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Accounting In

Action

Chapter
1-1
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
1-2
Accounting in Action

Using the
The Building The Basic
What is Basic Financial
Blocks of Accounting
Accounting? Accounting Statements
Accounting Equation Equation

Three Ethics in Assets Transaction Income


activities financial Liabilities analysis statement
Who uses reporting Summary of Statement of
Stockholders'
accounting Generally equity transactions retained
data accepted earnings
accounting Balance
principles sheet
Assumptions Statement of
cash flows

Chapter
1-3
What is Accounting?

The purpose of accounting is to:


• identify,
identify record,
record and communicate the
economic events of an
• organization to
• interested users.

Chapter
1-4 SO 1 Explain what accounting is.
What is Accounting?
Illustration 1-1
Three Activities 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

Human Investors
Resources

Labor
Unions
Finance Common Questions

Creditors
Marketing
Customers SEC
External
Users
Chapter
1-6 SO 2 Identify the users and uses of accounting.
Who Uses Accounting Data?
Common Questions Asked User
1. Can we afford to give our
employees a pay raise? Human Resources
2. Did the company earn a
satisfactory income? Investors
3. Do we need to borrow in the
near future? Management
4. Is cash sufficient to pay
dividends to the stockholders? 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

Financial Statements
Various users Balance Sheet
need financial Income Statement
Retained Earnings Statement
information Statement of Cash Flows
Note Disclosure

The accounting profession


has attempted to develop Generally Accepted
a set of standards that
Accounting
are generally accepted
and universally practiced.
Principles (GAAP)

Chapter
1-11 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.
Forms of
Partnership. Business Ownership
Corporation.
Chapter SO 5 Explain the monetary unit assumption
1-14
and the economic entity assumption.
Forms of Business Ownership

Proprietorship Partnership Corporation

Generally owned Owned by two or Ownership


by one person. more persons. divided into
Often small shares of stock
Often retail and
service-type service-type Separate legal
businesses businesses entity organized
Owner receives under state
Generally
any profits, corporation law
unlimited
suffers any personal liability Limited liability
losses, and is
Partnership
personally liable
agreement
for all debts.
Chapter SO 5 Explain the monetary unit assumption
1-15
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 SO 5 Explain the monetary unit assumption


1-16
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 SO 5 Explain the monetary unit assumption


1-17
and the economic entity assumption.
The Basic Accounting Equation

Stockholders’
Assets = Liabilities +
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 SO 6 State the accounting equation, and define


1-18
assets, liabilities, and stockholders’ equity.
The Basic Accounting Equation

Stockholders’
Assets = Liabilities +
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 SO 6 State the accounting equation, and define
1-19
assets, liabilities, and stockholders’ equity.
The Basic Accounting Equation

Stockholders’
Assets = Liabilities +
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 SO 6 State the accounting equation, and define
1-20
assets, liabilities, and stockholders’ equity.
The Basic Accounting Equation

Stockholders’
Assets = Liabilities +
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 SO 6 State the accounting equation, and define
1-21
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 SO 6 State the accounting equation, and define
1-22
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 SO 6 State the accounting equation, and define
1-23
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 SO 6 State the accounting equation, and define
1-24
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 SO 7 Analyze the effects of business transactions


1-25
on the accounting equation.
Transactions
Question: Are the following events recorded in the
accounting records?
Supplies are An employee Dividends are
Event purchased is hired. paid to
on account. stockholders’.

Criterion Is the financial position (assets, liabilities, or


stockholders’ equity) of the company changed?

