1 Accounting in Action

Learning Objectives

1 Explain what accounting is

Identify the users and uses of accounting.

2 Explain generally accepted accounting principles

3 State the accounting equation, and define its components.

4 Analyze the effects of business transactions on the accounting equation.

5 Describe the four financial statements and how they are prepared.
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LEARNING Identify the activities and users
1
OBJECTIVE associated with accounting.

Accounting: measure and report financial information

about an economic unit.

Accounting consists of three basic activities

 identifies,

 records, and classify and summarize

 communicates

the economic events of an organization to interested users.

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 Three Activities
Illustration 1-1
The activities of the accounting process

The accounting process includes

the bookkeeping function.

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 Who Uses Accounting Data
Internal Users
Management
Human Investors
Resources There are two broad
groups of users of Labor
financial information: Unions
Finance
internal users and
external users.
Creditors
Marketing
Customers
External
Users
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1-4 SO 2 Identify the users and uses of accounting.
 Who Uses Accounting Data

INTERNAL
USERS

Illustration 1-2
Questions that internal
users ask

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 Who Uses Accounting Data

EXTERNAL
USERS

Illustration 1-3
Questions that external
users ask
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 FINANCIAL ACCOUNTING
 External users

 Generating financial statements (Balance sheet,

income statement …)

 Financial reports prepared under the generally

accepted accounting principles (GAAP)

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 MANAGERIAL ACCOUNTING
 Internal users

 Generating internal reporting

 Internal reporting is being done logically and

rationally, but it need not follow any particular
guideline.

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 DO IT! 1 Basic Concepts

Indicate whether the following statements are true or false.

1. The three steps in the accounting process are identification,

recording, and communication.

2. Bookkeeping encompasses all steps in the accounting process.

3. Accountants prepare, but do not interpret, financial reports.

4. The two most common types of external users are investors and
company officers.

5. Managerial accounting activities focus on reports for internal users.

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 LEARNING
2 Generally Accepted
OBJECTIVE
Accounting Principles

Financial Statements
Various users  Balance Sheet
need financial  Income Statement
 Statement of Owner's Equity
information  Statement of Cash Flows
 Note Disclosure

The accounting profession

has developed standards Generally Accepted
that are generally accepted Accounting Principles
and universally practiced. (GAAP)

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 Assumptions in Financial Reporting

Monetary Unit Economic Entity

Requires that only those things States that every economic
that can be expressed in entity can be separately
money are included in the identified and accounted for.
accounting records.

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 Assumptions in Financial Reporting

Time Period Going Concern

States that the life of a The business will remain in
business can be divided into operation for the
artificial time periods. foreseeable future.

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 Assumptions

MONETARY UNIT ASSUMPTION requires that companies

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 Forms of Business
Ownership
 Corporation

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 Forms of Business Ownership

Proprietorship Partnership Corporation

 Owned by one  Owned by two or  Ownership

person more persons divided into
Owner is often shares of stock
  Often retail and
manager/operator service-type  Separate legal
 Owner receives businesses entity organized
any profits, suffers under state
 Generally
any losses, and is corporation law
unlimited
personally liable personal liability  Limited liability
for all debts
 Partnership
agreement

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 Assumptions

Accountants divide the economic life of a business into

artificial time periods (Time Period Assumption).
.....
Jan. Feb. Mar. Apr. Dec.

Generally a
Alternative Terminology
 month, The time period assumption
is also called the
 quarter, or periodicity assumption.
 year.

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 Assumptions

Question
The time period assumption states that:

a. revenue should be recognized in the accounting

period in which it is earned.

b. expenses should be matched with revenues.

c. the economic life of a business can be divided into

artificial time periods.

d. the fiscal year should correspond with the calendar

year.

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 Assumptions

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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 Assumptions

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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 Principles of Financial Reporting

MEASUREMENT PRINCIPLES

Historical Cost Fair Value

Or cost principle, Indicates that
dictates that assets and
companies record liabilities should be
assets at their cost. reported at fair
value (the price
received to sell an
asset or settle
a liability).

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 Measurement Principles

HISTORICAL COST PRINCIPLE (or cost principle) indicates that

companies record assets at their cost.

FAIR VALUE PRINCIPLE states that assets and liabilities should

be reported at fair value (the price received to sell an asset or
settle a liability).

Selection of which principle to

follow generally relates to trade-offs
between relevance and faithful
representation.

