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Fundamental Accounting Principles

Wild/Larson/Chiappetta
18th Edition
McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2007

Chapter 1
Accounting in Business

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Conceptual Chapter Objectives


C1: Explain the purpose and importance of accounting in the information age C2: Identify users and uses of accounting C3: Identify opportunities in accounting and related fields C4: Explain why ethics are crucial in accounting C5: Explain the meaning of GAAP, and define and apply several key accounting principles C6: Appendix 1B: Identify and describe the three major activities in organizations
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Analytical Chapter Objectives


A1: Define and interpret the accounting equation and each of its components A2: Analyze business transactions using the accounting equation A3: Compute and interpret return on assets A4: Appendix 1A: Explain the relation between return and risk

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Procedural Chapter Objectives


P1: Identify and prepare basic financial

statements and explain how they interrelate

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C1

Importance of Accounting
is a Accounting
system that Identifies

Records information Relevant Reliable Comparable


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that is

Communicates

to help users make better decisions.


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C1

Accounting Activities
Recording Business Activities

Identifying Business Activities

Communicating Business Activities

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C2

Users of Accounting Information


External Users Internal Users

Lenders

Consumer Groups

Managers Internal Auditors

Sales Staff Controllers

Shareholders External Auditors Governments Customers


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Officers/Directors Budget Officers

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C2

Users of Accounting Information


External Users Internal Users

Financial accounting provides external users with financial statements.


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Managerial accounting provides information needs for internal decision makers.


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C3

Opportunities in Accounting
Financial Managerial
General accounting Cost accounting Budgeting Internal auditing Consulting Controller Treasurer Strategy Lenders Consultants Analysts Traders Directors Underwriters Planners Appraisers

Taxation
Preparation Planning Regulatory Investigations Consulting Enforcement Legal services Estate plans FBI investigators Market researchers Systems designers Merger services Business valuation Human services Litigation support Entrepreneurs
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Preparation Analysis Auditing Regulatory Consulting Planning Criminal investigation

Accountingrelated

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C3

Accounting Jobs by Area

Public accounting 25%

Private accounting 60%

Government, not-for-profit, & education 15%


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C4

EthicsA Key Concept

Ethics
Beliefs that distinguish right from wrong
Accepted standards of good and bad behavior

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C4

Guidelines for Ethical Decisions


Analyze options Make ethical decision

Identify ethical concerns

Use personal Consider all good ethics to and bad recognize ethical consequences. concern.
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Choose best option after weighing all consequences.


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C5

Generally Accepted Accounting Principles


Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP).
Relevant Information Reliable Information Affects the decision of its users. Is trusted by users. Is helpful in contrasting organizations.
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Comparable Information
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C5

Setting Accounting Principles


Financial Accounting Standards Board is the private group that sets both broad and specific principles. The Securities and Exchange Commission is the government group that establishes reporting requirements for companies that issue stock to the public. The International Accounting Standards Board (IASB) issues International Financial Reporting Standards that identify preferred accounting practices.

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C5

Principles of Accounting

Objectivity Principle Accounting information is supported by independent, unbiased evidence.

Cost Principle Accounting information is based on actual cost.

Now

Future

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Going-Concern Principle Reflects assumption that the business will continue operating instead of being closed or sold. The McGraw-Hill Companies, Inc., 2007

C5

Principles of Accounting

Monetary Unit Principle Express transactions and events in monetary, or money, units.

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.

Business Entity Principle A business is accounted for separately from other business entities, including its owner.
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C5

Business Entity Forms

Sole Proprietorship

Partnership

Corporation

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C5

Characteristics of Businesses

Characteristic Proprietorship Partnership Corporation Business entity yes yes yes Legal entity no no yes Limited liability no* no* yes Unlimited life no no yes Business taxed no no yes One owner allowed yes no yes

* Proprietorships and partnerships that are set up as LLCs provide limited liability.

