978-0078025907 Chapter 1 Lecture Note Part 1

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Chapter 1

An Introduction to Accounting

General Comments for Chapter 1

Most students come to class the first day without a textbook. Even after students have

the textbook, many of them do not read assigned chapters prior to attending class. Many

students do not have the skill necessary to read technical material without some initial

oral explanation. They need help getting started. Consider allowing students to read the

chapter after you introduce the concepts in class. We would certainly prefer that our stu-

dents read the text prior to class. Most are incapable of doing so. Therefore, we assume

that initial exposure to new concepts occurs in class. Under this assumption, there is no

difference between the first day of class and any other day.

The primary objective of the text is to teach students to understand how business events

affect financial statements. The first step is for students to learn the elements of financial

statements. This chapter introduces the following elements: assets, liabilities, equity,

common stock, retained earnings, revenue, expenses, and distributions. Next, students

must learn how the elements are interrelated, and finally, how those interrelationships are

expressed in financial statements.

This first chapter introduces several terms and concepts that may be new to many, if not

all, students. This chapter also lays an important foundation for the rest of the course.

Since students are settling in to the new semester or quarter, and since there are often

changes in class composition due to add/drop activity during the first week of class, we

suggest more time be allocated to cover material in this chapter.

There are two distinct ways to introduce financial accounting using this text. One alter-

native is to first introduce financial statements and then show students how to record

events in the horizontal financial statements model. The second alternative is to show

students how to record transaction data using the accounting equation and then to develop

financial statements from the data organized in equation form. The text supports either

approach. In the following section, we provide detailed lesson plans for both approaches.

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Detailed Outline of a Lesson Plan for Chapter 1

(Horizontal Financial Statements Model Approach)

I. Use the problem-based learning case, “Ask Me Anything,” to introduce fi-

nancial statements to students.

(We describe problem-based learning in the introduction to this manual.)

Instructions: The case appears on the following page in a format you can copy or

display. Distribute copies of the case to the class before providing any explana-

tion of accounting. Ask students to read the case and individually develop an-

swers.

Chapter 1 Problem-Based Learning Case: Accounting Questions

Ask Me Anything

Assume that you are considering going into business

with Linda Wilson. Assume that I am Linda’s account-

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ant and that you can ask me three questions. Write

down the three questions that you would ask.

II. Create a collaborative experience where students share their questions. After

allowing students time to develop their individual responses, put them into groups

to compare their questions. For example, have students pair off with one another,

share their questions, and reach consensus on three questions that represent the

combined interest of the two people in the pair. Then combine those pairs of stu-

dents into groups of four, and have each group select three of their original

sixquestions that they would ask the accountant. Allow groups time to develop

answers. Also have each group select a spokesperson.

III. Briefly introduce the basic financial statements. Explain that accountants

communicate financial information to the public through a set of reports called fi-

nancial statements. At this point introduce three of these statements: 1) the bal-

ance sheet, 2) the income statement, and 3) the statement of cash flows. Use a

business cycle approach to introduce the statement of cash flows. Specifically,

starting a business requires some cash (financing activities); the cash is used to

buy operating assets (investing activities); and finally, the business runs on a day–

to-day basis (operating activities).

IV. Use student input to demonstrate the usefulness of financial statement infor-

mation. Ask the group spokespersons to share the questions their group would

like to have the accountant answer. Identify information that would appear in fi-

nancial statements. For example, “How much money does Linda make?” would

appear as revenue on the income statement. Draw a skeleton of an income state-

ment on the board and show the students where revenue appears on that state-

ment. You could use this question to expand the discussion into other areas. Ask,

for example, “Is the amount of Linda’s salary equal to the amount of her take-

home pay?” This question creates an opportunity to demonstrate the difference

between the income statement and the statement of cash flows. A question like

“Does she pay her bills on time?” affords the opportunity to explain that some in-

formation is not provided directly in the statements but is available through finan-

cial statement analysis. Some questions provide the opportunity to demonstrate

the limitations of financial statement data. For example, answers to questions like

“Is Linda an honest person?” cannot be found in the financial statements. How-

ever, this question invites you to point out the importance of ethical conduct by

accountants.

