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Introduction to Accounting and Business Unit 2 Laurie Hopkins

Chapter 1. Introduction to Accounting and Business Unit 2 Laurie Hopkins. Generally Accepted Accounting Principles p 7. Financial accountants follow generally accepted accounting principles (GAAP) in preparing reports.

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Introduction to Accounting and Business Unit 2 Laurie Hopkins

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  1. Chapter 1 Introduction to Accounting and Business Unit 2 Laurie Hopkins

  2. Generally Accepted Accounting Principles p 7 • Financial accountants follow generally accepted accounting principles (GAAP) in preparing reports. • Within the United States, the Financial Accounting Standards Board (FASB) has the primary responsibility for developing accounting principles.

  3. Why and How Those accounting principles along with accounting concepts are the how and why behind accounting. So let’s look at some concepts.

  4. Business Entity Concept p 8 Under the business entity concept, the activities of a business are recorded separately from the activities of its owners, creditors, or other businesses.

  5. Cost Concept p 8 Under the cost concept, amounts are initially recorded in the accounting records at their cost or purchase price.

  6. Objectivity Concept p 9 The objectivity concept requires that the amounts recorded in the accounting records be based on objective evidence. In other words, what it actually cost.

  7. Unit of Measure Concept p9 The unit of measure conceptrequires that economic data be recorded in dollars. In other words we use money as our measuring stick.

  8. Example Exercise 1-1 Page 9 Cost Concept On August 25, Gallatin Repair Service extended an offer of $125,000 for land that had been priced for sale at $150,000. On September 3, Gallatin Repair Service accepted the seller’s counteroffer of $137,000. On October 20, the land was assessed at a value of $98,000 for property tax purposes. On December 4, Gallatin Repair Service was offered $160,000 for the land by a national retail chain. At what value should the land be recorded in Gallatin Repair Service’s records? AND what concept helps us to determine our answer?

  9. Example Exercise 1-1 (continued) $137,000. Under the cost concept, the land should be recorded at the cost to Gallatin Repair Service.

  10. Objective 3 State the accounting equation and define each element of the equation. Assets=Liabilities + Owner’s Equity

  11. The Accounting Equation Assets = Liabilities + Owner’s Equity The resources owned by a business

  12. The Accounting Equation Assets = Liabilities + Owner’s Equity The rights of the creditors are the debts of the business.

  13. The Accounting Equation Assets = Liabilities + Owner’s Equity The rights of the owners

  14. Laurie’s Definitions: • Assets – what we own • Liabilities – what we owe • Equity – the difference between the two If I own a $50K house and owe $40K on it, what is the difference between the two? $10K – my equity or worth in the business

  15. Example Exercise 1-2 Page 9 Accounting Equation John Joos is the owner and operator of You’re A Star, a motivational consulting business. At the end of its accounting period, December 31, 2009, You’re A Star has assets of $800,000 and liabilities of $350,000. Using the accounting equation, determine the following amounts: • Owner’s equity, as of December 31, 2009. • Owner’s equity, as of December 31, 2010, assuming that assets increased by $130,000 and liabilities decreased by $25,000 during 2010. • Letter a first – remember the accounting equation • (A=L+E)

  16. Example Exercise 1-2 (continued) a.Assets = Liabilities + Owner’s Equity $800,000 = $350,000 + Owner’s Equity Owner’s Equity = $450,000

  17. b.First, determine the change in Owner’s Equity during 2010 as follows: Assets = Liabilities + Owner’s Equity $130,000 = –$25,000 + Owner’s Equity Owner’s Equity = $155,000 Next, add the change in Owner’s Equity on December 31, 2009 (remember the 2009 balance was $450K) to arrive at Owner’s Equity on December 31, 2010, as shown below: $605,000 = $450,000 + $155,000 For fun let’s put this into the accounting equation to check it. Example Exercise 1-2 (continued) Same equation A=L+E but the assets increased by 130K and liabilities decreased by $25K but both sides have to balance. 17

  18. A = L + E (or OE) • Balances: Assets were $800K and they increased by $130K to become $930K Liabilities were $350K and they decreased by $25K to become $325K So if A = L + E $930K = 325K + 605K – does it work?

