CHAPTER 1: PRINCIPLES OF ACCOUNTING

What is Accounting?
(1) Identify, record, and communicate the economic events of an
(2) Organization to
(3) Interested users.

Three Activities
Identification; select economic events (transactions)
Recording; record, classify, and summarize
Communication; prepare account reports; analyze and interpret for users

The accounting process includes the bookkeeping function.

Who uses the Accounting Data?

Two broad groups of users of financial information:
Internal users; management, human resources, finance, marketing
External users; IRS (internal revenue service), investors, labor unions, creditors, SEC
(Secured exchange commission, costumers)

The building blocks of Accounting

Ethics in Financial Reporting
Standards of conduct by which one’s actions are judged are right or wrong, honest or
dishonest, fair or not fair, are Ethics.
 Recent financial scandals include: Enron, WorldCom, HealthSouth, AIG, and
others.
 Congress passed Sarbanes-Oxley Act of 2002.
 Effective financial reporting depends on sounds ethical behavior.

Various users need financial information > Financial Statement; balance sheets,
income statement, statement of owner’s equity, statement of cash flows, notes
disclosure < Generally Accepted Accounting Principles (GAAP) < the accounting
profession has attempted to develop a set of standards that are generally accepted
and universally practiced.

Organization involved in standard settings:

Securities and Exchange Commission (SEC)
Financial Accounting Standards Board (FASB)
International Accounting Standards Board (IASB)

Cost Principle (Historical) - dictates that companies record assets at their cost.
Issues:
 Reported at cost when purchased and also over the time the assets is held.
 Cost easily verified, whereas market value is often subjective.
 Fair value information may be more useful.
Assumptions

Monetary unit assumption - include in the accounting records only transaction data
that can be expressed in terms of money.
Economic entity assumption - requires that activities of the entity be kept separate
and distinct from the activities of its owner and all other economic entities.

Forms of Business Ownership:

Proprietorship Partnership Corporation
- generally owned by - owned by two or more - ownership divided into
one person. persons. shares of stocks
- often small service- - often retail and service- - separated legal entity
type businesses type businesses. organized under state
- owner receives any - generally unlimited corporation law
profits, suffers any personal liability - limited liability
less, and is personally - partnership agreement
liable for all debts.

The Basic Accounting Equation

ASSETS = LIABILITIES + OWNER’S EQUITY

Provides the underlying framework for recording and summarizing economic
events.

Assets are claimed by either creditors or owners.

Claims of creditors must be paid before ownership claims

Account Titles
Types of accounts
(1) Balance Sheet
 Assets - any resources owned by the business
- Current Assets: cash/ can be converted to cash within 12 months/ 1year
 Cash is bills, coins, bank balances, money orders, and checks
 Cash Equivalents are investment securities that are meant for short-term
investing (maximum converted days; 90)
 Accounts Receivable are claims against customers arising from sale of services
or goods on credit
 Notes Receivable is written pledge that the customer will pay the business a
fixed amount of money on a certain date
 Inventories typically involves goods in three stages of production: raw goods, in-
progress goods, and finished goods
 Supplies is a cost of supplies on hand at a point in time
 Prepaid Expenses are expenses paid for by the business in advance
- Non-Current Assets: cash that can be converted for more than a year
 Property, Plant and Equipment are long-term assets vital to business operations
and not easily converted into cash;
Land Building
Equipment Furniture and fixtures
Service Vehicle
 Intangible Assets is an assets that is not physically in nature;
Brand name Patents
Copyrights Licenses
Franchise Trademark
 Liabilities - the debt or obligation of the business
- Current Liabilities: debts that should pay in a short period of time
 Accounts Payable is the money owned bi the business to its suppliers
 Notes Payable is a liability in writing
 Unearned Revenue is when a company receives payment from the customer
before providing the goods or services
 Accrued Liabilities are the amount owed to others for unpaid expenses;
Salaries Payable Utilities Payable
Interest Payable Taxes Payable
- Non-Current Liabilities: debts that should can pay in a long period of time
 Mortgage Payable is a long-term debt of a business for which the business has
pledge certain assets as security to the creditor
 Bonds Payable is a liability account contains the amount owned to bond holders
by the issuer
 Owner’s Equity - the residual in the assets after deducting the liabilities;
ASSETS - LIABILITIES = OWNER’S EQUITY
 Capital is used to record the original and additional investment of the owner of
the business entity
 Withdrawal is when the owner of the business removes cash or other assets
from the business
(2) Income Statement
 Revenue/ Income - the cash or other assets earned by the company’s
operations and business activities
 Service Revenue is earned by performing services for a customer
 Sales is earned as as a result of sales of merchandise
 Expenses - the cost of an asset used by the company in its operations to produce
revenues
 Cost of Sales is the incurred to purchase or to produce the products to
customers during the period
 Salaries Expenses is the incurred to pay the employees
 Utilities Expense is the cost incurred by using utilities such as electricity, water,
waste disposal, and heating
 Rent Expense is the expense for the space, equipment or other asset rentals
 Supplies Expense is the expense of using supplies
 Insurance Expense is the portion of premiums paid on insurance coverage which
has expired
 Interest Expense is the expense related to the use of borrowed funds
STEPS
1. JOURNALIZING - RECORDING
2. POSTING
3. TRIAL BALANCE

INCREASING AND DECREASE SIDE

DEBIT - LEFT
CREDIT - RIGHT
NORMAL - INCREASING
OPPOSITE - DECREASE

DEBIT - CREDIT
ASSETS = LIABILITIES + EQUITY

CAPITAL - INC - CREDIT

DRAWING - DEC - DEBIT
REVENUE - INC - CREDIT
EXPENSE - DEC - DEBIT

BALANCE SHEET ACCOUNTS

ASSETS
DEBIT CREDIT
(+) (-)
INCREASES DECREASES
Normal Balance
LIABILITIES AND OWNER’S EQUITY
DEBIT CREDIT
(-) (+)
DECREASES INCREASES
Normal Balance

INCOME STATEMENT ACCOUNTS

EXPENSES (DEBIT FOR DECREASES IN OWNER’S EQUITY)
DEBIT CREDIT
(+) (-)
INCREASES DECREASES
Normal Balance
INCOME (CREDIT FOR INCREASE IN OWNER’S EQUITY)
DEBIT CREDIT
(-) (+)
DECREASES INCREASES
Normal Balance
CASH - DECREASED - OPPOSITE - DEBIT
SALARIES - INCREASED - CREDIT

DEBIT - SALARIES EXPENSE

CREDIT - CASH

JOURNALIZING:
Jan. 1 SALARIES EXPENSE 10,000
CASH 10,000
TO RECORD PAYMENT OF SALARIES EXPENSE.
POSTING/ T-ACCOUNT:
CASH
CREDIT CREDIT
1/1 10,000
SALARIES EXPENSE
CREDIT CREDIT
1/1 10,000