Basic Accounting: Concepts, Techniques , and
Conventions
The Need for Accounting
 Accounting information can be used to assess
past financial performance of a company and
help predict its future performance. All kinds of
organizations—government agencies, nonprofit
organizations, and others —rely on accounting to
gauge their progress. The accounting process
begins with a transaction. A transaction is any
event that affects the financial position of an
organization and requires recording.
 Many concepts, conventions, and rules
determine what events a company records as
accounting transactions and how accountants
measure the financial impact of each transaction.
Financial statements are used to summarize the
recorded accounting transactions.
 Managers, investors, and other internal groups
want the answers to two important questions:
How well did the organization perform?
Where does the organization stand?
 Accountants answer these questions with three
major financial statements:
 Balance sheet (statement of financial position) is a
snapshot of the financial status of an organization
at a point in time.
The balance sheet has two sections:
(1) Assets
(2) Liabilities plus owners’ (stockholders’) equity.
Assets = Liabilities + Owners’ equity
 Assets are economic resources that are expected
to benefit future activities of the organization.
 Liabilities are the entity’s economic obligations to
non-owners.
 Owners’ equity is the excess of the assets over
the liabilities.
 The owners’ equity of a corporation is called
stockholders’ equity.
Stockholders’ equity
Paid-in capital Retained earnings
Revenues and Expenses
Revenues are increases in ownership claims arising
from the delivery of goods or services.
Recognize revenue by formally recording it in the
accounting records during the current period only
after it meets two tests:
1. The company must earn the revenues. That is, it
must deliver the goods or render the services to
customers.
2. The revenue must be realized or realizable.
Expenses are decreases in ownership claims
(stockholders’ equity) arising from delivering goods
or services or using up assets.
Income (also called net income, profits, or
earnings), is the excess of revenues over expenses.
It increases stockholders’ equity.
An income statement summarizes revenues and
expenses. It measures an organization’s performance
by matching its revenue and its expenses for a span of
time, often a month, a quarter, or a year.
The Analytical Power of the Balance Sheet Equation
The balance sheet equation can highlight the link
between the income statement and balance sheet.
Assets (A) = Liabilities (L) + Stockholders’ equity (SE)
A = L + Paid-in capital + Retained income
A = L + Paid-in capital + Revenue – Expenses
Accrual Basis and Cash Basis
The accrual basis of accounting recognizes revenues
and expenses when they occur regardless of when
cash is received or disbursed.
The cash basis of accounting recognizes revenue and
expense when cash is received and disbursed.
The major deficiency of the cash basis of accounting is
that it is incomplete.
It fails to match efforts and accomplishments in a
manner that properly measures economic
performance and financial position.
Nonprofit Organizations
Nonprofit organizations, such as government
agencies and charitable organizations, also use
balance sheets and income statements.
For years, most nonprofit organizations used cash-
basis rather than accrual accounting. As these
organizations face more pressure to develop accurate
 measures of performance, they are increasingly using
accrual accounting.
The basic concepts of assets, liabilities, revenues,
and expenses apply to all organizations, whatever
their goals and wherever they are located. However,
organizations that do not seek profits do not measure
income. Further, because they have no owners, there
is no owners’ equity.
Balance sheets of nonprofit organizations show a
category of “net assets” instead of “owners’ equity”
To measure the difference between assets and
liabilities. Instead of an income statement, nonprofit
organizations have a “statement of activities” that
reports changes in net assets.
Adjustments to the Accounts
Under the accrual basis of accounting, record:
1. Explicit transactions-day-to-day routine events
2. Implicit transactions - events that day-to-day
recording procedures temporarily ignore, such as
expiration of prepaid rent or accrual of interest due to
the passage of time.
Explicit transactions are easy to identify because they
are supported by source documents. Implicit
transactions are recorded at the end of each
accounting period by using adjusting entries.
Principal Adjustments
Four types of principal adjustments:
1. Expiration of unexpired costs -Assets other than
cash and receivables are viewed as economic services
awaiting future use—prepaid or stored costs, and
they are carried forward to future periods. The values
of assets frequently decline (and eventually
disappear) because of the passage of time. When a
company uses services represented by a particular
cost, the cost expires. An unexpired cost is any asset
that managers expect to become an expense in future
periods. Rather than immediately charge these costs
as expenses, they are charged as expenses in future
periods when the services are used.
 Assets frequently expire because of the passage of
time.
 Assets other than cash and receivables are viewed as
economic services awaiting future use.
 Unexpired costs are assets that managers
expect to become expenses in future accounting
periods.
