Study Objectives
1.
Explain what accounting is.
2.
Identify the users and uses of accounting.
3.
Understand why ethics is a fundamental business concept.
4.
Explain generally accepted accounting principles and the
cost principle.
5.
Explain the monetary unit assumption and the economic
entity assumption.
6.
State the accounting equation, and define assets, liabilities,
and stockholders’ equity.
7.
Analyze the effects of business transactions on the
accounting equation.
8.
Understand the four financial statements and how they are
prepared.
Chapter
1-1
Chapter 1
Accounting In
Action
Financial Accounting, Sixth Edition
Chapter
1-2
Accounting in Action
What is
Accounting?
Three
activities
Who uses
accounting
data
The Building
Blocks of
Accounting
Ethics in
financial
reporting
Generally
accepted
accounting
principles
Assumptions
Chapter
1-3
The Basic
Accounting
Equation
Assets
Using the
Basic
Accounting
Equation
Financial
Statements
Liabilities
Transaction
analysis
Income
statement
Stockholders'
equity
Summary of
transactions
Statement of
retained
earnings
Balance
sheet
Statement of
cash flows
What is Accounting?
The purpose of accounting is to:
(1) identify, record, and communicate the
economic events of an
(2) organization to
(3) interested users.
Chapter
1-4
SO 1 Explain what accounting is.
What is Accounting?
Three Activities
Illustration 1-1
Accounting process
The accounting process includes
the bookkeeping function.
Chapter
1-5
SO 1 Explain what accounting is.
Who Uses Accounting Data?
Internal Users
Management
IRS
Investors
Human
Resources
Finance
Common Questions
Creditors
Marketing
Customers
Chapter
1-6
Labor
Unions
SEC
External
Users
SO 2 Identify the users and uses of accounting.
Who Uses Accounting Data?
Common Questions Asked
1. Can we afford to give our
employees a pay raise?
User
Human Resources
2. Did the company earn a
satisfactory income?
Investors
3. Do we need to borrow in the
near future?
4. Is cash sufficient to pay
dividends to the stockholders?
Management
Finance
5. What price for our product
will maximize net income?
Marketing
6. Will the company be able to
pay its short-term debts?
Creditors
Chapter
1-7
SO 2 Identify the users and uses of accounting.
Who Uses Accounting Data?
Discussion Question
Q1. “Accounting is ingrained in our society and it is
vital to our economic system.” Do you agree? Explain.
See notes page for discussion
Chapter
1-8
SO 3 Understand why ethics is a fundamental business concept.
The Building Blocks of Accounting
Ethics In Financial Reporting
Standards of conduct by which one’s actions are
judged as right or wrong, honest or dishonest, fair or
not fair, are Ethics.
Recent financial scandals include: Enron,
WorldCom, HealthSouth, AIG, and others.
Congress passed Sarbanes-Oxley Act of 2002.
Effective financial reporting depends on sound
ethical behavior.
Chapter
1-9
SO 3 Understand why ethics is a fundamental business concept.
Ethics
Review Question
Ethics are the standards of conduct by which one's
actions are judged as:
a. right or wrong.
b. honest or dishonest.
c. fair or not fair.
d. all of these options.
Chapter
1-10
SO 3 Understand why ethics is a fundamental business concept.
The Building Blocks of Accounting
Various users
need financial
information
The accounting profession
has attempted to develop
a set of standards that
are generally accepted
and universally practiced.
Chapter
1-11
Financial Statements
Balance Sheet
Income Statement
Retained Earnings Statement
Statement of Cash Flows
Note Disclosure
Generally Accepted
Accounting
Principles (GAAP)
SO 4 Explain generally accepted accounting principles and the cost principle.
The Building Blocks of Accounting
Organizations Involved in Standard Setting:
Securities and Exchange Commission (SEC)
http://www.sec.gov/
Financial Accounting Standards Board (FASB)
http://www.fasb.org/
International Accounting Standards Board
(IASB)
http://www.iasb.org/
Chapter
1-12
SO 4 Explain generally accepted accounting principles and the cost principle.
