Weygandt Chap 01v2.qxd 10/25/01 10:32 pm Page b
▲
Concepts for Review
Before studying this chapter, you should understand or, if necessary, review:
a. How to use the study aids in this book. (Student Owner’s Manual, pp. vii-xvii)
b. How you learn best. (Student Owner’s Manual, pp. xix-xxi)
c. The student supplements that accompany this text. (Student Owner’s Manual,
p. xxii)
✔
THE
NAVIGATOR
The Navigator learning system encourages you to use the
learning aids in the chapter and
set priorities as you study.
The Feature Story helps you picture how the chapter topic relates to the real
world of accounting and business.You will find references to the story throughout
the chapter and in the “A Look Back at Our Feature Story” exercise toward the end
of the chapter.
Brewing Up
Success At The
Second Cup
TORONTO, Ont.—No organization
can hope to do a drop of business
without sound accounting information.
Take The Second Cup, for instance.
In 1975, Tom Culligan and Frank
O’Dea opened the original Second
Cup retail outlet at Scarborough Town
Centre, a large mall in eastern Toronto.
It sold only whole-bean coffee, but its
numbers were successful enough that
Culligan and O’Dea soon opened other
locations and began to sell brewed coffee and related merchandise.
By 1988, The Second Cup had
grown to 120 locations and was bought
by Toronto restaurant entrepreneur
Michael Bregman. In 1993, Bregman
incorporated The Second Cup Ltd.
Today, with its almost 400 locations
across the country,The Second Cup is
the largest specialty coffee retailer in
Canada. It has a major presence not
only in its franchised cafés but
through partnerships with companies
such as Kraft Canada, Air Canada,
Delta Hotels, and Cara Operations,
generating system-wide sales of over
$170 million in 2001.
Stop for a moment and think of all
the decisions that needed to be made
over 25 years for one small coffeebean store to grow this much.
To make these decisions,The Second Cup’s management, like that of
other companies, relied in large part
on accounting information. But management isn’t the only user of this
information.Most of The Second Cup’s
owners (shareholders) used the financial information in the annual report to
decide whether or not to invest in the
company. And this same information
was used by potential lenders (creditors) to know if a loan was a good risk.
It’s a warm summer evening. The
patio of the Danforth Avenue Second
Cup is bustling.Trendy young couples,
families with strollers, and business
people are among the patrons lingering
at the sidewalk tables over a cappuccino or an iced latté.The Second Cup
has come a long way since 1975, and
one can safely say that its accounting
information has been as much a part
of the company’s success as its brewed
coffee and coffee beans.
✔
www.secondcup.com
THE
NAVIGATOR
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THE NAVIGATOR
CHAPTER •
1
A CCOUNTING
✔
■
Understand Concepts for Review
■
Read Feature Story
■
Scan Study Objectives
■
Read Preview
■
Read text and answer Before You Go On
p. 9
p. 17
p. 23
p. 28
■
Work Demonstration Problem
■
Review Summary of Study Objectives
■
Answer Self-Study Questions
■
Complete assignments
IN ACTION
Study Objectives give you
a framework for learning the
specific concepts covered in
the chapter.
S T U DY O B J E C T I V E S After studying this chapter, you should be able to:
1. Explain what accounting is.
2. Identify the users and explain the uses of accounting.
3. Demonstrate an understanding of why ethics is a fundamental business concept.
4. Explain the meaning of generally accepted accounting principles and the cost principle.
5. Explain the meaning of the going concern, monetary unit, and economic entity
assumptions.
6. State and utilize the basic accounting equation and explain the meaning of
assets, liabilities, and owner’s equity.
7. Calculate the effect of business transactions on the basic accounting equation.
8. Understand what the four financial statements are and how they are prepared.
✔
THE
NAVIGATOR
1
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PREVIEW OF CHAPTER 1
The opening story about The Second Cup Ltd. highlights the importance of having
good financial information to make effective business decisions. Regardless of one’s
pursuits, the need for financial information is inescapable. You cannot earn a living,
spend money, buy on credit, make an investment, or pay taxes without receiving, using,
or giving financial information. Good decision-making depends on good information.
This chapter shows you that accounting is the system used to provide useful financial information. The chapter is organized as follows:
The Preview outlines
the major topics and
subtopics you will see in
the chapter.
ACCOUNTING
IN
ACTION
What Is
Accounting?
Who uses
accounting
information?
Brief history of
accounting
Distinguishing
between
bookkeeping and
accounting
Accounting and
you
The accounting
profession
✔
The Building Blocks
of Accounting
Ethics—a
fundamental
business concept
Generally accepted
accounting
principles
Assumptions
Basic accounting
equation
Using the
Building Blocks
Transaction
analysis
Summary of
transactions
Financial
statements
Using the
information in the
financial statements
THE
NAVIGATOR
What Is Accounting?
STUDY OBJECTIVE
1
Explain what accounting is.
Essential terms are printed
in blue when they first appear,
and are defined in the
end-of-chapter glossary.
Accounting is an information system that identifies, records, and communicates the
economic events of an organization to interested users. Economic events are activities related to the production and distribution of goods and services in an organization. Let’s take a closer look at these activities:
1. Identifying economic activities involves selecting those events that are
evidence of economic activity by a particular organization. The sale of coffee
by Second Cup, the delivery of telephone service by Bell Canada, and the payment of salaries by major league sports teams are examples of economic events.
2. Once identified, economic events are recorded to provide a history of the
financial activities of the organization. Recording consists of keeping a
systematic chronological diary of events measured in dollars and cents. In
recording, economic events are also classified and summarized.
3. This identification and recording of activities is only useful if the information is
communicated to interested users. The information is communicated through
accounting reports, the most common of which are called financial statements.
To make the financial information meaningful, accountants report the recorded
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What Is Accounting?
3
data in a standardized way. Information resulting from similar transactions is
accumulated and totalled. Because the transactions are grouped together, they
are said to be reported in aggregate.
For example, all sales transactions of Second Cup are accumulated over a certain
period of time and reported as one amount in its financial statements. By presenting
the recorded data in aggregate, the accounting process simplifies a multitude of transactions and makes a series of activities understandable and meaningful. This simplification can result in the loss of detail, though. The Second Cup’s financial statements
are highly condensed and some would argue that the presentation is oversimplified.
The Second Cup is not alone in this reporting practice, however. Most companies
report condensed information for simplicity, but also to avoid revealing significant
details to their competitors.
A vital part of communicating economic events is the accountant’s ability and
responsibility to analyse and interpret the reported information. Analysis involves
the use of ratios, percentages, graphs, and charts to highlight significant financial
trends and relationships. Interpretation involves explaining the uses, meaning, and
limitations of reported data.
The accounting process may be summarized as follows:
References throughout the chapter tie the accounting concepts
that you are learning to the story
that opened the chapter.
Illustration 1-1
Accounting process
Communication
Identification
SOFTBYTE
Recording
SOFTBYTE
Prepare accounting reports
CD-ROMs
Select economic events (transactions)
Record, classify, and summarize
TE rt
BY epo
FT l R
SOnnua
A
Analyse and interpret for users
Accounting must consider the needs of the users of financial information. Therefore, accountants need to know who these users are, and something about their needs
for information.
Who Uses Accounting Information?
Because it communicates financial information, accounting is often called the
language of business. The information a user of financial information needs depends
upon the kinds of decisions that user makes. The differences in the decisions divide the
users of financial information into two broad groups: internal users and external users.
Internal Users
Internal users of accounting information are those who plan, organize, and run a
business. These include marketing managers, production supervisors, finance directors, and company officers. In running a business, internal users must answer many
STUDY OBJECTIVE
2
Identify the users and
explain the uses of
accounting.
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CHAPTER 1
Accounting in Action
important questions, as shown in Illustration 1-2.
Questions Asked by Internal Users
BALL
MACHINE
BILL
COLLECTOR
Is cash sufficient to pay bills?
ST
Acme
Products
RIK
E
ST ON
RIK
E
What is the cost of manufacturing each unit of product?
r
fai es
Un ctic
a
r
P
Acme
Soccer Balls
Can we afford to give employee pay raises this year?
Illustration 1-2
Questions asked by internal
users
Acme
Products
Acme
Bowling Balls
Which product line is the most profitable?
To answer these and other questions, users need detailed information on a timely
basis. For internal users, accounting provides internal reports. Examples are financial
comparisons of operating alternatives, projections of earnings from new sales campaigns, and forecasts of cash needs for the next year.
External Users
External users are those who work for other organizations but who have an interest
in and need for information about the financial position and performance of the company. There are several types of external users of accounting information. Investors
(owners) use accounting information to make decisions to buy, hold, or sell their
shares. Creditors, such as suppliers and bankers, use accounting information to evaluate the risks of granting credit or lending money. Some questions that investors and
creditors may ask about a company are shown in Illustration 1-3.
The information needs and questions of other external users vary considerably.
Taxing authorities, such as the Canada Customs and Revenue Agency, want to know
whether the company respects the tax laws. Regulatory agencies, such as provincial
securities commissions, want to know whether the company is operating within prescribed rules. Customers are interested in whether a company will continue to honour product warranties and support its product lines. Labour unions want to know
whether the owners can pay increased wages and benefits. Economic planners use
accounting information to forecast economic activity.
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What Is Accounting?
Questions Asked by External Users
XYZ Tires
Yeah!
ABC Tires
Is the company earning satisfactory income?
How does the company compare in size
and profitability with competitors?
What do we do
if they catch us?
Will the company be able to pay its debts as they come due?
Illustration 1-3
Questions asked by external
users
Accounting in Action International Insight
When the chief engineer of Irkutsk Energo, a public utility in Moscow, addressed
a gathering of international investors, he provided them with all kinds of financial
information about the company.The reason? Russians desperately need foreign
investment. Foreign investors, in the past, had been reluctant to invest because
Russian firms were secretive—and sometimes deceptive—about their financial
affairs.Times change, and companies such as Irkutsk Energo are enjoying share price surges after
providing candid accounting information. Good accounting information may help Russia solve
some of its economic problems.
Source: Neela Banerjee,“Russian Concerns Find Glasnost Pays,” Wall Street Journal, June 9, 1995, A6.
Throughout this textbook, you will find Accounting in Action examples like this. These examples
illustrate important and interesting information from real accounting situations in business. Different icons highlight each type of issue: a globe, as here, for international insights, scales for ethics
insights, a lightbulb and city skyline for business insights, and an over the globe surrounded by
a gear wheel for e-business insights.
International Insight
Ethics Insight
Business Insight
-Business Insight
Brief History of Accounting
The origins of accounting are generally attributed to the work of Luca Pacioli, an
Italian Renaissance mathematician. Pacioli was a close friend and tutor to Leonardo
da Vinci. He was also a contemporary of Christopher Columbus. In his text Summa
de Arithmetica, Geometrica, Proportioni et Proportionalita, Pacioli described a system to
5
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CHAPTER 1
Accounting in Action
ensure that financial information was recorded efficiently and accurately.
With the beginning of the industrial age in the nineteenth century and, later, the
emergence of large corporations, a separation of the owners from the managers of
businesses took place. As a result, the need to report the financial status of the enterprise became more important to ensure that managers acted in the company’s (and
owners’) best interests. Also, transactions between businesses became more complex,
which made better approaches for reporting financial information necessary.
Our economy has now evolved into a post-industrial age—the information age—
in which information services are products. Globalization and the Internet have been
the drivers of the information age, and business now changes at a faster pace because
of them. Companies must remake themselves rapidly, and they are doing it by a
whole assortment of actions: rightsizing, worker empowerment, process reengineering, mergers, alliances, and novel financial instruments.
Responding to all these changes, accounting continues to adapt itself, reflecting
the types of financial information needed in today’s fast-paced business environment.
Distinguishing between Bookkeeping and Accounting
Many individuals mistakenly consider bookkeeping and accounting to be the same.
This confusion is understandable because the accounting process includes the bookkeeping function. However, accounting also includes much more. Bookkeeping usually involves only the recording of economic events. It is therefore just one part of the
accounting process. Accounting, however, involves the entire process of identifying,
recording, and communicating economic events. Accounting requires a higher level
of expertise and judgement than bookkeeping, because economic events must be
identified and measured, effectively communicated, and then interpreted meaningfully to help users in their decision-making.
Thanks to computers, much of the detail work that is part of the bookkeeping
process is now performed electronically, rather than manually. Businesses of all sizes
are finding that computers have made the entire recording process more efficient.
However, you will need to know the procedures used in a manual accounting system
in order to understand the operations a computer performs.
Now that you know the difference between bookkeeping and accounting, you
should also know that accounting may be further divided into financial accounting
and managerial accounting. Financial accounting is the field of accounting that provides economic and financial information for investors, creditors, and other external
users. Managerial accounting provides economic and financial information for managers and other internal users. Financial accounting is the focus of this text.
Accounting and You
One question frequently asked by students of accounting is, “How will the study of
accounting help me?” It should help you a great deal, because a working knowledge
of accounting is desirable for virtually every field of endeavour. Some examples of
how accounting is used in other careers include:
General management.—Imagine running Bombardier, the Toronto Hospital
for Sick Children, a Second Cup franchise, or the Vancouver Canucks. You
would need to understand accounting data in order to make wise business
decisions.
Finance.—Do you want to be a banker, an investment analyst, or a stock broker? These fields rely heavily on accounting. In all of them, you will regularly examine financial statements to understand the financial standing of
your customer. It is difficult to get a good job in finance without an adequate
foundation in accounting.
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What Is Accounting?
7
Marketing.—Marketing specialists use their knowledge and understanding of
consumers and competition to develop strategies that help an organization
meet its performance objectives. Whether the organization has a profit or a
social objective, its marketing specialists must be sensitive to costs and benefits. Accounting helps them quantify and understand these costs and benefits.
Information technology.—Accounting is an information business. Knowing
how to create, communicate, understand, and act upon accounting information will help you cope with information technology and e-commerce. Your
career may include the preparation, selection, or implementation of financial
software. You could specialize in hardware, databases, telecommunications,
or office productivity tools and project management. More Canadians now
work in the information technology industry than in banking, mining,
forestry, or automobile assembly.
Accounting in Action -Business Insight
E-business involves much more than simply selling goods over the Internet.
According to Lou Gerstner, IBM’s CEO, “e-business is all about cycle time, speed,
globalization, enhanced productivity, reaching new customers, and sharing knowledge across institutions for competitive advantage.” Many accountants are
involved in designing and implementing computer systems, including systems for
e-business. In fact, e-business consulting has been one of the greatest growth areas for large
accounting firms.
Accounting is even useful for occupations you might think completely unrelated,
such as doctor, lawyer, social worker, teacher, engineer, architect, or entrepreneur.
For your more personal needs, a knowledge of accounting will help you prepare a
household budget, decide whether to borrow money to purchase a car, judge how
quickly you can afford to repay your student loan, determine how to invest your
savings, and plan for retirement. For almost any endeavour, you will find that a
working knowledge of accounting is relevant.
The Accounting Profession
There are three primary organizations that provide precertification professional
accounting education and experience. You may choose to become a chartered accountant (CA) with the Canadian Institute of Chartered Accountants, a certified general
accountant (CGA) with the Canadian Certified General Accountants Association, or
a certified management accountant (CMA) with the Society of Management Accountants of Canada. Large numbers of these professional accountants apply their expertise in three major fields: public accounting, managerial accounting, and not-for-profit
accounting. If you would like to communicate with one or more of these organizations
and learn about their programs of study, the Weygandt website includes addresses
and hotlinks for these three bodies. It also includes other Internet business sites of
interest to students.
Public Accounting
In public accounting, you offer services to the general public in much the same way
as a doctor attends patients and a lawyer serves clients. A major portion of public
accounting involves auditing. In this area, a qualified professional accountant examines information and expresses an opinion as to whether or not it fairly reflects the
Careers in Accounting
This CD Icon informs you of
additional resources available on
the CD that came with your
text.
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CHAPTER 1
Accounting in Action
economic events that occurred during the accounting period. Audited financial statements are examined to determine whether they are fairly presented in accordance
with an appropriate disclosed basis of accounting, which is normally generally
accepted accounting principles. In the opening story, audited financial statements
would be required by Second Cup’s investors and creditors before they decide whether
or not to invest in the company or loan money to it.
Taxation is another major area of public accounting. The work performed by tax
specialists includes tax advice and planning, preparing tax returns, accounting for
Provincial Sales Tax (PST) and Goods and Services Tax (GST) or Harmonized Sales
Tax (HST), and representing clients before government agencies such as the Canada
Customs and Revenue Agency.