Depreciation
To account for long-lived assets, assets that will provide
services for more than one year:
(1) predict the length of the asset’s useful life
(2) predict the residual value
(3) allocate the cost of the equipment to the years of its
useful life in a systematic way.
2. Recognition (earning) of unearned revenues
Unearned Revenue (deferred revenue) is . . .
A liability recorded when a company receive collections
from customers before it earns the revenue
Because customers have already paid in advance for
merchandise or services . . .
An obligation exists to deliver merchandise or service
or refund the customers’ deposits if the goods or
services are not delivered
3. Accrual of unrecorded expenses
Accrue means to accumulate a receivable or payable
during a given period, even though no explicit
transaction occurs.
Interest expense
Employee wages
4. Accrual of unrecorded revenues
The recognition of revenues that a company has
earned but has not yet recorded in its accounts is. . .
the mirror image of the accrual of unrecorded
expenses. Interest Revenue
Dividends and Retained Earnings
Dividends are distributions of assets to stockholders
that reduce retained earnings. Cash dividends are
distributions of cash rather than some other asset.
The distribution reduces both assets and owners’
equity and is made possible by profitable operations.
Dividends reduce retained earnings, But they are not
expenses.
Companies do not deduct dividends from revenues
when measuring income because they do not help
generate sales or conduct operations.
Retained Earnings
Stockholders’ equity represents the claims of owners
arising out of their initial investment (paid-in capital)
and subsequent profitable operations (retained
earnings).
Retained earnings and paid-in capital represent a
general claim against, or undivided interest in, total
assets, not a specific claim against any asset.
Retained earnings and paid-in capital result from
profitable operations. Equity is not a pot of cash
awaiting distribution to stockholders.
Retained earnings and paid-in capital result from
profitable operations. Equity is not a pot of cash
awaiting distribution to stockholders.
Do not confuse retained earnings and cash. Cash can
increase while retained earnings decreases, and vice
versa. There is no direct relationship between
retained earnings and available cash.
Sole Proprietorships and Partnerships
A sole proprietorship is a business entity with a single
owner. A partnership is an organization that joins two
or more individuals together as co-owners.
Comparison of Owners’ Equity Reporting
Unlike corporations, sole proprietorships and
partnerships do not distinguish between paid-in
capital (i.e., amounts invested by owners) and
retained earnings. Instead, they typically accumulate
a single amount for each owner’s original investment,
subsequent investments, share of net income, and
withdrawals.
Generally Accepted Accounting Principles (GAAP)
Accounting is more an art than a science. It is
commonly misunderstood as being a precise
discipline that produces exact measurements of a
company’s financial position and performance.
Accounting is based on a set of principles on which
there is general agreement, not on rules that can be
“proved.”
The principles and procedures that together make up
accepted accounting practice at any given time are
known as generally accepted accounting principles
(GAAP).
Audit
An audit is an “examination” or in-depth inspection of
financial statements and companies’ records that is
made in accordance with generally accepted auditing
standards.
Auditing standards are approved by the Public
Company Accounting Oversight Board (PCAOB) which
is a part of the Securities and Exchange Commission
(SEC), a government agency that regulates the
financial markets in the U.S. including financial
reporting.
Accounting Standard Setters
The Financial Accounting Standards Board (FASB) is
the primary regulatory body over accounting
principles and practices in the U.S.
The FASB consists of seven full-time members plus a
staff of nearly 60 members, and it is an independent
creation of the private sector.
The IASB is a similar independent organization whose
pronouncements, called International Financial
Reporting Standards (IFRS) define GAAP in more than
100 other countries.
Ethics
The public sector–private sector relationship:
Confidence in financial information is important to
the smooth functioning of the world’s capital markets,
and confidence in financial statements depends on
the competence and integrity of accountants and
auditors.
A hallmark of the accounting profession has been its
ethics and integrity. Most accountants and auditors
are highly ethical and truthfully report their financial
results in accordance with GAAP.
Three Measurement Conventions
U. S. GAAP is based on a conceptual framework that
contains three broad measurement or valuation
conventions (principles) that underlie accrual
accounting:
Recognition
Matching and cost recovery
Stable monetary unit
 Recognition Principle  Relevance
 The recognition principle specifies when a company  Predictive value
should record revenue in the accounting records.  Confirmatory value
 Generally, companies recognize revenue when it is
both earned and realized or realizable.  Faithful representation
 Comparability
 In some industries revenue recognition is not so  Consistency
straightforward. These judgment issues require  Verifiability
company accountants together with its auditor to  Timeliness
decide when earning and realization are sufficiently  Understandable
complete to recognize the revenue.  Materiality
 Conservatism
 Cost-benefit

Using Ledger Accounts

Matching and Cost Recovery
Some techniques that accountants use to record
transactions.
