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Chapter One. Elements of Financial Statements. Learning Objective 1. Explain the role of accounting in society. Title Role of Accounting in Society. Should I invest money in IBM or General Motors?.
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Chapter One Elements of Financial Statements
Learning Objective 1 • Explain the role of accounting in society.
Title Role of Accounting in Society Should I invest money in IBM or General Motors? Accounting provides information that is useful in answering questions about resource allocation.
Market-Based Allocations A market is a group of people or entities organized to exchange things of value.
Market-Based Allocations Resource users Transform resources into desirable products Control the distribution of resources Consumers Conversion Agents Resource Owners
Market-Based Allocations Profit Income Earnings Here are some common terms for the added value created in the transformation process:
Financial Resources Investors Creditors Conversion agents need financial resources (money) to start and operate their businesses.
Liquidation If a business fails, any resources (assets) it still has are returned to the resource providers (investors and creditors). The process of dividing remaining assets and returning them to resource providers is called business liquidation.
Physical Resources In their most primitive form, physical resources are called natural resources. Owners of physical resources seek to sell those resources to profitable businesses because profitable businesses are more likely to be able to pay for them.
Labor Resources Labor resources include intellectual as well as physical labor.Workers seek relationships with businesses (conversion agents) that have high earnings potential because these businesses are better able to provide rewards (pay high wages).
Types of Accounting Information Financial Accounting Focused on the needs of external users Managerial Accounting Focused on the needs of internal users
Nonbusiness Resource Usage Not all entities allocate resources based on profitability. Organizations that are not motivated by profit are called not-for-profit entities. Government, foundations, religious groups, the Peace Corps, and various benevolent organizations prioritize resource usage based on humanitarian concerns.
Nonbusiness Resource Usage Not all entities allocate resources based on profitability. Organizations that are not motivated by profit are called not-for-profit entities. Other organizations allocate resources to support art, music, dance, and theater.
Measurement Rules Accountants establish measurement and reporting rules that businesses use to facilitate communication. Generally Accepted Accounting Principles
Learning Objective 2 • Distinguish among the different accounting entities involved in business events.
Reporting Entities Business Owner Bank Financial accounting reports disclose the financial activities of particular individuals or organizations described as reporting entities. Each entity is treated as a separate reporting unit.
Learning Objective 3 • Name and define the major elements of financial statements.
Financial Statements Income Statement Statement of Changes in Equity FASB Balance Sheet Statement of Cash Flows
Elements of Financial Statements • Assets • Liabilities • Equity • Contributed Capital • Revenue • Expenses • Distributions • Net Income • Gains • Losses The elements represent broad categories. We will discuss elements 1-8 in this chapter. We will save elements 9 and 10 for a later chapter.
Elements of Financial Statements • Assets—Cash, Equipment, Buildings, Land • Liabilities • Equity • Contributed Capital • Revenue • Expenses • Distributions • Net Income • Gains • Losses Subclassifications of the elements are frequently called accounts. Accounts are reported in the financial statements.
Learning Objective 4 • Describe the relationships expressed in the accounting equation.
Accounting Equation Assets = Claims • Claims on the assets are from two sources: • Creditors (liabilities) • Investors or owners (equity). Assets are resources that a business uses to produce earnings. Assets of a business belong to the resource providers (creditors and investors). Assets = Liabilities + Equity
Accounting Equation Assets = Liabilities + Equity
Accounting Equation Common Stock + Retained Earnings Assets = Liabilities + Equity Assets = Liabilities + Stockholders' Equity
Learning Objective 5 • Record business events in general ledger accounts organized under an accounting equation.
Recording Business Events Under the Accounting Equation • Businesses obtain assets from three sources: • Owners • Creditors • Profitable Operations Now, let’s look at the effects of asset source transactions on the accounting equation.
RCS increases assets (cash). • RCS increases stockholders’ equity (common stock). Asset Source Transaction Event 1: Rustic Camp Sites (RCS) was formed on January 1, 2004, when it acquired $120,000 cash from issuing common stock. Double-Entry Bookkeeping
RCS increases assets (cash). • RCS increases liabilities (notes payable). Asset Source Transaction Event 2: RCS acquired an additional $400,000 of cash by borrowing from a creditor.
RCS decreases assets (cash). • RCS increases assets (land). Asset Exchange Transaction Event 3: RCS paid $500,000 cash to purchase land.
RCS increases assets (cash). • RCS increases stockholders’ equity (retained earnings). Asset Source Transaction Event 4: RCS obtained $85,000 cash by leasing campsites to customers.
RCS decreases assets (cash). • RCS decreases stockholders’ equity (retained earnings). Asset Use Transaction Event 5: RCS paid $50,000 cash for operating expenses such as salaries, rent, and interest.
RCS decreases assets (cash). • RCS decreases stockholders’ equity (retained earnings). Asset Use Transaction Event 6: RCS paid $4,000 in cash dividends to its owners.
Learning Objective 6 • Explain how the historical cost and reliability concepts affect amounts reported in financial statements.
Historical Cost Concept Reliability Concept Requires that most assets be reported at the amount paid for them (their historical cost) regardless of increases in market value. Information is reliable if it can be independently verified. Appraised values are opinions and will vary from appraiser to appraiser. Event 7: The land that RCS paid $500,000 to purchase had an appraised market value of $525,000 on December 31, 2004.
Summary of Transactions Color Code Legend Green = numbers used in the statement of cash flows Red = numbers used in the balance sheet Blue = numbers used in the income statement Now, let’s prepare the financial statements for RCS using the data presented above.
Learning Objective 7 • Classify business events as asset source, use, or exchange transactions.
Classify business events Classify events into one of three categories: • Asset source transactions increase the total amount of assets and increase the total amount of claims • Asset exchange transactions decrease one asset and increase another asset • Asset use transactions decrease the total amount of assets and the total amount of claims.
Learning Objective 8 • Use general ledger account information to prepare four financial statements.
Preparing Financial Statements Matching Concept Net Loss Accounting Period
Preparing Financial Statements Liquidity
Preparing Financial Statements Operating Investing Financing
Learning Objective 9 • Record business events using a horizontal financial statements model.
Careers in Accounting An Accounting Career can take you to the top of the business world.
What do accountants do? Accountants identify, record, analyze and communicate information about the economic events that affect organizations.
Public Accountants provide services to various clients. CPA stands for certified public accountant. Services provided: Audit services Tax services Consulting services Private Accountants are employed by a specific company or nonprofit organization. Services provided include a wide variety of functions: Classify/record transactions Prepare financial statements Develop budgets Assess performance Measure costs What do accountants do?
