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Qualities of Accounting Information

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Presentation on theme: "Qualities of Accounting Information"— Presentation transcript:

1 Qualities of Accounting Information
Chapter 2 Qualities of Accounting Information Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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. Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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. Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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. Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

6 Copyright 2003 Prentice Hall Publishing
Objectives Qualities To provide useful information for decision-making. Reliable: representational faithfulness verifiable unbiased Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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. Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

8 Copyright 2003 Prentice Hall Publishing
Objectives Qualities To provide useful information for decision-making. Consistent: same rules used each time Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

9 Additional Concepts/Constraints
Cost/benefit Materiality Full disclosure Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

10 Elements of Financial Statements
Assets Liabilities Equity Revenue Expenses Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

13 More elements of financial statements
_____ Miscellaneous Expense _____ Prepaid Insurance _____ Rent Revenue _____ Retained Earnings _____ Salaries Expense _____ Salaries Payable _____ Service Revenue _____ Supplies Used _____ Unearned Rent Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing 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. Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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. Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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. Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

18 Acquisition of Inventory
Date February 1 Transactions Tom’s Wear purchases 200 T-shirts at $4 each on account. Assets = Liabilities CC RE Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing 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 Copyright Prentice Hall Publishing 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 Copyright Prentice Hall Publishing 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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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. Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

27 Acquisition/Payment Cycle
Date February 28 Transactions Tom’s Wear pays dividends of $100. Assets = Liabilities CC RE Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

28 Acquisition/Payment Cycle
Date February 28 Transactions Tom’s Wear pays dividends of $100. Assets = Liabilities CC RE (100) cash (100) dividends Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

30 Copyright 2003 Prentice Hall Publishing
Tom’s Wear, Inc. Income Statement For the month ended February 28, 2001 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

31 Copyright 2003 Prentice Hall Publishing
Tom’s Wear, Inc. Income Statement For the month ended February 28, 2001 Revenue Sales $1,850 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

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 Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

38 Tom’s Wear, Inc. Balance Sheet At 2/28/01
Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

39 Tom’s Wear, Inc. Balance Sheet At 2/28/01
Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

40 Tom’s Wear Statement of Cash Flows For the year ending 2/28/01
Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

41 Tom’s Wear Statement of Cash Flows For the year ending 2/28/01
Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing

42 Tom’s Wear Statement of Cash Flows For the year ending 2/28/01
Copyright Prentice Hall Publishing Copyright Prentice Hall Publishing


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