Chapter 1

Accounting In Action
Financial Accounting, Sixth Edition

What is Accounting?
The purpose of accounting is to:
(1) identify record and communicate the identify, record,

economic events of an
(2) organization to (3) interested users.

SO 1 Explain what accounting is.

What is Accounting?
Three Activities
Illustration 1-1 Accounting process

The accounting process includes the bookkeeping function.

SO 1 Explain what accounting is.

Who Uses Accounting Data?

Internal Users Human Resources Management IRS Investors Labor Unions Creditors Customers SEC External Users

Finance

Marketing

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, WorldCom, HealthSouth, AIG, and others. Congress passed Sarbanes-Oxley Act of 2002. Effective financial reporting depends on sound ethical behavior.
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 Retained Earnings Statement 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)

SO 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/

SO 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.

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

Forms of Business Ownership

Forms of Business Ownership

Proprietorship
Generally owned by one person. Often small serviceservice-type businesses Owner receives any profits, suffers any losses, and is personally liable for all debts.

Partnership
Owned by two or more persons. Often retail and serviceservice-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 Basic Accounting Equation

Assets Liabilities Stockholders 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.

SO 6 State the accounting equation, and define assets, liabilities, and stockholders equity.

The Basic Accounting Equation

Assets Liabilities Stockholders Equity

Resources a business owns. Provide future services or benefits. Cash, Supplies, Equipment, etc.
SO 6 State the accounting equation, and define assets, liabilities, and stockholders equity.

The Basic Accounting Equation

Assets Liabilities Stockholders Equity

Claims against assets (debts and obligations). Creditors - party to whom money is owed. Accounts payable, Notes payable, etc.

SO 6 State the accounting equation, and define assets, liabilities, and stockholders equity.

The Basic Accounting Equation

Assets Liabilities Stockholders Equity Ownership claim on total assets. Referred to as residual equity. 2 parts are : Paid-in Capital, Retained Earnings (Corporation).
SO 6 State the accounting equation, and define assets, liabilities, and stockholders equity.

Stockholders Equity
Illustration 1-6

Increases to Stockholders Equity: Investment by stockholders (Paid in Capital) are amounts paid in by stockholders in exchange for ownership interests called common stock.

SO 6 State the accounting equation, and define assets, liabilities, and stockholders equity.

Stockholders Equity
Illustration 1-6

Increases to Stockholders Equity: 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.
SO 6 State the accounting equation, and define assets, liabilities, and stockholders equity.

Stockholders Equity
Illustration 1-6

Decreases to Stockholders Equity: 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.
SO 6 State the accounting equation, and define assets, liabilities, and stockholders equity.

Stockholders Equity
Illustration 1-6

Decreases to Stockholders Equity: Dividends are the distribution of cash or other assets to stockholders. Dividends reduce retained earnings, however dividends are not an expense.
SO 6 State the accounting equation, and define assets, liabilities, and stockholders 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.

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

Transactions
Question: Are the following events recorded in the accounting records? Event
Supplies are purchased on account. An employee is hired. Dividends are paid to stockholders.

Criterion

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

Record/ Dont Record

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

Transactions (Problem)
P1P1-1A: Barones Repair Shop was started on May. Prepare a tabular analysis of the following transactions for the month of May. 1. Stockholders invested $10,000 cash to start the repair shop.
Assets Cash 1. Liabilities Stockholders Equity Accounts Accounts Common + Receivable + Equipment = Payable + Stock

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

Transactions (Problem)
2. Purchased equipment for $5,000 cash.
Assets Cash 1. +10,000 2. Liabilities Stockholders Equity Accounts Accounts Common + Receivable + Equipment = Payable + Stock +10,000 Investment

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

Transactions (Problem)
3. Paid $400 cash for May office rent.
Assets Cash 1. +10,000 2. 3. -5,000 +5,000 Liabilities Stockholders Equity Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings +10,000

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

Transactions (Problem)
4. Received $5,100 from customers for repair service.
Assets Cash 1. +10,000 2. 3. 4. -5,000 -400 +5,000 -400 Liabilities Stockholders Equity Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings +10,000

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

Transactions (Problem)
5. Paid dividends of $1,000 cash.
Assets Cash 1. +10,000 2. 3. 4. 5. -5,000 -400 +5,100 +5,000 -400 +5,100 Liabilities Stockholders Equity Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings +10,000

