INFO 7225

Module 1
1. Introduction to Accounting
2. Accounting Records & Information Flow
3. Financial Statements
Professor Shiaoming Shi
College of Engineering
Northeastern University
DEFINE ACCOUNTING
AND ITS PURPOSES

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 Structure of an Organization

Internal:
• Owners/Management
• Employees

Stakeholders
External:
• Investors/Creditors
• Customers
Organization • Regulators

Economic Activities
 Accounting Defined
Accounting is the process of identifying, measuring, recording, and
communicating an organization's economic activities to users.
• Users need information for decision making.
➢ Internal users:
✓ Work for the organization; responsible for planning, organizing, and
operating the entity.
✓ Managerial accounting serves the decision-making needs of internal users.
➢ External users:
✓ Include investors, creditors, labor unions, and customers.
✓ Financial accounting is the area of accounting that focuses on external
reporting and meeting the needs of external users.

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 Roles of Accounting

Internal:
• Owners/Management
• Employees
Decision Making
Stakeholders
External:
• Investors/Creditors
Financial and
• Customers
Organization managerial
• Regulators
accounting

Economic Activities Identifying, measuring, recording,

and communicating an
organization's economic activities
to users
ORGANIZATION STRUCTURE FOR ACCOUNTING AND FINANCE ACTIVITY

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Common Computerized Accounting Systems

• QuickBooks
➢ Designed for small organizations

• SAP and Oracle

➢ Designed for large and/or multinational organizations
➢ Customized to meet the unique informational needs of the entity

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 Accounting Information System:
The key functions performed by an accounting information system

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 Overall Structure of Module 1

By the end of this module, you will understand:

• How the accounting information is being analyzed and processed;
• How an accounting cycle is initiated and concluded
• How financial statements are prepared; and
• How business insights can be obtained from the output

The basics:
• GAAP Generally Accepted Accounting Principles (GAAP)
• Major classes of accounts
• Accounting documents
• Accounting equation
• Double-entry book-keeping system
• The financial statements
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 Overall Structure of Module 1

By the end of this module, you will understand:

• How the accounting information is being analyzed and processed;
• How an accounting cycle is initiated and concluded
• How financial statements are prepared; and
• How business insights can be obtained from the output

The basics:
• GAAP
• Major classes of accounts The accounting cycle:
• Accounting documents • Analyze and process the
• Accounting equation accounting information
• Double-entry book-keeping system
• The financial statements
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 Overall Structure of Module 1

By the end of this module, you will understand:

• How the accounting information is being analyzed and processed;
• How an accounting cycle is initiated and concluded
• How financial statements are prepared; and
• How business insights can be obtained from the output

Preparing financial statements:

• Income Statement
• Statement of Shareholders’ Equity
• Balance Sheet
• Statement of Cash Flows

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 Overall Structure of Module 1

By the end of this module, you will understand:

• How the accounting information is being analyzed and processed;
• How an accounting cycle is initiated and concluded
• How financial statements are prepared; and
• How business insights can be obtained from the output

Preparing financial statements: Financial statement analysis:

• Income Statement • Liquidity
• Statement of Shareholders’ Equity • Solvency
• Balance Sheet • Efficiency
• Statement of Cash Flows • Profitability

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Generally Accepted Accounting Principles
(GAAP)

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Accounting Information Must Possess the Quality of:

Relevance Verifiability
• Has the ability to make a • Others are able to confirm that the
difference in the decision- information faithfully represents the
making process economic activities of the business

Faithful representation Timeliness

• Is complete, neutral, and free • Is available to decision makers in
from error time to be useful

Comparability Understandability
• Tells users of the information • Is clear and concise
that businesses utilize similar
accounting practices

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GAAP Accounting Standards Connection Tree

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 GAAP Accounting Standards Connection Tree

:
• A business may only report activities on financial statements
that are specifically related to company operations, not
those activities that affect the owner personally.

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 GAAP Accounting Standards Connection Tree

:
• Assumes a business will continue to operate in the
foreseeable future.
• One should presume the business is doing well enough to
continue operations unless there is evidence to the contrary.

