UNIT 1: INTRODUCTION TO

ACCOUNTING

What is Accounting?

The primary objective of accounting is to provide

information that is useful for decision-making purposes.
From the very start, we emphasize that accounting is not
an end, but rather it is a means to an end. The final
product of accounting information is the decision that is
enhanced by the use of that information, whether the
decision is made by owners, management, creditors,
governmental regulatory bodies, labor unions, or the
many other groups that have an interest in the financial
performance of an enterprise.

ACCOUNTING - THE BASIS OF

DECISION MAKING

Accounting is the language of business

Accounting is the information system that





Measures business activities

Processes that information into reports
Communicates the results to decision makers

What is Accounting?

 Interpret
and record
business
transactions.

 Classify
similar
transactions
into useful
reports.
 Summarize
and
communicate
information to
decision
makers.

THE ACCOUNTING SYSTEM:

THE FLOW OF INFORMATION

1. People make decisions

2. Business transactions occur

3. Businesses prepare reports to show the

results of their operations

Who uses accounting data?

Owners
Creditors
Labor unions
Governmental agencies
Suppliers
Customers
Trade associations
General public

Users of accounting information

regulators
consumers

Tax officials
lenders
Financial
markets

suppliers
FIRM

Managers Interaction with External Parties

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USES OF ACCOUNTING

MANAGERS need INFORMATION:





To determine how to operate the business

To decide on which investments to make
To finance the companys operations

INVESTORS need INFORMATION:



To help them to make better decisions on which

investments to take

Who Uses Accounting Information?

Individuals

Government
regulatory
agencies

Businesses

Taxing
authorities

Investors and
creditors

Nonprofit
organizations
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HOW THEY USE ACCOUNTING

INFORMATION?

INDIVIDUALS:



BUSINESSES (BUSINESS MANAGERS):



To set goals, evaluate them and take corrective actions

INVESTORS:



To make investment decisions

To manage a checking account

To decide whether to invest or not

To evaluate an investment

CREDITORS:


To evaluate a borrowers ability to make required payments

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HOW THEY USE ACCOUNTING

INFORMATION? (Cont.)

GOVERNMENT REGULATORY AGENCIES:



TAXING AUTHORITIES


To determine the amount of tax due

NON-PROFIT ORGANIZATIONS


To determine if government regulations have been followed

Use accounting as a for-profit organization

OTHER POTENTIAL USERS:



e.g. employees, labour unions, etc.

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Internal Users
 Board of directors
 Chief executive officer (CEO)
 Chief financial officer (CFO)
 Vice presidents
 Business unit managers
 Plant managers
 Store managers
 Line supervisors

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Financial information and financial markets

The relationship between financial information and security

prices can influence investors direct demand for financial
information
Evidence shows:


Annual earnings are not timely information and are preempted by

alternative, more timely sources
However, significant price reaction was found in the week of the
anouncement of annual earnings
Prices act as if earnings anouncements alter investors belief in such a
way as to alter the price o security

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ACCOUNTING VS.
BOOKKEEPING

Bookkeeping provides a systematic record of

business events based on accounting
policies
Bookkeeping refers to the books in which
accountants record transactions. People think
that accountants simply count carefully, and
keep records, but accounting transcends
counting.

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ACCOUNTING VS.
BOOKKEEPING

Accounting
process
includes
the
bookkeeping function. However, accounting
also includes much more.
Bookkeeping usually only involves the
recording of economic events.
Accounting involves the entire process of
identifying, recording and communicating
economic events.

