CHAPTER 1

ACCOUNTING IN
ACTION

Accounting Principles, Eighth Edition

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 owners 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

The Building The Basic Using the

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 Owners
Owners
accounting Generally equity transactions equity
data accepted statement
accounting Balance
principles sheet
Assumptions Statement of
cash flows

Chapter
1-3
 What is Accounting?

The purpose of accounting is to:

(1) identify, record, and communicate the
economic events of an
(2) organization to
(3) interested users.

Chapter
1-4 LO 1 Explain what accounting is.
 What is Accounting?

Three Activities
Illustration 1-1
Accounting process

The accounting process includes

the bookkeeping function.

Chapter
1-5 LO 1 Explain what accounting is.
 Who Uses Accounting Data?
Internal Users
Management IRS
Human Investors
Resources
There are two broad
groups of users of Labor
financial information: Unions
Finance
internal users and
external users. Creditors
Marketing
SEC
Customers External
Users
Chapter
1-6 LO 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 LO 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

LO 3 Understand why ethics is a fundamental business concept .
Chapter
1-8
 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 passedSarbanes-Oxley Act of 2002.

Effective financial reporting depends on sound

ethical behavior.

LO 3 Understand why ethics is a fundamental business concept .

Chapter
1-9
 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.

LO 3 Understand why ethics is a fundamental business concept .

Chapter
1-10
 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.

LO 3 Understand why ethics is a fundamental business concept .

Chapter
1-11
 The Building Blocks of Accounting

Financial Statements
Various users Balance Sheet
need financial Income Statement
Statement of Owners Equity
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
1-12 LO 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
1-13 LO 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
1-14 LO 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 LO 5 Explain the monetary unit assumption
1-15
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 LO 5 Explain the monetary unit assumption
1-16
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 LO 5 Explain the monetary unit assumption

1-17
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 LO 5 Explain the monetary unit assumption

1-18
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 LO 5 Explain the monetary unit assumption

1-19
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 LO 5 Explain the monetary unit assumption

1-20
and the economic entity assumption.
 The Basic Accounting Equation

Owners
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 LO 6 State the accounting equation, and define

1-21
assets, liabilities, and owners equity.
 The Basic Accounting Equation

Owners
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 LO 6 State the accounting equation, and define
1-22
assets, liabilities, and owners equity.
 The Basic Accounting Equation

Owners
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 LO 6 State the accounting equation, and define
1-23
assets, liabilities, and owners equity.
 The Basic Accounting Equation

Owners
Assets = Liabilities +
Equity

Provides the underlying framework for recording and

summarizing economic events.

Owners Equity

Ownership claim on total assets.

Referred to as residual equity.
Capital, Drawings, etc. (Proprietorship or
Partnership).
Chapter LO 6 State the accounting equation, and define
1-24
assets, liabilities, and owners equity.
 Owners 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 LO 6 State the accounting equation, and define
1-25
assets, liabilities, and owners equity.
 Owners 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 LO 6 State the accounting equation, and define
1-26
assets, liabilities, and owners equity.
 Using The Basic 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.

Chapter LO 7 Analyze the effects of business transactions

1-27
on the accounting equation.
 Transactions (Question?)
Q1-15: Are the following events recorded in the
accounting records? Owner
Supplies are An employee withdraws
Event purchased is hired. cash for
on account. personal use.

Criterion Is the financial position (assets, liabilities, or

owners equity) of the company changed?

Record/
Dont Record

Chapter LO 7 Analyze the effects of business transactions

1-28
on the accounting equation.
 Transactions

Discussion Question
Q18. In February 2008, Paula King invested an
additional $10,000 in her business, Kings
Pharmacy, which is organized as a proprietorship.
Kings 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 LO 7 Analyze the effects of business transactions
1-29
on the accounting equation.
 Transactions (Problem)
P1-1A: Barones Repair Shop was started on May 1 by
Nancy. Prepare a tabular analysis of the following
transactions for the month of May.

1. Invested $10,000 cash to start the repair shop.

Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment

Chapter LO 7 Analyze the effects of business transactions

1-30
on the accounting equation.
 Transactions (Problem)
2. Purchased equipment for $5,000 cash.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000

Chapter LO 7 Analyze the effects of business transactions

1-31
on the accounting equation.
 Transactions (Problem)
3. Paid $400 cash for May office rent.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense

Chapter LO 7 Analyze the effects of business transactions

1-32
on the accounting equation.
 Transactions (Problem)
4. Received $5,100 from customers for repair service.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue

Chapter LO 7 Analyze the effects of business transactions

1-33
on the accounting equation.
 Transactions (Problem)
5. Withdrew $1,000 cash for personal use.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings

Chapter LO 7 Analyze the effects of business transactions

1-34
on the accounting equation.
 Transactions (Problem)
6. Paid part-time employee salaries of $2,000.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense

Chapter LO 7 Analyze the effects of business transactions

1-35
on the accounting equation.
 Transactions (Problem)
7. Incurred $250 of advertising costs, on account.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense
7. +250 -250 Expense

Chapter LO 7 Analyze the effects of business transactions

1-36
on the accounting equation.
 Transactions (Problem)
8. Provided $750 of repair services on account.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense
7. +250 -250 Expense
8. +750 +750 Revenue