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 Principles of Financial Reporting

Revenue Expense
Full Disclosure
Recognition Recognition
Principle
Principle Principle

Requires that Dictates that Requires that

companies efforts (expenses) companies disclose
recognize revenue be matched with all circumstances
in the accounting results (revenues). and events that
period in which the Thus, expenses would make a
performance follow revenues. difference to
obligation is financial statement
satisfied. users.

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 Recognizing Revenues and Expenses

REVENUE RECOGNITION PRINCIPLE

Recognize revenue in the
accounting period in which the
performance obligation is satisfied.

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 Recognizing Revenues and Expenses

EXPENSE RECOGNITION PRINCIPLE

Match expenses with revenues in
the period when the company
makes efforts that generate
those revenues.

“Let the expenses follow

the revenues.”

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 Illustration 3-1
GAAP relationships in
revenue and expense
recognition

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 DO IT! 2 Building Blocks of Accounting

Indicate whether each of the following statements presented

below is true or false.

1. GAAP stands for Generally Accepted Accounting

Procedures

2. The economic entity assumption requires that a

business is distinct from its owners

3. The historical cost principle indicates 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.

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 DO IT! 2 Building Blocks of Accounting

Indicate whether each of the following statements presented

below is true or false.

4. Recognize revenue in the accounting period in

which cash is paid.

5. A business owner’s personal expenses must be

separated from expenses of the business to comply with
accounting’s economic entity assumption.

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 DO IT! 2 Building Blocks of Accounting

Question
One of the following statements about the accrual basis of
accounting is false? That statement is:
a. Events that change a company’s financial statements are
recorded in the periods in which the events occur.
b. Revenue is recognized in the period in which the performance
obligation is satisfied.
c. The accrual basis of accounting is in accord with generally
accepted accounting principles.
d. Revenue is recorded only when cash is received, and
expenses are recorded only when cash is paid.

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LEARNING State the accounting equation, and define its
3
OBJECTIVE components.

Assets = Liabilities + Owner's Equity

Basic Accounting Equation

 Provides the underlying framework for recording and
summarizing economic events.
 Assets are claimed by either creditors or owners.
 If a business is liquidated, claims of creditors must be paid
before ownership claims.

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 Basic Accounting Equation

Assets = Liabilities + Owner's Equity

Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Supplies, Equipment, etc.

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 Basic Accounting Equation

Assets = Liabilities + Owner's Equity

Liabilities
 Claims against assets (debts and obligations).
 Creditors (party to whom money is owed).
 Accounts Payable, Notes Payable, Salaries and Wages
Payable, etc.

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 Basic Accounting Equation

Assets = Liabilities + Owner's Equity

Owner's Equity (Net asset)

 Ownership claim on total assets.
 Referred to as residual equity.
 Investment by owners and revenues (+)
 Drawings and expenses (-).

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 Owner’s Equity
Increases in Owner’s Equity
 Investments by owner are the assets the owner puts into the
business.
 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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 Owner’s Equity
Decreases in Owner’s Equity
 Drawings An owner may withdraw cash or other assets for
personal use.
 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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 Owner’s Equity

Owner's equity = Owner's Capital - Owner's drawing +

Revenues - Expenses

Owner's equity = Owner's Capital - Owner's drawing + Net

income

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 DO IT! 3 Owner's Equity Effects

Classify the following items as investment by owner, owner’s

drawings, revenue, or expenses. Then indicate whether each
item increases or decreases owner’s equity.

Classification Effect on Equity

1. Rent Expense

2. Service Revenue

3. Drawings

4. Salaries and Wages

Expense

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LEARNING Analyze the effects of business transactions on
4
OBJECTIVE the 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.

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 Transaction Analysis

Illustration: Are the following events recorded in the accounting

records?
Illustration 1-7
Discuss product
Purchase
Event design with Pay rent
computer
potential
customer

Criterion Is the financial position (assets, liabilities, or

owner’s equity) of the company changed?

Record/
Don’t Record

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 Transaction Analysis

TRANSACTION 1. INVESTMENT BY OWNER

Ray Neal decides to start a smartphone app development company which
he names Softbyte. On September 1, 2017, he invests $15,000 cash in the
business. This transaction results in an equal increase in assets and
owner’s equity.

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000

Illustration 1-8
Tabular summary of
Softbyte transactions

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 TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH
Softbyte Inc. purchases computer equipment for $7,000 cash.
Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
action
Cash + Receivable + Supplies + Equipment = Payable
+
Capital
-
Drawings
+ Rev. - Exp.