  19. Objective 4 Describe and illustrate how business transactions can be recorded in terms of the resulting change in the elements of the accounting equation. P 10 Make sure you go through the examples on pages 11 – 14 slowly.

  20. Business Transaction A business transaction is an economic event or condition that directly changes an entity’s financial condition or its results of operations.

  21. Example Exercise 1-3 p 15 Transactions Salvo Delivery Service is owned and operated by Joel Salvo. The following selected transactions were completed by Salvo Delivery Service during February: From the listed transactions numbered 1 through 5 indicate the effect of each transaction on the accounting equation elements (Assets, Liabilities, Owner’s Equity, Drawing, Revenue, and Expense) by listing the numbers identifying the transactions, (1) through (5). Also, indicate the specific item within the accounting equation element that is affected. To illustrate, the answer to (1) is shown. First, let’s back up and talk about 3 more elements

  22. Owner’s Equity • Okay if assets are things we own, liabilities are things we owe and equity is the difference between the two – where do our profits come into play? • Owner’s equity is our investment in the business so if we work hard and do well our investment grows – profits. • If we don’t make the best decisions or if the economy bites us our investment loses value – net losses.

  23. Owner’s Equity Con’t. • So net profits will increase our equity or worth in the business. • Net losses will reduce our worth. • How does that play out? • We figure our net profits or losses by taking our revenues and subtracting our expenses (or cost of doing business). • If revenues are higher we have a profit. • If expenses are higher then a loss. So back to the example exercise to see this play out a little.

  24. 1. Received cash from owner as additional investment, $35,000. • Asset (Cash) increases by $35,000; Owner’s Equity (Joel Salvo, Capital) increases by $35,000. • A=L + OE so… +35K to A = L (same) + add 35K to OE • 2. Paid creditors on account, $1800. • Asset (Cash) decreases by $1,800; Liability (Accounts Payable) decreases by $1,800. • Drop A and L by $1800, both sides still balance

  25. 3. Billed customers for delivery services on account (means they owe us for this), $11,250. (3) Asset (Accounts Receivable) increases by $11,250; Revenue (Delivery Service Fees) increases by $11,250. 4. Received cash from customers on account, $6,740. (4) Asset (Cash) increases by $6,740; Asset (Accounts Receivable) decreases by $6,740.

  26. 5. Paid cash to owner for personal use, $1,000. • (5) Asset (Cash) decreases by $1,000; Drawing (Joel Salvo, Drawing) increases by $1,000. • Any questions on this example exercise? • Is it as clear as mud? If so, that is perfectly fine. We are working on a painting and it takes awhile to see the big picture.

  27. Objective 5 Describe the financial statements of a proprietorship and explain how they interrelate. P 15

  28. Financial Statements After transactions have been recorded and summarized, reports are prepared for users. The accounting reports providing this information are called financial statements.

  29. Income Statement p 16 The income statement reports the revenues and expenses for a period of time, based on the matching concept (another concept to add to our list from page 8).

  30. Matching Concept The matching concept is applied by matching the expenses with the revenue generated during a period by those expenses.

  31. The excess of revenue over the expenses is called net income or net profit. If the expenses exceed the revenue, the excess is a net loss.

  32. Exhibit 6 Financial Statements for NetSolutions p 18 Net income is carried to the statement of owner’s equity.

  33. Example Exercise 1-4 p 16 Income Statement The assets and liabilities of Chickadee Travel Service at April 30, 2010, the end of the current year, and its revenue and expenses for the year are listed below. The capital of the owner, Adam Cellini, was $80,000 at May 1, 2009, the beginning of the current year. Accounts payable $ 12,200 Miscellaneous expense $ 12,950 Accounts receivable 31,350 Office expense 63,000 Cash 53,050 Supplies 3,350 Fees earned 263,200 Wages expense 131,700 Land 80,000 Prepare an income statement for the current year ended April 30, 2010. (we won’t need everything they just gave us)

  34. Example Exercise 1-4 (continued) CHICKADEE TRAVEL SERVICE INCOME STATEMENT For the Year Ended April 30, 2010 Fees earned $263,200 Expenses: Wages expense $131,700 Office expense 63,000 Miscellaneous expense 12,950 Total expenses 207,650 Net income $ 55,550

  35. Statement of Owner’s Equity The statement of owner’s equity reports the changes in the owner’s equity for a period of time.

