1. Qualities of Accounting Information
Chapter 2
Qualities of Accounting Information
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2. Copyright 2003 Prentice Hall Publishing
Who Sets the Rules?
Securities and Exchange Commission has the legal authority to set the accounting rules for companies that are publicly traded.
The SEC has delegated that responsibility to the accounting profession.
Currently, the Financial Accounting Standards Board is the standards-setting body.
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3. GAAP (not a clothes store)
Generally Accepted Accounting Principles (GAAP) are the rules that most companies follow in preparing their financial reports.
GAAP are not exact rules: professional judgment is needed.
Statements of Financial Accounting Concepts provide the basis and guidance for establishing accounting standards.
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4. Statements of Financial Accounting Concepts
Objectives of accounting information
Qualitative characteristics of accounting information
Elements of financial statements
Recognition and measurement in financial statements
GAAP
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5. Copyright 2003 Prentice Hall Publishing
Objectives Qualities
To provide useful information for decision-making.
Relevant:
specific to a business entity,
timely,
simplified and condensed,
focus on earnings,
all within a cost-benefit framework.
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6. Copyright 2003 Prentice Hall Publishing
Objectives Qualities
To provide useful information for decision-making.
Reliable:
representational faithfulness
verifiable
unbiased
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7. Copyright 2003 Prentice Hall Publishing
Objectives Qualities
To provide useful information for decision-making.
Comparable:
from year to year for one company,
across companies for a single year,
to industry averages,
estimates.
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8. Copyright 2003 Prentice Hall Publishing
Objectives Qualities
To provide useful information for decision-making.
Consistent:
same rules used each time
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9. Additional Concepts/Constraints
Cost/benefit
Materiality
Full disclosure
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10. Elements of Financial Statements
Assets
Liabilities
Equity
Revenue
Expenses
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11. Elements of Financial Statements
Next to each item, indicate whether it is an Asset, Liability, Equity, Revenue or Expense.
_____ Cash
_____ Common Stock ($1 par)
_____ Depreciation Expense
_____ Insurance Expense
_____ Interest Receivable
_____ Interest Earned
_____ Investment in U.S. Bonds
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12. Elements of Financial Statements
_____ Cash Asset
_____ Common Stock ($1 par) Equity
_____ Depreciation Expense Expense
_____ Insurance Expense Expense
_____ Interest Receivable Asset
_____ Interest Earned Revenue
_____ Investment in U.S. Bonds Asset
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13. More elements of financial statements
_____ Miscellaneous Expense
_____ Prepaid Insurance
_____ Rent Revenue
_____ Retained Earnings
_____ Salaries Expense
_____ Salaries Payable
_____ Service Revenue
_____ Supplies Used
_____ Unearned Rent
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14. More elements of financial statements
_____ Miscellaneous Expense Expense
_____ Prepaid Insurance Asset
_____ Rent Revenue Revenue
_____ Retained Earnings Equity
_____ Salaries Expense Expense
_____ Salaries Payable Liability
_____ Service Revenue Revenue
_____ Supplies Used Expense
_____ Unearned Rent Liability
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Copyright Prentice Hall Publishing

15. Recognition and Measurement in Financial Statements
Transactions are measured and recorded at COST.
Revenue is recognized--included on the income statement--when it is EARNED.
Expenses are recognized in the period in which the related revenue is recognized: MATCHING CONCEPT.
This is ACCRUAL ACCOUNTING.
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16. Accruals and Deferrals
Action first, dollars later
E.g., services are performed, payment to be received later
DEFERRALS:
Dollars first, action later
E.g., payment is made in advance for insurance or rent, the action of using it comes later
Both types of transactions and adjustments are part of ACCRUAL ACCOUNTING.
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17. Copyright 2003 Prentice Hall Publishing
Tom’s Wear: February 2001
Let’s look at each of the transactions that took place during February, Tom’s second month of business.
We’ll show how each affects the accounting equations, and then we’ll prepare the four basic financial statements.
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18. Acquisition of Inventory
Date
February 1
Transactions
Tom’s Wear purchases 200 T-shirts at $4 each on account.
Assets = Liabilities CC RE
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19. Acquisition of Inventory
Date
February 1
Transactions
Tom’s Wear purchases 200 T-shirts at $4 each on account.
Assets = Liabilities CC RE
$800 inventory $800 A/P
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Copyright Prentice Hall Publishing

20. Acquisition of a Service
Date
February 5
Transactions
Tom’s Wear hires a company to advertise his business for $150--$100 cash and $50 on account.
Assets = Liabilities CC RE
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Copyright Prentice Hall Publishing