Chapter LO 7 Analyze the effects of business transactions

1-37
on the accounting equation.
 Transactions (Problem)
9. Collected $120 cash for services previously billed.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense
7. +250 -250 Expense
8. +750 +750 Revenue
9. +120 -120
6,820 + 630 + 5,000 = 250 + 12,200
Chapter LO 7 Analyze the effects of business transactions
1-38
on the accounting equation.
 Financial Statements

Companies prepare four financial statements from

the summarized accounting data:

Owners Statement
Income Balance
Equity of Cash
Statement Sheet
Statement Flows

Chapter
1-39 LO 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
1-40 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements

Income Statement
Barones Repair Shop Reports the revenues
Income Statement
For the Month Ended May 31, 2008
and expenses for a
Revenues:
specific period of time.
Service revenue $ 5,850
Expenses: Net income revenues
Salary expense 2,000 exceed expenses.
Rent expense 400
Advertising expense 250
Total expenses 2,650
Net loss expenses
Net income $ 3,200 exceed revenues.

Chapter
1-41 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Owners Equity
Income Statement Statement
Barones Repair Shop Barones Repair Shop
Income Statement Owner's Equity Statement
For the Month Ended May 31, 2008 For the Month Ended May 31, 2008

Revenues: Barone's, Capital May 1 $ -

Service revenue $ 5,850 Add: Investment 10,000
Expenses: Net income 3,200
Salary expense 2,000 13,200
Rent expense 400 Less: Drawings 1,000
Advertising expense 250
Barone's, Capital May 31 $12,200
Total expenses 2,650
Net income $ 3,200
Net income is needed to determine
the ending balance in owners equity.
Chapter
1-42 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Owners Equity
Statement
Statement indicates the Barones Repair Shop

reasons why owners Owner's Equity Statement

For the Month Ended May 31, 2008
equity has increased or
Barone's, Capital May 1 $ -
decreased during the Add: Investment 10,000
period. Net income 3,200
13,200
Less: Drawings 1,000
Barone's, Capital May 31 $12,200

Chapter
1-43 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Owners Equity
Balance Sheet Statement
Barones Repair Shop
Barones Repair Shop
Balance Sheet
Owner's Equity Statement
May 31, 2008
For the Month Ended May 31, 2008
Assets
Cash $ 6,820 Barone's, Capital May 1 $ -
Accounts receivable 630 Add: Investment 10,000
Equipment 5,000 Net income 3,200
Total assets $12,450 13,200
Liabilities Less: Drawings 1,000
Accounts payable $ 250 Barone's, Capital May 31 $ 12,200
Owner's Equity
Barone's, capital 12,200
Total liab. & equity $12,450 The ending balance in owners equity is
needed in preparing the balance sheet
Chapter
1-44 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements

Balance Sheet
Barones Repair Shop
Reports the assets,
Balance Sheet liabilities, and owners
May 31, 2008
equity at a specific date.
Assets
Cash $ 6,820
Accounts receivable 630
Assets listed at the top,
Equipment 5,000 followed by liabilities
Total assets $12,450
and owners equity.
Liabilities
Accounts payable $ 250
Owner's Equity
Total assets must equal
Barone's, capital 12,200 total liabilities and
Total liab. & equity $12,450 owners equity.
Chapter
1-45 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Statement of Cash Flows
Balance Sheet Barones Repair Shop
Statement of Cash Flows
Barones Repair Shop
For the Month Ended May 31, 2008
Balance Sheet
Cash flow from operating activities
May 31, 2008
Cash receipts from revenues $ 5,220
Assets
Cash paid for expenses (2,400)
Cash $ 6,820 Cash provided by operations 2,820
Accounts receivable 630 Cash flow from investing activitites
Equipment 5,000 Purchase of equipment (5,000)
Total assets $12,450 Cash flow from financing activities
Liabilities Investment by owners 10,000
Accounts payable $ 250 Drawings by owners (1,000)
Owner's Equity Cash provided by financing 9,000
Barone's, capital 12,200 Net increase in cash 6,820
Total liab. & equity $12,450 Cash balance, May 1 -
Cash balance, May 31 $ 6,820
Chapter
1-46 LO 8 Understand the four financial statements and how they are prepared.
 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?
Chapter
1-47 LO 8 Understand the four financial statements and how they are prepared.
Barones Repair Shop
Statement of Cash Flows
For the Month Ended May 31, 2008
Cash flow from operating activities
Cash receipts from customers $ 5,220
Cash paid for expenses (2,400)
Cash provided by operations 2,820
Cash flow from investing activities
Purchase of equipment (5,000)
Cash flow from financing activities
Investment by owners 10,000
Drawings by owners (1,000)
Cash provided by financing 9,000
Net increase in cash 6,820
Cash balance, May 1 -
Cash balance, May 31 $ 6,820
 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.

Chapter
1-48 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements

Discussion Question
Q19. A companys net income appears directly
on the income statement and the owners equity
statement, and it is included indirectly in the
companys balance sheet. Do you agree? Explain.

See notes page for discussion

Chapter
1-49 LO 8 Understand the four financial statements and how they are prepared.
 Accounting Career Opportunities

Public Accounting
Careers in auditing and taxation serving the general public.

Private Accounting
Careers in industry working in cost accounting, budgeting,
accounting information systems, and taxation.

Opportunities in Government
Careers with the IRS, the FBI, the SEC, and in public
colleges and universities.

Forensic Accounting
Careers with insurance companies and law offices to conduct
investigations into theft and fraud.
Chapter
1-50 LO 9 Explain the career opportunities in accounting.
 Copyright

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Chapter
1-51