 The timing of revenue recognition is important
because it leads to the recording of expenses T-Accounts
through the concept of matching—the linking of Ledger Accounts
revenues with expenses incurred to generate them. Double-Entry System
Accountants apply matching as follows: Debits and Credits
1. Identify the revenue recognized during the period.
2. Record expenses that relate directly to the INTRODUCTION Overview of Managerial
recognized revenue. Accounting
3. Record expenses that are costs of operations during
a specific time period that have no measurable benefit PURPOSES OF MANAGEMENT ACCOUNTING
for a future period and must be linked to the current Provide information to assist management in four
period’s revenues. basic tasks:
 The heart of recognizing expense is the cost 1. Costing out products, services, and other items
recovery concept. Companies carry forward as and activities of interest
assets such items as inventories, prepayments, and 2. Planning and controlling operations
equipment because they expect to recover the costs 3. Evaluating the performances of individual
of these assets in the form of cash inflows (or managers and different operational units
reduced cash outflows) in future periods. 4. Making decisions .

Stable Monetary Unit CONTEMPORARY MANAGEMENT ACCOUNTING

 The monetary unit (for example, the dollar in the
United States, the yen in Japan, or the euro in the
European Union) is the principal means for
measuring assets, liabilities, and stockholders’
equity.
Additional Accounting Concepts
Concepts that are prominent parts of the body of
GAAP:
 Continuity (going concern)
INFORMATION SYSTEMS
• Increased accuracy in assigning and
determining costs
• Much greater emphasis on tracking
nonfinancial data and highlighting its
relationship to financial results
• Explicitly attempts to measure changes in
performance (improvement) over time
• More attuned to providing information for
employee empowerment
 Time As A Competitive Element
• Time is a crucial element in all phases of the value
Mgt. Acct. Vs. Fin. Acct. chain
Management Acct. Financial Acct. • World-class firms reduce time to market by
• Internally • Externally focused compressing design, implementation, and production
Focused cycles
 Not constrained by • Must follow GAAP • Quick delivery is accomplished by eliminating (or
mandatory rules & other reducing) non-value added activities
external rules • Information on the correlation between cost and
 Provides both  Objective time is also now needed by the firm
financial & non- financial
financial information Management Accountants’ Role
information • Management accountants are generally in staff
• Emphasis on future • Historical positions
Orientation • Their positions are usually supportive and
• Detailed • Information on the
participatory in nature
information on whole firm
individual units • They are not responsible for making operating
decisions, and thus only have indirect
responsibility for achieving the organization’s basic
Factors Bringing About Change in Management
and targeted objectives
Accounting
• They assist marketing, manufacturing, service and
• Customer orientation
financial managers in their decision making
• Cross-functional perspective The Controller
• Chief accounting officer
• Global competition • Supervises all accounting units
• Often viewed as a member of top management
• Total Quality Management team
• Often participates in planning, control and
• Time as a competitive element decision-making activities
• Has responsibilities for both external and internal
• Advances in information technology
accounting requirements
Management Accounting & Ethical Behavior
• Advances in the manufacturing environ.
• Profit maximization should be achieved
through legal and ethical means
• Growth and dereg. in the service industry
• Ethical behavior involves choosing actions
that are “right,” and “proper,” and “just”
• Activity-based management
• Underlying principle is the belief that each
Total Quality Management
member of the group bears some
• Where manufacturers strive to create an
responsibility for the well-being of other
environment that will enable workers to
members
manufacture perfect (zero-defect) products
• Willingness to sacrifice one’s self-interest for
• This approach is replacing the “acceptable
the group is the heart of ethical action
quality” attitudes of the past
• This increased emphasis on quality has
created a need for additional financial and
nonfinancial information about quality
 • Objectivity
– To not allow bias, conflict of interest
or undue influence of others to override
professional or business judgments.
• Professional Competence and Due Care
– To maintain professional knowledge and skill at
the level required to ensure competent
professional services based on current
Ten Core Values Underlying Ethical Behavior developments in practice, legislation and
Principles techniques
• Honesty – To act diligently in accordance with applicable
• Integrity technical and professional standards.
• Promise keeping • Confidentiality
• Fidelity – To refrain from disclosing confidential
• Fairness information acquired as a result of professional
• Caring for others and business relationships without proper and
• Respect for others specific authority to disclose unless there is a
• Responsible citizenship legal or professional right or duty to disclose.
