Accounting for Business Lecture 1

ACCOUNTING DEFINITION

PURPOSE OF ACCOUNTING

BASIC ACCOUNTING CONCEPTS Assumptions Business Entity: The business is separate from its owners and other businesses. Revenue and expense should be kept separate from personal expense. Monetary Unit: A stable currency is the unit of record. Periodicity: The economic activities of an enterprise can be divided into artificial time periods. Going Concern: Continuation of an entity as a going concern is presumed.

BASIC ACCOUNTING CONCEPTS Principles Historical cost principle: Companies must account for and report the acquisition costs of assets and liabilities rather than their fair market value. This principle provides information that is reliable (removing the opportunity to provide subjective and potentially biased market values), but not very relevant. Thus there is a trend toward the use of fair values. Most debts and securities are now reported at market values.

BASIC ACCOUNTING CONCEPTS Principles Revenue recognition principle: Companies should record revenue when earned but not when received. The flow of cash does not have any bearing on the recognition of revenue. This is the essence of accrual basis accounting. Conversely, however, losses must be recognized when their occurrence becomes probable, whether or not it has actually occurred. This comports with the constraint of conservatism, yet brings it into conflict with the constraint of consistency, in that reflecting revenues/gains is inconsistent with the way in which losses are reflected.

BASIC ACCOUNTING CONCEPTS Principles Matching principle: Expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. Only if no connection with revenue can be established, cost may be charged as expenses to the current period (e.g. office salaries and other administrative expenses).

BASIC ACCOUNTING CONCEPTS Principles Full disclosure principle: The amount and kinds of information disclosed should be decided based on trade-off analysis as a larger amount of information costs more to prepare and use. Information disclosed should be enough to make a judgment while keeping costs reasonable. Information is presented in the main body of financial statements, in the notes or as supplementary information

BASIC ACCOUNTING CONCEPTS Principles The objectivity principle is the concept that the financial statements of an organization be based on solid evidence Materiality Concept - Financial statement items are material if they could influence the economic decisions of users. The concept of materiality is relative in size and importance. Consistency principle: It means that the company uses the same accounting principles and methods from period to period. Cost Constraint: The benefits of reporting financial information should justify and be greater than the costs imposed on supplying it.

BASIC ACCOUNTING CONCEPTS Assumptions Business Entity: The business is separate from its owners and other businesses. Revenue and expense should be kept separate from personal expense. Monetary Unit: A stable currency is the unit of record. Periodicity: The economic activities of an enterprise can be divided into artificial time periods. Going Concern: Continuation of an entity as a going concern is presumed.

ACCOUNTING EQUATION

Practice Exercise 1 1.Made a cash investment to start the business 2.Paid monthly rent from cash 3.Purchased equipment on account 4.Billed customer for service 5.Withdrew cash for personal use 6.Received cash from customers billed in 4 7.Incurred advertisement expense on account 8.Purchased additional equipment for cash 9.Received cash from customer when service was performed

Practice Exercise 1

Practice Exercise 2 A number of transactions of Claypool Construction are described below in terms of accounts debited and credited: 1. Debit Wages Expense; credit Wages Payable. 2. Debit Accounts Receivable; credit Construction Revenue. 3. Debit Office Supplies; credit Accounts Payable. 4. Debit Repairs Expense; credit Cash. 5. Debit Cash; credit Accounts Receivable. 6. Debit Tools and Equipment; credit Cash and Notes Payable. 7. Debit Accounts Payable; credit Cash. Indicate the effects of each transaction upon the elements of the income statement and the balance sheet. Use the code letters I for increase, D for decrease, and NE for no effect. Organize your answer in tabular form using the column headings shown below. The answer for transaction 1 is provided as an example.

Practice Exercise 3