Financial accounting fundamentals

Financial Accounting
Fundamentals

John J. Wild

Third Edition
McGraw-Hill/Irwin

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


Chapter 01
Introducing Financial
Accounting

1-2


Conceptual Chapter Objectives
C1: Explain the purpose and importance of
accounting.
C2: Identify users and uses of accounting.
C3: Explain why ethics are crucial to
accounting.
C4: Explain generally accepted accounting
principles and define and apply
several accounting principles.
C5: Appendix 1B – Identify and describe the
three major activities of organizations.
1-3

Analytical Chapter Objectives
A1: Define and interpret the accounting
equation and each of its components.
A2: Compute and interpret return on assets.
A3: Appendix 1A – Explain the relation
between return and risk.

1-4


Procedural Chapter Objectives
P1: Analyze business transactions using
the accounting equation.
P2: Identify and prepare basic financial
statements and explain how they
interrelate.

1-5


C1

Importance of Accounting
Accounting
Accounting

is a
system that

Identifies
Identifies
Records
Records

Relevant
Relevant
Reliable
Reliable
Comparable
Comparable

information
that is

Communicates
Communicates

about
about an
an
organization’s
organization’s
business
businessactivities.
activities.
1-6


C1

Accounting Activities

 Identifying
Business
Activities

 Recording
Business
Activities


Communicating
Business
Activities

1-7


Users of Accounting
Information

C2

Internal Users

External Users

•Lenders

•Consumer Groups

•Managers

•Sales Staff

•Shareholders •External Auditors

•Officers

•Budget Officers

•Governments •Customers

•Internal Auditors •Controllers
1-8


C2

Users of Accounting
Information
External Users

Internal Users

Financial accounting provides
external users with financial
statements (shareholders,
lenders, etc.).

Managerial accounting provides
information needs for internal
decision makers (officers,
managers, etc.).
1-9


C2

Opportunities in Accounting
Financial
Financial

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

AccountingAccountingrelated
related

Managerial
Managerial
•General
•Generalaccounting
accounting
•Cost
•Costaccounting
accounting
•Budgeting
•Budgeting
•Internal
•Internalauditing
auditing
•Consulting
•Consulting
•Controller
•Controller
•Treasurer
•Treasurer
•Strategy
•Strategy
•Lenders
•Lenders
•Consultants
•Consultants
•Analysts

•Analysts
•Traders
•Traders
•Directors
•Directors
•Underwriters
•Underwriters
•Planners
•Planners
•Appraisers
•Appraisers

Taxation
Taxation
•Preparation
•Preparation
•Planning
•Planning
•Regulatory
•Regulatory
•Investigations
•Investigations
•Consulting
•Consulting
•Enforcement
•Enforcement
•Legal
•Legalservices
services
•Estate

•Estateplans
plans
•FBI
•FBIinvestigators
investigators
•Market
•Marketresearchers
researchers
•Systems
•Systemsdesigners
designers
•Merger
services
•Merger services
•Business
•Businessvaluation
valuation
•Forensic
•Forensicaccountant
accountant
•Litigation
•Litigationsupport
support
•Entrepreneurs
•Entrepreneurs
1-10


C2

Accounting Jobs by Area

1-11


C3

Ethics—A Key Concept
Ethics
Beliefs that
distinguish
right from
wrong

Accepted
standards of
good and bad
behavior

1-12


C3

Guidelines for Ethical Decisions
 Identify
ethical concerns

 Analyze
options

Use personal Consider all good
ethics to
and bad
recognize an
consequences.
ethical concern.