X
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• In order to record a transaction, we need a system of monetary measurement, or
a monetary unit by which to value the transaction (USD in the United States).
• Without this system, it would be impossible to record information in the financial
records. It also would leave stakeholders unable to make financial decisions,
because there is no comparability measurement between companies.
• This concept ignores any change in the purchasing power of the USD due to
inflation (nominal units of money).

X
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 GAAP Accounting Standards Connection Tree

:
• A company can present useful information in shorter time
periods, such as years, quarters, or months.
• The information is broken into time frames to make
comparisons and evaluations easier.

X X
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 GAAP Accounting Standards Connection Tree

:
• Everything the company owns or controls (assets) must be
recorded at its value at the date of acquisition.
• Exceptions: financial instruments (recorded at their fair
market value)

X X X
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 GAAP Accounting Standards Connection Tree
:
• Directs a company to recognize revenue in the period in which it is earned;
revenue is not considered earned until a product or service has been provided.
• This means the period of time in which you performed the service/gave the
customer the product is the period in which rev. is recognized.
• No correlation between when cash is collected and when revenue is
recognized.

X X X X
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 GAAP Accounting Standards Connection Tree

:
• States that we must match expenses with associated
revenues in the period in which the revenues were earned.
• Also referred to as the matching principle.

X X X X X
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 GAAP Accounting Standards Connection Tree
:
• States that a business must report any business activities that could affect
what is reported on the financial statements.
:
• These activities could be non-financial in nature or be supplemental details not
readily available on the main financial statement.
• Usually recorded in footnotes on the statements, or in addenda to the
statements.

X X

X X X X X
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 GAAP Accounting Standards Connection Tree

:
: financial estimate, a
• States that if there is uncertainty in a potential
company should err on the side of caution and report the most
conservative amount.
• Important when valuing a transaction for which the dollar value
cannot be as clearly determined.

X X X

X X X X X
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 Accounting Records:
Document, Journal, and Ledger

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ACCOUNTING RECORDS: DOCUMENT
Product Documents
• They are the result of transaction
Source Documents processing rather than the triggering
• Economic events result in the creation mechanism for the process.
of some documents at the beginning ➢ For example, a payroll check to an
(the source) of the transaction. employee is a product document of
• These are called source documents the payroll system.
and are used to capture and formalize
transaction data that the transaction Turnaround Documents
cycle uses for processing.
• Product documents of one system that
become source documents for another
system.
 Example: Documents Used and Generated in a Sales Process

Source document:
_

Product document:
_

Turnaround document:
_
ACCOUNTING RECORDS: JOURNALS

A journal is a chronological record of financial transactions.

➢ Journal entry:
At some point during the transaction process, when all relevant facts about the
transaction are known, the event is recorded in a journal in chronological order.

The primary sources of data entry into journals are documents.

TWO CLASSES OF JOURNALS

General Journal Special Journal

• Firms use the general journal to record • A journal used to record a large
nonrecurring, infrequent, and dissimilar number of repetitive transactions such
transactions. as
➢ For example, depreciation and closing ➢ Credit sales, cash receipts, purchases,
entries are typically recorded in the ~ and cash disbursements
Special journal example: a sales journal
ACCOUNTING RECORDS

Documents Ledger (organized by accounts)

➢ Source documents ➢ General ledger
➢ Product documents A ledger that contains summary-level data for
every asset, liability, equity, revenue, and
➢ Turnaround documents expense account of the organization.
Examples: AR, AP
➢ Subsidiary ledger
Journal (chronological
A ledger used to record detailed data for a
records) general ledger account with many individual
➢ General journal subaccounts
Breaks down certain general ledger accounts
➢ Special journal to provide more detailed information to users
Accounting
Information Flow /
Steps in Accounting
Process

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Five Classes of Accounts

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FIVE CLASSES OF ACCOUNTS

1. Assets
2. Liabilities
3. Equity
4. Revenues
5. Expenses

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FIVE CLASSES OF ACCOUNTS: DEFINITION

What are liabilities?