A third area in public accounting is business advisory services. Business advisory
services range all the way from the installation of basic computerized accounting systems, to helping small businesses plan for succession, to managing human resources
and executive remuneration, to advising on acquisitions and dispositions.
In Canada, the top five public accounting firms are KPMG, Deloitte & Touche,
Ernst & Young, PricewaterhouseCoopers, and Grant Thornton.
Private Accounting
Instead of working in public accounting, you might choose to work in private
accounting, also known as managerial accounting. Working as an employee of a business enterprise, you might be involved in one or more of the following activities:
1. General accounting. Recording daily transactions and preparing financial statements and related information.
2. Cost accounting. Determining the cost of producing specific products.
3. Budgeting. Helping management quantify goals concerning revenues, costs of
goods sold, and operating expenses.
4. Accounting information systems. Designing both manual and computerized
accounting information systems.
5. Income tax accounting. Preparing tax returns and doing tax planning for the
company.
6. Internal auditing. Reviewing the company’s operations to evaluate their compliance with management policies and efficiency.
You can see that in certain companies, private accountants can perform as wide a
variety of duties as public accountants.
Not-for-Profit Accounting
Like businesses that exist to make a profit, not-for-profit organizations also need
sound financial reporting and control. To decide whether they should continue supporting such organizations and events as the United Way, the Red Cross, and the
CIBC Run for the Cure, donors want information about how well the organization or
event has met its financial objectives. Hospitals, colleges, and universities must also
make decisions about allocating funds and reporting financial decisions. Municipal,
provincial, and federal government units provide financial information to legislators,
citizens, employees, and creditors.
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The Building Blocks of Accounting
9
Accounting in Action International Insight
Volunteer auditors each donated a minimum of 10 days evaluating processes,
devising warehousing procedures, ensuring safety, and monitoring the cash operations of such things as food stands, parking lots, and ticket sales at the Sydney
2000 Olympic Summer Games.The volunteers spent most of their time verifying
if users were licensed to rent the Olympic logo—the most protected trademark
in the world. For these Games, the price of becoming an Olympic sponsor and using the five rings
on company products cost anywhere from $10 million to $40 million. If companies had been
allowed to use the trademark without permission, millions of dollars would have been lost for
the International Olympic Committee (IOC). The IOC estimates that sponsorship revenues
account for about one-third of its total revenues, second only to revenue from television rights.
Before You Go On . . .
Review It
1.
2.
3.
4.
What is accounting?
Who uses accounting information?
What is the difference between bookkeeping and accounting?
How will you be able to use your accounting knowledge?
Related exercise material: BE1–1.
Before You Go On questions at
the end of major text sections offer
an opportunity to stop and reexamine the key points you have
studied. Related exercise material
directs you to Brief
Exercises (BE) and
Exercises (E) with simiTHE
NAVIGATOR lar study objectives.
✔
The Building Blocks of Accounting
Every profession develops a body of theory that consists of principles and assumptions. Accounting is no exception. Just as a doctor follows certain standards to treat a
patient’s illness, an accountant follows certain standards to report financial information. For these standards to work, a fundamental business concept is followed—ethical behaviour.
Ethics—A Fundamental Business Concept
Wherever you make your career—accounting, marketing, management, finance, government, or elsewhere—your behaviour and actions will affect other people and organizations. The standards of conduct by which one’s actions are judged as right or
wrong, honest or dishonest, fair or unfair, are ethics. Imagine trying to carry on a
business or invest money if you could not trust the individuals you dealt with. If
managers, customers, investors, co-workers, and creditors all consistently misled you,
effective communication and economic activity would be impossible. Information
would have no credibility.
Fortunately, most individuals in business are ethical. Their actions are both legal
and responsible. The organization’s interests are considered when they make decisions. However, in some situations, public officials, business executives, and respected
leaders act unethically and sometimes even illegally. For example, MLAs have been
convicted for falsifying expense accounts, a former mutual fund manager was
indicted for insider trading, a military leader resigned due to an unaccountable
absence of cash in his budget, and executives have been dismissed and sent to jail for
violating environmental legislation.
The three professional accounting bodies described earlier have extensive rules
of conduct to guide the behaviour of their members with each other and the public.
STUDY OBJECTIVE
3
Demonstrate an understanding of why ethics is
a fundamental business
concept.
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Accounting in Action
Many companies today have also adopted codes of conduct that outline their commitment to ethical behaviour in internal and external relationships.
Accounting in Action Ethics Insight
Canadian business is recognized around the world as being ethically, socially and
environmentally responsible. An International Code of Ethics for Canadian Business was adopted in 1997 by a group of companies wanting to demonstrate their
commitment to ethical business practices. It has been endorsed by the Minister
of Foreign Affairs and most of Canada’s leading business associations.
In adopting this Code, companies commit to doing business around the world in the same
way they do business in Canada.The following is a relevant excerpt from the Code:
“Concerning business conduct, we will:
• Not make illegal and improper payments and bribes and will refrain from participating in any
corrupt business practices.
• Comply with all applicable laws and conduct business activities in a transparent fashion.
• Ensure contractors’, suppliers’ and agents’ activities are consistent with these principles.”
Illustration 1-4
Steps used to analyse ethical
dilemmas
To sensitize you to ethical situations and to give you practice at solving ethical
dilemmas, we have included three types of ethics materials: (1) marginal notes that
provide helpful hints for developing ethical sensitivity, (2) ethics in accounting boxes
that highlight ethical situations and issues, and (3) in the end-of-chapter material, an
ethics case that simulates a business situation. When you analyse these ethical situations, you should apply the steps outlined in Illustration 1-4.
Solving an Ethical Dilemma
1. Recognize an ethical
situation and the ethical
issues involved.
Use your personal ethics or an
organization’s code of ethics to
identify ethical situations and
issues.
2. Identify and analyse
the principal elements
in the situation.
Identify the stakeholders—
persons or groups who may
be harmed or benefited. Ask
the question: What are the
responsibilities and obligations
of the parties involved?
3. Identify the alternatives,
and weigh the impact of
each alternative on various
stakeholders.
Select the most ethical
alternative, considering all the
consequences. Sometimes there
will be one right answer. Other
situations involve more than
one possible solution. These
situations require an evaluation
of each and a selection of the
best alternative.
#1
#2
ALT
ALT
Generally Accepted Accounting Principles
STUDY OBJECTIVE
4
Explain the meaning of
generally accepted
accounting principles
and the cost principle.
The accounting profession has developed a set of standards that are generally
accepted and universally practised. This common set of standards is called generally
accepted accounting principles (GAAP). These standards—developed over time in
response to tradition, experience, and user needs—recommend how to report economic events.
The Canadian Institute of Chartered Accountants (CICA) has the primary responsibility for the development and issuance of generally accepted accounting principles
in Canada. GAAP, as published in the CICA Handbook, has legal status for companies
that adhere to the regulations of the Canada Business Corporations Act and the provincial
securities commissions. It is important to understand that standards are not static. They
should, and do, change over time to ensure that their primary purpose—the provision
of information that is relevant to decision-making—continues to be met.
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The Building Blocks of Accounting
Internationally, accounting standards can vary from country to country. Most
countries have their own standard-setting body. One group, the International
Accounting Standards Board, has been working to reduce the differences in accounting practices across countries. This, in turn, improves the ability of investors, creditors, and others to make informed resource allocation and policy decisions.
Accounting in Action International Insight
Canada is teeming with foreign culture and products—Microsoft, Samsung,WalMart,The Gap,McDonald’s,NIKE,and Toyota,just to name a few.Foreign-controlled
companies—mostly American,some from Britain and Japan—accounted for 31.5%
of the $1.3 trillion in corporate revenue generated in Canada in a recent year.
Canadians have also become more global. More than 220 Canadian companies are listed on at least one stock exchange outside of Canada. Canadian companies are
expanding foreign operations, selling to foreign interests, and merging with companies located
in other countries to better compete in the global marketplace.
What does this mean to the users of financial information? One must understand not only
the differences in reporting requirements, but also important economic, legal, political, and cultural issues before well-informed business decisions can be made.
We need to have a good understanding of generally accepted accounting principles in order to prepare and understand accounting information. Many generally
accepted accounting principles will be introduced as you progress through the text.
In this chapter, we learn about the cost principle. In later chapters, we will introduce
the revenue recognition principle (Chapter 3), the matching principle (Chapter 3),
and the full disclosure principle (Chapter 12). Chapter 12 explores these principles,
and the underlying assumptions and constraints of accounting, in greater detail.
One of the basic principles is the cost principle. This principle states that assets
should be recorded at their original historical cost. Cost is the value exchanged at the
time something is acquired. If you buy a house today, the cost is the amount you pay
for it, say $125,000. If the house is appraised in two years at $130,000, the appraised
amount is its fair market value—the value determined by the market for homes at that
time. At the time of acquisition, cost and fair market value are the same. In later periods,
cost and fair market value may vary, but the cost amount continues to be used.
To see the importance of the cost principle, consider the following example. At
one time, Greyhound had 128 bus stations throughout North America with a cost of
approximately $200 million. The current market value of the stations is approximately
$1 billion. Under the cost principle, the bus stations are recorded and reported at $200
million, not $1 billion. Until the bus stations are actually sold, estimates of market
values are too subjective.
As the Greyhound example indicates, cost has an important advantage over other
valuations. It is reliable. Cost is definite and verifiable. The values exchanged at the
time something is acquired can be objectively measured. Users can rely on the information supplied as they know it is based on fact. However, critics argue that cost is
often not relevant. They believe market values provide more useful information.
Despite its shortcomings, cost continues to be used in financial statements because of
its reliability.
Assumptions
In developing generally accepted accounting principles, certain basic assumptions
are made. These assumptions provide a foundation for the accounting process. One
assumption that underlies the cost principle is the going concern assumption. Two
11
International note
The standard-setting processes
in Canada, Mexico, and the
United States are quite similar in
most respects.All three have
relatively open deliberations on
new rules, and they support
efforts to harmonize international standards.
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CHAPTER 1
Accounting in Action
other important assumptions are the monetary unit assumption and the economic
entity assumption.
Going Concern Assumption
STUDY OBJECTIVE
5
Explain the meaning of
the going concern,
monetary unit, and
economic entity
assumptions.
Implicit in the decision to record Greyhound’s bus stations at cost, rather than at market, is the going concern assumption. Going concern assumes the firm will continue
to operate in the foreseeable future. In spite of numerous business failures, companies
have a fairly high continuance rate (they stay in business year after year).
Historical cost is the most appropriate value at which to record assets such as
Greyhound’s bus stations because the stations were acquired for use in the business,
rather than for resale. What has relevance to the company is the amount they gave up
to acquire these assets, not an estimate of their current worth. The going concern
assumption presumes that the company will operate long enough to utilize these
assets for their intended purpose and to fulfill its commitments. The going concern
assumption and cost principle are modified if the company is expected to discontinue operations. In such cases, the lower of the cost and estimated market value is
used as the most relevant value for decision-makers.
Monetary Unit Assumption
The monetary unit assumption requires that only transaction data that can be
expressed in terms of money be included in the accounting records. This assumption
enables accounting to quantify (measure) economic events. In Canada, we use the
dollar to record these transactions. In Europe, the Euro is used. In Japan, the yen is
used.
This assumption does prevent some relevant information from being included
in the accounting records. For example, the health of the owner, the quality of service, and the morale of employees would not be included because they cannot be
quantified in terms of money.
An important part of the monetary unit assumption is the added assumption
that the unit of measure remains sufficiently constant over time. In other words,
inflation (a rise in prices) or deflation (a drop in prices) is ignored when adding, subtracting, or comparing dollars of different years. Assume a company purchases land
in 1962 for $100,000 and that land in a similar location and of the same size cost
$400,000 in 2002, 40 years later. If a second lot of land were purchased in 2002, the
land account for the company would show a total cost of land of $500,000. The fact
that these dollars had different value (or purchasing power) throughout the years is
overlooked. Although inflation was once a significant accounting issue, for the last
five years, inflation has averaged less than 2.5%. Inflation is considered a non-issue
for accounting purposes in Canada.
Economic Entity Assumption
An economic entity can be any organization or unit in society. It may be a business enterprise (such as Bombardier), a governmental unit (such as the Province of
Alberta), a municipality (such as the City of Toronto), a native band council (such
as the Kingsclear Indian Band), a school board (such as the Burnaby School Board),
a curling championship event (such as the Labatt’s Brier), or a club (such as the
Hamilton Rotary Club). The economic entity assumption requires that the activities of the entity be kept separate and distinct from the activities of its owner, and
all other economic entities.
To illustrate, if Ellen Gélinas, owner of Ellen’s Boutique, charges any of her personal living costs as expenses of the Boutique, then the economic entity assumption
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 13
The Building Blocks of Accounting
13
is violated. Similarly, the economic entity assumption assumes that the activities of
Second Cup and Swiss Chalet, both owned by Cara Operations, can each be segregated into separate economic entities for accounting purposes.
Accounting in Action Ethics Insight
A violation of the economic entity assumption contributed to the incarceration
of Bruce McNall, former co-owner of the Toronto Argonauts football team, Los
Angeles Kings hockey team, and other interests in the entertainment and sports
world. Creditors and investors were angered to learn that company invoices,
inventories, other assets, and income tax returns were falsified to help support
McNall’s $300,000-a-month glamorous personal lifestyle that included a Maserati, a Rolls-Royce,
and an Aston Martin.
The economic entity assumption is generally discussed regarding a business
enterprise, which may be organized as a proprietorship, partnership, or corporation.
Proprietorship.—A business owned by one person is a proprietorship. The owner is
generally the operator of the business. Small service businesses (hair stylists, service
stations, and bookkeepers), farms, and small retail stores (antique shops, corner grocery stores, and book stores) are often proprietorships. Usually only a relatively small
amount of money (capital) is necessary to start in business as a proprietorship. The
owner (the proprietor) receives any profits, suffers any losses, and is personally liable
for all debts of the business. There is no legal distinction between the business as an
economic unit and the owner. However, the records of the business activities are kept
separate from the personal records and activities of the owner, in accordance with
the economic entity assumption. Proprietorships represent the largest number of businesses in Canada, yet they are typically the smallest in size.
Partnership.—A business owned by two or more persons associated as partners is
a partnership. In most aspects, a partnership is similar to a proprietorship, except
that more than one owner is involved. Typically, a partnership agreement (written
or oral) defines such terms as initial investments, duties of each partner, division of
net income (or net loss), and settlement to be made upon death or withdrawal of a
partner. Each partner generally has unlimited personal liability for all debts of the
partnership, regardless of which partner created the debt. Similar to an owner in a
proprietorship, a partner’s personal assets may be sold to repay the partnership
debt. Like a proprietorship, the partnership activities must be kept separate from
the personal activities of the partners for accounting purposes. Partnerships are
often used to organize service-type businesses, including professional practices
(lawyers, doctors, architects, and accountants).
Corporation.—A business that is organized as a separate legal entity under federal
or provincial corporation law is a corporation. Its ownership is divided into transferable shares. The owners of the shares (shareholders) enjoy limited liability. They
are not personally liable for the debts of the corporate entity. Shareholders may sell
all or part of their shares to other investors at any time. Easy changes of ownership
add to the attractiveness of investing in a corporation. Because ownership can be
transferred without dissolving the corporation, the corporation enjoys an unlimited
life.
Although the combined number of proprietorships and partnerships in Canada
is more than the number of corporations, the revenue produced by corporations is far
greater. Most of the largest enterprises in Canada—for example, Bell Canada, Ford
Motor Company of Canada, George Weston, Nortel Networks, Alcan Aluminium,
and Loblaw—are corporations. The annual revenue of each of these corporations
Helpful hint—Principles and
assumptions will be discussed
throughout the text.Those discussed so far are shown in bold:
Principles
Cost
Revenue recognition
Matching
Full disclosure
Assumptions
Going concern
Monetary unit
Economic entity
Time period
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14
CHAPTER 1
Accounting in Action
ranges from $7 billion to $22 billion. These corporations are publicly traded. That is,
their shares are listed on Canadian stock exchanges. Public corporations commonly
distribute their financial statements to shareholders, creditors, other interested parties,
and the general public upon request.
Other companies are private corporations, which do not issue publicly traded
shares. Some of the largest private companies in Canada include McCain Foods, Irving Oil, the West Edmonton Mall, and Palliser Furniture. Along with proprietorships
and partnerships, these companies seldom distribute their financial statements publicly.
Basic Accounting Equation
STUDY OBJECTIVE
6
State and utilize the
basic accounting equation and explain the
meaning of assets, liabilities, and owner’s equity.
