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Chapter

One
An
Introduction
to
Accounting

McGraw-Hill Education

Copyright 2016 by McGraw-Hill Education. All rights reserved.

LO
LO 11
Explain the role of
accounting in
society.

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Role of Accounting in Society


Accounting
provides
information
that is useful
in answering
questions
about
resource
allocation.

Should I
invest
money in
Apple or
Google?

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Market-Based Allocations
A market is a
group of
people or
entities
organized to
exchange
items of value.
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0
0
7
3
3
5
9
9
0
4

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Market-Based Allocations
Common terms for the added value
created in the transformation
process:

Profit

Income

Earnings

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Financial Resources
Conversion agents need financial
resources (money) to establish and
operate their businesses.

Investors

Creditors

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Physical Resources
In their most primitive
form, physical
resources are called
natural resources.
Owners of physical
resources seek to sell
those resources to
profitable businesses
which are able to pay
higher prices and
make repeat
purchases.
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Labor Resources
Labor resources
include both
intellectual and
physical labor.
Workers seek
relationships with
businesses that have
high earnings
potential because
these businesses are
better able to pay
high wages.
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Types of Accounting Information


Financial
Accountin
g

Focused on the
needs of external
users

Manageria
l
Accountin
g

Focused on the
needs of internal
users

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Non-business Resource
Allocation
Not all entities allocate resources based on
profitability. Organizations that are not
motivated by profit are called not-for-profit
entities.
Government,
foundations,
religious groups, the
Peace Corps, and
various benevolent
organizations
allocate resources
based on
humanitarian
concerns.
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1-12

Careers in Accounting
Public
Accounting

Certified Public
Accountant
Audit services
Tax services
Consulting services

Private
Accounting

Certified Management
Accountant
Certified Internal Auditor

1-13

Measurement Rules
The Financial Accounting Standards
Board establishes measurement and
reporting rules that businesses use
to facilitate communication.

Generally
Accepted
Accounting
Principles
1-14

Reporting Entities
Financial accounting
reports disclose the
financial activities of
particular
individuals or
organizations
described as
reporting entities.
Each entity is
treated as a
separate reporting
unit.

Busines
s

Owner

Bank

1-15

LO 22
LO

Construct an
accounting
equation and
show how
business events
affect the
equation.
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Elements of Financial
Statements
1. Assets
2. Liabilities
3. Equity
4. Contributed Capital
5. Revenue
6. Expenses
7. Distributions
8. Net Income
9. Gains
10. Losses

The
elements
represent
broad
categories.
We will discuss
elements 1-8 in this
chapter. We will
save elements 9
and 10 for a later
chapter.
1-17

Elements of Financial
Statements
1. AssetsCash, Equipment, Buildings, Land
2. Liabilities
3. Equity
4. Contributed Capital
5. Revenue
6. Expenses
7. Distributions
8. Net Income
9. Gains

Subclassification
s of the
elements are
frequently called
accounts.
Accounts are
reported in the
financial
statements.

10. Losses
1-18

Accounting Equation
Assets = Claims
Claims on the assets are from two
sources:
1. Creditors (liabilities)
2. Investors or owners (equity)

Assets = Liabilities + Equity


1-19

Accounting Equation
Assets = Liabilities + Equity
Assets =

Liab.

$ 500 = $

Assets

$ 500

Equity

200 + $

Liab.
$

300

Equity

200 = $

300
1-20

Accounting Equation
Assets = Liabilities + Equity

Common Stock + Retained


Earnings

Assets = Liabilities + Stockholders' Equity


1-21

Recording Business Events Under


the Accounting Equation
Accounting
Event

Transaction
1. Source
2. Exchang
e
3. Use
1-22

Asset Source Transactions


Businesses obtain
assets from three
sources:
1. Owners
2. Creditors
3. Profitable
Operations

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Event 1: Rustic Camp Sites (RCS) was formed


on January 1, 2016, when it acquired $120,000
cash from issuing common stock.
1. RCS increases
assets (cash).
2. RCS increases
stockholders
equity (common
stock).

