Financial Accounting

Module 1: The Role of Accounting

Module Learning Outcomes

Explain the role of accounting in business

1.1: Define accounting and explain its history

1.2: Identify the ways we use accounting
1.3: State the accounting equation
1.4: Explain the effect of transactions on the accounting equation
1.5: Identify challenges in accounting
Accounting Defined
Learning Outcomes: Accounting Defined

1.1: Define accounting and explain its history

1.1.1: Define accounting
1.1.2: Describe the evolution of accounting
1.1.3: Explain the importance of accounting
What Is Accounting?

• The American Accounting Association defines accounting as:

the process of identifying, measuring, and communicating economic information to permit
informed judgments and decisions by the users of the information.
• Accounting vs. Bookkeeping
• Bookkeeping is a mechanical process that records the routine economic activities of
a business.
• Accounting includes bookkeeping but goes well beyond it in scope: for example,
accountants also analyze and interpret financial information and prepare financial
documents.
The Evolution of Accounting

• The earliest known accounting records were created over 7,000 years ago. 
• In 1494 Luca Bartolomeo de Pacioli wrote: “Summa de Arithmetica, Geometria, Proportioni
et Proportionalita,” which became the teaching text for bookkeeping and accounting for the
next several hundred years.
• It was the expansion of the railroad that transformed the practice of accounting: to get goods
and people to their destinations, you need a common set of standards.
• The profession of accounting was recognized in 1896 with a law stating the title of a
Certified Public Accountant (CPA) required passing a test and three years of experience.
Why Accounting Matters

• Accounting allows you to answer key business questions, such as:

• How is my business doing right now?
• Is it making money?
• How did we do last year?
• How much money is in the bank right now?
Accounting Information
Learning Outcomes: Accounting Information

1.2: Identify the ways we use accounting

1.2.1: Identify users of accounting information
1.2.2: Compare and contrast financial and managerial accounting
1.2.3: Describe the unique way the government uses accounting information
Users of Accounting Information

• Internal Users
• Owners
• Managers
• External Users
• Prospective and current board members or
investors
• Creditors and lenders
• Employees and their unions
• Customers
• General public
• Government
Financial vs Managerial Accounting

• Financial accounting information appears in

financial statements that are intended
primarily for external users, like
stockholders and creditors.
• Managerial accounting is the accounting
that provides managers and owners
(internal users) with financial information
that they need in order to make operational
and strategic decisions.
Other Areas of Accounting

• Non-Profit Accounting: Non-profit entities, as the name implies, exist for purposes other
than making a profit. Instead of business owners, a state incorporates a non-profit to benefit
the public, and so the major stakeholders are the public, or in the case of some clubs, the
members.
• Forensic Accounting: Forensic accounting involves investigating and reporting on financial
crimes, fraud, and harmful business practices. Forensic accountants may be called upon to
testify in court, and the work product of a forensic accountant may be admitted as evidence.
• Tax Accounting: Government agencies that track and use taxes are interested in the
financial story of a business. They want to know whether the business is paying taxes
according to current tax laws.
Government Reporting

• Today, taxes based on income or sales and

payroll taxes make up the vast majority of
federal and state revenues. 
• Federal tax law begins with the Internal
Revenue Code (IRC)
• State income tax laws are often different from
the federal laws, so the financial accountants
for a business may have to keep several sets of
records:
• managerial accounting for internal users
• financial accounting for external users
• tax accounting for governmental reporting
The Basic Accounting Equation
Learning Outcomes: The Basic Accounting Equation

1.3: State the accounting equation

1.3.1: Explain the basic accounting question
1.3.2: Define assets
1.3.3: Define liabilities
1.3.4: Define owners’ equity
The Accounting Equation

One of the cornerstones of financial

accounting is the accounting equation, which
in its simplest form, looks like this:

assets = liabilities + owner’s equity

or
A = L + OE

This equation has to always stay in balance.

Assets

• In financial accounting, an asset must meet two

criteria:
• The company must own or control it.
• It must be expected to generate future benefit for
that company.
• Assets fall into two general subcategories
• Current assets are expected to convert into cash
within a relatively short period of time (usually one
year). 
• Noncurrent assets produce revenue over a long
period of time by being used to produce inventory,
but they won’t be converted to cash any time soon.
Liabilities

• Liability is the accounting term for debt.