Other essential building blocks of accounting are the categories into which economic
events are classified. The two basic elements of a business are what it owns and what
it owes. Assets are the resources owned by a business. The Second Cup has total
assets of approximately $18.6 million. Liabilities and owner’s equity are the rights
or claims against these resources. Claims of those to whom money or other obligations
are owed (creditors) are called liabilities. Claims of owners are called owner’s equity.
The Second Cup has liabilities of $16.9 million and owner’s equity of $1.7 million.
This relationship of assets, liabilities, and owner’s equity can be expressed as an equation as follows:
Illustration 1-5
The basic accounting
equation
Accounting Cycle
Tutorial—Analysing
Business Transactions
Assets
=
Liabilities
+
Owner’s Equity
$18.6 million
=
$16.9 million
+
$1.7 million
This equation is referred to as the basic accounting equation. Assets must equal
the sum of liabilities and owner’s equity. Because creditors’ claims are paid before
ownership claims if a business is liquidated, liabilities are shown before owner’s
equity in the basic accounting equation.
The accounting equation applies to all economic entities regardless of size, nature
of business, or form of business organization. It applies to a small proprietorship such
as a corner grocery store as much as it does to a large corporation such as Second
Cup. The equation provides the underlying framework for recording and summarizing the economic events of a business enterprise.
Let’s look at the categories in the basic accounting equation in more detail.
Assets
As noted earlier, assets are the resources owned by a business. They are used to carry
out activities such as the production and distribution of merchandise. Every asset has
the capacity to provide future services or benefits. In a business enterprise, that service potential or future economic benefit eventually results in cash inflows (receipts)
to the enterprise.
For example, Campus Pizza owns a delivery truck that provides economic benefits because it is used to deliver pizzas. Other assets of Campus Pizza are tables, chairs,
a CD player, a cash register, an oven, dishes, silverware, inventory, supplies, and, of
course, cash.
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The Building Blocks of Accounting
Liabilities
Liabilities are claims against assets. That is, liabilities are existing debts and obligations. For example, businesses of all sizes usually borrow money and purchase merchandise inventory and supplies on credit. Campus Pizza, for instance, purchases
pizza ingredients and beverages on credit from suppliers. These obligations are called
accounts payable. Campus Pizza also has a note payable to the Bank of Montreal for
the money borrowed to purchase its delivery truck. Campus Pizza may also have
wages payable to employees, GST payable and PST payable to the federal and provincial governments, and property taxes payable to the municipality. All of these persons
or entities to which Campus Pizza owes money are called its creditors.
A creditor who is not paid may legally force the liquidation of a business. In that
case, the law requires that creditor claims be paid before ownership claims.
Owner’s Equity
The ownership claim on total assets is known as owner’s equity. It is equal to total
assets minus total liabilities. To find out what belongs to owners, we subtract creditors’ claims (the liabilities) from assets. The remainder—owner’s equity—is the
owner’s claim on the assets of the business. Since the claims of creditors must be paid
before ownership claims, the owner’s equity is often called residual equity. If the
equity is negative—that is, if total liabilities exceed total assets—the term owner’s
deficiency (or deficit) describes the shortage.
Increases in Owner’s Equity.—In a proprietorship, owner’s equity is increased by
owner’s investments and revenues.
Investments by Owner.—Investments by owner are the assets the owner puts into
the business. Investments may be in the form of cash or capital assets (e.g., vehicle,
computer) that are contributed by the owner.
Revenues.—Revenues result from business activities performed to earn income. Generally, revenues result from the sale of merchandise inventory, the performance of
services, the rental of property, and the lending of money.
Revenues normally result in an increase in an asset and an increase in owner’s
equity. They may arise from different sources and are identified by various names,
depending on the nature of the business. Campus Pizza, for instance, has two categories of sales revenues—pizza sales and beverage sales. Common sources of revenue include sales, fees, services, commissions, and rent.
Decreases in Owner’s Equity.—In a proprietorship, owner’s equity is decreased by
owner’s drawings and expenses.
Drawings.—An owner may withdraw cash (or other assets) for personal use. These
withdrawals could be recorded as a direct decrease of owner’s equity. It is generally
considered preferable to use a separate classification called drawings so the total withdrawals for the accounting period can be determined.
Expenses.—Expenses are the costs of assets consumed or services used in the process of
earning revenue. They are decreases in owner’s equity that result from operating the
business. Like revenues, expenses take many forms and are identified by various names,
depending on the type of asset consumed or service used. For example, Campus Pizza
recognizes (records) the following expenses: cost of ingredients (meat, flour, cheese,
tomato paste, mushrooms, etc.), cost of beverages, wages expense, utility expense (electric, gas, and water expense), telephone expense, delivery expense (gasoline, repairs,
licences, etc.), supplies expense (napkins, detergents, aprons, etc.), rent expense, insurance expense, interest expense, and property tax expense.
In summary, the principal sources (increases) of owner’s equity are (1) investments
15
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16
CHAPTER 1
Accounting in Action
by the owner, and (2) revenues. Decreases in owner’s equity are a result of (1) withdrawals of assets by the owner, and (2) expenses.
These relationships are shown in Illustration 1-6.
Illustration 1-6
Increases and decreases in
owner’s equity
INCREASE
DECREASE
Investments by owner
Withdrawals by owner
Owner’s Equity
Revenues
Expenses
Net income results when revenues exceed expenses. Conversely, a net loss occurs
when expenses exceed revenues. For information purposes, the components of
owner’s equity—investments by the owner, revenues, withdrawals, and expenses—
are separately identified for the reporting period.
Accounting Equation Distinctions by Type of Business Organization
Previously, you were introduced to the three forms of business organizations—proprietorship, partnership, and corporation. In the early chapters of this text, we focus
primarily on the proprietorship form of organization. Partnerships will be discussed
in more detail in Chapter 13, and corporations in Chapter 14. Until that time, you
need only a general understanding of the accounting distinctions between these types
of organization. Accounting for assets, liabilities, revenues, and expenses is the same,
regardless of the form of business organization. The primary distinction between the
forms of organization is found in (1) the terminology used to name the equity section,
and (2) the accounting and reporting of the owner’s investments and withdrawals.
In a proprietorship, the company is owned by one person and the equity is
termed owner’s equity. In a partnership, reflective of the two or more owners, the
equity is termed partners’ equity. In the corporate form of business organization, the
owners are the shareholders and the equity is called shareholders’ equity. In an earlier example, when the assets, liabilities, and equity were reported for The Second
Cup, the equity was identified as owner’s equity for simplicity. Technically, since The
Second Cup is a corporation, this equity should have been called shareholders’ equity.
You have learned that in a proprietorship, owner’s equity is increased by owner’s
investments and revenues, and decreased by owner’s drawings and expenses. In a
partnership, each partner’s equity is similarly increased by the investments of the
partner and their proportionate share of partnership revenues, and decreased by the
drawings of each partner and their proportionate share of partnership expenses. In
both proprietorships and partnerships, equity is reported for each owner in a oneline capital account.
It is not practical to do this for a corporation, where thousands of owners may
exist. In a corporation, the investments by the shareholders (owners) are made by
purchasing shares. These investments are aggregated and called share capital. They
are the first portion of shareholders’ equity. The second portion of shareholders’
equity is reported as retained earnings. Retained earnings represent the accumulated
earnings of the company that have been retained (i.e., not paid out to shareholders).
Payments to the shareholders are called dividends. Illustration 1-7 shows how equity
is reported for each different type of business organization.
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Using the Building Blocks
Proprietorship
Owner’s equity:
V. Buré, capital
Partnership
$50,000
Partners’ equity:
M. Wu, capital
A. Scholten, capital
Total partners’ equity
17
Corporation
$ 75,000
75,000
$150,000
Shareholders’ equity:
Share capital
$500,000
Retained earnings
350,000
Total shareholders’ equity $850,000
Before You Go On . . .
Review It
1.
2.
3.
4.
5.
6.
Illustration 1-7
Reporting equity by type of
business organization
Why is ethics a fundamental business concept?
What are generally accepted accounting principles? Give an example.
Explain the going concern, monetary unit, and economic entity assumptions.
What is the basic accounting equation?
What are assets, liabilities, and owner’s equity?
Distinguish the types of equity for each form of business organization.
Do It
Classify the following items as investment by owner (I), owner’s drawings (D), revenues (R), or
expenses (E), and indicate whether these items increase or decrease owner’s equity: (1) Rent
Expense, (2) Service Revenue, (3) Drawings, and (4) Salaries Expense.
Action Plan
• Review the rules for changes in owner’s equity: Investments and revenue increase owner’s
equity. Expenses and drawings decrease owner’s equity.
• Understand the sources of revenue: the sale of merchandise, performance of services, rental
of property, and lending of money.
• Understand what causes expenses: the consumption or use of assets or services.
• Recognize that drawings are withdrawals of cash or other assets from the business for personal
use.
Solution
1.
2.
3.
4.
Rent Expense is classified as an expense (E). It decreases owner’s equity.
Service Revenue is classified as revenue (R). It increases owner’s equity.
Drawings are classified as owner’s drawings (D). The decrease owner’s equity.
Salaries Expense is classified as an expense (E). It decreases owner’s equity.
Related exercise material: BE1–2, BE1–3, BE1–4, BE1–5, E1–1, E1–2, E1–3, and E1–4.
✔
THE
NAVIGATOR
Using the Building Blocks
Transactions are the economic events of an enterprise that are recorded. Transactions
may be external or internal. External transactions involve economic events between
the company and some outside party. For example, the purchase of cooking equipment by Campus Pizza from a supplier, the payment of monthly rent to the landlord,
and the sale of pizzas to customers are all external transactions. Internal transactions
are economic events that occur entirely within one company. The use of cooking
and cleaning supplies is an internal transaction for Campus Pizza.
A company may carry on many activities that do not in themselves represent
business transactions. Hiring employees, answering the telephone, talking with customers, and placing an order for merchandise with a supplier are examples. Some of
these activities, however, may lead to a business transaction. Employees will earn
STUDY OBJECTIVE
7
Calculate the effect of
business transactions on
the basic accounting
equation.
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CHAPTER 1
Accounting in Action
salaries, and merchandise will be delivered by the supplier. Each transaction must be
analysed for its effect upon the components of the basic accounting equation and
recorded in the accounting process. This analysis must identify the specific items
affected and the amount of change in each item.
Events
Ch
equ
e
CANADA
POST
Purchase computer
Criterion
Answer telephone
POSTES
CANADA
Pay rent
Is the financial position (assets, liabilities, and owner’s equity) of the company changed?
Yes
No
Yes
Record
Don't
record
Record
Record/
Don’t Record
Illustration 1-8
Transaction identification
process
The equality of the basic accounting equation must always be preserved. Therefore, each transaction must have a dual effect on the equation. For example, if an asset
is increased, there must be a corresponding:
1. Decrease in another asset, or
2. Increase in a liability, or
3. Increase in owner’s equity.
Two or more items could be affected when an asset is increased. For example, as
one asset is increased by $10,000, another asset could decrease by $6,000, and a liability
could increase by $4,000. Any change in a liability or ownership claim requires a similar analysis.
Transaction Analysis
The following examples are business transactions for a computer programming business during its first month of operations. You should study these transactions until
you are sure you understand them. They are not difficult, but they are important to
your success in this course. The ability to analyse transactions in terms of the basic
accounting equation is essential for an understanding of accounting.
When a specific account
title is used, the account
name is capitalized.
Transaction (1):—Investment by Owner.—Marc Doucet decides to open a computer
programming service. On September 1, 2002, he invests $15,000 cash in the business,
which he names Softbyte. This transaction results in an equal increase in assets and
owner’s equity. In this case, there is an increase in the asset Cash, $15,000, and an
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Using the Building Blocks
equal increase in the owner’s equity, M. Doucet, Capital, $15,000. The effect of this
transaction on the basic equation is:
(1)
Assets
=
Cash
+ $15,000
=
=
Liabilities
+
Owner’s Equity
M. Doucet,
Capital
+ $15,000
Investment
Observe that the equality of the basic equation has been maintained. Note also
that the source of the increase in owner’s equity (investments) is indicated. Why does
this matter? Because investments by the owner do not represent revenues. They are
excluded when determining net income. Therefore, it is necessary to make clear that
the increase is an investment rather than revenue from operations.
Transaction (2):—Purchase of Equipment for Cash.—Softbyte purchases computer
equipment for $7,000 cash. This transaction results in an equal increase and decrease
in total assets, though the composition of assets changes. Cash is decreased by $7,000,
and the asset Equipment is increased by $7,000. The specific effect of this transaction
and the cumulative effect of the first two transactions are:
Assets
Balance
Old
(2)
+
Equipment
$15,000
– 7,000
$ 8,000
Liabilities
+
Owner’s Equity
M. Doucet,
Capital
=
$15,000
+ $7,000
+
$7,000
=
$15,000
⎧
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⎨
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⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
New
Cash
=
$15,000
Observe that total assets are still $15,000, and that Doucet’s equity also remains at
$15,000, the amount of his original investment.
Transaction (3):—Purchase of Supplies on Credit.—Softbyte purchases $1,600 of
computer paper and other supplies expected to last several months from the Chuah
Supply Company. Chuah Supply agrees to allow Softbyte to pay this bill next month
(in October). This transaction is referred to as a purchase on account, or a credit purchase. Assets are increased because of the expected future benefits of using the paper
and supplies. Liabilities are increased by the amount due to Chuah Supply Company.
The asset Supplies is increased by $1,600, and the liability Accounts Payable is
increased by the same amount. The effect on the equation is:
Assets
Cash
Old
$8,000
+
(3)
Supplies
+ Equipment
Liabilities
+
Owner’s Equity
=
Accounts
Payable
+
M. Doucet,
Capital
$7,000
$15,000
+ $1,600
$8,000 +
$1,600
+
$7,000
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
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⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
New
+ $1,600
$16,600
=
$1,600
+
$15,000
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
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⎨
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⎪
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⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
Balance
=
$16,600
Total assets are now $16,600. This total is matched by a $1,600 creditor’s claim and a
$15,000 ownership claim.
19
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CHAPTER 1
Accounting in Action
Transaction (4):—Services Provided for Cash.—Softbyte receives $1,200 cash from
customers for programming services it has provided. This transaction represents Softbyte’s principal revenue-producing activity. Recall that revenue increases owner’s
equity. Cash is increased by $1,200, and M. Doucet, Capital, is increased by $1,200. The
new balances in the equation are:
Assets
Cash
Old
$8,000
+1,200
$1,600
$9,200 +
$1,600
(4)
Supplies
+ Equipment
Liabilities
=
Accounts
Payable
$7,000
+
$7,000
+
+
$1,600
=
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
New
+
=
$1,600
Owner’s Equity
M. Doucet,
Capital
$15,000
+ 1,200
+
Service Revenue
$16,200
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
Balance
$17,800
$17,800
The two sides of the equation balance at $17,800. The source of the increase in owner’s
equity is indicated as service revenue. Service revenue is included in determining
Softbyte’s net income.
Transaction (5):—Purchase of Advertising on Credit.—Softbyte receives a bill for
$250 from the local newspaper for advertising the opening of its business. It postpones payment of the bill until a later date. This transaction results in an increase in
liabilities and a decrease in owner’s equity (because the cost of the advertising is an
expense). The cost of advertising is an expense, as opposed to an asset, because the
benefits have already been used. This expense is included in determining net income,
and ultimately capital. The specific items involved are Accounts Payable and M.
Doucet, Capital. The effect on the accounting equation is:
Balance
Cash
+
Supplies
Old
$9,200
$1,600
New
$9,200 +
$1,600
+ Equipment
=
Liabilities
+
=
Accounts
Payable
+
$7,000
$1,600
+ 250
(5)
+
$7,000
$17,800
=
$1,850
Owner’s Equity
M. Doucet,
Capital
$16,200
– 250
+
Advertising Expense
$15,950
⎧
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⎨
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⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
Assets
⎧
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⎪
⎪
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⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
20
$17,800
The two sides of the equation still balance at $17,800. Owner’s equity is decreased
when the expense is incurred, and the specific cause of the decrease (advertising
expense) is noted. Expenses do not have to be paid in cash at the time they are
incurred. When payment is made at a later date, the liability Accounts Payable will
be decreased and the asset Cash will also be decreased [see Transaction (8)].
