Ch 1 lesson pp
- 1. ACCT-1004 – Principles of Accounting I Financial Statements and Personal Accounting
- 2. Why do I need to study accounting? Everyone should have a basic understanding of the principles and related concepts of accounting as they relate to many aspects of your life: Personal – To keep track of your financial records so you have an idea of the value of what you own vs. what you owe Employment – To be able to calculate whether or not your employer is paying you what you have earned Professional – You may be required to interpret financial information Example: Marketing Executive required to prepare Cash or sales budget Business – You may own a business and want to “keep the books” or at least know how to determine whether or not you are earning a profit
- 3. The purpose of Accounting •To keep track of activities that impact how much you are worth • Personal net worth and the business owner’s equity •Understand a few key definitions and terms • The “language of accounting.”
- 4. An introduction to Accounting – Key terms Assets What is the definition of an asset? Ownership
- 5. An introduction to Accounting – Key terms Liabilities What is a liability? Amounts that you owe. -Line of credit for tuition -Car loan -Credit cards
- 6. 1. Describe and calculate net worth “If you want an accounting of your worth, count your friends.” Merry Browne If you sell all your assets and use the cash to pay whatever you owe (liabilities), the remaining cash represents how much you are worth. Assets Liabilities $100,000 $60,000 $40,000
- 7. Calculation of Net Worth Assets – Liabilities = Net Worth OR Assets = Liabilities + Net Worth OWE OWN Do AP-1
- 8. The affect of transactions on Net Worth Refer to AP-1 found on page 6 of your workbook: 1. Darryl purchased a new laptop on January 1, 2010 worth $2,000. He paid the entire amount using cash. 2. He also purchased a new cell phone worth $300 and an mp3 player worth $100 on account(using his credit card). How will these transactions affect Darryl‟s net Worth? Assets = Liabilities + Net Worth 1. Darryl used his cash to purchase the laptop. Both are Assets; therefore, if he used one asset to purchase another, has his Net Worth changed? 2. Darryl then purchased a new cell phone and mp3 player using his credit card. The cell phone is an Asset. Darryl now owes a Liability for this purchase. Has his Net Worth changed? Answer: Neither activity has changed Darryl‟s Net Worth.
- 9. Other transactions that do not affect Net Worth • Not all transactions affect Net worth 1 +100 2 -100 1. When borrowing $100 from a friend: • You are richer in cash, but there is no change to net worth 1 +100 • You still owe the cash. 2 -100 2. When repaying your friend: INVESTMENT S • You are cash poorer, but there is still no change to net worth. NO CHANGE
- 10. Conclusion: Transactions involving buying or selling assets (for the same amount you paid) and, borrowing and paying back cash, have no affect on your Net Worth INVESTMENT S
- 11. 2. Interpret the Balance Sheet and The Income Statement •The Balance Sheet is the formal document to report your Assets, Liabilities and Net Worth on a specified date. Do AP-2 on page 6 in your workbook What is April Rose‟s Net Worth? Now do AP-3 INVESTMENT S
- 12. The Income Statement - The Income Statement is used to report revenues and expenses for a given period of time. - If our are greater than our , we have a or an increase in our Net Worth -If less, we are in a ( or Loss position or a decrease in our Net Worth SURPLUS(DEFICIT)
- 13. The “Accounting Period” An accounting period is typically a month, a quarter or a year. “Temporary Accounts” are used to keep track of transactions that resulted in Revenue and Expense amounts At the end of each period: • The income statement reports all Revenues and Expenses. This allows you to update your Net worth on the Balance Sheet. • Each new accounting period begins with zero balances in the Temporary Accounts so that we can keep track of whether we earned a Surplus(Net Income) or a Deficit(Loss) for that period of time.