DoubleEntry
Bookkeepin
g

Asset
Source
Transaction

Recorded in
Two Places
1-24

Event 2: RCS acquired an additional $400,000


of cash by borrowing from a creditor.
1. RCS increases assets
(cash).

Asset
Source
Transaction

2. RCS increases
liabilities (notes
payable).
Assets
Beginning Balance
Acquired Cash by Issuing Note
Ending Balance

Cash
120,000
400,000
520,000

+
+
+
+

Land
n/a
n/a
n/a

Liab.

Stockholders' Equity

=
=
=
=

N. Pay.
n/a
400,000
400,000

+
+
+
+

C. Stk.
120,000
n/a
120,000

+
+
+
+

Ret. Ear.
n/a
n/a
n/a

1-25

Event 3: RCS paid $500,000 cash to purchase


land.
1. RCS decreases
assets (cash).

Asset
Exchange
Transaction

2. RCS increases
assets (land).

Assets
Beginning Balance
Paid Cash to Buy Land
Ending Balance

Cash
520,000
(500,000)
20,000

+
+
+
+

=
Land
=
n/a
=
500,000 =
500,000 =

Liab.

N. Pay. +
400,000 +
n/a
+
400,000 +

Stockholders' Equity
C. Stk.
120,000
n/a
120,000

+
+
+
+

Ret. Ear.
n/a
n/a
n/a

1-26

Event 4: RCS obtained $85,000 cash by


leasing campsites to customers.
1. RCS increases
assets (cash).

Asset
Source
Transaction

2. RCS increases
stockholders
equity (retained
earnings).
Assets
Beginning Balance
Acquired Cash by Earning Revenue
Ending Balance

Cash
20,000
85,000
105,000

+
+
+
+

Land
500,000
n/a
500,000

Liab.

Stockholders' Equity

=
=
=
=

N. Pay.
400,000
n/a
400,000

+
+
+
+

C. Stk.
120,000
n/a
120,000

+
+
+
+

Ret. Ear.
n/a
85,000
85,000

revenues
1-27

Event 5: RCS paid $50,000 cash for


operating expenses such as salaries,
rent, and interest.
1. RCS decreases
assets (cash).

Asset Use
Transaction

2. RCS decreases
stockholders
equity (retained
earnings).
Assets
Beginning Balance
Used Cash to Pay Expenses
Ending Balance

Cash
105,000
(50,000)
55,000

+
+
+
+

Land
500,000
n/a
500,000

Liab.

Stockholders' Equity

=
=
=
=

N. Pay.
400,000
n/a
400,000

+
+
+
+

C. Stk.
120,000
n/a
120,000

+
+
+
+

expense
s

Ret. Ear.
85,000
(50,000)
35,000

1-28

Event 6: RCS paid $4,000 in cash


dividends to its owners.
1. RCS decreases
assets (cash).

Asset Use
Transaction

2. RCS decreases
stockholders
equity (retained
earnings).
Assets
Beginning Balance
Used Cash to Pay Dividends
Ending Balance

Cash
55,000
(4,000)
51,000

+
+
+
+

Land
500,000
n/a
500,000

Liab.

Stockholders' Equity

=
=
=
=

N. Pay.
400,000
n/a
400,000

+
+
+
+

C. Stk.
120,000
n/a
120,000

+
+
+
+

Ret. Ear.
35,000
(4,000)
31,000

dividend
1-29

Event 7: The land that RCS paid $500,000 to


purchase had an appraised market value of
$525,000 on December 31, 2016.
Historical
Cost
Concept

Reliability
Concept

Requires that most


assets be reported
at the amount paid
for them (their
historical cost)
regardless of
increases in market
value.

Information is
reliable if it can be
independently
verified.
Appraised values are
opinions and will
vary from appraiser
to appraiser.
1-30

LO 3

LO 5
Interpret
information shown
in an accounting
equation.