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The notion of accounting

Accountants:
measure, record

Economic
environment

communicate

USERS

Beliefs &
Perceptions

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Accounting as communication of financial information:

from income measurement to the informational approach

Management is the
steward to whom capital
suppliers entrust control
over a portion of their
financial resources

Purpose of financial
statements is to provide
a report to capital suppliers
to facilitate their evaluation
of managements
stewardship

Income
measurement

Financial data have to

facilitate contracting
between parties such
as management and
investors

Financial data have to

facilitate decisions
makers in selecting the
best action among
available alternatives

Informational
approach

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Types of Accounting

Financial accounting



Information for users outside the firm

e.g. investors, creditors, governments

Managerial Accounting



Information for internal users

e.g. managers, other internal decision makers

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Internal vs external users

Internal => management accounting




More focused and detailed information

Feed back possible

Managers can take corrective actions

External => financial accounting (annual

reports)




Global information
No influence on the reporting process
Relevant for parties not involved in the day-to-day
operations
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Regulation
The role of capital markets
as fund providers

Economic consequences
of financial information

Managerial incentives to
suppress unfavorable
information

Need for regulation

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ACCOUNTING PRINCIPLES
AND CONCEPTS

Generally accepted accounting

principles (GAAP) are:

Guidelines that govern how accountants

Measure

Process

Communicate

Financial information
Based upon a conceptual framework
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Accounting Principles and Concepts

Financial Accounting Standards Board

(FASB) establishes US GAAP


GAAP Generally Accepted Accounting

Principles
GAAP is derived from the conceptual framework

Other parties involved in defining how

accounting should be practised:



SEC: Securities and Exchange Commission

AICPA
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KEY US ACCOUNTING ORGANIZATIONS

Public Sector
Law creates the SEC to
regulate the stock and
bond market in the U.S.

Private Sector
Accountants apply
GAAP through
the AICPA

GAAP governs
accounting
information

Private Sector
The FASB determines
generally accepted
accounting principles

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KEY SPANISH ORGANIZATIONS

(relevant for the Accounting practice)

Ministry of Treasury
ICAC


Bank of Spain
UE Comission
CNMV


Instituto de Contabilidad y Auditora de Cuentas

Similar to SEC

AECA


Asociacin Espaola de Contabilidad y Auditora

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Forms of Business Organization

Three major forms of organization

These forms differ with respect to



number of owners,
degree of liability for debts of the business

Who pays if the company fails to repay its debts?

Status of legal entity

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Business Organizations

Types of organizations:
 Proprietorship
 Partnership
 Corporation

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Forms of Business Organization

Proprietorship



Has a single owner

Proprietor is personally liable for debts of the
business

Unlimited liability
Owner assumes personal responsibility





Actions can be taken against any of his goods

Not a separate legal entity

For accounting, the proprietorship is a separate
entity from the proprietor
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Forms of Business Organization

Partnerships



Two or more partners are co-owners

Each partner can be liable for all the debts of the
partnership




Each partner has unlimited liability

Not a separate legal entity

For accounting, the partnership is a separate
entity from its partners

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Forms of Business Organization

Corporations





May have many owners (stockholders)

Ownership represented by shares
Stockholders are not personally liable for debts of the
business

They have limited liability
Is a separate legal entity
Stockholders elect a Board of Directors to appoint corporate
officers and set policies
It has many of the rights a person is entitled to:

Right to enter into contracts

Right to sue and be sued

Right to own, buy and sell property
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Conceptual Framework

Accounting provides information useful for

decision making
To be useful, information must be




Relevant able to influence a decision

Reliable verifiable and free from error
Comparable can be compared with different
companies
Consistent can be compared from one period to
the next

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ACCOUNTING PRINCIPLES AND CONCEPTS

They are present in the elaboration of all

accounting information
They are mainly, five:






Entity concept
Reliability principle
Cost principle
Going-concern concept
Stable-monetary-unit concept

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ACCOUNTING PRINCIPLES AND CONCEPTS

The entity concept



States that an organization is an economic

unit that keeps its affairs separate from
those of the owner(s) or other entities
Example: the company sells the products,
not the owner.

