© The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Chapter One An Introduction to Accounting

© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Chapter One

An Introduction to Accounting

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LO 1

Explain the role of accounting in

society.

LO 1

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Role of Accounting in Society

Accounting provides

information that is useful in answering

questions about

resource allocation.

Should I invest

money in IBM or

General Motors?

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Market-Based Allocations

A market is a group of people or entities

organized to exchange things of

value.

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Market-Based Allocations

Consumers

Conversion Agents

Resource Owners

Resource users

Transform resources into

desirable products

Control the distribution of

resources

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Market-Based Allocations

Common terms for the added value created in the transformation

process:

Profit Income Earnings

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1-8

Financial Resources

Conversion agents need financial resources (money) to establish and

operate their businesses.

Investors Creditors

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Liquidation

If a business fails, any resources

(assets) it still has are

returned to the resource providers

(investors and creditors).

The process of dividing remaining

assets and returning them to resource providers is called business

liquidation.

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Physical Resources

In their most primitive form, physical

resources are called natural resources.

Owners of physical resources seek to sell

those resources to profitable businesses which are able to pay

higher prices and make repeat purchases.

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Labor Resources

Labor resources include both

intellectual and physical labor.

Workers seek relationships with

businesses that have high earnings

potential because these businesses are

better able to pay high wages.

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Types of Accounting Information

Financial Accountin

g

Focused on the needs of external

users

Managerial

Accounting

Focused on the needs of internal

users

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Non-business Resource Allocation

Not all entities allocate resources based on profitability. Organizations that are not

motivated by profit are called not-for-profit entities. Government,

foundations, religious groups, the

Peace Corps, and various benevolent

organizations allocate resources

based on humanitarian

concerns.

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Non-business Resource Allocation

Not all entities allocate resources based on profitability. Organizations that are not

motivated by profit are called not-for-profit entities. Other

organizations allocate resources to support art, music, dance, and theater.

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Careers in Accounting

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Public Accounting

Certified Public Accountant

Audit servicesTax services

Consulting services

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Measurement Rules

Accountants establish measurement and reporting rules that businesses

use to facilitate communication.

Generally Accepted

Accounting Principles

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LO 2

Distinguish among the different accounting

entities involved in business

events.

LO 2

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Reporting EntitiesFinancial accounting reports disclose the financial activities of

particular individuals or organizations described as

reporting entities.

Each entity is treated as a

separate reporting unit.

Business

Owner

Bank

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LO 3

Name and define the major

elements of financial

statements.

LO 3

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Financial Statements

Balance Sheet

Income Statement

Statement of Changes

in Equity

Statement of Cash Flows

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Elements of Financial Statements

The elements represent

broad categories.

1. Assets

2. Liabilities

3. Equity

4. Contributed Capital

5. Revenue

6. Expenses

7. Distributions

8. Net Income

9. Gains

10. Losses

We will discuss elements 1-8 in this

chapter. We will save elements 9 and 10 for a later

chapter.

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Elements of Financial Statements

1. Assets—Cash, Equipment, Buildings, Land

2. Liabilities

3. Equity

4. Contributed Capital

5. Revenue

6. Expenses

7. Distributions

8. Net Income

9. Gains

10. Losses

Subclassifications of the

elements are frequently called

accounts.Accounts are

reported in the financial

statements.

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LO 4

Describe the relationships

expressed in the accounting equation.

LO 4

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Accounting Equation

Claims on the assets are from two sources:

1. Creditors (liabilities)

2. Investors or owners (equity).

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Accounting Equation

Assets = Liab. + Equity

500$ = 200$ + 300$

Assets - Liab. = Equity

500$ - 200$ = 300$

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Accounting Equation

Common Stock + Retained Earnings

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LO 5

Record business events in general ledger accounts organized under an accounting

equation.

LO 5

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Recording Business Events Under the Accounting Equation

AccountingEvent

Transaction

1. Source

2. Exchange

3. Use

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Asset Source Transactions

Businesses obtain assets from three

sources:

1. Owners

2. Creditors

3. Profitable Operations

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Event 1: Rustic Camp Sites (RCS) was formed on January 1, 2008, when it acquired $120,000 cash from issuing common stock.

1. RCS increases assets (cash).

2. RCS increases stockholders’ equity (common stock).

Asset Source

Transaction

= Liab. +

Cash + Land = N. Pay. + C. Stk. + Ret. Ear.Acquired Cash through Stock Issue 120,000 + n/a = n/a + 120,000 + n/a

Assets Stockholders' Equity

Double-Entry

Bookkeeping

Recorded Twice

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Event 2: RCS acquired an additional $400,000 of cash by borrowing from a creditor.