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C5

Corporation

Owners of a corporation are called shareholders (or stockholders). When a corporation issues only one class of stock, we call it capital stock.
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A1

Accounting Equation
EQUITY Assets

Liabilities

Equity

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Sarbanes-Oxley Act

Also known as SOX Passed by Congress to help curb financial abuses at companies that sell stock to the public Requires accounting oversight and stringent internal controls Penalties include stock market delisting and criminal prosecution
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A1

Assets
Cash Accounts Receivable Notes Receivable

Vehicles

Resources owned or controlled by a company

Land

Store Supplies
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Buildings Equipment
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A1

Liabilities
Accounts Payable Notes Payable

Creditors claims on assets


Taxes Payable Wages Payable
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A1

Equity
Owner Investments

CAPITAL

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A1

Expanded Accounting Equation


Assets

=
_

Liabilities

+
Revenues

Equity

Owner Capital

Owner Withdrawals

Expenses

Owner's Equity
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A2

Transaction Analysis Equation


The accounting equation MUST remain in balance after each transaction.

Assets

Liabilities

Equity

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A2

Transaction Analysis
J. Scott invests $20,000 cash to start the business. The accounts involved are: (1) Cash (asset) (2) Owner Capital (equity)

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A2

Transaction Analysis

J. Scott invests $20,000 cash to start the business.


Assets Cash Supplies Equipment (1) $ 20,000 = Liabilities Accounts Notes Payable Payable + Equity Owner Capital $ 20,000

$ 20,000 $

$ $

20,000

$ 20,000

$ 20,000
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A2

Transaction Analysis
Purchased supplies paying $1,000 cash. The accounts involved are: (1) Cash (asset) (2) Supplies (asset)

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A2

Transaction Analysis
Purchased supplies paying $1,000 cash.
Assets = Liabilities Accounts Notes Payable Payable + Equity Owner Capital $ 20,000

Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000

$ 19,000 $

1,000 $

$ $

20,000

$ 20,000

$ 20,000
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A2

Transaction Analysis
Purchased equipment for $15,000 cash.

The accounts involved are: (1) Cash (asset) (2) Equipment (asset)

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A2

Transaction Analysis
Purchased equipment for $15,000 cash.
Assets = Liabilities Accounts Notes Payable Payable + Equity Owner Capital $ 20,000

Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000

4,000 $ 1,000 $ $ 20,000

15,000 =

$ $

20,000

$ 20,000

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A2

Transaction Analysis
Purchased Supplies of $200 and Equipment of $1,000 on account.

The accounts involved are: (1) Supplies (asset) (2) Equipment (asset) (3) Accounts Payable (liability)
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A2

Transaction Analysis
Purchased Supplies of $200 and Equipment of $1,000 on account.
Assets =

Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 (4) 200 1,000 $ 4,000 $ 1,200 $ $ 21,200
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Liabilities Accounts Notes Payable Payable

Equity Owner Capital $ 20,000

$ 1,200 $ 1,200 $ = $ 21,200 $ 20,000

16,000

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A2

Transaction Analysis

Borrowed $4,000 from 1st American Bank.


The accounts involved are: (1) Cash (asset) (2) Notes payable (liability)

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A2

Transaction Analysis

Borrowed $4,000 from 1st American Bank.


Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 (4) 200 1,000 (5) 4,000 $ 8,000 $ 1,200 $ 16,000 $ 25,200
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Liabilities Accounts Notes Payable Payable

Equity Owner Capital $ 20,000

$ 1,200 $ $ 1,200 $ = $ 4,000 4,000 25,200 $ 20,000

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A2

Transaction Analysis
The balances so far appear below. Note that the Balance Sheet Equation is still in balance.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity Owner Capital $ 20,000

8,000 $

1,200 $

16,000 =

1,200 $

4,000

$ 20,000

$ 25,200

$ 25,200

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A2

Transaction Analysis

Now, lets look at transactions involving revenue, expenses and withdrawals.

