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ACCOUNTING

 “Accounting is the systematic process of


measuring the economic activity of a business to
provide useful information to those who make
economic decisions.”
Definition
 Accounting is an information and measurement
system that identifies, records and communicates
relevant, reliable, and comparable information
about an organization’s business activities.
Identifying business activities requires selecting
transactions and events relevant to an organization.
Users Of Accounting Information
 Accounting information helps decision makers
determine where they are, where they have been,
and where they are going.
 Accounting can help with these decisions by
providing information about the results that owners
and other decision makers should expect will occur.
 The purpose of accounting is to help people make
decisions about economic activities
External Users of Accounting Information
 External users of accounting information are not directly
involved in running the organization. They include shareholders
(investors), lenders (creditor), directors, customers, suppliers,
regulators, lawyers and the press.
 External users have limited access to an organization’s
information. Yet their business decisions depend on
information that is reliable, relevant and comparable.
 Financial accounting is the area of accounting aimed at serving
external users by providing them with general purpose financial
statement.
 The term general purpose refers to the broad range of purposes
for which external users rely on these statements.
External Users of Accounting
Information
•Owners
•Creditors (lenders)
•Potential investors
•Governmental agencies
•Suppliers
•Customers
•General public
A. Financial Accounting
 Financial accounting provides information to decision makers
who are external to the business.
 Because of this, shareholders delegate most of their decision
making power to the corporation’s board of directors and
officers.
 Shareholders, however, need information to evaluate
 the performance of the business and
 the advisability of retaining their investment in the
business.
 Financial accounting is used by potential shareholders who
are considering an investment in the business.
Fundamentals of accounting
 Generally accepted accounting principles
Financial accounting practice is governed by
concepts and rules known as GAAP.
Accounting Principles
 The measurement principle also called historical
cost principle.
 The revenue recognition principle provide guidance
on when a company must recognize revenue (to
record it).
 Three concepts are important to revenue
recognition : 1 Revenue must be recognized when
earned. 2 Proceeds from selling products and
services need not be in cash. (credit sales)
 Revenue is measured by the cash received plus the
cash value of any other items received.
Accounting Principles
 The expense recognition principle (matching
principle) the company record the expenses
incurred to generate the revenue reported.
 The full disclosure principle prescribes that a
company reports the details behind financial
statements that would impact users’ decisions.
Those disclosures are often in footnotes to the
statements.
Accounting Assumptions
 The going concern assumption means that
accounting information reflects a presumption that
the business will continue operating instead of being
closed or sold.
 The monetary assumption means that we can
express transactions and events in monetary units.
 The time period assumption presumes that the life
of a company can be divided into time period such
as months or years and that useful reports can be
prepared for those periods.
 The business entity assumption means that a
business is accounted for separately from other
business entities including its owners.
Introduction to Financial
Statements
Balance Sheet
Three primary
Income Statement financial
Statement of Cash Flows statements.

We will use a corporation to describe these


statements.
Introduction to Financial
Statements
Balance Sheet
Describes
where the
Income Statement enterprise
stands at a
Statement of Cash Flows
specific date.
Introduction to Financial
Statements
Balance Sheet

Income Statement
Depicts the
revenue and
Statement of Cash Flows expenses for a
designated
period of time.
Introduction to Financial
Statements
Balance Sheet

Income Statement

Statement of Cash Flows


Depicts the
ways cash has
changed during
a designated
period of time.
A Starting Point: Statement of
Financial Position
Vagabond Travel Agency
Balance Sheet
December 31, 2009
Assets Liabilities & Owners' Equity
Cash $ 22,500 Liabilities:
Notes receivable 10,000 Notes payable $ 41,000
Accounts receivable 60,500 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
Building 90,000 Owners' Equity:
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000
The Concept of the Business Entity

A business
entity is
Vagabond separate from
Travel the personal
Agency
affairs of its
owner.
Assets

Vagabond Travel Agency


Balance Sheet
December 31, 2009
Assets Liabilities & Owners' Equity
Cash
Assets are
$ 22,500 Liabilities:
Notes receivable 10,000 economic
Notes payable $ 41,000
Accounts receivable 60,500 Accounts payable 36,000
Supplies 2,000
resources that are
Salaries payable 3,000
Land 100,000 owned by the
Total liabilities $ 80,000
Building 90,000 Owners' Equity:
Office equipment 15,000
business and are
Capital stock 150,000
expected to benefit
Retained earnings 70,000
Total $ 300,000 Total $ 300,000
future operations.
Liabilities

