FoA I PPT Chapter-1.pptx for undergraduate students

FoA I PPT Chapter-1.pptx

1. Fundamentals of Accounting I Chapter One Introduction to Accounting and Business

2. Nature of Business and Accounting A business is defined as an organization established to earn profit. Profit is the difference between the amounts received from customers for goods or services and the amounts paid for the inputs used to provide the goods or services. Businesses range in scale from a  sole proprietorship  to an international corporation.

3. Types of Businesses

4. Forms of Businesses

5. B. Partnership

6. C. Corporation

7. What is Accounting? Accounting is an information system that identifies, records and communicates the economic events of an organization to interested user. It is a process of identifying, analysing, measuring, recording, classifying, s ummarizing, reporting and i nterpreting the financial information or economic events of an entity to the decision-makers/interested users. Accounting  is “the language of business.”  This is because accounting is the means by which businesses’ financial information is communicated to users.

8. Cont. It is the  language  that Companies use to communicate the firm's financial information to interested parties such as Investors, Creditors etc. It is used as a means to exchange information among interested parties concerning the financial performance, financial position and related issues of an organization. Financial information refers to quantitative information expressed in monetary terms.

9. Generally, accounting involves the following steps: Identifying - tracing and collecting recordable economic activities. Accounting does not record and report all economic activities of an organization. Rather, it records and reports only those economic activities of the organization which can be expressed in terms of money. Analyzing and Measuring - This involves determining whether the economic activities bring changes (increase/decrease) assets, liabilities, capital, revenues, and/or expenses of an organization and expressing the changes in monetary terms. Recording - make, in a systematic way, a record of the effects of economic activities on assets, liabilities, capital, revenues and expenses.

10. Cont. Classifying - grouping recorded effects of economic activities into meaningful classes. Summarizing - gathering and arranging data needed for preparation of reports and statements. Reporting - preparing statements and reports in a manner that suits the need of users so as to communicate information useful for decision making. Interpreting - provide explanation on reported information so that users can understand and use the information as a basis for decision making.

11. Cont. The process by which accounting provides information to users is as follows: 1. Identify users. Internal and External 2. Assess users’ information needs. What type of accounting information they need? E.g some may need profit information others may need assets, liability information and so forth. 3. Design the accounting information system to meet users’ needs. 4. Record economic data about business activities and events. Record business transactions in the accounting book of the entity called Journal (will be discussed in Ch-2). 5. Prepare accounting reports for users. Income statement, Owner’s equity statement or Retained earning statement, Statement of financial position and Cash flow statement.

12. Users of Accounting Information 1. Internal users of accounting information include managers and employees. These users are directly involved in managing and operating the business. The area of accounting that provides internal users with information is called managerial accounting or management accounting. The objective of managerial accounting is to provide relevant and timely information for managers’ and employees’ decision-making needs. Often times, such information is sensitive and is not distributed outside the business . Examples of sensitive information might include information about customers, prices, and plans to expand the business. Managerial accountants employed by a business are employed in private accounting (it will be discussed later)

13. Users of Accounting Information 2. External users of accounting information include customers, creditors, investors, suppliers, government etc. These users are not directly involved in managing and operating the business. The area of accounting that provides external users with information is called F inancial Accounting . The objective of financial accounting is to provide relevant and timely information for the decision-making needs of users outside of the business. For example, financial reports on the operations and condition of the business are useful for banks and other creditors in deciding whether to lend money to the business.

14. Cont. General-purpose financial statements is the most common type of financial accounting report that is distributed to external users. The term general-purpose refers to the wide range of decision-making needs that these reports are designed to serve. C ompanies prepare a single set of  general-purpose financial statements aims to provide useful financial information about the reporting entity to interested users. Users expect these statements to present the company’s financial operations fairly, completely, and clearly.

15. Characteristics of Accounting Information Accounting information is mainly quantitative expressed in monetary terms. To be useful for decision making, accounting information should be: Reliable - represent facts, neutral, free material errors and bias. Relevant - highly related to and make a difference in decision. Understandable - users with a reasonable knowledge of accounting and economic activities should be able to easily understand and interpret the information.

