Accounting Principles

Thirteenth Edition
Weygandt Kimmel Kieso

Chapter 1

Accounting in Action
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
 Chapter 1

Accounting in Action
Chapter Outline
Learning Objectives
LO 1 Identify the activities and users associated with
accounting.
LO 2 Explain the building blocks of accounting: ethics,
principles, and assumptions.
LO 3 State the accounting equation, and define its
components.
LO 4 Analyze the effects of business transactions on the
accounting equation.
LO 5 Describe the four financial statements and how they
are prepared.
Copyright ©2019 John Wiley & Son, Inc. 3
What Is Accounting
Accounting is called the “language of business”
Accounting is measure and describe the results
of economic activities.
Decision makers need a clear understanding of
accounting terms and concepts if he or she is to
participate and communicate effectively in the
business community.

Copyright ©2018 John Wiley & Son, Inc. 4

The Purpose of Accounting
The basic purpose of accounting is to
provide decision makers with information
useful in making economic decisions.

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 Accounting Activities and Users
Accounting consists of three activities
1. Identification – Select economic events
(transactions)
2. Recording - Record, classify, and summarize
3. Communication
• Prepare accounting reports
• Analyze and interpret for users

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 Who Uses Accounting Data
Internal Users
• Finance - Is cash sufficient to pay dividends to
shareholders?
• Marketing – What price should Nokia charge for a cell
phone to maximize the company's net income?
• Human Resources – Can Toyota afford to give its
employees pay raises this year?
• Management - Which PepsiCo product line is the most
profitable? Should any product lines be eliminated?
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 Who Uses Accounting Data
External Users
• Investors
 Is Lenovo earning satisfactory income?
 How does Disney compare in size and profitability
with Time Warner?
• Creditors – Will Singapore Airlines be able to pay its
debts as they come due?

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Who Uses Accounting Data
• For those who are managing the business on a
day-to-day basis, special techniques have
been developed.
• This is called internal reporting or
management accounting.
 DO IT! 1 Basic Concepts
Indicate whether each of the statements is true or false. indicate
how to correct the statement.
1. The three steps in the accounting process are identification,
recording, and communication.
2. Bookkeeping encompasses all steps in the accounting process.
3. Accountants prepare, but do not interpret, financial reports.
4. The two most common types of external users are investors
and company officers.
5. Managerial accounting focuses on reports for internal users.

Solution: 1. True2. False 3. False 4. False 5.

True
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 The Building Blocks of Accounting
Ethics in Financial Reporting
• Financial scandals include: Satyam Computer Services (IND),
Toshiba (JPN), Pou Sheng International (HKG), Siwei (CHN),
and other companies
• Effective financial reporting depends on sound ethical
behavior

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 Ethics in Financial Reporting
Ethics are the standards of conduct by which one's
actions are judged as:
a. right or wrong
b. honest or dishonest
c. fair or not fair
d. all of these options

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 Generally Accepted Accounting
Principles
Standards that are generally accepted and universally
practiced.
These standards indicate how to report economic
events.
Standard-setting bodies:
a. Financial Accounting Standards Board (FASB)
b. International Accounting Standards Board (IASB)

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 Accounting Standards
IFRS Vs GAAP
IFRSs are determined by International Accounting
Standards Board (IASB)
The IASB is headquartered in London, with 15 board
members drawn from around the world.
However, Most companies in the United States follow
standards issued by the FASB, referred to as generally
accepted accounting principles (GAAP)

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 Accounting Standards
IFRS Vs GAAP
As markets become more global, and for
comparability issues, the two setting bodies made
efforts to reduce the differences between IFRS and
U.S. GAAP.
This process is referred to as convergence.

