1 Accounting Principles

Part (1)
Learning Objectives

1 Identify the activities and users associated with accounting.

2 Explain the building blocks of accounting: principles, and assumptions.

3 State the accounting equation, and define its components.

4 Analyze the effects of business transactions on the accounting equation.

Describe the basic financial statements and how they are

5 prepared.
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 1 Identify the activities and users
associated with accounting.

The Nature of Accounting

 Accounting - a process of identifying,
recording, summarizing, and reporting
economic information to decision makers in
the form of financial statements
 Financial accounting - focuses on the
specific needs of decision makers external
to the organization, such as stockholders,
suppliers, banks, and government agencies
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 The Nature of Accounting

 The accounting system is a series of

steps performed to analyze, record,
quantify, accumulate, summarize,
classify, report, and interpret economic
events and their effects on an
organization and to prepare the financial
statements.

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 What is accounting?

 Accounting is The language of business

 Measures financial aspects of a business

 Communicates this information to decision

makers

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 Accounting consists of three basic
activities—it

 identifies,

 records, and

 communicates

the economic events of an organization to

interested users.

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 Three Activities

The accounting process includes

the bookkeeping function.

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 The Need for Accounting

The primary questions about an organization’s

success that decision makers want to know
are:

What is the financial picture ( snapshot ) of

the organization on a given day?
How well did the organization do during a given
period?

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 The Need for Accounting

Accountants answer these primary questions

with three major financial statements.
 Balance Sheet - financial picture (snapshot )
on a given day
 Income Statement - performance over a
given period
 Statement of Cash Flows - performance over
a given period

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 The Need for Accounting

Managers, investors, and other internal groups

want the answers to two important questions:

How well did

the organization
perform?
Where does
the organization
stand?

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 The Need for Accounting

Accountants answer these questions

with three major financial statements:

Income Balance
statement sheet

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 Who Uses Accounting Data

INTERNAL
USERS

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 Who Uses Accounting Data

EXTERNAL
USERS

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 Accounting as an Aid to
Decision Making
 Accounting information is useful to anyone who
makes decisions that have economic results.
• Managers want to know if a new product will
be profitable.
• Owners want to know which employees are
productive.
• Investors want to know if a company is a good
investment.
• Creditors want to know if they should extend
credit, how much to extend, and for how long.
• Government regulators want to know if
financial statements conform to requirements.
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 DO IT! 1 Basic Concepts

Indicate whether the following statements are true or false.

1. The three steps in the accounting process are identification,

recording, and communication.

2. Bookkeeping encompasses ( includes) all steps in the accounting

process.

3. Accountants prepare, but do not interpret, financial reports.

4. The two most common types of external users are investors and
company officers.

5. Managerial accounting activities focus on reports for internal

users.

Solution: 1. True 2. False 3. False 4. False 5. True

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 2 Explain the building blocks of accounting:
principles, and assumptions.
Generally Accepted Accounting Principles
Financial Statements
 Balance Sheet
Various users  Income Statement
need financial 

Statement of Owner's Equity
Statement of Cash Flows
information  Note Disclosure

The accounting profession

has developed standards Generally Accepted
that are generally accepted
Accounting Principles
(GAAP)
and universally practiced.

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 Measurement Principles

HISTORICAL COST PRINCIPLE (or cost principle) dictates

that companies record assets at their cost.

FAIR VALUE PRINCIPLE states that assets and liabilities

should be reported at fair value (the price received to sell an asset
or settle a liability).

Selection of which principle to follow

generally relates to trade-offs
between relevance and faithful
representation.

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 Assumptions

MONETARY UNIT ASSUMPTION requires that companies

include in the accounting records only transaction data that can be
expressed in terms of money.

ECONOMIC ENTITY ASSUMPTION requires that activities of

the entity be kept separate and distinct from the activities of its
owner and all other economic entities.

 Proprietorship
Forms of Business
 Partnership
Ownership
 Corporation

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 Forms of Business Ownership

Proprietorship Partnership Corporation

 Owned by one  Owned by two or  Ownership

person more persons divided into
Owner is often shares of stock
  Often retail and
manager/operator service-type  Separate legal
 Owner receives businesses entity organized
any profits, suffers under state
 Generally
any losses, and is corporation law
unlimited
personally liable personal liability  Limited liability
for all debts
 Partnership
agreement

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 Assumptions

Question
Combining the activities of Hyundai and General
Motors would violate the

a. cost principle.

b. economic entity assumption.

c. monetary unit assumption.

d. ethics principle.

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 Assumptions

Question
A business organized as a separate legal entity under
state law having ownership divided into shares of stock
is a

a. proprietorship.

b. partnership.

c. corporation.

d. sole proprietorship.

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 DO IT! 2 Building Blocks of Accounting

Indicate whether each of the following statements presented

below is true or false.

1. The historical cost principle dictates that

companies record assets at their cost. In
later periods, however, the fair value of the False
asset must be used if fair value is higher
than its cost.

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 DO IT! 2 Building Blocks of Accounting

Indicate whether each of the following statements presented

below is true or false.

2. A business owner’s personal expenses

must be separated from expenses of True
the business to comply with accounting’s
economic entity assumption.

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 State the accounting equation, and define
3
its components.

Assets = Liabilities + Owner's Equity

Basic Accounting Equation

 Provides the underlying framework for recording and
summarizing economic events.

 Assets are claimed by either creditors or owners.

 If a business is liquidated, claims of creditors must be paid

before ownership claims.

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 Basic Accounting Equation

Assets = Liabilities + Owner's Equity

Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Supplies, Equipment, etc.

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 Basic Accounting Equation

Assets = Liabilities + Owner's Equity

Liabilities
 Claims against assets (debts and obligations).

 Creditors (party to whom money is owed).

 Accounts Payable, Notes Payable, Salaries and Wages

Payable, etc.

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 Basic Accounting Equation

Assets = Liabilities + Owner's Equity

Owner's Equity
 Ownership claim on total assets.

 Referred to as residual equity.

 (+) Investment by owners and revenues
 (-) Drawings and expenses.

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 Owner’s Equity Illustration 1-6
Expanded accounting
equation

Increases in Owner’s Equity

 Investments by owner are the assets the owner puts into the
business.

 Revenues result from business activities entered into for the

purpose of earning income.

► Common sources of revenue are: sales, fees, services,

commissions, interest, dividends, royalties, and rent.

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 Owner’s Equity Illustration 1-6
Expanded accounting
equation

Decreases in Owner’s Equity

 Drawings An owner may withdraw cash or other assets for
personal use.

 Expenses are the cost of assets consumed or services used in

the process of earning revenue.

► Common expenses are: salaries expense, rent expense,

utilities expense, tax expense, etc.

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 DO IT! 3 Owner's Equity Effects

Classify the following items as investment by owner, owner’s

drawings, revenue, or expenses. Then indicate whether each
item increases or decreases owner’s equity.

Classification Effect on Equity

1. Rent Expense Expense Decrease

2. Service Revenue Revenue Increase

3. Drawings Drawings Decrease

4. Salaries and Wages

Expense Decrease
Expense
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 DO IT! 3 Owner's Equity Effects

Classify the following items as investment by owner, owner’s

drawings, revenue, or expenses. Then indicate whether each
item increases or decreases owner’s equity.

Classification Effect on Equity

1. Rent Expense Expense

Expenses Decrease
decreases
2. Service Revenue Revenue
Revenue Increase
increases
3. Drawings Drawings
Owner’s Drawings Decrease
decreases
4. Salaries and Wages
Expense
Expenses Decrease
decreases
Expense
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