Fundamentals of Accounting I ACFN 2201 PDF

Addis Ababa University College of Business and Economics Department of Accounting and Finance --- --- --- Fundamentals of Accounting I ACFN 2201 Dr. Hussein Jarso Course Outline 1. Introduction to Accounting and Business..........Ch.1 2. The Accounting Cycle…...

Addis Ababa University College of Business and Economics Department of Accounting and Finance --- --- --- Fundamentals of Accounting I ACFN 2201 Dr. Hussein Jarso Course Outline 1. Introduction to Accounting and Business..........Ch.1 2. The Accounting Cycle…………………………………..Ch.2 3. Accounting for a Merchandising Business.........Ch.3 4. Accounting Systems...........................................Ch.4 5. Cash & Receivables............................................Ch.5  Text: Kieso et al., Financial Accounting, IFRS 2/3 Ed. 2  1 CHAPTER INTRODUCTION Learning Objectives 1. Definition, Evolution & Importance of Accounting. 2. Characteristics of Accounting Information & Its Users. 3. The Profession of Accountancy. 4. The Distinction Between Bookkeeping & Accounting. 5. Business Transactions & the Accounting Equation. 6. Financial Statements. 7. Accounting Principles & Concepts (in brief) 3 Definition, Evolution & Importance of Accounting  Accounting is an information system that measures, processes and communicates financial information about a business or other economic entity to permit informed judgments and decisions by users of the information or interested parties. Such that it [essential characteristics]:  Measures business financial activities  descriptive/analytical discipline  Processes that information into reports  Communicates that information to decision-makers  Service activity  Language of business  Link or bridge between business activities and decision-makers – An economic entity is a unit that exists independently, such as a business, hospital, or governmental body. 4 Definition, Evolution & Importance of Accounting 5 Definition, Evolution & Importance of Accounting Accounting is an art of recording, classifying, and summarizing in a significant manner and in terms of money transactions and events which are, in part at least, of a financial character, and interpreting the results thereof. As a descriptive/analytical discipline, it defines the great mass of events and transactions that characterize economic activity and through measurement, classification, and summarization, reduces those data to relatively small, highly significant, and interrelated items that, when properly assembled and reported, describe the financial condition, and results of operation of a specific economic activity. 6 Definition, Evolution & Importance of Accounting As a service activity its function is to provide interested parties with quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions [decisions about the deployment and use of resources in business and non-business entities and in the economy]., in making reasoned choices among alternative courses of action. As an information system, it collects and communicates economic information about a business enterprise or other entity to a wide variety of persons whose decision and actions are related to the activity. 7 Definition, Evolution & Importance of Accounting  Accounting as an information system. Output Process Financia Input Accounti l Econo ng Informat mic Cycle ion Activiti How of Why of es acct? acct? Objective Characteristics: Uses-Evaluate/ (Why) of Mainly Assess: Acct. : Supply Financial - Financial info useful for Monetary position making Quantitative- Financial decisions as to Numerical performance Resource Usefulness Efficient– Liquidity (cash Suppliers Allocation relevant & Users [DD] position) of capital reliable Users:ofInternal capital & Inefficient External 8 Definition, Evolution & Importance of Accounting  Role of Accounting in Capital Allocation- accounting assists in the efficient use of scare resources.  Resources are limited. Efficient use of resources often determines whether a business thrives. 9 Definition, Evolution & Importance of Accounting External users of accounting information/data do not directly run the organization and have limited access to its accounting information. Internal users of accounting information/data directly manage the organization. 