Chapter 1 1 CHAPTER 1 ACCOUNTING IN ACTION

Chapter 1 -1

CHAPTER 1 ACCOUNTING IN ACTION Accounting Principles, Eighth Edition Chapter 1 -2

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 owner’s 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 -3

Accounting in Action What is Accounting? Three activities Who uses accounting data Chapter 1 -4 The Building Blocks of Accounting Ethics in financial reporting Generally accepted accounting principles Assumptions The Basic Accounting Equation Assets Liabilities Owner’s equity Using the Basic Accounting Equation Transaction analysis Summary of transactions Financial Statements Income statement Owner’s equity statement Balance sheet Statement of cash flows

What is Accounting? The purpose of accounting is to: (1) identify, identify record, record and communicate the economic events of an (2) organization to (3) interested users. Chapter 1 -5 LO 1 Explain what accounting is.

What is Accounting? Three Activities Illustration 1 -1 Accounting process The accounting process includes the bookkeeping function. Chapter 1 -6 LO 1 Explain what accounting is.

Who Uses Accounting Data? Internal Users Human Resources Finance Management IRS/ NBR in BD There are two broad groups of users of financial information: internal users and external users. Marketing Customers Chapter 1 -7 SEC Investors Labor Unions Creditors External Users LO 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 -8 LO 2 Identify the users and uses of accounting.

Who Uses Accounting Data? Discussion Question Q 1. “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 -9 LO 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, World. Com, Health. South, AIG, and others. Congress passed. Sarbanes-Oxley Act of 2002. Effective financial reporting depends on sound ethical behavior. Chapter 1 -10 LO 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 -11 LO 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 -12 LO 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 -13 Financial Statements Balance Sheet Income Statement of Owner’s Equity Statement of Cash Flows Note Disclosure Generally Accepted Accounting Principles (GAAP) LO 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 -14 LO 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 -15 LO 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 -16 LO 5 Explain the monetary unit assumption and the economic entity assumption.

Forms of Business Ownership Proprietorship Chapter 1 -17 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 LO 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 -18 LO 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 -19 LO 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 -20 LO 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 -21 LO 5 Explain the monetary unit assumption and the economic entity assumption.

The Basic Accounting Equation Assets = Liabilities + Owner’s Equity Provides the underlying framework for recording and summarizing economic events. Assets are claimed by either creditors or owners. Claims of creditors must be paid before ownership claims. Chapter 1 -22 LO 6 State the accounting equation, and define assets, liabilities, and owner’s equity.

The Basic Accounting Equation Assets = Liabilities + Owner’s 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 -23 LO 6 State the accounting equation, and define assets, liabilities, and owner’s equity.

The Basic Accounting Equation Assets = Liabilities + Owner’s 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 -24 LO 6 State the accounting equation, and define assets, liabilities, and owner’s equity.

The Basic Accounting Equation Assets = Liabilities + Owner’s Equity Provides the underlying framework for recording and summarizing economic events. Owner’s Equity Ownership claim on total assets. Referred to as residual equity. Chapter 1 -25 Capital, Drawings, etc. (Proprietorship or Partnership). LO 6 State the accounting equation, and define assets, liabilities, and owner’s equity.

Owners’ 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 -26 LO 6 State the accounting equation, and define assets, liabilities, and owner’s equity.

Owners’ 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 -27 LO 6 State the accounting equation, and define assets, liabilities, and owner’s 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 -28 LO 7 Analyze the effects of business transactions on the accounting equation.

Transactions (Question? ) Q 1 -15: Are the following events recorded in the accounting records? Owner An employee is hired. withdraws cash for personal use. Event Supplies are purchased on account. Criterion Is the financial position (assets, liabilities, or owner’s equity) of the company changed? Record/ Don’t Record Chapter 1 -29 LO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Discussion Question Q 18. In February 2008, Paula King invested an additional $10, 000 in her business, King’s Pharmacy, which is organized as a proprietorship. King’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 -30 LO 7 Analyze the effects of business transactions on the accounting equation.

Transactions (Problem) P 1 -1 A: Barone’s Repair Shop was started on May 1 by Nancy. Prepare a tabular analysis of the following transactions for the month of May. 1. Invested $10, 000 cash to start the repair shop. Assets Cash 1. +10, 000 Chapter 1 -31 Liabilities Equity Accounts Barone, + Receivable + Equipment = Payable + Capital +10, 000 Investment LO 7 Analyze the effects of business transactions on the accounting equation.

Transactions (Problem) 2. Purchased equipment for $5, 000 cash. Liabilities Assets Cash Accounts Barone, + Receivable + Equipment = Payable + Capital 1. +10, 000 2. -5, 000 Chapter 1 -32 Equity +10, 000 Investment +5, 000 LO 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 Barone, + Receivable + Equipment = Payable + Capital 1. +10, 000 2. -5, 000 3. -400 Chapter 1 -33 Equity +10, 000 Investment +5, 000 -400 Expense LO 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 Barone, + Receivable + Equipment = Payable + Capital 1. +10, 000 2. -5, 000 3. 4. -400 +5, 100 Chapter 1 -34 Equity +10, 000 Investment +5, 000 -400 +5, 100 Expense Revenue LO 7 Analyze the effects of business transactions on the accounting equation.

