Chapter 01 – A Framework for Financial Accounting
1-1
Chapter 1
A Framework for Financial Accounting
INSTRUCTOR’S MANUAL
Learning Objectives
LO1-1 Describe the two primary functions of financial accounting.
LO1-2 Understand the business activities that financial accounting measures.
LO1-3 Determine how financial accounting information is communicated through financial
statements.
LO1-4 Describe the role that financial accounting plays in the decision-making process.
LO1-5 Explain the term generally accepted accounting principles (GAAP) and describe the
role of GAAP in financial accounting.
LO1-6 Identify career opportunities in accounting.
Appendix
LO1-7 Explain the nature of the conceptual framework used to develop generally accepted
accounting principles.
Chapter 01 – A Framework for Financial Accounting
1-2
Teaching Suggestions
Chapter 1 introduces students to the concept that accounting is not a math course; it’s the
language of business.
Part A emphasizes the two functions of accounting: measurement of business activities
and communication of these measurements to investors and creditors. These concepts are
reinforced by describing the business activities of a start-up company (Eagle Golf Academy)
and then discussing the measurements that various decision makers need. Financial statements
are presented for a fictitious company that will be used in Chapters 1—4. The importance of
accounting to decision makers, and its importance to our society, is discussed. This emphasis
is used to help students better understand the role of accounting and motivate their interest in
the course.
Part B provides the background and historical perspective of accounting standards. The
role of the auditor in adding credibility to financial information naturally leads to a discussion
of the ethical issues surrounding financial reporting.
Part C ends the main text with a discussion of careers in accounting. Again, this is used to
be both informative and motivational. This section emphasizes the broad range of job
opportunities available to those earning a degree in accounting, perhaps dispelling the
traditional view of accountants. It also discusses the strong demand for accounting majors.
For those interested, the conceptual framework is discussed in the appendix. The
instructor can cover the conceptual framework in this chapter and then refer back to it as
topics in subsequent chapters are covered. Alternatively, the instructor may wish to cover the
conceptual framework in conjunction with another chapter, such as Chapter 12, Financial
Statement Analysis.
Chapter 01 – A Framework for Financial Accounting
1-3
A
As
ss
si
ig
gn
nm
me
en
nt
t
C
Ch
ha
ar
rt
ts
s
Questions
Learning
Objective(s)
Topic
Time
(Min.)
1
LO1-1
Define accounting
5
2
LO1-1
Identify decision makers
5
3
LO1-1
Define financial accounting
5
4
LO1-1
Determine the functions of accounting
5
5
LO1-2
Classify business activities
5
6
LO1-2
Determine financing activities
5
7
LO1-2
Determine investing activities
5
8
LO1-2
Determine operating activities
5
9
LO1-2
Distinguish legal forms of business
5
10
LO1-2
Define account types
5
11
LO1-2
Name advantages and disadvantages of the legal
forms of business
5
12
LO1-3
Describe basic financial statements
5
13
LO1-3
Understand financial reporting periods
5
14
LO1-3
Identify revenues and expenses
5
15
LO1-3
Understand the accounting equation
5
16
LO1-3
Identify assets and liabilities
5
17
LO1-3
Understand the link between the income statement
and balance sheet
5
18
LO1-3
Identify cash flows
5
19
LO1-3
Explain other forms of financial accounting
information
5
20
LO1-4
Explain the role of accounting in society
5
21
LO1-5
Define GAAP
5
22
LO1-5
Describe the role of the FASB
5
23
LO1-5
Compare U.S. GAAP and IFRS
5
24
LO1-5
Understand the historical role of the securities acts
5
25
LO1-5
Describe the role of the auditor
5
26
LO1-5
List the three objectives of financial reporting
5
27
LO1-6
Understand the benefits of an accounting degree
5
28
LO1-7
Discuss relevance and faithful representation
5
29
LO1-7
Identify the components of relevance and faithful
representation
5
30
LO1-7
Describe cost effectiveness
5
31
LO1-7
Define the four basic assumption underlying GAAP
5
Chapter 01 – A Framework for Financial Accounting
1-4
Brief
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
BE1-1
LO1-1
Define accounting
5
BE1-2
LO1-2
Identify the different types of business activities
5
BE1-3
LO1-2
Identify the different forms of business
organizations
5
BE1-4
LO1-2
Recognize the different account classifications
5
BE1-5
LO1-2
Assign account classifications
5
BE1-6
LO1-2
Assign account classifications