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 Assumptions
Monetary Unit Assumption
Include in accounting records only transaction data
that can be expressed in terms of money
Economic Entity Assumption
Activities of entity be kept separate and distinct
from activities of its owner and all other entities
 Proprietorship
Forms of Business
 Partnership Ownership
 Corporation
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 Forms of Business Ownership
Proprietorship Partnership Corporation
• Owned by one • Owned by two or • Ownership divided
person more persons into shares
• Owner is often • Often retail and • Separate legal
manager/operator service-type entity organized
businesses under state
• Owner receives any corporation law
profits, suffers any • Generally
losses, and is unlimited personal • Limited liability
personally liable for liability
all debts
• Partnership
agreement

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 Assumptions
A business organized as a separate legal entity under
authority corporation law having ownership divided
into shares of stock is a
a. proprietorship
b. partnership
c. corporation
d. sole proprietorship

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 DO IT! 2 Building Blocks of Accounting
Indicate whether each of the statements is true or false.
1. Convergence refers to efforts to reduce differences between
IFRS and U.S. GAAP.
2. The primary accounting standard-setting body headquartered
in London is the International Accounting Standards Board
(IASB).
3. The study of accounting will be useful only if a
student is interested in working for a profit-oriented
business firm.
Solution: 1. True2. True3. False

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 DO IT! 2 Building Blocks of Accounting
Indicate whether each of the statements is true or false.
4. A business owner’s personal expenses must be separated from
expenses of the business to comply with accounting’s economic
entity assumption.

Solution: 1. True2. True3. False 4. True

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The Accounting Equation

A = L + SE
(Assets) (Liabilities) (Stockholders’
Equity)

Economic Sources of Financing for Economic

Resources Resources
Liabilities: From Creditors
Stockholders’ Equity: From Stockholders

1-21
21
 The Accounting Equation
Assets = Liabilities + Owner's Equity

Basic Accounting Equation

Provides underlying framework for recording and
summarizing economic events
Assets are claimed by either creditors or owners
If a business is liquidated, claims of creditors must
be paid before ownership claims
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 The Accounting Equation
Assets = Liabilities + Owner's Equity

Assets
Resources a business owns
Provide future services or benefits
Cash, Supplies, Equipment, etc.

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 The Accounting Equation
Assets = Liabilities + Owner's Equity

Liabilities
Claims against assets (debts and obligations)
Creditors (party to whom money is owed)
Accounts Payable, Notes Payable, Salaries and Wages
Payable, etc.

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 The Accounting Equation
Assets = Liabilities + Owner's Equity

Owner’s Equity
Ownership claim on total assets
Referred to as residual equity
Investment by owners and revenues (+)
Drawings and expenses (-)

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 The Accounting Equation ILLUSTRATION 1.6
Expanded accounting equation

Equation Assets = Liabilities + Owner's Equity

Expanded Owner's Owner's
Equation Assets = Liabilities + Capital - Drawings + Revenues - Expenses

Increase in Owner’s Equity

Investment by Owner. Assets the owner puts into
the business
Revenues. Increases in assets or decreases in
liabilities resulting from sale of goods or
performance of services in normal course of
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 The Accounting Equation ILLUSTRATION 1.6
Expanded accounting equation

Equation Assets = Liabilities + Owner's Equity

Expanded Owner's Owner's
Equation Assets = Liabilities + Capital - Drawings + Revenues - Expenses

Decrease in Owner’s Equity

Drawings. A withdraw of cash or other assets for
personal use
Expenses. Cost of assets consumed or services used
in the process of earning revenue

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 DO IT! 3 Owner’s Equity Effects
Classify the following items as investment by owner, owner’s
drawings, revenues, or expenses. Then indicate whether each
item increases or decreases owner’s equity.
Effect
Classification on Equity
1. Rent Expense Expense Decrease
2. Service Revenue Revenue Increase
Owner’s
3. Drawings Decrease
Drawings
4. Salaries and Wages Expense Expense Decrease

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 Analyzing Business Transactions
Transactions are a business’s economic events recorded by
accountants.
a. May be external or internal
b. Not all activities represent transactions
c. Have a dual effect on the accounting equation

Analyze
Trial Adjusting
business Journalize Post
Balance Entries
transactions

Adjusted
Financial Closing Post-Closing
Trial
Balance Statements Entries Trial Balance

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Principles of Transaction
Analysis
Every transaction affects at least two accounts
(duality of effects).
The accounting equation must remain in
balance after each transaction.

