Chapter

1-1
Introduction to
Accounting
Concepts and
Practice
BAC1614 Fundamentals of Financial Accounting
Topic 1
Chapter
1-2
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.
Study Objectives
Chapter
1-3
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.
Study Objectives
Chapter
1-4
Accounting in Action
Ethics in
financial
reporting
Generally
accepted
accounting
principles
Assumptions
Constraints
What is
Accounting?
Building
Blocks of
Accounting
The Basic
Accounting
Equation
Using the
Basic
Accounting
Equation
Financial
Statements
Three
activities
Who uses
accounting
data

Assets
Liabilities
Stockholders'
equity

Transaction
analysis
Summary of
transactions
Income
statement
Statement of
retained
earnings
Balance
sheet
Statement of
cash flows
Chapter
1-5
What is Accounting?
Importance of Accounting we live in the
information age, where information, and its reliability,
impacts the financial well-being of us all
Identify economic events, a company selects
economic events relevant to its business.
Once company identifies economic events, it records
those events in order to provide a history of the
organizations financial activities.
Recording consists of keeping a systematic,
chronological diary of events, measured in dollars and
cents.


Chapter
1-6
What is Accounting?
Communicates the collected information to
interested users by means of accounting reports
which are called financial statements.
A vital element in communicating economic events is
the accountants ability to analyze and interpret the
reported information.
Interpretation involves explaining the uses, meaning,
and limitations of reported data.
Bookkeeping usually involves only the recording of
economic events and is just one part of the
accounting process.



Chapter
1-7
Identifying
Select transactions and events
Recording
Input, measure and classify
Communicating
Prepare, analyze and interpret
Accounting
What is Accounting?
An information and
measurement
system
Relevant, reliable, and comparable information
about an organizations business activities.
Chapter
1-8
What is Accounting?
Identifying business activities requires selecting
transactions and events relevant to an organization.
Recording business activities requires keeping a
chronological log of transactions and events
measured in dollars and classified and summarized
in a useful format.
Communicating business activities requires
preparing accounting reports such as financial
statements. It also requires analyzing and
interpreting such reports.
Chapter
1-9
What is Accounting?
Purpose of accounting is to:
(1) identify, record, and communicate the economic
events of an
(2) organization to
(3) interested users.
Chapter
1-10
Three Activities
What is Accounting?
Accounting process
Accounting process includes
the bookkeeping function.
Chapter
1-11
Management
Common Questions
Human
Resources
Inland
Revenue
Labor
Unions
Securities
Exchange
Commission
Marketing
Finance
Investors
Creditors
Users of Accounting Data?
Customers
Internal Users
External
Users
Chapter
1-12
Users of Accounting Data?
Accountants prepare reports for both external and
internal users.
External users of accounting information are not
directly involved in running the organization.
Examples: lenders, shareholders (investors),
governments, consumer groups, customers, and
the external auditors.
Internal users of accounting information are those
directly involved in managing and operating an
organization.
Chapter
1-13
Users of Accounting Data?
Information are used to help improve the
efficiency and effectiveness of an organization.
Examples of internal users are managers,
officers/directors, internal auditors, sales staff,
budget officers and controllers.
Chapter
1-14
Internal Users External Users
Internal users of
accounting
information are those
individuals inside a
company who plan,
organize, and run a
business.
Include marketing
managers, finance
directors, and
company officers.

External users are individuals/
organizations outside the company who
are either:

a. Investors use accounting
information to make decisions to buy,
hold, or sell stock. Creditors
(suppliers and bankers) use
accounting information to evaluate
the risks of granting credit or lending
money.
b. Other external users: Tax
authorities (Inland Revenue Dept),
Regulatory agencies (Securities
Commission), customers and labor
unions.
Users of Accounting Data?
Chapter
1-15
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?
3. Do we need to borrow in the
near future?
4. Is cash sufficient to pay
dividends to the stockholders?
5. What price for our product will
maximize net income?
Users of Accounting Data?
6. Will the company be able to
pay its short-term debts?
Investors
Management
Finance
Marketing
Creditors
Chapter
1-16
Discussion Question
Q1. Accounting is ingrained in our society and it is
vital to our economic system. Do you agree? Explain.
Who Uses Accounting Data?
Yes, this is correct. Virtually every organization and
person in our society uses accounting information.
Businesses, investors, creditors, government
agencies, and not-for-profit organizations must use
accounting information to operate effectively.
Chapter
1-17
Building Blocks of Accounting
Regulators and lawmakers were very concerned that the
economy would suffer if investors lost confidence in
corporate accounting because of unethical financial
reporting.
Recent financial scandals include: Barclays Bank
(LIBOR rate-fixing scandal), Maddoff investment scam,
Enron, World.com
Malaysia (Sime Darbys E & O deals insider
trading allegation, PKFZ cost overruns, National
Feedlot Corp CBT misappropriating of funds)