Record/
Don’t Record

Chapter SO 7 Analyze the effects of business transactions


1-26
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 SO 7 Analyze the effects of business transactions


1-27
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 Liabilities Stockholders’ Equity
Accounts Accounts Common
Cash + Receivable + Equipment = Payable + Stock
1. +10,000 +10,000 Investment

Chapter SO 7 Analyze the effects of business transactions


1-28
on the accounting equation.
Transactions (Problem)
2. Purchased equipment for $5,000 cash.
Assets Liabilities Stockholders’ Equity
Accounts Accounts Common
Cash + Receivable + Equipment = Payable + Stock
1. +10,000 +10,000 Investment
2. -5,000 +5,000

Chapter SO 7 Analyze the effects of business transactions


1-29
on the accounting equation.
Transactions (Problem)
3. Paid $400 cash for May office rent.
Assets Liabilities Stockholders’ Equity
Accounts Accounts Common Retained
Cash + Receivable + Equipment = Payable + Stock + Earnings
1. +10,000 +10,000
2. -5,000 +5,000
3. -400 -400
Expense

Chapter SO 7 Analyze the effects of business transactions


1-30
on the accounting equation.
Transactions (Problem)
4. Received $5,100 from customers for repair service.
Assets Liabilities Stockholders’ Equity
Accounts Accounts Common Retained
Cash + Receivable + Equipment = Payable + Stock + Earnings
1. +10,000 +10,000
2. -5,000 +5,000
3. -400 -400
4. +5,100 +5,100
Revenue

Chapter SO 7 Analyze the effects of business transactions


1-31
on the accounting equation.
Transactions (Problem)
5. Paid dividends of $1,000 cash.
Assets Liabilities Stockholders’ Equity
Accounts Accounts Common Retained
Cash + Receivable + Equipment = Payable + Stock + Earnings
1. +10,000 +10,000
2. -5,000 +5,000
3. -400 -400
4. +5,100 +5,100
5. -1,000 -1,000

Chapter SO 7 Analyze the effects of business transactions


1-32
on the accounting equation.
Transactions (Problem)
6. Paid part-time employee salaries of $2,000.
Assets Liabilities Stockholders’ Equity
Accounts Accounts Common Retained
Cash + Receivable + Equipment = Payable + Stock + Earnings
1. +10,000 +10,000
2. -5,000 +5,000
3. -400 -400
4. +5,100 +5,100
5. -1,000 -1,000
6. -2,000 -2,000
Expense

Chapter SO 7 Analyze the effects of business transactions


1-33
on the accounting equation.
Transactions (Problem)
7. Incurred $250 of advertising costs, on account.
Assets Liabilities Stockholders’ Equity
Accounts Accounts Common Retained
Cash + Receivable + Equipment = Payable + Stock + Earnings
1. +10,000 +10,000
2. -5,000 +5,000
3. -400 -400
4. +5,100 +5,100
5. -1,000 -1,000
6. -2,000 -2,000
7. +250 -250
Expense

Chapter SO 7 Analyze the effects of business transactions


1-34
on the accounting equation.
Transactions (Problem)
8. Provided repair services on account to customers $750.
Assets Liabilities Stockholders’ Equity
Accounts Accounts Common Retained
Cash + Receivable + Equipment = Payable + Stock + Earnings
1. +10,000 +10,000
2. -5,000 +5,000
3. -400 -400
4. +5,100 +5,100
5. -1,000 -1,000
6. -2,000 -2,000
7. +250 -250
8. +750 +750
Revenue

Chapter SO 7 Analyze the effects of business transactions


1-35
on the accounting equation.
Transactions (Problem)
9. Collected $120 cash for services previously billed.
Assets Liabilities Stockholders’ Equity
Accounts Accounts Common Retained
Cash + Receivable + Equipment = Payable + Stock + Earnings
1. +10,000 +10,000
2. -5,000 +5,000
3. -400 -400
4. +5,100 +5,100
5. -1,000 -1,000
6. -2,000 -2,000
7. +250 -250
8. +750 +750
9. +120 -120
6,820 + 630 + 5,000 = 250 + 10,000 + 2,200
Chapter SO 7 Analyze the effects of business transactions
1-36
on the accounting equation.
Financial Statements

Companies prepare four financial statements from


the summarized accounting data:

Retained Statement
Income Balance
Earnings of Cash
Statement Sheet
Statement Flows

Chapter
1-37 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 Reports the revenues