A = L + SE
(Assets) (Liabilities) (Stockholders’
Equity)

1-30
30
 Transaction Analysis
Transaction 1. Ray Neal decides to start a smartphone app development
company which he names Softbyte. On September 1, 2020, he invests
€15,000 cash in the business. This transaction results in an equal increase
in assets and owner’s equity.

Assets Liabilities Owner’s Equity

Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€15,000 +€15,000
2
3

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 Transaction 2. Softbyte purchases computer equipment for €7,000 cash.

Assets Liabilities Owner’s Equity

Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€15,000 +€15,000
2 -7,000 +€7,000
3 +€1,600 +€1,600
4 +1,200 +€1,200
5 +250 -€250
6 +1,500 +€2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -€1,300
€ 8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 - €1,300 + €4,700 - €1,950

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 Transaction 3. Softbyte Inc. purchases for €1,600 headsets and other
accessories expected to last several months. The supplier allows Softbyte
to pay this bill in October.
Assets Liabilities Owner’s Equity
Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€15,000 +€15,000
2 -7,000 +€7,000
3 +€1,600 +€1,600
4 +1,200 +€1,200
5 +250 -€250
6 +1,500 +€2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -$1,300
€ 8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 - €1,300 + €4,700 - €1,950

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 Transaction 4. Softbyte receives €1,200 cash from customers for app
development services it has performed.

Assets Liabilities Owner’s Equity

Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€15,000 +€15,000
2 -7,000 +€7,000
3 +€1,600 +€1,600
4 +1,200 Service Revenue +€1,200
5 +250 -€250
6 +1,500 +€2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -€1,300
€ 8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 - €1,300 + €4,700 - €1,950

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 Transaction 5. Softbyte Inc. receives a bill for €250 from the Daily News
for advertising on its online website but postpones payment until a later
date.
Assets Liabilities Owner’s Equity
Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€15,000 +€15,000
2 -7,000 +€7,000
3 +€1,600 +€1,600
4 +1,200 +€1,200
5 +250 Advertising Expense -€250
6 +1,500 +€2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -€1,300
€ 8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 - €1,300 + €4,700 - €1,950

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 Transaction 6. Softbyte performs €3,500 of services. The company
receives cash of €1,500 from customers, and it bills the balance of €2,000
on account.
Assets Liabilities Owner’s Equity
Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€15,000 +€15,000
2 -7,000 +€7,000
3 +€1,600 +€1,600
4 +1,200 +€1,200
5 +250 -€250
6 +1,500 +€2,000 Service Revenue +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -€1,300
€ 8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 - €1,300 + €4,700 - €1,950

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 Transaction 7. Softbyte pays the following expenses in cash for
September: office rent €600, salaries and wages of employees €900, and
utilities €200.
Assets Liabilities Owner’s Equity
Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€15,000 +€15,000
2 -7,000 +€7,000
3 +€1,600 +€1,600
4 +1,200 +€1,200
5 +250 -€250
6 +1,500 +€2,000 +3,500
7 -600 Rent Expense -600
-900 Salaries and Wage Expense -900
-200 Utilities Expense -200
8 -250 -250
9 +600 -600
10 -1,300 -€1,300
€ 8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 - €1,300 + €4,700 - €1,950

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 Transaction 8. Softbyte pays its €250 Daily News bill in cash. The
company previously (in Transaction 5) recorded the bill as an increase in
Accounts Payable.
Assets Liabilities Owner’s Equity
Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€15,000 +€15,000
2 -7,000 +€7,000
3 +€1,600 +€1,600
4 +1,200 +€1,200
5 +250 -€250
6 +1,500 +€2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -€1,300
€ 8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 - €1,300 + €4,700 - €1,950

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 Transaction 9. Softbyte receives €600 in cash from customers who had
been billed for services (in Transaction 6).