Chapter
1-18
Building Blocks of Accounting
Imagine if you are trying to carry on a business or invest
money if you could not depend on the financial
statement to be honestly prepared
Information would have no credibility.
Economy will not function well & sound as it
depends on accurate and dependable financial
reporting.
Economy would suffers if investors lost confidence
in corporate accounting because of unethical
financial reporting.
Chapter
1-19
Building Blocks of Accounting
Sarbanes-Oxley Act 2002
Passed by Congress in 2002, in response to a
series of corporate scandals.
Requires principal executive and financial officers
to certify a number of statements regarding the
financials.
Places additional responsibilities on management
to ensure that adequate internal controls are in
place.
Chapter
1-20
Building Blocks of Accounting
Sarbanes-Oxley Act 2002
To reduce unethical financial reporting. Top
management to certify accuracy of financial
information
Reduce the likelihood of future corporate scandals.
Increased the independence of outside auditors
who review the accuracy of corporate financial
statements, and increased the oversight role of
boards of directors
Chapter
1-21
Building Blocks of Accounting
Fundamentals of Accounting accounting is guided
by principles, standards, concepts, and assumptions.
Goal of accounting is to provide useful information for
decisions.
For information to be useful, it must be trusted.
Demand ethics in accounting
Chapter
1-22
Beliefs that
distinguish right
from wrong
Accepted standards
of good and bad
behavior
Ethics
Building Blocks of Accounting
Ethics A key Concept
Chapter
1-23
Building Blocks of Accounting
Standards of conduct by which ones actions are judged
as right or wrong, honest or dishonest, fair or not fair, are
called Ethics.
Ethical behavior is the cornerstone of the accounting
profession.
Effective financial reporting depends on sound
ethical behavior.
Ethics A key Concept
Chapter
1-24
Building Blocks of Accounting
Ethics A key Concept
Identifying the ethical path is sometimes difficult.
Preferred path is a course of action that avoids
casting doubt on ones decisions.
Example: Accounting users are less likely to trust an
auditors report if the auditors pay depends on the
success of the clients business.
To avoid such concerns, ethics rules are often set.
Example: Auditors are banned from direct investment
in their client and cannot accept pay that depends on
figures in the clients reports.
Chapter
1-25
Building Blocks of Accounting
Ethics A key Concept
Guidelines for making ethical decisions.
Chapter
1-26
In the process of analyzing and solving ethical
dilemmas, the following steps should be applied:

a. Recognize an ethical situation and ethical issues
involved code of ethics for guidance.
b. Identify and analyze the principal elements in the
situation - identify the stakeholders persons or
groups who may be harmed or benefited .
c. Identify the alternatives and weigh the impact of
each alternative on various stakeholders select
the most ethical alternatives
Ethics in Financial Reporting
Chapter
1-27
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.
Review Question
Ethics in Financial Reporting
Chapter
1-28
Various users
need financial
information
Accounting profession has
attempted to develop a set
of standards that are
generally accepted and
universally practiced.
Financial Statements
Balance Sheet
Income Statement
Retained Earnings Statement
Statement of Cash Flows
Note Disclosure
Generally Accepted
Accounting
Principles (GAAP)
Generally Accepted Accounting Principles
Chapter
1-29
Financial accounting practice is governed by concepts
and rules known as Generally accepted accounting
principles (GAAP).
Relevant Information Affects the decision of its users.
Reliable Information Is trusted by users.
Comparable
Information
Is helpful in contrasting
organizations.
Generally Accepted Accounting Principles
Chapter
1-30
Generally Accepted Accounting Principles
Financial accounting is governed by a set of rules
we call Generally Accepted Accounting
Principles, or GAAP.
Generally accepted accounting principles identify
three major characteristics of information.
Information must be relevant. Relevant
information impacts the decision of the informed
user for financial information.
Information must be reliable.
Information must be comparable.
Comparability helps us evaluate financial
information from one period with that of the next
period.

