ACCT 2010 – Principles of Accounting I

Professor Xinlei Li

CHAPTER 1
Introduction and
Financial Statements and Business Decisions

1
Contact and Logistical Information
• Instructor: Dr. Xinlei Li
– Office: LSK 6051
– E-mail: acxinlei@ust.hk
– Office Hours: by appointment via email

• Teaching Assistant: Carrie LEUNG

– E-mail: accarrie@ust.hk
• Classes:
– L08: Tue & Thu 12:00-13:20 (LSK1034)
– L09: Tue & Thu 16:30-17:50 (LSK1009)
– L10: Tue & Thu 10:30-11:50 (LSK1034)

2
Who am I？
• Assistant Professor in Accounting

• Education
– PhD, Accounting, Columbia University
– MPhil, Accounting, Columbia University
– BS, Economics and Finance, Tsinghua University

3
Who are you?
Education Background:
• Hong Kong students?
• MTM students?
• International students?

Accounting exposure:
• Some accounting?
• No accounting?

4
Learning Objectives
• Understand the role of financial accounting in the decision-
making process of business organizations.

• Develop a comprehensive and well-founded knowledge of

financial accounting

5
Your Objectives?
• To major in accounting?

• To major in other business disciplines and perhaps minor in

Accounting?

• To major in non-business disciplines?

6
My Objectives
• Accounting is useful

• Accounting is not complicated

• Accounting is not boring

7
Course Materials
• Libby, Libby, and Hodge. Financial Accounting, 9th edition,
International edition, McGraw-Hill (Required).

• Lecture slides from the Canvas ACCT 2010.

– Print a hard copy on your own.

– Bring a paper notebook for in-class exercises.

8
 Course Roadmap
F/S overview
1. Financial Statements and Business Decisions
2. Investing and Financing Decisions and the Accounting System
3. Operating Decisions and the Accounting System
4. Adjustments, Financial Statements, and the Quality of Earnings
• Quiz 1
F/S Line items
1. Sales Revenue, Receivables, and Cash
2. Cost of Goods Sold and Inventory
3. Property, Plant, and Equipment; Intangibles and Natural Resources
4. Liabilities
5. Bond Securities
• Quiz 2
SSE, SCF and F/S Analyses
1. Stockholders’ Equity
2. Statement of Cash Flows
3. Analyzing Financial Statements
• Final exam
9
Course Assessment

Description Weight
Participation 5%
After-class Practice Problems 5%
Quiz 1 (7:30 pm – 9 pm, 4rd Oct, Thursday) 15%
Quiz 2 (7:30 pm – 9 pm, 8th Nov, Thursday) 15%
Final exam 60%
Total 100%

10
Course Conduct
• Class Preparation: Read the handouts before coming to the class.

• Class Review: Review the lecture slides and complete the practice
problems after each class.

• Canvas Discussion Board: After class, please use the discussion board
on Canvas to ask questions.

• Office Hours: Email me to schedule a meeting with me.

• No private conversations. No talking over phone. No usage of phone or

computer unless it’s class related.

• No attendance requirement. However, it is your sole responsibility to

find out what has been announced during your absence from the class.
11
Some advice

• The course requires constant attention and consistent effort.

• Batch processing will most likely be inefficient, frustrating,
and unproductive.
• Keep up with the class schedule!

The 3 Ps of success in this class

• Preparation
• Practice
• Participation
Let the FUN begin!

12
 Course Roadmap
F/S overview
1. Financial Statements and Business Decisions
2. Investing and Financing Decisions and the Accounting System
3. Operating Decisions and the Accounting System
4. Adjustments, Financial Statements, and the Quality of Earnings
• Quiz 1
F/S Line items
1. Sales Revenue, Receivables, and Cash
2. Cost of Goods Sold and Inventory
3. Property, Plant, and Equipment; Intangibles; and Natural Resources
4. Liabilities
5. Bond Securities
• Quiz 2
SSE, SCF and F/S Analyses
1. Stockholders’ Equity
2. Statement of Cash Flows
3. Analyzing Financial Statements
• Final exam
13
Learning Objectives
• Recognize the information conveyed in each of the four
basic financial statements and the way it is used by different
decision makers (investors, creditors, and managers).

• Identify the role of generally accepted accounting principles

(GAAP) in determining financial statement content and how
companies ensure the accuracy of their financial
statements.

14
What is accounting?
• Language of Business

• Accounting is the process of identifying, measuring,

recording, and communicating economic events in value
terms, to provide information for decision-making purposes.

• Financial accounting is concerned with providing

information for decision-makers primarily outside the firm.
• Managerial accounting is concerned with providing
information for decision-makers inside the firm.

15
What are the relevant economic events?
• Operating activities

• Investing activities

• Financing activities

16
What are the relevant
decision-making processes？
• How does the company make money (create value)?

• What resources does the company have? Are the resources

used efficiently?