Transaction (6):—Services Rendered for Cash and Credit.—Softbyte provides
$3,500 of programming services for customers. Cash of $1,500 is received from customers, and the balance of $2,000 is billed to customers on account. This transaction
results in an equal increase in assets and owner’s equity. Three specific items are
affected: Cash is increased by $1,500, Accounts Receivable is increased by $2,000, and
M. Doucet, Capital, is increased by $3,500. The new balances are as follows:
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 21
Using the Building Blocks
Assets
Cash
Old
$ 9,200
+ 1,500
(6)
Liabilities
=
Accounts
Payable
$7,000
+
+
$1,850
$10,700 +
$2,000
+
$1,600
+
$7,000
=
$1,850
Owner’s Equity
M. Doucet,
Capital
$15,950
+ 3,500
+$2,000
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
New
=
+
21
Service Revenue
$19,450
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
Balance
Accounts
+ Receivable + Supplies + Equipment
$21,300
$21,300
Why increase owner’s equity by $3,500 when only $1,500 has been collected? The reason is that the assets resulting from the earning of revenues do not have to be in the
form of cash. Owner’s equity is increased when revenues are earned. In Softbyte’s
case, revenues are earned when the service is provided. When collections on account
are received at a later date, Cash will be increased and Accounts Receivable will be
decreased [see Transaction (9)].
Transaction (7):—Payment of Expenses.—Expenses paid in cash for September are store
rent, $600, salaries of employees, $900, and utilities, $200. These payments result in an
equal decrease in assets and owner’s equity. Cash is decreased by $1,700 in total ($600 +
$900 + $200) and M. Doucet, Capital, is decreased by the same amount (because the rent,
salaries, and utilities are all expenses). The effect of these payments on the equation is:
Assets
Cash
Old
$10,700
– 600
– 900
– 200
(7)
$9,000 +
$2,000
$1,600
+
$1,600
Liabilities
=
Accounts
Payable
$7,000
+
$7,000
+
+
$1,850
=
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
New
$2,000
=
$1,850
Owner’s Equity
M. Doucet,
Capital
$19,450
– 600
– 900
– 200
+
Rent Expense
Salaries Expense
Utilities Expense
$17,750
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
Balance
Accounts
+ Receivable + Supplies + Equipment
The two sides of the equation now balance at $19,600. Three lines are required in the
analysis to indicate the different types of expenses that have been paid.
Transaction (8):—Payment of Accounts Payable.—Softbyte pays its $250 National
Post advertising bill in cash. Remember that the bill was previously recorded in Transaction (5) as an increase in Accounts Payable and a decrease in owner’s equity. This
payment on account decreases the asset Cash by $250 and also decreases the liability
Accounts Payable. The effect of this transaction on the equation is:
Balance
Cash
Old
$9,000
– 250
$2,000
New
$8,750 +
$2,000
$1,600
+
$1,600
$19,350
Liabilities
+
Owner’s Equity
=
Accounts
Payable
+
M. Doucet,
Capital
$7,000
+
$7,000
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
(8)
=
$1,850
– 250
=
$1,600
$17,750
+
$17,750
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
Assets
Accounts
+ Receivable + Supplies + Equipment
$19,350
Observe that the payment of a liability related to an expense that has previously
been recorded does not affect owner’s equity. This expense was recorded in Transaction (5) and should not be recorded again.
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 22
CHAPTER 1
Accounting in Action
Transaction (9):—Receipt of Cash on Account.—The sum of $600 in cash is received
from a few of the customers who have previously been billed for services in Transaction (6). This transaction does not change total assets, but it does change the composition of those assets. Cash is increased by $600, and Accounts Receivable is decreased
by $600. The new balances are:
Assets
Balance
Cash
Accounts
+ Receivable + Supplies + Equipment
=
Liabilities
+
Owner’s Equity
=
Accounts
Payable
+
M. Doucet,
Capital
$8,750 +
+ 600
$2,000
– 600
+
$1,600
+
$7,000
=
$1,600
+
$17,750
New
$9,350 +
$1,400
+
$1,600
+
$7,000
=
$1,600
+
$17,750
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
Old
(9)
$19,350
$19,350
Note that a collection on account for services previously billed and recorded does
not affect owner’s equity. Revenue was already recorded in Transaction (6) and must
not be recorded again.
Transaction (10):—Withdrawal of Cash by Owner.—Marc Doucet withdraws
$1,300 in cash from the business for his personal use. This transaction results in an
equal decrease in assets and owner’s equity. Both Cash and M. Doucet, Capital, are
decreased by $1,300, as shown below:
Assets
Balance
Cash
Accounts
+ Receivable + Supplies + Equipment
=
Liabilities
+
=
Accounts
Payable
+
Owner’s Equity
M. Doucet,
Capital
$9,350 +
–1,300
$1,400
+
$1,600
+
$7,000
=
$1,600
+
$17,750
– 1,300
New
$8,050 +
$1,400
+
$1,600
+
$7,000
=
$1,600
+
$16,450
Drawings
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
Old
(10)
.
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
22
Observe that the effect of a cash withdrawal by the owner is the opposite of the effect
of an investment by the owner. Also note, owner’s drawings are not expenses.
Expenses are incurred for the purpose of earning revenue. Drawings do not generate
revenue. They are a disinvestment. Like owner’s investments, drawings are excluded
in determining net income.
Summary of Transactions
The transactions of Softbyte are summarized in Illustration 1-9 to show their cumulative effect on the basic accounting equation. The transaction number, the specific
effects of the transaction, and the balances after each transaction are indicated.
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 23
Using the Building Blocks
Assets
Cash
(1)
(2)
Accounts
+ Receivable + Supplies + Equipment
+ $15,000
– 7,000
=
Liabilities
+
=
Accounts
Payable
+
Owner’s Equity
M. Doucet,
Capital
+ $15,000
8,000
+
7,000
=
+ $1,600
1,600 +
$15,000
8,000
+ 1,200
+
7,000
=
1,600
+
9,200
+
1,600 +
7,000
=
1,600
+ 250
+
16,200
– 250
9,200
+ 1,500
+
1,600 +
7,000
=
1,850
+
15,950
+ 3,500
Service Revenue
+
1,600 +
7,000
=
1,850
+
19,450
– 600
– 900
– 200
Rent Expense
Salaries Expense
Utilities Expense
+ $2,000
15,000
+ 1,200
10,700 +
– 600
– 900
– 200
2,000
9,000 +
– 250
2,000
+
1,600 +
7,000
=
1,850
– 250
+
17,750
(8)
8,750 +
+ 600
2,000
– 600
+
1,600 +
7,000
=
1,600
+
17,750
(9)
9,350 +
– 1,300
1,400
+
1,600 +
7,000
=
1,600
+
17,750
– 1,300
$ 8,050 +
$1,400
+
$1,600 +
$7,000
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
(10)
$18,050
=
$1,600
+
Service Revenue
Advertising Expense
Drawings
$16,450
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
(7)
Investment
+ $1,600
(5)
(6)
23
+ $7,000
(3)
(4)
$18,050
The illustration demonstrates some significant facts:
1. Each transaction must be analysed in terms of its effect on:
(a) the three components (assets, liabilities, and owner’s equity) of the basic
accounting equation, and
(b) specific items within each component.
2. The two sides of the equation must always be equal.
3. The causes of each change in the owner’s capital account must be indicated in
the owner’s equity column.
There! You made it through transaction analysis. If you feel a bit shaky on any of
the transactions, it might be a good idea to get up, take a short break, and come back
again for a 10- to 15-minute review of the transactions. Make sure you understand
them before moving on to the next section.
Before You Go On . . .
Review It
1. Give an example of an external transaction. Give an example of an internal transaction.
2. If an asset increases, what are the three possible effects on the basic accounting equation? What
are the possible effects if a liability increases?
Do It
A tabular analysis of the transactions made by Virmari & Co., a public accounting firm, for the
month of August is shown on the following page. Describe each transaction that occurred for the
month.
Illustration 1-9
Tabular summary of
Softbyte transactions
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 24
24
CHAPTER 1
Accounting in Action
Assets
Cash
1.
2.
3.
4.
+
Office
Equipment
=
Liabilities
+
=
Accounts
Payable
+
+ $25,000
Owner’s Equity
A. Virmari
Capital
+ $25,000 Investment
+ 7,000
+ 7,000
+ 8,000
– 850
+ 8,000
– 850
Service Revenue
Rent Expense
Action Plan
• Analyse the tabular analysis to determine each transaction.
• Keep the accounting equation in balance.
Solution
✔
THE
NAVIGATOR
1.
2.
3.
4.
The owner invested $25,000 of cash in the business
The company purchased $7,000 of office equipment on credit.
The company received $8,000 of cash in exchange for services performed.
The company paid $850 for this month’s rent.
Related exercise material: BE1–6, BE1–7, BE1–8, E1–5 and E1–6.
Financial Statements
STUDY OBJECTIVE
8
Understand what the
four financial statements are and how they
are prepared.
Helpful hint—The income
statement, statement of
owner’s equity, and cash flow
statement are all for a period of
time.The balance sheet is at a
point in time.
After transactions are identified, recorded, and summarized, four financial statements
are prepared from the summarized accounting data:
1. An income statement presents the revenues and expenses and resulting net
income or net loss for a specific period of time.
2. A statement of owner’s equity summarizes the changes in owner’s equity for a
specific period of time.
3. A balance sheet reports the assets, liabilities, and owner’s equity at a specific date.
4. A cash flow statement summarizes information about the cash inflows (receipts)
and outflows (payments) for a specific period of time.
Each statement provides management, owners, and other interested parties with relevant financial data.
The financial statements of Softbyte and their interrelationships are shown in
Illustration 1-10. The statements are interrelated: (1) Net income of $2,750 shown on
the income statement is added to the beginning balance of owner’s capital in the
statement of owner’s equity. (2) Owner’s capital of $16,450 at the end of the reporting period shown in the statement of owner’s equity is reported on the balance
sheet. (3) Cash of $8,050 on the balance sheet is reported on the cash flow statement.
The essential features of Softbyte’s four financial statements are briefly described
in the following sections.
Income Statement
Alternative terminology
The income statement is
sometimes called the
statement of earnings or
statement of operations.
Softbyte’s income statement reports the revenues and expenses for a specific period
of time. The income statement is prepared from the data appearing in the owner’s
equity column of Illustration 1-9. The heading of the statement identifies the company, the type of statement, and the time period covered by the statement. The primary focus of the income statement is reporting the profitability of the company’s
operations over a specified period of time (a month, a quarter, a year). To indicate
that it applies for a period of time, the income statement is dated For the Month
Ended September 30, 2002.
On the income statement, revenues are listed first, followed by expenses. Finally,
net income (or net loss) is determined. Note that investment and withdrawal transactions between the owner and the business are not included in the measurement of net
income. For example, the cash withdrawal by Marc Doucet from Softbyte is not there.
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 25
Using the Building Blocks
They are not included because they are not business expenses, as explained earlier.
Illustration 1-10
SOFTBYTE
Income Statement
For the Month Ended September 30, 2002
Revenues
Service revenue
Expenses
Salaries expense
Rent expense
Advertising expense
Utilities expense
Total expenses
Net income
Financial statements and
their interrelationships
$4,700
$900
600
250
200
1,950
$2,750
SOFTBYTE
Statement of Owner’s Equity
For the Month Ended September 30, 2002
M. Doucet, Capital, September 1
Add: Investments
Net income
1
$
$15,000
2,750
Less: Drawings
M. Doucet, Capital, September 30
0
17,750
17,750
1,300
$16,450
SOFTBYTE
Balance Sheet
September 30, 2002
Assets
Cash
Accounts receivable
Supplies
Equipment
Total assets
$ 8,050
1,400
1,600
7,000
$18,050
Liabilities and Owner’s Equity
Liabilities
Accounts payable
Owner’s equity
M. Doucet, Capital
Total liabilities and owner’s equity
3
$ 1,600
16,450
$18,050
SOFTBYTE
Cash Flow Statement
For the Month Ended September 30, 2002
Cash flows from operating activities
Cash receipts from customers
Cash payments to suppliers and employees
Net cash provided by operating activities
Cash flows from investing activities
Purchase of equipment
Net cash used by investing activities
Cash flows from financing activities
Investments by owner
Drawings by owner
Net cash provided by financing activities
Net increase in cash
Cash, September 1
Cash, September 30
$ 3,300)
(1,950)
$ 1,350
$ (7,000)
(7,000)
$15,000)
(1,300)
13,700)
8,050)
0)
$ 8,050)
2
25
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 26
26
CHAPTER 1
Accounting in Action
Statement of Owner’s Equity
Softbyte’s statement of owner’s equity reports the changes in owner’s equity for a
specific period of time. Data for the preparation of the statement of owner’s equity are
obtained from the owner’s equity column of the tabular summary (Illustration 1-9)
and from the income statement. The heading of this statement identifies the company, the type of statement, and the time period covered by the statement. The time
period is the same as that covered by the income statement. It is therefore dated For
the Month Ended September 30, 2002. The beginning owner’s equity amount is
shown on the first line of the statement. Then the owner’s investments, net income,
and the owner’s drawings are identified. The information in this statement indicates
the reasons why owner’s equity has increased or decreased during the period.
What if Softbyte reported a net loss in its first month? The loss would reduce
owner’s capital. There would be no addition of net income, and the loss would be
reported as a deduction, along with drawings.
Balance Sheet
Alternative terminology
The balance sheet is sometimes called the statement of
financial position.
Softbyte’s balance sheet reports the assets, liabilities, and owner’s equity at a specific
date. The balance sheet is prepared from the column headings and the month-end
data shown in the last line of the tabular summary (Illustration 1-9). The heading of
a balance sheet must identify the company, the statement, and the date. The balance
sheet is like a snapshot of the company’s financial condition at a specific moment in
time (usually the end of a quarter or year). To indicate that the balance sheet is at a specific point in time, it is dated September 30, 2002. Sometimes, the words “as at” precede the balance sheet date. Observe that the assets are listed at the top, followed by
liabilities and owner’s equity. Total assets must equal total liabilities and owner’s
equity. In the Softbyte balance sheet, only one liability, accounts payable, is reported.
In most cases, there will be more than one liability.
Cash Flow Statement
Alternative terminology
The cash flow statement is
sometimes called the statement
of changes in financial position.
Softbyte’s cash flow statement provides information about the cash receipts and cash
payments for a specific period of time. To aid investors, creditors, and others in their
analysis of cash, the cash flow statement reports the following: (1) the cash effects of
a company’s operations during a period, (2) the cash inflows and outflows from
investing transactions (e.g., purchase and sale of capital assets), (3) the cash inflows
and outflows from financing transactions (e.g., borrowing and repayment of debt), (4)
the net increase or decrease in cash during the period, and (5) the cash amount at the
end of the period.
Reporting the sources, uses, and change in cash is useful because investors, creditors, and others want to know what is happening to a company’s most liquid
resource, its money. The cash flow statement provides answers to the following simple but important questions:
1. Where did the cash come from during the period?
2. What was the cash used for during the period?
3. What was the change in the cash balance during the period?
Softbyte’s cash flow statement, provided in Illustration 1-10, covers the same
period of time as the income statement. As shown in the statement, cash increased by
$8,050 during the year. Net cash flow from operating activities increased cash by
$1,350. Cash flow from investing activities decreased cash by $7,000. Cash flow from
financing activities increased cash $13,700. At this time, you do not need to know
how these amounts are determined. Chapter 18 will examine the cash flow statement
in detail.
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 27
Using the Building Blocks
27
Using the Information in the Financial Statements
Illustration 1-10 introduced the financial statements for Softbyte. Every set of financial statements is accompanied by explanatory notes and supporting schedules that
are an integral part of the statements. Public corporations issue their financial statements and supplementary materials within an annual report. The annual report is a
document that includes useful non-financial information about the company, as well
as financial information.
Non-financial information may include a management discussion of the company’s mission, goals and objectives, market position, and people involved in the
company. Financial information may include a review of current operations and a
summary of historical key financial figures and ratios, in addition to comparative
financial statements. Public company financial statements are usually audited and
have the auditors’ report attached to them. A statement of management responsibility for the statements is also attached.
A vital element in communicating economic events is the accountant’s ability and
responsibility to analyse and interpret the reported information. Analysis involves
the use of ratios, percentages, graphs, and charts to highlight significant financial
trends and relationships. Interpretation involves explaining the uses, meaning, and
limitations of reported data.
Included in Appendix A at the end of this textbook is the annual report from The
Second Cup Ltd. Briefly examine Appendix A to see what kind of information Second
Cup includes in its annual report. Then look more specifically at Second Cup’s financial statements. Carefully examine the format and content of each financial statement
outlined earlier in Illustration 1-10. What similarities can you find between the financial statements in Illustration 1-10 and the more complicated financial statements for
The Second Cup Ltd.? We will continue to refer to The Second Cup’s financial statements to illustrate selected topics. By the end of this course, you’ll be surprised at
how much you understand about these and other financial statements.
Accounting in Action -Business Insight
A research study by the CICA examines the impact of technology on financial
reporting and the issues the accounting profession needs to consider as a result.