Chapter
1-31

Standard-setting bodies in consultation with
accounting profession and business community
determine these standards.
In U.S. major rule-setting bodies are the Securities
and Exchange Commission (SEC) and the
Financial Accounting Standards Board (FASB).
SEC delegated authority to set U.S. GAAP to the
FASB.
Generally Accepted Accounting Principles
Setting Accounting Principles
Chapter
1-32

a. Securities and Exchange Commission (SEC) is
a governmental agency that requires publicly
traded companies to file financial reports in
accordance with GAAP.
To develop and standardised financial information
presented to stakeholders.

Administer SEC Act 1934 and has broad powers to
prescribe the accounting practices and standards to be
employed by companies fall within its jurisdiction.



Generally Accepted Accounting Principles
Chapter
1-33
b. Financial Accounting Standards Board (FASB)
is a private organization responsible for the
promulgation of GAAP for financial statement or a
body that establishes common standards of how to
report economic events.

To establish & improve standards of financial accounting
and reporting for guidance and education of the public,
include issuers, auditors and users of financial information.

Generally Accepted Accounting Principles
Chapter
1-34
c. International Accounting Standards Board
(IASB) issues standards (International Financial
Reporting Standards or IFRS) that identify
preferred accounting practices in the global
economy. IASB hopes to create harmony among
accounting practices in different countries.
d. Differences between U.S. GAAP and IFRS are
fading as the FASB and IASB pursue convergence.

Generally Accepted Accounting Principles
Chapter
1-35
Organizations Involved in Standard Setting:
Securities and Exchange Commission (SEC)

Financial Accounting Standards Board (FASB)

International Accounting Standards Board (IASB)
Generally Accepted Accounting Principles
http://www.fasb.org/
http://www.sec.gov/
http://www.iasb.org/
Chapter
1-36
Generally Accepted Accounting Principles
FASB is recognized as the group in the private
sector that makes specific accounting principles. If
an accountant departs from the principles
established by the FASB, proper disclosure of the
departure must be made.
In the public sector, the SEC has the authority to
establish accounting principles for companies
reporting to the agency. Currently, the SEC has
accepted all pronouncements of the FASB for use
by public reporting companies.
Setting Accounting Principles
Chapter
1-37
Generally Accepted Accounting Principles

IASB issues International Financial Reporting
Standards (IFRS) that identify preferred accounting
practices to create harmony among accounting
practices of different countries.
Setting Accounting Principles
Chapter
1-38
IASB, an independent group (consisting of 16
individuals from many countries), issues International
Financial Reporting Standards (IFRS) that identify
preferred accounting practices.
IASB
Generally Accepted Accounting Principles
Chapter
1-39
Generally Accepted Accounting Principles
Setting Accounting Principles
In todays 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.

If standards are harmonized, one company can
potentially use a single set of financial statements in
all financial markets. Differences between U.S.
GAAP and IFRS are slowly fading as the FASB and
IASB pursue a convergence process aimed to
achieve a single set of accounting standards for
global use.
Chapter
1-40
In Malaysia, organizations involved in Standard Setting:


Generally Accepted Accounting Principles

Malaysian Institute of Accountant (MIA)
Malaysian Institute of Certified Public Accountant
(MICPA)
Malaysian Accounting Standard Board Malaysian Financial
Reporting Standard (MFRS))
Securities
Commission
BNM
Chapter
1-41
Building Blocks of Accounting
Conceptual framework of Financial Reporting
Conceptual Framework and Convergence The
FASB and IASB are attempting to converge and
enhance the conceptual framework that guides
standard setting. Framework consists of:
a. Objectives to provide information useful to
investors, creditors, and others.

b. Qualitative Characteristics to require
information that is relevant, reliable
comparable.
Chapter
1-42
Building Blocks of Accounting
Conceptual framework of Financial Reporting
Framework consists of:

c. Elements to define items that financial
statements can contain.

