Chapter 01

6/14/2017
Learning Objectives
1.Describe the four assumptions made
when communicating accounting
information.
2.Describe the purpose and structure of an
income statement and the terms and
principles used to create it.
3.Describe the purpose and structure of a
balance sheet and the terms and
principles used to create it.
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All rights reserved. 1
6/14/2017
Learning Objectives
4. Describe the purpose and structure of a

statement of retained earnings and how
it links the income statement and the
balance sheet.
5. Describe the purpose and structure of a
statement of cash flows and the terms
and principles used to create it.

Learning Objectives
6. Describe the qualitative characteristics

that make accounting information
useful.
7. Describe the conceptual framework of
accounting.


6/14/2017
LOI Beginning Assumptions
Accounting is the process of

identifying, measuring, and
communicating economic information
to permit informed judgments and
decisions. Put more simply,
accounting is the “language of
business.”

To accomplish the process of accounting,

accountants use four assumptions:
• Economic Entity
• This assumption states that the financial activities of a business
1 can be separated from the financial activities of the business’s
owner.
• Time Period
• Accountants assume that economic information can be
2 meaningfully captured and communicated over short periods of
time.
• Monetary Unit
• Accountants assume that the dollar is the most effective means
3
to communicate economic activity.
• Going Concern
4 • Accountants assume that a company will continue to
operate into the foreseeable future.

6/14/2017
LO2 Reporting Profitability:

The Income Statement
?
One of the first
questions any
business wants to
know is whether they
are making money or
are profitable.
These answers can be found in the

Income Statement.
The Income Statement and Terms

An income statement reports a
company’s revenues and expenses.
Matching Principle – Expenses should be recorded in the
period resources are used to generate revenues
Revenue – An Expense – A
increase in decrease in
resources Terms resources
resulting from resulting from
the sale of the sale of
goods or goods or
services services
Revenue Recognition Principle – A revenue should be
recorded when a resource has been earned

6/14/2017
Income Statement Example

Exhibit 1-1

Basic Structure of the Income

Statement
Revenues – Expenses = Net Income or Net Loss

Reported over a specific period, like for the year
ended December 31, 2010


6/14/2017
LO3 Reporting Financial Position:

The Balance Sheet and Related
Terms
Asset: An
Liability: An
economic Cost principle:
obligation of a
resource that is The principle
business that results
objectively that assets
from a past
measurable, that should be
transaction and will
results from a recorded and
require the sacrifice
prior transaction, reported at the
of economic
and that will cost paid to
resources at some
provide future acquire them.
future date.
economic benefit.
Equity: The difference
Contributed capital: The
between a company’s assets
resources that investors
and liabilities, representing
contribute to a business in
the share of assets that is
exchange for ownership
claimed by the company’s
interest.
owners.

Reporting Financial Position:

The Balance Sheet
?
An important issue for
any business is its
current financial
position. What does
the business own?
What does it owe?

Balance Sheet.

6/14/2017
Basic Structure of the Balance

Sheet
ACCOUNTING EQUATION
Assets = Liabilities + Equity
Reported at a given time or date

Balance Sheet Example

Exhibit 1-2


6/14/2017
LO4 Reporting Equity: The

Statement of Retained Earnings
A statement of retained earnings shows
the change in a company’s retained
earnings over a specific period of time.

Basic Structure of the Statement

of Retained Earnings


6/14/2017
Statement of Retained
Earnings Example
Exhibit 1-3

Linking the Income Statement and

the Balance Sheet
The
Statement of
Retained
Earnings links
the income
statement and
the balance
sheet.


6/14/2017
LO5 Reporting Cash Flows:

The Statement of Cash Flows
A business needs to answer
questions about the
management of cash:
?
• Where does a
company get its cash?
• Where does its cash
go?
• Will there be enough
cash to pay bills?

Statement of Cash Flows.
Reporting Cash Flows:

The Statement of Cash Flows
The details of cash inflows and outflows
for a business are reported on a
statement of cash flows in the following
three sections:
Operating Activities
Investing Activities
Financing Activities

6/14/2017
Statement of Cash Flows Example – Exhibit 1-5

LO6 Qualitative Characteristics of

Accounting Information
Understandability The ability of accounting information to
“be comprehensible to those who have a
reasonable understanding of
business…and are willing to study the
information with reasonable diligence.”
Relevance The capacity of accounting information
to make a difference in decisions.
Reliability The extent to which accounting
information can be depended upon to
represent what it purports to represent,
both in description and in number.
Comparability The ability to use accounting information
to compare or contrast the financial
activities of different companies.


6/14/2017
Qualitative Characteristics
(Continued)
Consistency The ability to use accounting
information to compare
or contrast the financial activities
of the same entity over time.
Materiality The threshold at which a financial

item begins to affect decision
making.
Conservatism The manner in which accountants
deal with uncertainty regarding
economic situations.

LO7
The Conceptual Framework
The grammar or terms, explaining financial accounting
language in this chapter, are more formally known as
components of the conceptual framework of accounting.
The conceptual framework of accounting is

the collection of concepts that guide the
manner in which accounting is practiced.


6/14/2017
Terms Used to Identify and Describe

Economic Information
Term Definition Reported on the
Asset A resource of a business Balance sheet
Liability An obligation of a business Balance sheet
Equity The difference between assets Balance sheet
and liabilities
Contributed Capital Equity resulting from Balance sheet
contributions from owners
Retained Earnings Equity resulting from profitable Balance sheet
operations and statement of
retained earnings
Revenue An increase in assets resulting Income
from selling a good or providing Statement
a service
Expense A decrease in assets resulting Income

from selling a good or providing Statement
a service
Dividend A distribution of profits to Statement of

owners retained earnings
Principles Used to Measure Economic

Information
Principle Definition Ramification
Revenue Revenues are The receipt of cash
Recognition recorded when they is not required to
are earned. record a revenue.
Matching Expenses are For many assets,
recorded in the time the cost of the asset
period when they must be spread
are incurred to over the periods
generate revenues. that it is used.
Cost Assets are recorded Except in a few
and maintained at cases, market
their historical values are not used
costs. for reporting asset
values.

