2 - 1 © 2005 Accounting 1/e, Terrell/Terrell Basic Concepts of Accounting and Financial Reporting Chapter 2

2 - 2 © 2005 Accounting 1/e, Terrell/Terrell Learning Objective 1 Describe the objectives of accounting and useful accounting information.

2 - 3 © 2005 Accounting 1/e, Terrell/Terrell Accounting Objectives Accountingdata The raw results of economic transactions and events. transactions and events. Information Data that are put into some useful form for decision making. Accountinginformation The product of accountant’s organization, classification, and summarization of economic and summarization of economic transactions and events.

2 - 4 © 2005 Accounting 1/e, Terrell/Terrell Learning Objective 2 Define the qualitative characteristics of accounting information and determine the effect of each on information.

2 - 5 © 2005 Accounting 1/e, Terrell/Terrell Conceptual Framework of Accounting Objectives: Objectives: To provide stakeholders with information 1. Useful for credit and investment decisions 2. To assess future cash flows 3. About enterprise resources, claims to resources, and changes in each over time.

2 - 6 © 2005 Accounting 1/e, Terrell/Terrell Qualitative Characteristics of Accounting Information Primarycharacteristics Secondarycharacteristics Relevance Reliability Consistency Comparability

2 - 7 © 2005 Accounting 1/e, Terrell/Terrell Qualitative Characteristics of Accounting Information Relevance Timeliness Predictive value Feedback value

2 - 8 © 2005 Accounting 1/e, Terrell/Terrell Qualitative Characteristics of Accounting Information Neutrality Reliability is a characteristic of useful accounting that requires the information to be reasonably unbiased and accurate. VerifiabilityRepresentationalfaithfulness

2 - 9 © 2005 Accounting 1/e, Terrell/Terrell Qualitative Characteristics of Accounting Information Comparability is the quality of information that allows users to identify similarities in and differences between two sets of accounting information. Consistency means conformity from period to period with accounting policies and procedures.

© 2005 Accounting 1/e, Terrell/Terrell Learning Objective 3 Define the elements of accounting and construct the accounting equation.

© 2005 Accounting 1/e, Terrell/Terrell Accounting Elements Accountants use an accounting system to transform accounting data into useful accounting information Accounting data Useful accounting information

© 2005 Accounting 1/e, Terrell/Terrell The Balance Sheet Assets LiabilitiesEquity Investments by owners Earnedequity

© 2005 Accounting 1/e, Terrell/Terrell The Accounting Equation

© 2005 Accounting 1/e, Terrell/Terrell Learning Objective 4 Recognize a balance sheet, income statement, statement of equity, and statement of cash flows and determine which accounting elements comprise each statement.

© 2005 Accounting 1/e, Terrell/Terrell Basic Financial Statements Statement of Cash Flows Statement of Equity Income Statement Balance Sheet FinancialStatements

© 2005 Accounting 1/e, Terrell/Terrell Balance Sheet for a Corporation AssetsLiabilities Cash$ 29,000 Accounts payable$100,000 Cash$ 29,000 Accounts payable$100,000 Investments 75,000 Mortgage payable 200,000 Investments 75,000 Mortgage payable 200,000 Inventory 200,000Total liabilities$300,000 Inventory 200,000Total liabilities$300,000 Land 80,000 Land 80,000 Building 300,000Stockholders’ equity Building 300,000Stockholders’ equity Equipment 60,000 Common stock$200,000 Equipment 60,000 Common stock$200,000 Retained earnings 244,000 Retained earnings 244,000 Total stockholders’ equity 444,000 Total liabilities and Total assets$744,000 stockholders’ equity$744,000 Jason’s Furniture Gallery, Inc. Balance Sheet December 31, 2004

© 2005 Accounting 1/e, Terrell/Terrell The Income Statement Revenues are increases in net assets (equity) that occur as a result of an entity’s selling or producing products and performing services for its customers. Expenses are sacrifices of the future value of assets used to generate revenues from customers.

© 2005 Accounting 1/e, Terrell/Terrell The Income Statement Gains are increases in net assets (equity) that result from incidental or other peripheral events that affect the entity. Losses are decreases in net assets (equity) that result from incidental or other peripheral events that affect the entity.

