PRINCIPLES OF ACCOUNTING

Lecture 1

Topic 1: Introduction and Subject Overview

Teaching Details
Lecturer in Charge:
Dr. Md. Hamid U Bhuiyan
Associate Professor
Department of Accounting & Information Systems
University of Dhaka
Email: [email protected]

Text Book
Accounting Principles, Weygandt, Kimmel,
and Kieso 10th Edition
Intermediate Accounting, Kieso, Weygandt,
Warfield 15th Edition
Everyone should have the access to this textbook, class
Test questions are set from it

Assessment
Assessment includes:
Mid-semester exam (15*2)
30%
Class test (best two out of three)
20%
Assignment & presentation
Final examination (2-hours)

10%
40%

Assessment components
Mid-semester exam 1 will comprise multiple-choice questions and be

of 90 minutes duration in Week 5

Mid-semester exam 2 will comprise problem solving questions and
be of 90 minutes duration in Week 10
Class test process will comprise 3 tests in week 3, 7, and 11. Your
best 2 will be counted towards the 20% of the total assessment
Final examination will be a 2-hour exam
Final exam will be divided into 3 sections:
Section 1 Multiple choice, Section 2 Short questions & Problem
Solving, and Section 3 Critical and detail problem solving

How to Succeed This Subject?

Regularly attend lectures
Be prepared before lectures
read the relevant chapters of the textbook before a

lecture
complete assigned class exercises independently

Balance work and study

Resolve study difficulties

and problems
immediately, by consulting the lecturer, and
never accumulate problems to the end of the
semester

Subject Content
Mixture of theory and practical topics
Lectures emphasis the important materials and both

theoretical element, application and practical

problems
Use of real company examples to support theory

concepts as much as possible

What is Accounting?
The primary function of accounting is to provide useful financial

information to users who are external to the business enterprise,

particularly investors and creditors
Accounting as a special language used to communicate financial

information about a business to those who wish to use the

information to make decisions
Accounting Consists Three Basic Activities:
1. identify, record, and communicate the economic events of an
2. organization to
3. interested users

The Activities in the Accounting Process

An Example of Accounting Process

Examples of economic events are sale of Motor Car, Payment of

Wages, and Manufacturing of Motor Car by Ford Motor

Corporation
Once Ford Motor identifies economic events, it records those events in order

to provide a history of its financial activities. Recording consists of keeping a

systematic, chronological diary of events, measured in monetary terms
In recording, Ford Motor also classifies and summarizes economic events

Finally, Ford Motor communicates the collected information to

interested users by means of accounting reports (known as

Financial Statements)

An Example of Accounting Process

To make the reported financial information meaningful, Ford

Motor reports the recorded data in a standardized way. It

accumulates information resulting from similar transactions
For example, Ford accumulates all sales transactions over a

certain period of time and reports the data as one amount in the
companys financial statements.
By presenting the recorded data in the aggregate, the accounting

process simplifies a multitude of transactions and makes a series

of activities understandable and meaningful

Users of Accounting Information

Internal Users:
Management
Human Resources
Dept.
Marketing Dept.
Finance Dept.

External Users:
Existing Investors
Potential Investors
Creditors and Lenders
Regulatory Agencies
Financial Intermediaries
Labor Unions
Customers
Govt. Organizations

Illustration Users of Accounting Information

Can we afford to give our employees a pay

raise?

Human Resources

Did the company earn a satisfactory income?

Do we need to borrow in the near future?
Is cash sufficient to pay dividends to the

Investors
Management

stockholders?
What price for our product will maximize net

Finance

income?

Marketing
Will the company be able to pay its short-term

debts?

Creditors

Generally Accepted Accounting Principles

GAAP: A set of rules and practices, having substantial

authoritative support, that the accounting profession recognizes

as a general guide for financial reporting purposes and are
generally accepted and universally practiced
Standard-setting bodies determine these guidelines:

Securities and Exchange Commission (SEC)

Financial Accounting Standards Board (FASB)

International Accounting Standards Board (IASB)

An Interview

Conceptual Framework for Accounting

The conceptual framework has been described as an Accounting

Constitution because it provides the underlying foundation for

accounting standards
It is a logical system of interrelated objectives and fundamentals

that are intended to lead to consistent standards

The fundamentals are the underlying concepts of accounting that

guide the selection of events to be accounted for, the measurement

of those events, and the means of summarizing and
communicating them to interested parties

Overview of Conceptual Framework

Objective of Financial Reporting

The objective of general-purpose financial reporting is to

provide financial information about the reporting entity that is

useful to present and potential equity investors, lenders, and
other creditors in making decisions about providing resources
to the entity
Those decisions involve buying, selling, or holding equity and

debt instruments, and providing or settling loans and other

forms of credit
Information that is decision-useful to capital providers may

also be useful to other users of financial reporting, who are

not capital providers

General-Purpose Financial Statements

General-purpose financial statements provide financial

reporting information to a wide variety of users

These statements help shareholders, creditors, suppliers,

employees, and regulators to better understand its financial

position and related performance.

