Chapter 8 General Principles of Accounting

Learning Objectives Consider the differences between financial and managerial accounting Discuss the elements of basic accounting

Financial v. Managerial Accounting What is financial accounting? -Financial accounting is the branch of accounting that provides general-purpose financial statements or reports to aid many decision-making groups, internal and external to the organization, in making a variety of decisions. -Example of financial accounting document: FINANCIAL STATEMENTS

What is managerial accounting? -Managerial accounting is primarily concerned with the preparation of financial information for specific purposes, usually for internal users. -Example of managerial accounting document: BUDGET Financial v. Managerial Accounting

Principles of Accounting Key Accounting Concepts: Entity: The entity for which the accounting/statements will take place. May be different from ‘legal entity.’ Money Measurement: An accounting transaction must be able to be expressed in monetary terms. –Economic resources and obligations

Principles of Accounting Cost: The price paid to acquire items owned (“assets”) by the company is recorded into the financial statements. This is different from the “worth” of the asset. This will be further explored when we discuss “depreciation.” Stable Monetary Unit: Historic and current dollars carry the same value in financial statements. A “2006 dollar” is equal to a “2012 dollar.”

Principles of Accounting Duality: This concept is the basis of the fundamental accounting equation Assets = Liabilities + Equity (aka ‘net assets’) Duality refers to the ‘double-entry’ or ‘dual-sided’ nature of businesses. Every transaction has an opposing transaction on each side of the equation. The principle implies that this equation must balance.

Principles of Accounting –Assets: the things owned by the business –Liabilities: debts owed by the business –Equity: the value of the business after accounting for liabilities… its “net worth”…also, what the business owes its owners/investors

Principles of Accounting Discussion Question: –Consider your own personal finances…what are examples of assets and liabilities

Principles of Accounting Discussion Question: –Is it possible to have a negative equity value and still be ‘in business?’

Principles of Accounting Business Transactions During the normal course of business, “transactions” take place that impact the financial standing of the company. Buying and selling goods, borrowing money to purchase equipment, are examples. Because of duality, the each transaction must “balance.”

Principles of Accounting –A transaction that increases total assets must also increase total liabilities or owner’s equity. –A transaction that decreases total assets must also decrease total liabilities or owner’s equity. –Some transactions may increase one account and decrease another on the same side of the equation (i.e. one asset increases and another decreases).

Principles of Accounting Recording Transactions: Cash vs Accrual Accounting –Cash accounting: transactions are recognized when they are received or paid. Example: recognizing sales revenue when the customer pays the bill.

Principles of Accounting –Accrual accounting: transactions of a business enterprise are recognized during the period to which they relate, not necessarily during the periods in which cash is received or paid. Example: recognizing sales revenue when the customer invoice is sent. –Which do you think is a better methodology? Why?

Principles of Accounting Knowing your debits and credits ACCOUNTDEBITCREDIT AssetsIncreasesDecreases LiabilitiesDecreasesIncreases RevenueDecreasesIncreases ExpensesIncreasesDecreases There must be a debit for every credit…part of duality

Principles of Accounting Sample Transactions –The accounting equation for a brand new company will look like this: Assets = Liabilities + Equity $0$0$0 –Transaction 1: A physician deposits $50,000 in the checking account to begin her practice Equation: Assets = Liabilities + Equity Transaction: $__________$__________ $__________ Balance: $__________$__________ $__________

Principles of Accounting Sample Transactions –Transaction 2: The practice purchases a computer, on credit, for $2,500 Equation: Assets = Liabilities + Equity Transaction: $__________$__________ $__________ Balance: $__________$__________ $__________

Principles of Accounting –Transaction 3: The practice purchases office supplies using $500 cash Equation: Assets = Liabilities + Equity Transaction: $__________$__________ $__________ Balance: $__________$__________ $__________

Principles of Accounting Sample Transactions –Transaction 4: The practice purchases a building for $100,000 with a $25,000 cash down-payment and a loan for the $75,000 outstanding. Equation: Assets = Liabilities + Equity Transaction: $__________$__________ $__________ Balance: $__________$__________ $__________

Principles of Accounting Revenues and Expenses –The expanded accounting equation breaks out owner’s equity (net assets) into two components: revenues and expenses.

Principles of Accounting –Revenue: money the business generates for providing goods and services (increases equity) –Expenses: money the business spends to maintain and grow operations (decreases equity) –Drawings or Dividends: money paid to owners (drawings: proprietorships and partnerships, dividends: corporations). –The business’ PROFIT equals REVENUES – EXPENSES

Principles of Accounting Revenues and Expenses –The expanded accounting equation looks like this: Assets = Liabilities + Equity + Revenues – Expenses – Drawings

Principles of Accounting Sample Transactions –Transaction 5: The practice invoices services for $12,000 Equation: Assets = Liabilities + Equity [Rev – Exp – Draw] Transaction: $__________ $__________ $_____________________ Balance: $__________ $__________ $_____________________

Principles of Accounting –Transaction 6: The practice pays its monthly equipment rent of $1,000 Equation: Assets = Liabilities + Equity [Rev – Exp – Draw] Transaction: $__________ $__________ $_____________________ Balance: $__________ $__________ $_____________________

Principles of Accounting Sample Transactions –Transaction 7: The physician withdraws $2,000 for her personal use. Equation: Assets = Liabilities + Equity [Rev – Exp – Draw] Transaction: $__________ $__________ $_____________________ Balance: $__________ $__________ $_____________________

Principles of Accounting –Transaction 8: The practice pays monthly payroll of $5,000 Equation: Assets = Liabilities + Equity [Rev – Exp – Draw] Transaction: $__________ $__________ $_____________________ Balance: $__________ $__________ $_____________________

Principles of Accounting Fund Accounting a system in which an entity’s assets and liabilities are segregated in the accounting records. 1.unrestricted net assets, 2.temporarily restricted net assets, and 3.permanently restricted net assets.

Principles of Accounting Accounting Conventions –Conservatism: “lower of cost or market” rule for valuing inventories and marketable securities –Materiality: permits certain transactions to be treated out of accordance with generally accepted accounting principles –Consistency: limits the accounting alternatives that can be used