“Technology is challenging the very nature of financial reporting in two significant
ways,” says the author of the study, Gerry Trites. “The increasing use of the Internet, as well as its multimedia capability and capacity for interactive communication,
is challenging the boundaries, framework and even the fundamental role of financial reporting
in society. Technology in general is changing the way financial information is communicated to
investors, creditors, and other interested parties.”
For example, the thought of putting a company’s annual financial statements on the Web
would have been viewed as frivolous and ineffective just a few years ago. Today, most companies are doing that and more.They are going beyond financial statements and offering many
other types of financial and non-financial information pertinent to understanding the financial
affairs of a business.
Source: Gerald Trites, The Impact of Technology on Financial and Business Reporting, CICA Research Report, 1999.
International note
The average annual report
runs about 44 pages. Foreign
reports tend to run a bit
longer. An Italian bank once
produced an annual report
that ran a record 302 pages!
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 28
28
CHAPTER 1
Accounting in Action
Before You Go On . . .
For Review It questions
marked with this “Second
Cup” icon, you need to use
The Second Cup’s
Annual Report.
Review It
®
✔
THE
NAVIGATOR
1. What are the income statement, statement of owner’s equity, balance sheet, and cash flow
statement?
2. Explain how The Second Cup’s financial statements are interrelated: identify specific accounts
and amounts. The answer to this question is provided at the end of the chapter.
3. What information is normally found in an annual report?
Related exercise material: BE1–9, BE1–10, BE1–11, BE1–12, E1–7, E1–8, E1–9, E1–10, E1–11, E1–12,
E1–13, E1–14, E1–15, and E1–16.
A Look Back at Our Feature Story
A Look Back exercises refer
to the chapter opening story.
These exercises help you
analyse the story’s real-world
situation in terms of the
accounting topic of the
chapter.
✔
THE
NAVIGATOR
Refer to the opening story about The Second Cup Ltd., and answer the following questions:
1. If you were interested in investing in The Second Cup Ltd., what would the balance sheet
and income statement tell you?
2. Would you request audited financial statements? Explain.
3. Will the financial statements show the market value of the company? Explain.
Solution
1. The balance sheet reports the assets, liabilities, and owner’s equity of the company. The balance sheet is like a snapshot of the company’s financial condition at a point in time. The
income statement presents the revenues and expenses and resulting net income (or net loss)
for a specific period of time. The income statement should give you a good indication of the
profitability of the company.
2. You should request audited financial statements—statements that a public accountant has
examined and for which he or she has expressed an opinion about whether or not the presentation is fair and in accordance with generally accepted accounting principles. You should
not make decisions without having audited financial statements.
3. The financial statements will not show the market value of the company. One important
principle of accounting is the cost principle, which states that assets should be recorded
at cost instead of market value. Cost has an important advantage over other valuations.
It is reliable.
DEMONSTRATION PROBLEM
Additional
Demonstration Problem
The Demonstration
Problem is a final review
before you work on the
assignment material. The
problem-solving strategies in
the margins give you tips about
how to approach the problem.
The solutions show both the
form and the content of
complete answers.
Raman Balakrishnan opens his own law office on July 1, 2003. During the first month of operations, the following transactions occur:
1. Invests $10,000 in cash in the law practice.
2. Pays $800 for July rent on office space.
3. Purchases office equipment on account, $3,000.
4. Provides legal services to clients for cash, $1,500.
5. Borrows $700 cash from a bank on a note payable.
6. Provides legal services to client on account, $2,000.
7. Pays monthly expenses: salaries, $500; utilities, $300; and telephone, $100.
Instructions
(a) Prepare a tabular summary of the transactions.
(b) Prepare the income statement, statement of owner’s equity, and balance sheet at July 31 for
Raman Balakrishnan, Barrister & Solicitor.
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 29
Demonstration Problem
29
Solution to Demonstration Problem
(a)
Assets
Transaction
Cash
(1)
(2)
+ $10,000
– 800
=
Accounts
+ Receivable + Equipment
Note
Payable
+
+
Accounts
Payable
+
=
(3)
9,200
+ 1,500
+
(4)
10,700
+ 700
+
(5)
+ $3,000
+ $3,000
3,000
=
3,000
3,000
Owner’s Equity
Balakrishnan,
Capital
+ $10,000
– 800
=
=
=
9,200
9,200
=
+
9,200
+ 1,500
3,000
+
10,700
+
3,000
=
700
+
3,000
+
10,700
+ 2,000
+
3,000
=
700
+
3,000
+
12,700
– 500
– 300
– 100
+ $2,000
Fees Earned
$10,500 +
$2,000
+
$3,000
=
$700
+
$3,000
+
$15,500
Revenues
Fees earned
Expenses
Rent expense
Salaries expense
Utilities expense
Telephone expense
$15,500
$3,500
$800
500
300
100
Total expenses
1,700
Net income
$1,800
RAMAN BALAKRISHNAN
Barrister & Solicitor
Statement of Owner’s Equity
For the Month Ended July 31, 2003
Raman Balakrishnan, Capital, July 31
Salaries Expense
Utilities Expense
Telephone Expense
$11,800
RAMAN BALAKRISHNAN
Barrister & Solicitor
Income Statement
For the Month Ended July 31, 2003
Raman Balakrishnan, Capital, July 1
Add: Investments
Net income
Fees Earned
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
2,000
⎧
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎨
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎪
⎩
11,400 +
– 500
– 300
– 100
(b)
Investment
Rent Expense
+$700
11,400
(6)
=
Liabilities
$
$10,000
1,800
0
11,800
$11,800
Action Plan
• Assets must equal liabilities
plus owner’s equity after
each transaction.
• Investments and revenues
increase owner’s equity.
• Withdrawals and expenses
decrease owner’s equity.
• The income statement
shows revenues and
expenses for a period of
time.
• The statement of owner’s
equity shows the changes in
owner’s equity for the same
period of time as the
income statement.
• The balance sheet reports
assets, liabilities, and owner’s
equity at a specific date.
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 30
30
CHAPTER 1
Accounting in Action
RAMAN BALAKRISHNAN
Barrister & Solicitor
Balance Sheet
July 31, 2003
Assets
Cash
Accounts receivable
Equipment
$10,500
2,000
3,000
Total assets
$15,500
Liabilities and Owner’s Equity
Liabilities
Note payable
Accounts payable
✔
THE
NAVIGATOR
$
Total liabilities
Owner’s equity
Raman Balakrishnan, Capital
700
3,000
3,700
11,800
Total liabilities and owner’s equity
$15,500
Summary of Study Objectives
1.–Explain what accounting is. Accounting identifies,
records, and communicates the economic events of an
organization to interested users.
2.–Identify the users and explain the uses of accounting.
The major users and uses of accounting are as follows: (a)
Management uses accounting information to plan, control, and evaluate business operations. (b) Investors (owners) decide whether to buy, hold, or sell their financial
interests on the basis of accounting data. (c) Creditors
(suppliers and bankers) evaluate the risks of granting
credit or lending money on the basis of accounting information. Other groups that use accounting information are
taxing authorities, regulatory agencies, customers, labour
unions, and economic planners.
3.–Understand why ethics is a fundamental business concept. Ethics are the standards of conduct by which one’s
actions are judged as right or wrong. If you cannot
depend on the honesty of the individuals you deal with,
effective communication and economic activity will be
impossible and information will have no credibility.
4.–Explain the meaning of generally accepted accounting
principles and the cost principle. Generally accepted
accounting principles are a common set of standards used
to prepare and report accounting information. The cost
principle states that assets should be recorded at their historical (original) cost.
✔
THE
NAVIGATOR
5.–Explain the meaning of the going concern, monetary
unit, and economic entity assumptions. The going concern assumption presumes that a business will continue
operations for enough time to use its assets for their
intended purpose and to fulfill its commitments. The
monetary unit assumption requires that only transaction
data that can be expressed in terms of money be included
in the accounting records. The economic entity assumption requires that the activities of each economic entity be
kept separate from the activities of its owner and other
economic entities.
6.–State and utilize the basic accounting equation and
explain the meaning of assets, liabilities, and owner’s
equity. The basic accounting equation is:
Assets = Liabilities + Owner’s Equity
Assets are resources owned by a business. Liabilities are
creditorship claims on total assets. Owner’s equity is the
ownership claim on total assets.
7.–Calculate the effect of business transactions on the
basic accounting equation. Each business transaction
must have a dual effect on the accounting equation. For
example, if an individual asset is increased, there must be
a corresponding (1) decrease in another asset, (2) increase
in a liability, and/or (3) increase in owner’s equity.
8.–Understand what the four financial statements are
and how they are prepared. An income statement presents the revenues and expenses of a company for a specific period of time. A statement of owner’s equity
summarizes the changes in owner’s equity that have
occurred for a specific period of time. A balance sheet
reports the assets, liabilities, and owner’s equity of a business at a specific date. A cash flow statement summarizes
information about the cash inflows (receipts) and outflows (payments) for a specific period of time.
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 31
Glossary
GLOSSARY
Key Term Matching Activity
Accounting—The process of identifying, recording, and
communicating the economic events of an organization to
interested users of the information. (p. 2)
Financial accounting—A field of accounting that provides
information for external users such as investors and creditors. (p. 6)
Accounting equation—Assets Liabilities Owner’s
Equity. (p. 14)
Generally accepted accounting principles (GAAP)—An
accepted set of standards that indicate how to report economic events. (p. 10)
Annual report—Information provided annually by a
company to its shareholders and other interested parties
concerning its operations and financial position. It includes
the financial statements and auditors’ report, in addition
to information and reports by management. (p. 27)
Assets–Resources owned by a business. (p. 14)
Assumptions—Basic assumptions (going concern, monetary unit, economic entity, and time period) underlie the
financial accounting structure. (p. 11)
Auditing—The examination of financial statements by
a qualified professional accountant in order to express
an opinion as to whether or not they are presented fairly
in accordance with generally accepted accounting principles. (p. 7)
Balance sheet—A financial statement that reports the
assets, liabilities, and owner’s equity at a specific date.
(p. 24)
Bookkeeping—A part of accounting that involves only
the recording of economic events. (p. 6)
Business advisory services—An area of public accounting that involves assisting management in a wide variety
of financial planning, information, and control initiatives.
(p. 8)
Cash flow statement—A financial statement that provides
information about the cash inflows (receipts) and cash outflows (payments) of an entity for a specific period of time.
(p. 24)
Corporation—A business organized as a separate legal
entity under corporation law, with ownership divided into
transferable shares. (p. 13)
Cost principle—An accounting principle which states that
assets should be recorded at their original historical cost. (p.
11)
Drawings—Withdrawal of cash or other assets from an
unincorporated business for the personal use of the owner.
(p. 15)
Economic entity assumption—An assumption that economic events can be identified with a particular unit of
accountability. (p. 12)
Economic events—Activities related to the production
and distribution of goods and services in an organization. (p. 2)
Ethics—The standards of conduct by which one’s
actions are judged as right or wrong, honest or dishonest, fair or unfair. (p. 9)
Expenses—The cost of assets consumed or services used
in the process of earning revenue. (p. 15)
Going concern assumption—An assumption which
states that the entity will continue operations for enough
time to use its assets for their intended purpose and to fulfill its obligations. (p. 12)
Income statement—A financial statement that presents the
revenues and expenses and resulting net income (or net loss)
for a company for a specific period of time. (p. 24)
Investments by owner—The assets put into the business
by the owner. (p. 15)
Liabilities—Creditorship claims on total assets. (p. 15)
Managerial accounting—A field of accounting that provides information for managers and other internal users. (p.
6)
Monetary unit assumption—An assumption which states
that only transaction data that can be expressed in terms
of money may be included in the accounting records. (p.
12)
Net income—The amount by which revenues exceed
expenses. (p. 16)
Net loss—The amount by which expenses exceed revenues. (p. 16)
Owner’s equity—The ownership claim on total assets.
(p. 15)
Partnership—An association of two or more persons to
carry on as co-owners of a business for profit. (p. 13)
Private corporation—A limited company whose shares
are not listed on a stock exchange and are not available to
a public investor. (p. 14)
Proprietorship—Asmall business owned by one person. (p.
13)
Public corporation—A limited company whose shares are
publicly traded and available for purchase by the general
public. (p. 14)
Revenues—The increase in owner’s equity that results
from business activities performed to earn income. (p. 15)
Statement of owner’s equity—A financial statement that
summarizes the changes in owner’s equity for a specific
period of time. (p. 24)
Taxation—An area of public accounting that involves tax
advice, tax planning, and preparing tax returns. (p. 8)
Transactions—The economic events of the enterprise
recorded by accountants. (p. 17)
31
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 32
Accounting in Action
ww
Answers are at the end of the chapter.
(SO 1) C
1. The accounting process does not include:
a. identification.
b. verification.
c. recording.
d. communication.
(SO 2) C
2. One of the following statements about users of
accounting information is incorrect. The incorrect
statement is:
a. Management is an internal user.
b. Taxing authorities are external users.
c. Creditors are external users.
d. Regulatory authorities are internal users.
(SO 2) K
3. The public accountant generally provides the following services:
a. auditing, taxation, and business advisory services.
b. auditing, budgeting, and business advisory services.
c. auditing, budgeting, and cost accounting.
d. internal auditing, budgeting, and business advisory services.
(SO 3) K
4. Ethics are the standards of conduct by which one’s
actions are judged to be:
a. decent or indecent.
b. successful or unsuccessful.
c. profitable or unprofitable.
d. right or wrong.
(SO 4) K
5. Generally accepted accounting principles:
a. are unwritten, but generally understood by
accountants.
b. may be found in the regulations which form part
of the Income Tax Act.
c. are similar to the basic laws of nature, and thus do
not change.
d. constitute accepted accounting theory and practice.
(SO 3) K
6. The cost principle states that:
a. assets should be recorded at cost and adjusted
when their market value changes.
b. activities of an entity should be kept separate and
distinct from those of its owner.
c. assets should be recorded at their original cost.
d. only transaction data capable of being expressed
in terms of money should be included in the
accounting records.
✔
THE
NAVIGATOR
weygan
a/
SELF-STUDY QUESTIONS
/canad
om
i
w.w ley.c
CHAPTER 1
Chapter 1 Self-Test
dt2
32
7. Which of the following statements about basic (SO 5) C
assumptions is incorrect?
a. Basic assumptions are the same as accounting principles.
b. The economic entity assumption states that there
should be a particular unit of accountability.
c. The monetary unit assumption enables accounting to measure economic events.
d. An important part of the monetary unit assumption is the stable monetary unit assumption.
8. As at December 31, Stoneland Company has assets of (SO 6) AP
$3,500 and owner’s equity of $2,000. What are the liabilities for Stoneland Company as at December 31?
a. $1,000.
b. $1,500.
c. $2,000.
d. $2,500.
9. 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.
(SO 6) C
10. The effects on the basic accounting equation of per- (SO 7) C
forming services on account are:
a. increased assets and decreased owner’s equity.
b. increased assets and increased owner’s equity.
c. increased assets and increased liabilities.
d. increased liabilities and increased owner’s equity.
11. Genesis Company buys a $10,000 machine on credit. (SO 7) C
This transaction will affect the:
a. income statement only.
b. balance sheet only.
c. income statement and statement of owner’s
equity only.
d. income statement, statement of owner’s equity,
and balance sheet.
12. The financial statement that reports assets, liabilities, (SO 8) K
and owner’s equity is the:
a. income statement.
b. statement of owner’s equity.
c. balance sheet.
d. cash flow statement.
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 33
Questions
33
QUESTIONS
(SO 1) C
1. “Accounting is ingrained in our society and it is vital
to our economic system.” Do you agree? Explain.
(SO 1) C
2. Identify and describe the steps in the accounting
process.
(SO 2) C
3. (a) Who are internal users of accounting data?
(b) How does accounting provide relevant data for
these users?
(SO 2) C
4. What uses of financial accounting information are
made by the following external users: (a) investors
and (b) creditors?
(SO 2) C
5. “Bookkeeping and accounting are the same.” Do you
agree? Explain.
(SO 3) AN
6. Why are ethics important to the accounting profession?
(SO 4) AP
7. Ouellette Travel Agency purchased land for $75,000
cash on December 10, 2002. At December 31, 2002, the
land’s value had increased to $95,000. What amount
should be reported for land on Ouellette’s balance
sheet at December 31, 2002? Would your answer differ if the land value declined to $65,000? Explain.
(SO 5) C
8. What is the monetary unit assumption? What impact
does inflation (rising prices) have on the monetary
unit assumption?
