ends when ownership changes, e.g partner
leaves or dies.

Copyright © by Houghton Mifflin Company. All rights reserved. 40

 Corporations

 One or more owners (stockholders.)

 Legally separate entity from owners.
 Owners can be separate from managers.
 Limited liability.
 Unlimited life.

Copyright © by Houghton Mifflin Company. All rights reserved. 41

Number and Receipts of U.S. Proprietorships,
Partnerships, and Corporations, 1997

Copyright © by Houghton Mifflin Company. All rights reserved. 42

 Discussion
Q. How do sole proprietorships, partnerships,
and corporations differ?
A.
 A sole proprietorship is a business
owned by one individual.
 A partnership is similar in most
respects to a proprietorship except
that more than one owner is involved.
 A corporation is an economic unit that
is legally separate from its owners.
Copyright © by Houghton Mifflin Company. All rights reserved. 43
 Financial Position and the
Accounting Equation

OBJECTIVE 5
Define financial position,
state the accounting equation, and
show how they are affected by
simple transactions.

Copyright © by Houghton Mifflin Company. All rights reserved. 44

 Financial Position

Economic Resources
= Equities.
= Creditors’ Equities + Owner’s Equity.
Assets = Liabilities + Owner’s Equity.

The Accounting Equation

Copyright © by Houghton Mifflin Company. All rights reserved. 45

 Assets

Assets are economic resources

owned by a business that are
expected to benefit future
operations.
 Monetary items.
 Nonmonetary physical things.
 Nonphysical things.

Copyright © by Houghton Mifflin Company. All rights reserved. 46

 Liabilities

Liabilities are present obligations of a

business to pay cash, transfer assets, or
provide services to other entities in the
future.

Liabilities are debts recognized by law.

Creditors must be paid before
stockholders.

Copyright © by Houghton Mifflin Company. All rights reserved. 47

 Owner’s Equity
the claims by the owner to the assets of
the business.
the residual equity that remains after
deducting liabilities from assets.

Owner’s Equity = Assets - Liabilities.

Copyright © by Houghton Mifflin Company. All rights reserved. 48

Four Types of Transactions That
Affect Retained Earnings

Copyright © by Houghton Mifflin Company. All rights reserved. 49

 Net Income / Loss

Revenues > Expenses Net Income

Revenues < Expenses Net Loss

Copyright © by Houghton Mifflin Company. All rights reserved. 50

Some Illustrative
Transactions

Copyright © by Houghton Mifflin Company. All rights reserved. 51

 T1. Owner’s Investments
Owner’s
Assets Liabilities Equity
J.S.,
Cash Capital
Beginning
Balance $0 $0

+$50,00
T1. +$50,000
0
Ending
Balance $50,000 $50,000

$50,000 $50,000

Copyright © by Houghton Mifflin Company. All rights reserved. 52

 T2. Purchase of Assets with Cash
Owner’s
Assets Liabilities Equity
J.S.,
Cash Land Building Capital
Beginning
Balance $50,000 $50,000

T2. -35,000 +$10,000 +$25,000

Ending
Balance $15,000 $10,000 $25,000 $50,000

$50,000 $50,000

Copyright © by Houghton Mifflin Company. All rights reserved. 53

 T3. Purchase of Assets by
Incurring a Liability
Owner’s
Assets Liabilities Equity
Accounts J.S.,
Cash Supplies Land Building Payable Capital
Beginning
Balance $15,000 $10,000 $25,000 $50,000

T3. +$500 +$500

Ending
Balance $15,000 $500 $10,000 $25,000 $500 $50,000

$50,500 $50,500

Copyright © by Houghton Mifflin Company. All rights reserved. 54

 T4. Payment of a Liability
Owner’s
Assets Liabilities Equity
Accounts J.S.,
Cash Supplies Land Building Payable Capital
Beginning
Balance $15,000 $500 $10,000 $25,000 $500 $50,000

T4. -200 -200

Ending
Balance $14,800 $500 $10,000 $25,000 $300 $50,000

$50,300 $50,300

Copyright © by Houghton Mifflin Company. All rights reserved. 55

 T5. Revenues Earned
Commission Received in Cash
Owner’s
Assets Liabilities Equity
Accounts J.S.,
Cash Supplies Land Building Payable Capital
Beginning
Balance $14,800 $500 $10,000 $25,000 $300 $50,000

T5. +1,500 +1,500

Ending
Balance $16,300 $500 $10,000 $25,000 $300 $51,500

$51,800 $51,800

Copyright © by Houghton Mifflin Company. All rights reserved. 56

 T6. Revenues Earned Commission
with Deferred Receipt
Owner’s
Assets Liabilities Equity
Accounts Suppli Accounts J.S.,
Cash Receivable es Land Building Payable Capital
Beginning
Balance $16,300 $500 $10,000 $25,000 $300 $51,500

