Unit 1: Introduction To Accounting

UNIT 1: INTRODUCTION TO
ACCOUNTING
What is Accounting?
The primary objective of accounting is to provide

information that is useful for decision-making purposes.
From the very start, we emphasize that accounting is not
an end, but rather it is a means to an end. The final
product of accounting information is the decision that is
enhanced by the use of that information, whether the
decision is made by owners, management, creditors,
governmental regulatory bodies, labor unions, or the
many other groups that have an interest in the financial
performance of an enterprise.
ACCOUNTING - THE BASIS OF

DECISION MAKING
Accounting is the language of business
Accounting is the information system that

Measures business activities

Processes that information into reports
Communicates the results to decision makers
What is Accounting?
Interpret
and record
business
transactions.
Classify
similar
transactions
into useful
reports.
Summarize
and
communicate
information to
decision
makers.
THE ACCOUNTING SYSTEM:

THE FLOW OF INFORMATION
1. People make decisions
2. Business transactions occur
3. Businesses prepare reports to show the

results of their operations
Who uses accounting data?

Owners
Creditors
Labor unions
Governmental agencies
Suppliers
Customers
Trade associations
General public
Users of accounting information
regulators
consumers
Tax officials
lenders
Financial
markets
suppliers
FIRM
Managers Interaction with External Parties

7
USES OF ACCOUNTING
MANAGERS need INFORMATION:

To determine how to operate the business

To decide on which investments to make
To finance the companys operations
INVESTORS need INFORMATION:

To help them to make better decisions on which

investments to take
Who Uses Accounting Information?

Individuals
Government
regulatory
agencies
Businesses
Taxing
authorities
Investors and
creditors
Nonprofit
organizations
9
HOW THEY USE ACCOUNTING

INFORMATION?
INDIVIDUALS:

BUSINESSES (BUSINESS MANAGERS):

To set goals, evaluate them and take corrective actions
INVESTORS:

To make investment decisions

To manage a checking account
To decide whether to invest or not

To evaluate an investment
CREDITORS:
To evaluate a borrowers ability to make required payments
10
HOW THEY USE ACCOUNTING

INFORMATION? (Cont.)
GOVERNMENT REGULATORY AGENCIES:

TAXING AUTHORITIES
To determine the amount of tax due
NON-PROFIT ORGANIZATIONS
To determine if government regulations have been followed
Use accounting as a for-profit organization
OTHER POTENTIAL USERS:

e.g. employees, labour unions, etc.
11
Internal Users
Board of directors
Chief executive officer (CEO)
Chief financial officer (CFO)
Vice presidents
Business unit managers
Plant managers
Store managers
Line supervisors
12
Financial information and financial markets

The relationship between financial information and security

prices can influence investors direct demand for financial
information
Evidence shows:
Annual earnings are not timely information and are preempted by

alternative, more timely sources
However, significant price reaction was found in the week of the
anouncement of annual earnings
Prices act as if earnings anouncements alter investors belief in such a
way as to alter the price o security
13
ACCOUNTING VS.
BOOKKEEPING
Bookkeeping provides a systematic record of

business events based on accounting
policies
Bookkeeping refers to the books in which
accountants record transactions. People think
that accountants simply count carefully, and
keep records, but accounting transcends
counting.
14
ACCOUNTING VS.
BOOKKEEPING
Accounting
process
includes
the
bookkeeping function. However, accounting
also includes much more.
Bookkeeping usually only involves the
recording of economic events.
Accounting involves the entire process of
identifying, recording and communicating
economic events.
15
The notion of accounting
Accountants:
measure, record
Economic
environment
communicate
USERS
Beliefs &
Perceptions
16
Accounting as communication of financial information:

from income measurement to the informational approach
Management is the
steward to whom capital
suppliers entrust control
over a portion of their
financial resources
Purpose of financial
statements is to provide
a report to capital suppliers
to facilitate their evaluation
of managements
stewardship
Income
measurement
Financial data have to

facilitate contracting
between parties such
as management and
investors
Financial data have to

facilitate decisions
makers in selecting the
best action among
available alternatives
Informational
approach
17
Types of Accounting
Financial accounting

Information for users outside the firm

e.g. investors, creditors, governments
Managerial Accounting

Information for internal users

e.g. managers, other internal decision makers
18
Internal vs external users

Internal => management accounting

More focused and detailed information

Feed back possible
Managers can take corrective actions
External => financial accounting (annual

reports)

