©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Chapter 16 Basic Accounting: Concepts, Techniques, and Conventions

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 1 Read and interpret the basic financial statements.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton The Need for Accounting Managers, investors, and other internal groups want the answers to two important questions: How well did the organization perform? Where does the organization stand?

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton The Need for Accounting Accountants answer these questions with two major financial statements: Income Statement Balance Sheet

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Business Transactions A transaction is any event that affects the financial position of an organization and requires recording.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Balance Sheet l The balance sheet (also called statement of financial position or statement of financial condition) is a snapshot of the financial status of an organization at a point in time.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Balance Sheet Assets = Equities Assets are economic resources that are expected to benefit future activities of the organization. Equities are the claims against, or interests in, the assets of the organization.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Balance Sheet Equation Assets = Liabilities + Owners’ equity Liabilities are the entity’s economic obligations to nonowners. Owners’ equity is the excess of the assets over the liabilities. The owners’ equity of a corporation is called stockholders’ equity.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Balance Sheet Accounts Stockholders’ Equity Paid-in CapitalRetained Earnings

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Balance Sheet Accounts Accounts payable are the amounts owed to vendors for purchases on open accounts. Accounts receivable are the amounts due from customers for sales on open accounts.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 2 Analyze typical business transactions using the balance sheet equation.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton King Hardware Transactions 1 Initial investment by owners, $100,000 cash. 2 Acquisition of inventory for $75,000 cash. 3 Acquisition of inventory for $35,000 on open account. 4 Merchandise costing $100,000 was sold on open account for $120,000.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton ) Cash+ $100,000+ $100,000 2) Cash– 75,000 Inventory+ 75,000 3) Inventory+ 35, ,000 4) Receivable+ 120, ,000 4b) Cost– 100,000– 100,000 King Hardware Transactions Stockholders’ Assets = Liabilities + Equity

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton King Hardware Transactions 5 Cash collections of accounts receivable, $30, Cash payments of accounts payable, $10, On March 1, paid $3,000 cash for rent for March, April, and May. Rent is $1,000 per month.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton ) Cash+ 30,000 Receivable– 30,000 6) Cash– 10,000–10,000 7) Cash– 3,000 7a) Prepaid+ 3,000 7b) Expense– 1,000 – 1,000 Totals$144,000$25,000$119,000 King Hardware Transactions Stockholders’ Assets = Liabilities + Equity

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Revenues Revenues are increases in ownership claims arising from the delivery of goods or services. Revenues must be earned. Revenues must be realized.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Expenses Expenses are decreases in ownership claims arising from delivering goods or services or using up assets.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Profits Profits (or earnings or income) are the excess of revenues over expenses.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Income Statement The income statement measures the performance of an organization by matching its accomplishments (revenue from customers, which is usually called sales) and its efforts (cost of goods sold and other expenses).

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Income Statement Balance Sheet February  2 Balance Sheet February  2 Balance Sheet March  2 Balance Sheet March  2 Balance Sheet April  2 Balance Sheet April  2 Income Statement for March Income Statement for AprilTime

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton The Analytical Power of the Balance Sheet Equation The balance sheet equation can highlight the link between the income statement and balance sheet. Assets (A) = Liabilities (L) + Stockholders’ equity (SE)

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton The Analytical Power of the Balance Sheet Equation A = L + Paid-in capital + Retained income A = L + Paid-in capital + Revenue – Expenses

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 3 Distinguish between the accrual basis of accounting and the cash basis of accounting.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Accrual Basis versus Cash Basis The accrual basis of accounting recognizes revenues and expenses when they occur instead of when cash is received or disbursed. The cash basis of accounting recognizes revenue and expense when cash is received and disbursed.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Accrual Basis versus Cash Basis The accrual basis is the principal conceptual framework for relating accomplishments (revenues) with efforts (expenses). The cash basis fails to match expenses and revenues in a manner that properly measures financial position.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 4 Relate the measurement of expenses to the expiration of assets.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Adjustments l Under the accrual basis of accounting, adjustments are used to record implicit transactions, in contrast to the explicit transactions that trigger nearly all day-to- day routine entries. l Adjustments are generally prepared by the accountant at month or year end.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Types of Adjustments Expiration of unexpired costs Recognition (earning) of unearned revenues Accrual of unrecorded expenses Accrual of unrecorded revenues