1. +15,000 +15,000
2. -7,000+7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200

8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 +$1,400 +
$1,600 +
$7,000 $1,600 = $15,000 $4,700
+ +
$1,950 $1,300
- -

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 TRANSACTION 3. PURCHASE OF SUPPLIES ON CREDIT
Softbyte Inc. purchases for $1,600 headsets and other accessories
expected to last several months. The supplier allows Softbyte to pay this
bill in October.
Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + -
Drawings
+ Rev. - Exp.
action Receivable Payable Capital

1. +15,000 +15,000

2. -7,000+7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250

7. -1,700 -600
6. +1,500 +2,000 -900 +3,500
-200

8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 +$1,400 +
$1,600 +
$7,000 $1,600 = $15,000 $4,700
+ +
$1,950 $1,300
- -

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 TRANSACTION 4. SERVICES PERFORMED FOR CASH
Softbyte Inc. receives $1,200 cash from customers for app development
Illustration 1-8
services it has performed.

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000+7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6.
7. +1,500
-1,700 +2,000 -600 +3,500
-900
-200

8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 +$1,400 +
$1,600 +
$7,000 $1,600 = $15,000 $4,700
+ +
$1,950 $1,300
- -

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 TRANSACTION 5. PURCHASE OF ADVERTISING ON CREDIT
Softbyte Inc. receives a bill for $250 from the Daily News for advertising
Illustration 1-8
on its online website but postpones payment until a later date.

Trans-
action Assets = Liabilities + Owner's Equity
Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000+7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
8. -250 -250
-200
9. +600 -600
10. -1,300 -1,300
$8,050 +$1,400 +
$1,600 +
$7,000 $1,600 = $15,000 $4,700
+ +
$1,950 $1,300
- -

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 TRANSACTION 6. SERVICES PERFORMED FOR CASH AND CREDIT.
Softbyte performs $3,500 of services. The company receives cash of $1,
500 from customers, and it bills the balance of $2,000 on account.
Illustration 1-8
Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
action
Cash + Receivable + Supplies + Equipment = Payable
+
Capital
-
Drawings
+ Rev. - Exp.

1. +15,000 +15,000
2. -7,000+7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200

8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 +$1,400 +
$1,600 +
$7,000 $1,600 = $15,000 $4,700
+ +
$1,950 $1,300
- -

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 TRANSACTION 7. PAYMENT OF EXPENSES Softbyte Inc. pays the
following expenses in cash for September: office rent $600, salaries and
wages of employees $900, and utilities $200. Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
action
Cash + Receivable + Supplies + Equipment = Payable
+
Capital
-
Drawings
+ Rev. - Exp.

1. +15,000 +15,000
2. -7,000+7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 +$1,400 +
$1,600 +
$7,000 $1,600 = $15,000 $4,700
+ +
$1,950 $1,300
- -

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 TRANSACTION 8. PAYMENT OF ACCOUNTS PAYABLE Softbyte Inc. pays
its $250 Daily News bill in cash. The company previously (in Transaction 5)
recorded the bill as an increase in Accounts Payable.
Illustration 1-8
Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
action
Cash + Receivable + Supplies + Equipment = Payable
+
Capital
-
Drawings
+ Rev. - Exp.

1. +15,000 +15,000
2. -7,000+7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 +$1,400 +
$1,600 +
$7,000 $1,600 = $15,000 $4,700
+ +
$1,950 $1,300
- -

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 TRANSACTION 9. RECEIPT OF CASH ON ACCOUNT Softbyte Inc.
receives $600 in cash from customers who had been billed for services
(in Transaction 6). Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
action
Cash + Receivable + Supplies + Equipment = Payable
+
Capital
-
Drawings
+ Rev. - Exp.

1. +15,000 +15,000
2. -7,000+7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 +$1,400 +
$1,600 +
$7,000 $1,600 = $15,000 $4,700
+ +
$1,950 $1,300
- -

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 TRANSACTION 10. WITHDRAWAL OF CASH BY OWNER Ray Neal
withdraws $1,300 in cash from the business for his personal use.
Illustration 1-8
Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
action
Cash + Receivable + Supplies + Equipment = Payable
+ - + Rev. - Exp.
Capital Drawings

1. +15,000 +15,000
2. -7,000+7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200

8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 +$1,400 +
$1,600 +
$7,000 $1,600 = $15,000 $1,300
+ -
$4,700 $1,950
+ -

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 Summary of Transactions

1. Each transaction is analyzed in terms of its effect

on:
a. The three components of the basic accounting
equation.
b. Specific of items within each component.
2. The two sides of the equation must always be equal.