Global information
No influence on the reporting process
Relevant for parties not involved in the day-to-day
operations
19
Regulation
The role of capital markets
as fund providers
Economic consequences
of financial information
Managerial incentives to
suppress unfavorable
information
Need for regulation

20
ACCOUNTING PRINCIPLES
AND CONCEPTS
Generally accepted accounting

principles (GAAP) are:
Guidelines that govern how accountants

Measure
Process
Communicate
Financial information
Based upon a conceptual framework
21
Accounting Principles and Concepts

Financial Accounting Standards Board

(FASB) establishes US GAAP
GAAP Generally Accepted Accounting

Principles
GAAP is derived from the conceptual framework
Other parties involved in defining how

accounting should be practised:

SEC: Securities and Exchange Commission

AICPA
22
KEY US ACCOUNTING ORGANIZATIONS

Public Sector
Law creates the SEC to
regulate the stock and
bond market in the U.S.
Private Sector
Accountants apply
GAAP through
the AICPA
GAAP governs
accounting
information
Private Sector
The FASB determines
generally accepted
accounting principles
23
KEY SPANISH ORGANIZATIONS

(relevant for the Accounting practice)

Ministry of Treasury
ICAC

Bank of Spain
UE Comission
CNMV
Instituto de Contabilidad y Auditora de Cuentas
Similar to SEC
AECA
Asociacin Espaola de Contabilidad y Auditora
24
Forms of Business Organization

Three major forms of organization

These forms differ with respect to

number of owners,
degree of liability for debts of the business
Who pays if the company fails to repay its debts?
Status of legal entity
25
Business Organizations
Types of organizations:
Proprietorship
Partnership
Corporation
26

Proprietorship

Has a single owner

Proprietor is personally liable for debts of the
business

Unlimited liability
Owner assumes personal responsibility

Actions can be taken against any of his goods
Not a separate legal entity

For accounting, the proprietorship is a separate
entity from the proprietor
27

Partnerships

Two or more partners are co-owners

Each partner can be liable for all the debts of the
partnership

Each partner has unlimited liability
Not a separate legal entity

For accounting, the partnership is a separate
entity from its partners
28

Corporations

May have many owners (stockholders)

Ownership represented by shares
Stockholders are not personally liable for debts of the
business
They have limited liability
Is a separate legal entity
Stockholders elect a Board of Directors to appoint corporate
officers and set policies
It has many of the rights a person is entitled to:
Right to enter into contracts
Right to sue and be sued
Right to own, buy and sell property
29
Conceptual Framework
Accounting provides information useful for

decision making
To be useful, information must be

Relevant able to influence a decision

Reliable verifiable and free from error
Comparable can be compared with different
companies
Consistent can be compared from one period to
the next
30
ACCOUNTING PRINCIPLES AND CONCEPTS
They are present in the elaboration of all

accounting information
They are mainly, five:

Entity concept
Reliability principle
Cost principle
Going-concern concept
Stable-monetary-unit concept
31
The entity concept

States that an organization is an economic

unit that keeps its affairs separate from
those of the owner(s) or other entities
Example: the company sells the products,
not the owner.
32
The reliability (or objectivity) principle

States that accounting records and statements

should be based on accurate data.
Use the most reliable data available and
documented by objective evidence
Actual cost is usually more reliable than market
value
Data is reliable if:

It is verifiable
It can be confirmed by an independent observer
33

The cost principle

States that acquired assets and services should be

recorded at their actual (historical) cost and should
maintain that historical cost for as long as they are
owned
34
The going-concern concept

States that the entity will remain in operation for

the foreseeable future
35

The stable-monetary-unit concept

States that each dollar has the same purchasing

power as any other dollar at any other time
It allows accounts to ignore the effect of inflation in
the accounting records
36
THE ACCOUNTING EQUATION

The accounting equation presents the

resources of the business and the claims to
those resources
Economic Resources = Claims to Economic Resources

or
37
ACCOUNTING EQUATION
Total Assets
=
Total Liabilities
+
Total Stockholders Equity
38
The Accounting Equation

Assets = Liabilities + Owners Equity
Economic
Resources
Claims to
Economic
Resources
39
ACCOUNTING EQUATION
IT SHOWS THE EQUALITY BETWEEN THE ASSETS