Vagabond Travel Agency


Balance Sheet
December 31, 2009
Assets Liabilities & Owners' Equity
Liabilities are
Cash $ 22,500 Liabilities:
Notes receivable 10,000 Notes payable $ 41,000
debts that
Accounts receivable 60,500 Accounts payable 36,000
represent
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
negative future
Building 90,000 Owners' Equity:
cash flows for the
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
enterprise.
Total $ 300,000 Total $ 300,000
Owners’ Equity

Vagabond Travel Agency


Balance Sheet
December 31, 2009
Assets Liabilities & Owners' Equity
Owners’ equity
Cash $ 22,500 Liabilities:
represents the
Notes receivable
Accounts receivable
10,000
60,500
Notes payable
Accounts payable
$ 41,000
36,000
owners’ claims on
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
the assets of the
Building 90,000 Owners' Equity:
Office equipment 15,000 Capital stock 150,000
business. Retained earnings 70,000
Total $ 300,000 Total $ 300,000
Assets
The = Liabilities Equation
Accounting + Owners’ Equity

$300,000 = $80,000 + $220,000


Vagabond Travel Agency
Balance Sheet
December 31, 2009
Assets Liabilities & Owners' Equity
Cash $ 22,500 Liabilities:
Notes receivable 10,000 Notes payable $ 41,000
Accounts receivable 60,500 Accounts payable 36,000
Supplies 2,000 Salaries payable 3,000
Land 100,000 Total liabilities $ 80,000
Building 90,000 Owners' Equity
Office equipment 15,000 Capital stock 150,000
Retained earnings 70,000
Total $ 300,000 Total $ 300,000
Let’s analyze
transactions
for JJ’s Lawn
Care Service.
On May 1, Jill Jones and her family
invested $8,000 in JJ’s Lawn Care Service
and received 800 shares of stock.
JJ's Lawn Care Service
Balance Sheet
May 1, 2009
Assets Owners' Equity
Cash $ 8,000 Capital Stock $ 8,000

Total $ 8,000 Total $ 8,000

2-23
On May 2, JJ’s purchased a riding lawn
mower for $2,500 cash.
JJ's Lawn Care Service
Balance Sheet
May 2, 2009
Assets Owners' Equity
Cash $ 5,500 Capital Stock $ 8,000
Tools & Equipment 2,500

Total $ 8,000 Total $ 8,000

2-24
On May 8, JJ’s purchased a $15,000 truck.
JJ’s paid $2,000 down in cash and issued a
note payable for the remaining $13,000.
JJ's Lawn Care Service
Balance Sheet
May 8, 2009
Assets Liabilities and Owners' Equity
Cash $ 3,500 Liabilities:
Tools & Equipment 2,500 Notes Payable $ 13,000
Truck 15,000 Owners' Equity:
Capital Stock 8,000

Total $ 21,000 Total $ 21,000

2-25
On May 11, JJ’s purchased some repair
parts for $300 on account.

JJ's Lawn Care Service


Balance Sheet
May 11, 2009
Assets Liabilities and Owners' Equity
Cash $ 3,500 Liabilities:
Tools & Equipment 2,800 Notes Payable $ 13,000
Truck 15,000 Accounts Payable 300
Total Liabilities $ 13,300
Owners' Equity:
Capital Stock 8,000

Total $ 21,300 Total $ 21,300

2-26
Jill realized she had purchased more repair parts than
needed.
On May 18, JJ’s was able to sell half of the repair parts to
ABC Lawns for $150, a price equal to JJ’s cost. JJ’s will
receive the cash within 30 days.
JJ's Lawn Care Service
Balance Sheet
May 18, 2009
Assets Liabilities and Owners' Equity
Cash $ 3,500 Liabilities:
Accounts Receivable 150 Notes Payable $ 13,000
Tools & Equipment 2,650 Accounts Payable 300
Truck 15,000 Total Liabilities $ 13,300
Owners' Equity:
Capital Stock 8,000

