1

Chapter 1Accounting as a Form of

Communication

Financial Accounting 4e by Porter and Norton

2

Decisions Made with Financial Information

Invest??

Borrow $$??

Sell stocks or bonds??

Build new plant??

Add new product line??

Start new business??

Loan $$??Extend credit $$??

3

What is Accounting?

Identifying

Measuring

Communicating

EconomicInformation

to various

users

4

Internal and ExternalUsers of Accounting Information

Internal Users -

Management

CreditorsCurrentand

PotentialOwners

GovernmentAgencies

SuppliersTrade

Organizations

FinancialAnalysts

Banks

5

The Accounting Equation

Basic Accounting Equation

Economic Sources of financing . . .resources Liabilities: from creditors

Equity: from stockholders.=

Assets = Liabilities + Stockholders’ Equity

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The Accounting Equation

Assets = Liabilities + Owners’ Equity (or Stockholders'

Equity)Creditors'

Claimsto Assets

Owners'Claims

to Assets

EconomicResources = +

Examples:CashAccounts receivableInventory

Accounts payableNotes payable

Capital stockRetained earnings

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The Balance Sheet

Body of the Statement– AssetsAssets

Economic benefits owned by the business as a result of past transactions.

– LiabilitiesLiabilities Debts or obligations of the business that result from past transactions.

Stockholders’ EquityStockholders’ Equity Amount of financing provided by owners of the business and

operations.

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MAXIDRIVE CORP.Balance Sheet

At December 31, 2014(in thousands of dollars)

AssetsCash 4,895$ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261$

Liabilities and Stockholders' EquityLiabilities

Accounts payable 7,156$ Notes payable 9,000 Total liabilities 16,156$

Stockholders' EquityContributed capital 2,000$ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261$

1. Name of entity2. Title of statement3. Specific date4. Unit of measure

The Balance Sheet

reports the financial

position of an entity at a particular

point in time.

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MAXIDRIVE CORP.Balance Sheet

At December 31, 2014(in thousands of dollars)

AssetsCash 4,895$ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261$

Liabilities and Stockholders' EquityLiabilities

Accounts payable 7,156$ Notes payable 9,000 Total liabilities 16,156$

Stockholders' EquityContributed capital 2,000$ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261$

Assets are listed by their

ease ofconversion into

cash.

Cash Amount of cash in the company’s bank accounts.

Accounts receivable

Amounts owed by customers from prior sales.

Inventories Parts and completed but unsold products.

Plant and equipment Factories and production machinery.

Land Land on which factories are built.

Assets are economic resources

owned by the business as a result of past transactions.

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MAXIDRIVE CORP.Balance Sheet

At December 31, 2014(In thousands of dollars)

AssetsCash 4,895$ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261$

Liabilities and Stockholders' EquityLiabilities

Accounts payable 7,156$ Notes payable 9,000 Total liabilities 16,156$

Stockholders' EquityContributed capital 2,000$ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261$

Assets are listed by their

ease ofconversion into

cash.

Cash Amount of cash in the company’s bank account.

Accounts receivable

Amounts owed by customers from prior sales.

Inventories Partial and completed but unsold product.

Plant and equipment Factories and production machinery.

Land Property on which factories are located.

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MAXIDRIVE CORP.Balance Sheet

At December 31, 2014(in thousands of dollars)

AssetsCash 4,895$ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261$

Liabilities and Stockholders' EquityLiabilities

Accounts payable 7,156$ Notes payable 9,000 Total liabilities 16,156$

Stockholders' EquityContributed capital 2,000$ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261$

Liabilities are debts or

obligations of the business

that result from past

transactions.

Accounts payable

Amounts owed to suppliers for prior purchases.

Notes payable

Amounts owed on written debt contracts.

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MAXIDRIVE CORP.Balance Sheet

At December 31, 2014(In thousands of dollars)

AssetsCash 4,895$ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261$

Liabilities and Stockholders' EquityLiabilities

Accounts payable 7,156$ Notes payable 9,000 Total liabilities 16,156$

Stockholders' EquityContributed capital 2,000$ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261$

Accounts payable

Amounts owed to suppliers for prior purchases.

Notes payable

Amounts owed on written debt contracts.

