Importance of Accounting Exhibit

1.1

Accounting is an information and measurement system that identifies,

records, and communicates an organization’s business activities.

© Mcraw-Hill LLC 1-1

Learning Objective C1: Explain the importance of accounting and identify its users.
 Users of Accounting Information
Accounting is called the language of business because it communicates
data that help people make better decisions. People using accounting
information are divided into two groups: external users and internal users.

• Shareholders • Purchasing managers

• Lenders • Human resource managers
• External auditors • Production managers
• Nonmanagerial employees • Research and development managers
• Regulators • Marketing managers
© McGraw-Hill LLC 1-2
Learning Objective C1: Explain the importance of accounting and identify its users.
 Artificial Intelligence
• Artificial Intelligence (AI) uses software and can be
used to complete repetitive tasks such as entering
invoices and transaction data.
• Accountants are needed to help develop advanced AI
systems and analyze reports and graphics.

© McGraw-Hill LLC 1-3

Learning Objective C1: Explain the importance of accounting and identify its users.
 Ethics – A Key Concept Exhibit
1.5

For information to be useful, it must be trusted. This

demands ethics in accounting. Ethics are beliefs that
separate right from wrong. They are accepted standards of
good and bad behavior.

Learning Objective C2: Describe the importance of ethics and GAAP.

© McGraw-Hill LLC 1-4
 Generally Accepted
Accounting Principles (GAAP)
Financial accounting is governed by concepts and rules known
as generally accepted accounting principles (GAAP). GAAP
wants information to have relevance and faithful representation.

Relevant information Faithful representation

affects decisions means information
of users. accurately reflects
business results.

Learning Objective C2: Describe the importance of ethics and GAAP.

© McGraw-Hill LLC 1-5
 Financial Accounting Standards Board
(FASB)

• The FASB sets GAAP.

• Authority provided by the Securities and
Exchange Commission (SEC).
• The SEC is a U.S. government agency that
oversees GAAP by companies that sell
stock and debt to the public.

Learning Objective C2: Describe the importance of ethics and GAAP.

© McGraw-Hill LLC 1-6
 International Standards
In today’s global economy, there is increased demand by external
users for comparability in accounting reports.

International Accounting Standards Board (IASB)

• Issues International Financial Reporting Standards
(IFRS).
• Standards identify preferred accounting practices.
• Standards are similar to, but sometimes different
from, U.S. GAAP.
• FASB and IASB are working to reduce differences.

Learning Objective C2: Describe the importance of ethics and GAAP.

© McGraw-Hill LLC 1-7
 Conceptual Framework
Exhibit
1.6
• Objectives – provide useful
information to investors, creditors,
and others.
• Qualitative characteristics –
information has relevance and faithful
representation.
• Elements – defines items in financial
statements.
• Recognition and measurement –
criteria for an item to be recognized
as an element and how to measure it.

Learning Objective C2: Describe the importance of ethics and GAAP.

© McGraw-Hill LLC 1-8
 Principles, Assumptions and
Constraint
Exhibit
1.7

General principles are the Specific principles are detailed rules

assumptions, concepts, and used in reporting business
guidelines for preparing financial transactions and events.
statements.

Learning Objective C2: Describe the importance of ethics and GAAP.

© McGraw-Hill LLC 1-9
 Accounting Principles
Measurement Principle Revenue Recognition Principle
(Cost Principle) 1. Recognize revenue when goods or
Accounting information is based on services are provided to customers
actual cost. Actual cost is and
considered objective. 2. at an amount expected to be
received from the customer.

Expense Recognition Principle Full Disclosure Principle

(Matching Principle) A company reports the details behind
A company records its expenses financial statements that would impact
incurred to generate the revenue users’ decisions in the notes to the
reported. financial statements.

Learning Objective C2: Describe the importance of ethics and GAAP.

© McGraw-Hill LLC 1-10
 Accounting Assumptions
Going-Concern Assumption Monetary Unit Assumption
The business is presumed to Transactions and events are
continue operating instead of being expressed in monetary, or
closed or sold. money, units.

Time Period Assumption Business Entity Assumption

The life of a company A business is accounted for
can be divided into time periods, separately from other business
such as months and years. entities, including its owner.

Learning Objective C2: Describe the importance of ethics and GAAP.

© McGraw-Hill LLC 1-11
 Proprietorship, Partnership,
and Corporation
Here are some of the major attributes of sole proprietorships,
partnerships, corporations, and limited liability companies (LLC):

Exhibit
1.8

Learning Objective C2: Describe the importance of ethics and GAAP. © McGraw-Hill LLC 1-12
 Accounting Constraints

Cost-benefit constraint
Information disclosed must have benefits to the user
greater than the cost of providing it.