T6. +$2,000 +2,000

Ending
Balance $16,300 $2,000 $500 $10,000 $25,000 $300 $53,500

$53,800 $53,800

Copyright © by Houghton Mifflin Company. All rights reserved. 57

 T7. Collection of Accounts
Receivable
Owner’s
Assets Liabilities Equity
Accounts Accounts J.S.,
Cash Receivable Supplies Land Building Payable Capital
Beginning
Balance $16,300 $2,000 $500 $10,000 $25,000 $300 $53,500

T7. +1,000 -1,000

Ending
Balance $17,300 $1,000 $500 $10,000 $25,000 $300 $53,500

$53,800 $53,800

Copyright © by Houghton Mifflin Company. All rights reserved. 58

 Expenses Incurred
T8. Paid Equipment Rental Expense
T9. Paid Wages Expense
Owner’s
Assets Liabilities Equity
Accounts Accounts J.S.,
Cash Receivable Supplies Land Building Payable Capital
Beginning
Balance $17,300 $1,000 $500 $10,000 $25,000 $300 $53,500

T8. -1,000 -1,000

T9. -400 -400

Ending
Balance $15,900 $1,000 $500 $10,000 $25,000 $300 $52,100

$52,400 $52,400

Copyright © by Houghton Mifflin Company. All rights reserved. 59

 T10. Utility Expense Incurred Current
Liability Recorded
Owner’s
Assets Liabilities Equity
Accounts Accounts J.S.,
Cash Receivable Supplies Land Building Payable Capital
Beginning
Balance $15,900 $1,000 $500 $10,000 $25,000 $300 $52,100

T10. +300 -300

Ending
Balance $15,900 $1,000 $500 $10,000 $25,000 $600 $51,800

$52,400 $52,400

Copyright © by Houghton Mifflin Company. All rights reserved. 60

 T11. Owner’s Withdrawals
Owner’s
Assets Liabilities Equity
Accounts Accounts J.S.,
Cash Receivable Supplies Land Building Payable Capital
Beginning
Balance $15,900 $1,000 $500 $10,000 $25,000 $600 $51,800

T11. -600 -600

Ending
Balance $15,300 $1,000 $500 $10,000 $25,000 $600 $51,200

$51,800 $51,800

Copyright © by Houghton Mifflin Company. All rights reserved. 61

 Communication Through
Financial Statements

OBJECTIVE 6
Identify the four financial statements.

Copyright © by Houghton Mifflin Company. All rights reserved. 62

 The Importance of
Financial Statements
 Financial statements are the primary
means of communicating important
accounting information to users.
 Financial statements represent models
of the business enterprise because they
show the business in financial terms.
 Financial statements are not perfect
pictures of the real thing.

Copyright © by Houghton Mifflin Company. All rights reserved. 63

 The Income Statement

 Summarizes revenues earned and

expenses incurred over a period of
time.
 Is considered by many to be the
most important financial report
because it shows whether or not a
business achieved its profitability
goal.

Copyright © by Houghton Mifflin Company. All rights reserved. 64

 Shannon Realty
Income Statement
For the Month Ended December 31, 20xx

Revenues
Commissions Earned $3,500
Expenses
Equipment Rental Expense $1,000
Wages Expense 400
Utilities Expense 300
Total Expenses $1,700
Net Income $1,800
Trace to the Statement of
Owner’s Equity

Copyright © by Houghton Mifflin Company. All rights reserved. 65

The Statement of Owner’s Equity

Shows the change in the owner’s

capital over a period of time.

Copyright © by Houghton Mifflin Company. All rights reserved. 66

 Shannon Realty
Statement of Owner’s Equity
For the Month Ended December 31, 20xx

John Shannon, Capital, 12/1/xx $ 0

Add: Investments by John Shannon $50,000
Net Income for the Month 1,800 51,800
Subtotal $ 5 1,800
Less Withdrawals by John Shannon 600
John Shannon, Capital, 12/31/xx $ 51,200

Copyright © by Houghton Mifflin Company. All rights reserved. 67

 The Balance Sheet

 Shows financial position at a point in time.

 Is often called the statement of financial
position.
 Presents a view of the business as the
holder of resources, or assets, that are
equal to the claims against those assets.

Copyright © by Houghton Mifflin Company. All rights reserved. 68

 Shannon Realty
Balance Sheet
December 31, 20xx
Assets
Cash $15,300
Accounts Receivable 1,000
Supplies 500
Land 10,000
Building 25,000
Total Assets $51,800

Copyright © by Houghton Mifflin Company. All rights reserved. 69

 Shannon Realty
Balance Sheet
December 31, 20xx (continued…)

Liabilities
Accounts Payable $600

Owner’s Equity
John Shannon, Capital $51,200
Total Liabilities and Owner’s Equity $51,800

Copyright © by Houghton Mifflin Company. All rights reserved. 70

 The Statement of Cash Flows

 Focuses on a company’s liquidity goal.

 Shows cash produced by operating a
business and important financing and
investing transactions that take place
during an accounting period.
 Is directly related to the other three
statements.