• How is the firm funded? What obligations does the company

have, and how are the obligations paid? Are there liquidity
risks?

17
Who are the decision makers?
Insiders:
• Management
• Boards
• Employees

Outsiders:
• Investors
• Creditors
• Financial Intermediaries
• Regulators
• Others: customers (long-term relations), courts (e.g., valuation),
competitors, consumer groups, and other special interest groups

18
Who sets the reporting rules?
• FASB (Financial Accounting Standards Board)
– GAAP(Generally Accepted Accounting Principles )
– Accounting rules in this class
• IASB (International Accounting Standards Board)
– IFRS (International Financial Reporting Standards)

• Norwalk Agreement (2002): FASB and IASB declared

commitment to convergence of US GAAP and IFRS.
–Convergence is in progress, but there are still important
differences.

• HKICPA (Hong Kong Institute of Certified Public Accountants)

– HKFRS (Hong Kong Financial Reporting Standards)
19
The Four Basic Financial Statements

• BALANCE SHEET – reports the amount of assets, liabilities, and

stockholders’ equity of an accounting entity at a point in time.
• INCOME STATEMENT – reports the revenues less the expenses of
the accounting period.
• STATEMENT OF STOCKHOLDERS’ EQUITY – reports the changes in
each of the company’s stockholders’ equity accounts, including
the change in the retained earnings balance caused by net
income and dividends during the reporting period.
• STATEMENT OF CASH FLOWS – reports inflows and outflows of
cash during the accounting period in the categories of operating,
investing, and financing.

• The notes are an integral part of these financial statements.

20
Elements of the Balance Sheet
Assets Liabilities
resource with potential to provide future arise when a firm receives benefits and in
economic benefit exchange promises to pay a reasonably
(ability to generate cash flow) definite amount (or provide services valued at
a reasonably definite amount), at a reasonably
Examples: definite time in the future.
Cash
Short-Term Investments Examples:
Accounts Receivable Accounts Payable
Notes Receivable
Accrued Expenses
Inventory
Supplies Notes Payable
Prepaid Expenses Taxes Payable
Long-Term Investments Unearned Revenue
Equipment Bonds Payable
Buildings
Land Stockholders’ Equity
Intangibles (goodwill, patents, and Common Stock
franchises) Retained Earnings

21
Example: the Balance Sheet
EXPLANATION
LE-NATURE’S INC. Name of the entity
Balance Sheet Title of the statement
At December 31, 2012 Specific date of the statement
(in millions of dollars) Unit of measure

Assets: Resources controlled by the company

Cash $ 10.6 Amount of cash in the company’s bank accounts
Accounts receivable 6.6 Amounts owed by customers from prior sales
Inventories 51.2 Ingredients and beverages ready for sale
Property, plant, and equipment 459.0 Factories, production equipment, and land
Total assets $527.4 Total amount of company’s resources

Liabilities and stockholders’ equity: Sources of financing for company’s resources

Liabilities Financing supplied by creditors
Accounts payable $ 26.0 Amounts owed to suppliers for prior purchases
Notes payable to banks 381.7 Amounts owed to banks on written debt contracts
Total liabilities 407.7
Stockholders’ equity Financing provided by stockholders
Common stock 55.7 Amounts invested in the business by stockholders
Retained earnings 64.0 Past earnings not distributed to stockholders
Total stockholders’ equity 119.7
Total liabilities and stockholders’ equity $527.4 Total sources of financing for company’s resources

22
 The Accounting Equation:
the Balance Sheet Equation

A = L + SE Liabilities
Stockholders’
Assets Equity

An Entity
Perspective:
Economic Sources of Financing for Resources
Resources Liabilities: From Creditors
Stockholders’ Equity: From Stockholders

The Shareholder Perspective:

Assets-Liabilities=Owners’ Equity

23
Exercise: Prepare a Balance Sheet
As a U.S. company, John Doe Company follows U.S. GAAP and reports its financial statements in
millions of dollars. Its recent balance sheet contained the following items (in millions):
Required:
Prepare a balance sheet as of April 30, current year, solving for the missing amount.