10 Definition, Evolution & Importance of Accounting Users of accounting Uses of accounting info info Managers [Internal] To help them to make decisions and plans for the business and to help them to exercise control to try to ensure that plans come to fruition Employees (non- To assess the ability of the business to continue to managerial/nonexec provide employment and to reward employees for their utives) labor. Bargain for better wages. Owners [Investors] To assess how effectively the managers are running the business and to make judgments about likely levels of risk and return in the future. Creditors [Lenders] To assess the ability of the business to meet its obligations and to pay interest and to repay the principal. [Solvency/Creditworthiness]. Government To assess how much tax the business should pay, whether it complies with agreed pricing polices 11 Definition, Evolution & Importance of Accounting Customers To assess the ability of the business to continue in business and to supply the needs of the customers. Suppliers To assess the ability of the business to pay for the goods and services supplied. Investment To assess the likely risks and returns associated with the analysts business in order to determine its investment potential and to advise clients accordingly. Community To assess the ability of the business to continue to provide representatives employment for the community and use community resources, to help fund for environmental improvements, etc. Board of Oversee the organization. directors 12 Definition, Evolution & Importance of Accounting  Accounting as an information system. Process Input Accounti Econo ng Outpu mic Cycle t Activiti How of es acct? Set of sequential Economic Entities activities governed by accounting objective ownership activity principles/concepts -framework of acct Business Sole Service [for proprietorship Enterprise profit] Partnerships Merchandising Nonbusin Ent. Go to next slide ess Corporations Manufacturing [Nonprofi Ent. t] 13 Definition, Evolution & Importance of Accounting Accounting information systems rely on a process referred to as the accounting cycle. Analyze Trial Adjusting business Journalize Post transactions Balance Entries Adjusted Financial Closing Post-Closing Trial Statements Entries Trial Balance Balance 14 Definition, Evolution & Importance of Accounting  Three basic forms of business organization are recognized as separate entities. 1. Sole proprietorship simply proprietorship—a business owned by 1 person  The owner takes all the profits or losses of the business and is liable for all its obligations. 2. Partnership—a business with 2 or more owners  The partners share the profits or losses according to a prearranged formula.  A partnership must be dissolved if a partner leaves or dies.  The partners have unlimited liability, which can be avoided by organizing as a limited liability partnership. 15 Definition, Evolution & Importance of Accounting Corporation—a business unit chartered by the state and legally separate from its owners  The owners are called stockholders because their ownership is represented by shares of stock.  The stockholders do not directly control the corporation’s operations but elect a board of directors to run the corporation for their benefit.  Stockholders enjoy limited liability, which means that their risk of loss is limited to the amount they paid for their shares.  Stockholders can sell their shares without dissolving the corporation, so the life of a corporation is unlimited. 16  1.2Evolution Definition, Evolution & of Importance Accounting of Accounting Accounting is highly affected by the economic, social, cultural, legal, technological and political developments of a society. Interplay below. Economic/Social/Cultural/ Legal/ InfluenceAccounting Technological/Political Re-influence Forces Higher-level economic, social, cultural, legal, technological, and political developments of a society need more elaborated and sophisticated accounting systems. In line with the changes in the aforementioned environmental factors, accounting has evolved through several phases. These phases may be grouped into two major classes: 17  1.2Evolution Definition, Evolution & of Importance Accounting of Accounting  Primitive - primitive accounting is believed to have begun about 4000 BC. At this stage, accounting was identified to be unsystematic and incomplete dealing with certain aspects and types of economic affairs (like receipts or payments of money), which does not provide information sufficient enough to evaluate the financial performance and position of an economic entity. Modern - modern accounting emerges with the invention of the “Double-entry accounting system” in 1494 by an Italian monk named Luca Pacioli. Double-entry accounting system provides for recording the dual, commonly called debit and credit, aspects of financial affairs of an entity which enhances the accuracy of records and facilitates preparation of reports. 