Copyright © by Houghton Mifflin Company. All rights reserved. 71

 Shannon Realty
Statement of Cash Flows
For the Month Ended December 31, 20xx

Cash Flows from Operating Activities

Net Income $1,800
Noncash Expenses and Revenues
Included in Income
Increase in Accounts Receivable $(1,000)
Increase in Supplies (500)
Increase in Accounts Payable 600 (900)
Net Cash Flows from
Operating Activities $900

Copyright © by Houghton Mifflin Company. All rights reserved. 72

 Shannon Realty
Statement of Cash Flows
For the Month Ended December 31, 20xx
(continued…)
Cash Flows from Investing Activities

Purchase of Land ($10,000)

Purchase of Building (25,000)
Net Cash Flows from Investing
Activities (35,000)

Copyright © by Houghton Mifflin Company. All rights reserved. 73

 Shannon Realty
Statement of Cash Flows
For the Month Ended December 31, 20xx
(continued…)
Cash Flows from Financing Activities
Investments by John Shannon $50,000
Withdrawals by John Shannon (600)
Net Cash Flows from
Financing Activities 49,400

Net Increase (Decrease) in Cash $15,300

Cash at Beginning of Month 0
Cash at End of Month $15,300

Copyright © by Houghton Mifflin Company. All rights reserved. 74

 Discussion
Q. Why is the balance sheet sometimes called
the statement of financial position?

A. Financial position consists of the economic

resources that belong to a business and the
claims against those resources as of a
certain date. This is the information shown
on the balance sheet.

Copyright © by Houghton Mifflin Company. All rights reserved. 75

 Generally Accepted
Accounting Principles
OBJECTIVE 7
State the relationship of generally
accepted accounting principles
(GAAP) to financial statements and
the independent CPA’s report, and
identify the organizations that
influence GAAP.

Copyright © by Houghton Mifflin Company. All rights reserved. 76

 Generally Accepted
Accounting Principles (GAAP)

Focus on understandability of
financial statements.

Encompass the conventions,

rules, and procedures
necessary to define accepted
accounting practice at a
particular time.
Copyright © by Houghton Mifflin Company. All rights reserved. 77
Financial Statements, GAAP, and
the Independent CPA’s Report
Financial statements are prepared
by management and may be
biased.
Financial statements are audited
by independent CPAs.
An audit ascertains that the
financial statements have been
prepared in accordance with
GAAP.
Copyright © by Houghton Mifflin Company. All rights reserved. 78
Organizations That Influence
Current Practice

FASB.
AICPA.
GASB.
IASC.
IRS.

Copyright © by Houghton Mifflin Company. All rights reserved. 79

 Discussion
Q. What are GAAP?

A. GAAP are generally accepted accounting

principles; they are the “conventions,
rules, and procedures necessary to define
accepted accounting practice at a
particular time.”

Copyright © by Houghton Mifflin Company. All rights reserved. 80

 Discussion

Q. Why are GAAP important to readers

of financial statements?

A. GAAP ensure that the financial

statements will be understandable to
their users.

Copyright © by Houghton Mifflin Company. All rights reserved. 81

 Professional Ethics and the
Accounting Profession

OBJECTIVE 8
Define ethics and describe the ethical
responsibilities of accountants.

Copyright © by Houghton Mifflin Company. All rights reserved. 82

What Are Professional Ethics?
 A code of conduct that applies to the
practice of a profession.
 Codes of conduct adopted by the
AICPA and each state.
 Responsibility to the public.
 Integrity.
 Objectivity.
 Independence.
 Due care.

Copyright © by Houghton Mifflin Company. All rights reserved. 83

The Institute of Management Accountants’ (IMA)
Code of Professional Conduct

 Competency.
 Confidentiality.
 Integrity.
 Avoidance of conflicts of interest.
 Communication of information
objectively and without bias.

Copyright © by Houghton Mifflin Company. All rights reserved. 84

 Discussion
Q. Discuss the importance of professional ethics
in the accounting profession.
A. Professional ethics is a code of conduct that
applies to the practice of a profession. As
members of a profession, accountants have a
responsibility, not only to their employers
and clients but to society as a whole, to
uphold the highest ethical standards.

Copyright © by Houghton Mifflin Company. All rights reserved. 85

 OK, LET’S REVIEW . . .

1. Define accounting, identify business goals

and activities, and describe the role of
accounting in making informed decisions.
2. Identify the many users of accounting
information in society.
3. Explain the importance of business
transactions, money measure, and separate
entity to accounting measurement.

Copyright © by Houghton Mifflin Company. All rights reserved. 86

CONTINUING OUR REVIEW . . .

4. Identify the three basic forms of

business organization.
5. Define financial position, state the
accounting equation, and show how
they are affected by simple
transactions.
6. Identify the four financial statements.

Copyright © by Houghton Mifflin Company. All rights reserved. 87

 AND FINALLY . . .

7. State the relationship of generally

accepted accounting principles
(GAAP) to financial statements and
the independent CPA’s report, and
identify the organizations that
influence GAAP.
8. Define ethics and describe the ethical
responsibilities of accountants.

Copyright © by Houghton Mifflin Company. All rights reserved. 88