Fundamental

Fundamental Accounting
Accounting Principles
Principles

18th Edition
Larson Wild Chiappetta

Dr. Hussein Khasharmeh

Chapter
Accounting in
Business

1
Dr. Hussein Khasharmeh
 Importance
Importance of
of Accounting
Accounting
is a
Accounting
Accounting Identifies
Identifies
system that

Records
Records
information
Relevant
Relevant Communicates
Communicates
that is

Reliable
Reliable
to
to help
help users
users make
make
Comparable better
better decisions.
decisions.
Comparable
Dr. Hussein Khasharmeh
 Accounting
Accounting Activities
Activities
 Identifying  Recording
Business Business
Activities Activities

Communicating
Business
Activities

Dr. Hussein Khasharmeh

 Identifying business activities requires
selecting transactions and events relevant to
an organization, such as sale of vehicles,
receipt of ticket money.
 Recording business activities requires
keeping a chronological log (order) of
transactions and events measured in dollars
and classified and summarized in a useful
format.
 Communicating business activities
requires preparing accounting reports such as
financial statements and requires also
analyzing and interpreting such reports.

Dr. Hussein Khasharmeh

 Users
Users of
of Accounting
Accounting Information
Information
Internal Users
External Users

•Managers •Sales Staff

•Lenders •Consumer Groups •Officers •Budget Officers
•Shareholders •External Auditors •Internal Auditors •Controllers
•Governments •Customers •

Dr. Hussein Khasharmeh

 External users are not directly involved in the
running of the organization. They have limited
access to organization’s information. Their
importance decisions depends on information
that is relevant, reliable and comparable.
 Each external user has special information
needs depending on the types of decisions to
be made. For example, lenders (creditors)
loan money to an organization. They look for
information to help them assess whether an
organization is likely to repay its loans with
interest or not.

Dr. Hussein Khasharmeh

 Shareholders (investors) are the owners of
the organization. They use accounting reports
in deciding whether to buy, hold, or sell stock
(shares). Shareholders typically elect a board
of directors to oversee their interests in an
organization.
 External (independent) auditors examine
financial statements to verify that they are
prepared according to GAAP.
 Employee and labor unions use financial
statements to judge the fairness of wages.
 Regulators have legal authority over certain
activities of organizations (ex. Tax authorities).
Dr. Hussein Khasharmeh
 Internal users: Are directly involved in managing
and operating an organization. They use
information to help improve the efficiency and
effectiveness of an organization.
 Managerial accounting is the area of internal
users. internal users include all types of
managers.
 Both internal and external users rely on internal
controls to monitor and control company
activities. Internal controls are procedures set up
to protect company’s property and equipment,
promote efficiencies (ex. good records, physical
controls such as locks and guards).
Dr. Hussein Khasharmeh
 Users
Users of
of Accounting
Accounting Information
Information

External Users
Internal Users

Financial accounting provides

external users with financial Managerial accounting provides
statements. information needs for internal
decision makers.

Dr. Hussein Khasharmeh

 Generally
Generally Accepted
Accepted Accounting
Accounting
Principles
Principles
Financial
Financial accounting
accountingpractice
practice is
isgoverned
governedby
by
concepts
conceptsandandrules
rulesknown
known asasgenerally
generallyaccepted
accepted
accounting
accountingprinciples
principles(GAAP).
(GAAP).AAmain
mainpurpose
purposeof
of
GAAP
GAAPis isto
tomake
makeinformation:
information:

Relevant
Relevant Affects
Affectsthethedecision
decision
Information of
of its
itsusers.
users.
Information
Reliable
Reliable Is
Istrusted
trustedby
by
Information users.
users.
Information
Comparable
Comparable Is
Ishelpful
helpfulinin
Information
Information contrasting
contrasting
organizations.
Dr. Hussein Khasharmeh
organizations.
Setting
Setting Accounting
Accounting Principles
Principles

Financial
FinancialAccounting
Accounting
Standards
StandardsBoard
Board(FASB)
(FASB) is is
the
theprivate
privategroup
groupthat
that sets
sets
both
bothbroad
broadand
andspecific
specific
principles.
principles.