  36. Exhibit 6 Financial Statements for NetSolutions p 18 From the income statement To the balance sheet

  37. Example Exercise 1-5 p 17 Statement of Owner’s Equity Using the data for Chickadee Travel Service shown in Example Exercise 1-4, prepare a statement of owner’s equity for the current year ended April 30, 2010. Adam Cellini invested an additional $50,000 in the business during the year and withdrew cash of $30,000 for personal use. CHICKADEE TRAVEL SERVICE INCOME STATEMENT For the Year Ended April 30, 2010 Fees earned $263,200 Expenses: Wages expense $131,700 Office expense 63,000 Miscellaneous expense 12,950 Total expenses 207,650 Net income $ 55,550

  38. Example Exercise 1-5 continued CHICKADEE TRAVEL SERVICE STATEMENT OF OWNER’S EQUITY For the Year Ended April 30, 2010 Adam Cellini, capital, May 1, 2009 $ 80,000 Additional investment by owner during year $ 50,000 Net income for the year 55,550 $105,550 Less withdrawals 30,000 Increase in owner’s equity 75,550 Adam Cellini, capital, April 30, 2010 $155,550

  39. Balance Sheet A balance sheet is a list of the assets, liabilities, and owner’s equity as of a specific date. Note: this is the accounting equation in a financial statement.

  40. Exhibit 6 Financial Statements for NetSolutions p 18 This amount is compared to the net cash flow on the statement of cash flows. From the statement of owner’s equity

  41. Example Exercise 1-6 p19 Balance Sheet Using the data for Chickadee Travel Service shown in Example Exercises 1-4 and 1-5, prepare the balance sheet as of April 30, 2010. Accounts payable $ 12,200 Miscellaneous expense(IS)$12,950 Accounts receivable 31,350 Office expense (IS) 63,000 Cash 53,050Supplies 3,350 Fees earned (IS) 263,200 Wages expense (IS) 131,700 Land 80,000 CHICKADEE TRAVEL SERVICE STATEMENT OF OWNER’S EQUITY For the Year Ended April 30, 2010 Adam Cellini, capital, May 1, 2009 $ 80,000 Additional investment by owner during year $ 50,000 Net income for the year 55,550 $105,550 Less withdrawals 30,000 Increase in owner’s equity 75,550 Adam Cellini, capital, April 30, 2010 $155,550

  42. Example Exercise 1-6 (continued) CHICKADEE TRAVEL SERVICE BALANCE SHEET April 30, 2010 Assets Liabilities Cash $ 53,050 Accounts payable $ 12,200 Accounts receivable 31,350 Supplies 3,350 Owner’s Equity Land 80,000 Adam Cellini, capital 155,550 Total assets $167,750 Total liab. & owner’s eq. $167,750

  43. Statement of Cash Flows A statement of cash flows is a summary of the cash receipts and payments for a specific period of time. It consists of three sections: (1) operating activities, (2) investing activities, and (3) financing activities. **We get to this in AC116.

  44. Exhibit 6 Financial Statements for NetSolutions (continued) This amount should match Cash on the balance sheet.

  45. Questions? Always read the Financial Analysis and Interpretation at the end of the chapter (page 21 in chapter 1). Your textbook exercises for this unit (due on Tuesday by 11:59 PM Eastern Time) are: Exercise 1-7 page 31 (Example Exercise 1-2) Exercise 1-8 page 31 (use transactions on pages 11-14) Exercise 1-12 page 32 (Example Exercise 1-3) Exercise 1-22 page 35 (Example Exercises 1-4 & 1-6) Problem 1-3A page 37 (Problem 1-3B, solution in Doc Sharing) NOTE!!! The cash flow on Problem 1-3A is required. Use the templates available in Doc Sharing to complete your textbook exercises. There is a set for each set of textbook exercises due this term.

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