Accounts payable and other current liabilities $ 5,297

Cash and cash equivalents 864
Common stock 324
Inventories 1,555
Investments 799
Long -term debt 2,417
Net property, plant and equipment 2,685
Other assets 7,805
Other liabilities 1,899
Retained earnings 4,839
Total assets ?
Total liabilities 9,613
Total liabilities and stockholders’ equity 14,776
Total stockholders’ equity 5,163
Trade accounts, notes, and other receivables 1,068

24
 JOHN DOE COMPANY
Balance Sheet
At April 30, Current Year
(in millions of dollars)
Assets
Cash and cash equivalents $ 864
Trade accounts, notes, and other receivables 1,068
Inventories 1,555
Investments 799
Net property, plant, and equipment 2,685
Other assets 7,805
Total assets $14,776
Liabilities and stockholders’ equity
Liabilities:
Accounts payable and other current liabilities $ 5,297
Long-term debt 2,417
Other liabilities 1,899
Total liabilities 9,613
Stockholders’ equity:
Common stock 324
Retained earnings 4,839
Total stockholders’ equity 5,163
Total liabilities and stockholders’ equity $14,776
25
Elements of the Income Statement
Revenues Expenses
Cash and promises Resources used to earn this
received from delivery period’s revenues.
of goods and services. Examples:
Cost of Goods Sold
Examples: Wages Expense
Sales Revenue Rent Expense
Fee Revenue Depreciation Expense
Interest Revenue Insurance Expense
Rent Revenue Repair Expense
Income Tax Expense
The Income Statement Equation: Revenues-Expenses=Net Income
26
Example: the Income Statement

EXPLANATION
LE-NATURE’S INC. Name of the entity
Income Statement Title of the statement
For the Year Ended December 31, 2012 Accounting period
(in millions of dollars) Unit of measure

Revenues
Sales revenue $275.1 Cash and promises received from sale of beverages
Expenses
Cost of goods sold 140.8 Cost to produce beverages sold
Selling, general, and administrative Other operating expenses (utilities, delivery costs, etc.)
expenses 77.1
Interest expense 17.2 Cost of using borrowed funds
Income before income taxes 40.0
Income tax expense 17.1 Income taxes on period’s income before income taxes
Net income $ 22.9 Revenues earned minus expenses incurred

27
Exercise: Infer Values Using
the Income Statement
and Balance Sheet Equations

Net
Independent Total Total Total Total Stockholders'
Income
Cases Revenues Expenses Assets Liabilities Equity
(Loss)

A $150,00 $95,000 $? $235,000 $75,000 $?

B ? 93,000 21,750 201,000 ? 180,250

C 75,000 91,500 ? 115,000 79,000 ?

28
Independent Total Total Net Income Total Total Stockholders'
Cases Revenues Expenses (Loss) Assets Liabilities Equity

A $150,000 $95,000 $55,000 $235,000 $75,000 $160,000

B 114,750 93,000 21,750 201,000 20,750 180,250

C 75,000 91,500 (16,500) 115,000 79,000 36,000

29
Exercise: Prepare an Income Statement
and Infer Missing Values
Mr. Bradley’s Bread Store bakes and sells fresh breads. Its income statement for the
quarter ended October 31, Year 1, contained the following items:
Cost of sales $ 27,500
Provision for income taxes (income tax expense) 672
Interest expense 25
Net earnings ?
Net sales 45,400
Pretax income ?
Selling, general, and administration expense 5,462
Total expenses ?
Total revenues/income ?

Required:
Solve for the missing amounts and prepare an income statement for the quarter ended
October 31, Year 1.
(Hint: First order the items as they would appear on the income statement and then confirm the
values of the subtotals and totals.)

30
 MR. BRADLEY’S BREAD STORE
Income Statement
for the Quarter Ended October 31, Year 1
Revenues
Net sales $45,400
Total revenues $45,400
Expenses
Cost of sales 27,500
Selling, general, and administration expenses 5,462
Interest expense 25
Total expenses 32,987
Pretax income 12,413
Income tax expense
672
Net earnings $11,741

31
Elements of the Statement
of Stockholders’ Equity
Common Stock:
(Funds invested by the shareholders for an ownership interest)

Beginning Common Stock

+Stock Issuance
Ending Common Stock

Retained Earnings:
(Earnings which are not paid out as dividends
and reinvested in the firm )

Beginning Retained Earnings

+Net Income
−Dividends
Ending Retained Earnings

32
Example: Statement of
Stockholders’ Equity

EXPLANATION
LE-NATURE’S INC. Name of the entity
Statement of Stockholders’ Equity Title of the statement
For the Year Ended December 31, 2012 Accounting period
(in millions of dollars) Unit of measure

Common Retained
Stock Earnings
Balance December 31, 2011 $55.7 $43.1 Last period’s ending balances
Net income for 2012 22.9 Net income reported on the income statement
Dividends for 2012 (2.0)
Balance December 31, 2012 $55.7 $64.0 Dividends declared during the period
Ending balances on the balance sheet

33
Exercise: Prepare a Statement of
Stockholders’ Equity
Bartles and James Corporation was organized on January 1, Year 1. For its first two years of
operations, it reported the following:

Net income for Year 1 $ 65,000

Net income for Year 2 61,000

Dividends for Year 1 45,500

Dividends for Year 2 22,000

Total assets at the end of Year 1 265,000

Total assets at the end of Year 2 302,000

Common stock at the beginning of Year 1 200,000

Common stock at the end of Year 1 200,000

Required:
On the basis of the data given, prepare a statement of stockholders’ equity for Year 2.