5
BE1-7
LO1-3
Describe each financial statement
5
BE1-8
LO1-3
Determine the location of items in financial
statements
5
BE1-9
LO1-5
Identify different groups engaged in providing high-
quality financial reporting
5
BE1-10
LO1-5
Identify the objectives of financial accounting
5
BE1-11
LO1-6
Identify careers for accounting majors
5
BE1-12
LO1-7
Identify the components/aspects of relevance
5
BE1-13
LO1-7
Identify the components/aspects of faithful
representation
5
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
E1-1
LO1-2
Identify the different types of business activities
5
E1-2
LO1-2
Identify account classifications and business
activities
5
E1-3
LO1-2
Identify account classifications and business
activities
5
E1-4
LO1-2
Calculate net income and stockholders’ equity
10
E1-5
LO1-2
Calculate net loss and stockholders’ equity
10
E1-6
LO1-3
Prepare an income statement
5
E1-7
LO1-3
Prepare a statement of stockholders’ equity
10
E1-8
LO1-3
Prepare a balance sheet
5
E1-9
LO1-3
Prepare a statement of cash flows
10
E1-10
LO1-3
Link the income statement to the statement of
stockholders’ equity
15
E1-11
LO1-3
Link the statement of stockholders’ equity to the
balance sheet
15
E1-12
LO1-3
Link the balance sheet to the statement of cash
flows
15
E1-13
LO1-3
Compute missing amounts from financial statements
10
E1-14
LO1-3
Calculate the balance of retained earnings
5
E1-15
LO1-3
Calculate amounts related to the balance of retained
earnings
10
1-5
E1-16
LO1-3
Use the accounting equation to calculate amounts
related to the balance sheet
10
E1-17
LO1-3
Calculate missing amounts related to the statement
of cash flows
10
E1-18
LO1-5
Understand the role of the auditor
E1-19
LO1-7
Identify the purpose of qualitative characteristics
10
E1-20
LO1-7
Identify business assumptions underlying GAAP
5
Problems
Learning
Objective(s)
Topic
Time
(Min.)
P1-1A
LO1-2
Classify business activities
10
P1-2A
LO1-2
Assign account classifications
10
P1-3A
LO1-3
Prepare financial statements
20
P1-4A
LO1-3
Understand the format of financial statements and
the links among them
25
P1-5A
LO1-3
Prepare financial statements
20
P1-6A
LO1-7
Identify underlying assumptions of GAAP
15
P1-7A
LO1-7
Understand the components of the FASB’s
conceptual framework
10
P1-1B
LO1-2
Classify accounts
10
P1-2B
LO1-2
Assign business transactions to account
classifications
10
P1-3B
LO1-3
Prepare financial statements
20
P1-4B
LO1-3
Understand the format of financial statements and
the links among them
25
P1-5B
LO1-3
Prepare financial statements
20
P1-6B
LO1-7
Identify underlying assumptions of GAAP
15
P1-7B
LO1-7
Understand the components of the FASB’s
conceptual framework
10
Additional
Perspectives
Topic
Time
(Min.)
AP1-1
Continuing Problem: Great Adventures
20
AP1-2
Financial Analysis: American Eagle Outfitters, Inc.
15
AP1-3
Financial Analysis: The Buckle, Inc.
15
AP1-4
Comparative Analysis: American Eagle Outfitters, Inc. vs. The Buckle,
Inc.
20
AP1-5
Ethics
20
AP1-6
Internet Research
30
AP1-7
Written Communication
25
Chapter 01 – A Framework for Financial Accounting
1-6
Chapter Quiz Questions
The following multiple-choice questions are 10 unique quiz questions that correspond to the
10 questions at the end of each chapter. Each question covers the same learning objective but
with a little different twist. The correct answer is highlighted in bold for each item.
LO1-1
1. Which of the following best describes financial accounting?
a. Artistic presentation.
LO1-2
2. Which definition best describes financial accounting?
a. A process of measuring income taxes owed to the government.
LO1-2
3. Which of the following represents an obligation of the company?
a. Assets.
LO1-2
4. Which of the following describes the cost of selling to customers?
a. Assets.
LO1-3
5. Which financial statement reports a company’s assets and liabilities?
a. Income statement.
Chapter 01 – A Framework for Financial Accounting
1-7
LO1-3
6. Which financial statement shows a company’s revenues and expenses?
LO1-4
7. Which of the following best describes an important function of financial accounting?
a. To increase the number of customers for a company.
LO1-5
8. Which body has the primary responsibility for the establishment of Generally Accepted
Accounting Principles?
a. American Institute of Certified Public Accountants (AICPA).
LO1-5
9. Traditional careers in public accounting include:
a. Auditors.
LO1-7
10. A component/aspect of relevant accounting information includes:
a. Faithful representation.
Chapter 01 – A Framework for Financial Accounting
1-8
Alternate Let’s Review
On December 31, Wortham Services reports the following year-end amounts.
