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CHAPTER # 01 REVIEW Atef Abuelaish 3

Chapter 01 Accounting in Business

Importance of Accounting For example, the sale by Apple of an i. Phone. C 1 Keep a chronological log of transactions. Prepare reports such as financial statements. 5

Users of Financial Information Accounting is called the language of business because all organizations set up an accounting information system to communicate data to help people make better decisions. Accounting serves many users who can be divided into two groups: external users and internal users. C 2 6

Opportunities in Accounting information is in all aspects of our lives. When we earn money, pay taxes, invest savings, budget earnings, and plan for the future, we use accounting. C 2 7

NEED-TO-KNOW 1 -1 Identify the following users of accounting information as either an (a) external or (b) internal user. Regulator CEO Shareholder Controller Executive Employee External Auditor Production Manager Nonexecutive Employee a) External user b) Internal user a) External users of accounting information are NOT directly involved in running the organization. Internal users of accounting information ARE directly involved in managing and operating an organization. 8

Ethics – A Key Concept The goal of accounting is to provide useful information for decisions. For information to be useful, it must be trusted. This demands ethics in accounting. Ethics are beliefs that distinguish right from wrong. They are accepted standards of good and bad behavior. C 3 9

Fraud Triangle Three factors must exist for a person to commit fraud: opportunity, pressure, and rationalization. Envision a way to commit fraud with a low perceived risk of getting caught C 3 Fails to see the criminal nature of the fraud or justifies the action Must have some pressure to commit fraud, like unpaid bills 10

Generally Accepted Accounting Principles (GAAP) Financial accounting is governed by concepts and rules known as generally accepted accounting principles (GAAP). GAAP aims to make information relevant, reliable, and comparable. Reliable information is trusted by users. Relevant information affects decisions of users. C 4 Comparable information is helpful in contrasting organizations. 11

International Standards In today’s global economy, there is increased demand by external users for comparability in accounting reports. This demand often arises when companies wish to raise money from lenders and investors in different countries. International Accounting Standards Board (IASB) International Financial Reporting Standards (IFRS) An independent group (consisting of individuals from many countries), issues International Financial Reporting Standards (IFRS) Identify preferred accounting practices Differences between U. S. GAAP and IFRS are decreasing as the FASB and IASB pursue a convergence process aimed to achieve a single set of accounting standards for global use. C 4 12

Accounting Principles Measurement Principle (or Cost Principle) Accounting information is based on actual cost. ; Actual cost is considered objective. Expense Recognition Principle (or Matching Principle) A company must record its expenses incurred to generate the revenue reported. C 4 Revenue Recognition Principle 1. Recognize revenue when it is earned 2. Proceeds need not be in cash. 3. Measure revenue by cash received plus cash value of items received. Full Disclosure Principle A company is required to report the details behind financial statements that would impact users’ decisions. 13

Accounting Assumptions Going-Concern Assumption Reflects assumption that the business will continue operating instead of being closed or sold. Time Period Assumption Presumes that the life of a company can be divided into time periods, such as months and years. C 4 Monetary Unit Assumption Express transactions and events in monetary, or money, units. Business Entity Assumption A business is accounted for separately from other business entities, including its owner. 14

Proprietorship, Partnership, and Corporation A business entity can take one of three legal forms: proprietorship, partnership, or corporation Here are some of the major attributes of proprietorships, partnerships, and corporations: C 4 15

Sarbanes–Oxley (SOX) Congress passed the Sarbanes–Oxley Act to help curb financial abuses at companies that issue their stock to the public. SOX requires that these public companies apply both accounting oversight and stringent internal controls. The desired results include more transparency, accountability, and truthfulness in reporting transactions. Here are some recent accounting scandals. C 4 16

Transaction Analysis and the Accounting Equation The Accounting Equation Assets = Liabilities + Equity Expanded Accounting Equation: Equity Assets = Liabilities + Contributed Capital + Retained Earnings = Liabilities + Common Stock - Dividends + Revenues - Expenses A 1 Net Income 17

NEED-TO-KNOW (1 -3) Use the accounting equation to compute the missing financial statement amounts. Bose Vogue Assets = Liabilities + Equity $150 = $30 + $120 $400 = $100 + $300 Use the expanded accounting equation to compute the missing financial statement amounts. Assets = Liabilities + Equity Nikon You. Tube $200 $400 $80 $160 $120 $240 +Common - Dividends + Revenues - Expenses Stock $100 $0 $60 ($40) $220 ($10) $120 ($90) 18