(SO 5) K
9. What is the economic entity assumption?
(SO 5) C
10. What are the three basic forms of business organization for profit-oriented enterprises?
(SO 5) AP
11. Martha Ross is the owner of a successful printing
shop. Recently, her business has been increasing, and
Martha has been thinking about changing the organization of her business from a proprietorship to a corporation. Identify the differences in accounting for
equity if Martha were to incorporate her business.
(SO 6) K
12. What is the basic accounting equation?
(SO 6) C
13. (a) Define assets, liabilities, and owner’s equity.
(b) What items affect owner’s equity?
(SO 6) K
14. Which of the following items are liabilities of Gilt Jewellery Store?
(a) Cash
(b) Accounts payable
(c) Drawings
(d) Accounts receivable
(e) Supplies
(f) Equipment
(g) Salaries payable
(h) Service revenue
(i) Rent expense
(SO 6) AP
15. Can a business enter into a transaction in which only
the left side of the basic accounting equation is
affected? If yes, give an example.
16. Are the following events recorded in the accounting (SO 7) AP
records? Explain your answer in each case.
(a) The owner of the company dies.
(b) Supplies are purchased on account.
(c) An employee is terminated.
(d) The owner of the business withdraws cash from
the business for personal use.
17. Indicate how the following business transactions (SO 7) AP
affect the basic accounting equation:
(a) Paid cash for janitorial services.
(b) Purchased equipment for cash.
(c) Invested cash in the business.
(d) Paid an account payable in full.
18. In February 2003, Paul Dumas invested an additional (SO 7) AN
$10,000 in his business, Dumas’s Pharmacy, which is
organized as a proprietorship. Dumas’s accountant,
Donna Wortham, recorded this receipt as an increase
in cash and revenues. Is this treatment appropriate?
Why or why not?
19. A company’s net income appears directly on the (SO 8) AP
income statement and the statement of owner’s
equity. It is also included indirectly in the company’s
balance sheet. Do you agree? Explain.
20. Below are some items found in the financial state- (SO 8) C
ments of Kaustev Sen, M.D. Indicate in which financial statement(s) the items would appear.
(a) Service revenue
(b) Equipment
(c) Advertising expense
(d) Accounts receivable
(e) Kaustev Sen, Capital (ending balance)
(f) Wages payable
21. Schwinghamer Enterprises had a capital balance of (SO 8) AP
$168,000 at the beginning of the period. At the end of
the accounting period, the capital balance was
$198,000.
(a) If there were no additional investments or withdrawals during the period, what is the net income
for the period?
(b) Assuming an additional investment of $18,000 but
no withdrawals during the period, what is the net
income for the period?
22. Summarized operations for the King Co. for the (SO 8) AP
month of July are as follows:
Revenues earned: for cash, $35,000;
on account, $70,000.
Expenses incurred: for cash, $26,000;
on account, $40,000.
Indicate the following for King Co.: (a) total revenues,
(b) total expenses and (c) net income for the month of
July.
23. What kind of information is presented in the notes to (SO 8) C
the financial statements? In the annual report?
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 34
34
CHAPTER 1
Accounting in Action
BRIEF EXERCISES
Identify users of accounting
information.
(SO 2) K
BE1–1—Match each of the following five decisions with the most appropriate decision-maker listed
in (a) to (e):
1. Determine whether the company complied with income tax regulations.
2. Determine whether the company can pay its obligations.
3. Determine whether a marketing proposal will be cost-effective.
4. Determine whether the company’s net income will result in an increase in drawings.
5. Determine how the company should finance its operations.
_____ (a) Owner
_____ (b) Marketing managers
_____ (c) Creditors
_____ (d) Chief Financial Officer
_____ (e) Canada Customs and Revenue Agency
Describe forms of business organization.
(SO 5) AP
BE1–2—Match each of the following forms of business organization with a set of characteristics: proprietorship (P), partnership (PP), corporation (C).
_____ (a) Simple to set up; founder retains control
_____ (b) Shared control; increased skills and resources
_____ (c) Easier to transfer ownership and raise funds; no personal liability
Solve basic accounting equation.
(SO 6) AP
BE1–3—Presented below is the basic accounting equation. Determine the missing amounts:
Assets
=
Liabilities
+
Owner’s Equity
(a)
(b)
(c)
$80,000
?
$94,000
$50,000
$45,000
?
?
$70,000
$62,000
Solve basic accounting equation.
(SO 6) AP
BE1–4—Use the accounting equation to answer each of the following questions:
(a) The liabilities of Logan Company are $90,000 and the owner’s equity is $240,000. What is the
amount of Logan Company’s total assets?
(b) The total assets of Pereira Company are $170,000 and its owner’s equity is $80,000. What is the
amount of its total liabilities?
(b) The total assets of Yap Co. are $600,000 and its liabilities are equal to two-thirds of its total
assets. What is the amount of Yap Co.’s owner’s equity?
Solve basic accounting equation.
(SO 6) AP
BE1–5—At the beginning of the year, Lam Company had total assets of $700,000 and total liabilities of $500,000. Answer the following questions:
(a) If total assets increased by $150,000 during the year and total liabilities decreased by $80,000,
what is the amount of owner’s equity at the end of the year?
(b) During the year, total liabilities increased by $100,000 and owner’s equity decreased by
$70,000. What is the amount of total assets at the end of the year?
(c) If total assets decreased by $90,000 and owner’s equity increased by $120,000 during the year,
what is the amount of total liabilities at the end of the year?
Determine effect of transactions
on basic accounting equation.
(SO 7) AP
BE1–6—Presented below are six business transactions. List the letters (a) through (f), with columns
for assets, liabilities, and owner’s equity. For each column, indicate whether the transactions
increased (+), decreased (–), or had no effect (NE) on assets, liabilities, and owner’s equity:
(a) Purchased supplies on account.
(b) Received cash for providing a service.
(c) Paid expenses in cash.
(d) Invested cash in the business.
(e) Cash withdrawn by owner.
(f) Received cash from a customer who had been billed previously for services provided.
Determine effect of transactions
on owner’s equity.
(SO 7) AP
BE1–7—Three transactions are presented below. Mark each transaction as affecting owner’s investment (I), owner’s drawings (D), revenue (R), expense (E), or not affecting owner’s equity (NA):
_____ (a) Received cash for services performed.
_____ (b) Paid cash to purchase equipment.
_____ (c) Paid employee salaries.
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 35
Exercises
BE1–8—Classify each of the following items as owner’s drawings (D), revenue (R), or expense (E)
_____ (a) Costs incurred for advertising
_____ (e) Services performed
_____ (b) Commission earnings
_____ (f) Rent received
_____ (c) Insurance paid
_____ (g) Utilities incurred
_____ (d) Amounts paid to employees
_____ (h) Cash distributed to owner
35
Determine effect of transactions
on owner’s equity.
(SO 7) AP
BE1–9—Balance sheet items for Yung Company at December 31, 2002, are in alphabetical order
below. Prepare a balance sheet.
Accounts payable
$80,000
Accounts receivable
71,000
Cash
40,500
Kim Yung, Capital
31,500
Prepare a balance sheet.
(SO 8) AP
BE1–10—Indicate whether each of the following items is an asset (A), liability (L), or part of owner’s
equity (OE).
Identify balance sheet elements.
(SO 8) C
_____ (a) Accounts receivable
_____ (e) Capital invested
_____ (b) Salaries payable
_____ (f) Notes payable
_____ (c) Equipment
_____ (g) Drawings
_____ (d) Office supplies
BE1–11—Indicate whether the following items would appear on the income statement (IS), balance sheet (BS), and/or statement of owner’s equity (OE).
_____ (a) Notes payable
_____ (e) Fees earned
_____ (b) Advertising expense
_____ (f) Interest receivable
_____ (c) Harrison, Capital (ending balance)
_____ (g) Service revenue
_____ (d) Cash
_____ (h) Harrison, Drawings
BE1–12—The Calgary Exhibition and Stampede Limited was established in 1886 to produce “The
Greatest Outdoor Show on Earth.” The Stampede has the following selected accounts included in
its financial statements. In each case, identify whether the item would appear on the balance sheet
(BS) or income statement (IS).
_____ (a) Accounts receivable
_____ (g) Horse racing revenue
_____ (b) Inventories
_____ (h) Accounts payable and accrued
_____ (c) Food services expense
Identify elements of financial
statements.
(SO 8) AP
liabilities
_____ (d) Share capital
_____ (i) Cash and short-term deposits
_____ (e) Building
_____ (j) Administration, marketing, and
park services expenses
_____ (f) Stampede revenue
Identify elements of financial
statements.
(SO 8) AP
Exercises
E1–1—Presented below are the assumptions and principles discussed in this chapter:
1. Cost principle
3. Going concern assumption
2. Monetary unit assumption
4. Economic entity assumption
Instructions
Identify by number the accounting assumption or principle that is described below. Do not use a
number more than once.
_____ (a) Is the rationale for why capital assets are not reported at liquidation value. (Note: Do
not use the cost principle.)
_____ (b) Indicates that personal and business record-keeping should be separately maintained.
_____ (c) Assumes that the dollar is the “measuring stick” used to report on financial performance.
_____ (d) Indicates that market value changes after purchase are not recorded in the accounts.
Identify accounting assumptions
and principles.
(SO 4, 5) C
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CHAPTER 1
Accounting in Action
Identify assumption or principle
that has been violated.
(SO 4, 5) C
E1–2—Marietta Company had three major business transactions during 2002:
(a) Land with a cost of $208,000 is reported at its market value of $260,000.
(b) The owner of Marietta, George Winston, purchased a truck for personal use and charged it to
his drawings account.
(c) Marietta wanted to make its 2002 net income look worse than it really was, so it reported its
figures in inflation-adjusted dollars, rather than actual dollars.
Instructions
In each situation, identify the assumption or principle that has been violated, if any, and discuss
what should have been done.
Classify items as assets, liabilities, and shareholders’ equity,
and prepare accounting equation.
(SO 6) AP
E1–3—The following items were taken from the balance sheet of NIKE, Inc. NIKE is the world’s
#1 shoe company, selling its products in 110 countries.
Instructions
(a) Classify each of these items as an asset (A), liability (L), or owner’s (shareholders’) equity (OE)
item (all items are in millions of U.S. dollars).
_____ Cash
$ 108.6
_____ Accounts receivable
1,674.4
_____ Inventories
_____ Income taxes payable
$1,396.6
28.9
_____ Share capital
265.4
_____ Property, plant, and equipment 1,153.1
_____ Notes payable
480.2
_____ Retained earnings
2,996.2
1,064.7
_____ Accounts payable
584.6
_____ Other assets
_____ Other liabilities
1,042.1
(b) Determine NIKE’s accounting equation by calculating the value of total assets, total liabilities,
and total shareholders’ equity.
Classify accounts as assets, liabilities, and owner’s equity.
(SO 6) AP
E1–4—Ace Cleaners has the following balance sheet items:
_____ (a) Accounts payable
_____ (e) Accounts receivable
_____ (b) Cash
_____ (f) Notes payable
_____ (c) Cleaning equipment
_____ (g) Salaries payable
_____ (d) Cleaning supplies
_____ (h) Ace, Capital
Instructions
Classify each item as an asset, liability, or owner’s equity.
Analyse effect of transactions.
(SO 7) AP
E1–5—Selected transactions for Lush Lawn Care Company are listed below:
1. Made cash investment to start business.
2. Paid monthly rent.
3. Purchased equipment on account.
4. Billed customers for services performed.
5. Withdrew cash for owner’s personal use.
6. Received cash from customers billed in transaction 4.
7. Incurred advertising expense on account.
8. Purchased additional equipment for cash.
9. Received cash from customers when service was rendered.
Instructions
List the numbers of the above transactions and describe the effect of each transaction on assets, liabilities,
and owner’s equity. For example, the first answer is (1) Increase in assets and increase in owner’s equity.
Analyse effect of transactions on
assets, liabilities, and owner’s
equity.
(SO 7) AN
E1–6—Wong Computer Company entered into the following transactions during May 2003:
1. Purchased computer terminals for $19,000 from Digital Equipment, on account.
2. Paid $4,000 cash for May rent of storage space.
3. Received $15,000 cash from customers for contracts billed in April.
4. Provided computer services to Brieske Construction Company for $3,000 cash.
5. Paid NB Power $11,000 cash for energy usage in May.
6. Mr. Wong invested an additional $32,000 in the business.
7. Paid Digital Equipment for the terminals purchased in transaction 1 above.
8. Incurred advertising expense for May of $1,000, on account.
Instructions
Indicate with the appropriate letter whether each of the transactions above results in:
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Exercises
37
(a) an increase in assets and a decrease in assets.
(b) an increase in assets and an increase in owner’s equity.
(c) an increase in assets and an increase in liabilities.
(d) a decrease in assets and a decrease in owner’s equity.
(e) a decrease in assets and a decrease in liabilities.
(f) an increase in liabilities and a decrease in owner’s equity.
(g) an increase in owner’s equity and a decrease in liabilities.
(Note: Some letters may be used more than once, or not at all.)
E1–7—Here is a list of words or phrases discussed in this chapter:
1. Accounts payable
5. Corporation
2. Creditor
6. Owner’s capital
3. Balance sheet
7. Accounts receivable
4. Proprietorship
8. Audit
Match words with descriptions.
(SO 5, 6, 8) K
Instructions
Match each word or phrase with the best description below.
_____ (a) An examination of financial statements to determine whether they are presented in
accordance with generally accepted accounting principles
_____ (b) A business enterprise that raises money by issuing shares
_____ (c) The portion of owner’s equity that results from receiving investments from the owner
_____ (d) Obligations to suppliers of goods
_____ (e) Amounts due from customers
_____ (f) A party to whom a business owes money
_____ (g) A financial statement that reports assets, liabilities, and owner’s equity at a specific date
_____ (h) A business that is owned by one individual
E1–8—The 2002 summaries of balance sheet and income statement data for the proprietorships Wyatt
Company and Maxim Enterprises are presented below. Two items are missing from each summary.
Wyatt
Maxim
Company
Enterprises
Beginning of year:
Total assets
Total liabilities
Total owner’s equity
End of year:
Total assets
Total liabilities
Total owner’s equity
Changes during year in owner’s equity:
Investments
Drawings
Total revenues
Total expenses
$ 95,000
80,000
(a)00
$125,000
(c)00
95,000
160,000
120,000
40,000
180,000
50,000
130,000
(b)00
24,000
215,000
175,000
25,000
(d)00
100,000
85,000
Analyse financial statement
items.
(SO 6, 8) AN
Instructions
Determine the missing amounts.
E1–9—The Depeau Company had the following assets and liabilities on the dates indicated:
December 31
Total Assets
Total Liabilities
2001
2002
2003
$400,000
460,000
590,000
$250,000
320,000
400,000
Depeau began business on January 1, 2001, with an investment of $100,000.
Determine net income (or loss).
(SO 6, 8) AP
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CHAPTER 1
Accounting in Action
Instructions
From an analysis of the accounting equation and the change in owner’s equity during the year, calculate the net income (or loss) for:
(a) 2001, assuming Depeau’s drawings were $15,000 for the year.
(b) 2002, assuming Depeau made an additional investment of $50,000 and had no drawings in 2002.
(c) 2003, assuming Depeau made an additional investment of $10,000 and had drawings of
$20,000 in 2003.
E1–10—An analysis of the transactions made by Bourque & Co., a public accounting firm, for the
month of August 2003 is shown below.
Analyse transactions and
calculate net income.
(SO 7, 8) AP
Cash
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Accounts
+ Receivable +
+ $12,000
– 2,000
– 750
+ 2,600
– 1,500
– 2,000
– 650
+ 450
– 2,900
Supplies
+
Office
Accounts
Equipment = Payable
+
Bourque, Capital
+ $12,000
+ $5,000
Investment
+ $3,000
+ $750
+ $3,400
+ 6,000
Fees Earned
– 2,000
– 650
Drawings
Rent Expense
– 2,900
– 500
Salaries Expense
Utilities Expense
– 1,500
– 450
+ 500
Instructions
(a) Describe each transaction that occurred in the month.
(b) Determine how much owner’s equity increased for the month.
(c) Calculate the amount of net income for the month.
Prepare financial statements.
(SO 8) AP
E1–11—An analysis of transactions for Bourque & Co. is presented in E1–10.
Prepare income statement and
statement of owner’s equity.
(SO 8) AP
E1–12—The following information relates to Serg Co. for the year ended December 31, 2002:
Serg, Capital, January 1, 2002
$48,000
Serg, Drawings
5,000
Service revenue
55,000
Salaries expense
28,000
Rent expense
10,400
Utilities expense
3,100
Interest expense
1,700
Advertising expense
1,800
Instructions
Prepare an income statement and statement of owner’s equity for August, and a balance sheet at
August 31, 2003.
