Chapter 1

ENVIRONMENT AND
THEORETICAL STRUCTURE OF
FINANCIAL ACCOUNTING

© 2023 The McGraw-Hill Companies, Inc

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Primary Focus of Financial Accounting

• Providing financial information to various

external users:

Investors Creditors Other external users

Investors Use different kinds ➢ To predict future
and risk and potential
of information
creditors return of
Financial information, investments or
conveyed through loans
financial statements and ➢ Before
disclosures notes, is a key supplying capital
component of that to businesses
information set.
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The Economic Environment

and Financial Reporting
A sole proprietorship A corporation is owned
is owned by a by shareholders,
single individual. frequently numbering
in the tens of thousands
in large corporations.
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A partnership is
owned by two or
more individuals.

A highly-developed system of financial

reporting is necessary to communicate
financial information from a corporation to
its many shareholders.
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Investment-Credit Decisions ─
A Cash Flow Perspective
Corporate shareholders receive cash
from their investments through . . .
• Periodic dividend distributions from the
corporation.
• The ultimate sale of the ownership shares.

Accounting information should help investors evaluate

the amount, timing, and uncertainty
of the enterprise’s future cash flows.
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Cash Versus Accrual Accounting

Cash-Basis Accounting
•Measurement of cash receipts and cash
payments from transactions related to providing
goods or services.
•Difference
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is net operating cash flow.
Accrual Basis Accounting
•Measurement of revenues and expenses,
regardless of when cash is received or paid.
•Difference is net profit or net loss.
also wet income , wet earnings
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Cash-Basis Example
• Carter company paid $60,000 for 3 years’ rent at
the beginning of year 1.
◦ Under cash basis accounting, the rent payment is
shown when paid.
Year 1 Year 2 Year 3 Total
Sales (on credit) $100,000 $100,000 $100,000 $300,000
Net Operating Cash Flows
Cash receipts from customers $ 50,000 $125,000 $125,000 $300,000
Cash disbursements:
Prepayment of three years’ rent (60,000) –0– –0– (60,000)
Salaries to employees (50,000) (50,000) (50,000) (150,000)
Utilities (5,000) (15,000) (10,000) (30,000)
Net operating cash flow $(65,000) $ 60,000 $ 65,000 $ 60,000

we
assets (when
prepaid expenses are
until it expired

use it ] it becomes expenses .

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Accrual Basis Example

• Carter company paid $60,000 for three years’ rent
at the beginning of year 1.
◦ Under accrual basis accounting, rent is
recognized as an expense in all three years even
though it was paid in year 1.
CARTER COMPANY
Statements of Profit or Loss
Year 1 Year 2 Year 3 Total

Revenues $100,000 $100,000 $100,000 $300,000

Expenses:
Rent 20,000 20,000 20,000 60,000
Salaries 50,000 50,000 50,000 150,000
Utilities 10,000 10,000 10,000 30,000
Total expenses 80,000 80,000 80,000 240,000
Net profit $ 20,000 $ 20,000 $ 20,000 $ 60,000
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The Development of Financial Accounting

and Reporting Standards

Two major sets

of accounting
Concepts, standards –
principles, and •IFRS 5ASP
->

procedures were
•U.S. GAAP ->

developed to meet the FASP

needs of external
users.

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Ethics in Accounting

• To be useful, accounting information must be

objective and reliable.
• Management may be under pressure to report
desired results and ignore or bend existing rules.
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Role of the Auditor

Independent intermediary to help

ensure that management has
appropriately applied accounting
standards.
 Reach .

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Qualitative Characteristics of Financial

Reporting Information

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Key Constraint

Cost
Effectiveness

The costs of providing financial information include those of

gathering, processing, and disseminating information.
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 Financial Statements
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Primary means of communicating financial information to

external parties: > balance sheel
•Statement of Financial Position: presents organized
list of assets, liabilities, and equity at a point in time.
•Statement of Profit or Loss and Other
isComprehensive Income: summarizes the income-
generating activities that caused shareholders’ equity to
change and that were not a result of transactions with
owners. Presented either in a single, continuous
statement, or in two separate but consecutive
statements.
•Statement of Cash Flows: summarizes and classifies
the transactions that caused cash to change.
•Statement of Changes in Equity: discloses the events
that caused shareholders’ equity accounts to change.
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Elements of Financial Statements

