Financial Accounting

Fundamentals

McGraw-Hill/Irwin

John J. Wild
2009 Edition

Copyright 2009 by The McGraw-Hill Companies, Inc. All

Chapter 1
Introducing Financial
Accounting

Conceptual Chapter Objectives

C1: Explain the purpose and importance of
accounting in the information age.
C2: Identify users and uses of accounting.
C3: Identify opportunities in accounting and
related fields.
C4: Explain why ethics are crucial to
accounting.
C5: Explain GAAP, and define and apply
several key accounting principles.
C6: 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: Analyze business transactions using the
accounting equation.
A3: Compute and interpret return on assets.
A4: Appendix 1A: Explain the relationship
between return and risk.

1-4

Procedural Chapter Objectives

P1: 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

information
that is

Communicates
Communicates

Reliable
Reliable
Comparable
Comparable

to
tohelp
helpusers
usersmake
make
better
betterdecisions.
decisions.

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.

Managerial accounting provides

information needs for internal
decision makers.

1-9

C3

Opportunities in Accounting
Managerial
Managerial

Financial
Financial

Taxation
Taxation

General
Generalaccounting
accounting
Cost
Costaccounting
accounting
Budgeting
Budgeting
Internal
Internalauditing
auditing
Consulting
Consulting
Controller
Controller
Treasurer
Treasurer
Strategy
Strategy

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

AccountingAccountingrelated
related

Lenders
Lenders
Consultants
Consultants
Analysts
Analysts
Traders
Traders
Directors
Directors
Underwriters
Underwriters
Planners
Planners
Appraisers
Appraisers

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

C3

Accounting Jobs by Area

1-11

C4

EthicsA Key Concept

Ethics
Beliefs that
distinguish
right from
wrong

Accepted
standards of
good and bad
behavior

1-12

C4

Guidelines for Ethical Decisions

Identify
ethical concerns

Make ethical
decision

Analyze
options

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

Choose best
option after
weighing all
consequences.

1-13

C5

Generally Accepted Accounting

Principles
Financial
Financial accounting
accountingpractice
practice is
isgoverned
governedby
by
concepts
conceptsand
andrules
rules known
knownas
as generally
generallyaccepted
accepted
accounting
accountingprinciples
principles (GAAP).
(GAAP).
Relevant
Relevant
Information
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

C5

Setting Accounting Principles

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
TheSecurities
Securitiesand
andExchange
ExchangeCommission
Commissionis
isthe
the
government
governmentgroup
groupthat
thatestablishes
establishesreporting
reporting
requirements
requirementsfor
forcompanies
companiesthat
thatissue
issuestock
stockto
to
the
thepublic.
public.

The International Accounting Standards Board (IASB) issues international standards that identify preferred accounting practices
in other countries. The IASB does not have authority to impose
its standards on companies.

1-15

C5

Principles of Accounting

Cost principle means that

accounting information is based
on actual cost.
Going-concern means that
accounting information reflects a
presumption the business will
continue operating.
Monetary unit means we can
express transactions in money.

Revenue recognition principle

provides guidance on when a
company must recognize
revenue.
Business entity means that a
business is accounted for
separately from its owner or other
business entities.
Matching Principle prescribes that
a company must record its
expenses incurred to generate the
revenue.

Full disclosure principle requires a company to report the details behind

financial statements that would impact users decisions.

1-16

C5

Business Entity Forms

Sole
Sole
Proprietorship
Proprietorship

Partnership
Partnership

Corporation
Corporation

1-17

A1

Accounting Equation
Assets
Assets

Liabilities
Liabilities

Assets

Equity
Equity

Liabilities
& Equity

1-18

Assets

A1

Cash
Cash
Accounts
Accounts
Receivable
Receivable

Vehicles
Vehicles

Store
Store
Supplies
Supplies

Notes
Notes
Receivable
Receivable

Resources
Resources
owned
owned or
or
controlled
controlled
by
by aa
company
company

Land
Land

Buildings
Buildings
Equipment
Equipment

1-19

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

1-20

A1

Equity
Retained
Retained
Earnings
Earnings

Contributed
Contributed
Capital
Capital

Owners
Owners
claim
claim on
on
assets
assets

Dividends
Dividends

1-21

A1

Expanded Accounting Equation

Assets
Assets
Assets
Assets

Common
Common
Stock
Stock

=
=
_

Liabilities
Liabilities
Liabilities
Liabilities

Dividends
Dividends

+
+

Revenues
Revenues

Equity
Equity
Equity
Equity

_ Expenses
Expenses

Retained Earnings

1-22

A2

Transaction Analysis

J. Scott invests $20,000 cash to start the

business in return for stock.

1-23

A2

Transaction Analysis
Purchased supplies paying $1,000 cash.

1-24

A2

Transaction Analysis
Purchased equipment for $15,000 cash.

1-25

A2

Transaction Analysis
Purchased Supplies of $200 and
Equipment of $1,000 on account.

1-26

A2

Transaction Analysis

Borrowed $4,000 from 1st American Bank.

1-27

A2

Transaction Analysis
The balances so far appear below. Note that the
Balance Sheet Equation is still in balance.

1-28

A2

Transaction Analysis

Now, lets look at transactions

involving revenue, expenses and
dividends.

1-29

A2

Transaction Analysis

Provided consulting services receiving

$3,000 cash.

1-30

A2

Transaction Analysis
Paid salaries of $800 to employees.

Remember that expenses decrease equity.

1-31

A2

Transaction Analysis

Dividends of $500 are paid to shareholders.

Remember that dividends decrease equity.

1-32

P1

Financial Statements
Lets prepare the Financial Statements reflecting
the transactions we have recorded.
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows

1-33

P1

Income Statement
Net income is the
difference
between
Revenues and
Expenses.
The income statement describes a
companys revenues and expenses along
with the resulting net income or loss over a
period of time
due to earnings activities.

1-34

P1

Statement of Retained Earnings

The net income of
$2,200 increases
Retained Earnings by
$2,200.

1-35

P1

Balance Sheet
The
TheBalance
BalanceSheet
Sheetdescribes
describes
aacompanys
companysfinancial
financialposition
position
at
ataapoint
pointin
intime.
time.

1-36

P1

Statement of Cash Flows

1-37

A3

Return on Assets (ROA)

Return on
Net income
=
assets
Average total assets

ROA
ROA is
is viewed
viewed as
as an
an
indicator
indicator of
of operating
operating
efficiency.
efficiency.

1-38

End of Chapter 1

1-39