Accounting FundamentalsAccounting Fundamentals
Dr. Yan XiongDr. Yan XiongDepartment of AccountancyDepartment of Accountancy
CSU SacramentoCSU SacramentoThe lecture notes are primarily based on Reimers The lecture notes are primarily based on Reimers
(2003).(2003). 7/11/037/11/03
Chapter 2: Quality of Accounting InfoChapter 2: Quality of Accounting Info
AgendaAgenda Objectives of accounting informationObjectives of accounting information Elements of financial statementsElements of financial statements Recognition and measurement in Recognition and measurement in
financial statementsfinancial statements
AgendaAgenda Objectives of Accounting InformationObjectives of Accounting Information
Securities and Exchange Commission has Securities and Exchange Commission has the legal authority to set the accounting the legal authority to set the accounting rules for companies that are publicly rules for companies that are publicly traded.traded.
The SEC has delegated that responsibility The SEC has delegated that responsibility to the accounting profession.to the accounting profession.
Currently, the Financial Accounting Currently, the Financial Accounting Standards Board is the standards-setting Standards Board is the standards-setting body.body.
Who Sets the Rules?Who Sets the Rules?
GAAP (not a clothes store)GAAP (not a clothes store) Generally Accepted Accounting Generally Accepted Accounting
Principles (GAAP) are the rules Principles (GAAP) are the rules that most companies follow in that most companies follow in preparing their financial reports.preparing their financial reports.
GAAP are not exact rules: GAAP are not exact rules: professional judgment is needed.professional judgment is needed.
Statements of Financial Statements of Financial Accounting Concepts provide the Accounting Concepts provide the basis and guidance for basis and guidance for establishing accounting standards.establishing accounting standards.
GAAPGAAP
Objectives Objectives QualitiesQualities To provide useful information for decision-To provide useful information for decision-
making.making. Relevant:Relevant:
specific to a business entityspecific to a business entity,, timelytimely, , simplified and condensedsimplified and condensed,, focus on earningsfocus on earnings, , all within a cost-benefit all within a cost-benefit
framework.framework.
Objectives Objectives Qualities Qualities
To provide useful information for To provide useful information for decision-making.decision-making. ReliableReliable::
representational faithfulnessrepresentational faithfulnessverifiableverifiableunbiasedunbiased
Objectives Objectives Qualities Qualities
To provide useful information for decision-To provide useful information for decision-making.making. ComparableComparable: :
from year to year for one from year to year for one companycompany,,
across companies for a single across companies for a single yearyear, ,
to industry averages,to industry averages,estimates.estimates.
Objectives Objectives Qualities Qualities
To provide useful information for decision-To provide useful information for decision-making.making. ConsistentConsistent::
same rules used each timesame rules used each time
Additional Concepts/ConstraintsAdditional Concepts/Constraints
Cost/benefitCost/benefit MaterialityMateriality Full disclosureFull disclosure
AgendaAgenda Elements of Financial StatementsElements of Financial Statements
Elements of Financial StatementsElements of Financial Statements
AssetsAssets LiabilitiesLiabilities EquityEquity RevenueRevenue ExpensesExpenses
Elements of Financial StatementsElements of Financial Statements
Next to each item, indicate whether it is an AAsset, LLiability, EEquity, RRevenue or EExpense.
_____ Cash
_____ Common Stock ($1 par)
_____ Depreciation Expense
_____ Insurance Expense
_____ Interest Receivable
_____ Interest Earned
_____ Investment in U.S. Bonds
Elements of Financial StatementsElements of Financial Statements
_____ Cash Asset
_____ Common Stock ($1 par) Equity
_____ Depreciation Expense Expense
_____ Insurance Expense Expense
_____ Interest Receivable Asset
_____ Interest Earned Revenue
_____ Investment in U.S. Bonds Asset
More elements of financial statementsMore elements of financial statements_____ Miscellaneous Expense
_____ Prepaid Insurance
_____ Rent Revenue
_____ Retained Earnings
_____ Salaries Expense
_____ Salaries Payable
_____ Service Revenue
_____ Supplies Used
_____ Unearned Rent
More elements of financial statementsMore elements of financial statements_____ Miscellaneous Expense Expense
_____ Prepaid Insurance Asset
_____ Rent Revenue Revenue
_____ Retained Earnings Equity
_____ Salaries Expense Expense
_____ Salaries Payable Liability
_____ Service Revenue Revenue
_____ Supplies Used Expense
_____ Unearned Rent Liability
AgendaAgenda Recognition and measurement in Recognition and measurement in
financial statementsfinancial statements
Transactions are measured and recorded Transactions are measured and recorded at COST.at COST.
Revenue is recognized--included on the Revenue is recognized--included on the income statement--when it is EARNED.income statement--when it is EARNED.
Expenses are recognized in the period in Expenses are recognized in the period in which the related revenue is recognized: which the related revenue is recognized: MATCHING CONCEPT.MATCHING CONCEPT.
This is ACCRUAL ACCOUNTING.This is ACCRUAL ACCOUNTING.
Recognition and Measurement in Recognition and Measurement in Financial StatementsFinancial Statements
Accruals and DeferralsAccruals and Deferrals ACCRUALS:ACCRUALS:
Action first, dollars Action first, dollars laterlater
E.g., services are E.g., services are performed, payment performed, payment to be received laterto be received later
DEFERRALS:DEFERRALS: Dollars first, action Dollars first, action
laterlater E.g., payment is E.g., payment is
made in advance for made in advance for insurance or rent, insurance or rent, the action of using it the action of using it comes latercomes later
Both types of transactions and adjustments Both types of transactions and adjustments are part of ACCRUAL ACCOUNTING.are part of ACCRUAL ACCOUNTING.