(what the company owns) AND THE CLAIMS TO THEM
FINANCIAL STATEMENTS ARE BASED ON THE

ACCOUNTING EQUATION
40

Assets are the economic resources of a

business that are expected to be of benefit in
the future
Claims to assets come from

Liabilities
Owners equity (capital)
41
The Accounting Equation

Liabilities are debts payable to outsiders, called

creditors
Owners Equity represents the ownership of the

owners

It is the owners claim on the entitys assets

Also known as Stockholders equity
It can be obtained by substracting::
Assets Liabilities = Owners Equity

42

In a corporation, Owners equity is knows as

Stockholders equity
Stockholders equity consists of two main

categories:

Paid-in capital
Retained earnings
Assets = Liabilities + Stockholders Equity

or
Assets = Liabilities + Paid-in Capital + Retained Earnings
43

Paid-in (contributed) capital is

The amount invested in the corporation by its

owners
Comprised basically of common stock
44

Retained earnings
Is the amount earned by income-producing

activities and kept for use in the business
Is affected by
Revenues - increases in retained earnings from

delivering goods or services
Expenses - decreases in retained earnings that result
from operations
45
COMPONENTS OF RETAINED EARNINGS
Revenues for the

Period
Expenses for the

Period
Start of the
Period
Beginning Balance
of Retained
Earnings
End of the
Period
=
+
-
Net Income (Loss)

for the Period
Dividends for the

Period
Ending Balance of
Retained
Earnings
46
OTHER IMPORTANT ACCOUNTING CONCEPTS

Net income (net earnings)

Net loss
Total revenues exceed total expenses

Total expenses exceed total revenues
Dividends
Distributions to stockholders (usually cash)

generated by net income
47
OWNERS EQUITY
REVENUESINCREASE NET INCOME

RETAINED EARNINGS
EXPENSESDECREASE NET INCOME

RETAINED EARNINGS
DIVIDENDSDECREASE RETAINED EARNINGS

48
OWNERS EQUITY SPECIAL

SITUATIONS
The owners equity of proprietorships and

partnerships
Makes no distinction between paid-in capital and

retained earnings
It does not distinguish what is invested from what is

earned
Accounts for the equity of each owner under the

single heading of Capital
49
THE ACCOUNTING CYCLE AND

In financial accounting, there are basically

nine steps from beginning to end. Although
you will be learning all these steps in detail in
the next few chapters, it may be a good time
for you to get a sneak preview of what
accounting is all about
50
THE ACCOUNTING CYCLE AND
51

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UNIT 1: INTRODUCTION TO

The primary objective of accounting is to provide

ACCOUNTING - THE BASIS OF

Accounting is the language of business

Accounting is the information system that

Measures business activities

THE ACCOUNTING SYSTEM:

1. People make decisions

2. Business transactions occur

3. Businesses prepare reports to show the

Who uses accounting data?

Users of accounting information

Managers Interaction with External Parties

MANAGERS need INFORMATION:

To determine how to operate the business

INVESTORS need INFORMATION:

To help them to make better decisions on which

Who Uses Accounting Information?

HOW THEY USE ACCOUNTING

BUSINESSES (BUSINESS MANAGERS):

To set goals, evaluate them and take corrective actions

To make investment decisions

To decide whether to invest or not

To evaluate a borrowers ability to make required payments

HOW THEY USE ACCOUNTING

GOVERNMENT REGULATORY AGENCIES:

To determine the amount of tax due

To determine if government regulations have been followed

Use accounting as a for-profit organization

OTHER POTENTIAL USERS:

e.g. employees, labour unions, etc.

Financial information and financial markets

The relationship between financial information and security

Annual earnings are not timely information and are preempted by

Bookkeeping provides a systematic record of

The notion of accounting

Accounting as communication of financial information:

Financial data have to

Financial data have to

Information for users outside the firm

Information for internal users

Internal vs external users

Internal => management accounting

More focused and detailed information

Managers can take corrective actions

External => financial accounting (annual

Need for regulation

Generally accepted accounting

Guidelines that govern how accountants

Accounting Principles and Concepts

Financial Accounting Standards Board

GAAP Generally Accepted Accounting

Other parties involved in defining how

SEC: Securities and Exchange Commission

KEY US ACCOUNTING ORGANIZATIONS

KEY SPANISH ORGANIZATIONS

Instituto de Contabilidad y Auditora de Cuentas