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ACCOUNTING PRINCIPLES AND CONCEPTS

The reliability (or objectivity) principle



States that accounting records and statements

should be based on accurate data.
Use the most reliable data available and
documented by objective evidence
Actual cost is usually more reliable than market
value
Data is reliable if:

It is verifiable
It can be confirmed by an independent observer

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ACCOUNTING PRINCIPLES AND CONCEPTS

The cost principle



States that acquired assets and services should be

recorded at their actual (historical) cost and should
maintain that historical cost for as long as they are
owned

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ACCOUNTING PRINCIPLES AND CONCEPTS

The going-concern concept



States that the entity will remain in operation for

the foreseeable future

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ACCOUNTING PRINCIPLES AND CONCEPTS

The stable-monetary-unit concept



States that each dollar has the same purchasing

power as any other dollar at any other time
It allows accounts to ignore the effect of inflation in
the accounting records

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THE ACCOUNTING EQUATION

The accounting equation presents the

resources of the business and the claims to
those resources

Economic Resources = Claims to Economic Resources

or

37

ACCOUNTING EQUATION

Total Assets
=
Total Liabilities
+
Total Stockholders Equity
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The Accounting Equation

Assets = Liabilities + Owners Equity

Economic
Resources

Claims to
Economic
Resources

39

ACCOUNTING EQUATION

IT SHOWS THE EQUALITY BETWEEN THE ASSETS

(what the company owns) AND THE CLAIMS TO THEM

FINANCIAL STATEMENTS ARE BASED ON THE

ACCOUNTING EQUATION

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THE ACCOUNTING EQUATION

Assets are the economic resources of a

business that are expected to be of benefit in
the future

Claims to assets come from




Liabilities
Owners equity (capital)

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The Accounting Equation

Liabilities are debts payable to outsiders, called

creditors

Owners Equity represents the ownership of the

owners




It is the owners claim on the entitys assets

Also known as Stockholders equity
It can be obtained by substracting::

Assets Liabilities = Owners Equity

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THE ACCOUNTING EQUATION

In a corporation, Owners equity is knows as

Stockholders equity

Stockholders equity consists of two main

categories:



Paid-in capital
Retained earnings

Assets = Liabilities + Stockholders Equity

or
Assets = Liabilities + Paid-in Capital + Retained Earnings
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THE ACCOUNTING EQUATION

Paid-in (contributed) capital is



The amount invested in the corporation by its

owners
Comprised basically of common stock

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THE ACCOUNTING EQUATION

Retained earnings


Is the amount earned by income-producing

activities and kept for use in the business
Is affected by

Revenues - increases in retained earnings from

delivering goods or services
Expenses - decreases in retained earnings that result
from operations

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COMPONENTS OF RETAINED EARNINGS

Revenues for the

Period

Expenses for the

Period
Start of the
Period
Beginning Balance
of Retained
Earnings

End of the
Period

=
+
-

Net Income (Loss)

for the Period

Dividends for the

Period

Ending Balance of
Retained
Earnings

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OTHER IMPORTANT ACCOUNTING CONCEPTS

Net income (net earnings)



Net loss


Total revenues exceed total expenses

Total expenses exceed total revenues

Dividends


Distributions to stockholders (usually cash)

generated by net income

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OWNERS EQUITY

REVENUESINCREASE NET INCOME

RETAINED EARNINGS

EXPENSESDECREASE NET INCOME

RETAINED EARNINGS

DIVIDENDSDECREASE RETAINED EARNINGS

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OWNERS EQUITY SPECIAL

SITUATIONS

The owners equity of proprietorships and

partnerships


Makes no distinction between paid-in capital and

retained earnings

It does not distinguish what is invested from what is

earned

Accounts for the equity of each owner under the

single heading of Capital

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THE ACCOUNTING CYCLE AND

THE FLOW OF INFORMATION

In financial accounting, there are basically

nine steps from beginning to end. Although
you will be learning all these steps in detail in
the next few chapters, it may be a good time
for you to get a sneak preview of what
accounting is all about

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THE ACCOUNTING CYCLE AND

THE FLOW OF INFORMATION

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