Assets:
Cash
$11,000
Revenues:
Service
$85,000
Accts. rec.
19,000
Buildings
32,000
Expenses:
Advertising
12,000
Liabilities:
Salaries payable
5,000
Insurance
18,000
Notes payable
20,000
Salaries
44,000
Additional information:
a. The balance of retained earnings at the beginning of the year is $6,000.
b. The company pays dividends of $5,000 on December 31.
c. Common stock is $20,000 at the beginning of the year, and $5,000 of additional shares are
issued during the year.
Required:
Prepare the (1) income statement, (2) statement of stockholders’ equity, and (3) balance sheet.
Solution:
1. Income statement:
2. Statement of stockholders’ equity:
Wortham Services
Income Statement
Year ended Dec. 31
Wortham Services
Statement of Stockholders’ Equity
Year ended Dec. 31
3. Balance sheet:
Wortham Services
Balance Sheet
December 31
Chapter 01 – A Framework for Financial Accounting
1-9
Key Points by Learning Objective
LO1-1 Describe the two primary functions of financial accounting.
LO1-2 Understand the business activities that financial accounting measures.
LO1-3 Determine how financial accounting information is communicated through
financial statements.
The income statement compares revenues and expenses for the current period to assess the
company’s ability to earn a profit from running its operations.
LO1-4 Describe the role that financial accounting plays in the decision-making process.
LO1-5 Explain the term generally accepted accounting principles (GAAP) and describe
the role of GAAP in financial accounting.
Chapter 01 – A Framework for Financial Accounting
1-10
LO1-6 Identify career opportunities in accounting.
Appendix
LO1-7 Explain the nature of the conceptual framework used to develop generally
accepted accounting principles.
Chapter 01 – A Framework for Financial Accounting
1-11
Common Mistakes
Common Mistake
Dividends represent the payment of cash but are not considered an expense in running the
business. Students sometimes mistakenly include the amount of dividends as an expense in the
income statement, rather than as a distribution of net income in the statement of stockholders’
equity.
Chapter 01 – A Framework for Financial Accounting
1-12
Decision Points
Question
Accounting Information
Analysis
How can I tell if a
company is
profitable?
Income statement
If revenues exceed expenses, a
company has net income and is
profitable.
Question
Accounting Information
Analysis
Was the change in
stockholders’ equity
the result of external
or internal sources?
Statement of stockholders’
equity
When a company sells common stock,
equity increases due to external
sources. When a company has profits
during the year in excess of dividends
paid, equity increases due to internal
sources.
Question
Accounting Information
Analysis
What are creditors’
claims and owners’
claims to the
company’s resources?
Balance sheet
The amount of total liabilities equals
creditors’ claims to the company’s
resources. The extent to which total
assets exceed total liabilities
represents owners’ claims.
Chapter 01 – A Framework for Financial Accounting
1-13
Career Corner
Career Corner
Over 20,000 employees join public accounting firms in entry-level jobs each year, and thousands
more go into other areas of accounting. While financial accountants learn how to measure
business transactions and prepare financial reports, they also learn a great deal about the business
itself. Because of this widespread business knowledge, accountants often play a key role on the
management team. In fact, it should come as no surprise to learn that most chief financial
officers (CFOs) started their careers as accountants.
Accounting, because of its dynamic and professional nature, offers an attractive career option.
You can learn more about a career in accounting by visiting the website of the American Institute
Chapter 01 – A Framework for Financial Accounting
1-14
Ethical Dilemma
Ethical Dilemma
You have been the manager of a local restaurant for the past five years. Because of increased
competition, you notice you’re getting fewer customers. Despite all your attempts to attract new
customers and cut costs, the restaurant’s profitability continues to decline. The restaurant owner
tells you that if this year’s profit is lower than last year’s, you’ll lose your job.
When preparing financial statements at the end of the year, you notice that this year’s profit
is lower. You know that by purposely understating certain expenses, you can falsely report
higher profits to the owner for this year. That will allow you to keep your job for at least one
more year and look for a new job in the meantime.
What should you do? What if you really believe the lower profitability is caused by factors
outside your control? Would this make the false reporting acceptable?
Key Issues
• Reporting higher profit makes the restaurant’s operations seem more profitable,
signaling better managerial performance.
Option 1: Do not understate expenses
• The actions we take depict the type of person we are, not whom we hope to be. You
may believe other causes besides your performance drove the decline in performance,
but that should not be an excuse to lie and manipulate your boss.
Option 2: Understate expenses
• As the decline in performance is not your fault, you may decide that falsifying the
financial statements will allow you time to either explain to the owner why