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Accounting in Action
Financial Accounting, Seventh Edition
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Study Objectives
1. 2. 3. 4. 5. 6. 7. 8. Explain what accounting is. Identify the users and uses of accounting. Understand why ethics is a fundamental business concept. Explain generally accepted accounting principles and the measurement principle. Explain the monetary unit assumption and the economic entity assumption. State the accounting equation, and define its components. Analyze the effects of business transactions on the accounting equation. Understand the four financial statements and how they are prepared.

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Accounting in Action

What is Accounting?

The Building Blocks of Accounting Ethics in financial reporting Generally accepted accounting principles Assumptions

The Basic Accounting Equation Assets Liabilities Stockholders equity

Using the Accounting Equation Transaction analysis Summary of transactions

Financial Statements

Three activities Who uses accounting data

Income statement Retained earnings statement Balance sheet Statement of cash flows

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What is Accounting? The purpose of accounting is to:


(1)

identify, record, identify record and communicate the economic communicate events of an

(2) (3)

organization to interested users.

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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.

Who Uses Accounting Data


Internal Users Human Resources Management IRS Investors

Finance

There are two broad groups of users of financial information: internal users and external users.
Customers SEC

Labor Unions Creditors External Users

Marketing

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SO 2 Identify the users and uses of accounting.

Who Uses Accounting Data


Common Questions Asked
1. Can we afford to give our employees a pay raise? 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? 6. Will the company be able to pay its short-term debts?
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User Human Resources Investors Management Finance Marketing Creditors

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.

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Solution on notes page

SO 3 Understand why ethics is a fundamental business concept.

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, WorldCom, HealthSouth, AIG, and others. Congress passed Sarbanes-Oxley Act of 2002. 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


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

The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced.

Generally Accepted Accounting Principles (GAAP)

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SO 4 Explain generally accepted accounting principles and the measurement principle.

The Building Blocks of Accounting Organizations Involved in Standard Setting:


Securities and Exchange Commission (SEC)
http://www.sec.gov/

Public Company Accounting Oversight http://www.pcaobus.org/ Board (PCAOB) Securities and Exchange Commission (SEC)
http://www.fasb.org/

International Accounting Standards Board (IASB)


http://www.iasb.org/
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SO 4

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, whereas market value is often subjective. Fair value information may be more useful.
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SO 4 Explain generally accepted accounting principles and the measurement principle.

The Building Blocks of Accounting


Measurement Principles
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).
FASB indicates that most assets must follow the cost principle because market values are not representationally faithful. Only in situations where assets are actively traded, such as investment securities, is the fair value principle applied.
SO 4 Explain generally accepted accounting principles and the measurement principle.

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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. Corporation.
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Forms of Business Ownership

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

Forms of Business Ownership


Proprietorship
Generally owned by one person. Often small service-type businesses Owner receives any profits, suffers any losses, and is personally liable for all debts.
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Partnership
Owned by two or more persons. Often retail and service-type businesses Generally unlimited personal liability Partnership agreement

Corporation
Ownership divided into shares of stock Separate legal entity organized under state corporation law Limited liability

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 of stock 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. Congress passed the Sarbanes-Oxley Act of 2002 to reduce unethical behavior and decrease the likelihood of future corporate scandals.

True False True

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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. 4. The primary accounting standard-setting body in the United States is the Financial Accounting Standards Board (FASB). 5. The cost principle dictates that companies record assets at their cost. In later periods, however, the fair value of the asset must be used if fair value is higher than its cost.

True

False

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Solution on notes page

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

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

The Basic Accounting Equation


Stockholders Equity

Assets

Liabilities

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.

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SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation


Stockholders Equity

Assets

Liabilities

Provides the underlying framework for recording and summarizing economic events.

Assets
Resources a business owns. Provide future services or benefits. Cash, Supplies, Equipment, etc.
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SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation


Stockholders Equity

Assets

Liabilities

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


Stockholders Equity

Assets

Liabilities

Provides the underlying framework for recording and summarizing economic events.

Stockholders Equity
Ownership claim on total assets. Referred to as residual equity. Common stock and retained earnings.
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SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation


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.
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SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation


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.
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SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation


Illustration 1-6

Dividends are the distribution of cash or other assets to stockholders. Dividends reduce retained earnings. However, dividends are 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 stock, dividends, revenues, or expenses. Then indicate whether each item increases or decreases stockholders equity. Classification 1. Rent expense 2. Service revenue 3. Dividends 4. Salaries expense
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Effect on Equity Decrease Increase Decrease Decrease

Expense Revenue Dividends Expense

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


Q1Q1-16: Are the following events recorded in the accounting records? Event
Supplies are purchased on account. An employee is hired. The president of the company dies.

Criterion

Is the financial position (assets, liabilities, or owners equity) of the company changed?

Record/ Dont Record


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SO 7 Analyze the effects of business transactions on the accounting equation.

Using The Accounting Equation

Discussion Question
Q1-19. In February 2011, 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?

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Solution on notes page

SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis

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SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis
P1P1-1A: Barones Repair Shop was started on May 1. Prepare a tabular analysis of the following transactions for the month of May. 1. Invested $10,000 cash to start the repair shop.

