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Chapter

Accounting in Action
Financial Accounting, IFRS Edition
Weygandt Kimmel Kieso
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Study Objectives

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1.

Explain what accounting is.

2.

Identify the users and uses of accounting.

3.

Understand why ethics is a fundamental business concept.

4.

Explain accounting standards and the measurement principles.

5.

Explain the monetary unit assumption and the economic entity


assumption.

6.

State the accounting equation, and define its components.

7.

Analyze the effects of business transactions on the accounting


equation.

8.

Understand the four financial statements and how they are


prepared.

Accounting in Action

What is
Accounting?

Three
activities
Who uses
accounting
data?

The Building
Blocks of
Accounting
Ethics in
financial
reporting
Accounting
standards
Assumptions

The Basic
Accounting
Equation
Assets
Liabilities
Equity

Using the
Accounting
Equation

Financial
Statements

Transaction
analysis

Income
statement

Summary of
transactions

Retained
earnings
statement
Statement of
financial
position
Statement of
cash flows

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What is Accounting?
The purpose of accounting:
(1)

to identify, record, and communicate the economic


events of an

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(2)

organization to

(3)

interested users.

SO 1 Explain what accounting is.

What is Accounting?
Three Activities

Illustration 1-1
The activities of the
accounting process

The accounting process includes


the bookkeeping function.
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SO 1 Explain what accounting is.

What is Accounting?
Who Uses Accounting Data
Internal
Users

Human
Resources

External
Users

Taxing
Authorities
Labor
Unions

Finance
Management

Customers
Creditors

Marketing

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Regulatory
Agencies

Investors

SO 2 Identify the users and uses of accounting.

What is Accounting?
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. Should any product lines be


eliminated?

Management

4. Is cash sufficient to pay


dividends to shareholders?

Finance

5. What price for our product will


maximize net income?

Marketing

6. Will the company be able to


pay its debts?

Creditors

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SO 2 Identify the users and uses of accounting.

The Building Blocks of Accounting


Ethics In Financial Reporting
Standards of conduct by which ones actions are judged
as right or wrong, honest or dishonest, fair or not fair,
are Ethics.
Recent financial scandals include: Enron (USA),
Parmalat (ITA), Satyam Computer Services (IND), AIG
(USA), and others.
Effective financial reporting depends on sound ethical
behavior.
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SO 3 Understand why ethics is a fundamental business concept.

The Building Blocks of Accounting


Ethics In Financial Reporting

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SO 3 Understand why ethics is a fundamental business concept.

The Building Blocks of Accounting

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.

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Solution on
notes page

SO 3 Understand why ethics is a fundamental business concept.

The Building Blocks of Accounting


Accounting Standards
International Accounting Standards Board (IASB)
http://www.iasb.org/
International Financial Reporting Standards (IFRS)

Financial Accounting Standards Board (FASB)


http://www.fasb.org/
Generally Accepted Accounting Principles (GAAP)

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SO 4 Explain accounting standards and the measurement principles.

The Building Blocks of Accounting


Measurement Principles
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, market value is often subjective.

Fair value information may be more useful.

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SO 4 Explain accounting standards and the measurement principles.

The Building Blocks of Accounting


Measurement Principles
Fair Value Principle indicates that assets and liabilities should

be reported at fair value.


In determining which measurement principle to use, companies
weigh the factual nature of cost figures versus the relevance of

fair value.
Only in situations where assets are actively traded, such as
investment securities, is the fair value principle applied.

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SO 4 Explain accounting standards and the measurement principles.

The Building Blocks of Accounting


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.
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SO 5 Explain the monetary unit assumption and the economic entity assumption.

The Building Blocks of Accounting

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Proprietorship

Partnership

Corporation

Generally owned
by one person.

Owned by two or
more persons.

Ownership divided
into shares

Often small
service-type
businesses

Often retail and


service-type
businesses

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

SO 5 Explain the monetary unit assumption and the economic entity assumption.

The Building Blocks of Accounting

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.

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Solution on
notes page

SO 5 Explain the monetary unit assumption


and the economic entity assumption.

The Building Blocks of Accounting

Review Question
A business organized as a separate legal entity under
state law having ownership divided into shares is a
a. proprietorship.

b. partnership.
c. corporation.
d. sole proprietorship.

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Solution on
notes page

SO 5 Explain the monetary unit assumption


and the economic entity assumption.

The Building Blocks of Accounting


Indicate whether each of the following
statements presented below is true or false.
1. The three steps in the accounting process are
identification, recording, and communication.
2. The two most common types of external users
are investors and company officers.
3. Shareholders in a corporation enjoy limited legal
liability as compared to partners in a partnership.

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Solution on
notes page

True
False
True

SO 5 Explain the monetary unit assumption


and the economic entity assumption.