16. The Role of Accounting in Business To identifying, recording and communicating the economic events of an organization to interested users. To prepare financial statements such as income statement, statement of financial position, owner’s equity statement and cash flow statement. To prepare necessary notes and disclosures to the users about the financial performances and positions of the organization. To perform the managerial functions for the organization i.e ; business and non-business activities maintaining, budgeting, standard-setting, controlling and decision making. To analyse and interprets financial activities for next rectifying and improvements.

17. Bookkeeping versus Accounting Bookkeeping refers to the art of recording, in a prescribed and systematic way, the economic activities of an organization. It is routine and clerical in nature. Accounting, on the other hand, goes beyond bookkeeping and is concerned with: Designing accounting and reporting systems. Recording economic activities. Preparing reports and statements. Interpreting reported information and Reviewing records and reports for their accuracy. Thus, it can be safely concluded that bookkeeping is one and the simplest part of accounting.

18. Opportunities for Accountants Numerous career opportunities are available for students majoring in accounting. Currently, the demand for accountants exceeds the number of new graduates entering the job market. This is partly due to the increased regulation of business caused by the accounting and business frauds. Also, more and more businesses have come to recognize the importance and value of accounting information . 1. Accountants employed by an entity are said to be employed in private accounting .

19. Opportunities for Accountants Private accountants have a variety of possible career options within a company. Under private accounting, a ccountants can be employed by companies, government, and not-for-profit entities on the basis of salary. They may be employed as Bookkeeper, Payroll clerk, Certified Payroll Professional (CPP), General accountant, Budget analyst or officer , Cost accountant, F inancial M anager , Certified Management Accountant (CMA), Internal auditor, Certified Internal Auditor (CIA ), Information technology auditor etc.

20. Cont. 2. Public Accounting :- Accountants employed individually or within a public accounting firm in tax, general consultant service , audit services etc. Accountants who provide audit services, called auditors, verify the accuracy of financial records, accounts, and systems. S everal private accounting careers have certification options. Accountants and their staff who provide services on a fee basis are said to be employed in public accounting. In public accounting, an accountant may practice as an individual or as a member of a public accounting firm. Public accountants who have met a state’s education, experience, and examination requirements may become Certified Public Accountants (CPAs ). CPAs generally perform general accounting, audit, or tax services. The required certification at the international level is having Certified Public Accountant (CPA)

21. Role of Ethics in Accounting and Business The objective of accounting is to provide relevant, timely information for user decision making. Accountants must behave in an ethical manner so that the information they provide will be trustworthy and, thus, useful for decision making. Managers and employees must also behave in an ethical manner in managing and operating a business. Otherwise , no one will be willing to invest in or loan money to the business.

22. Role of Ethics in Accounting and Business Ethics are moral principles that guide the conduct of individuals. Unfortunately , business managers and accountants sometimes behave in an unethical manner. A number of managers of the companies engaged in accounting or business fraud. These ethical violations led to fines, firings, and lawsuits. In some cases, managers were criminally prosecuted, convicted, and sent to prison. E.g American International Group, Inc. (AIG) inflate its performance u sed sham accounting transactions. This led to CEO resigned. Executives criminally convicted. AIG paid $126 million in fines.

23. International Financial Reporting Standards (IFRS) IFRS:- a common set of standards that indicates how to report economic events. Financial accountants follow International Financial Reporting Standards (IFRS) in preparing reports. These reports allow investors and other users to compare one company to another. International Accounting Standard bord (IASB) has the primary responsibility for developing accounting principles. The objective of IASB is to develop and improve accounting standards (IFRS ). The objective of IFRS is to provide financial information about the reporting entity that is useful to interested users. IFRS are considered to be more “principles-based” than U.S. GAAP, which is considered to be more “rules-based.”

24. Cont. 1 . Business Entity Concept:- T he business is viewed as an entity separate from its owners, creditors, or other businesses. For example, the accountant for a business with one owner would record the activities of the business only and would not record the personal activities, property, or debts of the owner. Under this principle, the activities of a business are recorded separately from the activities of its owners, creditors, or other businesses. 2 . The Monetary unit concept:- R equires that economic data be recorded in birr, dollars etc. Money is a common unit of measurement for reporting financial data and reports.

25. 3 . Measurement Principles Fair value measurement : indicates that assets and liabilities should be reported at market value. IFRS and the IFRS for SMEs require (or permit) fair value measurement for a number of assets and liabilities. Existing Ethiopian Reporting does not permit use of fair value measurement except in financial institutions. This measurement principle provides more relevant or useful and reliable information for decision making than historical cost principle.