Total $ 21,300 Total $ 21,300

2-27
On May 25, ABC Lawns pays JJ’s $75 as a
partial settlement of its accounts
receivable.
JJ's Lawn Care Service
Balance Sheet
May 25, 2009
Assets Liabilities and Owners' Equity
Cash $ 3,575 Liabilities:
Accounts Receivable 75 Notes Payable $ 13,000
Tools & Equipment 2,650 Accounts Payable 300
Truck 15,000 Total Liabilities $ 13,300
Owners' Equity:
Capital Stock 8,000

Total $ 21,300 Total $ 21,300

2-28
On May 28, JJ’s pays $150 of its accounts
payable.
JJ's Lawn Care Service
Balance Sheet
May 28, 2009
Assets Liabilities and Owners' Equity
Cash $ 3,425 Liabilities:
Accounts Receivable 75 Notes Payable $ 13,000
Tools & Equipment 2,650 Accounts Payable 150
Truck 15,000 Total Liabilities 13,150
Owners' Equity:
Capital Stock 8,000

Total $ 21,150 Total $ 21,150

2-29
On May 29, JJ’s recorded lawn care
services provided during May of $750. All
clients were paid in cash.
JJ's Lawn Care Service
Balance Sheet
May 29, 2009
Assets Liabilities and Owners' Equity
Cash $ 4,175 Liabilities:
Accounts Receivable 75 Notes Payable $ 13,000
Tools & Equipment 2,650 Accounts Payable 150
Truck 15,000 Total Liabilities 13,150
Owners' Equity:
Capital Stock 8,000
Retained Earnings 750
Total $ 21,900 Total $ 21,900

2-30
On May 31, JJ’s purchased gasoline for the
lawn mower and the truck for $50 cash.
JJ's Lawn Care Service
Balance Sheet
May 31, 2009
Assets Liabilities and Owners' Equity
Cash $ 4,125 Liabilities:
Accounts Receivable 75 Notes Payable $ 13,000
Tools & Equipment 2,650 Accounts Payable 150
Truck 15,000 Total Liabilities 13,150
Owners' Equity:
Capital Stock 8,000
Retained Earnings 700
Total $ 21,850 Total $ 21,850

Now, let’s review how JJ’s transactions


affected the accounting equation. 2-31
JJ's Lawn Care Service
Income Statement
For the Month Ended May 31, 2009

Sales Revenue $ 750


Operating Expense:
Gasoline Expense 50
Net Income $ 700
Investments by and payments to the owners
are not included on the Income Statement.
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2009
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash provided by operating activities $ 700
Cash flows from investing activities:
Purchase of lawn mower $ (2,500)
Purchase of truck (2,000)
Collection for sale of repair parts 75
Payment for repair parts (150)
Net cash used by investing activities (4,575)
Cash flows from financing activities:
Investment by owners 8,000
Increase in cash for month $ 4,125
Cash balance, May 1, 2009 -
Cash balance, May 31, 2009 $ 4,125
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2009
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash provided by operating activities $ 700
Cash flows from investing activities:
Operating activities include the cash
Purchase of lawn mower $ (2,500)
effects of revenue and expense
Purchase of truck (2,000)
Collection for sale of repair parts 75
transactions.
Payment for repair parts (150)
Net cash used by investing activities (4,575)
Cash flows from financing activities:
Investment by owners 8,000
Increase in cash for month $ 4,125
Cash balance, May 1, 2009 -
Cash balance, May 31, 2009 $ 4,125
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2009
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash provided by operating activities $ 700
Cash flows from investing activities:
Purchase of lawn mower $ (2,500)
Purchase of truck (2,000)
Collection for sale of repair parts 75
Payment for repair parts (150)
Net cash used by investing activities (4,575)
Cash flows from financing activities:
Investing activities include the cash
Investment by owners 8,000
effects of purchasing and selling 4,125
Increase in cash for month $
Cash balance, May 1, 2009 -
assets.
Cash balance, May 31, 2009 4,125 $
JJ's Lawn Care Service
Statement of Cash Flows
For the Month Ended May 31, 2009
Cash flows from operating activities:
Cash received from revenue transactions $ 750
Cash paid for expenses (50)
Net cash provided by operating activities $ 700
Cash flows from investing activities:
Purchase of lawn mower $ (2,500)
Financing activities include the cash
Purchase of truck (2,000)
effects of transactions with the owners
Collection for sale of repair parts 75
Payment for repair parts (150)
and creditors.
Net cash used by investing activities
(4,575)
Cash flows from financing activities:
Investment by owners 8,000
Increase in cash for month $ 4,125
Cash balance, May 1, 2009 -
Cash balance, May 31, 2009 $ 4,125
JJ's Lawn Care Service
Balance Sheet
May 31, 2009
Assets Liabilities
Cash $ 4,125 Notes payable $ 13,000
Accounts receivable 75 Accounts payable 150
Tools & equipment 2,650 Owners' Equity
Truck 15,000 Capital stock 8,000
Retained earnings 700
Total assets $ 21,850 Total liabilities & equity $ 21,850