d. Recognition and Measurement to set
criteria that an item must meet for it to be
recognized as an element; and how
Chapter
1-43
Concepts of recognition and measurement.
Concepts explain which, when and how financial
elements and events should be recognized,
measured and reported by accounting system.
FASB Statement of Financial Accounting Concepts
No.5 Recognition and Measurement in Financial Statements
of Business Enterprise stated - to be recognised, an item
(event or transaction) must meet the definition of an
element of financial statement and must be
measurable.
Building Blocks of Accounting
Conceptual framework of Financial Reporting
Chapter
1-44
Accounting profession has identify the concepts as
basic principles of accounting, basic assumptions and
constraints.
GAAP generally uses one of two measurement
principles ,
Revenue Recognition principle
Matching principle
Cost principle
Full Disclosure principle
Fair Value principle
Building Blocks of Accounting
Conceptual framework of Financial Reporting
Chapter
1-45
Cost Principle
Accounting information is based on
actual cost. Actual cost is considered
objective.
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.

Matching Principle
A company must record its expenses
incurred to generate the revenue
reported.

Full Disclosure Principle
A company is required to report the details
behind financial statements that would impact
users decisions.
Principles of Accounting
Chapter
1-46
Revenue Recognition Principle.
Revenue Recognition Principles
Revenue recognition principle states that revenue is
to recognized when it is earned,

Revenue need not be in the form of cash and

Measure revenue by the cash received plus cash
value of other items received.
Chapter
1-47
Expenses Recognition Principle.
Expenses Recognition Principles
Also called matching Principle

prescribes that a company records expenses
incurred to generate revenues it reported.

Matching principle dictates that expenses incurred
by a company must be matched against revenue
generated as a result of those expenses.
Chapter
1-48
Measurement principle also called Cost Principle
(Historical) dictates that companies record assets at
cost.
Issues:
Financial statements are based on actual costs
(with a potential for subsequent adjustments to
market) incurred in business transactions.
Cost is measured on a cash or equal-to-cash basis.
Principle emphasizes reliability and verifiability, and
information based on cost considered objective.
Cost Principles
Chapter
1-49
Measurement principle also called Cost Principle
(Historical)
Issues:
Objectivity means information is supported by
unbiased evidence: more than someone's opinion.
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.
Cost Principles
Chapter
1-50
Full Disclosure Principle - requires that companies
disclose all circumstances and events that would make
a difference to financial statement users.
Issues:

prescribes reporting the details behind the
financial statements that would impacts users
decisions.
If an important item cannot reasonably be
reported directly in one of four types of financial
statement, then it should be disclose in the notes
that accompany the statements.

Full Disclosure Principles
Chapter
1-51
Fair Value Principle indicates that assets and
liabilities should be reported at fair value (the price
received to sell an asset or settle a liability).
Issues:
Fair value information may be more useful than
historical cost for certain types of assets &
liabilities.
Example: Investment in securities (debts, stock)
are reported at fair value because market price
information is often readily available for these type
of assets.
Fair Value Principles
Chapter
1-52
Fair Value Principle
Issues:
Choosing between cost and fair value, FASB
uses two qualities that make a accounting
information useful for decision making
relevance of fair value (if it would make a
difference in business decisions) and faithful
representation (information accurately depicts
what really happened)
FASB indicates that most assets must follow the
cost principle because market values may not be
representationally faithful.
Fair Value Principles
Chapter
1-53
Basic assumptions are foundations of financial
accounting measurements
Basic assumptions of accounting are:
Going Concern
Business/Economic Entity
Monetary Unit
Time Period
Assumptions of Accounting
Chapter
1-54
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.
Time Period Assumption
Presumes that the life of a company
can be divided into time periods,
such as months and years.
Now Future
Going-Concern Assumption
Reflects assumption that the business will
continue operating instead of being closed or
sold.
Assumptions of Accounting
Chapter
1-55
Going Concern
In the absence of information to the contrary, the
business entity is assumed to continue operations
into the foreseeable future.
Life of an economic entity is assumed to be
indefinite
Assets, defined as having future economic benefit,
require this assumption.
Allocation of costs to future periods is supported
by the going concern assumption examples
depreciation, amortization
Assumptions of Accounting
Chapter
1-56
Going Concern
Business enterprise will have a long life and going
concern assumption applies in most business.
Many businesses do fail, but in general, it is
reasonable to assume that the business will
continue.
Only where liquidation appears imminent is the
assumption inapplicable.
Assumptions of Accounting
Chapter
1-57
Economic Entity
A company is assumed to be a separate economic
entity that can be identified and measured.
Requires that activities of the entity be kept
separate and distinct from the activities of its
owner and all other economic entities.
Every economic entity can be separately identified
and accounted for.