________________
1. Assets • Probable future sacrifice of economic benefits arising
from present obligations of a particular entity to transfer
2. Liabilities assets or provide services to other entities in the future
as a result of past transactions or events
3. Equity ➢ Current ______: debt or obligation due within one
4. Revenues year or, in rare cases, a company’s standard
operating cycle, whichever is greater
5. Expenses ➢ Non-current ________: _________ that is expected
to be settled in more than one year

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FIVE CLASSES OF ACCOUNTS: DEFINITION
What are assets?
______________

• Tangible or intangible resource owned or controlled by a company,

1. Assets individual, or other entity with the intent that it will provide economic value
➢ Current ___ = ___ that will be used or consumed in one year or less
2. Liabilities ➢ Noncurrent ___ = ___ that will be used or consumed over more than
one year
3. Equity What is ?
_____________
4. Revenues • Residual interest in the assets of an entity that remains after deducting its
_____________.
5. Expenses ➢ _______________: corporation’s primary class of stock issued, with
each share representing a partial claim to ownership or a share of the
company’s business
➢ _______________: cumulative, undistributed net income or net loss
for the business since its inception. = net income - dividends 37
FIVE CLASSES OF ACCOUNTS: DEFINITION

____________
What are revenues?
1. Assets
• Inflows or other enhancements of assets of an
2. Liabilities entity or settlements of its liabilities (or a
combination of both) from delivering or
3. Equity producing goods, rendering services, or other
activities that constitute the entity’s ongoing
4. Revenues major or central operations

5. Expenses What are expenses?

__________________

• Cost associated with providing goods or

services

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FIVE CLASSES OF ACCOUNTS: EXAMPLES
Accounts Payable (AP) 2 Land 1
1. Assets
Accounts Receivable (AR) 1 Notes Payable 2
2. Liabilities Bonds Payable 2 Raw Material Expense 5
3. Equity Building 1 Retained Earnings 3
Cash 1 Sales 4
4. Revenues Common Stock Service Revenue
3 4
5. Expenses Equipment 1 Supplies 1
Fees Earned 4 Unearned Revenue 2
Prepaid Insurance 1 Utility 5
Interest payable 2 Wage Payable 2
Interest expense 5 Wage Expense 5
Inventory 1 Warranty Liability 2
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Chart of Accounts (1)
Chart of Accounts (2)
Normal Balance of Major Accounts

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A LE | R E

Assets and Expenses have what is Liabilities, Equity, and Revenue have
known as a normal debit balance. normal credit balances.
➢ This simply means that the balance of ➢ This means that in order to increase any
that item will increase if it is debited, and it of these accounts, you would need to
will decrease if it is credited. credit them.

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NORMAL BALANCE OF MAJOR ACCOUNTS

______________________ ______________________

A LE R E
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 NORMAL BALANCE OF MAJOR ACCOUNTS

Balance Sheet Income Statement

Assets Liabilities Equity Revenue Expenses

DR CR DR CR DR CR DR CR DR CR

A LE R E
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 NORMAL BALANCE OF MAJOR ACCOUNTS

Balance Sheet Income Statement

Assets Liabilities Equity Revenue Expenses

DR CR DR CR DR CR DR CR DR CR

A LE R E
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CONTRA ACCOUNTS
A contra account is an account that is related to another account and typically
has an opposite normal balance that is subtracted from the balance of its
related account on the financial statements.
➢ Contra accounts to sales or revenue (contra revenue accounts):
▪ Sales returns
▪ Sale discounts
accounts receivable account)
➢ Allowance for doubtful accounts (a contra _______________
fixed assets
➢ Accumulated depreciation (a contra _______________ account)

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FOUR FINANCIAL STATEMENTS

1. The Income Statement

2. The Statement of Shareholders’ Equity
3. The Balance Sheet
4. The Statement of Cash Flows

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1. INCOME STATEMENT
The heading of the income statement includes three lines:
i. The first line lists the business name.
ii. The middle line indicates the financial statement that is
being presented.
iii. The last line indicates the time frame of the financial
statement. Do not forget the income statement is for a
period of time (the month of January in our example).
There are three columns:
i. Going from left to right, the first column is the category
heading or account.
ii. The second column is used when there are numerous
accounts in a particular category (Expenses, in our
example).
iii. The third column is a total column. In this illustration, it is
the column where subtotals are listed and net income is
determined (subtracting Expenses from Revenues).