 Make ethical
decision

Choose best
option after
weighing all
consequences.
1-13


C4

Generally Accepted Accounting
Principles
Financial
Financialaccounting
accounting practice
practiceis
isgoverned
governedby
by
concepts

conceptsand
and rules
rulesknown
knownas
as generally
generallyaccepted
accepted
accounting
accountingprinciples
principles (GAAP).
(GAAP).
Relevant
RelevantInformation
Information
Reliable
Reliable Information
Information

Comparable
Comparable
Information
Information

Affects
Affectsthe
thedecision
decisionof
of
its
itsusers.

users.
Is
Istrusted
trustedby
by
users.
users.
Used
Usedin
incomparisons
comparisons
across
acrossyears
years&&companies.
companies.
1-14


C4

Setting Accounting Principles
In
Inthe
theUnited
UnitedStates,
States,the
theSecurities
Securitiesand
andExchange
Exchange

Commission,
Commission,aagovernment
governmentagency,
agency,has
hasthe
thelegal
legalauthority
authority
to
toestablish
establishreporting
reportingrequirements
requirementsand
andset
setGAAP
GAAPfor
for
companies
companiesthat
thatissue
issuestock
stockto
tothe
thepublic.
public.
The
The Financial
Financial Accounting
Accounting
Standards

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

The International Accounting Standards Board (IASB) issues international standards that identify preferred accounting practices
in other countries. More than 100 countries now require or permit
companies to prepare financial reports following IFRS standards.
1-15


C4

Principles and Assumptions
of Accounting

Measurement principle (also called
cost principle) means that accounting
information is based on actual cost.

Going-concern assumption means
that accounting information reflects a
presumption the business will
continue operating.

Revenue recognition principle
provides guidance on when a
company must recognize revenue.

Monetary unit assumption means we
can express transactions in money.

Matching principle (expense
recognition) prescribes that a
company must record its expenses
incurred to generate the revenue.

Time period assumption presumes
that the life of a company can be
divided into time periods, such as
months and years.

Full disclosure principle requires a
company to report the details behind
financial statements that would impact
users’ decisions.

Business entity assumption means
that a business is accounted for

separately from its owner or other
business entities.
1-16


C4

Business Entity Forms

Sole
Sole
Proprietorship
Proprietorship

Partnership
Partnership

Corporation
Corporation

1-17


C4

Sarbanes-Oxley Act
In response to a number of publicized
accounting scandals (Enron, WorldCom, Tyco,
ImClone), Congress passed the Sarbanes-Oxley
Act (also called SOX) in 2002 to help curb

financial abuses at companies that issue their
stock to the public. The act requires that public
companies apply both accounting oversight and
stringent internal controls. The desired results
include more transparency, accountability, and
truthfulness in reporting transactions.
1-18


A1

Accounting Equation
Assets
Assets

=

Liabilities
Liabilities

Assets

+

Equity
Equity

Liabilities
+ Equity

1-19


Assets

A1

Cash
Cash
Accounts
Accounts
Receivable
Receivable

Vehicles
Vehicles

Store
Store
Supplies
Supplies

Resources
Resources
owned
owned or
or
controlled
controlled
by

by aa
company
company

Notes
Notes
Receivable
Receivable

Land
Land

Buildings
Buildings
Equipment
Equipment
1-20


A1

Liabilities
Accounts
Accounts
Payable
Payable

Notes
Notes
Payable

Payable

Creditors’
Creditors’
claims
claims on
on
assets
assets
Taxes
Taxes
Payable
Payable

Wages
Wages
Payable
Payable
1-21


A1

Equity
Retained
Retained
Earnings
Earnings

Contributed

Contributed
Capital
Capital

Owner’s
Owner’s
claim
claim on
on
assets
assets

Dividends
Dividends
1-22


A1

Expanded Accounting Equation
Assets
Assets
Assets
Assets

Contributed
Contributed
Capital
Capital

=
=
_

Liabilities
Liabilities
Liabilities
Liabilities

Dividends
Dividends

+

+
+

Revenues
Revenues

Equity
Equity
Equity
Equity

_ Expenses
Expenses

Retained Earnings
1-23

P1

Transaction Analysis
Business activities can be described in terms
of transactions and events. External
transactions are exchanges of value between
two entities, which yield changes in the
accounting equation. Internal transactions are
exchanges within any entity; they can also
affect the accounting equation. Events refer to
happenings that affect an entity’s accounting
equation and can be reliably measured.
Transaction analysis is defined as the process
used to analyze transactions and events.
1-24


P1

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

1-25