26. Cont. 3.1. Cost Principle (Historical) – states that companies record assets at their cost. Assets are reported at cost when purchased and also over the time the asset is held. To illustrate, assume that Aaron Publishers purchased the following building on February 20, 2008: Price listed by seller on January 1, 2008 $160,000, Aaron Publishers’ initial offer to buy on January 31, 2008 140,000, Purchase price on February 20, 2008 150,000, Estimated selling price on December 31, 2010 220,000 and Assessed value for property taxes, December 31, 2010 190,000. Under the cost concept, Aaron Publishers records the purchase of the building on February 20, 2008, at the purchase price of $150,000. The other amounts listed above have no effect on the accounting records.

27. Cont. 4 . The objectivity concept:- Indicates that the amounts recorded in the accounting records be based on objective evidence. Only the final agreed-upon amount is objective enough to be recorded in the accounting records. 5 . Periodicity principle: It states that an organization can report its financial results within certain designated periods of time. This typically means that an entity consistently reports its results and cash flows on a monthly, quarterly, or annual basis. The economic life of business can be divided into artificial time periods usually on annual basis.

28. Cont. 6 . Going Concern/Continuity Assumption - the life of an economic entity is indeterminate and the economic entity will continue in operation long enough to carry out its existing objectives and commitments. 7 . Revenue and expense recognition principle (Accrual Basis principle): It states that revenues  are  recognized  when earned and  expenses are recognized when consumed or incurred (accrual basis of accounting). 8 . Matching principle :  It states that expenses incurred during a period be recorded in the same period in which the related revenues are earned. This principle recognizes that businesses must incur expenses to earn revenues . (The remaining IFRS standards will be discussed in Intermediate Accounting I Course)

29. Exercise 1. Combining the activities of Kellogg and General Mills would violate the A. C ost principle. C. E conomic entity assumption. B. M onetary unit assumption. D. Ethics principle. 2 . A business organized as a separate legal entity under state law having ownership divided into shares is a A. P roprietorship. C. P artnership. B. C orporation. D. Sole proprietorship.

30. The Basic Accounting Equation Accounting Equation shows the mathematical r elationship among the assets, liabilities and equity of a business. A ssets are resources controlled by a business and provide future benefits. Examples of assets include cash, land, buildings, and equipment etc. The rights or claims to the assets are divided into two types: (1) the rights of creditors and (2) the rights of owners. The rights of creditors are the debts of the business and are called liabilities . The rights of the owners are called owner’s equity . The following equation shows the relationship among assets, liabilities, and owner’s equity: Assets = Liabilities + Equity

31. Cont. Liabilities usually are shown before owner’s equity in the accounting equation because creditors have first rights to the assets. However, owners have residual right over the assets of an entity. Provides the underlying framework for recording and summarizing economic events. Applies to all economic entities regardless of size.

32. Cont. The expanded Accounting Equation is as follows: Assets =Liabilities +Share Capital + Retained Earning ( For Corporate business) OR Assets =Liabilities +Share Capital + Revenue-Expense – Dividend ( For Corporate business) OR Assets =Liabilities +Owner’s investment+ Revenue - Expense – Owner’s withdrawal (For non corporate business ) The equation must be in balance after every transaction.

33. Cont. According to IFRS, assets are defined as resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity.” Liability is a present obligation of an entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits ” Some examples of liability are Bank loan payable, Bond payable, Accounts payable, Salary payable, Tax payable etc. Equity = assets – liabilities (‘net financial position’)

34. Cont. Revenue :- are total incomes generated from performing operative activities. Generally results from selling merchandise, performing services, renting property, and lending money. It is the i ncreases in economic benefits or returns during the accounting period in the form of enhancements of assets or decreases of liabilities that result in increases in equity. E.g. Sales, Service revenue, Rent   revenue, Dividend   revenue, Interest   revenue etc.

35. Cont. Expense :- are the cost of assets consumed or services used in the process of earning revenue. It is the d ecreases in economic benefits during the accounting period in the form of outflows or reductions of assets or incurrences of liabilities that result in decreases in equity or i t is the d ecreases in assets. Common examples of expenses are salaries expense, rent expense, utilities expense, tax expense, etc. Utilities expense  is the cost incurred by using utilities such as electricity, water etc.