1. +10,000

+10,000

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SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis
2. Purchased equipment for $5,000 cash.

1. +10,000 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. +120 $6,180 Slide 1-37 +5,100 -1,000 -2,000 -140 +750 -120 $630 $12,310 $500 $5,000 $250 -5,000 -400 -500 +500 +250 +5,000

+10,000

-400

-250 +5,100 -1,000 -2,000 -140 +750

$10,000

$5,850 $12,310

$2,790

$1,000

SO 7

Transactions Analysis
3. Paid $400 cash for May office rent.

1. +10,000 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. +120 $6,180 Slide 1-38 +5,100 -1,000 -2,000 -140 +750 -120 $630 $12,310 $500 $5,000 $250 -5,000 -400 -500 +500 +250 +5,000

+10,000

-400

-250 +5,100 -1,000 -2,000 -140 +750

$10,000

$5,850 $12,310

$2,790

$1,000

SO 7

Transactions Analysis
3. Paid $500 cash for supplies.

1. +10,000 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. +120 $6,180 Slide 1-39 +5,100 -1,000 -2,000 -140 +750 -120 $630 $12,310 $500 $5,000 $250 -5,000 -400 -500 +500 +250 +5,000

+10,000

-400

-250 +5,100 -1,000 -2,000 -140 +750

$10,000

$5,850 $12,310

$2,790

$1,000

SO 7

Transactions Analysis
5. Incurred $250 of advertising costs, on account.

1. +10,000 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. +120 $6,180 Slide 1-40 +5,100 -1,000 -2,000 -140 +750 -120 $630 $12,310 $500 $5,000 $250 -5,000 -400 -500 +500 +250 +5,000

+10,000

-400

-250 +5,100 -1,000 -2,000 -140 +750

$10,000

$5,850 $12,310

$2,790

$1,000

SO 7

Transactions Analysis
6. Received $5,100 from customers for repair service.

1. +10,000 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. +120 $6,180 Slide 1-41 +5,100 -1,000 -2,000 -140 +750 -120 $630 $12,310 $500 $5,000 $250 -5,000 -400 -500 +500 +250 +5,000

+10,000

-400

-250 +5,100 -1,000 -2,000 -140 +750

$10,000

$5,850 $12,310

$2,790

$1,000

SO 7

Transactions Analysis
7. Declared and paid a $1,000 cash dividend.

1. +10,000 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. +120 $6,180 Slide 1-42 +5,100 -1,000 -2,000 -140 +750 -120 $630 $12,310 $500 $5,000 $250 -5,000 -400 -500 +500 +250 +5,000

+10,000

-400

-250 +5,100 -1,000 -2,000 -140 +750

$10,000

$5,850 $12,310

$2,790

$1,000

SO 7

Transactions Analysis
8. Paid part-time employee salaries of $2,000.

1. +10,000 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. +120 $6,180 Slide 1-43 +5,100 -1,000 -2,000 -140 +750 -120 $630 $12,310 $500 $5,000 $250 -5,000 -400 -500 +500 +250 +5,000

+10,000

-400

-250 +5,100 -1,000 -2,000 -140 +750

$10,000

$5,850 $12,310

$2,790

$1,000

SO 7

Transactions Analysis
9. Paid utility bills $140.

1. +10,000 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. +120 $6,180 Slide 1-44 +5,100 -1,000 -2,000 -140 +750 -120 $630 $12,310 $500 $5,000 $250 -5,000 -400 -500 +500 +250 +5,000

+10,000

-400

-250 +5,100 -1,000 -2,000 -140 +750

$10,000

$5,850 $12,310

$2,790

$1,000

SO 7

Transactions Analysis
10. Provided $750 of repair services on account.

1. +10,000 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. +120 $6,180 Slide 1-45 +5,100 -1,000 -2,000 -140 +750 -120 $630 $12,310 $500 $5,000 $250 -5,000 -400 -500 +500 +250 +5,000

+10,000

-400

-250 +5,100 -1,000 -2,000 -140 +750

$10,000

$5,850 $12,310

$2,790

$1,000

SO 7

Transactions Analysis
11. Collected $120 cash for services previously billed.

1. +10,000 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. +120 $6,180 Slide 1-46 +5,100 -1,000 -2,000 -140 +750 -120 $630 $12,310 $500 $5,000 $250 -5,000 -400 -500 +500 +250 +5,000

+10,000

-400

-250 +5,100 -1,000 -2,000 -140 +750

$10,000

$5,850 $12,310

$2,790

$1,000

SO 7

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

Income Statement

Retained Earnings Statement

Balance Sheet

Statement of Cash Flows

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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 Slide 1-48

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

Financial Statements
Income Statement
Barones Repair Shop Income Statement
For the Month Ended May 31, 2010

Reports the revenues and expenses for a specific period of time. Net income revenues exceed expenses. Net loss expenses exceed revenues.