• Like assets, liabilities are categorized as
current and noncurrent.
• There are a wide variety of items that can be
liabilities, and many accounts are unique to a
specific company.
• Current liabilities are items that must be paid
soon.
• Noncurrent liabilities are more long-term
debts.
Owner’s Equity

• Owner’s equity can be further broken down into four components:

• Capital contributed. This represents the dollar value of resources put into the company by the owner.
Often, this is cash, but it could also be assets like machinery or accounts receivable. In any case, these
are personal assets that are used to fund the business.
• Withdrawals. This is the dollar value of resources (usually cash) taken out of the company by the owner
for personal use.
• Revenues. This is the income a business takes in. We’ll further define and discuss revenues on this page.
• Expenses. This is what the business spends. We’ll further define and discuss expenses on this page.

• Note: revenue – expense = profit

Practice Question 1

Sanjay started a new company this year called SanTec. The first thing he did was contribute
$50,000 of his savings and $5,000 of computer equipment to the company. After a year of
operation, SanTec earned $35,000 in revenue and incurred $5,500 in expenses. Sanjay needed
to pay off his leased car and needed to withdraw some of the funds from the company to do it.
What is the maximum cash amount from which Sanjay could withdraw from the company?

A. $50,000
B. $35,000
C. $79,500
D. $29,500
Accounting in Business
Learning Outcomes: Accounting in Business

1.4: Explain the effect of transactions on the accounting equation

1.4.1: Explain the effect of various transactions on the accounting equation
1.4.2: Differentiate among service, manufacturing, and merchandising businesses
1.4.3: Differentiate among common financial statements
Transactions and the Accounting Equation

•  One of the key aspects of the process is keeping “running totals” of things.
• Examples of items a business might keep track of include the following:
• the amount of cash the business currently has
• what a company has paid for utilities for the month
• the amount of money it owes
• a company’s income for the entire year
• the total cost of all the equipment it has purchased
• It’s important that businesses keep these running totals up to date so they are readily
available when they need the information.
Types of Business Activities

• There are three forms of business organizations:

• Service companies perform services for a fee. This
group includes accounting firms, law firms, and dry
cleaning establishments.
• Merchandising companies purchase goods that are
ready for sale and then sell them to customers.
Merchandising companies include auto dealerships,
clothing stores, and supermarkets.
• Manufacturing companies buy materials, convert
them into products, and then sell the products to
other companies or the final consumers.
Manufacturing companies include steel mills, auto
manufacturers, and clothing manufacturers.
Financial Statements

• There are four basic financial statements and they are prepared in the following
order:
• Income Statement
• Statement of Owner’s Equity
• Balance Sheet
• Statement of Cash Flows
Challenges in Accounting
Learning Outcomes: Challenges in Accounting

1.5: Identify challenges in accounting

1.5.1: Describe the role of ethics in accounting
1.5.2: Identify significant events in the history of accounting
1.5.3: Identify the organizations that govern accounting
Ethics in Accounting

• An accountant’s career is heavily reliant on their

clients’ trust in them.
• Several accounting organizations have codes of
ethics governing the behavior of their members. 
• AICPA’S Code of Professional Conduct:
• Responsibilities principle.
• The public interest principle.
• Integrity principle.
• Objectivity and independence principle. 
• Due care principle.
• Scope and nature of services principle.
Significant Events in Accounting

Over the past five hundred plus years, accounting has seen its share of ups and downs. 
Regulations in Accounting

• SEC (Securities and Exchange Commission): has

the legal authority to provide oversight and
regulation of the accounting profession
• FASB (Financial Accounting Standards Board):
the organization officially recognized by the SEC as
the governing body for the accounting profession
• IRC (Internal Revenue Code): the rules and
regulations accountants must adhere to
• IASB (International Accounting Standards
Board): the standard-setting body for International
Financial Reporting Standards
Practice Question 2

Which of the following institutions sets the standards for international standards for financial
reporting?

A. IASB
B. FASB
C. IFA
D. SEC
Quick Review

• What is the definition of accounting?

• Describe the evolution of accounting.
• Why is accounting important?
• Who uses financial accounting information?
• What are the differences between financial and managerial accounting?
• Describe the unique way the government uses accounting information.
• What is the basic accounting question?
• What is the definition of assets in accounting?
• Define what liabilities are in accounting.
More Quick Review

• What does owner’s equity mean in accounting?

• What is the effect of various transactions on the accounting equation?
• Differentiate between service, manufacturing, and merchandising businesses.
• What are the differences between the common financial statements?
• How do ethics play a role in accounting?
• What are significant historic events in the long history of accounting?
• Which organizations govern and set rules and principles for accounting?