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CHAPTER1
Accounting in
Action
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PreviewofCHAPTER1
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What is Accounting?
Purpose of accounting is to:
● identify, record, and communicate the economic
events of an
● organization to
● interested users.
1- 1 SO 1 Explain what accounting is.
What is Accounting?
Illustration 1- 1
Three Activities Accounting process
The accounting process includes
the bookkeeping function.
1- 1 SO 1 Explain what accounting is.
Who Uses Accounting Data
Internal Users
Management IRS
Human Investors
Resources There are two broad
groups of users of Labor
financial information: Unions
Finance
internal users and external
users.
Creditors
Marketing
SEC
Customers External
Users
1- 1 SO 2 Identify the users and uses of accounting.
Who Uses Accounting Data
Common Questions Asked User
1. Can we afford to give our
employees a pay raise? Human Resources
2. Did the company earn a
satisfactory income? Investors
3. Do we need to borrow in the
near future? Management
4. Is cash sufficient to pay
dividends to the stockholders? Finance
5. What price for our product will
maximize net income? Marketing
6. Will the company be able to
pay its short- term debts? Creditors
1- 1 SO 2
The Building Blocks of Accounting
Ethics In Financial Reporting
Standards of conduct by which one’s actions are judged as
right or wrong, honest or dishonest, fair or not fair, are Ethics.
Recent financial scandals include: Enron, WorldCom,
HealthSouth, AIG, and others.
Congress passed Sarbanes- Oxley Act of 2002.
Effective financial reporting depends on sound ethical
behavior.
1- 1 SO 3 Understand why ethics is a fundamental business concept.
Ethics in Financial Reporting
Question
Ethics are the standards of conduct by which one's
actions are judged as:
● right or wrong.
● honest or dishonest.
● fair or not fair.
● all of these options.
1- 1 SO 3 Understand why ethics is a fundamental business concept.
Generally Accepted Accounting Principles
Financial Statements
Various users ● Balance Sheet
need financial ●
●
Income Statement
Statement of Owner’s Equity
information ● Statement of Cash Flows
● Note Disclosure
The accounting profession
has attempted to develop a
Generally Accepted
set of standards that are
Accounting
generally accepted and
Principles (GAAP)
universally practiced.
1- 1 SO 4 Explain generally accepted accounting principles.
Generally Accepted Accounting Principles
Generally Accepted Accounting Principles (GAAP) - A set of
rules and practices, having substantial authoritative support, that
the accounting profession recognizes as a general guide for
financial reporting purposes.
Standard- setting bodies determine these guidelines:
● Securities and Exchange Commission (SEC)
● Financial Accounting Standards Board (FASB)
● International Accounting Standards Board (IASB)
1- 1 SO 4 Explain generally accepted accounting principles.
Generally Accepted Accounting Principles
Measurement Principles
Cost Principle – Or historical cost principle, dictates that
companies record assets at their cost.
Fair Value Principle – Indicates that assets and liabilities
should be reported at fair value (the price received to sell an
asset or settle a liability).
1- 1 SO 4 Explain generally accepted accounting principles.
Generally Accepted Accounting Principles
Assumptions
Monetary Unit – include in the accounting records only
transaction data that can be expressed in terms of money.
Economic Entity – requires that activities of the entity be
kept separate and distinct from the activities of its owner and
all other economic entities.
Proprietorship.
Partnership. Forms of Business
Ownership
Corporation.
SO 5 Explain the monetary unit assumption and
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the economic entity assumption.
Forms of Business Ownership
Proprietorship Partnership Corporation
Generally owned Owned by two or Ownership
by one person. more persons. divided into
Often small shares of stock
Often retail and
service- type service- type Separate legal
businesses businesses entity organized
Owner receives under state
Generally
any profits, corporation law
unlimited
suffers any personal liability Limited liability
losses, and is
Partnership
personally liable
agreement
for all debts.
SO 5 Explain the monetary unit assumption and
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the economic entity assumption.
Generally Accepted Accounting Principles
Question
Combining the activities of Kellogg and General Mills
would violate the
● cost principle.
● economic entity assumption.
● monetary unit assumption.
● ethics principle.
SO 5 Explain the monetary unit assumption and
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the economic entity assumption.
Generally Accepted Accounting Principles
Question
A business organized as a separate legal entity under state
law having ownership divided into shares of stock is a
● proprietorship.
● partnership.
● corporation.
● sole proprietorship.
SO 5 Explain the monetary unit assumption and
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the economic entity assumption.
The Basic Accounting Equation
Assets Liabilities Owner’s
= + Equity
Provides the underlying framework for recording and
summarizing economic events.
Assets are claimed by either creditors or owners.
Claims of creditors must be paid before ownership claims.
1- 1 SO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
Assets
Resources a business owns.
Provide future services or benefits.
Cash, Supplies, Equipment, etc.
Assets Liabilities Owner’s
= + Equity
1- 1 SO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
Liabilities
Claims against assets (debts and obligations).
Creditors - party to whom money is owed.
Accounts payable, Notes payable, etc.
Assets Liabilities Owner’s
= + Equity
1- 1 SO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
Owner’s Equity
Ownership claim on total assets.
Referred to as residual equity.
Investment by owners and revenues (+)
Drawings and expenses (- ).