= Liab. +

Cash + Land = N. Pay. + C. Stk. + Ret. Ear.Beginning Balance 120,000 + n/a = n/a + 120,000 + n/aAcquired Cash by Issuing Note 400,000 + n/a = 400,000 + n/a + n/aEnding Balance 520,000 + n/a = 400,000 + 120,000 + n/a

Assets Stockholders' Equity

1. RCS increases assets (cash).

2. RCS increases liabilities (notes payable).

Asset Source

Transaction

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Event 3: RCS paid $500,000 cash to purchase land.

= Liab. +

Cash + Land = N. Pay. + C. Stk. + Ret. Ear.Beginning Balance 520,000 + n/a = 400,000 + 120,000 + n/aPaid Cash to Buy Land (500,000) + 500,000 = n/a + n/a + n/aEnding Balance 20,000 + 500,000 = 400,000 + 120,000 + n/a

Assets Stockholders' Equity

1. RCS decreases assets (cash).

2. RCS increases assets (land).

Asset Exchange

Transaction

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Event 4: RCS obtained $85,000 cash by leasing campsites to customers.

= Liab. +

Cash + Land = N. Pay. + C. Stk. + Ret. Ear.Beginning Balance 20,000 + 500,000 = 400,000 + 120,000 + n/aAcquired Cash by Earning Revenue 85,000 + n/a = n/a + n/a + 85,000 Ending Balance 105,000 + 500,000 = 400,000 + 120,000 + 85,000

Assets Stockholders' Equity

1. RCS increases assets (cash).

2. RCS increases stockholders’ equity (retained earnings).

Asset Source

Transaction

revenues

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Event 5: RCS paid $50,000 cash for operating expenses such as salaries, rent, and interest.

= Liab. +

Cash + Land = N. Pay. + C. Stk. + Ret. Ear.Beginning Balance 105,000 + 500,000 = 400,000 + 120,000 + 85,000 Used Cash to Pay Expenses (50,000) + n/a = n/a + n/a + (50,000) Ending Balance 55,000 + 500,000 = 400,000 + 120,000 + 35,000

Assets Stockholders' Equity

1. RCS decreases assets (cash).

2. RCS decreases stockholders’ equity (retained earnings).

Asset Use Transaction

expenses

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Event 6: RCS paid $4,000 in cash dividends to its owners.

= Liab. +

Cash + Land = N. Pay. + C. Stk. + Ret. Ear.Beginning Balance 55,000 + 500,000 = 400,000 + 120,000 + 35,000 Used Cash to Pay Dividends (4,000) + n/a = n/a + n/a + (4,000) Ending Balance 51,000 + 500,000 = 400,000 + 120,000 + 31,000

Assets Stockholders' Equity

1. RCS decreases assets (cash).

2. RCS decreases stockholders’ equity (retained earnings).

Asset Use Transaction

dividends

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LO 6Explain how the

historical cost and reliability

concepts affect amounts reported

in the financial statements.

LO 6

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Event 7: The land that RCS paid $500,000 to purchase had an appraised market value of $525,000 on December 31, 2008.

Historical Cost

Concept

Requires that most assets be reported at the amount paid

for them (their historical cost) regardless of

increases in market value.

Reliability Concept

Information is reliable if it can be

independently verified.

Appraised values are opinions and will

vary from appraiser to appraiser.

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LO 7

Classify business events as asset source, use, or

exchange.

LO 7

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Recap: Types of Transactions

The described transactions have been classified into one of three

categories:Asset Source

Asset Exchange

AssetUse

Increase assets,

increase claims on

assets

Increase one asset, decrease another

asset

Decrease assets,

decrease claims on

assets

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Summary of Transactions

= Liab. +

Cash + Land = Notes

Payable + Common

Stock + Retained Earnings

Other Account

Titles Event -$ -$ -$ -$ -$

1 120,000 120,000 2 400,000 400,000 3 (500,000) 500,000 4 85,000 85,000 Revenue5 (50,000) (50,000) Expense6 (4,000) (4,000) Dividend7 n/a n/a n/a n/a n/a

51,000$ + 500,000$ = 400,000$ + 120,000$ + 31,000$

Assets Stockholders' Equity

Now, let’s prepare the financial statements for RCS using the data

presented above.