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The Income
Statement

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Statement of
Shareholders
’ Equity

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Statement of
Shareholders
’ Equity

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Statement of
Shareholders
’ Equity

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Statement of
Shareholders
’ Equity

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The Balance
Sheet

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The Balance
Sheet

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The Balance
Sheet

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Differentiate Cash Flows From Operating, Investing, & Financing Activities

💵
• Provided by sales/revenue
• Used in operations – expenses (vendors and employees) and
inventory purchases

💵
• Proceeds from the sale of fixed assets of other investments
• Used in purchasing new equipment, facilities, and investing
excess cash into investment vehicles

💵
• Provided via borrowings or equity infusions from shareholders
• Used for paying principal payments on debt owed and
dividends or distributions paid out to shareholders
RELATIONSHIPS AMONG THE THREE TYPES OF BUSINESS ACTIVITIES

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Statement
of Cash
Flows

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Statement
of Cash
Flows $

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Statement
of Cash
Flows $

(2,000)

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Statement
of Cash
Flows $

(2,000)

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THE CLASSIFIED BALANCE SHEET

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THE CLASSIFIED BALANCE SHEET
• A classified balance sheet organizes the asset and liability accounts into
categories.
• The classification of asset and liability accounts into meaningful categories is
designed to facilitate the analysis of balance sheet information by external users.

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CURRENT ASSETS
• Current assets are those resources that the entity expects to convert
to cash, or to consume during the next year or within the operating
cycle of the entity, whichever is longer:
✓ Cash; short-term investments; notes receivable; merchandise inventory;
supplies; prepaid expenses
• On the balance sheet, current assets are normally reported before
non-current assets. They are listed by decreasing levels of liquidity —
their ability to be converted into cash. Therefore, cash appears first
under the current asset heading since it is already liquid.

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NON-CURRENT ASSETS: PPE
• Assets that will be useful for more than one year; they are
sometimes referred to as long-lived assets.
➢ Include property, plant, and equipment (PPE) items used in the operations
of the business.
➢ Some examples of PPE are:
a) land
b) buildings
c) equipment, and
d) motor vehicles such as trucks

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NON-CURRENT ASSETS: INTANGIBLE ASSETS
• Other types of non-current assets include long-term investments and
intangible assets.
➡ Intangible assets are resources that do not have a physical form and whose
value comes from the rights held by the owner.
➡ They are used over the long term to produce or sell products and services and
include:
✓ copyrights
✓ patents
✓ trademarks, and
✓ franchises

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ASSET CLASSIFICATION FLOWCHART

No
CURRENT LIABILITIES
• Obligations that must be paid within the next 12 months or within the
entity’s next operating cycle, whichever is longer.
• They are shown first in the liabilities section of the balance sheet and
generally listed in order of maturity (their due dates).
• The order of liabilities is not as structured as that of assets and may vary
somewhat from company to company.
• Examples:
✓ AP, unearned revenue, accrued liabilities such as interest payable and wages
payable, income taxes payable, the current portion of long-term liabilities

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NON-CURRENT LIABILITIES
• Also referred to as long-term liabilities
• Borrowings that do not require repayment for more than one year,
such as the long-term portion of a bank loan or a mortgage.
➢ A mortgage is a liability that is secured by real estate.

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3. THE CLASSIFIED BALANCE SHEET

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SUMMARY

GAAP Accounting equation

Accounting records Normal balance of each account
Five classes of accounts Four financial statements

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Thank you!
Questions?

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