18  1.2Evolution Definition, Evolution & of Importance Accounting of Accounting  Influencing Factors  Industrial revolution England & USA Mid 18th –Mid 19th century Small scale (handicraft) to large scale (factory) production Need for determination of cost of large volume of machine made identical products Cost accounting-specialized field of accounting accumulating & providing cost data for: – Product pricing – Planning future operations – Measuring efficiency of current operations – Solve management problems 19  1.2Evolution Definition, Evolution & of Importance Accounting of Accounting Corporate organization England in 1845 Industrial revolution Large scale production Demand for large capital Corporate Enterprises Separation of Ownership & Management Increased Demand for Accounting Information - Financial Accounting [External Reporting] Owners Government Agencies Employees, Labor Others - Appraise mgt - levy & collect tax unions, Customers --- performance - regulation - Judge firm stability & Profitability 20  1.2Evolution Definition, Evolution & of Importance Accounting of Accounting Public accounting Industrial revolution Large scale production Demand for large capital Corporate Enterprises Separation of Ownership & Management Demand for Credibility of Management Representations [Accounting Information] by Stakeholders Auditing (Public Accounting] Producer User 21  1.2Evolution Definition, Evolution & of Importance Accounting of Accounting Income Tax Need for accounting information for enactment and enforcement of income tax laws and regulations Requirement to maintain [keep] sufficient records to enable companies file accurate tax returns Reliance on both private and public accountants for advice on legal methods of tax minimization, for preparation of tax returns, handle tax disputes, etc 22  1.2Evolution Definition, Evolution & of Importance Accounting of Accounting  Government Influence Increased intervention of government in economic and social matters =Increased demand for large vol. of accounting data Regulate investment activities [e.g. protect rights of investors, encourage savings] Regulate price of goods and services [e.g. permit “fair return” on invested capital or control excessive charges- Control INFLATION] Regulate financing activities [e.g. operations of financial 23 Definition, Evolution & Importance of Accounting First known Arabic Industrial records 4000 numbers 600 revolution Modern day B.C. A.D. 1800s accounting Coins invented Double entry Economic 900 B.C. bookkeeping consequences 1400s of accounting 1970s Accountants employed by a business firm or a not-for-profit organization are said to be engaged in private accounting. Accountants and their staff who provide services on a fee basis are said to be employed in public accounting. 24 The Accountancy Profession 25  1.3 The Accounting The Accountancy Profession Profession Accountants may specialize in different accounting fields some of which include the following.  Financial accounting - area of accounting aimed at serving information needs of external users.  Managerial accounting - field of accounting concerned with serving information needs of internal users - managers.  Cost accounting - a managerial accounting activity designed to help managers in identifying, measuring and controlling operating costs. Tax accounting - field of accounting that includes preparing tax returns and planning future transactions to manage the amount profit tax payable. 26  1.3 The Accounting The Accountancy ProfessionProfession Governmental Accounting, also known as public accounting or federal accounting, refers to the type of accounting information system used in the public sector. Forensic Accounting is the use of accounting, auditing and investigative techniques in cases of litigation or disputes. Social Accounting, also known as Corporate Social Responsibility Reporting and Sustainability Accounting, refers to the process of reporting implications of an organization's activities on its ecological and social environment. Auditing-assure the credibility of accounting information 27 Bookkeeping & 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. [BK is the mechanical and repetitive recordkeeping aspect of accounting] 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. Accounting plays three important roles: 1. Scorekeeping-Bookkeeping 2. Attention directing 3. Problem solving 28 Business Transactions & The Accounting Equation  Business transactions are economic events that affect a business’s financial position. – Business’s economic events recorded by accountants. – A transaction can be an exchange of value (a purchase, sale, payment, collection, or loan) between two or more parties-External. – A transaction also can be an economic event that does not involve an exchange, such as losses from fire, flood, explosion, and theft; physical wear and tear on machinery and equipment- Internal. – Each transaction has a dual effect on the accounting equation. – To be recorded, a transaction must relate directly to a business entity. 