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Chapter 1Principles of
Accounting
Uses of Accounting
Information and theFinancial Statements
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CVS: How Is Success Measured?
Learn more about the company at
CVS.com
More than 5,000 stores
Quality products
Holds #1 or #2 marketshare in 73% of the top100 markets in which itserves
Large selection
Good service
Strong management
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Accounting as an Information System
LO1
Define accounting, and
describe its role in
making informed
decisions, identify
business goals and
activities, and explain
the importance of ethicsin accounting.
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What Is Accounting?
Accounting is an
information system
that measures,
processes, and
communicatesfinancial information
about an economic
entity
Supplies information for reasoned choices among
alternative uses of scarce resources in business and
economic activities
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Economic Entity: Business
Economic
unit that aims
to sell goods
and servicesto customers
Provides adequate return to owners
Examples:Wal-Mart, Best Buy,Wendys
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Why Is AccountingImportant to Business?
To achieve
business goals
Profitability
Liquidity
To carry on
business activities
Operating
Investing
Financing
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Meeting Business Goals
Profitability
Is the business
earning enough
income to attract
and hold
investment
capital?
Liquidity
Does the
business have
enough cash to
pay debts when
they are due?
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Conducting Business Activities
Operating
Activities
Investing
Activities
Financing
Activities
Buying land,buildings, and
equipment Purchasing other
resourcesnecessary tooperate thebusiness
Selling theseresources when nolonger needed
Obtaining capitalfrom creditors
Gathering fundsfrom owners
Repaying creditors
Paying returns toowners
Selling goods and
services to
customers
Employing
managers and
workers
Buying and
producing goodsand services
Paying taxes
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Performance Measures
Indicate whethermanagers areachievingbusiness goals
and whetherbusinessactivities are wellmanaged
Should be crafted in a way that motivates managers to
act in the best interests of the owners of the business
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Performance Measures: Ratios
Used to compare a companys financialperformance from one year to the next
Helpful when making comparisons among
companies
Examples:
Total Liabilities / Total Assets
Total Expenses / Total Revenues
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Who Needs Accounting Information?
Internal Users External Users
Management Accounting
Information about past
performance and what canbe expected in the future
Financial Accounting
Financial statements
report on profitability andliquidity to evaluate the
success of a business
Employees
Managers
Creditors
Government regulators
Owners (or stockholders)
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Components of Accounting
AccountingRecord Transactions:
Bookkeeping
System
Design
Analyze & Interpret
Information
Communicate
Information
Processing can be
done:
Manually, By computer, or
Using a
management
information system
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Importance ofEthics
in Financial Reporting Users of reports depend on
the good faith of those who
prepared the reports
Users rely on the accuracy ofthe reports and the disclosureof all relevant facts
Investors make decisions
based on the reliability of
the reports
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Sarbanes-Oxley Act
Chief executives and chief financial officers ofall publicly traded U.S. companies must attestto the accuracy and completeness of their
quarterly statements and annual reports filedwith the SEC
On theWeb
Violations can result in criminal penalties
Want to learn more about the legislation?
Sarbanes-Oxley.com
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Management Responsibility
What assurance does management give that a companysreports are not false or misleading?
Research: Find the current years annual report forCVS
on the companys website and locate ManagementsReport.What language is used?
CVSs SEC Filings
W
e are responsible for establishing and maintaining effective internalcontrol over financial reporting. . . . the unauthorized acquisition, use or
disposition of assets are prevented or timely detected and that transactions
are authorized, recorded and reported properly to permit the preparation of
financial statements in accordance with GAAP and receipt and expenditures
are duly authorized.
On theWeb
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Stop & Review
Q.What is accounting and what business goals
does it help managers achieve?
A. Accounting measures, processes, andcommunicates financial information about
an economic entity. It helps managers
achieve the goals of profitability andliquidity.
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Stop & Review
Q.What is the difference between management
accounting and financial accounting?
A. Management accounting provides internalusers like managers and employees with
information to make operating decisions.
Financial accounting provides financialstatements to external users like creditors
and owners.
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Decision Makers:
The Users of Accounting Information
LO2Identify
the users of
accounting
information.
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Who Uses
Accounting Information?
ThoseWith Direct
Financial Interests
Management ThoseWith Indirect
Financial Interests Finance
Investment
Operations &Production
Marketing
Human
Resources
Accounting
TaxAuthorities
Regulators Labor Unions
Customers
Economic
Planners
Owners
Creditors
Banks
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If You Were a Manager
Making good financial decisions requiresreliable accounting information.
Does my company have enough cash?
Which products are most profitable?
Is the rate of return to owners adequate?