The Building Blocks of Accounting


Indicate whether each of the following
statements presented below is true or false.
4. The primary accounting standard-setting body
outside the United States is the International

True

Accounting Standards Board (IASB).

5. The cost principle dictates that companies


record assets at their cost. In later periods,

False

however, the fair value of the asset must be

used if fair value is higher than its cost.

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Solution on
notes page

SO 5 Explain the monetary unit assumption


and the economic entity assumption.

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Answer on notes page

SO 5 Explain the monetary unit assumption and the economic entity assumption.

The Basic Accounting Equation


Assets

Liabilities

Equity

Provides the underlying framework for recording and


summarizing economic events.
Applies to all economic entities regardless of size.

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SO 6

State the accounting equation, and define its components.

The Basic Accounting Equation


Assets

Liabilities

Equity

Provides the underlying framework for recording and


summarizing economic events.

Assets
Resources a business owns.

Provide future services or benefits.


Cash, Inventory, Equipment, etc.
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SO 6

State the accounting equation, and define its components.

The Basic Accounting Equation


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.
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SO 6

State the accounting equation, and define its components.

The Basic Accounting Equation


Assets

Liabilities

Equity

Provides the underlying framework for recording and


summarizing economic events.

Equity
Ownership claim on total assets.

Referred to as residual equity.


Share capital and retained earnings.
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SO 6

State the accounting equation, and define its components.

The Basic Accounting Equation


Illustration 1-7

Revenues result from business activities entered into for the purpose
of earning income.
Generally results from selling merchandise, performing services,
renting property, and lending money.
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SO 6

State the accounting equation, and define its components.

The Basic Accounting Equation


Illustration 1-7

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.
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SO 6

State the accounting equation, and define its components.

The Basic Accounting Equation


Illustration 1-7

Dividends are the distribution of cash or other assets to shareholders.


Reduce retained earnings
Not an expense

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SO 6

State the accounting equation, and define its components.

The Basic Accounting Equation


Classify the following items as issuance of
shares, dividends, revenues, or expenses.
Then indicate whether each item increases or decreases
equity.

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Classification

Effect on Equity

1. Rent expense

Expense

Decrease

2. Service revenue

Revenue

Increase

3. Dividends

Dividends

Decrease

4. Salaries expense

Expense

Decrease

Solution on
notes page

SO 6

State the accounting equation, and define its components.

Using The Accounting Equation


Transactions are a businesss 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.

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SO 7

Analyze the effects of business transactions on the accounting equation.

Using The Accounting Equation


Illustration: Are the following events recorded in the
accounting records?
Illustration 1-8
Discuss
product
design with
customer.

Event

Purchase
computer.

Criterion

Is the financial position (assets, liabilities, or


equity) of the company changed?

Pay rent.

Record/
Dont Record
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SO 7

Analyze the effects of business transactions on the accounting equation.

Using The Accounting Equation


Transaction Analysis

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SO 7

Analyze the effects of business transactions on the accounting equation.

Transactions Analysis
Transaction (1). Investment by Shareholders. Ray and
Barbara Neal decides to open a computer programming service
which he names Softbyte. On September 1, 2011, they invest
$15,000 cash in exchange for capital shares. The effect of this
transaction on the basic equation is:

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Solution on
notes page

SO 7

Analyze the effects of business transactions


on the accounting equation.

Transactions Analysis
Transaction (2). Purchase of Equipment for Cash. Softbyte
purchases computer equipment for $7,000 cash.

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Solution on
notes page

SO 7

Analyze the effects of business transactions


on the accounting equation.

Transactions Analysis
Transaction (3). Purchase of Supplies on Credit. Softbyte
purchases for $1,600 from Acme Supply Company computer
paper and other supplies expected to last several months.

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Solution on
notes page

SO 7

Analyze the effects of business transactions


on the accounting equation.

Transactions Analysis
Transaction (4). Services Provided for Cash. Softbyte
receives $1,200 cash from customers for programming services
it has provided.

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Solution on
notes page

SO 7

Analyze the effects of business transactions


on the accounting equation.

Transactions Analysis
Transaction (5). Purchase of Advertising on Credit. Softbyte
receives a bill for $250 from the Daily News for advertising but
postpones payment until a later date.

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Solution on
notes page

SO 7

Analyze the effects of business transactions


on the accounting equation.

Transactions Analysis
Transaction (6). Services Provided for Cash and Credit.
Softbyte provides $3,500 of programming services for
customers. The company receives cash of $1,500 from
customers, and it bills the balance of $2,000 on account.

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Solution on
notes page

SO 7

Analyze the effects of business transactions


on the accounting equation.

Transactions Analysis
Transaction (7). Payment of Expenses. Softbyte pays the
following Expenses in cash for September: store rent $600,
salaries of employees $900, and utilities $200.

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Solution on
notes page

SO 7

Analyze the effects of business transactions


on the accounting equation.