6/14/2017
Assumptions Made When Communicating

Economic Information
Assumption Definition Ramification
Economic entity The financial activities of a We do not have to worry
business can be accounted that the financial information
for separately from the of the owner is mixed with
business's owners. the financial information of
the business.
Monetary unit The dollar, unadjusted for All transactions in foreign
inflation, is the best means currencies are converted to
of communicating dollars.
accounting information in the
United States.
Time period Accounting information can Most businesses prepare
be communicated effectively quarterly and annual
over short periods of time. financial statements.
Going concern The company for which we If an entity is not selling its
are accounting will continue assets, then the cost
its operations indefinitely. principle is appropriate.
Qualitative Characteristics of
Accounting Information
Term Definition Ramification
Understandability Accounting Users must spend a

information should reasonable amount of
be comprehensible time studying
by those willing to accounting information
spend a reasonable for it to be
amount of time understandable.
studying it.
Relevance The capacity of Information should
accounting have predictive or
information to feedback value and
make a difference in should be timely.
decisions.


6/14/2017
Accounting Information (continued)
Term Definition Ramification
Reliability The extent to which Information should be

accounting information free from error, a faithful
can be depended upon representation, and
to represent what it neutral.
purports to represent,
both in description and
in number.
Comparability The ability to use Entities must disclose the
accounting information accounting methods that
to compare or contrast they use so that
the financial activities comparisons across
of different companies. companies can be made.

Accounting Information (Continued)
Terms Definition Ramifications
Consistency Accounting An entity should use

information should be the same accounting
comparable methods year to year
across different time and disclose when
periods within a they change methods.
company.
Materiality The threshold over When an amount is
which an item could small enough, normal
begin to affect accounting procedures
decisions. are not always
followed.


6/14/2017
Accounting Information (Continued)
Terms Definition Ramifications
Conservatism When uncertainty An entity should

exists, accounting choose accounting
information techniques
should present the that guard against
least optimistic overstating revenues
alternative. or assets.

Financial Statements Used to

Communicate Economic Information
Statement Purpose Structure Links to Other

Statements
Balance sheet Shows a company’s Assets = Liabilities The balance in retained
assets, liabilities, and + Equity earnings comes from
equity at a specific the statement of
point in time. retained earnings.
The balance in cash
should agree with the
ending cash balance on
the statement of cash
flows.
Income Shows a company’s Revenue - Net income/loss goes
revenues and expenses Expenses = Net to the statement of
statement
over a specific period Income/ retained earnings to
of time. Loss compute retained
earnings.

6/14/2017
Financial Statements Used to

Communicate Economic Information
(continued)
Statement Purpose Structure Links to Other

Statements
Statement of Shows the changes in a Beginning Ending retained
company’s Retained Earnings earnings goes to the
retained
retained earnings over +/- Net balance sheet.
earnings a specific Income/Loss -
period of time. Dividends =
Ending
Retained Earnings
Statement of Shows a company’s Operating Cash The ending cash
inflows and outflows of Flows +/- balance on the
cash flows
cash over a specific Investing statement of cash
period of time. Cash Flows +/- flows should agree
Financing Cash with the balance in
Flows = Net cash on the balance
change in cash sheet.
End of Chapter 1



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© 2016 Cengage Learning India Pvt Ltd.

4. Describe the purpose and structure of a

© 2016 Cengage Learning India

6. Describe the qualitative characteristics

© 2016 Cengage Learning India

© 2016 Cengage Learning India Pvt Ltd.

LOI Beginning Assumptions

Accounting is the process of

© 2016 Cengage Learning India

To accomplish the process of accounting,

© 2016 Cengage Learning India Pvt Ltd.

LO2 Reporting Profitability:

These answers can be found in the

The Income Statement and Terms

© 2016 Cengage Learning India Pvt Ltd.

Income Statement Example

© 2016 Cengage Learning India

Basic Structure of the Income

Revenues – Expenses = Net Income or Net Loss

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© 2016 Cengage Learning India Pvt Ltd.

LO3 Reporting Financial Position:

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Reporting Financial Position:

These answers can be found in the

© 2016 Cengage Learning India Pvt Ltd.

Basic Structure of the Balance

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Balance Sheet Example

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© 2016 Cengage Learning India Pvt Ltd.

LO4 Reporting Equity: The

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Basic Structure of the Statement

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© 2016 Cengage Learning India Pvt Ltd.

© 2016 Cengage Learning India

Linking the Income Statement and

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© 2016 Cengage Learning India Pvt Ltd.

LO5 Reporting Cash Flows:

These answers can be found in the

Reporting Cash Flows:

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Statement of Cash Flows Example – Exhibit 1-5

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LO6 Qualitative Characteristics of

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Materiality The threshold at which a financial

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The conceptual framework of accounting is

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© 2016 Cengage Learning India Pvt Ltd.

Terms Used to Identify and Describe

Expense A decrease in assets resulting Income

Dividend A distribution of profits to Statement of

Principles Used to Measure Economic

© 2016 Cengage Learning India Pvt Ltd.

Assumptions Made When Communicating

Understandability Accounting Users must spend a

© 2016 Cengage Learning India

© 2016 Cengage Learning India Pvt Ltd.