Instructions
After analysing the data, prepare an income statement and a statement of owner’s equity for the
year ended December 31, 2002.
Correct incorrectly prepared balance sheet.
(SO 8) AN
E1–13—Clare Gardner is the bookkeeper for Otago Company. Clare has prepared the balance sheet
of Otago Company, as follows:
OTAGO COMPANY
Balance Sheet
December 31, 2002
Assets
Cash
Supplies
Equipment
Otago, Drawings
Total assets
Instructions
Prepare a correct balance sheet.
Liabilities
$20,500
8,000
46,000
3,000
$77,500
Accounts payable
Accounts receivable
Otago, Capital
Total liabilities and
owner’s equity
$20,000)
(10,000)
67,500)
$77,500)
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Problems: Set A
E1–14—Judy Cumby is the sole owner of Deer Park, a public camping ground near Gros Morne
National Park. Judy has compiled the following financial information as at December 31, 2002:
Revenues during 2002, camping fees $160,000 Revenues during 2002, general store $ 40,000
Expenses during 2002
150,000 Cash on hand
20,000
Supplies on hand
2,500 Original cost of equipment
115,500
Market value of equipment
140,000 Notes payable
60,000
Accounts payable
11,000 Capital, January 1, 2002
17,000
Calculate net income and
prepare balance sheet.
(SO 8) AP
Instructions
(a) Determine Judy’s net income from Deer Park for the year ended December 31, 2002.
(b) Prepare a balance sheet for Deer Park as at December 31, 2002.
E1–15—Financial information for the October 2003 operations of the Atlantic Cruise Company is
presented below:
Maintenance expense
$ 80,000
Property tax expense (on dock facilities)
10,000
Salaries expense
142,000
Advertising expense
3,500
Ticket revenue
325,000
Food, fuel, and other operating expenses
20,500
Prepare income statement.
(SO 8) AN
Instructions
Prepare the income statement for the month of October 2003 for the Atlantic Cruise Company.
E1–16—Information related to the proprietorship of Lorraine Ring, lawyer, for the year ended January 31, 2003, is presented below:
Legal fees earned
$360,000
Total expenses
205,000
Assets, February 1, 2002
85,000
Liabilities, February 1, 2002
62,000
Assets, January 31, 2003
168,000
Liabilities, January 31, 2003
70,000
Drawings
?00
Prepare statement of owner’s
equity.
(SO 8) AN
Instructions
Prepare the statement of owner’s equity for Lorraine Ring’s legal practice, for the year ended January 31, 2003, after determining the missing amount for drawings.
PROBLEMS: SET A
P1–1A—Financial decisions often depend more on one type of financial statement than others. Consider each of the following hypothetical situations independently:
(a) The North Face is considering extending credit to a new customer. The terms of the credit
would require the customer to pay within 30 days of receipt of the goods.
(b) An investor is considering investing in WestJet Airlines. The investor plans on holding the
investment for at least five years.
(c) Caisse D’Economie Base Montréal is thinking about extending a loan to a small company. The
company would be required to make interest payments at the end of each year for five years,
and to repay the loan at the end of the fifth year.
Identify users and uses of
financial statements.
(SO 2) AP
Instructions
In each situation, state whether the individual would depend mostly on the information provided
by the income statement, the balance sheet, or the cash flow statement. Provide a brief justification
for your choice.
P1–2A—The president of Richelieu Motors received a draft income statement from his controller
for the year ended December 31, 2002. “Suzanne,” he said to the controller, “the statement indicates
that a net income of $2 million was earned last year. You know the value of the company is more
than $2 million greater than it was this time last year.”
“You’re probably right,” replied Suzanne. “You see, there is an assumption and a generally
Discuss accounting assumptions and GAAP related to
value.
(SO 4, 5) S
39
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CHAPTER 1
Accounting in Action
accepted accounting principle that sometimes keep reported operating results from reflecting the
change in value of a company.”
Instructions
Prepare a short memo explaining what the controller is referring to.
Identify assumption or principle
violated.
(SO 4, 5) AN
P1–3A—A number of accounting reporting situations are described below:
1. Dot.com Company believes its people are its most significant assets. It estimates and records
their value on its balance sheet.
2. Barton Co. is carrying its land at its current market value of $100,000. The land had an original cost of $75,000.
3. Steph Wolfson, president of the Classic CD Company, bought a computer for her personal
use. She paid for the computer with company funds and debited the Computers account.
Instructions
For each of the above, list any assumption or principle that has been violated and explain why the
situation violates this assumption or principle.
Analyse transactions and
calculate net income.
(SO 6, 7) AN
P1–4A—On April 1, Merle Peper established the Peper Travel Agency. The following transactions
were completed during the month:
Apr. 1 Deposited $15,000 cash in the Canadian Imperial Bank of Commerce, in the name of the
agency.
2 Paid $400 cash for April office rent.
2 Purchased office equipment for $2,500 cash.
7 Incurred $300 of advertising costs, on account.
8 Paid $600 cash for office supplies.
11 Earned $9,000 for services rendered: cash of $1,000 is received from customers, and the
balance of $8,000 is billed to customers on account.
15 Withdrew $200 cash for personal use.
25 Paid the amount due in the April 7 transaction.
30 Paid employees’ salaries, $2,200.
30 Received $8,000 in cash from customers who were billed in the April 11 transaction.
Instructions
(a) Prepare a tabular analysis of the transactions using the following column headings: Cash,
Accounts Receivable, Supplies, Office Equipment, Accounts Payable, and Merle Peper, Capital.
(b) From an analysis of the column Capital Merle Peper, calculate the net income or net loss for April.
Analyse transactions and
prepare financial statements.
(SO 7, 8) AN
P1–5A—Julie Szo operates a law office under the name Julie Szo, Barrister & Solicitor. On July 31,
2003, the balance sheet showed Cash $4,000; Accounts Receivable $1,500; Supplies $500; Office
Equipment $5,000; Accounts Payable $4,200; and Julie Szo, Capital $6,800. During August the following transactions occurred:
Aug. 4 Collected $1,400 of accounts receivable.
7 Paid $2,700 cash on accounts payable.
8 Earned fees of $6,400, of which $3,000 is collected in cash and the balance is due in September.
12 Purchased additional office equipment for $1,000, paying $400 in cash and the balance on
account.
15 Paid salaries, $2,500; rent for August, $900; and advertising expenses, $350.
20 Withdrew $550 in cash for personal use.
26 Received $2,000 from the Bank of Montreal—money borrowed on a note payable.
29 Incurred utility expenses for the month on account, $250.
Instructions
(a) Beginning with July the 31 balances, prepare a tabular analysis of the August transactions.
The column headings should be as follows: Cash Accounts Receivable Supplies Office
Equipment Notes Payable Accounts Payable Julie Szo, Capital.
(b) Prepare an income statement for August, a statement of owner’s equity for August, and a balance sheet at August 31, 2003.
Analyse transactions and prepare balance sheet.
(SO 7, 8) AN
P1–6A—The following events relate to Jeannie LeTourneau, a Manitoba law school graduate:
1. On March 4, 2003, she spent $10 on a Lucky Seven Lottery ticket.
2. On March 7, she won $240,000 in the lottery and immediately quit her job as a legal assistant.
3. On March 10, she decided to open her own law practice, and deposited $75,000 of her winnings in a business chequing account.
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Problems: Set A
41
4. On March 14, she purchased a new condominium with a downpayment of $100,000 from her
personal funds plus a home mortgage of $200,000.
5. On March 16, Ms. LeTourneau signed a rental agreement for her law office space, commencing on April 1, 2003. She had to pay a $2,000 cash damage deposit (from her business cash).
It will be fully refundable when she vacates the premises, provided they are in good condition. (Hint: This deposit should be treated as a company asset.) The monthly rental payments
are to be made in advance on the first business day of each month. The first payment of $1,000
is due April 1.
6. On March 20, she hired a receptionist. He will be paid $500 per week, and will report to work
on April 1.
7. On March 25, she purchased a computer and related equipment for her law practice for $3,000
cash plus a $4,000 note payable due in six months.
8. On March 27, she purchased $1,500 of office supplies, on account (to be paid in one month).
9. On March 31, she purchased office furniture for her law practice. The total cost of $5,000 was
paid in cash.
Instructions
(a) Use the accounting equation to analyse the effects of the transactions on Jeannie LeTourneau’s
law practice.
(b) Prepare a balance sheet for Jeannie LeTourneau’s law practice as at March 31, 2003.
P1–7A—The following selected data from the 2002 financial statements for Jatou Trading Company
are in random order:
Liabilities at the end of the year
$ 940,000
Investment by the owner during the year
23,000
Assets at the beginning of the year
1,235,000
Drawings by the owner during the year
64,000
Net income for the year
59,000
Capital at the beginning of the year
250,000
Total revenue for the year
749,000
Use financial statement relationships to determine missing
amounts.
(SO 6, 8) AN
Instructions
Determine the amount of each of the following items:
(a) Liabilities at the beginning of the year
(b) Total expenses for the year
(c) Capital at the end of the year
(d) Assets at the end of the year
P1–8A—On June 1, Ann Okah started Natural Cosmetics Co., a company that provides individual
skin care treatment to clients at their residence. She invested $27,200 cash in the business. Listed
below, in alphabetical order, are the assets and liabilities of the company at June 30, and the revenues
and expenses for the month of June:
Accounts payable
Accounts receivable
Advertising expense
Cash
Cosmetic supplies on hand
Equipment
$ 1,200
4,000
500
12,000
2,400
25,000
Gas and oil expense
Notes payable
Service revenue
Supplies expense
Utilities expense
$ 800
13,000
6,500
1,200
300
Ann made no additional investment in June, but withdrew $1,700 in cash for personal use during
the month.
Instructions
(a) Prepare an income statement and statement of owner’s equity for the month of June, and a balance sheet at June 30, 2003.
(b) Indicate how the financial statements in (a) would be affected by the following additional
data: (1) $800 of fees were earned but not billed or collected at June 30, and (2) $100 of gas and
oil expense was incurred but not recorded or paid.
Prepare financial statements.
(SO 7, 8) AP
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42
CHAPTER 1
Accounting in Action
Determine financial statement
amounts, prepare a statement of
owner’s equity, and comment.
(SO 7, 8) AN
P1–9A—Financial statement information for four different companies is as follows:
Baker Lake
Come By Chance Georgian Bay
Company
Company
Company
January 1, 2002:
Assets
Edmonton
Company
$ 75,000
$ 90,000
(g)00
$150,000
50,000
(d)00
75,000
(j)0i0
(a)00
60,000
45,000
90,000
(b)00
120,000
180,000
(k)0i0
Liabilities
55,000
62,000
(h)00
80,000
Owner’s equity
45,000
(e)00
110,000
140,000
Owner’s equity changes in year:
Investment
(c)ii0
8,000
10,000
15,000
Liabilities
Owner’s equity
December 31, 2002:
Assets
Drawings
10,000
(f)00
12,000
10,000
Total revenues
350,000
400,000
(i)0i0
500,000
Total expenses
335,000
385,000
360,000
(l)i00
Instructions
(a) Determine the missing amounts.
(b) Prepare the statement of owner’s equity for Baker Lake Company.
(c) Write a memorandum explaining (1) the sequence for preparing financial statements, and (2)
the interrelationship of the statement of owner’s equity with the income statement and balance sheet.
Analyse transactions and prepare balance sheet.
(SO 7, 8) AP
P1–10A—The Loonie Bin Coin Shop’s balance sheet at April 29, 2003, consisted of the following
items (listed here in alphabetical order):
Accounts payable
$ 10,000
Furnishings (store)
$ 48,000
Accounts receivable
7,000
Land
36,000
Building
110,000
Long-term debt payable
107,000
Capital
137,000
Notes payable
22,000
Cash
12,000
Office and store supplies
4,000
Equipment (office)
59,000
On the following day, April 30, these transactions and events occurred:
1. Paid $3,000 of the amount owed on accounts payable.
2. Purchased equipment for $15,000. Paid $1,000 in cash and signed a short-term note for the
balance.
3. A professional real estate appraiser estimated the value of the land at $40,000.
4. Sold some surplus office equipment for $5,000 in cash, which was the same as the original
acquisition cost of the equipment.
5. Made a payment of $7,000 on the long-term debt.
Instructions
Prepare, in good form, a balance sheet for the Loonie Bin Coin Shop, as at April 30, 2003. Show supporting calculations for all new amounts.
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Problems: Set B
P1–11A—Michel Carrier organized the Multi-Media Consulting Co. on March 1, 2003. The owner’s
equity column of the tabular summary for the month of March contained the following recorded
data:
Transaction
Amount
Description
1.
4.
6.
8.
11.
12.
15.
18.
20.
22.
24.
27.
29.
32.
34.
36.
$15,000
750
3,250
400
1,000
2,100
250
500
3,200
200
1,000
300
1,100
900
200
150
43
Prepare income statement and
statement of owner’s equity.
(SO 8) AP
Investment
Rent expense
Fees earned
Advertising expense
Salaries expense
Fees earned
Utilities expense
Drawings
Fees earned
Repair expense
Advertising expense
Drawings
Fees earned
Salaries expense
Property tax expense
Utilities expense
All data were properly recorded except the following:
• In transaction 22, $50 of the repair expense was applicable to Michel’s personal residence.
• In transaction 34, $150 was applicable to business property; the remainder was applicable to
the owner’s personal residence.
Instructions
(a) Prepare an income statement for the month of March.
(b) Prepare a statement of owner’s equity for March.
PROBLEMS: SET B
P1–1B—Financial decisions often depend more on one type of financial statement than on others.
Consider each of the following hypothetical situations independently:
(a) An Ontario investor is considering investing in Bally Total Fitness Company, which operates
13 fitness centres in the Toronto area. The investor plans on holding the investment for at least
three years.
(b) Bombardier is considering extending credit to a new customer. The company would require
the customer to pay within 60 days of receipt of the goods.
(c) The Laurentian Bank is considering extending a loan to a small company. The company would
be required to make interest payments at the end of each month for five years, and to repay
the loan at the end of the fifth year.
Identify users and uses of financial statements.
(SO 2) AP
Instructions
In each situation, state whether the individual would depend mostly on the information provided
by the income statement, balance sheet, or cash flow statement. Provide a brief justification for your
choice.
P1–2B—The president of Montiero Company received a draft balance sheet from her controller for
the year ended December 31, 2002. “Sergio,” she said to her controller, “the statement shows total
assets of $2 million. You know the value of the company’s assets is far more than $2 million.”
“You’re right,” replied Sergio. “You see, there is an assumption and a generally accepted
accounting principle that prohibit the recording of assets on the books at their market value.”
Instructions
Prepare a short memo explaining what the controller is referring to.
Discuss accounting assumptions
and GAAP related to value.
(SO 4, 5) S
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CHAPTER 1
Accounting in Action
Identify assumption or principle
violated.
(SO 4, 5) AN
P1–3B—A number of accounting reporting situations are described below:
1. In preparing its financial statements, Karim Corporation tried to estimate and record the
impact of the recent death of its president.
2. Paradis Company recently purchased a power boat. It plans on inviting clients for outings
occasionally, so the boat was paid for with company funds, and recorded in the company’s
records. Marc Paradis’s family will use the boat whenever it is not being used to entertain
clients. It is estimated that the boat will be used by the family about 75 percent of the time.
3. Because of a “flood sale,” equipment worth $300,000 was purchased for only $200,000. The
equipment was recorded for $300,000 on the company’s books.
Instructions
For each of the above, list any assumption or principle that has been violated. Explain why the situation described violates the assumptions or principles.
Analyse transactions and
calculate net income.
(SO 6, 7) AN
P1–4B—Kumar’s Repair Shop was started on May 1 by U. Kumar. A summary of the May transactions is presented below:
May 1 Invested $15,000 cash to start the repair shop.
2 Purchased equipment for $5,000 cash.
5 Paid $400 cash for May office rent.
7 Purchased $500 of supplies on account.
9 Received $4,100 in cash from customers for repair service.
15 Withdrew $500 cash for personal use.
15 Paid part-time employee salaries, $1,000.
23 Paid utility bills, $140.
28 Provided repair service on account to customers, $400.
30 Collected cash of $120 for services billed on May 28.
Instructions
(a) Prepare a tabular analysis of the transactions, using the following column headings: Cash,
Accounts Receivable, Supplies, Equipment, Accounts Payable, and U. Kumar, Capital. Revenue is called Service Revenue.
(b) From an analysis of the U. Kumar, Capital column, calculate the net income or net loss for May.