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A2

Transaction Analysis
Provided consulting services receiving $3,000 cash. The accounts involved are: (1) Cash (asset) (2) Revenues (equity)

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A2

Transaction Analysis
Provided consulting services receiving $3,000 cash.
Assets = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity Owner Capital Revenue $ 20,000 $ 3,000

Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000

$ 11,000 $

1,200 $

16,000 =

$ 1,200 $ 4,000 $ 28,200

20,000 $

3,000

$ 28,200

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A2

Transaction Analysis
Paid salaries of $800 to employees. The accounts involved are: (1) Cash (asset) (2) Salaries expense (equity)
Remember that the balance in the salaries expense account actually increases. But, equity decreases because expenses reduce equity.

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A2

Transaction Analysis
Paid salaries of $800 to employees.
Assets = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity Owner Capital Revenue Expenses $ 20,000 $ 3,000 $ (800) $ 20,000 $ 3,000 $ (800)

Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000 (7) (800) $ 10,200 $ $ 1,200 $ 16,000 27,400 =

$ 1,200 $ 4,000 $ 27,400

Remember that expenses decrease equity.


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A2

Transaction Analysis

A withdrawal of $500 is made by the owner. The accounts involved are: (1) Cash (asset) (2) Withdrawals (equity)
Remember that the withdrawal account actually increases. But, total equity decreases because the withdrawal reduces equity.
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A2

Transaction Analysis

A withdrawal of $500 is made by the owner.


Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000 (7) (800) (8) (500) $ 9,700 $ 1,200 $ 16,000 $ 26,900 = = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Owner Capital $ 20,000 Equity Owner Withdrawals Revenue $ $ 20,000 $ (500) (500) $ 3,000 $ $ 1,200 $ 4,000 $ 3,000 $ (800) (800) Expenses

$ 26,900

Remember that withdrawals decrease equity.


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P1

Financial Statements
Lets prepare the Financial Statements reflecting the transactions we have recorded.
1. Income Statement

2. Statement of Owners Equity


3. Balance Sheet 4. Statement of Cash Flows

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P1

Income Statement
Scott Company Income Statement For Month Ended December 31, 2007 Revenues: Consulting revenue Expenses: Salaries expense Net income

3,000 800 2,200

Net income is the difference between Revenues and Expenses.

The income statement describes a companys revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities.
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P1

Statement of Owners Equity


Scott Company Income Statement For Month Ended December 31, 2007 Revenues: Consulting revenue Expenses: Salaries expense Net income

The net income of $2,200 increases Owner's Equity by $2,200.

3,000 800 2,200


Scott Company Statement of Owner's Equity For Month Ended December 31, 2007 Capital, December 1, 2007 Plus: Investments by Owner Net Income Less: Withdrawals by owner Capital, December 31, 2007 $ $ 20,000 2,200 22,200 22,200 500 21,700

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P1

Balance Sheet
The Balance Sheet describes a companys financial position at a point in time.

Scott Company Balance Sheet December 31, 2007 Assets $ Liabilities & Equity Accounts payable $ Notes payable Total liabilities Owner Capital Total liabilities and equity $

Cash Supplies Equipment

9,700 1,200 16,000

1,200 4,000 5,200 21,700 26,900

Total assets
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26,900

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P1

Statement of Cash Flows


Scott Company Statement of Cash Flows For Month Ended December 31, 2007 Cash flows from operating activities: Cash received from clients $ 3,000 Purchase of supplies (1,000) Cash paid to employees (800) Net cash provided by operating activities $ 1,200 Cash flows from investing activities: Purchase of equipment (15,000) Net cash used in investing activities (15,000) Cash flows from financing activities: Investment by owner 20,000 Borrowed at bank 4,000 Withdrawal by owner (500) Net cash provided by financing activities 23,500 Net increase in cash $ 9,700 Cash balance, December 1, 2007 Cash balance, December 31, 2007 $ 9,700 The McGraw-Hill Companies, Inc., 2007

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A3

Return on Assets (ROA)


Return on assets Net income = Average total assets

ROA is viewed as an indicator of operating efficiency.

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End of Chapter 1

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