Assumptions of Accounting
Chapter
1-58
Economic Entity
This concept helps determine the scope of
financial statements.
Must not blur on company transactions with
personal transactions (especially those of its
managers) or transactions of other companies
Examples: MMU and Telekom, UNITEN and TNB
Assumptions of Accounting
Chapter
1-59
Economic Entity
Proprietorship.
Partnership.
Corporation.
Assumptions of Accounting
Forms of Business
Ownership
Sole
Proprietorship
Partnership Corporation
Chapter
1-60
Proprietorship Partnership
Corporation
Owned by two or
more persons.
Often retail and
service-type
businesses
Generally
unlimited
personal liability
Partnership
agreement
Ownership
divided into
shares of stock
Separate legal
entity organized
under state
corporation law
Limited liability

Forms of Business Ownership
Generally owned
by one person.
Often small
service-type
businesses
Owner receives
any profits,
suffers any
losses, and is
personally liable
for all debts.
Chapter
1-61
Monetary Unit
Include in the accounting records only transaction
data that can be expressed in terms of money.
Examples: MYR, US Dollars
Value of the monetary unit used to measure an
economic entitys performance and position is
assumed stable.
This assumption enables accounting to quantify
(measure) economic events and to applying the
cost principle.
Assumptions of Accounting
Chapter
1-62
Monetary Unit
Monetary unit must maintain constant purchasing
power.
Monetary unit assumption is vital to applying the
cost principle.
Certain important information needed by
investors, creditors, and managers such as
customer satisfaction is not reported in the
financial statements.
Assumptions of Accounting
Chapter
1-63
Time Period
Presumed that the life of an economic entity can
be broken down into accounting periods such as
months and years.
Useful reports covering those periods can be
prepared for business.
The result is a trade-off between objectivity and
timeliness.
Assumptions of Accounting
Chapter
1-64
Time Period
Users need to be apprised of performance and
economic status on a timely basis so that they can
evaluate and compare firms, and take appropriate
actions.
Information must be reported periodically.
Alternative accounting periods include the
calendar or fiscal year.
Assumptions of Accounting
Chapter
1-65
Efforts to provide useful information can be costly to a
company. Two (2) overriding constraints must be
considered to ensure that companies apply accounting
rules in reasonable manner, from the perspective of the
company and user.

Materiality constraint: Relates to financial
statement items impact on a companys overall
financial conditions / operations.
Material when sizes is likely to influence the decision of
investors/creditors or the amount is significant that have
an impact on the financial position.
Accounting Constraints
Chapter
1-66
Cost/Benefit constraint: Relates to the fact that
providing information is costly.

To decide whether the Company should required to
provide certain type of information.
Accounting standard - setters must weigh the cost incur to
provide such information against the benefit that can be
derived from having the information available.
Accounting Constraints
Chapter
1-67
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.
Assumptions of Accounting
Review Question
Chapter
1-68
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.
Forms of Business Ownership
Review Question
Chapter
1-69
Assets Liabilities
Stockholders
Equity
= +
Provides the underlying framework for recording
and summarizing economic events.
During the process of recording business
transactions, it is important that we always keep the
accounting equation in balance.
We cant let our books get out of balance.



Basic Accounting Equation
Chapter
1-70
Assets Liabilities
Stockholders
Equity
= +
You have probably heard this saying before, but
may not have been sure what we meant by
keeping the books in balance.
The accounting equation MUST remain in balance
after each transaction.




Basic Accounting Equation
Chapter
1-71
Assets Liabilities
Stockholders
Equity
= +
Basic Accounting Equation
Resources a business owns. Business uses its
assets in carrying out activities such as production
and sales.
These resources are expected to yield future
benefits.
Service potential or future economic benefits
eventually result in cash inflows (receipts).
Assets
Chapter
1-72
Land
Equipment
Buildings
Cash
Vehicles
Store
Supplies
Notes
Receivable
Accounts
Receivable
Resources
owned or
controlled by
a company
Basic Accounting Equation
Chapter
1-73
Assets Liabilities
Stockholders
Equity
= +
Basic Accounting Equation
Liabilities
Creditors Claims against assets (debts and
obligations).
Creditors - party to whom money is owed.
These claims reflect company obligations to provide
assets, products or services to others.
Chapter
1-74
Assets Liabilities
Stockholders
Equity
= +
Basic Accounting Equation
Liabilities
The term payable refers to a liability that promises a
future outflow of resources
Examples are wages payable to workers, accounts
payable to suppliers, notes payable to banks, and
taxes payable to the government.