1-31

The Left versus the Right Side of the


Accounting Equation
1. Educate, Inc.
purchases land for
$2,000 cash.
2. After the purchase,
the company has
zero cash.

3. The right side of


the equation
represents sources
of the companys
assets.

Liabilities,
common stock
and retained
earnings are not
cash.

1-32

Cash and Retained Earnings


Retained
earnings does
not represent
cash, but it
can limit
dividends.

Creative
Associates sells its
land for $1,900.
Although the
company has
$2,300 in cash, it
may only pay $600
in dividends.
1-33

LO 4

LO 7
Classify business
events as asset
source, use, or
exchange
transactions.

1-34

Recap: Types of Transactions


The described transactions have
been classified into one of three
categories:
Asset
Asset
Asset
Source
Exchange
Use
Increase
total assets,
increase
total claims

Increase
one asset,
decrease
another
asset

Decrease
total assets,
decrease
total claims
1-35

Summary of Transactions
Assets

Event
1
2
3
4
5
6
7

Cash
+
Land
$
$
120,000
400,000
(500,000)
500,000
85,000
(50,000)
(4,000)
n/a
n/a
$ 51,000 + $ 500,000

Liab.

Notes
=
Payable
$
-

Stockholders' Equity

Common
+
Stock
$
120,000

Retained
+ Earnings
$
-

Other
Account
Titles

400,000

= $

n/a
400,000

+ $

n/a
120,000

85,000 Revenue
(50,000) Expense
(4,000) Dividend
n/a
+ $ 31,000

Now, lets prepare the financial


statements for RCS using the data
presented above.
1-36

LO 5

LO 8

Prepare an income
statement, a
statement of
changes in
stockholders
equity, and a
balance sheet.
1-37

Preparing Financial Statements


{
Matching
Concept

Revenues exceeded
Income is
expenses.
measured for a
span of time
Net Loss
called the

Revenues
are matched
to expenses. results when expenses Accounti
ng Period
exceed revenues.

1-38

Preparing Financial Statements

1-39

Preparing Financial Statements

Assets
are
displayed
in order
of
liquidity.

equa
l

1-40

LO 6

LO 8
Prepare a
statement of cash
flows.

1-41

Preparing Financial Statements


Operating

Investing

Financing

1-42

LO 7

LO 8

Explain the
closing process.

1-43

The Closing Process


Transfers net income
(or loss) and dividends
to Retained Earnings.

Establishes zero
balances in all
revenue, expense, and
dividend accounts.
1-44

Temporary and Permanent


Accounts

Temporary
Temporaryaccounts
accounts
track
trackfinancial
financial
results
resultsfor
foraalimited
limited
period
periodof
of time.
time.

Permanent
Accounts

Equity

Liabilities

Expenses

Temporary
Accounts

Assets
Dividends

Revenues

Permanent
Permanent accounts
accounts
track
trackfinancial
financial
results
resultsfrom
fromyear
year to
to
year.
year.
1-45

LO 8

LO 9
Record business
events using a
horizontal
financial
statements
model.
1-46

Horizontal Financial Statements


Model

1-47

Real World Financial Reports


Service
Businesses

Merchandisin
g Businesses

Manufacturin
g Businesses

1-48

Annual Reports
(1) Financial Statements
(2) Notes
(3) Auditors Report Chapter 6
(4) Managements Discussion
and Analysis (MD&A)

Traditionally, large companies


have distributed expensive
annual reports with many color
photographs.
Increasingly, however,
companies are issuing more
modest annual reports or are
simply distributing their 10-K
reports.

1-49

Special Terms in Real-World


Reports
The financial statements of real-world companies
include numerous items relating to advanced topics
that are not covered in introductory accounting
textbooks.
However, we encourage you to look for annual
reports in the library, from your employer, or on the
Internet.

The best way


to learn
accounting is
to use it.

1-50

End of Chapter One

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