• An asset is an economic resource that a company has
control over and that arises from past events.
• The definition of a liability consists of three components:
present obligation, obligation to transfer economic
resources, and past events.
• Equity comprises the remaining interest in a company’s
assets after deducting liabilities.
• Income (revenues and gains) comes about from increment
in assets or reduction in liabilities and leads to increases in
equity, except those pertaining to shareholder contribution.
• Expenses (including losses) come about from reduction in
assets or increment in liabilities and result in decreases in
equity, except those pertaining to shareholder distributions.
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Underlying Assumptions
• Going concern assumption presumes a business
entity will continue to operate indefinitely.
• Three other useful assumptions:
- Economic entity assumption presumes economic events
can be identified specifically with a particular economic
entity.
- Periodicity assumption allows a company’s life to be
divided into artificial time periods to provide timely
information.
- Monetary unit assumption requires financial statement
elements to be measured in nominal units of money.
 Basic Principles
The full disclosure principle is the accounting principle that
requires an entity to disclose all necessary information in
its financial statements and other related signification.

The matching principle is one of the accounting principles that

require the expenses correlated with revenues should be
recognized in the same period in the financial statements. This
concept tries to ensure that there are no over or under revenue or
expenses records in the financial statements. If the revenue or
expenses are recorded inconsistently, then there will be over or
under income or expenses. misstatement)

Revenue recognition is a generally accepted accounting principle

(GAAP) that stipulates how and when revenue is to be recognized.

© 2023 The McGraw-Hill Companies, In

Brief Exercise 1: Listed below are several statements that relate to
financial accounting and reporting, Identify the basic assumption or
broad accounting principle to each statement.

1.Fujitsu Limited files its annual and quarterly financial statements

with the Tokyo Stock Exchange. periodeity .

2. The president of Applebee’s International, Inc. travels on the

corporate jet for business purpose only and does not use the jet for
personal use. economic activity.

3. Rockville Engineering records revenue only after products have

been shipped, even though customers pay Rockville 50% of the sales
price in advance. revenue recognition .

4. Winderl Corporation disclosed that it was the defendant in a

material lawsuit because the trail was still in progress.
&I

full disclosure .

© 2023 The McGraw-Hill Companies, In

·
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Measurement of Elements of Financial Statements

Measurement attributes in IFRS:
1.Historical cost (amount given or received in the exchange
transaction)
2.Net realizable value (amount of cash into which the asset or
liability will be converted in the ordinary course of business)
3.Current cost (cost that would be incurred to purchase or
reproduce the goods)
4.Present value of future cash flow (future cash flows discounted
for the time value of money)
5.Fair value (price that would be received to sell assets or transfer
liabilities in an orderly market transaction)

The attribute chosen to measure a particular item should be the one

that maximizes the combination of relevance and representational
faithfulness.

© 2023 The McGraw-Hill Companies, Inc

Chapter 2

REVIEW OF THE
ACCOUNTING PROCESS

© 2013 The McGraw-Hill Companies, Inc

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The Accounting Equation

A = L + OE
+ Revenue - Expenses
+ Owner Investments - Owner Withdrawals
+ Gains - Losses
(capital -I
profit or loss
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Accounting Equation for a-

Corporation
equit
Stockholder 3r

assets Liability Shewehstehr equity

A = Loading…
L + SE
+ Issued Capital + Retained Earnings
Profits
-paid
S-
in Capital) after
distributed a enteres
in

+ Revenues - Expenses - Dividends

+ Gains - Losses
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Account Relationships
Debits and credits affect the Statement of
Financial Position Model as follows:

* A = L + PIC + RE P
P Issued Retained
S

P P
Assets Liabilities Capital Earnings
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
+ - - + - + - +
permentately ·

recy Revenues T ExpensesI

our er

P Permanent Accounts -
and Gains and Losses
4 Temporary Accounts Dr. Cr.
relatech ↳ one period - +
Dr. Cr.
of time . + -
 During the Accounting Period Slide 0

Source Transaction Record in Post to

documents Analysis Journal Ledger

At the End of the Accounting Period

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Financial Adjusted Record & Post Unadjusted
Statements Trial Balance Adjusting Trial Balance
Entries

The
At the End Accounting
of the Year Processing
Close Temporary Post-Closing
Accounts Trial Balance
Cycle
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Accounting Processing Cycle

cash
On January 1, $40,000 was borrowed from a
bank and a note payablepwas signed.

Two accounts are affected:

● Cash (an asset) increases by $40,000.
● Notes Payable (a liability) increases by $40,000.
(a written promises
.

change of debit first .

*
GENERAL JOURNAL Page 1
Post.
Prepare
Date
Jan 1 Cash
the journal entry.
Description
40,000
Ref. Debit Credit

Notes Payable 40,000

note payable
borrowed from bank qnd signed
.

a
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General Ledger beg .