Assets = Liabilities + Owners’ Equity

$21,850 = $13,150 + $8,700


Financial Reporting and Financial
Statements
Financial statements are
just one source of
financial accounting Income
Statement
information. Balance
Sheet
Statement
of Cash
Flows

Other Information:
•Industry
•Competitors
•National economy
The Need for Adequate Disclosure

Balance Sheet Notes to the


financial
Income Statement
statements
Statement of Cash Flows often provide
facts necessary
for the proper
interpretation of
the statements.
Evaluating the Business

Evaluating Evaluating
Profitability Liquidity

Net Income Net Income Working Current Assets –


= =
Percentage Total Revenue Capital Current Liabilities

Return on Net Income Current Current Assets


= =
Equity Avg. Stockholders’ Ratio Current Liabilities
Equity
The Accounting Cycle:
Capturing Economic Events
Basic Functions of an Accounting
System
 Interpret  Classify
and record similar
business transactions
transactions. into useful
reports.
 Summarize
and
communicate
information to
decision makers.
The Ledger

Accounts are
Cash individual records
showing increases
Accounts and decreases.
Payable

The entire group of


Capital accounts is kept
Stock
together in an
accounting record
called a ledger.
The Use of Accounts

Increases are recorded on


one side of the T Title of Account
account, and decreases
Left Right
are recorded on the or or
other side. Debit Credit
Side Side
Debit and Credit Entries

Cash
Receipts are 5/1 8,000 5/2 2,500 Payments are
on the debit
side. 5/25 75 5/8 2,000 on the credit
side.
5/29 750 5/28 150
5/31 50
5/31 4,125 The balance is the
difference between the
Bal. debit and credit entries
in the account.
Debit and Credit Entries
Debits and credits affect accounts as follows:

A = L + OE
ASSETS LIABILITIES EQUITIES
Debit Credit Debit Credit Debit Credit
for for for for for for
Increase Decrease Decrease Increase Decrease Increase
Double Entry AccountingThe Equality of
Debits and Credits

A = L + OE
Debit Credit
=
balances balances

In the double-entry accounting system,


every transaction is recorded by equal
dollar amounts of debits and credits.
Let’s record
selected
transactions
for JJ’s Lawn
Care Service in
the accounts.
 May 1: Jill Jones and her family invested $8,000
in JJ’s Lawn Care Service and received 800 shares
of stock.

Will
Capital
Capital
Stock
Stock
Will
Cash
Cash
increases
increase
increases
increase$8,000
or
$8,000
or decrease?
with a debit.
with
decrease?
a credit.

Cash Capital Stock


5/1 8,000 5/1 8,000

3-49
 May 2: JJ’s purchased a riding lawn mower
for $2,500 cash.

Tools
Will
& Tools
Equipment
&
Will
CashCash
decreases
increase
Equipment
increases increase
$2,500
$2,500
or decrease?
with a credit.
or
with
decrease?
a debit.

Cash Tools & Equipment


5/1 8,000 5/2 2,500 5/2 2,500

3-50
 May 8: JJ’s purchased a $15,000 truck. JJ’s paid
$2,000 in cash and issued a note payable for the
remaining $13,000.

Cash decreases $2,000


Will Cash and
with a credit. Notes
Truck
Will increases
Truck increase Notes Payable
Payable increases
$15,000 with a debit.
or decrease? increase or
$13,000 with a credit.
decrease?

Cash
5/1 8,000 5/2 2,500
Truck
5/8 2,000
5/8 15,000
Notes Payable
5/8 13,000

3-51
 May 11: JJ’s purchased some repair parts
for $300 on account.