- 14. 3. Explain how the Accounting Equation works Imagine the accounting equation as a scale The scale must always be in balance. Do AP-4 and AP-5 on page 8 in your workbook
- 15. 4. Record double entries in T-Accounts -If we place each item into its own “T-Account” we can keep track of transactions that will have an affect on the balance in that particular account Liabilities Net Worth 80,000 42,000 Assets 122,000 Rule#1: Rule #2: -Increases to Assets will result in an Increases to Liabilities or Net Worth amount being added to the “left side” will result in an amount being added of the T-account while decreases will to the “right side” of the T-account be placed on the “right side” while decreases will be placed on the “left side”
- 16. Record double entries in T-Accounts Since the “Net Worth” account merely reports its final balance on a given date, we need to keep track of Revenues, which „increase‟ Net Worth, and Expenses which „decrease‟ Net Worth, separately in their own T-Accounts Assets Liabilities Net Worth 122,000 80,000 42,000 2. 1,000 1. 3,000 3. 2,000 124,000 44,000 Revenue 1. 3,000 3. Revenue – = Surplus 2. 1,000 3,000 1,000 2,000 ASSETS = LIABILITIES + NET WORTH 124,000 80,000 44,000
- 17. Revenue and Expense Accounts Temporary Accounts Salary Revenue x Car Interest Expense Insurance Expense x x Entertainment Expense Food Expense x x
- 18. Increasing (decreasing) Net Worth • If Total Revenues are greater than Total Expenses, Net Worth has been increased. • If Total Expenses are greater than Total +$1,000 Revenues, Net Worth has been decreased. Revenues Expenses +$1,000 Surplus/Net Income or (Deficit/Net Loss) Do AP-6 AP-8,9,10 & 11 should also be done for more practice
- 19. 5. Explain Accrual Accounting • Accrual Accounting is based on the premise that Revenues should be recognized in the period they were „earned‟ and Expenses should be recorded in the period which they were „incurred‟ or happened, which may or may not be in the same period when cash was either received or paid. Revenue Recognition and Matching Principle • Cash-Based Accounting recognizes Revenues in the period when the cash was received and Expenses when cash was paid Violates Revenue Recognition and Matching Principle
- 20. 6. Understand and apply the matching principle and the concept of materiality Accrual Accounting Matching Principle Revenues: Salary $5,000 Expenses: Food $ 1,000 Gas Gas 0 500 Entertainment 1,500 2,500 3,000 Net Income X $2,500 2,000
- 21. Materiality • The word „materiality‟ in accounting refers to the level of importance placed on whether or not a transaction is recorded properly. • When related to the Matching Principle, it can be said that if something is “not material” then we aren‟t concerned that it hasn‟t been recorded in the correct accounting period. • If something is said to be of a „material‟ amount, then we should try to record in the correct accounting period • The level or dollar amount of materiality is sometimes determined by applying a percentage of total Assets, total Revenues or some other amount • $500 amount for Gasoline Expense: Material or not material? Do AP-16 and18 should now be completed, AP-17 done for more practice
- 22. Prepaid Expenses Amounts paid “in advance” of when the expense is reported. -Insurance -Rent -Property taxes Example: On Jan. 1 you paid $3,600 for a one year automobile insurance policy. Cash Jan. 1 3,600 Insurance Expense Prepaid Expenses Jan. 31 300 Jan. 1 3,600 Jan. 31 300 3,300
- 23. 7. Understand the concept of depreciation under the personal context According to the text, the word „depreciation‟ means to record a portion of an asset‟s cost as an expense for each period it is used to help earn revenue. A “non-cash” expense of the period Page 31 of the text demonstrates how „depreciation‟ is applied to a computer that cost $1,200 and is expected to last 3 years. $1,200/3 = $400 (Straight-line Depreciation Method) Asset Accounts – Balance Sheet Computer Accumulated Depreciation - Computer 1,200 Yr. 1 400 Yr. 2 400 Expense Accounts - Income Statement Depreciation Expense Yr. 3 400 800 1,200 Yr. 2 1 Yr.3 400 Do AP-19, 20 Yr. 1 $1,200 – $400 = $800 Yr. 2 $1,200 – $800 = $400 Yr. 3 $1,200 – $1,200 = $0