• Pursuit of excellence – To refrain from using confidential information
• Accountability acquired as a result of professional and
Standards of Ethical Conduct for Management business relationships for personal advantage
Accountants or the advantage of third parties.
• The standards are specified within the following • Professional behavior
categories: – Obligation to comply with relevant laws and
I. Competence regulations and avoid any action that discredits
II. Confidentiality the profession.
III. Integrity Conceptual Framework Approach
IV. Objectivity • Requires active consideration of issues
V. Resolution of Ethical Conflict • Establishes basic principles
Certification of Professional Competence for Mgt. • Can be applied to differing circumstances
Accountants • Responsive to rapid change
• Numerous forms of certification available to • Requires judgment rather than literal
management accountants interpretations encouraged by a pure rules
• These certifications offer evidence that the approach.
holder has achieved a minimum level of Threats
professional competence • Self-interest
• Three major certification programs:
– The CMA (Certified Management Accountant) • Self-review
– The CPA (Certified Public Accountant)
– The CIA (Certified Internal Auditor) • Advocacy
Code of Ethics for Professional Accountants
Fundamental Principles • Familiarity
• Integrity
• Intimidation
– To be straight forward and honest in all
Safeguards
professional and business relationships
 Two categories:
• Created by the profession, legislation or regulation
• In the work environment
Prohibitions
When safeguards are never adequate
Professional Accountants in Public Practice
• Professional Appointment
• Conflicts of Interest
• Second Opinions
• Fees and Other Types of Remuneration
• Marketing Professional Services
• Gifts and Hospitality
• Custody of Client Assets
• Objectivity – All Services
• Independence – Audit and Review Engagements
• Independence – Other Assurance Engagements
Independence for Audit and Review Engagements
• Firm includes network firm, except where
otherwise stated
• Independence of mind and independence in
appearance
• Public interest entities: additional provisions in
Section 290 that reflect the extent of public
interest in certain entities
• Documentation: conclusions regarding compliance
with independence requirements, and substance
of any relevant discussions that support those
conclusions.
• Financial interests
• Loans and guarantees
• Business relationships
• Family and personal relationships
• Employment with an audit client
• Temporary staff assignments
• Recent service with an audit client
• Serving as a director or officer of an audit client
• Long association of senior personnel (including
partner rotation) with an audit client
• Provision of non-assurance services to audit clients
• Management responsibilities
• Preparing accounting records and financial
statements
• Valuation services
• Taxation services
• Internal audit services
• IT systems services
• Litigation support services
• Legal services
• Recruiting services
• Fees
• Compensation and evaluation policies
• Actual or threatened litigation
• Reports that include a restriction on use or
distribution
• Corporate finance services
Independence for Other Assurance Engagements
• Assurance engagements that are not audit or
review engagements
• Include related entities when reason to believe
relevant to independence
• Include network firms when reason to believe
relevant to independence.
• Assertion-based assurance engagements
• Independence required from assurance client
(party responsible for the subject matter
information, and which may be responsible for
the subject matter)
• When client not responsible for subject matter
evaluate the threats firm has reason to believe
created by interests and relationships with party
responsible for subject matter
• Direct reporting engagements
• Independence required from assurance client
(party responsible for the subject matter)
• Multiple responsible parties
• Firm may take into account whether interest or
relationship with a particular responsible party
creates a threat. Consider:
• Materiality of subject matter information (or
subject matter) for which the particular
responsible party is responsible
• Degree of public interest associated with
engagement.
Professional Accountants in Business
• Potential conflicts
• Preparation and reporting of information
• Acting with sufficient expertise
• Financial interests
 • Inducements Staff Assistant 0-2 years Performs most of
Effective Date the detailed
• January 1, 2011 audit work.

Senior or in- 2-5 years Responsible for

• Transitional provisions
charge auditor the audit field
work, including
– Public interest entities supervising staff
work.
– Partner rotation
Manager 5-10 years Helps the plan,
– Non-assurance services manages the
audit, reviews
– Fees – relative size work, and works
with the client.
