CHAPTER 1 ACCOUNTING IN ACTION Learning Objectives: Explain what accounting is. Identify the users and uses of accounting, Understand why ethics Is @ fundamental business concept Explain accounting standards ond the measurement principles. Explain the meaning of the monetary unit assumption and the economic entity assumption. State the bosic accounting equation and explain the meaning of assets, liabilities, and owner's equity, Analyze the effects of business transactions on the basic accounting equation. Describe the four components of financial statements and how they are prepared. f { f‘WHAT IS ACCOUNTING? Accounting is the financial information system that 1) identifies, 2) records, and 3) communicates the economic events of an organization to interested users. THE ACCOUNTING PROCESS 1) Identificotion 2) Recording 3) Communication gy pea Select economic Record, Classify & Prepare accounting Analyze and events (transactions) Summarize reports Interpret for users wu lnIdentify the users and uses of Accounting Cea ee Accounting Data © Management © Investors © Employees © Creditors © Suppliers © Customers © Tax authorities © Regulatory authorities al1) Internal Users : are managers who plan, organize and run a business. This includes marketing managers, production supervisor, finance directors and company officers, Managerial Accounting provide financial information to Internal Users. 2) External users: @) Investors: use accounting information to make decisions to buy, hold or sell stocks. b) Creditors: Suppliers/banks use accounting information to evaluate the risk of granting credits or lending money.Users of Accounting Data (CONT’D) ©) Tax authorities: Wants to know whether the company’ complies with the tax © laws. d) Regulatory agencies: Want to know whether the company Is operating within prescribed rules. e) Customers: Are interested in whether a company will Continue to honor product warranties and support. f) Labor union: want to know whether the owners pay’ increased wages and benefits. g) Economic planners: use accounting information to forecast economic activity, Financial Accounting provide financial information to External Users.BOOKKEEPING DISTINGUISHED FROM ACCOUNTING é Q Accounting: 1. Includes bookkeeping 2, And also includes much more O Bookkeeping: 1. Involves only the recording of economic events. 2. Is just one part of accounting. sit,THE BUILDING BLOCKS OF ACCOUNTING 6) ¥ 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. Effective financial reporting depends on sound ethical behavior. ¥ Accounting Standards : 1. International Financial Reporting Standards (IFRS) : International accounting standards set by the IASB. > IASB (International Accounting Standards Board) : An Accounting standard setting body that issues standards followed by many countries outside of the United States. 2. Generally Accepted Accounting Principles (GAAP) : Accounting standards issued in the United States by the FASB. Most companies in the United States follow this standards. : > FASB (Financial Accounting Standards Board) : An organization that establishes GAAP. sit,THE BUILDING BLOCKS OF ACCOUNTING (CONT’D) ¥ Accounting Standards in Bangladesh (Extra) > > The Institute of Chartered Accountants of Bangladesh (ICAB): 1. Bangladesh Financial Reporting Standards (BFRS) 2. Bangladesh Accounting Standards (BAS) ¥ Measurement Principles : 1. Historical Cost Principle : Companies record asset at their cost. 2. Fair Value Principle : Assets and Liabilities should be recorded at fair value ¥ Assumptions : 1. Monetary Unit Assumption : requires that only transaction data that can be expressed in terms of money be included in the accounting records. 2. Economic Entity Assumption : requires that activities of the business be kept separate and distinct from the activities of its owner and all other economic entities. (Entity includes any organization or unit in society.)BUSINESS ENTERPRISES ¥ A business owned by one person Is generally 9 proprietorship. vA business owned by two or more persons associated as partners is a partnership. ¥ Abusiness organized as a separate legal entity under corporation law and having ownership divided into transferable shares is a corporation. ieAccounting Equation A Assets Resources owned by the business. Assets are used in carrying out such activities as production and soles. . ty + E | | Liabilities are claims against assets - that is, existing debts and obligations. So, it is claim from other parties (creditors) on assets, Represents the ‘ownership claim ‘ona company's total assets, It is equal to total assets minus total liabilities,| Types of Owner’s Equity » é Y Equity is of 2 types: 1. Share Capital - Ordinary : A corporation may obtain funds by selling ordinary shares to investors. So, share capital - ordinary is the amounts paid by the shareholders for the ordinary shares they purchase. 