Analyze Business Transactions Using the Accounting Equation. 19

Transaction Analysis Chas Taylor invests $30, 000 cash to start a company. The accounts involved are: (1) Cash (asset) (2) Common Stock (equity) P 1

Let’s use the Accounting Equation: Chas Taylor invests $30, 000 cash to start the business, Fast Forward. P 1

Let’s try another transaction. . Company purchased supplies paying $2, 500 cash. The accounts involved are: (1) Cash (asset) (2) Supplies (asset) P 1

Transaction Analysis Company purchased supplies paying $2, 500 cash. . . Accounting Equation must remain in balance!! P 1

Let’s try another transaction. . . Purchased equipment for $26, 000 cash. The accounts involved are: (1) Cash (asset) (2) Equipment (asset) P 1

Using the Accounting Equation: Purchased equipment for $26, 000 cash. Accounting Equation still remains in balance!! P 1

Transaction Analysis Purchased supplies of $7, 100 on account. The accounts involved are: (1) Supplies (asset) (2) Accounts Payable (liability) P 1

Using the Accounting Equation Purchased Supplies of $7, 100 on account. Accounting Equation still remains in balance!! P 1

Transaction Analysis Now, let’s look at transactions involving revenues, expenses and dividends. P 1

Transaction Analysis Provided consulting services to a customer and received $4, 200 cash right away. The accounts involved are: (1) Cash (asset) (2) Revenues (equity) P 1

Transaction Analysis Provided consulting services to a customer and received $4, 200 cash right away. P 1

Transaction Analysis Paid rent of $1, 000 and salaries of $700 to employees. The accounts involved are: (1) Cash (asset) (2) Rent expense (equity) (3) Salaries expense (equity) Remember that the balance in the Expense accounts actually increase. P 1 But, total Equity decreases, because expenses reduce equity.

Transaction Analysis Paid rent of $1, 000 and salaries of $700 to employees. P 1 Remember that expenses decrease equity.

Transaction Analysis Dividends of $200 are paid to shareholders. The accounts involved are: (1) Cash (asset) (2) Dividends (equity) Remember that the Dividend account actually increases (just like our Expenses account. . . ) P 1 But, total Equity decreases because dividends cause equity to go down !!

Transaction Analysis Dividends of $200 are paid to shareholders. Remember that dividends decrease equity. P 1

NEED-TO-KNOW (1 -4) Assume Tata began operations on January 1 and completed the following transactions during its first month of operations. Jan. 1 Jan. 5 Jan. 14 Jan. 21 Jamsetji invested $4, 000 cash in the Tata Company in exchange of common stock. The company purchased $2, 000 of equipment on credit. The company provided $540 of services for a client on credit. The company paid $250 cash for an employee’s salary Arrange the following asset, liability, and equity titles in a table: Cash; Accounts Receivable; Equipment; Accounts Payable; Common Stock; Dividends; Revenues; and Expenses. Jan. 1 Jan. 5 Jan. 14 Jan. 21 Assets = Liabilities + Equity Cash Accounts Equipment Accounts + Common - Dividends + Revenues - Expenses Receivable Payable Stock $4, 000 $2, 000 $540 ($250) $3, 750 $540 $2, 000 $4, 000 $0 $540 ($250) Total Assets Total Liabilities Total Equity $6, 290 2, 000 $4, 290 35

Financial Statements The four financial statements and their purposes are: 1. Income statement — describes a company’s revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities. 2. Statement of retained earnings— earnings explains changes in equity from net income (or loss) and from any dividends over a period of time. 3. Balance sheet — describes a company’s financial position (types and amounts of assets, liabilities, and equity) at a point in time. 4. Statement of cash flows — identifies cash inflows (receipts) and cash outflows (payments) over a period of time. P 2 36

NEED-TO-KNOW (1 -5) Prepare the (a) income statement, (b) statement of retained earnings, and (c) balance sheet, for Apple using the following condensed data from its fiscal year ended September 28, 20 X 3. Accounts payable Other liabilities Cost of sales (expense) Cash Retained Earnings, Sept. 29, 20 X 2 Dividends in fiscal year 20 X 3 Revenues $22, 367 61, 084 119, 724 14, 259 101, 289 34, 070 170, 910 Income Statement Assets Liabilities Equity: + Common stock - Dividends + Revenues - Expenses Detail of Revenues Detail of Expenses Net income (loss) Investments and other assets Land equipment Selling and other expense Accounts receivable Net income Retained Earnings, Sept. 28, 20 X 3 Common stock Statement of Retained Earnings Beginning Retained Earnings ± Net income (loss) - Dividends $163, 042 16, 597 14, 149 13, 102 37, 037 104, 256 19, 293 Balance Sheet Detail of Assets Detail of Liabilities Common stock + Ending Retained Earnings 37