34
 BARTLES AND JAMES CORPORATION
Statement of Stockholders’ Equity
for the Year Ended December 31, Year 2
Common Retained
Stock Earnings
Balance December 31, Year 1 $200,000 $19,500
Net income for Year 2 61,000
Dividends for Year 2 (22,000)
Balance December 31, Year 2 $200,000 $58,500

Beginning Retained Earnings + Net Income – Dividends = Ending Retained Earnings

For Year 1: $0 + $65,000 – $45,500 = $19,500

Ending Retained Earnings for Year 1 becomes beginning retained earnings for Year 2.

35
The Statement of Cash Flows
• Cash Flows from Operating Activities
• Cash Flows from Investing Activities
• Cash Flows from Financing Activities

• Revenues ≠ cash inflows, Expenses ≠ cash outflows

Net Income ≠ Change in cash

• Need SCF because revenues and expenses are not recorded at

the time when cash is received or paid

• Note that each of the three cash flow sources can be positive (net
cash inflow) or negative (net cash outflow)

36
Example: Statement of Cash Flows
LE-NATURE’S INC.
Statement of Cash Flows (Summary)
For the Year Ended December 31, 2012
(in millions of dollars)
Cash flows from operating activities $ 87.5
Cash flows from investing activities (125.5)
Cash flows from financing activities 47.0
Net increase (decrease) in cash 9.0
Cash balance December 31, 2011 1.6
Cash balance December 31, 2012 $ 10.6
Analyze cash flow from operations activities in
order to check the following:
Ability to repay creditors
Opportunity for expansion
Ability to distribute cash dividends
EXPLANATION
Name of the entity
Title of the statement
Accounting period
Unit of measure
Cash flows directly related to earning income
Cash flows from purchase/sale of plant, equipment, & investments
Cash flows from investors and creditors
Change in cash during the period
Last period’s cash on the balance sheet
Ending cash on the balance sheet
37
Financial Statements Linkages

38
Relationships Among
Financial Statements

Statement of Stockholders’ Equity

Income Statement Common Retained
Revenues $ 275.1 Stock Earnings
− Expenses 252.2 1 Beginning $55.7 $43.1
Net Income $ 22.9 + Net Income 22.9
− Dividends (2.0)
Ending $55.7 $64.0

Statement of Cash Flows

+/− Cash Flows from Operating
Activities $ 87.5 Balance Sheet
Cash $ 10.6 2
+/− Cash Flows from Investing
Other Assets 516.8
Activities (125.5) 3 Total Assets $527.4
+/− Cash Flows from Financing
Activities 47.0 Liabilities $407.7
Change in Cash 9.0 Common Stock 55.7
+ Cash at Beginning of Period 1.6 Retained Earnings 64.0
Cash at End of Period $ 10.6 Total Liabilities &
Stockholders’ Equity $527.4

39
Accounting Equation:
Increasing the Level of Details
• Assets = Liabilities + Stockholders’ equity

• Stockholders’ equity = Common Stock+ Retained earnings

2
• Retained earnings = Beginning retained earnings + Net
income for the period –Dividends
1

• Net income = Revenues -Expenses

40
Summary of the Four Basic
Financial Statements
Financial Statement Purpose
Balance Sheet Reports the financial position
(Statement of (economic resources and
Financial Position) sources of financing) of an
accounting entity at a point
in time.
Income Statement Reports the accountant’s
(Statement of Income, primary measure of
Statement of Earnings, economic performance
Statement of Operations) during the accounting period.
Statement of Reports changes in the
Stockholders’ Equity company’s common stock
and retained earnings during
the accounting period.
Statement of Cash Flows Reports inflows (receipts)
(Cash Flow Statement) and outflows (payments) of
cash during the accounting
period in the categories of
operating, investing, and
financing.
Structure Examples of Content
Cash, accounts receivable,
plant and equipment, long-
term debt, common stock
Sales revenue, cost of goods
sold, selling expense, interest
expense
Beginning and ending
stockholders’ equity
balances, stock issuances,
net income, dividends
Cash collected from
customers, cash paid to
suppliers, cash paid to
purchase equipment, cash
borrowed from banks
41
Notes

• Notes give you supplemental information

(a) Description of accounting rules applied
(b) More details of an item on the statements
(c) Information of items not on the statements

42
Consequences of Unethical Behavior
• After it was determined that the financial statements for Le-
Nature’s Inc. were misleading, the consequences for the
defendants were severe.

43
Responsibility and
the Need for Controls
To ensure the accuracy of a company’s financial information,
management:
 Maintains a system of controls.
 Hires external independent auditors.
 Forms a committee of the board of directors to review these
other two safeguards.

44