- 24. 8. Distinguish between Capital and Revenue • Revenues, which „increase‟ Net Worth, and Expenses which „decrease‟ Net Worth, separately in their own T-Accounts with the “Net Income (Loss) added to the “Net Worth” account at the end of the accounting period. •Depositing a „gift‟ of $5,000 will increase Assets and Net Worth but, it is not considered or recorded as a Revenue because it was not earned Assets Liabilities Net Worth 80,000 42,000 122,000 80,000 5,000 5,000 1. 3,000 2. 1,000 3. 2,000 129,000 49,000 Revenue 1. 3,000 3. Revenue – = Surplus 2. 1,000 3,000 1,000 2,000 ASSETS = LIABILITIES + NET WORTH 129,000 80,000 49,000 AP-21, 22
- 25. 9. Describe the three sources and uses of cash • Fact: Changes in Cash don‟t necessarily mean a change in Net Worth! • Cash Flow Statement Operating – Amounts received(paid) in connection with earning revenues and expenses Investing – Purchasing or selling assets used to help earn revenues(Example: Vehicle) Financing – Borrowing(paying back) loans AP-23
- 26. 10. Understand the differences between market value and book value Market value – What the asset would be worth if it was sold “The market value of your car is what you would get for it if it were sold today” Book value – The initial amount an asset was recorded on your books less any accumulated depreciation. “The book value of your car is what you paid for it initially less any Accumulated Depreciation you have recorded in your books.”
- 27. Homework to be completed before starting Chapter 2 •Complete all AS and AP questions listed on the Detailed Course Content page for Chapter 1. Complete online: Chapter 2 Quiz
Editor's Notes
- #2: Welcome to ACCT-1004, Principles of Accounting I!Chapter 1 will introduce you to the subject of accounting and how it is related your personal life. We will also introduce two of the basic financial statements, the Balance Sheet and the Income Statement and how they are used to report your financial position at the end of an accounting period.
- #9: We see in this problem that Darryl purchased a laptop using cash and a new cell phone using his credit card. In trying to determine whether or not Darryl’s net worth has changed we need to determine the elements of each of these transactions. In the first transaction. Both are assets. He used one to increase the other; therefore, his net worth has not changed.In the second transactions, he increased his assets and also his liabilities. Here again, his net worth has not changed. Therefore, neither transaction has affected his net worth
- #20: Upon examining the explanation of Accrual Accounting we see the words ‘earned’ and ‘incurred’ being used which indicates that an economic event has occurred. By recognizing Revenues when they are earned and Expenses when they were incurred we are following two of the fundamental principles of Accounting which are the Revenue Recognition and the Matching Principle. We will further explain the Matching Principle on the next slide and again in Chapter 4 with Revenue Recognition.The other method of accounting is “cash-based” which by definition means that revenues and expenses are reported in the period when the cash was received and paid. This method is not widely used by businesses for the obvious reason that it violates both of the above principles and does not provide for an accurate measurement of the changes in net worth for the accounting period.
- #21: As mentioned, accounting is based on a number of key concepts and principles. Since accrual accounting involves recording revenues when they are earned and Expenses when are incurred, it would make sense that if we want to report an accurate profit or loss for the period that we must do our best to ‘match’ and record the expenses in the same accounting period with the revenues to which they helped earn. This process is said to follow the Matching Principle. For example suppose you earned a salary of $5,000 for the month of January. During that month you incurred expenses of $1,000 for food, $500 for gasoline which you charged to your credit card, and $1,500 on Entertainment. Your expenses total $3,000; therefore, according to the Matching Principle this amount would be ‘matched’ against the revenue of $5,0000 resulting inn determining your Net Income of $2,000 for the month of September. Suppose you didn’t include the Gas as an expense because you didn’t pay your credit card bill until the following month. This would result in reporting a lower amount for expenses than you actually incurred and an incorrect amount of net income than you actually earned. Which amount of net income is correct, $2,000 or $2,500? According to the Matching Principle, the answer should be $2,000 because you incurred the gasoline expense to help you get back and forth to work and earn your salary.