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LO 8

Use general ledger account information to prepare four

financial statements.

LO 8

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Preparing Financial Statements

Net Loss

Accounting Period

Matching Concept

results when expenses exceed revenues.

Revenues exceeded expenses.Income is

measured for a span of time

called the

{

Revenues are matched to expenses.

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Revenue (asset increases) 85,000$ Operating Expenses (asset decreases) (50,000) Net Income 35,000$

Beginning Common Stock -$ Plus: Common Stock Issued 120,000 Ending Common Stock 120,000$ Beginning Retained Earnings -$ Plus: Net Income 35,000 Less: Dividends (4,000) Ending Retained Earnings 31,000 Total Stockholders' Equity 151,000$

RUSTIC CAMP SITESStatement of Changes in Stockholders' Equity

For the Year Ended December 31, 2008

RUSTIC CAMP SITESIncome Statement

For the Year Ended December 31, 2008

Preparing Financial Statements

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AssetsCash 51,000$ Land 500,000 Total Assets 551,000$

LiabilitiesNotes Payable 400,000$

Stockholders' EquityCommn Stock 120,000$ Retained Earnings 31,000 Total Stockholders' Equity 151,000 Total Liabilities and Stockholders' Equity 551,000$

Balance SheetAs of December 31, 2008

RUSTIC CAMP SITES

Preparing Financial Statements

equal

Assets are

displayed in order

of liquidity.

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Cash Flows from Operating ActivitiesCash Receipts from Revenue 85,000$ Cash Payments for Expenses (50,000)

Net Cash Flow from Operating Activities 35,000$ Cash Flows for Investing ActivitiesCash Payments to Purchase Land (500,000) Cash Flows from Financing ActivitiesCash Receipts from Borrowing Funds 400,000 Cash Receipts from Issuing Common Stock 120,000 Cash Payments for Dividends (4,000) Net Cash Flow from Financing Activities 516,000 Net Increase in Cash 51,000 Plus Beginning Cash Balance - Ending Cash Balance 51,000$

RUSTIC CAMP SITESStatement of Cash Flows

For the Year Ended December 31, 2008

Operating

Investing

Financing

Preparing Financial Statements

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The Closing Process

Transfers net income (or loss) and dividends to Retained Earnings.

Establishes zero balances in all

revenue, expense, and dividend accounts.

248

Temporary accounts track financial

results for a limited period of time.

Temporary accounts track financial

results for a limited period of time.

Temporary and Permanent Accounts

Revenues

Exp

ense

s

Divid

end

s

TemporaryAccounts

Permanent Accounts

Assets

Lia

bili

ties E

qu

ity

Permanent accounts track financial

results from year to year.

Permanent accounts track financial

results from year to year.

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LO 9

Record business events using a

horizontal financial

statements model.

LO 9

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Horizontal Financial Statements Model

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Real World Financial Reports

Service Businesses

Merchandising Businesses

Manufacturing Businesses

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Annual Reports

(1)Financial Statements

(2)Notes

(3)Auditor’s Report –Chapter 2

(4)Management’s Discussion and Analysis (MD&A)—Chapter 4

Traditionally, large companies have distributed expensive

annual reports with many color photographs.

Increasingly, however, companies are issuing more modest annual reports or are simply distributing their 10-K

reports.

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Special Terms in Real-World ReportsThe financial statements of real-world companies

include numerous items relating to advanced topics that are not covered in introductory accounting

textbooks.

However, we encourage you to look for annual reports in the library, from your employer, or on the

Internet. The best way

to learn accounting is

to use it.

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LO 10

AppendixExplain the price-

earnings ratio.

LO 10

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Price-Earnings Ratio (Appendix)

Price-EarningsRatio

Market Price Per Share Earnings Per Share

=

A higher price-earnings ratio means that investors are willing to pay a premium for a

company’s stock because of optimistic future growth prospects.

Earnings per share (EPS), in its simplest form, is computed by dividing the

company’s net income by the number of shares of common stock outstanding.

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Measuring Growth Through Percent Analysis

Company 2008 2009 Growth PercentageCammeron 42.4$ 46.6$ 4.2$ 9.9%Diller 9.9 12.8 2.9 29.3%

Alternative Year Earnings – Base Year Earnings

Base Year Earnings

The following earnings information was taken from the 2008 and 2009 income statements of

Cammeron, Inc. and Diller Enterprises.

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End of Chapter One