Chapter
1-75
Taxes
Payable
Wages
Payable
Notes
Payable
Accounts
Payable
Creditors
claims on
assets
Basic Accounting Equation
Chapter
1-76
Assets Liabilities
Stockholders
Equity
= +
Basic Accounting Equation
Stockholders
equity
Ownership claim on total assets.
Referred to as residual equity.
Stockholders equity section of a corporations
balance sheet consists of paid-in (contributed) capital
and retained earnings.
Chapter
1-77
Owners
Claims on
Assets
Basic Accounting Equation
Equity is the owners claim on assets. Equity is equal to
assets minus liabilities. This is the reason equity is also called
net assets or residual equity. Net income occurs when
revenues exceed expenses. Net income increases equity. Net
loss occurs when expenses exceed revenues, which
decreases equity.
Chapter
1-78
Basic Accounting Equation
Paid-in capital - total amount paid in by stockholders.
Retained earnings consists of three items: revenues,
expenses and dividends.
1. Revenues - gross increase in stockholders equity
resulting from business activities entered into for
the purpose of earning income.
2. Expenses - cost of assets consumed or services
used in the process of earning revenue.
3. Dividends - distributions of cash or other assets to
stockholders; dividends reduce retained earnings.
Stockholders equity
Chapter
1-79
Stockholders Equity
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
1-80
Expenses - 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.
Stockholders Equity
Chapter
1-81
Dividends - distribution of cash or other assets to
stockholders.
Dividends reduce retained earnings, however
dividends are not an expense.
Stockholders Equity
Chapter
1-82
Accounting Transactions
Transactions - economic events that require recording
in the financial statements or businesss economic
events recorded by accountants
Not all activities represent transactions
Assets, liabilities, or stockholders equity items
change as a result of some economic event.
May be external or internal transactions.
Chapter
1-83
Accounting Transactions
Transactions - economic events that require recording
in the financial statements or businesss economic
events recorded by accountants
External transactions are economic events between
the company and some outside enterprise.
Internal transactions are economic events that occur
entirely within one company.

