Basic Concepts of Accounting and Financial Reporting Chapter

Learning Objective 1 Describe the objectives of accounting and useful accounting information. © 2005

Accounting Objectives Accounting data The raw results of economic transactions and events. Information Data that are put into some useful form for decision making. Accounting information The product of accountant’s organization, classification, and summarization of economic transactions and events. © 2005 Accounting 1/e, Terrell/Terrell 2 -3

Learning Objective 2 Define the qualitative characteristics of accounting information and determine the effect

Conceptual Framework of Accounting Objectives: To provide stakeholders with information 1. Useful for credit and investment decisions 2. To assess future cash flows 3. About enterprise resources, claims to resources, and changes in each over time. © 2005 Accounting 1/e, Terrell/Terrell 2 -5

Qualitative Characteristics of Accounting Information Primary characteristics Secondary characteristics © 2005 Accounting 1/e, Terrell/Terrell

Qualitative Characteristics of Accounting Information Relevance Timeliness Predictive value Feedback value © 2005 Accounting

Qualitative Characteristics of Accounting Information Reliability is a characteristic of useful accounting that requires the information to be reasonably unbiased and accurate. Verifiability Representational faithfulness © 2005 Accounting 1/e, Terrell/Terrell Neutrality 2 -8

Qualitative Characteristics of Accounting Information Comparability is the quality of information that allows users to identify similarities in and differences between two sets of accounting information. Consistency means conformity from period to period with accounting policies and procedures. © 2005 Accounting 1/e, Terrell/Terrell 2 -9

Learning Objective 3 Define the elements of accounting and construct the accounting equation. ©

Accounting Elements Accountants use an accounting system to transform accounting data into useful accounting information Accounting data Useful accounting information © 2005 Accounting 1/e, Terrell/Terrell 2 - 11

The Balance Sheet Assets Liabilities Equity Investments by owners Earned equity © 2005 Accounting

The Accounting Equation © 2005 Accounting 1/e, Terrell/Terrell 2 - 13

Learning Objective 4 Recognize a balance sheet, income statement, statement of equity, and statement of cash flows and determine which accounting elements comprise each statement. © 2005 Accounting 1/e, Terrell/Terrell 2 - 14

Basic Financial Statements Statement of Cash Flows Statement of Equity Income Statement Balance Sheet

Balance Sheet for a Corporation Jason’s Furniture Gallery, Inc. Balance Sheet December 31, 2004 Assets Cash $ 29, 000 Investments 75, 000 Inventory 200, 000 Land 80, 000 Building 300, 000 Equipment 60, 000 Total assets $744, 000 Liabilities Accounts payable Mortgage payable Total liabilities $100, 000 200, 000 Stockholders’ equity Common stock $200, 000 Retained earnings 244, 000 Total stockholders’ equity Total liabilities and stockholders’ equity © 2005 Accounting 1/e, Terrell/Terrell $300, 000 444, 000 $744, 000 2 - 16

The Income Statement Revenues are increases in net assets (equity) that occur as a result of an entity’s selling or producing products and performing services for its customers. Expenses are sacrifices of the future value of assets used to generate revenues from customers. © 2005 Accounting 1/e, Terrell/Terrell 2 - 17

The Income Statement Gains are increases in net assets (equity) that result from incidental or other peripheral events that affect the entity. Losses are decreases in net assets (equity) that result from incidental or other peripheral events that affect the entity. © 2005 Accounting 1/e, Terrell/Terrell 2 - 18

Income Statement for a Corporation Jason’s Furniture Gallery, Income Statement For the Year Ended December 31, 2004 Sales revenues Cost of goods sold Gross profit Operating expenses Selling expenses Administrative expenses Total operating expenses Operating income Other revenues and expenses Gain on the sale of equipment Loss on investments sold Income before taxes Income taxes Net income © 2005 Accounting 1/e, Terrell/Terrell $455, 000 245, 000 $210, 000 $105, 000 60, 000 $ 25, 000 (8, 000) 165, 000 $ 45, 000 17, 000 $ 62, 000 21, 000 $ 41, 000 2 - 19

Statement of Stockholders’ Equity Investments by owners Comprehensive income Distributions to owners © 2005 Accounting 1/e, Terrell/Terrell • Revenues • Gains • Expenses • Losses • Other comprehensive income 2 - 20

Statement of Stockholders’ Equity Jason’s Furniture Gallery, Inc. Statement of Stockholders’ Equity For the Year Ended December 31, 2004 Total stockholders’ equity Common stock Retained earnings Balance, January 1, 2004 Stock issued Net income Dividend distributions $150, 000 – – $233, 000 41, 000 30, 000 $383, 000 50, 000 41, 000 30, 000 Balance, Dec. 31, 2004 $200, 000 $244, 000 $444, 000 © 2005 Accounting 1/e, Terrell/Terrell 2 - 21

Statement of Cash Flows Jason’s Furniture Gallery, Inc. Statement of Cash Flows For the Year Ended December 31, 2004 Operating activities: Cash received from customers Cash paid for: Merchandise Operating expenses Income taxes Cash provided by operating activities Investing activities: Purchase of equipment Purchase of building Cash used by investing activities © 2005 Accounting 1/e, Terrell/Terrell $ 455, 000 $160, 000 150, 000 21, 000 $( 35, 000) (300, 000) 331, 000 $ 124, 000 $(335, 000) 2 - 22

Statement of Cash Flows Jason’s Furniture Gallery, Inc. Statement of Cash Flows For the Year Ended December 31, 2004 Financing activities: Sale of common stock Proceeds of mortgage on building Dividends paid Cash provided by financing activities Net change in cash Cash balance, January 1, 2004 Cash balance, December 31, 2004 © 2005 Accounting 1/e, Terrell/Terrell $ 50, 000 200, 000 (30, 000) $220, 000 $ 9, 000 20, 000 $ 29, 000 2 - 23

Articulation The four financial statements are intertwined. The linkage between then is known as

Articulation Net income is the same on both the income statement and the statement of equity. The equity balance on the statement of equity agrees with the balance sheet. The cash balance on the balance sheet agrees with the ending cash amount on the cash flow statement. © 2005 Accounting 1/e, Terrell/Terrell 2 - 25

Learning Objective 5 Name the underlying assumptions of accounting and describe how they affect

Assumptions Separate entity Going concern Monetary unit Periodicity © 2005 Accounting 1/e, Terrell/Terrell 2

Learning Objective 6 Define the underlying principles of accounting and determine the appropriate application

Principles Historical cost Revenue recognition Matching principle Full disclosure © 2005 Accounting 1/e, Terrell/Terrell

Learning Objective 7 Identify the underlying constraints of accounting and describe how they affect

Constraints Materiality Cost-benefit relationship Conservatism Industry practices © 2005 Accounting 1/e, Terrell/Terrell 2 -

Conceptual Framework of Accounting Summary Objectives Qualitative characteristics of accounting information Assumptions © 2005 Accounting 1/e, Terrell/Terrell Accounting elements Principles Constraints 2 - 32