29 Business Transactions & The Accounting Equation Question: Are the following events recorded in the accounting records? An employee is hired Purchase Event Pay rent computer Criterion Is the financial position (assets, liabilities, or stockholders’ equity) of the company changed? Record/ Don’t Record 30 Business Transactions 1.4 The & The Equation Accounting Accounting Equation The Basic Accounting Equation Assets = Liabilities + Owner’s Equity This is the same idea as Investing = Financing Resources = Sources of Resources Resources = Claims on Resources 3131  Business Transactions & The Accounting Equation  Provides the underlying framework for recording and summarizing economic events  It is derived from the four principal business activities 1. Establishing goals and strategies  Goals: End results toward which the firm directs its energies  Strategies: Means for achieving goals – For example: A corporate goal may be to provide a good working environment for employees and a strategy to achieve this may be to offer enhanced benefits and training leading to opportunities for advancement 2. Obtaining financing 3. Making investments 4. Conducting operations  Purchasing, Marketing, Production, Administration 32 Business Transactions & The Accounting Equation  Financial position refers to a company’s economic resources, such as cash, inventory, and buildings, and the claims against those resources at a particular time. Another term for claims is equities.  Every company has two types of equities: creditors’ equities, such as bank loans, and owner’s equity. The sum of these equities equals a company’s resources: Economic Resources = Creditors’ Equity + Owner’s Equity  In accounting terminology, economic resources are called assets and creditors’ equities are called liabilities, so the equation can be written: Assets = Liabilities + Owner’s Equity -This equation is known as the accounting equation (A = L + OE). -The two sides of the equation must always be equal, or “in balance,”. 34 Business Transactions & The Accounting Equation  Assets –Economic resources a business owns or controls. –Provide future services or benefits. –They include: – monetary items (cash and money owed from customers called account receivables) – nonmonetary, physical items (inventories, land, buildings, equipment) – nonphysical items (rights granted by patents, trademarks, and copyrights) 35  Business Transactions & The Accounting Equation  Liabilities – present obligations to pay cash, transfer assets, or provide services to other entities in the future. – creditors’ claims on assets (debts and obligations). – debts/amounts owed, that are payable to outsiders (often called creditors- party to whom money is owed). – they include: – amounts to suppliers for goods or services bought on credit (called accounts payable) – borrowed money such as bank loans – salaries and wages owed to employees – taxes owed to the government – services to be performed 36  Business Transactions & The Accounting Equation  Owner’s equity – represents owners’ claims on assets of the business – ownership claim on total assets. – referred to as residual equity or net assets because theoretically, owner’s equity is what would be left if all liabilities were paid, hence, Owner’s Equity = Assets − Liabilities – components 37  Business Transactions & The Accounting Equation Revenues result from business activities entered into for the purpose of earning income. are increases in owner’s equity that result from operating a business. common sources of revenue are: sales, fees, services, commissions, interest, dividends, royalties, and rent. 38  1.4 The Business Accounting Equation Transactions & The Accounting Equation Expenses the cost of assets consumed or services used in the process of earning revenue. decreases in owner’s equity that result from operating a business. common expenses are: salaries expense, rent expense, utilities expense, tax expense, etc. 39  Business Transactions & The Accounting Equation  Owners’ investments/capital are assets that the owner puts into the business.  Withdrawals are assets that the owner takes out of the business for personal use.  When revenues exceed expenses and when expenses exceed revenues the difference is called net income and net loss, respectively, i.e. Net income (loss) = Revenues – Expenses  Dual-Entry [Double-Entry] Recording Framework o Every economic event has two sides, a give and a take. o Accountants record both sides economic events as a transaction. o The two sides of a transaction must balance so that the basic accounting equation remains in balance. o Any transaction will effect one or more on the three classes of 40  Business Transactions & The Accounting Equation  Dual Effect of a Transaction on the Equation – Remember that the transaction must balance, and that the basic equation must balance. – Remember the basic rule of math, you can do whatever you want to an equation as long as you do it to both sides of the equal sign. There are four general combinations: 1.Increase an asset and a liability or owners’ equity by the same amount, 2.Decrease an asset and a liability or owners’ equity by the same amount, 3.Increase an asset & decrease another by the same amount, & 4.Increase a liability or owners’ equity and decrease another liability or owners’ equity by the same amount. 