The
TheSecurities
Securitiesand
andExchange
ExchangeCommission
Commission
(SEC)
(SEC) is
isthe
the government
government group
groupthat
that
establishes
establishesreporting
reportingrequirements
requirements for
for
companies
companiesthatthatissue
issuestock
stockto
tothe
thepublic.
public.
Dr. Hussein Khasharmeh
 Principles
Principles of
of Accounting
Accounting

Cost Principle
Objectivity Principle Accounting information is
Accounting information is
based on actual cost. It
supported by independent,
emphasizes reliability and
unbiased evidence. It makes
objectivity
financial statements more reliable
Now Future
and verifiable
Going-Concern Principle
Reflects assumption that the
business will continue operating
instead of being closed or sold.
This means that property is
reported at cost instead of
liquidation value. Khasharmeh
Dr. Hussein
 Revenue Recognition
Monetary Unit Principle Principle
Express transactions and events 1. Recognize revenue when it is
in monetary, or money, units. earned.
2. Proceeds from selling products
and services need not be in
cash.
3. Revenue is measured by cash
received plus cash value of
items received.
Business Entity Principle
A business is accounted for separately
from other business entities, including
its owner.
Dr. Hussein Khasharmeh
 Business
Business Entity
Entity Forms:
Forms:

Proprietorship
Proprietorship Partnership
Partnership Corporation
Corporation

Dr. Hussein Khasharmeh

 A sole proprietorship: A business owned by one
person. No special legal requirements must be
met to start a proprietorship. It is not a separate
legal entity form its owners. The owner has
unlimited liability. It is not subject to a business
income tax but instead it is reported and taxed on
the owners personal income tax.
 A partnership: A business owned by two or more
persons. No special legal requirements must be
met to start a partnership. The only requirement is
an agreement between partners. A partnership is
not legally separated from its owners. Unlimited
liability for its owners.

Dr. Hussein Khasharmeh

 A corporation: It is legally separated
from its owners. Limited liability.
Double taxation. Ownership of
corporation is divided into units called
shares or stocks. When a company
issues only one class of stocks, it is
called common stock or (capital stock).

Dr. Hussein Khasharmeh

 Exh.
1.8

Characteristics
Characteristics of
of Businesses
Businesses

Characteristics
Characteristics Proprietorship
Proprietorship Partnership
Partnership Corporation
Corporation
Business
Businessentity
entity yes
yes yes
yes yes
yes
Legal
Legal entity
entity no
no no
no yes
yes
Limited
Limited liability
liability no
no* no
no* yes
yes
Unlimited
Unlimited life
life no
no no
no yes
yes
Business
Businesstaxed
taxed no
no no
no yes
yes
One
One owner
owner allowed
allowed yes
yes no
no no
no

**Proprietorships
Proprietorships and
and partnerships
partnerships that
that are
are set
set up
up
as
as LLC’s
LLC’s provide
provide limited
limited liability.
liability.
Dr. Hussein Khasharmeh
 Corporation
Corporation

Owners of a corporation are called

shareholders (or stockholders).

When a corporation issues only

one class of stock, we call it
common stock (or capital stock).
Dr. Hussein Khasharmeh
Transaction
Transaction analysis
analysis and
and Accounting
Accounting
Equation
Equation
Assets
Assets = Liabilities
Liabilities + Equity
Equity

Liabilities
Assets & Equity

Dr. Hussein Khasharmeh

 Assets
Assets

Cash
Cash
Accounts
Accounts Notes
Notes
Receivable
Receivable Receivable
Receivable
Assets
Assets are
are
Resources
Resources
Vehicles
Vehicles
owned
owned or
or
controlled Land
Land
controlled by
by
aa company
company
Store
Store Buildings
Buildings
Supplies
Supplies Equipment
Equipment
Dr. Hussein Khasharmeh
 Liabilities
Liabilities

Accounts
Accounts Notes
Notes
Payable
Payable Payable
Payable

Creditors’
Creditors’
claims
claims on
on
assets
assets
Taxes
Taxes Wages
Wages
Payable
Payable Payable
Payable

Dr. Hussein Khasharmeh

 Equity
Equity

Owner
Owner Owner
Owner
Investments
Investments Withdrawals
Withdrawals
Owner’s
Owner’s
claims
claims
on
on
Assets
Assets or
or
residual
residual equity
equity
Revenues
Revenues Expenses
Expenses

Dr. Hussein Khasharmeh

 Expanded
Expanded Accounting
Accounting Equation
Equation

Assets
Assets = Liabilities
Liabilities + Equity
Equity

Owner
Owner _ Owner
Owner _
Capital
Capital Withdrawals
Withdrawals + Revenues
Revenues Expenses
Expenses

Dr. Hussein Khasharmeh

 Owner investments: Are the assets an owner
puts into the company.
 Revenues: Are gross increase in equity from a
company’s earnings activities (such as sales,
services rendered).
 Owner withdrawals: Are the assets the owner
takes from the company for personal use.
 Expenses: Are the cost of assets or services to
earn revenues (such as use of supplies,
utilities……).

Dr. Hussein Khasharmeh

 Transaction
Transaction analysis
analysis
There are two types of transactions:
1. External transactions: Are exchanges of values
between two entities, while yields changes in the
accounting equation. Example, purchase
inventory from another party.
2. Internal transactions: Are exchanges within an
entity. They can also affect the accounting
equation. Example, using supplies (reported as
expense).
 Events (transactions): Refer to those
happenings that affect an entity’s accounting
equation and can be reliably measured.
Dr. Hussein Khasharmeh
 Transaction
Transaction Analysis
Analysis Equation
Equation

The accounting equation must remain in

balance after each transaction (or event).