Assets Liabilities Owner’s Equity

Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€15,000 +€15,000
2 -7,000 +€7,000
3 +€1,600 +€1,600
4 +1,200 +€1,200
5 +250 -€250
6 +1,500 +€2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -€1,300
€ 8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 - €1,300 + €4,700 - €1,950

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 Transaction 10. Ray Neal withdraws €1,300 in cash from the business for
his personal use.

Assets Liabilities Owner’s Equity

Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€15,000 +€15,000
2 -7,000 +€7,000
3 +€1,600 +€1,600
4 +1,200 +€1,200
5 +250 -$250
6 +1,500 +€2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -€1,300
€ 8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 - €1,300 + €4,700 - €1,950

€18,050 €18,050

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 Summary of Transactions
1. Each transaction analyzed in terms of effect on:
a. Three components of basic accounting
equation
• Assets
• Liabilities
• Owner’s equity
b. Specific types of items, such as Cash
2. Two sides of equation must always be equal

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 DO IT! 4 Tabular Analysis
Transactions made by Virmari SA, a public accounting firm, for the
month of August are shown below. Prepare a tabular analysis
which shows the effects of these transactions on the expanded
accounting equation, similar to that shown in Illustration 1.8.
1. The owner invested €25,000 cash in the business.
2. The company purchased €7,000 of office equipment on credit.
3. The company received €8,000 cash in exchange for services
performed.
4. The company paid €850 for this month’s rent.
5. The owner withdrew €1,000 cash for personal use.

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 DO IT! 4 Tabular Analysis
Transaction 1. The owner invested €25,000 cash in the
business.
Assets Liabilities Owner’s Equity
Accounts Owner's Owner's
No. Cash + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€25,000 +€25,000
2
3
4
5

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 DO IT! 4 Tabular Analysis
Transaction 2. The company purchased €7,000 of office
equipment on credit.
Assets Liabilities Owner’s Equity
Accounts Owner's Owner's
No. Cash + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€25,000 +€25,000
2 +€7,000 +€7,000
3
4
5

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 DO IT! 4 Tabular Analysis
Transaction 3. The company received €8,000 cash in
exchange for services performed.
Assets Liabilities Owner’s Equity
Accounts Owner's Owner's
No. Cash + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€25,000 +€25,000
2 +€7,000 +€7,000
3 +8,000 Service Revenue +€8,000
4
5

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 DO IT! 4 Tabular Analysis
Transaction 4. The company paid €850 for this month’s
rent.
Assets Liabilities Owner’s Equity
Accounts Owner's Owner's
No. Cash + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€25,000 +€25,000
2 +€7,000 +€7,000
3 +8,000 +€8,000
4 -850 Rent Expense -€850
5

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 DO IT! 4 Tabular Analysis
Transaction 5. The owner withdrew €1,000 cash for
personal use.
Assets Liabilities Owner’s Equity
Accounts Owner's Owner's
No. Cash + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€25,000 +€25,000
2 +€7,000 +€7,000
3 +8,000 +€8,000
4 -850 -€850
5 -1,000 -€1,000
€ 31,150 + €7,000 = €7,000 + €25,000 - €1,000 + €8,000 - €850

€38,150 €38,150

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 The Four Financial Statements
Companies prepare four financial statements:

Owner's Statement Statement

Income
Equity of Financial of Cash
Statement
Statement Position Flows

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 Financial Statements
Net income will result during a time period when:
a. assets exceed liabilities
b. assets exceed revenues
c. expenses exceed revenues
d. revenues exceed expenses

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 Income Statement
Financial Revenues €4,700

Statements Service revenue

Expenses
Salaries and wages expense 900
Softbyte Rent expense 600
Advertising expense 250
statements for Utilities expense 200
the Month Total expenses 1,950
Net income €2,750
Ended
September 30, Owner’s Equity Statement
2020 Owner’s capital, September 1 € 0
Add: Investments 15,000
Add: Net income 2,750
ILLUSTRATION 1.9
Financial statements and
Less: Drawings 1,300
their interrelationships Owner’s capital, September 30 $16,450