We hope these examples demonstrate the need for the instructor to be flexible and

creative in handling the student input. Expect a variety of questions. Also, be

prepared to raise questions if the students do not ask about some of the things you

want to discuss. Problem-based learning is designed to provide an opportunity for

student discovery, not discovery on the part of the professor. The instructor

should be prepared to address predetermined learning objectives. In this case, one

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objective is to introduce financial statements in a way that engages students. The

exercise is designed to stimulate student interest and critical thinking. The prima-

ry learning objective, however, is for students to leave class able to name three fi-

nancial statements and to describe the specific elements that appear in each state-

ment. The instructor should guide the discussion toward the accomplishment of

these objectives.

V. Distribute copies of the Self Study Review Problem. The self-study review

problem immediately follows the text at the end of each chapter, just before the

listing of key terms. After establishing an understanding of financial statements,

you can use this problem to show students how to record business events directly

into a set of financial statements. The solutions are included in the text so that

students can refer back as they review the material covered during class. You can

mention this to the students before you begin working on the problem. This way,

the students can focus their attention on the class discussion rather than focusing

their attention on taking notes and recording your comments. The material is also

supplemented with narrated slides to help students if they cannot recall details of

the discussion in class.

VI. Create a horizontal financial statements model for the Self-Study Review

Problem. Either draw on the board or use an e-transparency to display a horizon-

tal financial statements model for the students. Explain that the statements model

is a learning tool that doesn’t include many details (titles, dates, headings, etc.)

that normally appear in formal financial statements. In lecture mode, analyze and

record the transactions. Each transaction introduces a new financial statement el-

ement. Provide a clear explanation of each element including the interrelation-

ships between elements and their statements effects. For example, describe reve-

nue as an economic benefit a company obtains by providing customers with goods

and services. Revenue causes an increase in equity and a corresponding increase

in assets. At this early point, you can limit the explanation of revenue to an in-

crease in equity with a corresponding increase in assets. How does revenue differ

from issuing stock which also results in an increase in assets? Revenue results

from work performed by the company, while a successful stock issue results from

convincing stockholders that the company can produce revenue. Point out that

revenue is reported on the income statement but a stock issue is not. Similarly,

describe each element and show the students how the business events affect the

financial statements.

VII. Actively involve the students in learning. After explaining the accounting

transactions in the self-study review problem, show how last year’s ending bal-

ances became this year’s beginning balances. Record the ending balances in a

statements model. Observe that the balance sheet accounts carry forward from

year to year while the income statement accounts are closed, resulting in zero be-

ginning balances for all revenue and expense accounts. This is an excellent time

to mention the closing process without getting into procedural detail. Sometimes

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it helps students understand that the way we record revenue and expense transac-

tions in the horizontal financial statements model actually combines 2 entries into

1 – the entry to record the transaction and the entry to close the revenues and ex-

penses to equity. After explaining the self-study review problem, ask the students

to complete Exercise 1-11B or the Demonstration problem (at the end of this sec-

tion of the Instructor’s Manual) on their own. You will probably need to make

copies of whichever item you ask them to complete, since not all students will

bring their text to class every day. The value of the Demonstration problem is

that it allows the students to see how to move from one fiscal period to the next.

Walk around the room and provide assistance as needed. If you notice that a par-

ticular transaction is confusing a lot of students, stop the class and provide a brief

explanation to the class as a whole.

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Detailed Outline of an Alternative Lesson Plan for Chapter 1

(Equation Approach)

I. Distribute copies of the Self-Study Review Problem. As indicated earlier, the

self study problem and solution is located immediately after the text at the end of

each chapter.

II. Define assets. Use the simplest definition possible. It is extremely important to

use words that students can understand. They will read the technical terminology

in the text. For example:

Assets are things of value to a business. The value is the capacity of the asset to

be used in the production of greater quantities of other assets.