NEED-TO-KNOW Accounts payable Other liabilities Cost of sales (expense) Cash Retained Earnings, Sept. 29, 20 X 2 Dividends in fiscal year 20 X 3 Revenues $22, 367 61, 084 119, 724 14, 259 101, 289 34, 070 170, 910 APPLE Income Statement For Fiscal Year Ended September 28, 20 X 3 Revenues $170, 910 Expenses Cost of sales (expense) $119, 724 Selling and other expense 14, 149 Total expenses 133, 873 Net income $37, 037 Investments and other assets Land equipment Selling and other expense Accounts receivable Net income Retained Earnings, Sept. 28, 20 X 3 Common stock $163, 042 16, 597 14, 149 13, 102 37, 037 104, 256 19, 293 APPLE Statement of Retained Earnings For Fiscal Year Ended September 28, 20 X 3 Retained Earnings, Sept. 29, 20 X 2 $101, 289 Plus: Net income 37, 037 Less: Dividends (34, 070) Retained Earnings, Sept. 28, 20 X 3 $104, 256 APPLE Balance Sheet September 28, 20 X 3 Assets Cash Accounts receivable Land equipment Investments and other assets Liabilities $14, 259 13, 102 16, 597 163, 042 Accounts payable Other liabilities Total liabilities $22, 367 61, 084 83, 451 Equity Common Stock Retained earnings Total equity Total assets $207, 000 Total liabilities and equity 19, 293 104, 256 123, 549 $207, 000 38

1) Return on Assets Return on assets (ROA) is stated in ratio form as net income divided by the average of total assets invested. Return on assets = A 2 Net income Average total assets 39

Business Activities and the Accounting Equation Three major types of business activities: 1) Financing activities provide the means organizations use to pay for resources such as land, buildings, and equipment to carry out plans. C 5 § Owner financing—resources contributed by the owner along with any income the owner leaves in the organization. § Nonowner financing—resources contributed by creditors (lenders). § Financial management —the task of planning how to obtain these resources and to set the right mix between owner and creditor financing. 40

Business Activities and the Accounting Equation Three major types of business activities: 2) Investing activities are the acquiring and disposing of resources (assets) that an organization uses to acquire and sell its products or services. § Asset management—determining the amount and type of assets for operations. § Assets—invested amounts. § Liabilities—creditors’ claims. § Equity—owner’s claim. C 5 41

Business Activities and the Accounting Equation Three major types of business activities: 3) Operating activities involve using resources to research, develop, purchase, produce, distribute, and market products and services. § Strategic management —the process of determining the right mix of operating activities for the type of organization, its plans, and its market. C 5 42

Business Activities and the Accounting Equation C 5 43

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Chapter 02 Accounting for Business Transactions

Explain the steps in processing transactions and the role of source documents. 47

Analyzing and Posting Process The accounting process identifies business transactions and events, analyzes and records their effects, and summarizes and presents information in reports and financial statements. These reports and statements are used for making investing, lending, and other business decisions. C 1 48

Source Documents Checks Employee Earnings Records Bills from Suppliers Purchase Orders Bank Statements Sales Tickets C 1 49

Describe an account and its use in recording transactions. 50

The Account and Its Analysis An account is a record of increases and decreases in a specific asset, liability, equity, revenue, or expense item. C 2 The general ledger is a record containing all accounts used by the company. 51

The Account and Its Analysis Dividends Common Stock C 2 52

Asset Accounts Cash Land Buildings Asset Accounts Receivable Notes Receivable Prepaid Accounts Equipment Supplies C 2 53

Liability Accounts Payable Notes Payable Liability Accounts Accrued Liabilities C 2 Unearned Revenue 54

Equity Accounts Common Stock Dividends Equity Accounts Revenues C 2 Expenses 55

The Account and Its Analysis Revenues and owner’s contributions increase equity. Expenses and owner’s withdrawals decrease equity. C 2 56

NEED-TO-KNOW Classify each of the following as assets (A), liabilities (L), or equity (EQ). 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) (A) Asset (EQ) Equity (A) Asset (L) Liability (A) Asset Prepaid Rent Common Stock Note Receivable Accounts Payable Accounts Receivable Equipment Interest Payable Unearned Revenue Land Prepaid Insurance Key words to look for in account titles: Prepaid Receivable Payable Unearned C 2 Always an asset Always a liability 57