Transactions Analysis
Transaction (8). Payment of Accounts Payable. Softbyte
pays its $250 Daily News bill in cash.

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Solution on
notes page

SO 7

Analyze the effects of business transactions


on the accounting equation.

Transactions Analysis
Transaction (9). Receipt of Cash on Account. Softbyte
receives $600 in cash from customers who had been billed for
services [in Transaction (6)].

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Solution on
notes page

SO 7

Analyze the effects of business transactions


on the accounting equation.

Transactions Analysis
Transaction (10). Dividends. The corporation pays a dividend
of $1,300 in cash.

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Solution on
notes page

SO 7

Analyze the effects of business transactions


on the accounting equation.

Transactions Analysis
Summary of Transactions

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SO 7

Illustration 1-10
Tabular summary of
Softbyte transactions

Analyze the effects of business transactions on the accounting equation.

Financial Statements
Companies prepare four financial statements from the
summarized accounting data:

Income
Statement

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Retained
Earnings
Statement

Statement
of Financial
Position

Statement
of Cash
Flows

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.

Solution on
notes page
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SO 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.
Illustration 1-11
Financial statements and
Net loss expenses exceed revenues.
their interrelationships
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SO 8 Understand the four financial statements and how they are prepared.

Financial Statements

Net income is needed to determine the


ending balance in retained earnings.

Illustration 1-11
Financial statements and
their interrelationships

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SO 8

Financial Statements

Statement indicates the reasons why


retained earnings has increased or
decreased during the period.

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Retained Earnings
Statement

Illustration 1-11
Financial statements and
their interrelationships

SO 8 Understand the four financial statements and how they are prepared.

Financial
Statements

The ending
balance in
retained
earnings is
needed in
preparing the
statement of
financial position

Illustration 1-11
Financial statements and
their interrelationships
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SO 8 Understand the four financial statements and how they are prepared.

Financial Statements

Balance Sheet

Illustration 1-11
Financial statements and
their interrelationships

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SO 8 Understand the four financial statements and how they are prepared.

Financial
Statements

Illustration 1-11
Financial statements and
their interrelationships

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Financial Statements
Statement of Cash Flows
Information for a specific period of time.
Answers the following:
1. Where did cash come from?

2. What was cash used for?


3. What was the change in the cash balance?

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SO 8 Understand the four financial statements and how they are prepared.

Financial Statements

Statement of Cash Flows

Illustration 1-11
Financial statements and
their interrelationships

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SO 8 Understand the four financial statements and how they are prepared.

Answer on
notes page
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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. Retained earnings statement.
d. Statement of cash flows.

Solution on
notes page.
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SO 8 Understand the four financial statements and how they are prepared.

Understanding U.S. GAAP


Key Differences

Accounting in Action

In 2002, the U.S. Congress issued the Sarbanes-Oxley Act (SOX),


which mandated certain internal controls for large public
companies listed on U.S. exchanges. Debate about international
companies (non-U.S.) adopting SOX-type standards centers on
whether the benefits exceed the costs. The concern is that the
higher costs of SOX compliance are making the U.S. securities
markets less competitive.
Financial frauds have occurred at companies such as Satyam
Computer Services (IND), Parmalat (ITA), and Royal Ahold (NLD).
They have also occurred at large U.S. companies such as Enron,
WorldCom, and AIG.
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Understanding U.S. GAAP


Key Differences

Accounting in Action

IFRS tends to be less detailed in its accounting and disclosure


requirements than GAAP. This difference in approach has resulted
in a debate about the merits of principles-based (IFRS) versus
rules-based (GAAP) standards.
U.S. regulators have recently eliminated the need for foreign
companies that trade shares in U.S. markets to reconcile their
accounting with GAAP.
GAAP is based on a conceptual framework that is similar to that

used to develop IFRS.

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Understanding U.S. GAAP


Key Differences

Accounting in Action

The three common forms of business organization that are


presented in the chapter, proprietorships, partnerships, and
corporations, are also found in the United States. Because the
choice of business organization is influenced by factors such as
legal environment, tax rates and regulations, and degree of
entrepreneurism, the relative use of each form will vary across
countries.
Transaction analysis is basically the same under IFRS and GAAP
but, as you will see in later chapters, the different standards may
impact how transactions are recorded.

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Understanding U.S. GAAP


Looking to the Future

Accounting in Action

Both the IASB and the FASB are hard at work developing
standards that will lead to the elimination of major differences in
the way certain transactions are accounted for and reported.
Consider, for example, that as a result of a joint project on the
conceptual framework, the definitions of the most fundamental
elements (assets, liabilities, equity, revenues, and expenses) may
actually change. However, whether the IASB adopts internal
control provisions similar to those in SOX remains to be seen.

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Career Opportunities

APPENDIX

Public accounting

Government

Private accounting

Forensic accounting

Show me
the Money

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SO 9 Explain the career opportunities in accounting.

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