Chapter 1
Accounting in Action
ACT 201
By: Ms. Adina Malik (ALK)
Accounting
What is Accounting?
◦ Accounting is an information system that identifies, records
and communicates the economic events of an organization
to interested users.
Economic Events?
◦ Monetary transactions
◦ For e.g. Cement bags sold by Crown Cement for Tk. 500,000.
◦ For e.g. Payment of salaries to BRAC Bank employees.
Users of Accounting Data
Internal
 marketing managers,
production supervisors, finance
directors, company officers
(more in Managerial Accounting)
External
◦ Investors, creditors, taxing
authorities, regulatory
agencies, labor unions,
customers & so on.
(in financial accounting)
What is Accounting?
◦ Identification:
 Of economic events
◦ Recording:
 Systematic, chronological diary of events.
 Classifies and summarizes economic
events.
◦ Communication
involves
analyzing
and interpreting the reported information.
◦ Analysis involves use of ratios, graph, charts,
and percentages to highlight significant
financial trends and relationships.
◦ Interpretation involves explaining the uses,
meaning & limitations of the reported data.
The Activities of the Accounting
Process
The Accounting Process involves the
bookkeeping function, another
name for recording.
Ethics in Financial Reporting

Ethics: The standards of conduct by which

Enron:
one’s actions are judged as right or wrong,
honest or dishonest, fair or not fair.
 Recent financial scandals include: Enron,
WorldCom,AIG, etc.
◦ American natural gas pipeline company, based
in Texas
◦ Company executives manipulated the earnings
report-showed more profit, losses were
hidden
◦ Scandal was revealed in October 2001
◦ Losses exceeded $70 billion and the company
went into bankruptcy
◦ It led to the dissolution of the accounting
firm, Arthur and Anderson
Ethics in Financial Reporting

Congress passes the Sarbanes Oxley Act of 2002: To reduce
unethical corporate behavior and decrease the likelihood of future
corporate scandals.

Top management has to certify the accuracy of the financial statements

Top management will face huge penalty for fraudulent financial activity

The accuracy of the financial statements are required to be reviewed by external
auditor

The Board of Directors will have an oversight role

Effective financial reporting depends on sound ethical behavior.

GAAP (Generally Accepted Accounting Principles):

Generally Accepted & Universally Practiced

Common set of standards or general guide for financial reporting purpose
The Building Blocks of Accounting
Reporting Standards of
Financial Information
•
•
•
•
GAAP (Generally Accepted
Accounting Principles)
FINANCIAL
STATEMENTS:
Income Statement
Statement of Retained
Earnings/ Owner’s Equity
Statement
Balance Sheet
Statement of Cash Flow
*Note Disclosure
The Building Blocks of Accounting

Cost Principle
(Historical)
◦ It 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 or
fair value is often
subjective.
Assumptions
Assumptions are foundation for the accounting process:

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. An economic entity can be any organization or unit in
a society.
◦ Proprietorship.
◦ Partnership.
◦ Corporation.
Forms of Business
Ownership
Forms of Business Ownership
Proprietorship
• Generally owned by
one person.
• Often small
service-type
businesses
• Owner receives any
profits, suffers any
losses, and is
personally liable for
all debts
Partnership
• Owned by two or
more persons.
• Often retail and
service-type
businesses
• Generally unlimited
personal liability
• Partnership
agreement
Corporation
• Separate legal
entity.
• Ownership divided
into shares of stock
• Stockholders enjoy
Limited liability
• Shares are
transferrable
• Corporation enjoys
an unlimited life.
The Basic Accounting Equation
Assets
Liabilities
Owner’s
Equity
The equation provides the underlying framework
for recording and summarizing economic events
The Basic Accounting Equation
Assets:
• Resources a business owns.
E.g. Cash, Supplies,
Equipment, Accounts
Receivables, Inventories,
Land, Building, etc.
• The capacity to provide
future services or benefits.
• They are claimed by either
creditors or owners.
The Basic Accounting Equation

Liabilities (debts &
obligations):
•
Claims against Assets
•
Creditors: Party to whom
money is owed
•
E.g. accounts payable, note
payable, wages payable, etc.
•
Liabilities appear before
owner’s equity because they
are paid first if a business is
liquidated.
The Basic Accounting Equation
Owner’s Equity

The ownership claim on Total Assets are called Owner’s Equity. Often
referred to as Residual Equity.

Owner’s Capital: Investments by owners or assets that owners put
into the business.

Owner’s Drawings: Withdrawal of owner (cash/other assets) for
personal use.

Revenues: Resulting from business activities entered into for the
purpose of earning income. E.g. sales, fees, services, commissions, etc.

Expenses: the cost of assets consumed or services used in the process
of earning revenue. E.g. utility expense, salaries and wages, telephone
expense, travel expense, rent expense, internet expense, etc.
Expanded Accounting Equation
Note:
Revenue – Expenses=Net Income/Net Loss
Transactions

Transactions are economic events of a business, recorded by
Accountants.

May be external or internal.

Not all activities represent transactions. Note that ‘Discussing about
product design with potential customer’ is not a transaction.

Is the financial position (assets, liabilities or owner’s equity) of
the company changed?

Each transaction must have a dual effect on the accounting
equation.
◦ An increase in asset must have a corresponding decrease in another asset, or
an increase in liability or an increase in owner’s equity

Two or more items could be affected.
Transaction Analysis
Transaction (1): Ray Neal decides to open a computer programming
service which he names Softbyte. On September 1, 2011, Ray Neal
invests $15,000 cash in the business.
SO 7
Transaction Analysis
Transaction (2): Purchase of Equipment for Cash. Softbyte purchases
computer equipment for $7,000 cash.
SO 7
Transaction Analysis
Transaction (3): Softbyte purchases for $1,600 from Acme Supply
Company computer paper and other supplies expected to last several
months. The purchase is made on account.
SO 7
Transaction Analysis
Transaction (4): Softbyte receives $1,200 cash from customers for
programming services it has provided.
SO 7
Transaction Analysis
Transaction (5): Softbyte receives a bill for $250 from the Daily News
for advertising but postpones payment until a later date.
SO 7
Transaction Analysis
Transaction (6): Softbyte provides $3,500 of programming services for
customers. The company receives cash of $1,500 from customers, and it
bills the balance of $2,000 on account.
SO 7
Transaction Analysis
Transaction (7): Softbyte pays the following expenses in cash for
September: store rent $600, salaries of employees $900, and utilities
$200.
SO 7
Transaction Analysis
Transaction (8): Softbyte pays its $250 Daily News bill in cash.
SO 7
Transaction Analysis
Transaction (9): Softbyte receives $600 in cash from customers who
had been billed for services [in Transaction (6)].
SO 7
Transaction Analysis
Transaction (10): Ray Neal withdraws $1,300 in cash from the
business for his personal use.
SO 7
Financial Statements

An income statement presents the revenues and expenses and
resulting net income or net loss for a specific period of time.

An owner’s equity statement summarizes the changes in
owner’s equity for a specific period of time.

A balance sheet reports the assets, liabilities and owner’s equity
at a specific date.

A statement of cash flows summarizes information about the
cash inflows (receipts) and outflows (payments) for a specific
period of time.