– Compensation and evaluation policies
Partner 10+ years Reviews overall
audit work and is
involved in
A. Organizational Forms with High Personal Liability significant audit
The following forms of firm organization are decisions. Has
unpopular because they provide no owner ultimate
protection against litigation: responsibility for
 Proprietorship – Only firms with one owner the audit
can operate in this form. II. The Regulation of Public Corporations
 General Partnership – Same form as a A. The Public Company Accounting Oversight Board
proprietorship except that there are 2 or (PCAOB)
more owners. 1. A Primary Responsibility of the PCAOB
B. Organizational Forms with Limited Liability -Establishment of standards for auditing,
 General corporation – An owner’s loss in a quality control, ethics, and independence, as
corporation is limited to the amount invested. well as attestation, for registered accounting
However, most states prohibit CPA firms from firms.
organizing in this manner. 2. Meet the Board Members of the PCAOB
 Professional corporation (PC) – Although this -In addition to appointing or removing
form provides some legal liability, the amount members, the SEC, among other things, must
of protection can vary significantly from state approve the Board’s budget and rules,
to state. including auditing standards, and may review
 Limited Liability Company (LLC) – Firm is appeals of adverse Board inspection reports
taxed like a partnership, but the partners and disciplinary actions against registered
have limited liability like a corporation. accounting firms.
Limited Liability Partnership – Partner’s are 3. SEC Oversight Over PCAOB
personally liable for partnership obligations, their -In addition to appointing or removing members,
own acts, and the acts of those under their the SEC, among other things, must approve the
supervision. Not responsible for the acts of other Board’s budget and rules, including auditing
partners or staff not under their supervision. standards, and may review appeals of adverse
C. Staff Levels and Responsibilities Board inspection reports and disciplinary actions
STAFF LEVEL AVERAGE TYPICAL against registered accounting firms.
EXPERIENCE RESPONSIBILITIES
 4. Standard Setting Input from Outside the
PCAOB
 -Although the Sarbanes-Oxley Act would
allow the PCAOB to designate a professional
group of accountants to propose standards to
the Board, the Board decided early in 2003
that it could best protect investors by
developing standards itself.
 The Board will rely on advice from a standing
advisory group, and be involved in soliciting
public comment to obtain the views of
issuers, accountants, investors, and other
interested parties.
B. The Securities Acts
Securities Act of 1933
Requires most companies planning to issue new
securities to the public to submit a registration
statement to the SEC for approval.
Securities Exchange Act of 1934
Requires companies to file detailed annual reports
with the commission in order to have their securities
publicly traded on the stock exchanges.
C. The Role of the SEC
 The SEC has legal power to establish rules for any
CPA associated with audited financial statements
submitted to the commission.
 The SEC has taken the position that accounting
principles and auditing standards should be set by
the profession. However, they can override the
profession and their opinion is strongly
considered.
D. Specific SEC Forms
 Forms S1 to S16 – Completed when new securities
are to be issued to the public.
 Form 8K – Filed at the end of any month in which a
significant investor event has occurred (i.e., sale of
subsidiary, change of auditor, etc.)
 Form 10-K – Filed annually within 90 days of the
close of each fiscal year. Includes audited financial
statements.
 Form 10-Q – Filed quarterly with financial
statements reviewed by the auditor.
III. American Institute of Certified Public Accountants
The AICPA sets standards and rules that all members
and other practicing CPAs must follow. This
authority extends to the following areas:
1. Auditing Standards
-The Auditing Standards Board (ASB) is responsible for
issuing pronouncements on auditing matters for all
entities other than publicly traded companies.
-The pronouncements are known as Statements on
Auditing Standards (SASs)
2. Compilation and Review Standards
=The Accounting and Review Services Committee is
responsible for issuing pronouncements of the CPAs
responsibilities when the CPA is associated with
financial statements of non-public companies that are
not audited.
-The Statements on Standards for Accounting and
Review Services (SSARS), provide guidance for
providing compilation (no assurance on financials)
and review services (limited assurance on financials).
3. Other Attestation Standards
-Forms of attestation are often performed for
other than historical financial statements.
-Examples of other attestation services involve
prospective financial information in forecasts and
projections
4. Consulting Standards
-The Management Consulting Services Executive
Committee is responsible for issuing
pronouncements on consulting services.
-Consulting differs from attestation in that the
CPA does not report on another party’s assertion.
Rather, the CPA develops findings, conclusions,
and recommendations
5. Code of Professional Conduct
-The AICPA Committee on Professional Ethics sets
rules of conduct that CPAs are required to meet.
A Key Performance Indicator (KPI) is a
measurable value that demonstrates how
effectively a company is achieving key business
objectives. Organizations use key performance
indicators at multiple levels to evaluate their
success at reaching targets. High-level KPIs may
focus on the overall performance of the
enterprise, while low-level KPIs may focus on
processes or employees in departments such as
sales, marketing or a call center.

Smart KPI

Specific
Measurable
Attainable
Relevant
Time-Bound