Tools
Will
& Tools
Equipment
& Accounts Payable
Will Accounts
Equipment
increases $300
increase
with increasesincrease
Payable $300 withor
a
or decrease?
a debit. credit.
decrease?

Tools & Equipment Accounts Payable


5/2 2,500 5/11 300
5/11 300

3-52
 May 18: JJ’s sold half of the repair parts to
ABC Lawns for $150, a price equal to JJ’s cost.
ABC Lawns agrees to pay JJ’s within 30 days.

Tools
Will
& Tools
Equipment
& Accounts Receivable
Will Accounts
decreases
Equipment$150
increase
with increases $150
Receivable with a
increase
or adecrease?
credit. debit.
or decrease?

Tools & Equipment Accounts Receivable


5/2 2,500 5/18 150 5/18 150
5/11 300

3-53
The Journal
In an actual accounting system, transactions
are initially recorded in the journal.

GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit


2009
May 1 Cash 8,000
Capital Stock 8,000
Owners invest cash in the business.
Posting Journal Entries to the
Ledger Accounts

Posting simply
means updating the
ledger accounts for
the effects of the
transactions
recorded in the
journal.
Posting Journal Entries to the
Ledger Accounts
GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit


2009
May 1 Cash 8,000
Capital Stock 8,000
General
Owners invest Ledger
cash in the business.

Cash
Date Debit Credit Balance
2009
May 1 8,000 8,000
Posting Journal Entries to the
Ledger Accounts
GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit


2009
May 1 Cash 8,000
Capital Stock 8,000
General
Owners invest Ledger
cash in the business.

Capital Stock
Date Debit Credit Balance
2009
May 1 8,000 8,000
Posting Journal Entries to the
Ledger Accounts
GENERAL JOURNAL

Date Account Titles and Explanation Debit Credit


2009
May 2 Tools & Equipment 2,500
Cash 2,500
Purchased lawn mower.

Let’s see what the cash account looks like after


posting the cash portion of this transaction for JJ’s
Lawn Care Service.
Ledger Accounts After Posting
General Ledger
Cash
Date Debit Credit Balance
2009
May 1 8,000 8,000
2 2,500 5,500

This ledger format is referred to as a running


balance.
Ledger Accounts After Posting
General Ledger
Cash
Date Debit Credit Balance
2009
May 1 8,000 8,000
2 2,500 5,500

T accounts are simplified versions of


the ledger account that only show the
debit and credit columns.
What is Net Income?
Net income is not an asset it’s an increase
in owners’ equity from profits of the
business.

A = L + OE
Increase Decrease Increase

As income is earned, Net income


either an asset is always results in
increased or a liability is the increase of
decreased. Owners’ Equity
Retained Earnings

A = L + OE
Capital Retained
Stock Earnings

The balance in the Retained Earnings account represents


the total net income of the corporation over the entire
lifetime of the business, less all amounts which have been
distributed to the stockholders as dividends.
The Income Statement: A
Preview
JJ's Lawn Care Service
Income Statement
For the Month Ended May 31, 2009

Sales Revenue $ 750


Operating Expense:
Gasoline Expense 50
Net Income $ 700

The income statement summarizes the profitability


of a business for a specified period of time.
Accounting Periods

Time Period Principle


To provide users of
financial statements
with timely information,
net income is
measured for relatively
short accounting
periods of equal
length.
Revenue and Expenses
The price for
goods sold
and services Increases
rendered during a owners’ equity.
given accounting
period.

The costs of
goods and Decreases
services used up owner’s equity.
in the process of
earning revenue.
The Matching Principle: When To
Record Revenue

Matching Principle
Revenue should be
recognized at the
time goods are sold
and services are
rendered.
The Matching Principle: When To
Record Expenses

Matching Principle
Expenses should be
recorded in the
period in which they
are used up.
The Accrual Basis of Accounting
Current Future
Accounting Period Accounting Period

Jan. 1, 2009 Dec. 1, 2009 Jan. 1, 2010 Dec. 1, 2010

The income statement


Cash is received or paid But . . .
reports revenue or
here
expense here

OR

The income statement But . . . Cash is received or paid


reports revenue or
here
expenses here