What is the cost of manufacturing each
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Users with Direct Financial Interests
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Require financial
information toanalyze the past
success and potential
earnings ofa business
Creditors
Require financial
information toassess whether acompany will havethe cash to repaythe debt beforemaking a loan
Investors
(including Owners)
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Users with Indirect Financial Interests
Labor Unions, ConsumerGroups,Customers, and OtherGroups the financial
performance and prospects ofbusinesses affect the economy,environment, and public policy
Regulatory Agencies publicly traded companies must
report periodically to the SEC
Tax Authorities require special tax returns and
recordkeeping
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Stop & Review
Q. Who are some users of financial information
with an indirect financial interest?
A. Consumer groups, taxing authorities,
government agencies, the general public, andlabor unions are a few groups with an
indirect financial interest in financial
accounting information.
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Accounting Measurement
LO3
Explain the
importance ofbusiness
transactions,
money measure,
and separate
entity.
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Making an Accounting Measurement
What is measured?Business
transactions
Economic events that affect the financial position of a business
Sale of goods
Loss from theft
Collection of loan
Wear and tear on machinery
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Concept of Money Measure
All business transactions
are recorded in terms of
money.
The monetary unit useddepends on the country
in which the business
resides. An exchange rate is used to translate one
currency to another for international
transactions.
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Concept of Separate Entity
A business is considered distinct from its
creditors and customers as well as its owners
Business
reports &
accounts
Personalreports &
accounts
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Stop & Review
Q. If Ray Coldwell has a bank account that he
uses for his personal transactions as well as
his business transactions, is the concept of
separate entity being employed?
A. No. A business must keep its records and
accounting separate from its owners
personal accounts.
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Stop & Review
Q. Describe at least two business transactionsthat affect the financial position of a
business.
A. The sale of goods or services, collection ofa loan, payment of an invoice, or purchase
of supplies are examples of transactions
that affect the financial position of a
business.
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The Forms of Business Organization
LO4
Identify the
three basic
forms of
business
organization.
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Forms of Business
Sole Proprietorship Partnership Corporation One owner
Owner takes all
profits and losses
Owner is liable forall business
obligations
Two or more
owners
Partners share in
profits and losses One partner can
obligate the
business to another
party
Must be dissolvedif ownership
changes
Business unit
chartered by the
state with articles
of incorporation;
legally separatefrom owners
(stockholders)
Stockholders enjoy
limited liability
Life of corporation
is unlimited
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Corporation
Stockholders
Elect a board
of directors
and own
shares ofstock
Board of
Directors
Determines
corporate
policy, declares
dividends, and
appointscorporate
officers
Management
Carries out
corporate
policies and
manages thebusiness
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IMCO Recycling Inc.
View this video to
learn what factors
were considered when
IMCO Recycling
chose its form of
business organization.
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Stop & Review
Q. What are the characteristics of a corporation?
A. A corporation is a separate legal entity
owned by its stockholders. The stockholderselect a board of directors to run the
corporation.
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Financial Position
and the AccountingE
quation
LO5Define financial
position, and state the
accounting equation.
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Financial Position
Economic resources (cash,
inventory, buildings) and
the claims against those
resources at a particularpoint in time
Economic Resources = CreditorsEquities + Owners Equity
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Building the Accounting Equation
Economic Resources = CreditorsEquities + Owners Equity
In accountingterms
Assets = Liabilities + Owners Equity
The two sides of the equation must always be in balance.
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Assets
Economic resources
expected to benefit
the companys future
operations
Patents, trademarks, copyrights (nonphysical)
Inventory, land,
equipment,
buildings (physical
items)
Cash, accounts receivable (monetary items)
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Liabilities
Obligations to pay cash, transfer assets, or provide
services to other entities in the future
May take the form of
accounts payable,
taxes payable, loans,
or wages owed to
employees
Liabilities are claims
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Owners Equity
Claims of the owners of a company to
the assets of the business
Revenues and investmentsincrease owners equity
Expenses and withdrawals decreaseowners equity
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Stop & Review
Q. State the accounting equation.
A. Assets = Liabilities + Owners Equity
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Stop & Review
Q. Can you name a transaction that would
increase both assets and liabilities?
A. The purchase of a piece of equipment onaccount would increase assets and liabilities.
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Stop & Apply
Q. If Abbott Industries had assets of $40
million and liabilities of $22 million,
what is the amount of owners equity?
A. Owners equity = $40 million
$22 million or$18 million
Assets = Liabilities + OwnersE
quity$40 million = $22 million + $18 million
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Financial Statements
LO6
Identify the fourbasic financial
statements.