Use the classroom to provide specific examples. For example, the chairs, desks, and

building the students are using are assets of the university because they are used to

produce tuition dollars (other assets). Emphasize the point further by distinguishing

between personal assets and business assets. Tom uses an old key chain his brother

gave him over twenty years ago. While it has great value to Tom, it would have lit-

tle value to a business because it could not be sold or otherwise used to produce oth-

er assets. If you saw this key chain you would truly understand its limitations as a

business asset. You may not have an old key chain, but we’re sure you can think of

something meaningful to you that has little usefulness as a business asset. Nancy

uses framed photographs of her beautiful daughters. It is important that you person-

alize your comments. We highly encourage you to adapt our examples to reflect

your personality. Students respond favorably to personalized examples. Often stu-

dents have often heard the statement that ‘people are our most valuable assets’. This

is a great time to distinguish between the accounting concept of an asset and the in-

tangible value of key employees.

III. Introduce the accounting equation. You can make a smooth transition from defin-

ing assets to introducing the accounting equation by noting that assets belong to

some person or organization. The individual or institutional interests in the assets

are called claims. The accounting equation expresses the relationship between

assets and claims as follows:

Assets

=

Claims

IV. Use the Self Study Problem that follows the text in Chapter 1 as an explanatory

platform. Using the Self Study Problems in the text to explain concepts allows the

students to focus their attention entirely on your explanation rather than trying to take

notes and capture all your comments for future reference and study support. Since

the text also illustrates the solution to this self study problem, the students can use the

text to refresh their memories when completing assigned homework or studying for

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tests. The narrated slides can also serve to remind students of the classroom discus-

sion.

Explain that individuals or institutions acquire claims by providing assets to a

business. There are three primary sources of assets. The first two events of the

self-study problem illustrate the two of the three sources. Discuss each event sep-

arately. Define the appropriate terms, and explain how the event affects the ac-

counting equation.

A. Event No. 1: Use Event No. 1 to introduce and define common stock. Ex-

plain that when a business acquires assets from owners, the assets of the busi-

ness increase and the business establishes a corresponding claims account

called common stock. Introduce the accounting equation and the term equity.

Show students how to record the event under the accounting equation. Record

common stock under the term equity. Leave room for retained earnings which

will be illustrated in Event No. 2. Note that equity represents ownership in-

terest in the business.

B. Event No. 2: This event introduces the concept of revenue. Define revenue

as an increase in assets resulting from the operating activities of providing

services or goods to customers.1 This definition defines revenue in terms of

its relationship with assets. It is essential that students understand how the el-

ements of financial statements articulate. You can achieve this goal by defin-

ing various elements in terms of their relationship to other elements. Expand

the accounting equation to include retained earnings and record Event No. 3

under the equation.

C. Introduce liabilities and tell the students that creditors also have an interest in

the assets of a business. Define liabilities as obligations of a business.

Identify Events 1 and 2, along with liabilities, as asset source transactions.

Emphasize that thousands of different events can be classified into one of these

three types of transactions. For example, businesses may increase their assets by

providing consulting services, cleaning services, music lessons, investment ad-

vice, legal services, medical assistance, mechanical work, painting, and so on.

Although these services represent distinctly different events, they can all be clas-

sified as asset source transactions. Emphasize that it is easier to understand the

three types of transactions than to memorize the infinite number of specific trans-

actions in which businesses engage. The next two events represent asset use

transactions.

1Revenues can also result from activities that decrease liabilities. Revenue recognition within this context

requires an understanding of deferrals. Deferrals are introduced in Chapter 2. Within the context of cash

basis accounting, which is the underlying assumption for Chapter 1, revenue can be defined simply as an

increase in assets from providing services and expenses as decreases in assets from revenue-producing ac-

tivities. These definitions will be expanded as accrual accounting topics are gradually introduced.

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D. Event No. 3: This event introduces the concept of asset use (cash) to pay ex-

penses. Define expenses as decreases in assets that occur in the process of at-

tempting to earn revenue. Explain that assets are used to settle or pay for the

expenses incurred in the earnings process.