36. Cont. Dividends are the distribution of cash or other assets to shareholders or the portion of net income distributed to shareholders. Reduce retained earnings Not an expense

37. Exercise :- Classify the following items as issuance of shares, dividends, revenues, or expenses. Then indicate whether each item increases or decreases equity . . Classification Rent expense Service revenue Dividends Salaries expense Expense Decrease Revenue Increase Dividends Decrease Expense Decrease Effect on Equity

38. Business Transactions and the Accounting Equation Transactions are a business’s economic events or activities recorded by accountants. Economic events that affect the financial performance or position of an entity. E.g. P aying a monthly telephone bill of $ 168, affects a business’s financial condition because it now has less cash on hand, purchasing land for $50,000, Paying $10,000 salary to employees, borrowing $ 100,000 cash from bank, selling of goods at $ 2,000 etc. Transactions may be external or internal. Not all activities represent business transactions. Each transaction has a dual effect on the accounting equation and the effect may be only in the left/right or both side of the accounting equation.

39. Exercise :- Are the following events recorded in the accounting records? And a nalyze the effects of business transactions on the accounting equation. . Event Purchase computer. Criterion Is the financial position (assets , liabilities, or equity ) or financial performance (income) of the company changed? Discuss product design with customer. Pay rent. Record/ Don’t Record

40. Illustration: Transactions Analysis Consider the following business transactions, and identify which component of the accounting equation is affected and analyze the effect (increase or decrease) of the following transactions on the basic accounting equation. Transaction (1). Investment by Shareholders. Alex decides to open a computer programming service entity which he names Softbyte . On September 1, 2011, He invest $15,000 cash in exchange for capital shares. Transaction (2). Purchase of Equipment for Cash. Soft byte purchases computer equipment for $7,000 cash. Transaction (3). Purchase of Supplies on Credit. Soft byte purchases for $1,600 from Acme Supply Company computer paper and other supplies expected to last several months.

41. Cont. Transaction (4). Services Provided for Cash. Softbyte receives $1,200 cash from customers for programming services it has provided. Transaction (5). Purchase of Advertising on Credit. Softbyte receives a bill for $250 from the Daily News for advertising but postpones payment until a later date. Transaction (6). Services Provided for Cash and Credit. Softbyte provides $3,500 of programming services for customers. The company receives cash of $1,500 from customers, and it bills the balance of $2,000 on account. Transaction (7). Payment of Expenses. Softbyte pays the following Expenses in cash for September: store rent $600, salaries of employees $900, and utilities $200.

42. Cont. Transaction (8). Payment of Accounts Payable. Softbyte pays its $250 Daily News bill in cash. Transaction (9). Receipt of Cash on Account. Softbyte receives $600 in cash from customers who had been billed for services [in Transaction (6)]. Transaction (10). Dividends. The corporation pays a dividend of $1,300 in cash.

43. Tabular summary of Softbyte transactions .

44. Cont. You should note the following in the above business transaction summary: 1. The effect of every transaction is an increase or a decrease in one or more of the accounting equation elements. 2. The two sides of the accounting equation are always equal. 3. The owner’s equity is increased by amounts invested by the owner and is decreased by withdrawals by the owner. In addition, the owner’s equity is increased by revenues and is decreased by expenses.

45. Financial Statements After transactions have been recorded and summarized, reports are prepared for users. The accounting reports providing this information are called financial statements . The primary financial statements of a proprietorship are the income statement, the statement of owner’s equity, the balance sheet, and the statement of cash flows. The order that the financial statements are prepared and the nature of each statement is described as follows.

46. Financial Statements are prepared in the following order: A. Income statement:- A summary of the revenue and expenses for a specific period of time, such as a month or a year. This statement reports the revenues and expenses for a period of time, based on the matching concept . This concept is applied by matching the expenses with the revenue generated during a period by those expenses. The excess of the revenue over the expenses is called net income or net profit . If the expenses exceed the revenue, the excess is a net loss . Net income for a period increases the owner’s equity (capital) for the period. A net loss decreases the owner’s equity (capital) for the period.

47. Cont. Reports the revenues and expenses for a specific period of time. Net income – revenues exceed expenses. Net loss – expenses exceed revenues.

