Basic Accounting

Prepared By: Ms.Deepti Bindal

The Need for Accounting

Managers, investors, and other internal groups want the answers to two important questions: How well did the organization perform? Where does the organization stand?

Fundamental concepts
What is accounting?  The language of business.  A means to communicate financial information.  A way to convey information about a business to users.

2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton

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Fundamental concepts
Who uses accounting information?  Owners  Managers  Investors (including potential)


Analysts on their behalf

2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton

Creditors (including potential)  Government (tax assessment)  Regulators  Customers



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Fundamental concepts
Accounting has two main divisions:  Financial accounting


Primarily prepared for users external to the company.



Revenues, earnings, assets, etc.

Management accounting


Primarily for internal purposes



Costing, budgeting, net present value, etc.

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2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton

These can be organized into three categories: Operations

Payments from customers  Refunds from suppliers Financing  Investment by owners  Investment by creditors (loans) Investing  Return on investments (interest and dividend)  Proceeds from selling assets  Repayment of amounts loaned to other entities

2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton

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The Need for Accounting

Accountants answer these questions with two major financial statements:

Income Statement Balance Sheet

Balance Sheet


The balance sheet (also called statement of financial position or statement of financial condition) is a snapshot of the financial status of an organization at a point in time.

Balance Sheet
Assets = Equities
Assets are economic resources that are expected to benefit future activities of the organization. Equities are the claims against, or interests in, the assets of the organization.

Business Transactions

A transaction is any event that affects the financial position of an organization and requires recording.

King Hardware Transactions

1 2 3 4

Initial investment by owners, Rs.100,000 cash. Acquisition of inventory for Rs.75,000 cash. Acquisition of inventory for Rs.35,000 on open account. Merchandise costing Rs.100,000 was sold on open account for Rs.120,000.

King Hardware Transactions

Value in the company Borrowed

Owners claim

Stockholders Assets = Liabilities + Equity

1) Cash 2) Cash Inventory 3) Inventory 4) Receivable 4b) Cost

+ 100,000 75,000 + 75,000 + 35,000 + 120,000 100,000

+ 100,000 + 35,000 + 120,000 100,000

King Hardware Transactions

5 6 7

Cash collections of accounts receivable, Rs.30,000. Cash payments of accounts payable, Rs.10,000. On March 1, paid Rs.3,000 cash for rent for March, April, and May. Rent is Rs.1,000 per month.

King Hardware Transactions

Stockholders Assets = Liabilities + Equity

5) Cash Receivable 6) Cash 7) Cash 7a) Prepaid 7b) Expense Totals

+ 30,000 30,000 10,000 10,000 3,000 + 3,000 1,000 1,000 Rs.144,000 Rs.25,000 Rs.119,000

Revenues
Revenues are increases in ownership claims arising from the delivery of goods or services. Revenues must be earned. Revenues must be realized.

Expenses
Expenses are decreases in ownership claims arising from delivering goods or services or using up assets.

Profits
Profits (or earnings or income) are the excess of revenues over expenses.

Income Statement
The income statement measures the performance of an organization by matching its accomplishments (revenue from customers, which is usually called sales) and its efforts (cost of goods sold and other expenses).

Income Statement
Balance Sheet February 28 20 2 Balance Sheet March 31 20 2 Balance Sheet April 30 20 2

Time

Income Statement for March

Income Statement for April

Time

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)

The Analytical Power of the Balance Sheet Equation

A = L + Paid-in capital + Retained income

A = L + Paid-in capital + Re enue E penses

Learning Objective Distinguish between the accrual basis of accounting and the cash basis of accounting.

Accrual Basis versus Cash Basis

The accrual basis of accounting recognizes revenues and expenses when they occur instead of when cash is received or disbursed. The cash basis of accounting recognizes revenue and expense when cash is received and disbursed.

Accrual Basis versus Cash Basis

The accrual basis is the principal conceptual framework for relating accomplishments (revenues) with efforts (expenses). The cash basis fails to match expenses and revenues in a manner that properly measures financial position.

Learning Objective Relate the measurement of expenses to the expiration of assets.

Adjustments
Under the accrual basis of accounting, adjustments are used to record implicit transactions, in contrast to the explicit transactions that trigger nearly all day-today routine entries.  Adjustments are generally prepared by the accountant at month or year end.


Types of Adjustments
Expiration of unexpired costs Recognition (earning) of unearned revenues Accrual of unrecorded expenses Accrual of unrecorded revenues

Depreciation
Accountants usually predict the residual value. predict the length of the useful life. allocate the cost to the years of its useful life.

Learning Objective Explain the nature of dividends and retained income.

Dividends
Dividends are distributions of assets to stockholders that reduce retained income. Cash dividends are distributions of assets that liquidate a portion of the ownership claim. The distribution is made possible by profitable operations.

Retained Income
Retained income is a result of profitable operations, it is not a pot of cash awaiting distribution to stockholders. The retained income is, in effect, invested in the assets and liabilities of the entity.

Learning Objective Select relevant items from a set of data and assemble them into a balance sheet, an income statement, and a statement of retained income.

King Hardware Company

Income Statement for the Month Ended April 30, 20x1

Sales Cost of goods sold Gross profit Operating expenses: Rent 1,000 Wages 6,600 Net income

85,000 70,000 15,000

7,600 7,400

King Hardware Company

Statement of Retained Income for the Month Ended April 30, 20x1

Retained income, March 31, 20X1 Add: Net income for April Total Deduct: Dividends Retained income, April 30, 19X1

19,000 7,400 26,400 18,000 8,400

King Hardware Company

Balance Sheet as of April 30, 20x1

Assets Cash Accounts receivable Inventory Prepaid rent Total assets 85,000 87,000 20,000 1,000 193,000

King Hardware Company

Balance Sheet as of April 30, 20x1

Liabilities and Stockholders Equity Liabilities Accounts payable 81,000 Accrued wages payable 600 Unearned sales revenue 3,000 84,600 Stockholders equity Paid-in capital 100,000 108,400 Retained income 8,400 Total equities 193,000

Learning Objective Distinguish between the reporting of corporate owners equity and the reporting of owners equity for partnerships and sole proprietorships.

Sole Proprietorship/ Partnership

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

Owners Equity for a Corporation Stockholders equity Capital stock (paid-in capital) Retained income Total stockholders equity 100,000 8,400 108,400

Comparison of Owners Equity Reporting

Owners Equity for a Sole Proprietorship

Alice Walsh, capital

108,400

Comparison of Owners Equity Reporting

Owners Equity for a Partnership Susan Zingler, capital John Martin, capital Total partners equity 54,200 54,200 108,400

Generally Accepted Accounting Principles (GAAP) rsregnskabslov (L) International Accounting Standards Committee (IASC)

Accounting is based on a set of principles on which there is general agreement, not on rules that can be proved.

Audit

A audit is a e a i ati r i -de th i s ecti f fi a cial state e ts a d c a ies rec rds that is ade i acc rda ce ith e erall acce ted auditi sta dards.

Learning Objective Understand how managers and investors can learn about the financial position and prospects of an organization from its financial statements.

Financial Statements
Managers and investors can learn about the financial position and prospects of an organization from its financial statements.
Financial statements describe the financial results of an organization in a consistent way that allows comparison to historical results of the organization and to the results of other organizations.

2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton

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