Income Statement
and expenses for a
For the Month Ended May 31, 2007
specific period of time.
Revenues:
Service revenue $ 5,850 Net income – revenues
Expenses: exceed expenses.
Salary expense 2,000
Rent expense 400 Net loss – expenses
Advertising expense 250 exceed revenues.
Total expenses 2,650
Net income $ 3,200

Chapter
1-39 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Retained Earnings
Income Statement 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:
Add: Net income 3,200
Service revenue $ 5,850
Less: Dividends (1,000)
Expenses:
Retained earnings, May 31 $ 2,200
Salary expense 2,000
Rent expense 400
Advertising expense 250 Net income is needed to
Total expenses 2,650 determine the ending balance in
Net income $ 3,200 retained earnings.

Chapter
1-40 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Retained Earnings
Statement
Statement indicates the Barone’s Repair Shop

reasons why retained Retained Earnings Statement


For the Month Ended May 31, 2007
earnings has increased
or decreased during the Retained earnings, May 1 $ -

period. Add: Net income 3,200


Less: Dividends (1,000)
Retained earnings, May 31 $ 2,200

Chapter
1-41 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Balance Sheet Retained Earnings
Barone’s Repair Shop Statement
Balance Sheet
Barone’s Repair Shop
May 31, 2007
Retained Earnings Statement
Assets
For the Month Ended May 31, 2007
Cash $ 6,820
Accounts receivable 630 Retained earnings, May 1 $ -
Equipment 5,000 Add: Net income 3,200
Total assets $ 12,450
Less: Dividends (1,000)
Liabilities Retained earnings, May 31 $ 2,200
Accounts payable $ 250
Stockholders' Equity
Common stock 10,000 The ending balance in retained
Retained earnings 2,200 earnings is needed in preparing the
Total liab. & equity $ 12,450 balance sheet.
Chapter
1-42 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Balance Sheet
Barone’s Repair Shop Reports the assets,
Balance Sheet
liabilities, and
May 31, 2007
Assets
stockholders’ equity at a
Cash $ 6,820 specific date.
Accounts receivable 630
Equipment 5,000 Assets listed at the top,
Total assets $ 12,450 followed by liabilities
Liabilities
and stockholders’ equity.
Accounts payable $ 250
Stockholders' Equity
Total assets must equal
Common stock 10,000
Retained earnings 2,200
total liabilities and
Total liab. & equity $ 12,450 stockholders’ equity.
Chapter
1-43 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
Assets Cash flow from Operations
Cash receipts from customers $ 5,220
Cash $ 6,820
Cash paid for expenses (2,400)
Accounts receivable 630 Cash provided by operations 2,820
Equipment 5,000 Cash flow from Investing
Total assets $ 12,450 Purchase of equipment (5,000)
Cash flow from Financing
Liabilities
Investment by owners 10,000
Accounts payable $ 250
Drawings by owners (1,000)
Stockholders' Equity Cash provided by financing 9,000
Common stock 10,000 Net increase in cash 6,820
Retained earnings 2,200 Cash balance, May 1 -
Cash balance, May 31 $ 6,820
Total liab. & equity $ 12,450
Chapter
1-44 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Statement of Cash Flows
Information for a
specific period of time. Barone’s Repair Shop
Statement of Cash Flows
For the Month Ended May 31, 2007
Answers the following: Cash flow from Operations
Cash receipts from customers $ 5,220
1. Where did cash come Cash paid for expenses (2,400)
from? Cash provided by operations 2,820
Cash flow from Investing

2. What was cash used Purchase of equipment (5,000)


Cash flow from Financing
for? Investment by owners 10,000
Drawings by owners (1,000)
3. What was the change Cash provided by financing 9,000
Net increase in cash 6,820
in the cash balance? Cash balance, May 1 -
Cash balance, May 31 $ 6,820

Chapter
1-45 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.

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.
Chapter
1-51
Copyright

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caused by the use of these programs or from the use of the
information contained herein.

Chapter
1-52