Generally Accepted Accounting Principles

Relevant Information Affects the decision of its users. Reliable Information Is trusted by users. Comparable Information Used in comparisons across years & companies. Generally Accepted Accounting Principles Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP). 1-1

Principles and Assumptions of Accounting Measurement principle (also called cost principle) means that accounting information is based on actual cost. Going-concern assumption means that accounting information reflects a presumption the business will continue operating. Revenue recognition principle provides guidance on when a company must recognize revenue. Monetary unit assumption means we can express transactions in money. Matching principle (expense recognition) prescribes that a company must record its expenses incurred to generate the revenue. Time period assumption presumes that the life of a company can be divided into time periods, such as months and years. Full disclosure principle requires a company to report the details behind financial statements that would impact users’ decisions. Business entity assumption means that a business is accounted for separately from its owner or other business entities. 1-2

= + Assets Liabilities Equity Accounting Equation Liabilities + Equity Assets 1-3

Assets Cash Accounts Receivable Notes Receivable Resources owned or controlled by a company Vehicles Land Buildings Store Supplies Equipment 1-4

Liabilities Accounts Payable Notes Payable Creditors’ claims on assets Wages Payable Taxes Payable 1-5

Equity Retained Earnings Contributed Capital Owner’s claim on assets Dividends 1-6

Assets Liabilities Equity _ _ = + Contributed Capital Dividends + Revenues Expenses = + Assets Liabilities Equity Retained Earnings Expanded Accounting Equation 1-7

Transaction Analysis Business activities can be described in terms of transactions and events. External transactions are exchanges of value between two entities, which yield changes in the accounting equation. Internal transactions are exchanges within any entity; they can also affect the accounting equation. Events refer to happenings that affect an entity’s accounting equation and can be reliably measured. Transaction analysis is defined as the process used to analyze transactions and events. 1-8

Transaction Analysis J. Scott invests $20,000 cash to start the business in return for stock. 1-9

Transaction Analysis Purchased supplies paying $1,000 cash. 1-10

Transaction Analysis Purchased equipment for $15,000 cash. 1-11

Transaction Analysis Purchased Supplies of $200 and Equipment of $1,000 on account. 1-12

Transaction Analysis Borrowed $4,000 from 1st American Bank. 1-13

Transaction Analysis The balances so far appear below. Note that the Balance Sheet Equation is still in balance. 1-14

Transaction Analysis Now, let’s look at transactions involving revenue, expenses and dividends. 1-15

Transaction Analysis Provided consulting services receiving $3,000 cash. 1-16

Transaction Analysis Paid salaries of $800 to employees. Remember that expensesdecreaseequity. 1-17

Transaction Analysis Dividends of $500 are paid to shareholders. Remember that dividendsdecreaseequity. 1-18

Financial Statements Let’s prepare the Financial Statements reflecting the transactions we have recorded. • Income Statement • Statement of Retained Earnings • Balance Sheet • Statement of Cash Flows 1-19

Income Statement Net income is the difference between Revenues and Expenses. The income statementdescribes a company’s revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities. 1-20

Balance Sheet TheBalance Sheetdescribes a company’s financial position at a point in time. 1-21

Tool to analyze and determine the balance in a given account Account Name (Left Side) Debit (Right Side) Credit T-Account

= + Assets Liabilities Equity Debit Credit Debit Credit Debit Credit + - - + - + Rules of Debit and Credit

Owner’s Capital Owner’s Withdrawals Debit Credit Debit Credit + - - + Revenues Expenses Debit Credit - + Debit Credit + - Rules of Debit and Credit Owner’s Equity Debit Credit - +

Expanding the Rules of Debit and Credit Owner’s Equity _ _ Owner’s Capital Owner’s Withdrawals + Revenues Expenses Debit Credit Debit Credit Debit Credit Debit Credit + - + - - + - +

Remember: Just ask ALICE! The middle three are increased with credits The first and the last are increased with a debit * Really, this is revenues, but “r” just doesn’t fit in!

Journalizing Transactions • Identify accounts affected and its type • Determine whether each account is increased or decreased. Apply the rules of debit and credit • Record transaction in journal. • Debit side of entry is entered first • Total debit $ must = Total credit $

General Journal Transaction Date Accounts Affected Optional: Explanation of transaction Dollar amount of debits and credits

General Journal • Debits are ALWAYS entered 1st. • Credits are INDENTED and listed after the debit accounts or accounts. • Do not use dollar signs. • SKIP A LINE between each entry

Cash Aug 2 200 Aug 1 60,000 Aug 4 50,000 Aug 9 100 Aug 6 3,000 Aug 9 100 Bal. 100 Aug 23 1,200 Aug 31 1,200 Aug 31 500 R. Woodward, Capital Bal. 12,400 Aug 1 60,000 Rent Expense Supplies Accounts Payable Service Revenue Accounts Receivable Aug 6 3,000 Aug 17 2,100 Aug 23 1,200 Aug 17 2,100 Bal. 900 Bal. 5,100 Building Aug 31 500 Aug 2 200 Salary Expense Aug 4 50, 000 Aug 31 1,200 Exercise 2-19 Take the difference between total debits and total credits to determine the balance in each account. If debits are greater than credits, the account has a debit balance and vice versa

Revenue Principle • When is revenue recognized (entered into the accounting records) ? • When it is earned • Not necessarily when cash is received • How much revenue is recognized? • Cash value of item transferred to customer

The Matching Principle • Measure all expenses incurred during the accounting period • When are expenses recognized? • Match the expenses against the revenues earned during the period

Adjusting Entries • At the end of an accounting period, ask yourself these questions: • Have I recorded all revenues earned during this accounting period? • Have I recognized all expenses incurred during this accounting period? • If “No”, prepare an adjusting entry

Adjusting Entries • Prepared at end of an accounting period • Recorded to bring an asset or liability account balance to its proper amount • Recognize all revenues when earned • Recognize all expenses incurred

Resources paid for prior to receiving the actual benefits Adjusting Prepaid Expenses

Straight-Line Depreciation Expense Asset Cost Useful Life = Adjusting for Depreciation Depreciation - process of allocating the cost of a plant asset to expense over its expected useful life Long term plant assets except for land are depreciated

Depreciation • Depreciation, for accounting purposes, has NOTHING to do with market value, resale value or insurance value of an asset. • It is a way to allocate the cost of the asset to each period that asset helps earn revenue • Accumulated Depreciation • A contra asset account … it is the amount of depreciation on that asset taken to date,

Tips • An adjusting entry will NEVER involve a debit or credit to Cash. • Each adjusting entry will affect at least one balance sheet account and one income statement account

Generally Accepted Accounting Principles