41  1.4 Tabular Analysis of Business Business Transactions Transactions & The using theAccounting AccountingEquation Equation Accounting information systems rely on a process referred to as the accounting cycle. Analyze Trial Adjusting business Journalize Post transactions Balance Entries Adjusted Financial Closing Post-Closing Trial Statements Entries Trial Balance Balance 42  1.4 Tabular Analysis of Business Business Transactions Transactions & The using theAccounting AccountingEquation Equation ACCOUNTING EQUATION A = L + C (OE) A = L + OE (I) – W + R - E Balance sheet Owner’s Equity Income statement Financial statement Financial performance/ Position/Status Statement of progress A = L + OE Net profit (loss) = R - E changes in OE OE (I) – W + R - E Statement of Cash Flows Cash collections Cash payments Financial Net cash = statements/Reports C/Collections – C/Payments 43 Business Transactions and Financial Statements Name of the Company Title of the Statement Date of the Statement Heading Format/ Layout of Financial statements -------------------------------- --------------------------------- Body --------------------------------- ------------------------------ Notes ------------------ ------------------------------ ------------------------------ 44 Business Transactions and Financial Statements Companies prepare four primary financial statements : Owner’s Income Statemen Equity Balance Statemen t of Cash Statemen Sheet t Flows t 3rd 1st 4th 2nd  Headings Each financial statement has a heading that provides three pieces of data: 1. Name of the business 2. Name of the financial statement (income statement, balance sheet, or other financial statement) 3. Date or time period covered by the statement 45 Business Transactions and Financial Statements 46  1.5 Business Financial Statements Transactions and Financial Statements  Income Statement A summary of [Reports] the revenue and expenses for a specific period of time. Lists revenues first, followed by expenses. Shows net income (or net loss). Does not include investment and withdrawal transactions between the owner and the business in measuring net income. Expenses could be listed alphabetically or from largest to smallest in amount 47  1.5 Business Financial Statements Transactions and Financial Statements  Owner’s Equity Statement A summary of [Reports] the changes in the owner’s equity that have occurred during/for a specific period of time.  Owner’s equity is affected by investments in the business by the owner, net income (or loss), and withdrawals by the owner.  The net income or loss on the statement of owner’s equity comes from the income statement. To show the period to which the statement applies, it is dated “For the [Month/Year] Ended [Date]” 48  1.5 Business Financial Statements Transactions and Financial Statements  Balance Sheet Reports the assets, liabilities, and owner's equity at a specific date. Lists assets at the top, followed by liabilities and owner’s equity. Total assets must equal total liabilities and owner's equity. Is a snapshot of the company’s financial condition at a specific moment in time (usually the month-end or year-end) For this reason, it is often called the statement of financial49  1.5 Financial Statements Business Transactions and Financial Statements  Statement of Cash Flows A summary of the cash receipts and disbursements for a specific period of time. The statement of cash flows focuses on liquidity, that is, it Shows where the firm: oGenerates cash-Sources/cash inflows oSpends or uses cash-Uses/cash outflows The statement of cash flows is organized according to three major business activities: o Cash flows from operating activities o Cash flows from investing activities o Cash flows from financing activities 50  1.5 Business Financial Statements Transactions and Financial Statements – Operating activities—buying, producing, and selling goods and services; hiring managers and other employees; paying taxes. – Investing activities—buying resources for operating the business, such as land, buildings, and equipment; selling those resources when no longer needed. – Financing activities—obtaining capital from creditors and from the company’s owners; repaying creditors; paying a return to owners. 51  1.4 Tabular Analysis of Business Business Transactions Transactions &usingThe Accounting the Accounting Equation: Example On January 3, 2021, HZ., forms a consulting business named “HZ Equation Consultancy Services" and set up as a proprietorship. The objective of the business is to render financial consultancy services to clients on a fee basis. The following business activities occurred during the first month of operations of the business (January 3 to January 31, 2021). 