To be cost effective in providing this information, general-

purpose financial statements are most appropriate.

In other words, general-purpose financial statements provide

at the least cost the most useful information possible

General-Purpose Financial Statements

The primary means of conveying financial information to investors, creditors,
and other external users is through financial statements and related
disclosure notes
The financial statements most frequently provided are:
1.
2.
3.
4.

The balance sheet, also called the statement of financial position

The income statement, also called the statement of operations
The statement of cash flows, and
The statement of shareholders equity

. Also, starting in 2012, companies must either provide a statement of other

comprehensive income immediately following the income statement, or

present a combined statement of comprehensive income that includes the
information normally contained in both the income statement and the
statement of other comprehensive income

Qualitative Characteristics of Accounting Information

How does a company choose an acceptable accounting method, the

amount and types of information to disclose, and the format in which to

present it?
The answer:
By determining which alternative provides the most useful information

for decision making purposes (decision-usefulness)

The FASB (Financial Accounting Standard Board) identified the

qualitative characteristics of accounting information that distinguish

better (more useful) information from inferior (less useful) information
for decision-making purposes

Hierarchy of Accounting Qualities

Fundamental Quality - Relevance

To be relevant, accounting information must be capable of

making a difference in a decision

Relevance Ingredients

Financial information has predictive value if it has value as an

input to predictive processes used by investors to form their own
expectations about the future. For example, Current-period net
income has predictive value if it helps users predict a companys
future cash flows

Relevance Ingredients

Relevant information also helps users confirm or correct

prior expectations. For example, It has confirmatory value if
it helps investors confirm or change their prior assessments
regarding a companys cash-flow generating ability.

Relevance Ingredients

Information is material if omitting it or misstating it could

influence decisions that users make on the basis of the reported
financial information. The threshold for materiality often depends
on the relative dollar amount of the transaction
For example, $10,000 in total anticipated bad debts for a multibillion dollar
company like Dell would not be considered material. This same $10,000
amount, however, might easily be material for a neighborhood pizza parlor

Fundamental Quality Faithful Representation

Faithful representation means that the numbers and descriptions

match what really existed or happened
For example, assume that the term inventory in the balance sheet of
a retail company is understood by external users to represent items
that are intended for sale in the ordinary course of business. If
inventory includes, say, machines used to produce inventory, then
it lacks faithful representation

Faithful Representation Ingredients

Completeness means that all the information that is necessary for

faithful representation is provided.
A representation of an economic occurrence is complete if it includes all the
information necessary for faithful representation of the economic phenomenon
that it significance to represent. Omitting a portion of that information can cause
it to be false or misleading and thus not helpful.

Faithful Representation Ingredients

Neutrality means that a company cannot select information to favor

one set of interested parties over another. Accounting information
should be free from bias.
Accounting standards should be established with the goal of providing highquality information, and should try not to achieve particular social outcomes or
favor particular groups or companies

Faithful Representation Ingredients

An information item that is free from error will be a more accurate

(faithful) representation of a financial item.
Accounting estimates are common, and some inaccuracy is likely. An estimate is
represented faithfully if it is described clearly and accurately as being an estimate,
and financial statement users are given enough information to understand the
potential for inaccuracy that exists

Enhancing Qualities - Comparability

Information that is measured and reported in a similar manner for

different companies is considered comparable.
Comparability ensures investors and creditors being able to compare information
among companies to make their resource allocation decisions. Closely related to
comparability is the notion that consistency of accounting practices over time
permits valid comparisons among different reporting periods.

Enhancing Qualities Verifiability

Verifiability occurs when independent measurers, using the same

methods, obtain similar results.
Verifiability implies that different knowledgeable and independent measurers
would reach consensus regarding whether information is a faithful representation
of what it is intended to depict. Direct verification involves observing the item
being depicted. For example, the historical cost of a piece of land to be reported in
a companys balance sheet usually is highly verifiable, however, the fair value of
the piece of land is much more difficult to verify.

Enhancing Qualities Timeliness

Timeliness means having information available to decision-makers

before it loses its capacity to influence decisions.
Information is timely when its available to users early enough to allow them to
use it in their decision process. The need for timely information requires that
companies provide information on a periodic basis. To enhance timeliness, the
SEC requires its registrants to submit financial statement information on a
quarterly as well as on an annual basis for each fiscal year.