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MAXIDRIVE CORP.Balance Sheet

At December 31, 2014(in thousands of dollars)

AssetsCash 4,895$ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261$

Liabilities and Stockholders' EquityLiabilities

Accounts payable 7,156$ Notes payable 9,000 Total liabilities 16,156$

Stockholders' EquityContributed capital 2,000$ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261$

Contributed capital

Amounts invested in the business by stockholders.

Retained earnings

Past earnings not distributed to stockholders.

Equity is the amount of financing

provided by owners of the business and

earnings.

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MAXIDRIVE CORP.Balance Sheet

At December 31, 2014(In thousands of dollars)

AssetsCash 4,895$ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261$

Liabilities and Stockholders' EquityLiabilities

Accounts payable 7,156$ Notes payable 9,000 Total liabilities 16,156$

Stockholders' EquityContributed capital 2,000$ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261$

Contributed capital

Amounts invested in the business by stockholders.

Retained earnings

Past earnings not distributed to stockholders.

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MAXIDRIVE CORP.Balance Sheet

At December 31, 2014(In thousands of dollars)

AssetsCash 4,895$ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261$

Liabilities and Stockholders' EquityLiabilities

Accounts payable 7,156$ Notes payable 9,000 Total liabilities 16,156$

Stockholders' EquityContributed capital 2,000$ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261$

Use $ on the first item in a

groupand on the group total.

Assets = Liabilities + Stockholders’ Equity

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1. Name of entity2. Title of statement 3. Specific date (Unlike the balance sheet, this statement covers a specified period of time.)4. Unit of measure

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Revenues are earnings from the sale of goods or services to customers.

Revenue is recognized in the period in whichgoods and services are sold, not necessarily

the period in which cash is received.

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Expenses are the dollar amount of resources usedup by the entity to earn revenues during a period.

An expense is recognized in the period in whichgoods and services are used, not necessarily

the period in which cash is paid.

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If expenses exceed revenues,we report net loss.

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MAXIDRIVE CORP.Statement of Retained Earnings

For the Year Ended December 31, 2014(In thousands of dollars)

Retained earnings, January 1, 2014 6,805$ Net income for 2014 3,300 Dividends for 2014 (1,000) Retained earnings, December 31, 2014 9,105$

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MAXIDRIVE CORP.Statement of Retained Earnings

For the Year Ended December 31, 2014(in thousands of dollars)

Retained earnings, January 1, 2014 6,805$ Net income for 2014 3,300 Dividends for 2014 (1,000) Retained earnings, December 31, 2014 9,105$

1. Name of entity2. Title of statement 3. Specific date (Like the income statement, this statement covers a specified period of time.)4. Unit of measure

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MAXIDRIVE CORP.Statement of Retained Earnings

For the Year Ended December 31, 2014(in thousands of dollars)

Retained earnings, January 1, 2014 6,805$ Net income for 2014 3,300 Dividends for 2014 (1,000) Retained earnings, December 31, 2014 9,105$

The Statement of Retained Earnings reports the way that net income and the distribution of dividends affect the financial position of the company during a period.

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MAXIDRIVE CORP.Statement of Cash Flows

For the Year Ended December 31, 2014(In thousands of dollars)

Cash flows from operating activities: Cash collected from customers 33,563$ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069$ Cash flow from investing activities: Cash paid to purchase equipment (1,625)$ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400$ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156)$ Cash at beginning of the year 5,051 Cash at end of the year 4,895$

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MAXIDRIVE CORP.Statement of Cash Flows

For the Year Ended December 31, 2014(in thousands of dollars)

Cash flows from operating activities: Cash collected from customers 33,563$ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069$ Cash flow from investing activities: Cash paid to purchase equipment (1,625)$ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400$ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156)$ Cash at beginning of the year 5,051 Cash at end of the year 4,895$

1. Name of entity2. Title of statement 3. Specific date (Like the income statement and statement of retained earnings, this statement covers a specified period of time.)4. Unit of measure

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MAXIDRIVE CORP.Statement of Cash Flows

For the Year Ended December 31, 2014(in thousands of dollars)

Cash flows from operating activities: Cash collected from customers 33,563$ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069$ Cash flow from investing activities: Cash paid to purchase equipment (1,625)$ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400$ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156)$ Cash at beginning of the year 5,051 Cash at end of the year 4,895$

The Statement of Cash Flows reports the inflows and outflows of cash during the period in the

categories of operating, investing, and financing.