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

Transactions (Problem)
6. Paid part-time employee salaries of $2,000.
Assets Cash 1. +10,000 2. 3. 4. 5. 6. -5,000 -400 +5,100 -1,000 +5,000 -400 +5,100 -1,000 Liabilities Stockholders Equity Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings +10,000

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

Transactions (Problem)
7. Incurred $250 of advertising costs, on account.
Assets Cash 1. +10,000 2. 3. 4. 5. 6. 7. -5,000 -400 +5,100 -1,000 -2,000 +5,000 -400 +5,100 -1,000 -2,000 Liabilities Stockholders Equity Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings +10,000

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

Transactions (Problem)
8. Provided repair services on account to customers $750.
Assets Cash 1. +10,000 2. 3. 4. 5. 6. 7. 8. -5,000 -400 +5,100 -1,000 -2,000 +250 +5,000 -400 +5,100 -1,000 -2,000 -250 Liabilities Stockholders Equity Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings +10,000

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

Transactions (Problem)
9. Collected $120 cash for services previously billed.
Assets Cash 1. +10,000 2. 3. 4. 5. 6. 7. 8. 9. -5,000 -400 +5,100 -1,000 -2,000 +250 +750 +5,000 -400 +5,100 -1,000 -2,000 -250 +750 10,000 + 2,200 Liabilities Stockholders Equity Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings +10,000

+120
6,820 +

-120
630 + 5,000 = 250 +
SO 7 Analyze the effects of business transactions on the accounting equation.

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

Income Statement

Retained Earnings Statement

Balance Sheet

Statement of Cash Flows

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, 2007 Revenues: Service revenue Expenses: Salary expense Rent expense Advertising expense Total expenses Net income $ 2,000 400 250 2,650 3,200 $ 5,850

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

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, 2007 Revenues: Service revenue Expenses: Salary expense Rent expense Advertising expense Total expenses Net income $ 2,000 400 250 2,650 3,200 $ 5,850

Retained Earnings Statement

Barones Repair Shop Retained Earnings Statement For the Month Ended May 31, 2007 Retained earnings, May 1 Add: Net income Less: Dividends Retained earnings, May 31 $ $ 3,200 (1,000) 2,200

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

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, 2007 Retained earnings, May 1 Add: Net income Less: Dividends Retained earnings, May 31 $ $ 3,200 (1,000) 2,200

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

Financial Statements
Balance Sheet
Barones Repair Shop Balance Sheet May 31, 2007 Assets Cash Accounts receivable Equipment Total assets Liabilities Accounts payable Stockholders' Equity Common stock Retained earnings Total liab. & equity 10,000 2,200 $ 12,450 $ 250 $ 6,820 630 5,000 $ 12,450

Retained Earnings Statement

Barones Repair Shop Retained Earnings Statement For the Month Ended May 31, 2007 Retained earnings, May 1 Add: Net income Less: Dividends Retained earnings, May 31 $ $ 3,200 (1,000) 2,200

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, 2007 Assets Cash Accounts receivable Equipment Total assets Liabilities Accounts payable Stockholders' Equity Common stock Retained earnings Total liab. & equity 10,000 2,200 $ 12,450 $ 250 $ 6,820 630 5,000 $ 12,450

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, 2007 Assets Cash Accounts receivable Equipment Total assets Liabilities Accounts payable Stockholders' Equity Common stock Retained earnings Total liab. & equity 10,000 2,200 $ 12,450 $ 250 $ 6,820 630 5,000 $ 12,450

Statement of Cash Flows

Barones Repair Shop Statement of Cash Flows For the Month Ended May 31, 2007 Cash flow from Operations Cash receipts from customers Cash paid for expenses Cash provided by operations Cash flow from Investing Purchase of equipment Cash flow from Financing Investment by owners Drawings by owners Cash provided by financing Net increase in cash Cash balance, May 1 Cash balance, May 31 $ $ 5,220 (2,400) 2,820 (5,000) 10,000 (1,000) 9,000 6,820 6,820

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

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, 2007 Cash flow from Operations Cash receipts from customers Cash paid for expenses Cash provided by operations Cash flow from Investing Purchase of equipment Cash flow from Financing Investment by owners Drawings by owners Cash provided by financing Net increase in cash Cash balance, May 1 Cash balance, May 31 $ $ 5,220 (2,400) 2,820 (5,000) 10,000 (1,000) 9,000 6,820 6,820

from?
2. What was cash used

for?
3. What was the change

in the cash balance?

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

Copyright
Copyright 2008 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.