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 DO IT! 4 Tabular Analysis

Transactions made by Virmari & Co., a public accounting firm, for the
month of August are shown below. Prepare a tabular analysis which
shows the effects of these transactions on the expanded accounting
equation, similar to that shown in Illustration 1-8.
1. The owner invested $25,000 cash in the business.
2. The company purchased $7,000 of office equipment on credit.
3. The company received $8,000 cash in exchange for services
performed.
4. The company paid $850 for this month’s rent.
5. The owner withdrew $1,000 cash for personal use.

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 DO IT! 4 Tabular Analysis

1. The owner invested $25,000 cash in the business.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + - + Rev. - Exp.
action Payable Capital Drawings

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

+
$31,150 $7,000 =
$7,000 $25,000 +
$8,000 $850 $1,000 + - -

$18,050 $18,050
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 DO IT! 4 Tabular Analysis

2. The company purchased $7,000 of office equipment on credit.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + - + Rev. - Exp.
action Payable Capital Drawings

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

+
$31,150 $7,000 =
$7,000 $25,000 +
$8,000 $850 $1,000 + - -

$18,050 $18,050
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 DO IT! 4 Tabular Analysis

3. The company received $8,000 cash in exchange for services

performed.
Assets = Liabilities + Owner's Equity
Trans- Accounts Owner's
Cash + Equipment = + Owner's - + Rev. - Exp.
action Payable Capital Drawings

4. -850 -850

5. -1,000 -1,000

+
$31,150 $7,000 =
$7,000 $25,000 +
$8,000 $850 $1,000 + - -

$18,050 $18,050
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 DO IT! 4 Tabular Analysis

4. The company paid $850 for this month’s rent.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + - + Rev. - Exp.
action Payable Capital Drawings

5. -1,000 -1,000

+
$31,150 $7,000 =
$7,000 $25,000 +
$8,000 $850 $1,000 + - -

$18,050 $18,050
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 DO IT! 4 Tabular Analysis

5. The owner withdrew $1,000 cash for personal use.

Assets = Liabilities + Owner's Equity

Trans- Accounts Owner's Owner's
Cash + Equipment = + - + Rev. - Exp.
action Payable Capital Drawings

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LEARNING Describe the four financial statements
5
OBJECTIVE and how they are prepared.

Companies prepare four financial statements :

Owner’s Statement
Income Balance
Equity of Cash
Statement Sheet
Statement Flows

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 Income Statement

 Reports the revenues and expenses for a specific period

of time.
 Lists revenues first, followed by expenses.
 Shows net income (or net loss).

 Does not include

investment and
withdrawal transactions
between the owner and
the business in
measuring net income.

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 Owner’s Equity Statement

 Reports the changes in owner’s equity for a specific

period of time.
 The time period is the same as that covered by the
income statement.

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 Net income is needed to determine the
Financial Statements ending balance in owner’s equity.

SOFTBYTE
Income Statement
For the Month Ended September 30, 2017

Illustration 1-9
Financial statements
and
their interrelationships

SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017

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 Balance Sheet

 Reports the assets, liabilities, and owner's equity at a

specific date.
 Lists assets at the top, followed by liabilities and owner’s
equity.
 Total assets must equal total liabilities and owner's
equity.
 Is a snapshot of the company’s financial condition at a
specific moment in time (usually the month-end or year-
end).

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 Statement of Cash Flows

 Information on the cash receipts and payments for a

specific period of time.
 Answers the following:
Where did cash come from?
What was cash used for?
What was the change in the cash balance?

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 SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017

Illustration 1-9
The ending
balance in SOFTBYTE
owner’s equity Balance Sheet
is needed in September 30, 2017
preparing the
balance sheet.

Illustration 1-9
Financial statements
and their
interrelationships

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 SOFTBYTE
Financial Balance Sheet
September 30, 2017
Statements

Balance sheet and

income statement
are needed to
prepare statement of
cash flows.
SOFTBYTE
Statement of Cash Flows
For the Month Ended September 30, 2017

Illustration 1-9
Financial statements
and their
interrelationships

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 Financial Statements

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.

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 Financial Statements

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.

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 DO IT! 5 Financial Statement Items

Presented below is selected information related to Flanagan Company

at December 31, 2022. Flanagan reports financial information monthly.
Equipment $10,000 Utilities Expense $ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000

(a) Determine the total assets of at December 31, 2022.

(b) Determine the net income reported for December 2022.
(c) Determine the owner’s equity at December 31, 2022.

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