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© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Chapter One
An Introduction to Accounting
1-2
LO 1
Explain the role of accounting in
society.
LO 1
1-3
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?
1-4
Market-Based Allocations
A market is a group of people or entities
organized to exchange things of
value.
1-5
Market-Based Allocations
Consumers
Conversion Agents
Resource Owners
Resource users
Transform resources into
desirable products
Control the distribution of
resources
1-6
Market-Based Allocations
Common terms for the added value created in the transformation
process:
Profit Income Earnings
1-7
1-8
Financial Resources
Conversion agents need financial resources (money) to establish and
operate their businesses.
Investors Creditors
1-9
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.
1-10
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.
1-11
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.
1-12
Types of Accounting Information
Financial Accountin
g
Focused on the needs of external
users
Managerial
Accounting
Focused on the needs of internal
users
1-13
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.
1-14
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.
1-15
Careers in Accounting
1-16
Public Accounting
Certified Public Accountant
Audit servicesTax services
Consulting services
1-17
Measurement Rules
Accountants establish measurement and reporting rules that businesses
use to facilitate communication.
Generally Accepted
Accounting Principles
1-18
LO 2
Distinguish among the different accounting
entities involved in business
events.
LO 2
1-19
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
1-20
LO 3
Name and define the major
elements of financial
statements.
LO 3
1-21
Financial Statements
Balance Sheet
Income Statement
Statement of Changes
in Equity
Statement of Cash Flows
1-22
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.
1-23
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.
1-24
LO 4
Describe the relationships
expressed in the accounting equation.
LO 4
1-25
Accounting Equation
Claims on the assets are from two sources:
1. Creditors (liabilities)
2. Investors or owners (equity).
1-26
Accounting Equation
Assets = Liab. + Equity
500$ = 200$ + 300$
Assets - Liab. = Equity
500$ - 200$ = 300$
1-27
Accounting Equation
Common Stock + Retained Earnings
1-28
LO 5
Record business events in general ledger accounts organized under an accounting
equation.
LO 5
1-29
Recording Business Events Under the Accounting Equation
AccountingEvent
Transaction
1. Source
2. Exchange
3. Use
1-30
Asset Source Transactions
Businesses obtain assets from three
sources:
1. Owners
2. Creditors
3. Profitable Operations
1-31
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
1-32
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
1-33
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
1-34
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
1-35
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
1-36
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
1-37
LO 6Explain how the
historical cost and reliability
concepts affect amounts reported
in the financial statements.
LO 6
1-38
Event 7: The land that RCS paid $500,000 to purchase had an appraised market value of $525,000 on December 31, 2008.
Historical Cost
Concept
Requires that most assets be reported at the amount paid
for them (their historical cost) regardless of
increases in market value.
Reliability Concept
Information is reliable if it can be
independently verified.
Appraised values are opinions and will
vary from appraiser to appraiser.
1-39
LO 7
Classify business events as asset source, use, or
exchange.
LO 7
1-40
Recap: Types of Transactions
The described transactions have been classified into one of three
categories:Asset Source
Asset Exchange
AssetUse
Increase assets,
increase claims on
assets
Increase one asset, decrease another
asset
Decrease assets,
decrease claims on
assets
1-41
Summary of Transactions
= Liab. +
Cash + Land = Notes
Payable + Common
Stock + Retained Earnings
Other Account
Titles Event -$ -$ -$ -$ -$
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.
1-42
LO 8
Use general ledger account information to prepare four
financial statements.
LO 8
1-43
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.
1-44
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
1-45
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.
1-46
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
1-47
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.
1-49
LO 9
Record business events using a
horizontal financial
statements model.
LO 9
1-50
Horizontal Financial Statements Model
1-51
Real World Financial Reports
Service Businesses
Merchandising Businesses
Manufacturing Businesses
1-52
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.
1-53
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.
1-54
LO 10
AppendixExplain the price-
earnings ratio.
LO 10
1-55
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.
1-56
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.
1-57
End of Chapter One