Describe a ledger and chart of accounts 58

Ledger and Chart of Accounts The ledger is a collection of all accounts for an information system. A company’s size and diversity of operations affect the number of accounts needed. The chart of accounts is a list of all accounts and includes an identifying number for each account. C 3 59

Define debits and credits and explain double-entry accounting. 60

Debits and Credits A T-account represents a ledger account and is a tool used to understand the effects of one or more transactions. C 4 61

Double-Entry Accounting Assets C 4 = Liabilities + Equity 62

Double-Entry Accounting Here is the expanded accounting equation showing the equity section. C 4 63

Double-Entry Accounting An account balance is the difference between the increases and decreases in an account. Notice the T-Account. C 4 64

NEED-TO-KNOW Identify the normal balance (debit [Dr] or credit [Cr]) for each of the following accounts. 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) Dr. Debit Cr. Credit Dr. Debit Assets Increase Debits Credits Normal Prepaid Rent Common Stock Note Receivable Accounts Payable Accounts Receivable Equipment Interest Payable Unearned Revenue Land Prepaid Insurance = Liabilities Decrease Increase Debits Credits + Equity Decrease Increase Debits Credits Dividends Expenses Normal Dividends ↓ Equity Common Stock ↑ Equity Dividends Investments Normal Expenses ↓ Equity C 4 Investments Revenues ↑ Equity Expenses Revenues Normal 65

Record transactions in a journal and post entries to a ledger. 66

Journalizing and Posting Transactions P 1 67

Journalizing Transactions a. Transaction Date b. Titles of Affected Accounts Common stock P 1 d. Transaction explanation c. Dollar amount of debits and credits 68

Balance Account Column T-accounts are useful illustrations, but balance column ledger accounts are used in practice. P 1 69

Posting Journal Entries P 1 70

Analyze the impact of transactions on accounts and financial statements 71

Analyzing Transactions Double-entry accounting is useful in analyzing and processing transactions. Analysis of each transaction follows these four steps. A 1 72

Analyzing Transactions A 1 73

Analyzing Transactions A 1 74

Analyzing Transactions A 1 75

Analyzing Transactions A 1 76

Analyzing Transactions A 1 77

NEED-TO-KNOW Assume Tata began operations on January 1 and completed the following transactions during its first month of operations. Jan. 1 Jan. 5 Jan. 14 Jamsetji invested $4, 000 cash in the Tata company in exchange for common stock. The company purchased $2, 000 of equipment on credit. The company provided $540 of services for a client on credit. For each transaction, (a) analyze the transaction using the accounting equation, (b) record the transaction in journal entry form, and c) post the entry using T-accounts to represent the general ledger accounts. A 1 78

NEED-TO-KNOW Jan. 1 Jamsetji invested $4, 000 cash in the Tata company in exchange for common stock. a) Analyze Assets = Liabilities + Equity + $4, 000 b) Record Date Jan. 1 General Journal Cash Common Stock c) Post A 1 4, 000 Common Stock Jan. 1 Normal Credit Cash Jan. 1 Assets Increase Debits Credits Debit 4, 000 = Liabilities Decrease Increase Debits Credits Normal 4, 000 + Equity Decrease Increase Debits Credits Dividends Expenses Common stock Revenues 79

NEED-TO-KNOW Jan. 5 The company purchased $2, 000 of equipment on credit. a) Analyze Assets = Liabilities + Equity + $2, 000 b) Record Date Jan. 5 c) Post Jan. 5 General Journal Equipment Accounts Payable Normal A 1 = Credit 2, 000 Equipment 2, 000 Accounts Payable Jan. 5 Assets Increase Debits Credits Debit 2, 000 Liabilities Decrease Increase Debits Credits Normal 2, 000 + Equity Decrease Increase Debits Credits Dividends Expenses Common stock Revenues 80

NEED-TO-KNOW Jan. 14 The company provided $540 of services for a client on credit. a) Analyze Assets = Liabilities + Equity + $540 b) Record Date Jan. 14 c) Post Jan. 14 General Journal Accounts receivable Services revenue Normal A 1 = Credit 540 Accounts receivable 540 Services revenue Jan. 14 Assets Increase Debits Credits Debit 540 Liabilities Decrease Increase Debits Credits Normal 540 + Equity Decrease Increase Debits Credits Dividends Expenses Common stock Revenues 81

Prepare and explain the use of a Trial Balance 82

Preparing the Trial Balance Preparing a trial balance involves three steps: 1. List each account title and its amount (from ledger) in the trial balance. If an account has a zero balance, list it with a zero in the normal balance column (or omit it entirely). 2. Compute the total of debit balances and the total of credit balances. 3. Verify (prove) total debit balances equal total credit balances. P 2 83