Analyse transactions and prepare financial statements.
(SO 7, 8) AP
P1–5B—Bruce Smith opened Smith Veterinary Clinic in Saskatoon, on August 1, 2003. On August
31, the balance sheet showed Cash $9,000; Accounts Receivable $1,700; Supplies $600; Office Equipment $6,000; Accounts Payable $3,600; and B. Smith, Capital $13,700. During September the following transactions occurred:
Sept. 1 Paid $3,100 cash on accounts payable.
4 Collected $1,300 of accounts receivable.
8 Purchased additional office equipment for $2,100, paying $800 in cash and the balance on
account.
17 Earned revenue of $5,900, of which $2,500 is paid in cash and the balance is due in October.
19 Withdrew $600 cash for personal use.
25 Received $7,000 from the Western Bank––money borrowed on a note payable.
30 Paid salaries, $700; rent for September, $900; and advertising expense, $300.
30 Incurred utility expenses for the month on account, $170.
Instructions
(a) Prepare a tabular analysis of the September transactions beginning with the August 31 balances. The column headings should be as follows: Cash + Accounts Receivable + Supplies +
Office Equipment = Notes Payable + Accounts Payable + B. Smith, Capital.
(b) Prepare an income statement for September, a statement of owner’s equity for September, and
a balance sheet at September 30, 2003.
Analyse transactions and
prepare income statement and
balance sheet.
(SO 7, 8) AP
P1–6B—Jessica Bell started her own consulting firm, Bell Consulting, on May 1, 2003. The following transactions occurred during the month of May:
May 1 Bell invested $4,000 cash in the business.
2 Paid $800 for office rent for the month.
3 Purchased $500 of supplies on account.
5 Paid $50 to advertise in the County News.
9 Received $1,000 cash for services provided.
12 Withdrew $700 cash for personal use.
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Problems: Set B
15
17
20
23
26
29
30
Performed $3,000 of services on account.
Paid $2,500 for employee salaries.
Paid for the supplies purchased on account on May 3.
Received a cash payment of $2,000 for services provided on account on May 15.
Borrowed $5,000 from the bank on a note payable.
Purchased office equipment for $2,400.
Paid $150 for utilities.
Instructions
(a) Show the effects of each transaction on the accounting equation.
(b) Prepare an income statement for the month of May.
(c) Prepare a balance sheet at May 31, 2003.
P1–7B—The following selected data from the 2002 financial statements for the Ojibway Trading
Company are in random order:
Liabilities at the end of the year
$ 910,000
Investments by the owner during the year
30,000
Assets at the beginning of the year
1,265,000
Drawings by the owner during the year
74,000
Net income for the year
56,000
Capital at the beginning of the year
245,000
Total revenue for the year
687,000
Use financial statement
relationships to determine
missing amounts.
(SO 6, 8) AN
Instructions
Determine the amount of each of the following items:
(a) Liabilities at the beginning of the year
(b) Total expenses for the year
(c) Capital at the end of the year
(d) Assets at the end of the year
P1–8B—On September 1, Emily Jackson started Specialty Cosmetics Co., by investing $10,000 cash
in the business. The alphabetical list below shows the assets and liabilities of the company at September 30, and the revenues and expenses for the month of September:
Accounts payable
$1,800
Equipment
$20,000
Accounts receivable
5,000
Notes payable
15,000
Advertising expense
600
Service revenue
5,900
Cash
9,000
Supplies expense
1,500
Cosmetic supplies
2,700
Utilities expense
1,300
Emily invested an additional $10,000 on September 20, and withdrew $2,600 in cash for personal use
during the month.
Instructions
(a) Prepare an income statement and statement of owner’s equity for the month of September, and
a balance sheet at September 30, 2003.
(b) Indicate how the financial statements in (a) would be affected by the following additional
data: (1) Fees of $900 were earned but not billed or collected at September 30. (2) Gas and oil
expense of $300 was incurred but not recorded or paid.
Prepare financial statements.
(SO 7, 8) AP
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CHAPTER 1
Accounting in Action
Determine financial statement
amounts, prepare a statement of
owner’s equity, and comment.
(SO 7, 8) AP
P1–9B—Financial statement information for four different companies is as follows:
Montreal
Calgary
Edmonton
Vancouver
Company
Company
Company
Company
January 1, 2002:
Assets
$80,000
$110,000
(g)—
$170,000
50,000
(d)—
75,000
(j)—
(a)—
60,000
50,000
90,000
December 31, 2002:
Assets
— (b)—
Liabilities
55,000
145,000
200,000
(k)—
65,000
(h)—
80,000
(e)—
130,000
180,000
15,000
10,000
15,000
(f)—
14,000
20,000
(i)—
520,000
Liabilities
Owner’s equity —
Owner’s equity
58,000
Owner’s equity changes in year:
Investments
— (c)—
Drawings
25,000
—
Total revenues
350,000
420,000
Total expenses
320,000
385,000
—
—
—
350,000
—
(l)—
Instructions
(a) Determine the missing amounts.
(b) Prepare a statement of owner’s equity for Calgary Company.
(c) Write a memorandum explaining (1) the sequence for preparing financial statements, and (2) the
interrelationship of the statement of owner’s equity with the income statement and balance sheet.
Analyse transactions and prepare balance sheet.
(SO 7, 8) AP
P1–10B—The Franc d’Or Coin Shop’s balance sheet at June 29, 2003, consisted of the following
items (which are listed here in alphabetical order):
Accounts payable
$ 11,000
Equipment (store)
$ 24,000
Accounts receivable
6,000
Land
40,000
Building
120,000
Long-term debt payable
111,000
Capital
189,000
Merchandise inventory
110,000
Cash
13,000
Notes payable
20,000
Equipment (office)
12,000
Office and store supplies
6,000
On the following day, June 30, these transactions and events occurred:
1. Paid $4,000 of the amounts owed on accounts payable.
2. Purchased office equipment for $5,000, paid $1,500 in cash, and signed a short-term note for
the balance.
3. A professional real estate appraiser estimated the value of the land at $150,000.
4. Sold some surplus store equipment for $4,500 in cash, which was the same as the original
acquisition cost of the equipment.
5. Made a payment of $8,000 on the long-term debt.
Instructions
Prepare, in good form, a balance sheet for the Franc d’Or Coin Shop as at June 30, 2003. Show supporting calculations for all new amounts. (Hint: Merchandise inventory is an asset, representing
goods on hand for sale.)
Prepare income statement and
statement of owner’s equity.
(SO 8) AP
P1–11B— Theresa Nash organized Nash Consulting Co. on January 1, 2003. The owner’s equity
column of the tabular summary for the month of January contained the following recorded data:
Transaction
Amount
1.
4.
6.
8.
11.
12.
15.
18.
20.
22.
$12,000
800
3,750
450
1,200
2,300
300
600
3,700
250
Description
Investment
Rent expense
Service revenue
Advertising expense
Salaries expense
Service revenue
Utilities expense
Drawings
Service revenue
Repair expense
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 47
Financial Reporting and Analysis
24.
27.
29.
32.
34.
36.
1,100
400
1,200
1,000
250
180
Advertising expense
Drawings
Service revenue
Salaries expense
Property tax expense
Utilities expense
All data were properly recorded except the following:
• In transaction 32, $500 of the salary expense was paid to Theresa Nash herself.
• In transaction 34, $150 was applicable to business property, and the remainder to the owner’s
personal residence.
Instructions
(a) Prepare an income statement for the month of January.
(b) Prepare a statement of owner’s equity for January.
Broadening Your Perspective
FINANCIAL REPORTING AND ANALYSIS
Financial Reporting Problem
BYP1–1—The actual financial statements of The Second Cup Ltd., as presented in the company’s
2000 Annual Report, are contained in Appendix A (at the back of the textbook).
Instructions
Refer to The Second Cup’s financial statements and answer the following questions:
(a) How many notes to the financial statements are presented for The Second Cup? How many
pages of the annual report do these notes occupy? How many pages do the financial statements themselves occupy?
(b) Notice that the dates on the financial statements are June 24, 2000, and June 30, 1999. (The
company’s 1998 financial statements were dated June 27.) What is The Second Cup’s fiscal
year end?
(c) Who are the auditors for The Second Cup Ltd.?
(d) What were The Second Cup’s total assets as at June 24, 2000? June 30, 1999?
(e) What is the amount of change in The Second Cup’s net earnings (loss) from 1999 to 2000?
(f) What amount of cash and cash equivalents did The Second Cup have on June 24, 2000?
June 30, 1999?
(g) Refer to the five-year financial review which is included in the annual report. What was the
percentage change in systemwide sales from 1996 to 2000?
®
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CHAPTER 1
Accounting in Action
Interpreting Financial Statements
BYP1–2—Corel Corporation is an innovative Canadian software company. The company’s products,
which include CorelDRAW® and WordPerfect® 1, are used by more than 50 million people worldwide. Corel’s 2000 annual report included the following excerpt from its corporate profile statement:
With over 1,300 employees in two locations and sales offices worldwide, Corel is one of the
world’s top software developers. The Company’s corporate headquarters in Ottawa,
Canada, is home to its business and graphics development teams. Its Dublin, Ireland, office
handles software localization, along with a portion of the Company’s technical support and
customer service. ... Recognized the world over, Corel’s award-winning products ship in
over 15 languages through a network of more than 160 distributors in over 60 countries.
Additional Cases
COREL CORPORATION
Balance Sheet
As at November 30
(in thousands of US$)
4
2000
1999
$127,430
1,136
$ 18,021
28,620
773
3,117
54,770
3,954
13,567
5,135
1,642
2,042
Assets
Current assets
Cash and cash equivalents
Restricted cash
Accounts receivable
Trade
Other
Inventory
Income taxes recoverable
Future tax asset
Prepaid expenses
Total current assets
Investments
Capital assets
Other assets
Total assets
479
1,050
162,605
11,996
42,471
1,515
99,131
2,873
49,697
$218,587
$151,701
Instructions
(a) What do you think the most important economic resources (assets) would be for a software
development company such as Corel? Where would these be recorded on the balance sheet?
At what value (if any) should they be shown?
(b) Does the balance sheet tell you what Corel Corporation is worth? What information does the
balance sheet give you about the value of the Company?
(c) Why do you think a Canadian company such as Corel would prepare its financial statements
in U.S. dollars?
1
Corel, CorelDraw, WordPerfect, and the Corel logo are registered trademarks of Corel Corporation or Corel Corporation Limited.
Accounting on the Web
t2
nd
le
.wi y.co
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weyga
a/
canad
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BYP1–3—This case views the websites of professional accounting organizations and firms, amongst
others, to learn about career opportunities. We’ll find out the educational and experience requirements for accounting and related careers, and read about the exciting lives of prominent accountants
in sports, entertainment, industry, business, and government.
Instructions
Specific requirements of this Internet case are available on-line on the Weygandt website.
ww
Weygandt Chap 01v2.qxd 10/25/01 10:33 pm Page 49
Critical Thinking
CRITICAL THINKING
Collaborative Learning Activity
BYP1–4—Patsy and Perry Ross, local golf stars, opened the Long-Shot Driving Range on May 1,
2003, by investing $10,000 of their cash savings in the business. A caddy shack was constructed for
cash at a cost of $4,000, and $1,800 was spent on golf balls and golf clubs. The Rosses leased five acres
of land at a cost of $1,000 per month and paid the first month’s rent. During the first month, advertising costs totalled $750, of which $150 was unpaid at May 31. Members of the high school golf team
were paid $400 for retrieving golf balls. All fees from customers were deposited in the company’s
bank account. On May 15, Patsy and Perry withdrew $800 in cash for personal living expenses. A
$100 utility bill was received on May 31, but it was not paid. On May 31, the balance in the company’s bank account was $7,550.
Patsy and Perry weren’t sure how they did in their first month of operations. Their estimates
of profitability ranged from a loss of $2,450 to net income of $3,100.
Instructions
With the class divided into groups, answer the following:
(a) How could the Rosses have concluded that the business operated at a loss of $2,450? Was this
a valid way to determine net income?
(b) How could the Rosses have concluded that the business operated at a net income of $3,100?
(Hint: Prepare a balance sheet at May 31.) Was this a valid way to determine net income?
(c) Without preparing an income statement, determine the actual net income for May.
(d) What were the fees earned in May? (Hint: You can determine this either by (1) preparing an
income statement, and using your answer from part (c) and the information about expenses,
and then inserting the missing amount for fees earned [revenue], or (2) by analysing the
changes in cash and inserting the missing amount for fees [cash receipts].)
Communication Activity
BYP1–5—Israel Unger is the owner of Mount Company. Israel has prepared the following balance
sheet:
MOUNT COMPANY
Balance Sheet
For the Month Ended December 31, 2002
Assets
Equipment
Cash
Supplies
Accounts payable
$21,500
9,000
2,000
(6,000)
Total assets
$26,500
Liabilities and Owner’s Equity
Unger, Capital
Accounts receivable
Unger, Drawings
Notes payable
Total liabilities and owner’s equity
$21,000
(3,000)
(2,000)
10,500
$26,500
Instructions
Explain to Israel, in a memo, why the original balance sheet is incorrect and what should be done
to correct it.
49
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CHAPTER 1
Accounting in Action
Ethics Case
BYP1–6—After numerous campus interviews, Stephane Pelli, a graduating student at the University of New Brunswick, Fredericton, received interview offers from two large firms located in Saint
John, New Brunswick. Both firms offered to cover his out-of-pocket expenses (travel, hotel, and
meals). He scheduled the interviews for both firms on the same day, one in the morning and one in
the afternoon.
At the conclusion of each interview, Stephane submitted to each firm his total out-of-pocket
expenses for the trip: use of private vehicle $70 (280 kilometres at $0.25), hotel $120, meals $36, plus
parking and tips $18, for a total of $244. He believes this approach is appropriate. If he had made
two trips, his cost would have been two times $244. He is also certain that neither firm knew he had
visited the other on that same trip.
Within a few days, Stephane received two cheques in the mail, each for $244.
Instructions
(a) Who are the stakeholders (affected parties) in this situation?
(b) What are the ethical issues in this case?
(c) What would you do in this situation?
Answers to Self-Study Questions
1. b–2. d–3. a–4. d–5. d–6. c–7. a–8. b–9. d–10. b–11. b–12. c
®
Answer to Review It Question 2
The net earnings of $972,000 on the Statement of Operations (also known as the Income Statement)
are included on the Statement of Retained Earnings (Deficit) to determine the ending deficit of
$60,657,000. In fact, these two statements are combined as one for presentation purposes. The ending deficit amount of $60,657,000 is reported on the Balance Sheet. The cash and cash equivalents
of $1,446,000 on the balance sheet is also shown on the Cash Flow Statement as the ending balance.
✔
Remember to go back to the Navigator box on the chapter-opening page
to check off your completed work.
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▲
Concepts for Review
Before studying this chapter, you should understand or, if necessary, review:
a. What assets, liabilities, owner's capital, owner's drawings, revenues, and
expenses are. (Ch. 1, pp. 14–16)
b. Why assets equal liabilities plus owner's equity. (Ch. 1, p. 14)
c. What transactions are, and how they affect the basic accounting equation.
(Ch. 1, pp. 18–23)
✔
THE
NAVIGATOR
No Such Thing As
a Perfect World
SURREY, B.C.—When she got a job
doing the accounting for Forster’s
Restaurants, Tanis Anderson had
almost finished her Business Administration degree at Simon Fraser University. But even after Tanis completed
her degree requirements, her education still continued—this time, in the
real world.
Tanis’s responsibilities include
paying the bills, tracking food and
labour costs, and managing the payroll
for The Mug and Musket, a popular
destination restaurant in Surrey, B.C.
“My title is Director of Finance,” she
laughs, “but really that means I take
care of whatever needs doing!”
The use of judgement is a big part
of the job. As Tanis says,“I learned all
the fundamentals in my business
classes, but school prepares you for a
perfect world, and there is no such
thing.”
She feels fortunate that her
boss understands that her job is a
learning experience as well as a
responsibility.“Sometimes he’s let me
do something he knew perfectly well
was a mistake so I can learn some-
thing through experience,” she admits.
On the other hand, some tasks,
like recording transactions, she finds
easier to do in the real world than
they were in school. “Our computer
software, Simply Accounting, really
helps,” she explains.“Recording transactions using the software, after
you’ve learned how to do it by hand,
is like boiling water in a microwave
instead of on a campfire. It’s fast and
easy.” It also makes repairing mistakes
much easier. “If I goof up an entry,”
says Tanis,“I can just go back and fix it,
without making fifteen adjustments.”
✔
THE
NAVIGATOR