1.HZ deposited Br. 20,000 cash in a bank account in the name of owner’s business - HZ Consultancy Services. The owner has 250,000 cash in owner’s personal bank account with Dashen Bank and 50,000 cash in a safe deposit box at owner’s residence. 2.HZ transferred furniture worth Br. 30,000 from owner’s home for office purposes by HZ Consultancy Services. The owner also has extra home furniture, residential house and personal car worth 620,000, 800,000 and 360,000, respectively. 52  Business Transactions & The Accounting Equation: Example 3.HZ purchased office supplies worth Br. 5,000 from various suppliers agreeing to pay the sum in the near future. Two-fifth of the supplies will be used for personal purposes while the remaining [3,000] is for use by HZ. Three-fifth [3,000] of the liability is arranged to be settled from business cash sources. 4.HZ received Br. 20,000 cash for consultancy services it rendered to a cash client. 5.HZ paid Br. 3,000 cash for advertising aired through ETV. 6.HZ forecasted that services fees in the next two weeks will amount to Br. 5,000. 53  1.4 Tabular Analysis of Business Business Transactions Transactions &using The Accounting the Accounting Equation: Example Equation 9.HZ sold one of the furniture invested by its owner for Br. 5,000 cash. The furniture had a recorded value of 5,000. 10.HZ collected Br. 5,000 cash from clients who received services in item-8 above. 11.HZ paid Br. 2,000 cash to suppliers on credit. 12.HZ purchased a computer for business purposes. The business paid Br. 8,000 cash for the computer. 13.HZ borrowed Br. 4,000 cash from Dashen Bank. The loan is repayable over ten months. 14.HZ employed an accountant and a secretary for monthly salary of Br. 1,200 and 700, respectively. 15.HZ incurred and paid for the following expenses Wages................................................. Br. 6,000 Rent.................................................... 4,500 54  Business Transactions & The Accounting Equation: Example 16.HZ determined that cost of supplies remained on hand at the end of the current month total Br. 1,300. 17.HZ paid Br. 450 cash to Dashen Bank consisting of 400 principal and 50 one month interest on the loan due in January. 18.HZ paid its owner Br. 5,000 cash for personal uses (to pay house utility expenses). Required: 1. Using the Accounting Equation analyze the above transactions in terms of their effect on the elements of financial statement 2. Prepare an income statement for January. 3. Prepare a statement of owner’s equity for January. 4. Prepare a balance sheet as of January 31. 5. Prepare a statement of cash flows for January. 55  Business Transactions & The Accounting Equation: Example Transacti on Assets = Liabilities + Capital Supplie Furnitur Bank AH, Cash A/R s e Equipment A/Payable Loan Capital. +2000 original 1 0.+20000 investment balance 20000 20000. additional 2 -..+30000.+30000 investment balance 20000 30000 50000. 3 -..+3000. -..+3000. -. balance 20000 3000 30000 3000 50000. +2000 cash fees 4 0. -.. -.. -..+20000 earned balance 40000 3000 30000 3000 70000 advertizing 5.-3000. -.. -.. -..-3000 expenses balance 37000 3000 30000 3000 67000. 6 -.. -.. -.. -.. -. balance 37000 3000 30000 3000 67000 56  Business Transactions & The Accounting Equation: Example Assets = Liabilities + Capital Transaction Cash A/R Supplies Furniture Equipment A/Payable Bank Loan AH, Capital balance 47000 3000 30000 3000 77000 8. -..+15000. -.. -.. -..+15000 credit fees earned balance 47000 15000 3000 30000 3000 92000 9.+5000. -.. -..-5000. -.. -. balance 52000 15000 3000 25000 3000 92000 10.+5000.-5000. -.. -.. -.. -. balance 57000 10000 3000 25000 3000 92000 11.-2000. -.. -.. -..-2000. -. balance 55000 10000 3000 25000 1000 92000 12.-8000. -.. -.. -..+8000. -.. -. balance 47000 10000 3000 25000 8000 1000 92000 13.+4000. -.. -.. -.. -.. -..+4000. -. balance 51000 10000 3000 25000 8000 1000 4000 92000 57  1.4 Tabular Analysis of Business Business Transactions Transactions &using The Accounting the Accounting Equation: Example Transaction Equation Assets = Liabilities + Capital Cash A/R Supplies Furniture Equipment A/Payable Bank Loan Alemu, Capital 14. -.. -.. -.. -.. -... -.. -.. -. balance 51000 10000 3000 25000 8000 1000 4000 92000 15.-6000 - - - - - -.-6000 wages expenses.-4500 - - - - - -.-4500 rent expenses.-1200 - - - - - -.-1200 utilities expenses.-800. -.. -.. -.. -.. -.. -..-800 miscellaneous expen. balance 38500 10000 3000 25000 8000 1000 4000 79500 16. -.. -..-1700. -.. -.. -.. -..-1700 supplies expenses balance 38500 10000 1300 25000 8000 1000 4000 77800 17.-450. -.. -.. -.. -.. -..-400.-50 interest expenses balance 38050 10000 1300 25000 8000 1000 3600 77750 18.-5000. -.. -.. -.. -.. -.. -..