Accounting Concept and Practice

Topic 2
After completing this chapter, you should be able to:

1. Generally accepted accounting principles

• Accounting assumptions
• Accounting principles
• Accounting constraints

2. Types of financial statement

i. Statement of Profit or Loss and Other Comprehensive Income
ii. Statement of Changes in Equity
iii. Statement of Financial Position
iv. Statement of Cash Flows

3. Business transactions and the accounting equation

2
 Generally Accepted Accounting Principles
(GAAP)
• the standard framework of guidelines for
financial accounting used in any given
jurisdiction; generally known as accounting
standards or standard accounting practice.
These include the standards, conventions, and
rules that accountants follow in recording and
summarizing and in the preparation of
financial statements.
Generally Accepted Accounting
Principles (GAAP)

Principles Assumptions Constraints

(5) (4) (2)

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 5 Accounting Principles

Historical cost Objectivity

Matching

Revenue
Full-disclosure
recognition

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 • Historical cost principle
requires companies to
account and report based
Historical cost on acquisition costs rather
than fair market value for
most assets and liabilities.

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 • financial and accounting
information needs to be
independent and free from
bias. This means that
Objectivity
financial reporting like a
company's
financial statements need
to be based on evidence
and not opinions.
 • Expenses have to be
matched with revenues as
long as it is reasonable to
do so. Expenses are
recognized not when the
work is performed, or
Matching
when a product is
produced, but when the
work or the product
actually makes its
contribution to revenue.
 • companies may not record
revenue until (1) it is
realized or realizable and
(2) when it is earned. The
Revenue flow of cash does not have
recognition any bearing on the
recognition of revenue.
This is the essence of
accrual basis accounting.
 • It requires that all material
information has to be
disclosed in the financial
Full-disclosure statements either on the face
of the financial statements or
in the notes to the financial
statements.
 4 Accounting Assumptions

Economic entity

Going concern

Time period

Monetary-unit

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Economic entity
• a business or an
organization and its owners
are treated as two
separately identifiable
parties
• It is necessary to record the
business's transactions
separately, to distinguish
them from the owners'
personal transactions
Going concern

• a business that functions

without the threat of
liquidation for the
foreseeable future
• the entity has neither the
intention nor the need to
stop its operations.
Time period

• a firm's operating cycle is divided into

separate accounting periods that can be
reported on in a manner that is timely

The time period principle is the concept

that a business should report the
financial results of its activities over a
standard time period, which is usually
monthly, quarterly, or annually
 2 Accounting Constraints

Conservatism Materiality

when in doubt on how to record or Report only those that are considered
report or when two different significant. Insignificant amounts need not
acceptable methods could be used, be recorded and reported
choose the one that won’t overstate
assets or profits
Not to overstate or give false Strong or impactful to change a
impression decision

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 Financial Statements
• What are they?
• A set of statements that explained about the
profitability, equity or ownership, financial
position or status, and cash operations of an
entity.
• It consists of four main statements.
Statement of
Comprehensive
Income
• Describes a
company’s revenues
and expenses along
with the resulting net
income or loss over a
period of time due to
earnings activities
Statement of Comprehensive Income

• The income statement reports the revenues and

expenses for a period of time based on the matching
concept. This concept is applied by matching the
expenses with the revenue generated during a period
by those expenses.
• The excess of revenue over the expenses is called net
income or net profit. If the expenses exceed the
revenue, the excess is a net loss.
 Explains changes in equity from
Statement of
net income (loss) and from any
Changes in owner investments and
Equity withdrawals over a period of time

From the comprehensive income stmnt

To the Stmnt Financial Position

 • Describes a company’s financial
Statement of position (types and amounts of
Financial assets, liabilities and equity) at point
Position of time

This amount is compared

to the net cash flow on the From the statement
statement of cash flows of owner’s equity
 • Describes a company’s cash inflows
Statement of (receipts) and cash outflows
Cash Flows (payments) over a period of time

This amount should match Cash on

the Stmnt of Fin Position.
 Business Transaction
• An economic event that initiates the
accounting process of recording it in a
company's accounting system.

• A business event (activity) which can be

measured in monetary unit. It must be
recorded in business book (or system) of
account.
 Accounting Equation
• The most fundamental equation of the accounting
system, it expresses the relationship between
what is owned and what is owed by an entity.
Owned = Owed

• It is the basis upon which the double entry

accounting system is constructed. In essence, the
accounting equation is:

Assets = Liabilities + Owners' Equity

The Accounting Equation 1-9

Assets = Liabilities + Owner’s Equity

The resources
owned by a
business
The Accounting Equation 1-9

Assets = Liabilities + Owner’s Equity

The rights of the

creditors, which
represent debts
of the business
The Accounting Equation 1-9

Assets = Liabilities + Owner’s Equity

The rights of the

owners
 Accounting Equation
Assets = Liabilities + Owners' Equity

Owned

The assets in the accounting equation are the

resources that a company has available for its use,
such as cash, accounts receivable, fixed assets, and
inventory.
 Accounting Equation
• Liabilities - comprised of amounts that that are
owed to suppliers known as accounts payable, a
variety of accrued liabilities, such as sales taxes
and income taxes, and debt payable to lenders.