The Building Blocks of Accounting
Cost Principle (Historical) – dictates that companies
record assets at their cost.
Issues:
Reported at cost when purchased and also over the
time the asset is held.
Cost easily verified, whereas market value is often
subjective.
Fair value information may be more useful.
Chapter
1-13
SO 4 Explain generally accepted accounting principles and the cost principle.
Assumptions
Monetary Unit Assumption – include in the
accounting records only transaction data that can be
expressed in terms of money.
Economic Entity Assumption – requires that
activities of the entity be kept separate and distinct
from the activities of its owner and all other economic
entities.
Proprietorship.
Partnership.
Forms of
Business Ownership
Corporation.
Chapter
1-14
SO 5 Explain the monetary unit assumption
and the economic entity assumption.
Forms of Business Ownership
Proprietorship
Chapter
1-15
Partnership
Corporation
Generally owned
by one person.
Owned by two or
more persons.
Often small
service-type
businesses
Often retail and
service-type
businesses
Ownership
divided into
shares of stock
Owner receives
any profits,
suffers any
losses, and is
personally liable
for all debts.
Generally
unlimited
personal liability
Separate legal
entity organized
under state
corporation law
Limited liability
Partnership
agreement
SO 5 Explain the monetary unit assumption
and the economic entity assumption.
Assumptions
Review Question
Combining the activities of Kellogg and General
Mills would violate the
a. cost principle.
b. economic entity assumption.
c. monetary unit assumption.
d. ethics principle.
Chapter
1-16
SO 5 Explain the monetary unit assumption
and the economic entity assumption.
Forms of Business Ownership
Review Question
A business organized as a separate legal entity
under state law having ownership divided into
shares of stock is a
a. proprietorship.
b. partnership.
c. corporation.
d. sole proprietorship.
Chapter
1-17
SO 5 Explain the monetary unit assumption
and the economic entity assumption.
The Basic Accounting Equation
Assets
=
Liabilities
+
Stockholders’
Equity
Provides the underlying framework for recording and
summarizing economic events.
Assets are claimed by either creditors or owners.
Claims of creditors must be paid before ownership
claims.
Chapter
1-18
SO 6 State the accounting equation, and define
assets, liabilities, and stockholders’ equity.
The Basic Accounting Equation
Assets
=
Liabilities
+
Stockholders’
Equity
Provides the underlying framework for recording and
summarizing economic events.
Assets
Resources a business owns.
Provide future services or benefits.
Cash, Supplies, Equipment, etc.
Chapter
1-19
SO 6 State the accounting equation, and define
assets, liabilities, and stockholders’ equity.
The Basic Accounting Equation
Assets
=
Liabilities
+
Stockholders’
Equity
Provides the underlying framework for recording and
summarizing economic events.
Liabilities
Claims against assets (debts and obligations).
Creditors - party to whom money is owed.
Accounts payable, Notes payable, etc.
Chapter
1-20
SO 6 State the accounting equation, and define
assets, liabilities, and stockholders’ equity.
The Basic Accounting Equation
Assets
=
Liabilities
+
Stockholders’
Equity
Provides the underlying framework for recording and
summarizing economic events.
Stockholders’ Equity
Ownership claim on total assets.
Referred to as residual equity.
Paid-in Capital, Retained Earnings (Corporation).
Chapter
1-21
SO 6 State the accounting equation, and define
assets, liabilities, and stockholders’ equity.
Stockholders’ Equity
Illustration 1-6
Revenues result from business activities entered into for
the purpose of earning income.
Common sources of revenue are: sales, fees, services,
commissions, interest, dividends, royalties, and rent.
Chapter
1-22
SO 6 State the accounting equation, and define
assets, liabilities, and stockholders’ equity.
Stockholders’ Equity
Illustration 1-6
Expenses are the cost of assets consumed or services
used in the process of earning revenue.
Common expenses are: salaries expense, rent expense,
utilities expense, tax expense, etc.
Chapter
1-23
SO 6 State the accounting equation, and define
assets, liabilities, and stockholders’ equity.
Stockholders’ Equity
Illustration 1-6
Dividends are the distribution of cash or other assets to
stockholders.