Materiality constraint
Ability of information to influence decisions of a user
need be disclosed.

Conservatism and industry practices

are sometimes included as a constraint, also.

Learning Objective C2: Describe the importance of ethics and GAAP.

© McGraw-Hill LLC 1-13
Business Transactions and Accounting
The Accounting Equation

Assets = Liabilities + Equity

Expanded Accounting Equation:

Net Income
Learning Objective A1: Define and interpret the accounting equation and each of its components. © McGraw-Hill LLC 1-14
 Transaction 1:
Investment by Owner
Chas Taylor forms a consulting
business named FastFoward set up as a
corporation. Taylor invests $30,000 cash
in the new company in exchange for
common stock.
The accounts involved are:
(1) Cash (asset)
(2) Common Stock (equity)

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-15
 Accounting Equation 1
Chas Taylor invests $30,000 cash to start
the business, FastForward.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 30,000 $ 30,000

$ 30,000 $ - $ - $ - $ - $ 30,000

$ 30,000 = $ 30,000
Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-16
 Transaction 2:
Purchase Supplies for Cash
FastFoward purchased supplies paying
$2,500 cash.
The accounts involved are:
(1) Cash (asset)
(2) Supplies (asset)

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-17
 Accounting Equation 2
FastFoward purchased supplies paying
$2,500 cash.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 30,000 $ 30,000
(2) (2,500) $ 2,500
Accounting Equation
must remain in
balance!!

$ 27,500 $ 2,500 $ - $ - $ - $ 30,000

$ 30,000 = $ 30,000
Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-18
 Transaction 3:
Purchase Equipment for Cash
FastForward purchased equipment for
$26,000 cash.
The accounts involved are:
(1) Cash (asset)
(2) Equipment (asset)

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-19
 Accounting Equation 3
Purchased equipment for $26,000 cash.

Assets = Liabilities + Equity

Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 30,000 $ 30,000
(2) (2,500) $ 2,500
(3) (26,000) $ 26,000 Accounting Equation
still remains in
balance!!
$ 1,500 $ 2,500 $ 26,000 $ - $ - $ 30,000

$ 30,000 = $ 30,000

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-20
 Transaction 4:
Purchase Supplies on Credit
FastFoward purchased supplies of $7,100
on credit.

The accounts involved are:

(1) Supplies (asset)
(2) Accounts Payable (liability)

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-21
 Accounting Equation 4
FastForward purchased supplies of $7,100
on credit.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock
(1) $ 30,000 $ 30,000
(2) (2,500) $ 2,500
(3) (26,000) $ 26,000
Accounting Equation still
(4) 7,100 $ 7,100 remains in balance!!

$ 1,500 $ 9,600 $ 26,000 $ 7,100 $ - $ 30,000

$ 37,100 = $ 37,100

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-22
 Transaction 5:
Provide Services for Cash
FastForward provided consulting services to
a customer and received $4,200 cash
immediately.

The accounts involved are:

(1) Cash (asset)
(2) Revenues (equity)

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-23
 Accounting Equation 5
FastForward provided consulting services to a
customer and received $4,200 cash
immediately.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock Revenue
Bal. $ 1,500 $ 9,600 $ 26,000 $ 7,100 $ 30,000
(5) 4,200 $ 4,200

$ 5,700 $ 9,600 $ 26,000 $ 7,100 $ - $ 30,000 $ 4,200

$ 41,300 = $ 41,300

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-24
 Transactions 6 and 7:
Payment of Expenses in Cash
FastForward paid rent of $1,000 and
salaries of $700 to employees.
The accounts involved are:
(1) Cash (asset)
(2) Rent expense (equity)
(3) Salaries expense (equity)
Remember that the balance in the Expense accounts actually increase.

But, total Equity decreases, because expenses reduce equity.

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-25
 Accounting Equation 6 and 7
FastForward paid rent of $1,000 and
salaries of $700 to employees.
Assets = Liabilities + Equity
Accounts Notes Common
Cash Supplies Equipment Payable Payable Stock Revenue Expenses
Bal. $ 5,700 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200
(6) (1,000) (1,000)
(7) (700) $ (700)

$ 4,000 $ 9,600 $ 26,000 $ 7,100 $ - $ 30,000 $ 4,200 $ (1,700)

$ 39,600 = $ 39,600

Remember that expenses decrease equity.

