Accounting

Principles

Chapter
1-1
 CHAPTER 1

ACCOUNTING IN ACTION

Chapter
1-2
 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 owner’s equity.
7. Analyze the effects of business transactions on the
accounting equation.
8. Understand the four financial statements and how they are
prepared.
Chapter
1-3
 Accounting in Action

The Building The Basic Using the Basic

What is Financial
Blocks of Accounting Accounting
Accounting? Equation Statements
Accounting Equation

Three Ethics in Assets Transaction Income

activities financial Liabilities analysis statement
Who uses reporting Summary of Owner’s
Owner’s
accounting Generally equity transactions equity
data accepted statement
accounting Balance
principles sheet
Assumptions Statement of
cash flows

Chapter
1-4
 What is Accounting?

The purpose of accounting is to:

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

Chapter
1-5 LO 1 Explain what accounting is.
 What is Accounting?
Illustration 1-1
Three Activities Accounting process

The accounting process includes

the bookkeeping function.

Chapter
1-6 LO 1 Explain what accounting is.
 Who Uses Accounting Data?
Internal Users
Management IRS

Human Investors
Resources

Labor
Unions
Finance Common Questions

Creditors
Marketing
Customers SEC
External
Users
Chapter
1-7 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
1-8 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

Chapter
1-9 LO 3 Understand why ethics is a fundamental business concept.
 The Building Blocks of Accounting

Ethics In Financial Reporting

Standards of conduct by which one’s actions are
judged as right or wrong, honest or dishonest, fair
or not fair, are Ethics.

• Recent financial scandals include: Enron,

WorldCom, HealthSouth, AIG, and others.

• Congress passed Sarbanes-Oxley Act of 2002.

• Effective financial reporting depends on sound

ethical behavior.
Chapter
1-10 LO 3 Understand why ethics is a fundamental business concept.
 Ethics

Review Question
Ethics are the standards of conduct by which one's
actions are judged as:
a. right or wrong.
b. honest or dishonest.
c. fair or not fair.
d. all of these options.

Chapter
1-11 LO 3 Understand why ethics is a fundamental business concept.
 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.
 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

1-18
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

1-19
assets, liabilities, and owner’s 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
1-20
assets, liabilities, and owner’s 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
1-21
assets, liabilities, and owner’s 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
1-22
assets, liabilities, and owner’s 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
1-23
assets, liabilities, and owner’s 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
1-24
assets, liabilities, and owner’s equity.
 Using The Basic Accounting Equation

Transactions are a business’s economic events

recorded by accountants.
• May be external or internal.

• Not all activities represent transactions.

• Each transaction has a dual effect on the

accounting equation.

Chapter LO 7 Analyze the effects of business transactions

1-25
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

owner’s equity) of the company changed?

Record/
Don’t Record

Chapter LO 7 Analyze the effects of business transactions

1-26
on the accounting equation.
 Transactions

Discussion Question
Q18. In February 2008, Paula King invested an
additional $10,000 in her business, King’s
Pharmacy, which is organized as a proprietorship.
King’s accountant, Lance Jones, recorded this
receipt as an increase in cash and revenues. Is
this treatment appropriate? Why or why not?

See notes page for discussion

Chapter LO 7 Analyze the effects of business transactions
1-27
on the accounting equation.
 Transactions (Problem)
P1-1A: Barone’s Repair Shop was started on May 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

1-28
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

1-29
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

1-30
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

1-31
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

1-32
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

1-33
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

1-34
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

1-35
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
1-36
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
1-37 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
1-38 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements

Income Statement
Barone’s Repair Shop Reports the revenues
Income Statement
For the Month Ended May 31, 2007
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
1-39 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Income Statement
Barone’s Repair Shop
Income Statement
For the Month Ended May 31, 2007
Owners’ Equity
Statement
Barone’s Repair Shop
Owners' Equity Statement
For the Month Ended May 31, 2007

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 owner’s equity.
Chapter
1-40 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Owners’ Equity
Statement
Statement indicates the Barone’s Repair Shop
reasons why owner’s Owners' Equity Statement
For the Month Ended May 31, 2007
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
1-41 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Owners’ Equity
Balance Sheet Statement
Barone’s Repair Shop
Barone’s Repair Shop
Balance Sheet
Owners' Equity Statement
May 31, 2007
For the Month Ended May 31, 2007
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
Owners' Equity
Barone's, capital 12,200
Total liab. & equity $ 12,450 The ending balance in owner’s equity is
needed in preparing the balance sheet
Chapter
1-42 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements

Balance Sheet
Reports the assets,
Barone’s Repair Shop
Balance Sheet liabilities, and owner’s
May 31, 2007 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
Liabilities
and owner’s equity.
Accounts payable $ 250
Owners' Equity Total assets must equal
Barone's, capital 12,200
total liabilities and
Total liab. & equity $ 12,450
owner’s equity.
Chapter
1-43 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Statement of Cash Flows
Balance Sheet
Barone’s Repair Shop
Barone’s Repair Shop Statement of Cash Flows

Balance Sheet For the Month Ended May 31, 2007

Cash flow from Operations
May 31, 2007
Cash receipts from customers $ 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
Equipment 5,000
Purchase of equipment (5,000)
Total assets $ 12,450
Cash flow from Financing
Liabilities
Investment by owners 10,000
Accounts payable $ 250 Drawings by owners (1,000)
Owners' 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
1-44 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
1-45 LO 8 Understand the four financial statements and how they are prepared.
Barone’s Repair Shop
Statement of Cash Flows
For the Month Ended May 31, 2007
Cash flow from Operations
Cash receipts from customers $ 5,220
Cash paid for expenses (2,400)
Cash provided by operations 2,820
Cash flow from Investing
Purchase of equipment (5,000)
Cash flow from Financing
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
1-46 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements

Discussion Question
Q19. “A company’s net income appears directly
on the income statement and the owner’s equity
statement, and it is included indirectly in the
company’s balance sheet.” Do you agree? Explain.

See notes page for discussion

Chapter
1-47 LO 8 Understand the four financial statements and how they are prepared.