Revenues: Service revenue Expenses: Salary expense Rent expense Utility expense Advertising expense Total expenses Net income $ 5,850 2,000 400 140 250 2,790 $ 3,060

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

Financial Statements
Income Statement
Barones Repair Shop Income Statement
For the Month Ended May 31, 2010

Retained Earnings Statement


Barones Repair Shop Retained Earnings Statement
For the Month Ended May 31, 2010

Revenues: Service revenue Expenses: Salary expense Rent expense Utility expense Advertising expense Total expenses Net income $ 5,850 2,000 400 140 250 2,790 $ 3,060

Beginning balance, May 1 Add: Net income Less: Dividends Ending balance, May 31

3,060 3,060 1,000

$ 2,060

Net income is needed to determine the ending balance in the retained earnings account.

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

Financial Statements
Retained Earnings Statement
Statement indicates the reasons why retained earnings has increased or decreased during the period.
Barones Repair Shop Retained Earnings Statement
For the Month Ended May 31, 2010

Beginning balance, May 1 Add: Net income Less: Dividends Ending balance, May 31

3,060 3,060 1,000

$ 2,060

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

Financial Statements
Balance Sheet
Barones Repair Shop Balance Sheet May 31, 2010 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities Accounts payable Owner's Equity Common stock Retained earnings Total liab. & equity
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Retained Earnings Statement


Barones Repair Shop Retained Earnings Statement
For the Month Ended May 31, 2010

$ 6,180 630 500 5,000 $ 12,310 $ 250 10,000 2,060 $ 12,310

Beginning balance, May 1 Add: Net income Less: Dividends Ending balance, May 31

3,060 3,060 1,000

$ 2,060

The ending balance in retained earnings is needed in preparing the balance sheet

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

Financial Statements
Balance Sheet
Barones Repair Shop Balance Sheet May 31, 2010 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities Accounts payable Owner's Equity Common stock Retained earnings Total liab. & equity
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$ 6,180 630 500 5,000 $ 12,310 $ 250 10,000 2,060 $ 12,310

Reports the assets, liabilities, and stockholders equity at a specific date. Assets listed at the top, followed by liabilities and stockholders equity. Total assets must equal total liabilities and stockholders equity.

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

Financial Statements
Balance Sheet
Barones Repair Shop Balance Sheet May 31, 2010 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities Accounts payable Owner's Equity Common stock Retained earnings Total liab. & equity
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Statement of Cash Flows


Barones Repair Shop Statement of Cash Flows
For the Month Ended May 31, 2010

Cash flow from operating activities


$ 6,180 630 500 5,000 $ 12,310 $ 250 10,000 2,060 $ 12,310

Cash receipts from revenues $ 5,220 Cash paid for expenses (3,040) Cash provided by operations 2,180 Cash flow from investing activitites Purchase of equipment (5,000) Cash flow from financing activities Issuance of common stock Dividend paid Cash provided by financing Net increase in cash Cash balance, May 1 Cash balance, May 31 10,000 (1,000) 9,000 6,180 $ 6,180

SO 8

Financial Statements
Information for a specific period of time. Answers the following:
1. Where did cash come

Statement of Cash Flows


Barones Repair Shop Statement of Cash Flows
For the Month Ended May 31, 2010

Cash flow from operating activities

from?
2. What was cash used

Cash receipts from revenues $ 5,220 Cash paid for expenses (3,040) Cash provided by operations 2,180 Cash flow from investing activitites Purchase of equipment (5,000) Cash flow from financing activities Issuance of common stock Dividend paid Cash provided by financing Net increase in cash Cash balance, May 1 Cash balance, May 31 10,000 (1,000) 9,000 6,180 $ 6,180

for?
3. What was the change

in the cash balance?

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SO 8

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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. Owner's equity statement. d. Statement of cash flows.

Solution on notes page. Slide 1-57

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

Financial Statements

Discussion Question
Q1-20. A companys net income appears directly on the income statement and the retained earnings, and it is included indirectly in the companys balance sheet. Do you agree? Explain.

Solution on notes page Slide 1-58

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

Ethics: Managing Personal Financial Reporting

 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, according to an analysis of data from the Department of Educations National Postsecondary Student Aid Study. That does not include any debt that their parents might incur.
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 Colleges are required to audit the FAFSA forms of at least one-third of their students; some audit 100%. (Compare that to the IRS, which audits a very small percentage of tax returns.) Thus, if you lie on your financial aid forms, theres a very good chance youll get caught.

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Consider the following and decide what action you would take: Suppose you have $4,000 in cash and $4,000 in credit card bills. The more cash and other assets that you have, the less likely you are to get financial aid. Also, if you have a lot of consumer debt (credit card bills), schools are not more likely to loan you money. To increase your chances of receiving aid, should you use the cash to pay off your credit card bills, and therefore make yourself look worse off to the financial aid decision makers? YES: You are playing within the rules. You are not hiding assets. You are restructuring your assets and liabilities to best conform with the preferences that are built into the federal aid formulas. NO: You are engaging in a transaction solely to take advantage of a loophole in the federal aid rules. You are potentially depriving someone who is actually worse off than you from receiving aid.

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Career Opportunities
Public accounting Private accounting Show me the Money

APPENDIX
Government Forensic accounting

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SO 9 Explain the career opportunities in accounting.

Copyright
Copyright 2010 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.

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