• Owners equity - is the investment (initial and

additional) plus any subsequent gains, minus
any subsequent losses, minus any dividends or
other withdrawals paid to the investors.
 Types of Accounts

Assets
Assets

Expenses
Expenses Liabilities
Liabilities

Accounts

Owner’s
Owner’s
Revenues equity
equity

Drawing
Drawing
Statement of Financial Position Accounts
2-1

Assets Liabilities Owner’s Equity Drawing

• resources • debts owed •owner’s right • withdrawals
owned by to outsiders to the assets by owner
the business (creditors) of the business
• Examples: • Examples:
• cash, AP, salaries
supplies, AR, payable
office
equipment
Statement of Comprehensive Income Accounts 2-1

Revenues Expenses
• increases in owner’s • cost of using up assets
equity as a result of or consuming services
selling services or in the process of
products generating revenues
• Examples: fees • Examples: wages
earned, commission expense, rent
revenue, rent revenue expense,
miscellaneous
expense
 2-1
IMPORTANT NOTE …

Every transaction would

affect at least
2 accounts
 Double entry in accounting

Double entry accounting is based on the fact that every

financial transaction has equal and opposite effects in at
least two different accounts. It is used to satisfy the
equation:

Assets = Liabilities + Equity

whereby each entry is recorded so as to maintain the

relationship.
 Analyze the effects of business
transactions on the basic elements
of the accounting equation.
 1-10

A business transaction is an
economic event or condition that
directly changes an entity’s
financial condition or directly
affects its results of operations.
 1-10

On November 1, 2007, Neymar

begins a business that will be
known as On-Sport.
 1-10

Assets = Owner’s Equity

Cash
= Neymar, Capital
a. 25,000
25,000 Investment
by Neymar

a. Neymar deposits $25,000 in a bank

account in the name of On-Sport.
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 Assets = Owner’s Equity
Cash + Land Neymar, Capital
Bal. 25,000 = 25,000
b. –20,000 +20,000
Bal. 5,000 20,000 25,000

b. On-Sport exchanged $20,000 for land.

51
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 1-10

Owner’s
Assets = Liabilities + Equity
Accounts Neymar,
Cash + Supplies + Land Payable Capital
=
Bal. 5,000 20,000 25,000
c. +1,350 +1,350
Bal. 5,000 1,350 20,000 1,350 25,000

c. During the month, On-Sport purchased

supplies for $1,350 and agreed to pay the
supplier in the near future (on account). 52
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 Beginning with entry (d) the asset
section will be shown first, then the
liabilities and owner’s equity will be
shown in the following slide.
 1-10

Assets

Cash + Supplies + Land

5,000 1,350 20,000
Bal.
d. +7,500
12,500 1,350 20,000
Bal.

d. On-Sport provided services to

customers, earning fees of $7,500 and
received the amount in cash. 54
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 1-10

Liabilities + Owner’s Equity

Accounts Neymar, Fees
Payable + Capital + Earned
1,350 25,000 Bal.
+7,500 d.
1,350 25,000 7,500 Bal.

d. On-Sport provided services to

customers, earning fees of $7,500 and
received the amount in cash.
55
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Expenses 1-10

The amounts used in earning revenue are

called expenses. Adding expenses to the
owner’s equity section results in a space
problem. To adjust for these added
headings, the word “Bal.” has been omitted
from the following Slides. The bottom row
in these four slides provides the balances
after each transaction.
 1-10

Assets
Cash + Supplies + Land
Bal. 12,500 1,350 20,000
e. –3,650
Bal. 8,850 1,350 20,000

e. On-Sport paid the following expenses:

wages, $2,125; rent, $800; utilities,
$450; and miscellaneous, $275.
57
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 1-10

Liabilities + Owner’s Equity

Accounts Neymar, Fees Wages Rent Utilities Misc.
Payable + Capital + Earned Expense Expense Expense
Expense
1,350 25,000 7,500
–2,125 –800 –450 –275 e.
1,350 25,000 7,500 –2,125 –800 –450 –275

e. On-Sport paid the following expenses: wages,

$2,125; rent, $800; utilities, $450; and
miscellaneous, $275.
58
45
 1-10

Assets
Cash + Supplies + Land
Bal. 8,850 1,350 20,000
f. –950
Bal. 7,900 1,350 20,000

f. On-Sport paid $950 to creditors

during the month.
59
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 1-10

Liabilities + Owner’s Equity

Accounts Neymar, Fees Wages Rent Utilities Misc.
Payable + Capital + Earned Expense Expense Expense
Expense
1,350 25,000 7,500 –2,125 –800 –450 –275
–950 f.
400 25,000 7,500 –2,125 –800 –450 –275

f. On-Sport paid $950 to creditors

during the month.
60
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 Assets
Cash + Supplies + Land
Bal. 7,900 1,350 20,000
g. –800
Bal. 7,900 550 20,000

g. At the end of the month, the cost

of supplies on hand is $550, so
$800 of supplies were used. 61
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 1-10

Liabilities + Owner’s Equity

Accounts Neymar, Fees Wages Rent Supplies Util. Misc.
Payable + Capital + Earned Exp. Exp. Exp. Exp. Exp.
400 25,000 7,500 –2,125 –800 –450 –275
–800 g.
400 25,000 7,500 –2,125 –800 –800 –450 –275

g. At the end of the month, the cost

of supplies on hand is $550, so
$800 of supplies were used. 62
49
 1-10

Assets
Cash + Supplies + Land
Bal. 7,900 550 20,000
h. –2,000
Bal. 5,900 550 20,000

h. At the end of the month, Neymar

withdrew $2,000 in cash from the
business for personal use.
63
50
 1-10

Liabilities + Owner’s Equity

Accounts Neymar, Neymar, Fees Wages Rent Supplies
Util. Misc.
Payable + Capital + Drawing Earned Exp. Exp.
Exp. Exp. Exp.

400 25,000 7,500 –2,125 –800 –800 –450 –275

–2,000 h.
400 25,000 –2,000 7,500 –2,125 –800 –800 –450 –275

h. At the end of the month, Neymar withdrew

$2,000 in cash from the business for 64
personal use. 51
 Owner’s Equity

Increased by Decreased by

Owner’s Owner’s
investments withdrawals
Revenues Expenses

65
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