48. Cont. B. Statement of owner’s equity:- A summary of the changes in the owner’s equity that have occurred during a specific period of time, such as a month or a year. It is prepared after the income statement because the net income or net loss for the period must be reported in this statement. Similarly, it is prepared before the balance sheet, since the amount of owner’s equity at the end of the period must be reported on the balance sheet. Because of this, the statement of owner’s equity is often viewed as the connecting link between the income statement and balance sheet . It applies to proprietorship and partnership (it is called capital statement for partnership business ) form of business.

49. Retained Earning Statement:- indicates the reasons why retained earnings has increased or decreased during the period . R etained earnings   statement applies to corporations . I t p resents changes in equity during the reporting period. The report format varies, but can include the sale or repurchase of shares , dividend payments, and changes caused by reported profits or losses.

50. Cont. C. Statement of Financial Position :- A list of the assets, liabilities, and owner’s equity as of a specific date, usually at the close of the last day of a month or a year. It reports the amounts of the company's’ assets, liabilities, and owner’s equity as of the specific date (the date at the end of the accounting period). The asset and liability amounts are taken from the last line of the summary of transactions. Capital as of the end of the accounting period, is taken from the statement of owner’s equity. There are two forms of Balance Sheet (1) A ccount form (2) Report form

51. Cont. A ccount form:- it resembles the basic format of the accounting equation, with assets on the left side and the liabilities and owner’s equity sections on the right side. Report form:- All components of the accounting equation (Assets, Liabilities and Capital) are reported consecutively. The assets section of the balance sheet presents assets in the order that they will be converted into cash or used in operations. Cash is presented first, followed by receivables, supplies, prepaid insurance, and other assets. The assets of a more permanent nature are shown next, such as land, buildings, and equipment ( Under GAAP), but under IFRS the inverse is used.

52. Statement of Financial Position

53. Cont. D. Statement of cash flows:- A summary of the cash receipts and cash payments for a specific period of time , such as a month or a year. The statement of cash flows consists of three sections, as (1) operating activities, (2) investing activities, and (3) financing activities. Each of these sections is briefly described below. Cash Flows from Operating Activities This section reports a summary of cash receipts and cash payments from operations. The net cash flow from operating activities normally differs from the amount of net income for the period.

54. Cont. 2. Cash Flows from Investing Activities:- This section reports the cash transactions for the acquisition and sale of relatively permanent assets. 3. Cash Flows from Financing Activities:- This section reports the cash transactions related to cash investments by the owner, borrowings, and withdrawals by the owner. Preparing the statement of cash flows requires that each of the September cash transactions for Softbite be classified as operating, investing, or financing activities. Answers the following: Where did the cash come from? What was cash used for? What was the change in the cash balance?

55. Statement of cash flows

56. Cont. All financial statements are identified by the name of the business, the title of the statement, and the date or period of time. The data presented in the income statement, the statement of owner’s equity, and the statement of cash flows are for a period of time. The data presented in the statement of financial position (balance sheet) are for a specific date. Generally, Financial statements are prepared in the order of the income statement, statement of owner’s equity, statement of financial position (balance sheet), and statement of cash flows. This order is important because the financial statements are interrelated.

57. Exercise Net income will result during a time period when: assets exceed liabilities. assets exceed revenues. expenses exceed revenues. revenues exceed expenses.

58. Review Question Cecil Jameson, Attorney-at-Law, is a proprietorship owned and operated by Cecil Jameson. On July 1, 2009, Cecil Jameson, Attorney-at-Law, has the following assets and liabilities: cash, $1,000; accounts receivable, $3,200; supplies, $850; land, $10,000; accounts payable, $1,530. Office space and office equipment are currently being rented, pending the construction of an office complex on land purchased last year. Business transactions during July are summarized as follows:

59. Review Question a. Received cash from clients for services, $3,928. b. Paid creditors on account, $1,055. c. Received cash from Cecil Jameson as an additional investment, $3,700. d. Paid office rent for the month, $1,200. e. Charged clients for legal services on account, $2,025. f. Purchased supplies on account, $245. g. Received cash from clients on account, $3,000. h. Received invoice for paralegal services from Legal Aid Inc. for July (to be paid on August 10), $1,635. i . Paid the following: wages expense, $850; answering service expense, $250; utilities expense, $325; and miscellaneous expense, $75. j. Determined that the cost of supplies on hand was $980; therefore, the cost of supplies used during the month was $115. k. Jameson withdrew $1,000 in cash from the business for personal use.