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MAXIDRIVE CORP.Statement of Cash Flows

For the Year Ended December 31, 2014(in thousands of dollars)

Cash flows from operating activities: Cash collected from customers 33,563$ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069$ Cash flow from investing activities: Cash paid to purchase equipment (1,625)$ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400$ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156)$ Cash at beginning of the year 5,051 Cash at end of the year 4,895$

The statement ends with a reconciliation of Cash.

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Relationship Among the Financial Statements

MAXIDRIVE CORP.Statement of Retained Earnings

For the Year Ended December 31, 2014(in thousands of dollars)

Retained earnings, January 1, 2014 6,805$ Net income for 2014 3,300 Dividends for 2014 (1,000) Retained earnings, December 31, 2014 9,105$

Net income from the income statement increases ending

retained earnings on the statement of retained

earnings.

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Relationship Among the Financial Statements

MAXIDRIVE CORP.Statement of Retained Earnings

For the Year Ended December 31, 2014(in thousands of dollars)

Retained earnings, January 1, 2014 6,805$ Net income for 2014 3,300 Dividends for 2014 (1,000) Retained earnings, December 31, 2014 9,105$

Ending retained earnings from the statement of

retained earnings is one of the components of

stockholders’ equity on the balance sheet.

MAXIDRIVE CORP.Balance Sheet

At December 31, 2014(in thousands of dollars)

AssetsCash 4,895$ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261$

Liabilities and Stockholders' EquityLiabilities

Accounts payable 7,156$ Notes payable 9,000 Total liabilities 16,156$

Stockholders' EquityContributed capital 2,000$ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261$

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Relationship Among the Financial Statements

The change in cash on the statement of cash flows added to the beginning of the year balance in cash equals the ending

balance in cash on the balance sheet.

MAXIDRIVE CORP.Balance Sheet

At December 31, 2014(in thousands of dollars)

AssetsCash 4,895$ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261$

Liabilities and Stockholders' EquityLiabilities

Accounts payable 7,156$ Notes payable 9,000 Total liabilities 16,156$

Stockholders' EquityContributed capital 2,000$ Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity 27,261$

MAXIDRIVE CORP.Statement of Cash Flows

For the Year Ended December 31, 2014(in thousands of dollars)

Cash flows from operating activities: Cash collected from customers 33,563$ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069$ Cash flow from investing activities: Cash paid to purchase equipment (1,625)$ Net cash flow from investing activities (1,625) Cash flow from financing activities: Cash received from bank loan 1,400$ Cash paid for dividends (1,000) Net cash flow from financing activities 400 Net decrease in cash during the year (156)$ Cash at beginning of the year 5,051 Cash at end of the year 4,895$

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The Rules of the Game

GAAP

FASB

SEC

AICPA

The rulesThe rule makersThe rule enforcersThe CPA regulators

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Financial Statement Assumptions

EconomicEntity

CostPrinciple

GoingConcern

MonetaryUnit

TimePeriod

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Economic Entity Concept

Each entity has its own books, records and financial statements that are separate from owners

No intermingling of personal and business assets and liabilities or income and expenses

BusinessBooks &Records

Owners’Books &Records

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Cost Principle

Record assets at cost paid to acquire them

Continue to value assets at historical cost until sold

More objective than market value

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Going Concern

Assume business will continue indefinitely into the foreseeable future

Justifies use of historical cost

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Monetary Unit

How we measure (e.g. U.S. dollar, Japanese yen, Mexican peso, etc.)

Assumes economic measure is relatively stable; no adjustment for inflation made in financial statements

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Time Period Assumption Assumes it is possible to break up an

entity’s earnings in discrete time periods (a month, quarter, year)

Necessary to provide users with financial results on a timely basis

Requires use of estimates 1 2 3

4 5 6 7 8 9 10

11 12 13 14 15 16 17

18 19 20 21 22 23 24

25 26 28 29 30 3127

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Where Accountants Work Private Business Nonprofit Organizations Public Accounting

– audit– tax– management consulting

Educational Institutions

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End of Chapter 1