Each transaction has a dual effect on the accounting
equation.
Chapter
1-84
Question: Are the following events recorded in the
accounting records?
Event
Purchase
computer.
Criterion
Is the financial position (assets, liabilities, or
stockholders equity) of the company changed?
Pay rent.
Record/Dont
Record
Accounting Transactions
Discuss
guided trip
options with
potential
customer.
Chapter
1-85
Assets
Liabilities
Stockholders
Equity
=
+
Analyzing Transactions
Accounting Transactions
First step in the accounting process is transaction
analysis.
The process of identifying specific effects of economic
events on the accounting equation.
This process examines relevant, objectively
measurable economic events through their effect on
the accounting equation:
Chapter
1-86
Analyzing Transactions
Accounting Transactions
Expanded Accounting Equation
Chapter
1-87
Discussion Question
Question. In February 2008, Paula King invested an
additional $10,000 in Hardy Company. Hardys
accountant, Lance Jones, recorded this receipt as an
increase in cash and revenues. Is this treatment
appropriate? Why or why not?
Accounting Transactions
No, this treatment is not proper. While the transaction does
involve a receipt of cash, it does not represent revenues.
Revenues are the gross increase in stockholders equity
resulting from business activities entered into for the purpose
of earning income. This transaction is simply an additional
investment made by one of the owners of the business.
Chapter
1-88
Illustration: 1. On October 1, cash of $10,000 is invested in Sierra
Corporation by investors in exchange for $10,000 of common
stock.
Accounting Transactions
1. +10,000 +10,000
Analyze the effect of business transactions on the
basic accounting equation.
Chapter
1-89
2. On October 1, Sierra borrowed $5,000 from Castle Bank by
signing a 3-month, 12%, $5,000 note payable.
Accounting Transactions
1. +10,000 +10,000
2. +5,000 +5,000
Chapter
1-90
3. On October 2, Sierra purchased equipment by paying $5,000
cash to Superior Equipment Sales Co.
Accounting Transactions
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000
Chapter
1-91
4. On October 2, Sierra received a $1,200 cash advance from R.
Knox, a client.
Accounting Transactions
4. +1,200 +1,200
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000
Chapter
1-92
5. On October 3, Sierra received $10,000 in cash from Copa
Company for guide services performed.
Accounting Transactions
4. +1,200 +1,200
5. +10,000 +10,000
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000
Chapter
1-93
6. On October 3, Sierra Corporation paid its office rent for the
month of October in cash, $900.
Accounting Transactions
4. +1,200 +1,200
5. +10,000 +10,000
6. -900 -900
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000
Chapter
1-94
7. On October 4, Sierra paid $600 for a one-year insurance policy
that will expire next year on September 30.
Accounting Transactions
4. +1,200 +1,200
5. +10,000 +10,000
6. -900 -900
7. -600 +600
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000
Chapter
1-95
8. On October 5, Sierra purchased supplies on account from Aero
Supply for $2,500.
Accounting Transactions
4. +1,200 +1,200
5. +10,000 +10,000
6. -900 -900
7. -600 +600
8. +2,500 +2,500
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000
Chapter
1-96
10. On October 20, Sierra paid a $500 dividend.
Accounting Transactions
4. +1,200 +1,200
5. +10,000 +10,000
6. -900 -900
7. -600 +600
8. +2,500 +2,500
10. -500 -500
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000
Chapter
1-97
11. Employees have worked two weeks, earning $4,000 in
salaries, which were paid on October 26.
Accounting Transactions
4. +1,200 +1,200
5. +10,000 +10,000
6. -900 -900
7. -600 +600
8. +2,500 +2,500
10. -500 -500
11. -4,000 -4,000
3. -5,000 +5,000
1. +10,000 +10,000
2. +5,000 +5,000
Chapter
1-98
Each transaction must be analyzed in terms of its
effect on the components of basic accounting
equation.
Assets = Liabilities + Stockholders Equity
Analysis must identify the specific items affected
and the amount of change in each item. Specific
items refers to specific accounts to the basic
accounting transactions.
A tabular summary may be prepared to show the
cumulative effect of transactions on the basic
accounting equation.
Accounting Transactions
Analyzing Transactions
Chapter
1-99
The summary demonstrates that:
a. Each transaction must be analyzed in terms of its effect
on (1) the three components of the equation (Assets
= Liabilities + stockholders equity) and (2) specific
types of items within each component.
b. Two sides of the equation must always be equal.
c. Common Stock and Retained Earnings column indicate
the causes of each change in the stockholders claim
on assets.
Stockholders equity = Common stock + Retained
Earnings (Revenue, Expenses and Dividend)
Accounting Transactions
Chapter
1-100
All businesses are involved in three types of activity :
financing,
investing,
operating.
Business Activities
Accounting information system keeps track of the
results of each of these business activities.
Chapter
1-101
Provide the means organizations use to pay for
resources such as land, buildings, and equipment
to carry out plans.
Two primary sources of outside funds are:
1. Borrowing money
2. Issuing shares of stock for cash.
Business Activities
Financing Activities
Chapter
1-102
1. Borrowing money
Amounts owed are called liabilities.
Party to whom amounts are owed are creditors.
Notes payable and bonds payable are different
type of liabilities.
2. Issuing shares of stock for cash.