Dividends reduce retained earnings, however dividends are
not an expense.
Chapter
1-24
SO 6 State the accounting equation, and define
assets, liabilities, and stockholders’ equity.
Using The Basic Accounting Equation
Transactions are a business’s economic events
recorded by accountants.
May be external or internal.
Not all activities represent transactions.
Each transaction has a dual effect on the
accounting equation.
Chapter
1-25
SO 7 Analyze the effects of business transactions
on the accounting equation.
Transactions
Question: Are the following events recorded in the
accounting records?
An employee
is hired.
Dividends are
paid to
stockholders’.
Event
Supplies are
purchased
on account.
Criterion
Is the financial position (assets, liabilities, or
stockholders’ equity) of the company changed?
Record/
Don’t Record
Chapter
1-26
SO 7 Analyze the effects of business transactions
on the accounting equation.
Transactions
Discussion Question
Q18. In February 2008, Paula King invested an
additional $10,000 in Hardy Company. Hardy’s
accountant, Lance Jones, recorded this receipt
as an increase in cash and revenues. Is this
treatment appropriate? Why or why not?
See notes page for discussion
Chapter
1-27
SO 7 Analyze the effects of business transactions
on the accounting equation.
Transactions (Problem)
P1-1A: Barone’s Repair Shop was started on May.
Prepare a tabular analysis of the following transactions
for the month of May.
1. Stockholders invested $10,000 cash to start the
repair shop.
Assets
Cash
1. +10,000
Chapter
1-28
Liabilities
Stockholders’ Equity
Accounts
Accounts
Common
+ Receivable + Equipment = Payable + Stock
+10,000
Investment
SO 7 Analyze the effects of business transactions
on the accounting equation.
Transactions (Problem)
2. Purchased equipment for $5,000 cash.
Liabilities
Assets
Cash
Accounts
Accounts
Common
+ Receivable + Equipment = Payable + Stock
1. +10,000
2. -5,000
Chapter
1-29
Stockholders’ Equity
+10,000
Investment
+5,000
SO 7 Analyze the effects of business transactions
on the accounting equation.
Transactions (Problem)
3. Paid $400 cash for May office rent.
Liabilities
Assets
Cash
Accounts
Accounts
Common Retained
+ Receivable + Equipment = Payable + Stock + Earnings
1. +10,000
2. -5,000
3.
Chapter
1-30
-400
Stockholders’ Equity
+10,000
+5,000
-400
Expense
SO 7 Analyze the effects of business transactions
on the accounting equation.
Transactions (Problem)
4. Received $5,100 from customers for repair service.
Liabilities
Assets
Cash
Accounts
Accounts
Common Retained
+ Receivable + Equipment = Payable + Stock + Earnings
1. +10,000
2. -5,000
3.
4.
-400
+5,100
Chapter
1-31
Stockholders’ Equity
+10,000
+5,000
-400
+5,100
Revenue
SO 7 Analyze the effects of business transactions
on the accounting equation.
Transactions (Problem)
5. Paid dividends of $1,000 cash.
Liabilities
Assets
Cash
Accounts
Accounts
Common Retained
+ Receivable + Equipment = Payable + Stock + Earnings
1. +10,000
2. -5,000
Stockholders’ Equity
+10,000
+5,000
3.
4.
-400
+5,100
-400
+5,100
5.
-1,000
-1,000
Chapter
1-32
SO 7 Analyze the effects of business transactions
on the accounting equation.
Transactions (Problem)
6. Paid part-time employee salaries of $2,000.
Liabilities
Assets
Cash
Accounts
Accounts
Common Retained
+ Receivable + Equipment = Payable + Stock + Earnings
1. +10,000
2. -5,000
3.
4.
Stockholders’ Equity
+10,000
+5,000
-400
+5,100
-400
+5,100
5. -1,000
6. -2,000
-1,000
-2,000
Expense
Chapter
1-33
SO 7 Analyze the effects of business transactions
on the accounting equation.
Transactions (Problem)
7. Incurred $250 of advertising costs, on account.
Liabilities
Assets
Cash
Accounts
Accounts
Common Retained
+ Receivable + Equipment = Payable + Stock + Earnings
1. +10,000
2. -5,000
3.
