May 15, 2006 Monday
Chapter 1: The Financial Statements
1. Use accounting vocabulary for decision making
2. Apply accounting concepts and principles
3. Use the accounting equation to describe an organization
4. Evaluate operating performance, financial position and cash flows 5. Explain the relationships among the financial statements
Use of Accounting Information
1. Accounting helps manager‟s measure revenue, expenses and profits.
2. Accounting measures the cost of the investment.
3. Accounting measures the cost of obtaining funds or financing operations. B. Investors - the financial statements (accounting information) provide the information one
needs to help make informed investment decisions
Use accounting vocabulary for decision making
A. What is Accounting? - It is an information system that measures, processes and
communicates financial information about an economic entity to interested persons by means
of financial statements. Accounting is both:
1. the language of business
2. an information System
B. Who uses Accounting Information?
2. Business Managers
5. Government regulatory agencies
7. Non-profit organizations
8. Employees, labor unions, etc.
C. Two general accounting categories
1. Financial Accounting - provides information to external users
2. Managerial Accounting - provides information for internal use by management D. Types of business organizations
1. Proprietorship - one owner with unlimited liability
2. Partnership - two or more owners with unlimited liability
3. Corporation - owned by shareholders with limited liability; ownership evidenced by
number of shares of stock held; run by the board of directors who are elected by the
stockholders; legally separate from its owners (stockholders) so it can enter into
contracts, sue and be sued and own buy and sell property.
ACG 2021 - Principles of Financial Accounting | Page 1 of 8
Sherlock Notes Inc. ? May 21, 2006 | Veit Exam 1 | Summer „06
Apply accounting concepts and principles
A. How do accountants measure, process and communicate financial information? They
use guidelines or GAAP (Generally Accepted Accounting Principles) - guidelines that
have developed over time that govern how accountants measure, process and communicate
1. Primary objective - provide information that is useful for making investment and
lending decisions - information that is relevant, reliable and comparable.
2. Three organizations involved in GAAP:
a. FASB (Financial Accounting Standards Board)
b. SEC (Securities and Exchange Commission)
c. AICPA (American Institute of Certified Public Accountants)
B. Principles and Concepts discussed in Chapter 1:
1. The entity concept - each business is an economic unit kept separate from other
2. The reliability (objectivity) principle - actual costs are usually more reliable than
market value, therefore records should be based on actual costs.
3. The cost principle - actual costs should be used when recording assets and services.
4. The going concern principle - assumes that the business will remain in operation
5. The stable-monetary-unit concept - ignores the effects of inflation on the accounting
records (assumes that the dollar is stable).
Example: Suppose you purchased land on Jan 1 for $100,000. You had to borrow $100,000 from the bank to pay for the land. The bank appraised the land at $105,000 and charged you 10% interest for 2 years. During the same year you receive an offer for the land for $110,000 but you
do not want to sell the land. At what value will you report the land on the balance sheet? (Answer:
May 16, 2006 Tuesday
Chapter 1: The Financial Statements, cont.
Use the accounting equation to describe an organization
A. The accounting equation: - basic tool for compiling the financial statements
Assets = Liabilities + Owners’ Equity
B. What do these terms mean?
1. Assets - economic resources owned by the business that are anticipated to profit
future operations. What the business owns to make money. For example: buildings,
land, and inventory.
2. Liabilities - debts of the business payable to outsiders (creditors). The most
common form of liability is debts payable (owed).
3. Owners’ Equity - owners‟ residual claim to the assets (Assets - Liabilities)
a. Proprietorships and partnerships - owners‟ equity = Capital
b. Corporations - stockholders’ equity = two main categories:
ACG 2021 - Principles of Financial Accounting | Page 2 of 8
Sherlock Notes Inc. ? May 21, 2006 | Veit Exam 1 | Summer „06
1. Paid-in or contributed capital - amount invested in the corporation by
its owners (stockholders). This is how owners of a corporation get money
into a business.
2. Retained earnings - income or profit (revenue - expenses) that has
been reinvested in the company.
a. Revenue - amounts earned by the business by delivering goods
or services (increase net income (NI) and retained earnings
(RE)). Basically, what is earned in course of doing regular
b. Expenses - costs of operating a business (decrease NI and RE)
c. Net loss - expenses>revenues (decrease RE) – spending more
than you make.
d. Dividends - distributions of assets to the stockholders
(decrease RE). This is not paid to sole proprietorships, as they
have no stock.
Evaluate a company’s operating performance, financial position, and cash flows
A. Income Statement - provides information as to how well the company performed or operated during the period by summarizing revenues, expenses and net income or loss for the
B. Statement of Retained Earnings - reports the portion of net income that has been kept in the business and reports the changes in retained earnings during the period. (Exhibit 1-8) 1. The income reported on the income statement is added to the beginning balance of
2. The board of directors decides whether to retain income for use in the business or to pay
dividends. If they decide to pay dividends, the amount of the dividends is deducted on the
statement of retained earnings.
3. RE = Beg RE + NI - Div
C. Balance Sheet – “How much cash do we have today?” Reports the company‟s financial position at a particular date based on the balance sheet equation:
assets = liabilities + owners’ equity
1. Assets - economic resources
a. Current Assets - assets the company expects to convert to cash, sell or
consume within the operating cycle or year whichever is longer (cash,
receivables ,inventory and prepaid expenses)
b. Long-term Assets - assets the company expects to use for more than a year
(property, plant, and equipment). These assets are partially used or depreciated.
c. Intangible and other assets
a. Intangible assets have no physical form (patents, trademarks, goodwill)
b. Other assets are assets that do not “fit” anywhere else on the balance sheet
2. Liabilities - debts
a. Current Liabilities - debts due in one year or the operating cycle whichever is
longer (accounts payable, accrued expenses payable, short-term notes payable,
b. Long-term Liabilities - debts that are due in the long-term (mortgages, bonds
3. Owners’ or Stockholders’ Equity - residual claim on the assets (contributed capital