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Financial Accounting

John J. Wild

4th Edition

John J. Wild

4th Edition

Information for DecisionsInformation for Decisions

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Chapter 1

Introducing Accounting

in Business

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Conceptual Chapter Objectives

C1: Explain the purpose and importance of accounting in the information age

C2: Identify users and uses of accountingC3: Identify opportunities in accounting and

related fieldsC4: Explain why ethics are crucial in

accountingC5: Explain the meaning of GAAP, and define

and apply several key accounting principles

C6: Appendix 1B: Identify and describe the three major activities in organizations

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Analytical Chapter Objectives

A1: Define and interpret the accounting equation and each of its components

A2: Analyze business transactions using the accounting equation

A3: Compute and interpret return on assets

A4: Appendix 1A: Explain the relationship between return and risk

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Procedural Chapter Objectives

P1: Identify and prepare basic financial statements and explain how they interrelate

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IdentifiesIdentifies

RecordsRecords

CommunicatesCommunicatesRelevantRelevant

ReliableReliable

ComparableComparable

Importance of Accounting

AccountingAccountingis a

system that

information

that is

to help users make better decisions.

to help users make better decisions.

C1

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Identifying Business Activities

Recording Business Activities

Communicating Business Activities

Accounting ActivitiesC 1

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Users of Accounting Information

External Users

•Lenders

•Shareholders

•Governments

•Consumer Groups

•External Auditors

•Customers

Internal Users

•Managers

•Officers/Directors

•Internal Auditors

•Sales Staff

•Budget Officers

•Controllers

C 2

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Users of Accounting Information

External Users

Financial accounting provides external users with financial

statements.

Internal Users

Managerial accounting provides information needs for internal

decision makers.

C 2

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Opportunities in Accounting

FinancialFinancial

•Preparation•Analysis•Auditing•Regulatory•Consulting•Planning•Criminal investigation

•Preparation•Analysis•Auditing•Regulatory•Consulting•Planning•Criminal investigation

ManagerialManagerial

•General accounting •Cost accounting•Budgeting•Internal auditing•Consulting•Controller•Treasurer•Strategy

•General accounting •Cost accounting•Budgeting•Internal auditing•Consulting•Controller•Treasurer•Strategy

TaxationTaxation

•Preparation•Planning•Regulatory•Investigations•Consulting•Enforcement•Legal services•Estate plans

•Preparation•Planning•Regulatory•Investigations•Consulting•Enforcement•Legal services•Estate plans

Accounting-related

Accounting-related

•Lenders•Consultants•Analysts•Traders•Directors•Underwriters•Planners•Appraisers

•Lenders•Consultants•Analysts•Traders•Directors•Underwriters•Planners•Appraisers

•FBI investigators•Market researchers•Systems designers•Merger services•Business valuation•Human services•Litigation support•Entrepreneurs

•FBI investigators•Market researchers•Systems designers•Merger services•Business valuation•Human services•Litigation support•Entrepreneurs

C 3

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Accounting Jobs by Area

Government, not-for-profit, & education

15%

Public accounting

25%

Private accounting

60%

C 3

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Beliefs that distinguish right from

wrong

Accepted standards of good and bad

behavior

Ethics

Ethics—A Key ConceptC 4

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Identify ethical concerns

Analyze options

Make ethical decision

Use personal ethics to

recognize ethical concern.

Consider all good and bad

consequences.

Choose best option after weighing all

consequences.

Guidelines for Ethical Decisions

C 4

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Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP).

Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP).

Generally Accepted Accounting Principles

Relevant Information

Relevant Information

Affects the decision of its users.

Affects the decision of its users.

Reliable InformationReliable Information Is trusted by users.

Is trusted by users.

C 5

Comparable Information

Comparable Information

Used in comparisons across years & companies.

Used in comparisons across years & companies.

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The Securities and Exchange Commission is the government group that establishes reporting requirements for companies that issue stock to the public.

The Securities and Exchange Commission is the government group that establishes reporting requirements for companies that issue stock to the public.

Setting Accounting Principles

Financial Accounting Standards Board is the private group that sets both broad and specific principles.

Financial Accounting Standards Board is the private group that sets both broad and specific principles.

C 5

The International Accounting Standards Board (IASB) issues inter-national standards that identify preferred accounting practicesin other countries. The IASB does not have authority to imposeits standards on companies.

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Principles of Accounting

Now Future

Going-Concern PrincipleReflects assumption that the

business will continue operating instead of being closed or sold.

Cost PrincipleAccounting information is

based on actual cost.

Objectivity PrincipleAccounting information is supported by independent,

unbiased evidence.

C 5

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Principles of Accounting

Revenue Recognition Principle1. Recognize revenue when it is

earned.2. Proceeds need not be in cash.3. Measure revenue by cash

received plus cash value of items received.

Monetary Unit PrincipleExpress transactions and events in

monetary, or money, units.

Business Entity PrincipleA business is accounted for

separately from other business entities, including its owner.

C 5

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Business Entity Forms

Sole Proprietorship

Sole Proprietorship

PartnershipPartnership CorporationCorporation

C 5

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* Proprietorships and partnerships that are set up as LLC’s provide limited liability.

* Proprietorships and partnerships that are set up as LLC’s provide limited liability.