Assets Liabilities Owner’s
= + Equity
1- 1 SO 6 State the accounting equation, and define its components.
Owner’s Equity
Illustration 1- 6
Revenues result from business activities entered into for the
purpose of earning income.
Common sources of revenue are: sales, fees, services,
commissions, interest, dividends, royalties, and rent.
1- 1 SO 6 State the accounting equation, and define its components.
Owner’s Equity
Illustration 1- 6
Expenses are the cost of assets consumed or services used in
the process of earning revenue.
Common expenses are: salaries expense, rent expense, utilities
expense, tax expense, etc.
1- 1 SO 6 State the accounting equation, and define its components.
Using the Accounting Equation
Transactions are a business’s economic events recorded
by accountants.
May be external or internal.
Not all activities represent transactions.
Each transaction has a dual effect on the accounting
equation.
1- 1 SO 7 Analyze the effects of business transactions on the accounting equation.
Using the Accounting Equation
Illustration: Are the following events recorded in the accounting
records?
Owner
Supplies are An employee withdraws
Event purchased is hired. cash for
on account. personal use.
Criterion Is the financial position (assets, liabilities, or
owner’s equity) of the company changed?
Record/
Don’t Record
1- 1 SO 7 Analyze the effects of business transactions on the accounting equation.
Transaction Analysis
Transaction (1): Ray Neal decides to open a computer programming
service which he names Softbyte. On September 1, 2012, Ray Neal
invests $15,000 cash in the business.
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Transaction Analysis
Transaction (2): Purchase of Equipment for Cash. Softbyte purchases
computer equipment for $7,000 cash.
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Transaction Analysis
Transaction (3): Softbyte purchases for $1,600 from Acme Supply
Company computer paper and other supplies expected to last several
months. The purchase is made on account.
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Transaction Analysis
Transaction (4): Softbyte receives $1,200 cash from customers for
programming services it has provided.
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Transaction Analysis
Transaction (5): Softbyte receives a bill for $250 from the Daily News
for advertising but postpones payment until a later date.
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Transaction Analysis
Transaction (6): Softbyte provides $3,500 of programming services for
customers. The company receives cash of $1,500 from customers, and
it bills the balance of $2,000 on account.
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Transaction Analysis
Transaction (7): Softbyte pays the following expenses in cash for
September: store rent $600, salaries of employees $900, and utilities
$200.
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Transaction Analysis
Transaction (8): Softbyte pays its $250 Daily News bill in cash.
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Transaction Analysis
Transaction (9): Softbyte receives $600 in cash from customers who
had been billed for services [in Transaction (6)].
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SO 7
Transaction Analysis
Transaction (10): Ray Neal withdraws $1,300 in cash from the business
for his personal use. Illustration 1- 8
Tabular summary of
Softbyte transactions
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SO 7
Financial Statements
Companies prepare four financial statements :
Owner’s Statement
Income Balance
Equity of Cash
Statement Sheet
Statement Flows
1- 1 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Question
Net income will result during a time period when:
● assets exceed liabilities.
● assets exceed revenues.
● expenses exceed revenues.
● revenues exceed expenses.
1- 1 SO 8 Understand the four financial statements and how they are prepared.
Net income is needed to determine the
Financial Statements ending balance in owner’s equity.
Illustration 1- 9
Financial statements and
their interrelationships
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The ending balance in owner’s equity is
Financial Statements needed in preparing the balance sheet
Illustration 1- 9
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The balance sheet and income statement are
Financial Statements needed to prepare statement of cash flows.
Illustration 1- 9
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Financial Statements
Statement of Cash Flows
Information for a specific period of time.
Answers the following:
● Where did cash come from?
● What was cash used for?
● What was the change in the cash balance?
1- 1 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Question
Which of the following financial statements is prepared as
of a specific date?
● Balance sheet.
● Income statement.
● Owner's equity statement.
● Statement of cash flows.
1- 1 SO 8 Understand the four financial statements and how they are prepared.
Accounting Career
APPENDIX1A Opportunities
Public Accounting Private Accounting
Careers in auditing, taxation, Careers in industry working in
and management consulting cost accounting, budgeting,
serving the general public. accounting information
systems, and taxation.
Government Forensic Accounting
Careers with the IRS, the FBI, Uses accounting, auditing,
the SEC, and in public and investigative skills to
colleges and universities. conduct investigations into
theft and fraud.
1- 1 SO 9 Explain the career opportunities in accounting.
Key Points
The more substantive definitions, using the IASB definitional
structure, are as follows.
● Assets. A resource controlled by the entity as a result of past
events and from which future economic benefits are expected
to flow to the entity.
● Liabilities. A present obligation of the entity arising from past
events, the settlement of which is expected to result in an
outflow from the entity of resources embodying economic
benefits. Liabilities may be legally enforceable via a contract
or law, but need not be, i.e., they can arise due to normal
business practice or customs.
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Key Points
The more substantive definitions, using the IASB definitional
structure, are as follows.
● Equity. A residual interest in the assets of the entity after
deducting all its liabilities.
● Income. Increases in economic benefits that result in
increases in equity (other than those related to contributions
from shareholders). Income includes both revenues (resulting
from ordinary activities) and gains.
● Expenses. Decreases in economic benefits that result in
decreases in equity (other than those related to distributions to
shareholders). Expenses includes losses that are not the result
of ordinary activities.
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