© 2005 Accounting 1/e, Terrell/Terrell Income Statement for a Corporation Sales revenues$455,000 Cost of goods sold 245,000 Gross profit$210,000 Operating expenses Selling expenses$105,000 Selling expenses$105,000 Administrative expenses 60,000 Administrative expenses 60,000 Total operating expenses 165,000 Total operating expenses 165,000 Operating income$ 45,000 Other revenues and expenses Gain on the sale of equipment$ 25,000 Gain on the sale of equipment$ 25,000 Loss on investments sold (8,000) 17,000 Loss on investments sold (8,000) 17,000 Income before taxes$ 62,000 Income taxes 21,000 Net income$ 41,000 Jason’s Furniture Gallery, Inc. Income Statement For the Year Ended December 31, 2004

© 2005 Accounting 1/e, Terrell/Terrell Statement of Stockholders’ Equity Investments by owners Comprehensive income Distributions to owners Revenues Revenues Gains Gains Expenses Expenses Losses Losses Other Other comprehensive comprehensive income income

© 2005 Accounting 1/e, Terrell/Terrell Statement of Stockholders’ Equity Balance, January 1, 2004$150,000$233,000$383,000 Stock issued 50,000 50,000 Net income– 41,000 41,000 Dividend distributions – 30,000 30,000 Balance, Dec. 31, 2004$200,000$244,000$444,000 CommonstockRetainedearningsTotalstockholders’equity Jason’s Furniture Gallery, Inc. Statement of Stockholders’ Equity For the Year Ended December 31, 2004

© 2005 Accounting 1/e, Terrell/Terrell Statement of Cash Flows Operating activities: Cash received from customers$ 455,000 Cash paid for: Merchandise$160,000 Merchandise$160,000 Operating expenses 150,000 Operating expenses 150,000 Income taxes 21, ,000 Income taxes 21, ,000 Cash provided by operating activities$ 124,000 Investing activities: Purchase of equipment$( 35,000) Purchase of building (300,000) Cash used by investing activities$(335,000) Jason’s Furniture Gallery, Inc. Statement of Cash Flows For the Year Ended December 31, 2004

© 2005 Accounting 1/e, Terrell/Terrell Statement of Cash Flows Financing activities: Sale of common stock$ 50,000 Proceeds of mortgage on building 200,000 Dividends paid (30,000) Cash provided by financing activities$220,000 Net change in cash$ 9,000 Cash balance, January 1, ,000 Cash balance, December 31, 2004$ 29,000 Jason’s Furniture Gallery, Inc. Statement of Cash Flows For the Year Ended December 31, 2004

© 2005 Accounting 1/e, Terrell/Terrell Articulation The four financial statements are intertwined. The linkage between then is known as articulation.

© 2005 Accounting 1/e, Terrell/Terrell Articulation Net income is the same on both the income statement and the statement of equity. The equity balance on the statement of equity agrees with the balance sheet. The cash balance on the balance sheet agrees with the ending cash amount on the cash flow statement.

© 2005 Accounting 1/e, Terrell/Terrell Learning Objective 5 Name the underlying assumptions of accounting and describe how they affect financial reporting.

© 2005 Accounting 1/e, Terrell/Terrell Assumptions Separate entity Separate entity Going concern Monetary unit Periodicity

© 2005 Accounting 1/e, Terrell/Terrell Learning Objective 6 Define the underlying principles of accounting and determine the appropriate application of each.

© 2005 Accounting 1/e, Terrell/Terrell Principles Historical cost Revenue recognition Matching principle Full disclosure Full disclosure

© 2005 Accounting 1/e, Terrell/Terrell Learning Objective 7 Identify the underlying constraints of accounting and describe how they affect accounting decisions and reporting.

© 2005 Accounting 1/e, Terrell/Terrell Constraints Materiality Cost-benefit relationship Conservatism Industry practices

© 2005 Accounting 1/e, Terrell/Terrell Conceptual Framework of Accounting Summary Objectives AssumptionsPrinciplesConstraints Qualitativecharacteristics of accounting information Accountingelements

© 2005 Accounting 1/e, Terrell/Terrell End of Chapter 2