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 Owner’s Equity Statement

Financial Owner’s capital, September 1

Add: Investments
€ 0
15,000
Statements Add: Net income
Less: Drawings
2,750
1,300
Owner’s capital, September 30 €16,450
Softbyte
statements for Statement of Financial Position
Assets
the Month
Cash € 8,050
Ended Accounts receivable 1,400
September 30, Supplies 1,600
Equipment 7,000
2020 Total assets €18,050
Owner’s Equity and Liabilities
ILLUSTRATION 1.9
Accounts payable € 1,600
Financial statements and Owner’s capital 16,450
their interrelationships
Total owner’s equity and liabilities €18,050
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 Statement of Financial Position (partial)
Assets
Financial Cash
Accounts receivable
€ 8,050
1,400
Statements Supplies 1,600
Statement of Cash Flows
Softbyte Cash flows from operating activities
Cash receipts from revenues 3,300
statements for Cash payments from expenses (1,950)
the Month Net cash from operating activities 1,350
Cash flows from investing activities
Ended Purchase of equipment (7,000)
September 30, Cash flows from financing activities
Investments by owner 15,000
2020 Drawings by owner (1,300)
Net cash from financing activities 13,700
ILLUSTRATION 1.9
Net increase in cash 8,050
Financial statements and Cash at beginning of period 0
their interrelationships
Cash at end of period € 8,050
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 Income Statement
• Reports revenues and expenses for a specific period
of time
• Lists revenues first, followed by expenses
• Shows net income (or net loss)
• Does not include investment and withdrawal
transactions between owner and business in
measuring net income

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 Owner’s Equity Statement
• Reports changes in owner’s equity for a specific
period of time
• Time period is the same as that covered by the
income statement

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 Statement of Financial Position
• Reports assets, liabilities, and owner's equity at a
specific date
• Lists assets at top, followed by liabilities and owner’s
equity
• Total assets must equal total owner’s equity and
liabilities
• Snapshot of company’s financial condition at a
specific moment in time (usually month-end or year-
end)

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 Statement of Cash Flows
• Information on cash receipts and payments for a
specific period of time
• Answers the following:
 Where did cash come from?
 What was cash used for?
 What was change in cash balance?

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 Financial Statements
Which of the following financial statements is prepared as
of a specific date?
a. Statement of financial position
b. Income statement
c. Owner's equity statement
d. Statement of cash flows

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 DO IT! 5 Financial Statement Items
Presented below is selected information related to Li Fashions at
December 31, 2020. Li reports financial information monthly.
Equipment HK$10,000 Utilities Expense HK$4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000
a. Determine the total assets at December 31, 2020.
b. Determine the net income reported for December 2020.
c. Determine the owner’s equity at December 31, 2020.

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 DO IT! 5 Financial Statement Items
Li reports financial information monthly.
Equipment HK$10,000 Utilities Expense HK$4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000
a. Determine the total assets at December 31, 2020.

Cash $ 8,000
Accounts receivable 9,000
Equipment 10,000
Total assets $27,000

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 DO IT! 5 Financial Statement Items
Li reports financial information monthly.
Equipment HK$10,000 Utilities Expense HK$4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000
b. Determine the net income reported for December 2020.
Service revenue $36,000
Rent expense 11,000
Salaries and wages expense 7,000
Utilities expense 4,000
Net income $14,000

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 DO IT! 5 Financial Statement Items
Li reports financial information monthly.
Equipment HK$10,000 Utilities Expense HK$4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000
c. Determine the owner’s equity at December 31, 2020.

Total assets $27,000

Less: Notes payable expense 16,500
Less: Accounts payable 2,000
Owner’s equity $ 8,500

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Copyright
Copyright © 2019 John Wiley & Sons, Inc.
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