E. Event No. 4: This event introduces dividends. Clearly distinguish dividends

from expenses. Although both are asset use transactions, dividends represent

a transfer of wealth rather than a sacrifice made to obtain revenue.

F. Event No. 5: This event introduces the concept of asset exchange. Explain

how assets (generally cash) can be exchanged for other assets (like land, in

this example) and how the total asset balance doesn’t change when an asset

exchange occurs.

G. Event No. 6: This event reinforces the concept of asset use.

V. Introduce the horizontal financial statements model to show your students how to

record the effects (increase, decrease, no effect) of transactions on the statements, us-

ing the transactions from the Self-Study Review problem. Link the horizontal finan-

cial statements model to the accounting equation and show how every transaction

leaves the accounting equation in balance.

VI. Actively involve the students in learning. After explaining the accounting transac-

tions in the Self-Study Review problem, show how last year’s ending balances be-

came this year’s beginning balances. Record the ending balances in a statements

model. Observe that the balance sheet accounts carry forward from year to year

while the income statement accounts are closed, resulting in zero beginning balances

for all revenue and expense accounts. This is an excellent time to mention the clos-

ing process without getting into procedural detail. It sometimes helps students un-

derstand that revenue, expense, and dividend transactions recorded in the financial

statement model actually combine 2 transactions into 1 – the recording of the event

itself plus the recording of the closing transaction.

After explaining the Self-Study Review problem, ask the students to complete Exer-

cise 1-11B or the Demonstration problem (at the end of this section of the Instruc-

tor’s Manual) on their own. You will probably need to make copies of whichever

item you ask them to complete, since not all students will bring their text to class

every day. The value of the Demonstration problem is that is allows the students to

see how to move from one fiscal period to the next. Walk around the room and

provide assistance as needed. If you notice that a particular transaction is confusing

a lot of students, stop the class and provide a brief explanation to the class as a

whole.

VII. Introduce financial statements. Return to the Self-Study Review problem and

show students how the information recorded in the accounting equation and horizon-

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tal financial statements model is summarized in financial statements. Emphasize

that financial statements are designed to provide information useful in decision–

making. This is a good time to say a few words about the different types of account-

ing information. Explain how outsiders (e.g., investors and creditors) need different

kinds of information than insiders (e.g., managers). For example, a person deciding

whether to invest in Kmart versus Wal-Mart is interested in knowing which compa-

ny generated more earnings. In contrast, a Wal-Mart vice-president needs infor-

mation about specific stores and specific items in each store. Different branches of

accounting have been established to satisfy the information needs of different users.

Emphasize that financial accounting focuses on the information needs of investors

and creditors. Make the discussion light and breezy. Students quickly get bored

with this kind of general discussion.

Present the statements in this order: (1) income statement, (2) statement of changes

in stockholders’ equity, (3) balance sheet, and (4) statement of cash flows. As you

explain, point out the importance of this sequence. You need the amount of net in-

come to prepare the statement of changes in stockholders’ equity. You need the

amount of stockholders’ equity to prepare the balance sheet. Comments relevant to

each statement follow:

A. Income statement. Emphasize how the elements of the income statement

are related to the elements of the balance sheet. Reiterate that revenue in-

creases assets from providing services and expenses decrease assets in efforts

to earn revenue. Teach students more than the formula for computing net in-

come (Revenue – Expenses = Net Income). Help them understand that net in-

come represents the change in wealth (net assets) resulting from business op-

erations during the accounting period. If you want your students to under-

stand interrelationships, you must emphasize those relationships in your class-

room discussions and your examinations.

B. Statement of changes in stockholders’ equity. This statement provides the

opportunity to reemphasize the difference between expenses and dividends.

Expenses affect the measurement of net income, after which a decision is

made regarding how much of the income to distribute versus how much to re-

tain in the business. Emphasize that net income is a periodic measurement,

while retained earnings is a cumulative amount.