Balance of
000
cash 100 ,

GENERAL LEDGER
Account: Acct. No. ##
Balance
Post. sick of
deces e
Date Item Ref. Debit Credit DR (CR)
Jan 7 cash 40 , 180 140 , 830
note payable 10 , 088 130 , 000

The “T” account is a shorthand format of an account

used by accountants to analyze transactions.
It is not part of the bookkeeping system.
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Posting Journal Entries

casuf
On July 1, the owners invest $60,000 in a new
business, Dress Right Clothing Corporation.

GENERAL JOURNAL Page 1

Post.
Date Description Ref. Debit Credit
July 1 Cash 60,000
Ordinary Share Capital 60,000
issued Capital)

Post the debit portion of the entry to the Cash

ledger account.
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Posting Journal Entries

GENERAL JOURNAL Page 1

Post.
Date Description Ref. Debit Credit
July 1 Cash 100 60,000
Ordinary Share Capital 60,000

GENERAL LEDGER
Account: Cash Acct. No. 100

Post.
Date Item Ref. Debit Credit Balance
July 1 J1 60,000 60,000
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Posting Journal Entries

GENERAL JOURNAL Page 1

Post.
Date Description Ref. Debit Credit
July 1 Cash 100 60,000
Ordinary Share Capital 300 60,000

We follow the same procedure to post the credit portion of

the entry to the Ordinary Share Capital account.
GENERAL LEDGER
Account: Ordinary Share Capital Acct. No. 300

Post.
Date Item Ref. Debit Credit Balance
July 1 J1 60,000 60,000
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credit
cast prechense
purchase ↑ cast
beasu postpone
-

later
paying

Rite Shoes was involved in the transactions described

below.
Required: Prepare the appropriate journal entry for each
transaction. If an entry is not required, state "No Entry."
1. Purchased $8,200 of inventory on account. DrYcr
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-

2. Paid weekly salaries, $920.

3. Recorded sales for the first week: Cash: $7,100; On
account: $5,300. Cash sales-> Cash
+

4. Paid for inventory purchased in event (1).

5. Placed an order for $6,200 of inventory.

© 2013 The McGraw-Hill Companies, Inc

#
Date description

I
july inventory
accounts $8 , 200
payable
2 Salaries
July expenses
cast

3 7100
July Cash

accounts reciverbe

sales newen we $ ↳400

only Y a count payable $8/ 200

Leigh

July S
After recording all entries for the period, Dress Right’s
Unadjusted Trial Balance would be as follows:

Dress Right Clothing Corporation

Unadjusted Trial Balance
July 31, 2013
A Trial Balance
Account Title Debits Credits
Cash $ 68,500 is a listing of all
Accounts receivable 2,000 accounts and
Supplies 2,000
Prepaid rent 24,000
their balances
Inventory 38,000 at a point in
Furniture and fixtures 12,000
time.
Accounts payable $ 35,000
Notes payable 40,000
Unearned rent revenue 1,000
Ordinary share capital 60,000
Retained earnings 1,000
Sales revenue 38,500
Cost of goods sold 22,000
Salaries expense 5,000
Total $ 174,500 $ 174,500
Debits = Credits
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Adjusting Entries

Prepayments Accruals Estimates

(Deferrals)
deprecation
-

-
accruch
reveuces

Transactions where
accrue
cash is paid or received
->

expenses
before a related
expense or revenue is
recognized.
-
Prepaid expenses
Transactions where
-
uncerned cash is paid or received
after a related expense
(becfeced) revenue

or revenue is
recognized.
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Prepaid Expenses

Asset Expense
Unadjusted Credit Debit
Balance Adjustment Adjustment

Today, I will pay

for my first
6 months’ rent. Prepaid Expenses
Items paid for in advance
of receiving their benefits
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Estimates

• Uncollectible
accounts and
depreciation of fixed
assets are estimated.
• An estimated item is a
function of future
events and $
developments.
 fixed assets (ame , building equipment Slide 0
,

madines ↑

Depreciation depreciations method

an accounting
of fixed assets
of allocating
=
cost

Pbook
⑰ -
acculmalted
value
apreciation as expenses .

cost Depreciation is the process of computing

expense by allocating the cost of plant and
equipment over their expected useful lives.
resoucel value
↳ at the eve
Straight-Line Asset Cost - Salvage Value of the
Depreciation = usefull
Expense Useful Life life .

000
20st 100 ,

/apreciatio ai
=

O
value
sawage
month
at useful life 68
=

100 , 080
-
%
=50, 666motefh,
67

per

60 month