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Communicating Financial Information
Four primary financial statements
Balance Sheet
Statement of
Cash Flows
Income Statement
Statement ofOwners Equity
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Income Statement
Ramirez AgencyIncome Statement
For the Month Ended December 31, 20xx
R
evenuesCommissions earned $7,000
Expenses
Equipment rental ex pense $1,400Wages ex pense 800Utilities ex pense 600
Total ex penses Net income $4,200
Summarizes
revenues and
expenses over an
accounting
period
Shows whether the goal of
profitability was achieved
Oftenconsidered the
most important
financial
statement
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Statement of Owners Equity
Ramirez Agency
Statement ofOwners Equity
For the Month Ended December 31, 20xx
R. Ramirez, Capital, December 1, 20xxInvestment by R. Ramirez
$ 0100,000
Net income for the month 4,200
Subtotal $104,200Less withdrawals 1,200
R. Ramirez, Capital, December 31, 20xx $103,000
Shows changes inowners equity over
an accounting
period
Net income figure
from income
statement
Use this figure to
prepare the balance
sheet
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Balance Sheet
Ramirez Agency
Balance Sheet
December 31, 20xx
Assets Liabilities
CashAccounts receivableSupplies
$31,2002,0001,000
Accounts payableTotal liabilities
$1,200$1,200
Land 20,000 Owners EquityBuildings 50,000 R. Ramirez, capital 103,000
Total assets $104,200 Total liabilities and owners equity $104,200
Shows financial
position on a
certain date
Ending balance of owners capital
from statement of owners equity
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Statement ofCash Flows
Ramirez Agency
Statement ofCash Flows
For the Month Ended December 31, 20xx
Cash flows from operating activities Net income $4,200Adjustments to reconcile net income to net cash
flows from operating activities
Increase in accounts receivable ($2,000)Increase in supplies (1,000)Increase in accounts payable 1,200 (1,800)
Net cash flows from operating activities $2,400Cash flows from investing activitiesPurchase of land ($20,000)Purchase of building (50,000)
Net cash flows from investing activities (70,000)
Cashflows
from
financing activitiesInvestments by owners $100,000
Withdrawals (1,200)
Net cash flows from financing activities 98,800
Net increase (decrease) in cash $31,200Cash at beginning of month 0
Cash at end of month $31,200
Shows cash inflowsand outflows for an
accounting period
Net income
from income
statement
Matches cash
account on
balance sheet
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Stop & Review
Q. How does the income statement differ from
the balance sheet?
A. The income statement covers an accountingperiod while the balance sheet is a snapshot
of a companys financial position at a
particular date. The income statement
shows whether the company achieved itsprofitability goal.
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Stop & Review
Q. The income statement for MembersPharmacy reported $246,050 in net income.On what other statements would this amount
appear?
A. This amount would appear on the statement
of owners equity and the statement of cash
flows.
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Generally Accepted
Accounting Principles
LO7
Explain how generally
accepted accounting
principles (GAAP)relate to financial
statements and the
independent CPAs
report, and identify the
organizations that
influence GAAP. Royalty-Free/Corbis
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What Are GAAP?
Generally acceptedaccounting principles(GAAP) encompass the
conventions, rules, andprocedures necessary todefine acceptedaccounting practice at a
particular time.
GAAP are constantly growing, changing, and improving
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GAAP and the Audit
Audits are performed by independent CPAs
The CPA renders an opinion about whether the
statements present fairly or conform in all
material respects to GAAP
Audits are performed to determine that
financial statements have been prepared in
accordance with GAAP
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Organizations
That Influence GAAP
GAAP
PublicCompany
Accounting Oversight
Board (PCAOB)
Financial Accounting
Standards Board (FASB)
American Institute of
Certified Public
Accountants (AICPA)
Securities and
Exchange
Commission
(SEC)
GovernmentalAccounting Standards
Board (GASB)
InternationalAccounting Standards
Board (IASB)
Primary source
of GAAP
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Professional Ethics
Key to the accountantsreputation for independence
and competence
The AICPAs code ofprofessional ethics governs
conduct ofCPAs
Is the accountant honest and candid? Does he or sheput aside personal gain in service of the public trust?
Is the accountant impartial and intellectually honest?
Does the accountant avoid all relationships that
impair or appear to impair his or her objectivity?
Integrity
Objectivity
Independence
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Discussion: Ethics on the Job
Carla McDonald is a CPA working on an
audit with Trevor Industries. Teresa Wong,
the staff accountant with Trevor Industries,
invites her and her audit team to dinner at an
expensive restaurant and insists on picking
up the check.
Q. If Carla allows Teresa to pick up the check,
has she violated any ethical standard?Why
or why not?
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Stop & Review
Q. What are GAAP?
A. GAAP are the conventions, rules, and
procedures necessary to define acceptedaccounting practice at a particular time.
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Stop & Review
Q. Which organization is the primary source
of GAAP?
A. The FASB is the most important body fordeveloping rules on accounting practice.
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Chapter Review Problem
Callahan Properties had net income of $52,500 for the year
ended December 31, 20x8. The beginning balance of J.
Callahan, Capital at January 1, 20x8 was $200,000. No
withdrawals were made during the year. Total assets at
December 31, 20x8 were $257,500. Determine total liabilities
at December 31, 20x8.
Solution:
Assets = Liabilities + Owners Equity
$257,500 = X + ($200,000 + $52,500)
$257,500 = X + $252,500
X = $5,000
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