-5000 withdrawals balance 33,050 10,000 1,300 25,000 8,000 1,000 3,600 72,750 58 Business Transactions & The Accounting Equation: Example HZ Consultancy Services HZ Consultancy Services Income Statement Statement of Owner's Equity For the month ended January 31, 2016 For the month ended January 31, 2016 Revenues: HZ, Capital, January 1, 2016 Br. 0 Br. Fees earned 35,000 Add: Investment during the month 60,000 Net income 17,750 Expenses: Less: Withdrawals (5,000) Br. Br. Wages expense 6,000 HZ, Capital, January 31, 2016 72,750 Rent expense 4,500 Advertising expense 3,000 Supplies expense 1,700 Utilities expense 1,200 Interest expense 50 Miscellaneous expenses 800 Total expenses (17,250) Br. 59  1.4 Tabular Analysis of Business Business Transactions Transactions &using The Accounting Equation: Example the Accounting Equation HZ Consultancy Services Statement of Owner's Equity HZ Consultancy Services Balance Sheet For the month ended January 31, 2016.January 31, 2016. AH, Capital, January 1, 2016 Br. 0 Assets: Br. Add: Investment during the month 60,000 Cash 33,050 Net income 17,750 A/Receivable 10,000 Less: Withdrawals (5,000) Supplies 1,300 Br. HZ, Capital, January 31, 2016 72,750 Furniture 25,000 Equipment 8,000 Br. Total assets 77,350 Liabilities: A/Payable Br. 1,000 Bank loan 3,600 Total liabilities 4,600 Owner's equity: HZ, Capital 72,750 60 Br.  1.4 Tabular Analysis of Business Business Transactions Transactions &using The Accounting Equation: Example the Accounting Equation AH Consultancy Services Statement of Cash Flows For the month ended January 31, 2016 Cash flows from operating activities: Br. Cash received from customers 25,000 Less: cash payments for expenses and suppliers on account (17,550) Net cash inflow from operating activities 7,450 Cash flows from investing activities: Cash purchase of computer (8,000) Cash sale of furniture 5,000 Net cash outflow in investing activities (3,000) Cash flows from financing activities: Cash received from the owner 30,000 Cash received from bank loan 4,000 Cash withdrawal by the owner (5,000) Cash repayment of bank loan (400) Net cash inflow from financing activities 28,600 Net increase in cash for the month 33,050 Add: Cash balance, January 1, 2016. 0 Cash balance, January 31, 2016 Br. 33,050 61  1.6 Accounting Accounting Concepts Principles & Concepts (overview)  Accounting Assumptions -There are four accounting assumptions. 1. Economic Entity Concept [Business is separate/independent!] Who Reports [Reporting Entity] ? The concept that a business organization is distinct from its owners, creditors, and customers. Single, identifiable unit must be accounted for in all situations Specific entity be the subject of a set of financial statements Does not intermingle the personal assets and liabilities of the employees or any of the other stockholders 2. Going Concern [Business economic life is Operating life indefinite!] Assume an entity is not in the process of liquidation and that it will continue indefinitely unless there is evidence to the contrary. 62 Accounting Principles & Concepts (overview) 63  1.6 Accounting Accounting Concepts Principles & Concepts (overview) 3. Monetary Unit [Money is stable!] Unit of measurement? Yardstick used to measure amounts in financial statements Assumes monetary unit is relatively stable; no adjustment for inflation made in financial statements Money is the common denominator in business. 4. Time Period Assumption [Business economic life is When to report? divisible!] Presumes that the life of a company can be divided into time periods, such as months and years called accounting period. Arbitrary or artificial equal intervals of reporting time periods. Fiscal year-conventional, longest, and 12 consecutive months. 64  1.6 Accounting Accounting Concepts Principles & Concepts (overview) Periodicity Assumption Accountants divide the economic life of a business into artificial time periods (Periodicity Assumption)...... Jan. Feb. Mar. Apr. Dec.  Generally a month, a quarter, or a year. ▼ HELPFUL HINT  Fiscal year vs. calendar year. An accounting time period that is one year long is called a fiscal year. 65 Accounting Principles & Concepts (overview) Broad Accounting Principles - there are four general principles. – Measurement principle (cost principle): Accounting information is based on actual cost. – Revenue recognition principle Revenue is recognized (1) when goods or services are provided to customers and (2) at the amount expected to be received from the customer. – Expense recognition principle (matching principle) A company records the expenses it incurred to generate the revenue reported. – Full disclosure principle A company reports the details behind financial statements that would impact users’ decisions. Those disclosures are often in footnotes to the statements Accounting Constraint – The cost-benefit constraint, or cost constraint, says that information disclosed by an entity must have benefits to the user that are greater than the costs 66 End of CH 1