C. Balance sheet. Explain that the balance sheet is little more than a summary

of the accounting equation. The statement lists assets and the corresponding

claims on those assets. In this chapter, too few assets are illustrated to intro-

duce the idea of presenting assets in accordance with liquidity. This subject is

introduced later in the text. Explain that the statement represents a company’s

financial condition at a specific point in time.

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D. Statement of cash flows. Introduce the categories of the statement of cash

flows in a sequence consistent with forming a business. First, a business must

obtain financing. Once a business has cash, it invests the cash. Finally, the

business uses and generates cash through its operating activities. Use the di-

rect method. Prepare the statement by analyzing the cash account. Students

must merely learn to identify cash transactions as operating, investing, or fi-

nancing. Many students find this task to be a real challenge. Do not be dis-

couraged if your students have difficulty at first. While mastery requires a

significant level of reinforcement, be assured that your students will grasp this

critically important topic after working through several of the multicycle prob-

lems. Since the first chapter covers only cash transactions, the amount of cash

flow from operating activities will equal the amount of net income. There-

fore, we do not contrast these two amounts until Chapter 2. Instead, we em-

phasize that the statement of cash flows is more inclusive than the income

statement. We point out that it reports investing and financing activities as

well as operating activities.

VIII. Fill in the gaps. You will find additional terms and concepts covered in the text

but not in the teaching notes. Although we do not expect our students to read the

text prior to coming to class, we do expect them to read it after we have intro-

duced the material. In other words, we expect our students to read behind us.

They are responsible for filling in the gaps. There is not enough time to cover

every single point in class. Class is a place to get started. Try to cover the more

important and conceptually complex points there. Hold your students responsible

for a reasonable level of homework. Remind them accounting is a “learn by do-

ing” subject. Regardless of how skillfully you explain the concepts, students can-

not learn to work accounting problems without actually working accounting prob-

lems.

IX. Enrichment. Appendix B contains excerpts from the Target 10-K report. It

helps students to see a ‘real world’ example of what is being covered in class.

While they are not yet ready to fully analyze financial statements as complex as

those presented in this Appendix, you can point out the fact that the 4 financial

statements are included here and discuss how they tie to the example that has been

covered in class.

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Demonstration Problem 1-1 – The Accounting Cycle

The events below apply to Computer Services Company (CSC). Assume that all transac-

tions involve receiving or paying cash.

Transactions for the year 2015:

1. CSC was started when it acquired $9,000 cash by issuing common stock.

2. The company borrowed $5,000 from a bank.

3. The company provided services to customers and received $4,000.

4. The company paid operating expenses of $2,900.

5. The company paid $500 in dividends to its stockholders.

Transactions for the year 2016:

1. The company issued additional common stock for $4,500.

2. The company paid $2,000 to reduce its liabilities.

3. The company provided services to customers and received $6,700.

4. The company paid operating expenses of $4,300.

5. The company paid $700 in dividends to its stockholders.

Transactions for the year 2017:

1. The company issued additional common stock for $2,500.

2. The company borrowed an additional $1,000 from creditors.

3. The company provided services to customers and received $7,400.

4. The company paid operating expenses of $7,900.

5. The company paid $300 in dividends to its stockholders.

6. The company paid $9,000 to purchase land.

Required

a. Record the events using the horizontal financial statements model.

b. Prepare an income statement, statement of changes in stockholders’ equity, balance

sheet and statement of cash flows for each year.

Demonstration Problem 1-1 Solution, part a.

2015

Assets

=

Liab.

+

Equity

Rev.

Ä

Exp.

=

Net Inc.

Cash Flow

No.

Cash

+

Land

=

Liab.

+

C. Stk.

+

Ret. Earn.

Beg. bal.

+

=

+

–

=

1

9,000

+

=

+

9,000

+

–

=

9,000 FA

2

5,000

+

=

5,000

+

–

=

5,000 FA

3

4,000

+

=

+

4,000

–

=

4,000

4,000 OA

4

(2,900)

+

=

+

(2,900)

–

2,900

=

(2,900)

(2,900) OA

5

(500)

+

=

+

(500)

–

=

(500) FA