Tom’s Wear: February 2001Tom’s Wear: February 2001 Let’s look at each of the transactions Let’s look at each of the transactions
that took place during February, that took place during February, Tom’s second month of business.Tom’s second month of business.
We’ll show how each affects the We’ll show how each affects the accounting equations, and then we’ll accounting equations, and then we’ll prepare the four basic financial prepare the four basic financial statements.statements.
Acquisition of Inventory Acquisition of Inventory DateDate
February February 11
TransactionsTransactions Tom’s Wear purchases 200 Tom’s Wear purchases 200
T-shirts at $4 each on T-shirts at $4 each on account. account. Assets = Liabilities + CC + RE
$800 inventory $800 A/P
Acquisition of a ServiceAcquisition of a ServiceDateDate
FebruaryFebruary55
TransactionsTransactions Tom’s Wear hires a Tom’s Wear hires a
company to advertise his company to advertise his business for $150--$100 business for $150--$100 cash and $50 on account. cash and $50 on account.
Assets = Liabilities + CC + RE
(100) cash 50 other payables (150) expenses
Sales and Collection CycleSales and Collection CycleDateDate
February 14February 14TransactionsTransactions
Tom’s Wear pays for 3 Tom’s Wear pays for 3 month’s worth of insurance month’s worth of insurance for $150. for $150.
Assets = Liabilities + CC + RE
+ 150 prepaid insurance (150) cash
Sales and Collection CycleSales and Collection CycleDateDate
February 20February 20TransactionsTransactions
Tom’s Wear sells 185 T-Tom’s Wear sells 185 T-shirts for $10 each. 170 shirts for $10 each. 170 shirts were cash sales and shirts were cash sales and the other sales were on the other sales were on account.account. Assets = Liabilities + CC + RE
+1,700 cash
+1,850 sales
+ 150 A/R
Sales and Collection CycleSales and Collection CycleDateDate
February 20February 20
TransactionsTransactions Tom’s Wear sells 185 T-shirts Tom’s Wear sells 185 T-shirts
for $10 each. 170 shirts were for $10 each. 170 shirts were cash sales and the other sales cash sales and the other sales were on account.were on account. Assets = Liabilities + CC + RE
+1,700 cash
+1,850 sales
+ 150 A/R
(740) inventory (740) cost of goods sold
Note: Recall that the cost of shirts was $4 each.
Acquisition/Payment CycleAcquisition/Payment CycleDateDate
February 28February 28TransactionsTransactions
Tom’s Wear pays dividends Tom’s Wear pays dividends of $100.of $100.
Assets = Liabilities + CC + RE
(100) cash (100) dividends
Adjustment for Year-end Adjustment for Year-end Financial Statements Financial Statements
DateDate February 28February 28
Prepaid insurance that has Prepaid insurance that has been used needs to be been used needs to be recorded as an expense. recorded as an expense. Only the unused portion Only the unused portion remains on the balance remains on the balance sheet as an asset. sheet as an asset. Assets = Liabilities + CC + RE
(25) prepaid insurance (25) insurance expense
Tom’s Wear, Inc.Tom’s Wear, Inc.Income StatementIncome Statement
For the month ended February 28, 2001For the month ended February 28, 2001RevenueRevenue
SalesSales $1,850$1,850ExpensesExpenses
Cost of salesCost of sales $ 740 $ 740Other expensesOther expenses 175 175 915915
Net incomeNet income $ 935$ 935
Tom’s Wear, Inc.Tom’s Wear, Inc.Statement of Changes in Statement of Changes in
Shareholder’s EquityShareholder’s EquityFor the month ending 2/28/01For the month ending 2/28/01
Beginning contributed capitalBeginning contributed capital $5,000$5,000
Contributions during the yearContributions during the year -0- -0-Ending contributed capitalEnding contributed capital 5,0005,000Beginning retained earning $ 385Beginning retained earning $ 385Net Income for the yearNet Income for the year 935 935 Dividends Dividends (100)(100)Ending Retained earningEnding Retained earning
$1,220$1,220Total shareholder’s equityTotal shareholder’s equity $6,220$6,220
Tom’s WearTom’s WearBalance SheetBalance SheetAs of 2/28/01As of 2/28/01
AssetsAssets Liabilities + Shareholder’s EquityLiabilities + Shareholder’s Equity
CashCash $6,695$6,695 Accounts payableAccounts payable 800800
A/R 150A/R 150 Other Payables Other Payables 5050
InventoryInventory $ 100$ 100 Common stock, Common stock, T. PhillipsT. Phillips $5,000 $5,000 Prepaid Ins 125Prepaid Ins 125 Retained earningsRetained earnings
12201220
Total assetsTotal assets $ 7,070 Total liabilities + SH’s Equity$ 7,070 Total liabilities + SH’s Equity $ $ 7,0707,070
Tom’s Wear, Inc.Tom’s Wear, Inc.Statement of Cash FlowsStatement of Cash Flows
For the month ended 2/28/01For the month ended 2/28/01Cash from operating activitiesCash from operating activities
Cash from customersCash from customers $ 1700$ 1700Cash paid for advertisingCash paid for advertising (100) (100)Cash paid for insuranceCash paid for insurance (150) (150)
Total cash from operationsTotal cash from operations $1450$1450
Cash from investing activitiesCash from investing activities -0- -0-Cash from financing activitiesCash from financing activities
DividendsDividends (100) (100)
Total Cash from FinancingTotal Cash from Financing (100)(100)
Net Increase in CashNet Increase in Cash $ 1350 $ 1350Cash, Beginning Balance Cash, Beginning Balance 53455345Cash, ending BalanceCash, ending Balance 6,6956,695