After processing its remaining transactions for December, Fast. Forward’s Trial Balance is prepared. The trial balance lists all account balances in the general ledger. If the books are in balance, the total debits will equal the total credits. P 2 84

Searching for and Correcting Errors If the trial balance does not balance, the error(s) must be found and corrected. Make sure the trial balance columns are correctly added. Re-compute each account balance in the ledger Make sure account balances are correctly entered from the ledger Verify that each journal entry is posted correctly See if debit or credit accounts are mistakenly placed on the trial balance. Verify that each original journal entry has equal debits and credits. P 2 85

NEED-TO-KNOW (2 -4) Prepare a trial balance for Apple using the following condensed data from its fiscal year-ended September 29, 20 X 2. Common stock Accounts payable Other liabilities Cost of sales (expense) Cash Revenues $16, 422 21, 175 36, 679 101, 876 10, 746 156, 508 Dividends Investments and other assets Land equipment Selling and other expense Accounts receivable Retained earnings APPLE Trial Balance September 29, 20 X 2 Debit Assets Credit Normal Liabilities Normal Common Stock Normal Retained Earnings Normal Dividends Normal Revenues P 2 $2, 523 138, 936 15, 452 12, 899 10, 930 62, 578 Normal Expenses Normal Totals Debits = Credits 86

NEED-TO-KNOW (2 -4) Prepare a trial balance for Apple using the following condensed data from its fiscal year-ended September 29, 20 X 2. Common stock $16, 422 Dividends $2, 523 Accounts payable 21, 175 Investments and other assets 138, 936 Other liabilities 36, 679 Land equipment 15, 452 Cost of sales (expense) 101, 876 Selling and other expense 12, 899 Cash 10, 746 Accounts receivable 10, 930 Revenues 156, 508 Retained earnings 62, 578 APPLE Trial Balance September 29, 20 X 2 Debit Credit Cash $10, 746 Accounts receivable 10, 930 Land equipment 15, 452 Investments and other assets 138, 936 Accounts payable $21, 175 Other liabilities 36, 679 Common stock 16, 422 Retained earnings 62, 578 Dividends 2, 523 Revenues 156, 508 Cost of sales (expense) 101, 876 Selling and other expense 12, 899 Totals $293, 362 P 2 87

Prepare financial statements from business transactions. 88

Using a Trial Balance to Prepare Financial Statements P 3 89

Financial Statements The four financial statements and their purposes are: 1. Income statement — describes a company’s revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities. 2. Statement of retained earnings— earnings explains changes in the retained earnings from net income (or loss) and from any dividends declared over a period of time. 3. Balance sheet — describes a company’s financial position (types and amounts of assets, liabilities, and equity) at a point in time. 4. Statement of cash flows —identifies cash inflows (receipts) and cash outflows (payments) over a period of time. P 3 90

1) Income Statement P 3 91

2) Statement of Retained Earnings P 3 92

3) Balance Sheet P 3 93

Presentation Issues 1. Dollar signs are not used in journals and ledgers. 2. Dollar signs appear in financial statements and other reports such as trial balances. The usual practice is to put dollar signs beside only the first and last numbers in a column. 3. When amounts are entered in the journal, ledger, or trial balance, commas are optional to indicate thousands, millions, and so forth. 4. Commas are always used in financial statements. 5. Companies commonly round amounts in reports to the nearest dollar, or even to a higher level. P 3 94

Global View Both U. S. GAAP and IFRS prepare the same four basic financial statements. A few differences are found within each statement, but over time these differences are likely to be eliminated. Here is a typical IFRS balance sheet presentation. 95

Global View Accounting systems depend on control procedures that assure the proper principles were applied in processing accounting information. The passage of SOX legislation strengthened U. S. control procedures in recent years. The percentage of employees in information technology that report observing specific types of misconduct in 2009. 96

Compute the debt ratio and describe its use in analyzing financial condition. 97

2) Debt Ratio Total Liabilities Debt Ratio = Total Assets Evaluates the level of debt risk. A higher ratio indicates that there is a greater probability that a company will not be able to pay its debt in the future. A 2 98

Homework assignment Ø Using Connect – 6 Questions for 60 Points. Ø Log in Connect web site and do “Connect Orientation” for 10 Points before 2/15/2016. 3 “Adjusting Accounting for Financial Statements. ” Ø Prepare chapter Happiness is having all homework up to date Atef Abuelaish 99

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