Assets
Assets = Liabilities
Liabilities + Equity
Equity

Dr. Hussein Khasharmeh

 Transaction
Transaction Analysis
Analysis

1. J. Scott, the owner, contributed $20,000

cash to start the business.

The accounts involved are:

(1) Cash (asset)
(2) J. Scott, Capital (equity)

Dr. Hussein Khasharmeh

Transaction
Transaction Analysis
Analysis
J. Scott, the owner, contributed $20,000
cash to start the business.

Dr. Hussein Khasharmeh

Transaction
Transaction Analysis
Analysis
2. Purchased supplies paying $1,000
cash.
The accounts involved are:
(1) Cash (asset)
(2) Supplies (asset)

Dr. Hussein Khasharmeh

Transaction
Transaction Analysis
Analysis
Purchased supplies paying $1,000
cash.

Dr. Hussein Khasharmeh

 Transaction
Transaction Analysis
Analysis
3. Purchased equipment for $15,000
cash.

The accounts involved are:

(1) Cash (asset)
(2) Equipment (asset)

Dr. Hussein Khasharmeh

 Transaction
Transaction Analysis
Analysis
Purchased equipment for $15,000
cash.

Dr. Hussein Khasharmeh

 Transaction
Transaction Analysis
Analysis

4. Purchased Supplies of $200 and

Equipment of $1,000 on account.
The accounts involved are:
(1) Supplies (asset)
(2) Equipment (asset)
(3) Accounts Payable (liability)

Dr. Hussein Khasharmeh

 Transaction
Transaction Analysis
Analysis

Purchased Supplies of $200 and

Equipment of $1,000 on account.

Dr. Hussein Khasharmeh

 Transaction
Transaction Analysis
Analysis

5. Borrowed $4,000 from 1st American

Bank.
The accounts involved are:
(1) Cash (asset)
(2) Notes payable (liability)

Dr. Hussein Khasharmeh

 Transaction
Transaction Analysis
Analysis

Borrowed $4,000 from 1st American

Bank.

Dr. Hussein Khasharmeh

 Transaction
Transaction Analysis
Analysis
The balances so far appear below. Note that the
Balance Sheet Equation is still in balance.

Now let’s look at transactions involving

revenue, expenses and withdrawals.
Dr. Hussein Khasharmeh
Transaction
Transaction Analysis
Analysis

6. Rendered consulting services

receiving $3,000 cash.

The accounts involved are:

(1) Cash (asset)
(2) Revenues (equity)

Dr. Hussein Khasharmeh

Transaction
Transaction Analysis
Analysis
Rendered consulting services
receiving $3,000 cash.

Dr. Hussein Khasharmeh

 Transaction
Transaction Analysis
Analysis
7. Paid salaries of $800 to employees.

The accounts involved are:

(1) Cash (asset)
(2) Salaries expense (equity)
Remember that the balance in the salaries
expense account actually increases.
But, equity actually decreases because
expenses reduce equity.
Dr. Hussein Khasharmeh
 Transaction
Transaction Analysis
Analysis

Paid salaries of $800 to employees.

Remember that expenses decrease equity.

Dr. Hussein Khasharmeh
Transaction
Transaction Analysis
Analysis
8. J. Scott withdrew $500 from the
business for personal use.
The accounts involved are:
(1) Cash (asset)
(2) J. Scott, Withdrawals (equity)

Remember that the balance in the J. Scott,

Withdrawals account actually increases.
But, equity actually decreases because
withdrawals reduce equity.
Dr. Hussein Khasharmeh
 Transaction
Transaction Analysis
Analysis

J. Scott withdrew $500 from the

business for personal use.

Remember that withdrawals decrease equity.

Dr. Hussein Khasharmeh
 Financial
Financial Statements
Statements

Let’s prepare the Financial Statements

reflecting the transactions we have recorded.

1. Income Statement
2. Statement of Owner’s Equity
3. Balance Sheet
4. Statement of Cash Flows

Dr. Hussein Khasharmeh

 Net income is the
difference
between
Revenues and
Expenses.

The income statement describes a

company’s revenues and expenses
along with the resulting net income or
loss over a period of time due to
earnings activities.
Dr. Hussein Khasharmeh
 The net income
of $2,200
increases
Scott’s capital
by $2,200.

The Statement of
Owner’s Equity
explains changes
in equity from net
income (or net
loss) and from
owner
investments and
withdrawals for a
period of time. Dr. Hussein Khasharmeh
The
The Balance
Balance Sheet
Sheet
describes
describes aa
company’s
company’s
financial
financial position
position
at
at aa point
point in
in time.
time.

Dr. Hussein Khasharmeh