Enhancing Qualities Understandability

Understandability is the quality of information that lets reasonably

informed users see its significance.
Understandability means that users must be able to comprehend the information
within the context of the decision being made. This is a user-specific quality
because users will differ in their ability to comprehend any set of information.

Key Constraint
Information is cost effective only if the benefit of increased
decision usefulness exceeds the costs of providing that
information.
The benefits of endowing financial information with all the
qualitative characteristics weve discussed must exceed the costs
of doing so. The costs of providing financial information include
those of gathering, processing, and disseminating information.
There also are costs to users when interpreting information.
In addition, costs include possible adverse economic consequences
of implementing accounting standards

Elements of Financial Statements

Ten interrelated elements that relate to measuring the performance
and financial status of a business enterprise.

Moment in Time

Period of Time

Assets

Investment by owners

Liabilities

Distribution to owners

Equity

Comprehensive income

Revenue

Expenses

Gains

Losses

Basic Assumptions
Four basic assumptions underlie GAAP:
1. The economic entity assumption
2. The going concern assumption
3. The periodicity assumption
4. The monetary unit assumption
. These assumptions identify the entity that is being

reported on, the assumption that the entity will

continue to exist, and the frequency and denomination
in which reports occur

Basic Assumptions
Economic Entity company keeps its activity separate from its

owners and other businesses.

For example, if you were considering buying some ownership
stock in Google , you would want information on the various
operating units that constitute Google.

Going Concern - company to last long enough to fulfill objectives

and commitments.
In absence of this assumption assets and liabilities assets and
liabilities would be measured in their current liquation value

Basic Assumptions
Periodicity - company can divide its economic activities into time

periods.
The accounting profession and the SEC advocate that companies adopt a fiscal

year that corresponds to their natural business year. A natural business year is
the 12-month period that ends when the business activities of a company reach
their lowest point in the annual cycle.
For example, many retailers, Wall-Mart have a fiscal year ending on January

31; Dell companys fiscal year ends at the end of January; The Campbell Soup
Company s fiscal year ends in July; Cloroxs in June; and Monsantos in
August.

Monetary Unit - money is the common denominator.

In the United States, the U.S. dollar is the monetary unit used in financial
statements. In the EU, the euro is the monetary unit. Other countries use other
currencies as their monetary units.
One problem is that the purchasing power of currencies are not stable. However,
in Accounting it is presumed that the monetary unit is stable over time

Basic Assumptions - Illustration

(a) The economic activities of KC Corporation are divided into 12-

month periods for the purpose of issuing annual reports.

PERIODICITY
(b)Solectron Corporation, Inc. does not adjust amounts in its

financial statements for the effects of inflation.

MONETARY UNIT
(c) Walgreen Co. reports current and noncurrent classifications in

its balance sheet.

GOING CONCERN
(d)The economic activities of General Electric and its subsidiaries

are merged for accounting and reporting purposes.

ECONOMIC ENTITY

Basic Principles
Measurement

Principle The most commonly used

measurements are based on historical cost and fair value.

Issues:

Historical cost provides a reliable benchmark for measuring

historical trends.

Fair value information may be more useful.

Recently the FASB has taken the step of giving companies

the option to use fair value as the basis for measurement of
financial assets and financial liabilities.

Reporting of fair value information is increasing.

Basic Principles
Revenue Recognition - requires that companies recognize

revenue in the accounting period in which the performance

obligation is satisfied
Expense Recognition - Let the expense follow the revenues.

Basic Principles
Full Disclosure providing information that is of

sufficient importance to influence the judgment

and decisions of an informed user.
Provided through:

Financial Statements

Notes to the Financial Statements

Supplementary information

Illustration
KC Corporation reports revenue in its income statement when it is

earned instead of when the cash is collected

Revenue Recognition
Yahoo, Inc. recognizes depreciation expense for a machine over the 2-

year period during which that machine helps the company earn revenue
Expense Recognition
Oracle Corporation reports information about pending lawsuits in the

notes to its financial statements

Full Disclosure
Eastman Kodak Company reports land on its balance sheet at the

amount paid to acquire it, even though the estimated fair market value is
greater
Measurement

Constraint
Cost Constraint cost of providing information must be weighed

against the benefits that can be derived from using it

Illustration:

The following two situations represent

applications of the cost constraint.

Rafael Corporation discloses fair value information on its

loans because it already gathers this information internally

Willis Company does not disclose any information in the

notes to the financial statements unless the value of the

information to users exceeds the expense of gathering it