Characteristics of Businesses

Characteristic Proprietorship Partnership CorporationBusiness entity yes yes yesLegal entity no no yesLimited liability no no yesUnlimited life no no yesBusiness taxed no no yesOne owner allowed yes no yes

Characteristic Proprietorship Partnership CorporationBusiness entity yes yes yesLegal entity no no yesLimited liability no no yesUnlimited life no no yesBusiness taxed no no yesOne owner allowed yes no yes

**

C 5

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Owners of a corporation are called shareholders (or stockholders).

When a corporation issues only one class of stock, we call it common stock

(or capital stock).

CorporationC 5

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AssetsLiabilities & Equity

Accounting Equation

LiabilitiesLiabilities EquityEquityAssetsAssets = +

A1

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LandLand

EquipmentEquipment

BuildingsBuildings

CashCash

VehiclesVehicles

Store Supplies

Store Supplies

Notes Receivable

Notes Receivable

Accounts Receivable

Accounts Receivable

Resources owned or controlled

by a company

Resources owned or controlled

by a company

AssetsA1

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Taxes Payable

Taxes Payable

Wages Payable

Wages Payable

Notes Payable

Notes Payable

Accounts Payable

Accounts Payable

Creditors’ claims on

assets

Creditors’ claims on

assets

LiabilitiesA1

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Owner’sclaim on

assets

Owner’sclaim on

assets

DividendsDividends

Contributed Capital

Contributed Capital

Retained Earnings

Retained Earnings

EquityA1

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LiabilitiesLiabilities EquityEquityAssetsAssets = +

Expanded Accounting Equation

RevenuesRevenues ExpensesExpensesCommon

StockCommon

StockDividendsDividends__ ++ __

Retained Earnings

LiabilitiesLiabilities EquityEquityAssetsAssets = +

A1

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Transaction Analysis Equation

The accounting equation MUST remain in balance after each transaction.

LiabilitiesLiabilities EquityEquityAssetsAssets = +

A2

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Transaction Analysis

The accounts involved are:

(1) Cash (asset)

(2) Common Stock (equity)

J. Scott invests $20,000 cash to start the business in exchange for stock.

A2

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Transaction Analysis

J. Scott invests $20,000 cash to start the business in return for stock.

A2

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The accounts involved are:

(1) Cash (asset)

(2) Supplies (asset)

Transaction Analysis

Purchased supplies paying $1,000 cash.

A2

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Transaction Analysis

Purchased supplies paying $1,000 cash.

A2

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The accounts involved are:

(1) Cash (asset)

(2) Equipment (asset)

Transaction Analysis

Purchased equipment for $15,000 cash.

A2

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Transaction Analysis

Purchased equipment for $15,000 cash.

A2

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The accounts involved are:

(1) Supplies (asset)

(2) Equipment (asset)

(3) Accounts Payable (liability)

Transaction Analysis

Purchased Supplies of $200 and Equipment of $1,000 on account.

A2

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Transaction Analysis

Purchased Supplies of $200 and Equipment of $1,000 on account.

A2

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Transaction Analysis

Borrowed $4,000 from 1st American Bank.

A2

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Transaction Analysis

The balances so far appear below. Note that the Balance Sheet Equation is still in balance.

A2

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Transaction Analysis

Now, let’s look at transactions involving revenue, expenses and

dividends.

A2

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The accounts involved are:

(1) Cash (asset)

(2) Revenues (equity)

Transaction Analysis

Provided consulting services receiving $3,000 cash.

A2

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Transaction Analysis

Provided consulting services receiving $3,000 cash.

A2

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The accounts involved are:

(1) Cash (asset)

(2) Salaries expense (equity)

Transaction Analysis

Paid salaries of $800 to employees.

Remember that the balance in the salaries expense account actually increases.

But, equity decreases because expenses reduce equity.

A2

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Transaction Analysis

Remember that expenses decrease equity.

Paid salaries of $800 to employees.

A2

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The accounts involved are:

(1) Cash (asset)

(2) Dividends (equity)

Transaction Analysis

Dividends of $500 are paid to shareholders.

Remember that the Dividend account actually increases.

But, equity decreases because dividends reduce equity.

A2

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Transaction Analysis

Remember that dividends decrease equity.

Dividends of $500 are paid to shareholders.

A2

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Financial Statements

Let’s prepare the Financial Statements reflecting the transactions we have recorded.

1. Income Statement

2. Statement of Retained Earnings

3. Balance Sheet

4. Statement of Cash Flows

1. Income Statement

2. Statement of Retained Earnings

3. Balance Sheet

4. Statement of Cash Flows

P1

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Net income is the difference between

Revenues and Expenses.

Net income is the difference between

Revenues and Expenses.

The income statement describes a company’s revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities.

The income statement describes a company’s revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities.

Income StatementP1

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The net income of $2,200 increases Retained Earnings by $2,200.

The net income of $2,200 increases Retained Earnings by $2,200.

Statement of Retained EarningsP1

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The Balance Sheet describes a company’s financial position at a point in time.

The Balance Sheet describes a company’s financial position at a point in time.

Balance SheetP1

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Statement of Cash FlowsP1

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ROA is viewed as an indicator of operating

efficiency.

ROA is viewed as an indicator of operating

efficiency.

Return on Assets (ROA)

Net incomeAverage total assets

Return onassets

=

P1

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End of Chapter 1