4.
Stockholders’ Equity
+10,000
+5,000
-400
+5,100
-400
+5,100
5. -1,000
6. -2,000
-1,000
-2,000
7.
Chapter
1-34
+250
-250
Expense
SO 7 Analyze the effects of business transactions
on the accounting equation.
Transactions (Problem)
8. Provided repair services on account to customers $750.
Liabilities
Assets
Cash
Accounts
Accounts
Common Retained
+ Receivable + Equipment = Payable + Stock + Earnings
1. +10,000
+10,000
2. -5,000
3.
4.
Stockholders’ Equity
+5,000
-400
+5,100
-400
+5,100
5. -1,000
6. -2,000
-1,000
-2,000
7.
8.
+250
+750
-250
+750
Revenue
Chapter
1-35
SO 7 Analyze the effects of business transactions
on the accounting equation.
Transactions (Problem)
9. Collected $120 cash for services previously billed.
Liabilities
Assets
Cash
Accounts
Accounts
Common Retained
+ Receivable + Equipment = Payable + Stock + Earnings
1. +10,000
+10,000
2. -5,000
3.
4.
Stockholders’ Equity
+5,000
-400
+5,100
-400
+5,100
5. -1,000
6. -2,000
-1,000
-2,000
7.
8.
9.
Chapter
1-36
+250
-250
+750
+750
+120
6,820 +
-120
630 +
5,000 =
250 +
10,000 +
2,200
SO 7 Analyze the effects of business transactions
on the accounting equation.
Financial Statements
Companies prepare four financial statements from
the summarized accounting data:
Income
Statement
Chapter
1-37
Retained
Earnings
Statement
Balance
Sheet
Statement
of Cash
Flows
SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Review Question
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.
Chapter
1-38
SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Income Statement
Barone’s Repair Shop
Income Statement
For the Month Ended May 31, 2007
Revenues:
Service revenue
$
5,850
Expenses:
2,000
Salary expense
Rent expense
400
Advertising expense
250
2,650
Total expenses
Net income
Chapter
1-39
$
Reports the revenues
and expenses for a
specific period of time.
Net income – revenues
exceed expenses.
Net loss – expenses
exceed revenues.
3,200
SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Income Statement
Retained Earnings
Statement
Barone’s Repair Shop
Barone’s Repair Shop
Income Statement
Retained Earnings Statement
For the Month Ended May 31, 2007
For the Month Ended May 31, 2007
Retained earnings, May 1
Revenues:
Service revenue
$
5,850
Expenses:
2,000
Salary expense
Rent expense
400
Advertising expense
250
2,650
Total expenses
Net income
Chapter
1-40
$
3,200
$
-
Add: Net income
3,200
Less: Dividends
(1,000)
Retained earnings, May 31 $
2,200
Net income is needed to
determine the ending balance in
retained earnings.
SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Retained Earnings
Statement
Statement indicates the
reasons why retained
earnings has increased
or decreased during the
period.
Chapter
1-41
Barone’s Repair Shop
Retained Earnings Statement
For the Month Ended May 31, 2007
Retained earnings, May 1
$
-
Add: Net income
3,200
Less: Dividends
(1,000)
Retained earnings, May 31 $
2,200
SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Retained Earnings
Statement
Balance Sheet
Barone’s Repair Shop
Balance Sheet
Barone’s Repair Shop
May 31, 2007
Retained Earnings Statement
Assets
Cash
$
Accounts receivable
630
Equipment
Total assets
6,820
5,000
$ 12,450
Liabilities
Accounts payable
$
250
For the Month Ended May 31, 2007
Retained earnings, May 1
$
-
Add: Net income
3,200
Less: Dividends
(1,000)
Retained earnings, May 31 $
2,200
Stockholders' Equity
Common stock
10,000
Retained earnings
2,200
Total liab. & equity
Chapter
1-42
$ 12,450
The ending balance in retained
earnings is needed in preparing the
balance sheet.
SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Balance Sheet
Barone’s Repair Shop
Balance Sheet
May 31, 2007
Assets
Cash
$
Accounts receivable
630
Equipment
Total assets
6,820
5,000
$ 12,450
Liabilities
Accounts payable
$
250
Stockholders' Equity
Common stock
10,000
Retained earnings
2,200
Total liab. & equity
Chapter
1-43
$ 12,450
Reports the assets,
liabilities, and
stockholders’ equity at a
specific date.
Assets listed at the top,
followed by liabilities
and stockholders’ equity.
Total assets must equal
total liabilities and
stockholders’ equity.
SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Balance Sheet
Statement of Cash Flows
Barone’s Repair Shop
Barone’s Repair Shop
Balance Sheet
Statement of Cash Flows
May 31, 2007
For the Month Ended May 31, 2007
Common stock
10,000
Cash flow from Operations
Cash receipts from customers
Cash paid for expenses
Cash provided by operations
Cash flow from Investing
Purchase of equipment
Cash flow from Financing
Investment by owners
Drawings by owners
Cash provided by financing
Net increase in cash
Retained earnings
2,200
Cash balance, May 1
Assets
Cash
$
Accounts receivable
630
Equipment
Total assets
6,820
5,000
$ 12,450
Liabilities
Accounts payable
$
250
Stockholders' Equity
Total liab. & equity
Chapter
1-44
$ 12,450
Cash balance, May 31
$
5,220
(2,400)
2,820
(5,000)
10,000
(1,000)
9,000
6,820
-
$
6,820
SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Information for a
specific period of time.
Answers the following:
1. Where did cash come
from?
2. What was cash used
for?
3. What was the change
in the cash balance?
Statement of Cash Flows
Barone’s Repair Shop
Statement of Cash Flows
For the Month Ended May 31, 2007
Cash flow from Operations
Cash receipts from customers
Cash paid for expenses
Cash provided by operations
Cash flow from Investing
Purchase of equipment
Cash flow from Financing
Investment by owners
Drawings by owners
Cash provided by financing
Net increase in cash
5,220
(2,400)
2,820
(5,000)
10,000
(1,000)
9,000
6,820
Cash balance, May 1
Cash balance, May 31
Chapter
1-45
$
$
6,820
SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Review Question
Which of the following financial statements is
prepared as of a specific date?
a. Balance sheet.
b. Income statement.
c. Statement of stockholders’ equity.
d. Statement of cash flows.
Chapter
1-46
SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Discussion Question
Q19. “A company’s net income appears directly
on the income statement and the retained
earnings statement, and it is included indirectly
in the company’s balance sheet.” Do you agree?
Explain.
See notes page for discussion
Chapter
1-47
SO 8 Understand the four financial statements and how they are prepared.
All About You
Ethics: Managing Personal Financial Reporting
When students need money for school, they often
apply for financial aid. Why do the Department of
Education and your school want this information?
Bottom line: The worse off you look financially, the
more likely you are to get money.
Question: Should you intentionally make yourself
look worse off than you are?
Chapter
1-48
All About You
Some Facts:
After adjusting for inflation, private-college
tuition and fees have increased 37% over the
past decade; public-college tuition has risen 54%.
Two-thirds (65.6%) of undergraduate students
graduate with some debt.
Among graduating seniors, the average debt load
is $19,202.
Chapter
1-49
All About You
Source: College
Board, Princeton
Review, as reported in
“College Admissions:
Is Gate Open or
Closed?,” Wall Street
Journal, March 25,
2006, p. A7.
Chapter
1-50
All About You
What Do You Think?
To increase your chances of receiving aid, should you
use available cash to pay off your credit card bills, and
therefore make yourself look “worse off” to the
financial aid decision makers?
YES: You are simply restructuring your assets and
liabilities to best conform with the preferences
that are built into the federal aid formulas.
Chapter
1-51
NO: You are taking advantage of a loophole in the
federal aid rules and potentially depriving someone who
is actually worse off than you from receiving aid.
Copyright
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Reproduction or translation of this work beyond that permitted
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use of these programs or from the use of the information
contained herein.
Chapter
1-52