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Depreciation Accountants usually… predict the length of the useful life. predict the residual value. allocate the cost to the years of its useful life.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 5 Explain the nature of dividends and retained income.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Dividends Dividends are distributions of assets to stockholders that reduce retained income. Cash dividends are distributions of assets that liquidate a portion of the ownership claim. The distribution is made possible by profitable operations.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Retained Income Retained income is a result of profitable operations, it is not a pot of cash awaiting distribution to stockholders. The retained income is, in effect, invested in the assets and liabilities of the entity.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 6 Select relevant items from a set of data and assemble them into a balance sheet, an income statement, and a statement of retained income.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton King Hardware Company Income Statement for the Month Ended April 30, 20x1 Sales$85,000 Cost of goods sold 70,000 Gross profit$15,000 Operating expenses: Rent$1,000 Wages 6,600 7,600 Net income$ 7,400

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton King Hardware Company Statement of Retained Income for the Month Ended April 30, 20x1 Retained income, March 31, 20X1$19,000 Add: Net income for April 7,400 Total 26,400 Deduct: Dividends 18,000 Retained income, April 30, 19X1$ 8,400

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton King Hardware Company Balance Sheet as of April 30, 20x1 Assets Cash$ 85,000 Accounts receivable 87,000 Inventory 20,000 Prepaid rent 1,000 Total assets$193,000

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton King Hardware Company Balance Sheet as of April 30, 20x1 Liabilities and Stockholders’ Equity Liabilities Accounts payable$ 81,000 Accrued wages payable 600 Unearned sales revenue 3,000$ 84,600 Stockholders’ equity Paid-in capital$100,000 Retained income 8, ,400 Total equities$193,000

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 7 Distinguish between the reporting of corporate owners’ equity and the reporting of owners’ equity for partnerships and sole proprietorships.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Sole Proprietorship/ Partnership A sole proprietorship is a business entity with a single owner. A partnership is an organization that joins two or more individuals together as co-owners.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Comparison of Owners’ Equity Reporting Owners’ Equity for a Corporation Stockholders’ equity Capital stock (paid-in capital)$100,000 Retained income 8,400 Total stockholders’ equity$108,400

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Comparison of Owners’ Equity Reporting Owner’s Equity for a Sole Proprietorship Alice Walsh, capital$108,400

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Comparison of Owners’ Equity Reporting Owners’ Equity for a Partnership Susan Zingler, capital$ 54,200 John Martin, capital 54,200 Total partners’ equity$108,400

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Generally Accepted Accounting Principles (GAAP) Accounting is based on a set of principles on which there is general agreement, not on rules that can be “proved.”

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Audit An audit is an examination or in-depth inspection of financial statements and companies’ records that is made in accordance with generally accepted auditing standards.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Financial Accounting Standards Board (FASB) l The Financial Accounting Standards Board (FASB) is the primary regulatory body over accounting principles and practices in the U.S. l It consists of seven full-time members and is an independent creation of the private sector.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton International Accounting Standards Committee (IASC) l International GAAP is set by the International Accounting Standards Committee (IASC), a group sponsored by accountancy bodies in more than 80 countries.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Securities and Exchange Commission (SEC) l By federal law, the Securities and Exchange Commission (SEC), a government agency, has the ultimate responsibility for specifying GAAP for U.S. companies whose stock is held by the general investing public.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 8 Identify how the measurement conventions of recognition, matching and cost recovery, and stable monetary unit affect financial reporting.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Three Measurement Conventions Three broad measurement or valuation conventions (principles) underlie accrual accounting: Recognition Matching and cost recovery Stable monetary unit

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 9 Understand how managers and investors can learn about the financial position and prospects of an organization from its financial statements.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Financial Statements Managers and investors can learn about the financial position and prospects of an organization from its financial statements.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Financial Statements Financial statements describe the financial results of an organization in a consistent way that allows comparison to historical results of the organization and to the results of other organizations.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton End of Chapter 16