21. Acquisition of a Service
Date
February 5
Transactions
Tom’s Wear hires a company to advertise his business for $150--$100 cash and $50 on account.
Assets = Liabilities CC RE
(100) cash other payables (150) expenses
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Copyright Prentice Hall Publishing

22. Sales and Collection Cycle
Date
February 14
Transactions
Tom’s Wear pays for 3 month’s worth of insurance for $150.
Assets = Liabilities CC RE
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23. Sales and Collection Cycle
Date
February 14
Transactions
Tom’s Wear pays for 3 month’s worth of insurance for $150.
Assets = Liabilities CC RE
+ 150 prepaid insurance
(150) cash
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24. Sales and Collection Cycle
Date
February 20
Transactions
Tom’s Wear sells 185 T-shirts for $10 each. 170 shirts were cash sales and the other sales were on account.
Assets = Liabilities CC RE
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25. Sales and Collection Cycle
Date
February 20
Transactions
Tom’s Wear sells 185 T-shirts for $10 each. 170 shirts were cash sales and the other sales were on account.
Assets = Liabilities CC RE
+1,700 cash +1,850 sales
A/R
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26. Sales and Collection Cycle
Transactions
Tom’s Wear sells 185 T-shirts for $10 each. 170 shirts were cash sales and the other sales were on account.
Date
February 20
Assets = Liabilities CC RE
+1,700 cash +1,850 sales
A/R
(740) inventory (740) cost of goods sold
Note: Recall that the cost of shirts was $4 each.
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27. Acquisition/Payment Cycle
Date
February 28
Transactions
Tom’s Wear pays dividends of $100.
Assets = Liabilities CC RE
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28. Acquisition/Payment Cycle
Date
February 28
Transactions
Tom’s Wear pays dividends of $100.
Assets = Liabilities CC RE
(100) cash (100) dividends
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29. Adjustment for Year-end Financial Statements
Prepaid insurance that has been used needs to be recorded as an expense. Only the unused portion remains on the balance sheet as an asset.
Date
February 28
Assets = Liabilities CC RE
(25) prepaid insurance (25) insurance expense
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30. Copyright 2003 Prentice Hall Publishing
Tom’s Wear, Inc. Income Statement For the month ended February 28, 2001
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31. Copyright 2003 Prentice Hall Publishing
Tom’s Wear, Inc. Income Statement For the month ended February 28, 2001
Revenue
Sales $1,850
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32. Copyright 2003 Prentice Hall Publishing
Tom’s Wear, Inc. Income Statement For the month ended February 28, 2001
Revenue
Sales $1,850
Expenses
Cost of sales $ Total Expenses
Net Income
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33. Copyright 2003 Prentice Hall Publishing
Tom’s Wear, Inc. Income Statement For the month ended February 28, 2001
Revenue
Sales $1,850
Expenses
Cost of sales $ Other expenses
Net income $ 935
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34. Statement of Changes in
Tom’s Wear, Inc.
Statement of Changes in
Shareholder’s Equity
For the month ending 2/28/01
Beginning contributed capital $5,000
Contributions during the year
Ending contributed capital ,000
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35. Statement of Changes in
Tom’s Wear, Inc.
Statement of Changes in
Shareholder’s Equity
For the month ending 2/28/01
Beginning contributed capital $5,000
Contributions during the year
Ending contributed capital ,000
Beginning retained earnings $ 385
Net income for the year
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36. Statement of Changes in
Tom’s Wear, Inc.
Statement of Changes in
Shareholder’s Equity
For the month ending 2/28/01
Beginning contributed capital $5,000
Contributions during the year
Ending contributed capital ,000
Beginning retained earnings $ 385
Net income for the year 935
Dividends (100)
Ending retained earnings $1,220
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37. Statement of Changes in
Tom’s Wear, Inc.
Statement of Changes in
Shareholder’s Equity
For the month ending 2/28/01
Beginning contributed capital $5,000
Contributions during the year
Ending contributed capital ,000
Beginning retained earnings $ 385
Net Income for the year
Dividends (100)
Ending Retained earning $1,220
Total shareholders’s equity $6,220
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38. Tom’s Wear, Inc. Balance Sheet At 2/28/01
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39. Tom’s Wear, Inc. Balance Sheet At 2/28/01
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40. Tom’s Wear Statement of Cash Flows For the year ending 2/28/01
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41. Tom’s Wear Statement of Cash Flows For the year ending 2/28/01
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42. Tom’s Wear Statement of Cash Flows For the year ending 2/28/01
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