I. What Is Accounting?

- accounting identifies, records, and communicates the economic events of an organization to interested
users
A. Three Activities
- identify events relevant to its business
- records event to provide history of financial activities
- bookkeeping only involves recording of economic events
- communicates collected info to interested users, by means of accounting reports
- most common reports = financial statements
- analyze and interpret, through explaining uses, meaning, and limitations of reported data
B. Who Uses Accounting Data
1. Internal Users

- managers, supervisors, finance directors, company officers, etc.

- questions asked: finance, marketing, human resources, management
2. External Users

- investors decide whether to buy/hold/sell ownership shares of company

- creditors evaluate risk of granting credit or lending money
- taxing authorities see if company complies with tax laws
- regulatory agencies see if company is operating within rules
- customers see if companies honor product warranties and support its product lines
- labor unions see if owners have ability to pay increased wages and benefits
II. The Building Blocks of Accounting

- sound functional economy depends on accurate and dependable financial reporting

A. Ethics in Financial Reporting

- sarbanes-oxley act (SOX)

B. Generally Accepted Accounting Principles

- GAAP is common set of standards

- FASB (financial accounting standards board) is accounting standard-setting body in USA
- SEC (securities and exchange commission) is agency that oversees financial markets and
accounting-standard setting body
- IASB (international accounting standards board)
- IFRS (international financial reporting standards)
- convergence = increase comparability between GAAP and IFRS
C. Measurement Principles

- tradeoff between relevance and faithful representation

- relevance = financial info can make difference in decision
- faithful representation = numbers match what really existed or happened (they are factual)

- companies weigh factual nature of cost figures (cost principle) vs. relevance of fair value
1. Historical Cost Principle (or Cost Principle)

- record assets at their cost

- even if the asset has changed in price over time
2. Fair Value Principle
- report at fair value, the price received to sell an asset or settle a liability
- example: investment securities (market price info is readily info)
D. Assumptions
1. Monetary Unit Assumption

- include in accounting records only transactions that can be expressed in money terms
- accounting can be quantified/measured; vital to cost principle
- prevents qualitative info such as health of owner, quality of service, morale of employees, etc.
2. Economic Entity Assumption

- any organization or unit in society

- activities of entity is separate and distinct from owner and other entities
- proprietorship = one owner, liable for all profits/losses
- partnership = two or more owners
- corporation = separate legal entity under corporation law, ownership divided into transferable
shares of stock; stockholders have limited liability
III. The Basic Accounting Equation

assets = liabilities + owner's equity

A. Assets
- resources a business owns
- capacity to provide future services or benefits
- used to make money
B. Liabilities
- claims against assets, e.g. debts and obligations to creditors
- accounts payable, notes payable, salaries and wages payable, taxes payable
- liabilities must be paid before ownership claims
C. Owner's Equity
- ownership claim on assets
- since creditors must be paid before ownership claims, owner's equity often called residual equity
1. Increases in Owner's Equity

- investments by owner / owner's capital

- revenues = sales, fees, services, commissions, interests, dividends, royalties, rent
2. Decreases in Owner's Equity

- drawings by owner
- expenses = cost of supplies, salaries and wages, utilities, rent, interest, tax
IV. Using the Accounting Equation
- the full order is:
- transaction analysis
- journal
- ledger
- unadjusted trial balance
- trial balance
- close
- balance sheet

- external and internal transactions; some activities are not business transactions, e.g.
answering the phone
V. Financial Statements
A. Income Statement

- revenues and expenses = net income/loss

B. Owner's Equity Statement

- investments, drawings, net income

C. Balance Sheet

- assets, liabilities, owner's equity

D. Statement of Cash Flows
- cash inflow (receipts) and cash outflows (payments)
- cash effects of operations
- investing activities
- financing activities
- net increase or decrease in cash
- cash amount at the end of period
answers:
- where did cash come from?
- what was cash used for?
- what was change in cash balance?