Payments to stockholders are called dividends.
Business Activities
Financing Activities
Chapter
1-103
Investing Activities
Are the acquiring and disposing of resources (assets)
that an organization uses to acquire and sell its
products or services.
Purchase of resources a company needs to operate.
Computers, delivery trucks, furniture, buildings, etc.
Resources owned by a business are called assets.
Business Activities
Chapter
1-104
Operating Activities
Involve using resources to research, develop, and purchase,
produce, distribute, and market products and services.
Once a business has the assets it needs, it can begin its
operations.
Revenues - Amounts earned from the sale of products
(sales revenue, service revenue, and interest revenue).
Inventory - Goods available for sale to customers.
Accounts receivable - Right to receive money from a
customer in the future, as the result of a sale.
Business Activities
Chapter
1-105
Operating Activities
Expenses - cost of assets consumed or services used.
(cost of goods sold, selling, marketing, administrative,
interest, and income taxes expense).
Liabilities arising from expenses include accounts
payable, interest payable, wages payable, sales taxes
payable, and income taxes payable.
Net income when revenues exceed expenses.
Net loss when expenses exceed revenues.
Business Activities
Chapter
1-106
Companies prepare four financial statements from the
summarized accounting data:
Balance
Sheet
Income
Statement
Statement
of Cash
Flows
Retained
Earnings
Statement
Financial Statements
Chapter
1-107
1. Income statement presents the revenues and
expenses and resulting net income or net loss for a
specific period of time.
2. Retained earnings statement summarizes the
changes in retained earnings for a specific period of
time.
3. Balance sheet reports the assets, liabilities, and
stockholders equity of a company at a specific date.
4. A statement of cash flows summarizes information
about the cash inflows (receipts) and outflows
(payments) for a specific period of time.
Financial Statements
Chapter
1-108
Financial statements are interrelated because:
a. Net income (or net loss) shown on the income
statement is added (subtracted) to (from) the
beginning balance of retained earnings in the
retained earnings statement.
b. Retained earnings at the end of reporting period
shown in the retained earnings statement is reported
in the balance sheet.
c. Amount of cash shown on the balance sheet is
reported on the statement of cash flows.
Financial Statements
Chapter
1-109
Statement of
Cash Flows
Income
Statement
Statement of
Stockholders Equity
Ending
Balance Sheet
Assets
(Cash)
=
Liabilities
+
Equity
Beginning
Balance Sheet
Assets
(Cash)
=
Liabilities
+
Equity
Financial Statement
Relationships Among the Financial Statements
Chapter
1-110
In income statement,
revenues are listed
first, followed by
expenses. Then
below expenses is
the resulting amount
of net income (or net
loss).
Reports revenues
and expenses for a
specific period of
time.
Financial Statement
Income Statement
Chapter
1-111
Net income
revenues exceed
expenses.
Net loss expenses
exceed revenues.
Past net income
provides information
for predicting future
net income.
Financial Statement
Income Statement
Chapter
1-112
Financial Statement
Retained Earnings
Statement
Net income is needed to determine
the ending balance in retained
earnings.
Income Statement
Chapter
1-113
Financial Statement
Statement shows amounts
and causes of changes in
retained earnings during the
period.
Statement shows retained
earnings at beginning of the
period, net income (or net
loss) for the period,
dividends, and retained
earnings at the end of the
period.
Retained Earnings
Statement
Chapter
1-114
Financial Statement
Time period is the same as
that covered by the income
statement.
Users can evaluate dividend
payment practices.
Retained Earnings
Statement
Chapter
1-115
Financial Statements
Retained Earnings
Statement
Ending balance in retained
earnings is needed in preparing
the balance sheet.
Balance Sheet
Chapter
1-116
Financial Statements
Balance Sheet
Reports assets and
claims to assets at a
specific point in time.
Assets = Liabilities +
Stockholders Equity.
Lists assets first,
followed by liabilities
and stockholders
equity.
Chapter
1-117
Financial Statements
Balance Sheet Statement of Cash Flows
Chapter
1-118
Answers:
Where did cash
come from during
the period?
How was cash
used during the
period?
What was the
change in the cash
balance during the
period?
Financial Statements
Statement of Cash Flows
Sources
Uses
Net increase or
decrease in
cash
Chapter
1-119
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.
Financial Statements
Review Question
Chapter
1-120
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.
Financial Statements
Review Question
Chapter
1-121
Discussion Question
Question. A companys net income appears directly on
the income statement and the retained earnings
statement, and it is included indirectly in the companys
balance sheet. Do you agree? Explain.
Financial Statements
Yes. Net income does appear on the income statement. It is the
result of subtracting expenses from revenues. In addition, net
income appears in the retained earnings statement. It is shown as an
addition to the beginning-of-period retained earnings. Indirectly, the
net income of a company is also included in the balance sheet. It is
included in the Retained Earnings account which appears in the
stockholders equity section of the balance sheet.
Chapter
1-122
Copyright 2008 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.
Copyright