- #22: In accounting, we define materiality as a level of importance placed on whether or not a transaction is recorded properly. When related to the matching principle if we say that something is not material, we mean that its ok if we don’t record an expense in the same period in which it helped earn revenue.However, if the amount is said to be material, we should do our best to make sure it is included in the appropriate period. Most businesses usually determine a $ amount which they consider amounts greater than to be material and less than to be immaterial. The level can be deterimined a number of ways such as a % of total assets, total revenues or some other amount.In the previous example if $500 was considered to be a material amount, then failure to report the Gasoline expense in the same period as when the $5,000 revenue was earned, would be in violation of the Matching Principle
- #23: Prepaid Expenses represent another area where the concept of Materiality and Matching Principle are considered. We often pay for things like an insurance policy, rent and property taxes in advance of the time period to which the amount is related. In this example assume you paid $3,600 on Jan. 1 for your car insurance for your car for the next 12 months. Also assume that you consider amounts over $200 to be material and that this amount will be initially recorded as an Asset in an account titled “Prepaid Expenses” This transaction requires an entry on the left side of the Prepaid Expenses account and on the right side of the Cash account. Since you prepare monthly financial statements, at the end of January you will adjust your accounting records to reflect that 1 month’s worth of Insurance has expired and you now only have $3,300 left as a Prepaid Expense. This process will be done at the end of each of the remaining 11 months in the year until the balance in the Prepaid expense account is $0 and the balance in the Insurance Expense for the year is $3,600.
- #24: Depreciation is accounting related term where we allocate a portion of the asset’s cost as an expense each period it helped to earn income. Depreciation also represents a non-cash expense for the period in that the cash account is not involved when recording depreciation expense. In this example the cost of the asset of $1,200 is being matched or ‘depreciated’ over the 3 years during which it helps to earn revenue; therefore, the Matching Principle is being followed. For purpose of this course, we will only be discussing one method of depreciation and that is “Straight-line” where an equal amount of depreciation is taken over each of the asset’s years of useful life. In year 1 $400 is recognized as Depreciation expense on the Income Statement. The other half of this entry will be entered on the right side of the Accumulated Depreciation account which is known as a “contra-asset as it is related to the asset account, Computer, and will reduce the value of the asset each year that it is depreciated until the total amount of Accumulated Depreciation equals the cost of the asset. In this example, after 1 year of use, the asset is said to have a “Net Book Value” of $800 . In year 2, we record another $400 for Depreciation expense on that year’s Income Statement and add $400 to the accumulation depreciation account. We now have a total of $800 accumulated depreciation resulting in a net book value for the asset reported on the Balance Sheet of $400.Year 3 reports the final $400 for Depreciation Expense and the Accumulated Depreciation account is increased for a total of $1,200. The asset would be reported on the balance sheet at $1,200 less the accumulated depreciation of $1,200 for a net book value of $0 which means the asset has been fully depreciated on the books.AP-19 and 20 on page 24 in the text should now be completed
- #26: After reviewing the material for this chapter you should have a better understanding why an increase or decrease in Cash, does not necessarily mean that Net Worth has increased or decreased. In accounting we report the change in Cash for an accounting period on the Cash Flow Statement which is usually prepared along with the Income Statement and Balance Sheet. While we will learn more about how to prepare this statement later on in the course, for now it will suffice to mention that transactions involving cash can be categorized as operating, investing or financing activities and that we need to analyze each of these areas to reconcile the net change in cash during the accounting period. While detailed coverage of the Cash flow statement is reserved for more advanced accounting courses we can apply we expect students to come away from this course with an understand of what is to be reported on this statement. You should do AP-23 at this time.
- #27: To conclude this chapter we think it necessary to provide explanation of two terms used frequently in accounting. Market value is the amount a person would receive for an asset if it were sold today. On a personal level if you apply for a car or other type of loan you are usually asked what the value of your assets are. In this case you would use the market value or what you could realize from selling your assets that day. Let’s assume you own a car and know you could get $4,000 for it if sold today. The market value would be $4,000Book value, on the other hand is the value the asset appears on your books, less accumulated depreciation. For example if you own a car and have it listed on your books at a cost of $5,000 but, have taken 2,000 in depreciation since you have owned it then the book value of your car is $3,000 .Often market values do not equal book values. This concept will be demonstrated later in the course.