Transactions (Problem) 5. Withdrew $1, 000 cash for personal use. Liabilities Assets Cash Equity Accounts Barone, + Receivable + Equipment = Payable + Capital 1. +10, 000 Investment 2. -5, 000 3. 4. -400 +5, 100 Expense Revenue 5. -1, 000 Drawings Chapter 1 -35 +5, 000 LO 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 Equity Accounts Barone, + Receivable + Equipment = Payable + Capital 1. +10, 000 Investment 2. -5, 000 3. 4. -400 +5, 100 Expense Revenue 5. 6. -1, 000 -2, 000 Drawings Expense Chapter 1 -36 +5, 000 LO 7 Analyze the effects of business transactions on the accounting equation.

Transactions (Problem) 7. Incurred $250 of advertising costs, on account. Liabilities Assets Cash Equity Accounts Barone, + Receivable + Equipment = Payable + Capital 1. +10, 000 Investment 2. -5, 000 3. 4. -400 +5, 100 Expense Revenue 5. 6. -1, 000 -2, 000 Drawings Expense 7. Chapter 1 -37 +5, 000 +250 -250 Expense LO 7 Analyze the effects of business transactions on the accounting equation.

Transactions (Problem) 8. Provided $750 of repair services on account. Liabilities Assets Cash Equity Accounts Barone, + Receivable + Equipment = Payable + Capital 1. +10, 000 Investment 2. -5, 000 3. 4. -400 +5, 100 Expense Revenue 5. 6. -1, 000 -2, 000 Drawings Expense 7. 8. Chapter 1 -38 +5, 000 +250 +750 -250 +750 Expense Revenue LO 7 Analyze the effects of business transactions on the accounting equation.

Transactions (Problem) 9. Collected $120 cash for services previously billed. Liabilities Assets Cash Equity Accounts Barone, + Receivable + Equipment = Payable + Capital 1. +10, 000 Investment 2. -5, 000 3. 4. -400 +5, 100 Expense Revenue 5. 6. -1, 000 -2, 000 Drawings Expense 7. 8. 9. Chapter 1 -39 +5, 000 +250 +750 +120 6, 820 + -120 630 + 5, 000 = 250 + -250 +750 Expense Revenue 12, 200 LO 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 -40 Owner’s Equity Statement Balance Sheet Statement of Cash Flows LO 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 -41 LO 8 Understand the four financial statements and how they are prepared.

Financial Statements Income Statement Reports the revenues and expenses for a specific period of time. Net income – revenues exceed expenses. Net loss – expenses exceed revenues. Chapter 1 -42 LO 8 Understand the four financial statements and how they are prepared.

Financial Statements Income Statement Owner’s Equity Statement Net income is needed to determine the ending balance in owner’s equity. Chapter 1 -43 LO 8 Understand the four financial statements and how they are prepared.

Financial Statements Owner’s Equity Statement indicates the reasons why owner’s equity has increased or decreased during the period. Chapter 1 -44 LO 8 Understand the four financial statements and how they are prepared.

Financial Statements Balance Sheet Owners’ Equity Statement The ending balance in owner’s equity is needed in preparing the balance sheet Chapter 1 -45 LO 8 Understand the four financial statements and how they are prepared.

Financial Statements Balance Sheet Reports the assets, liabilities, and owner’s equity at a specific date. Assets listed at the top, followed by liabilities and owner’s equity. Total assets must equal total liabilities and owner’s equity. Chapter 1 -46 LO 8 Understand the four financial statements and how they are prepared.

Financial Statements Balance Sheet Chapter 1 -47 Statement of Cash Flows LO 8 Understand the four financial statements and how they are prepared.

Financial Statements Information for a specific period of time. Statement of Cash Flows Answers the following: 1. Where did cash come from? 2. What was cash used for? 3. What was the change in the cash balance? Chapter 1 -48 LO 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. Owner's equity statement. d. Statement of cash flows. Chapter 1 -49 LO 8 Understand the four financial statements and how they are prepared.

Financial Statements Discussion Question Q 19. “A company’s net income appears directly on the income statement and the owner’s equity statement, and it is included indirectly in the company’s balance sheet. ” Do you agree? Explain. See notes page for discussion Chapter 1 -50 LO 8 Understand the four financial statements and how they are prepared.

Accounting Career Opportunities Public Accounting Careers in auditing and taxation serving the general public. Private Accounting Careers in industry working in cost accounting, budgeting, accounting information systems, and taxation. Opportunities in Government Careers with the IRS, the FBI, the SEC, and in public colleges and universities. Forensic Accounting Careers with insurance companies and law offices to conduct investigations into theft and fraud. Chapter 1 -51 LO 9 Explain the career opportunities in accounting.