Learning Objective P1: Analyze business transactions using the accounting equation.
© McGraw-Hill LLC 1-26
 Transaction 8:
Provide Services and Facilities for Credit
FastForward provided consulting services of
$1,600 and rents facilities for $300 to a customer
for credit.

The accounts involved are:

(1) Accounts receivable (asset)
(2) Consulting revenues (equity)
(3) Rental revenue (equity)

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-27
 Accounting Equation 8
FastForward provided consulting services of $1,600
and rents facilities for $300 to a customer for credit.

Assets = Liabilities + Equity

Accounts Accounts Common
Cash Receivable Supplies Equipment Payable Stock Revenue Expenses
Bal. $ 4,000 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200 (1,700)
(8) 1,900 $ 1,600
300

$ 4,000 $ 1,900 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 6,100 $ (1,700)

$ 41,500 = $ 41,500

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-28
 Transaction 9:
Receipt of Cash from Accounts Receivable
Client in transaction 8 pays $1,900 for consulting
services.

The accounts involved are:

(1) Cash (asset)
(2) Accounts receivable (asset)

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-29
 Accounting Equation 9
Client in transaction 8 pays $1,900 for consulting services.

Assets = Liabilities + Equity

Accounts Accounts Common
Cash Receivable Supplies Equipment Payable Stock Revenue Expenses
Bal. $ 4,000 1,900 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200 (1,700)
(9) 1,900 (1,900) $ 1,600
300

$ 5,900 0 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 6,100 $ (1,700)

$ 41,500 = $ 41,500

Learning Objective P1: Analyze business transactions using the accounting equation.
© McGraw-Hill LLC 1-30
 Transaction 10:
Payment of Accounts Payable
FastForward pays $900 as partial payment for
supplies purchased in transaction 4.

The accounts involved are:

(1) Cash (asset)
(2) Accounts payable (liability)

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-31
 Accounting Equation 10
FastForward pays $900 as partial payment for supplies
purchased in transaction 4.
Assets = Liabilities + Equity
Accounts Accounts Common
Cash Receivable Supplies Equipment Payable Stock Revenue Expenses
Bal. $ 5,900 0 $ 9,600 $ 26,000 $ 7,100 $ 30,000 $ 4,200 (1,700)
(10) (900) (900) $ 1,600
300

$ 5,000 0 $ 9,600 $ 26,000 $ 6,200 $ 30,000 $ 6,100 $ (1,700)

$ 40,600 = $ 40,600

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-32
 Transaction 11:
Payment of Cash Dividend
FastFoward declares and pays a $200 cash
dividend to its shareholder.
The accounts involved are:
(1) Cash (asset)
(2) Dividends (equity)
Remember that Dividends increases.

But total Equity decreases because dividends cause equity to go

down!!

Learning Objective P1: Analyze business transactions using the accounting equation.
© McGraw-Hill LLC 1-33
 Accounting Equation 11
FastForward paid a $200 cash dividend.

Assets = Liabilities + Equity

Accounts Accounts Common
Cash Receivable Supplies Equipment Payable Stock Dividends Revenue Expenses
Bal. $ 5,000 0 $ 9,600 $ 26,000 $ 6,200 $ 30,000 $ 4,200 (1,700)
(11) (200) (200) $ 1,600
300

$ 4,800 0 $ 9,600 $ 26,000 $ 6,200 $ 30,000 $ (200) $ 6,100 $ (1,700)

$ 40,400 = $ 40,400

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-34
 Summary of Transactions Exhibit
1.9

Learning Objective P1: Analyze business transactions using the accounting equation. © McGraw-Hill LLC 1-35
 Financial Statements

© McGraw-Hill LLC 1-36

Learning Objective P2: Identify and prepare basic financial statements and explain how they interrelate.
 Exhibit 1.10: Financial Statements and Their Links – Part 1

Income Statement, Statement of

Retained Earnings, and Balance Sheet
Exhibit
1.10

Learning Objective P2: Identify and prepare basic financial statements and explain how they interrelate. © McGraw-Hill LLC 1-37
 Exhibit 1.10: Financial Statements and Their Links – Part 2

Balance Sheet &

Statement of Cash Flows
Exhibit
1.10

Learning Objective P2: Identify and prepare basic financial statements and explain how they interrelate. © McGraw-Hill LLC 1-38
 Return on Assets
Return on assets (ROA) is stated in ratio form as net
income divided by the average total assets invested.

Net income Exhibit

Return on assets =
Average total assets 1.11

Exhibit
1.12

Learning Objective A2: Compute and interpret return on assets. 1-39

© McGraw-Hill LLC