2. Retained Earnings : are the amount of money a company has left after paying dividends to shareholders. It is a source of internal. financing for a company. It can be used to reinvest in the business, pay off debt, or fund new assets Retained Earnings are determined by 3 items: we (a) Revenues (b) Expenses (c) Dividends weTypes of Owner’s Equity (Cont.) » ‘are the gross increases in equity resulting from business activities a. Revenues entered into for the purpose of earning income. Revenues may result from sale of merchandise, performance of services, rental of property, or lending of money, b. Expenses : are the decreases In equity that result from. operating the business. They are the cost of assets consumed or services used in the process of earning revenue. Examples of expenses may be utility expense, rent expense, supplies expense, and tax expense. ¢. Dividends : Net income represents an increase in net assets which is then available to distribute shareholders. The distribution of cash or others assets to shareholders is called a dividend, Dividends reduce retained earningsILLUSTRATION of INCREASES AND DECREASES IN EQUITY INCREASES (pac Investments shareholders |) I Equity ie Revenues DECREASES Dividends to shgreholders ExpensesTRANSACTION IDENTIFICATION PROCESS eo Purchase. computer wasodsy A Answer, eau ae telephone Criterion [i= fence! postion esses, iobities, and owners equity oF the icompony changed? [Yes] Record/ [rece Don't Record 3 [wo] [Yes]Expanded Accounting Equation ies ¥ Each transaction must have a dual effect on the accounting equation. For example, if an asset is increased, there must be a corresponding (1) decrease in another asset, (2) increase in @ specific liability, or (3) increase in equity. ¥ Two or more items could be affected. For example, as one asset is increased NT$10,000, another asset could decrease NT$6,000 and a liability could increase NT$4,000FINANCIAL STATEMENTS After transactions are identified, recorded, and summarized, 4 financial statements are prepared from the summarized accounting data: 1. An income statement presents the revenues, expenses and resulting net income or net loss for a specific period of _ time 2. A retained earnings statement summarizes the changes in retained earnings for a specific period of time. Retained Earnings = Beginning retained earning + net income - dividend. 3. A statement of financial position (sometimes referred to as a balance sheet) reports the assets, liabilities, and equity of a company at a specific date. 4, A statement of cash flows summarizes information about the cash inflows (receipts), cash outflows (payments) and resulting net cash for a specific period of time.Problem 1 ‘Ray and Neal decides to open a smartphone app development company thet they incorporate os Softbyte SA. On September 1, 2017, they invest $15,000 cash in the business in exchange for $15000 of ordinary shares. 2. Softbyte purchases computer equipment for $7000 cash. 3. Softbyte purchases for $1600 from Mobile Solutions Company headsets ond other computer accessories expected to last several months. Mobile Solutions agrees to allow Softee to pay this bil next month, in October. This transaction i referred to as @ purchase on account or @ credit purchase 4,Softbyte receives $1200 cash from customers for app development services it has performed, 5. Softbyte receives c bill for $250 from Programming News for advertising on its website but postpones payment of the bill until a loter date. 6, Softoyte performs $3500 of app development services for customers. The company receives cash of $1500 from customers and the balance of $2000 is billed on account 7. Softbyte pays the followings expenses in cash for September : office rent $600, salaries and wages employees $900 and utlities $200, 8. Softoyte pays its $250 Programming News bil in cash, 9. Softoyte receives $600 in cash from customers who have previously been biled for services, 10, The corporation pays a dividend of $1300 in cash to Ray and Neal, the shareholders of Softoute Instruction: (0) Prepare o tabular analysis of the September transaction beginning with September Ist bolances, (b) Prepare an income statement for September, a Retained Earnings Statement for September and Statement of Financial Position September $0, 2017Solution of Problem 1(a) : Softbyte Tabular analysis of transactions For the month ended Sép 30, 2017 Assets = abiltie Equity s+ “Transaction [Caan [Recounts | Supplies +] Eavement |accounté Shar Retained Earnin * ecevaote j : Poyobe'» | coptel eh | Revenue | Expense - [Dividend 1 $415,000) | |$#15000 | | | ii 2 7000 $4700 3 ‘$4600 | |'$+1600 Hi 4 +1200 | } +1200 5 4250 6250 | 6 +1500 | $+2000 +3500 i 7 600 600 900 900 200 200 ‘planation | Issued Shares Purchased Equipment Purchased supplies on credit Service Revenue Advertisement expense Service Revenue Rent expense laries expense Utilities expenseSolution of Problem 2(a)(CONT’D) sinus ‘Tabular analysis of transactions For the month ended Sep 30, 2017 Assets = Licbilties + Equity Tonsaeibns [Ean | Aeeuns | Sips] eGvpions| Acne ole | sha ‘eiained tarings fapionation Recewable cont Hi Revenue] txpense ] Bridend | 8 “250 "250 7 Poyment of ‘Accounts, ht i Payable ° +600 -600 Received | from | ‘Accounts nails | se Mitiritst pecetvabte 70 |-1300 $7300 | Dividends | | a A | 50+ $1400+ ‘$1600 $7000= $1600+ $1500 $4700- $1950- $1500 + Capea | a $18050 $18050Solution of Problem 1(b) Softbyte Income Statement For the month ended Sep 30, 2017 Particulars ‘Amount Amount | even Service revenue (1200+3500) $2700 Total Revenue $4,700) Less: Expenses ae and wages Expense. Rent Expense ‘Advertising expense Utilities Expense Total Expense L Net Income 950) $2,750 Net income of $2,750 shown on the income statement is added to the beginning balance of retained earnings in the retained earnings statement.Solution of problem 1(b)......(CONT’D) Soft byte Retained Earnings Statement For the month ended September 30, 2017 Particulars Amount Amount Retained earnings, Sep 1 $0 \Add: Net income \2750 \2750 } ‘Less: Dividends Retained earnings, Sep 30 pao // Retained earnings of $1450 shown in the retained earnings statement is reported on the statement of financial position.Solution of problem 1(b)......(CONT’D) Softbyte Statement of Financial Position Sep 30, 2017 adits) [Amount _ Particulars Equipment | ‘Accounts Receivable Supplies Cash Total Assets Equity and Liabilities Equity Share capital - ordinary Retained Earnings Total Equity Liabilities ‘Accounts Payable Total Equity and Liabilities | 1600, [Amount $7,000 MER OO 1400 805 $15,000, 1,450Problem 1-2A (Page 42) a On August 31, 2017 the Statement of Financial Position of Donahue Veterinary Clinic Ltd. showed cash $9000,Accounts Receivables $1700Supplies $600, Equipment $6000,Accounts Payable $3600 and Share Capital - Ordinary $1300 and Retained Earning $700. During September, the following transactions occurred 1. Paid $2900 cash for accounts payable due. 2. Collected $1300 of accounts receivable. 3. Purchased additional equipment for $2100, paying $800 in cash and the balance on account 4, Recognized/Earned revenue of $7300 of which $2500 is received in cash and the balance is due in October. 5. Declared and paid a $400 cash dividend. 6. Paid salaries $1700, rent for September $900 ond advertising expense $200. 7. Incurred utllties expense for month on account $170, 8. Received $10000 from Capital Bank-money borrowed on a 6 month note payable. Instruction: a) Prepore a tabular analysis of the September transaction beginning with August 31 balances, The column headings should be as follows: Cash + Accounts Receivable + Supplies + Equipment = Notes Payable + ‘Accounts Payable + Share Capital + Retained Earnings + Revenues ~ Expenses ~ Dividends, b) Prepare an income statement for September, a retained earning statement for September and a statement of financial position at September 30, 2017.Solution of problem 1-2A(a) Donahue Veterinary Clinic Ltd ‘Tabular Analysis of Transactions For the month ended September 30, 2017 ac a [rensoction oun ACCU Receivable Suppin Gaupmert (accounts Povble (Not shag conte. FG, pe lemon poe nnn emg sne an ge rs fw i 2900} aren eee ee TT ean | 5 waa Thieme 900} } 4 — LS Equipment. | | sos age soos ams voo80+ 000+ 1002 $25,000 7s00- 2270. $400Solution of Problem 1-2A(b) Donahue Veterinary Clinic Ltd Income Statement For the month ended September 30, 2017 Particulars Revenues: Service Revenue Total Revenue Less: Expenses Solaries Expense Rent Expense Advertising Expense Utilities Expense Total Expense Net IncomeSolution of Problem 1-2A(b).....(CONT’D) Donahve Veterinary Clinic Ltd Retained Earnings Statement For the month ended September 30, 2017 ~~ Particulars ~ | Amount ~~] Amount $700 ey, = Retained earnings, Sep 1 Add: Net income (4330 | | 5030 Less: Dividends (400) Retained earnings, Sep 30 $4,630Solution of Problem 1-2A(b! (CONT’D) Donahue Veterinary Clinic Ltd Statement of Financial Position Sep 30, 2017 Particulars ‘Amount ‘Amount Assets: Equipment ‘Accounts Receivable _ ‘Supplies Cash Total Assets Equity ond Liabilities: Equit Share capital - ordinary Retained Earnings Total Equity Liabilities Notes Payable ‘Accounts Payable Total Liabilities ‘$2170 Total Liabilities and Owner's Equity $29.800 $17,630,Problem 2 Legal Services Company Ltd. wos formed on July 1, 2017, During the first month of operations, the following transactions occurred. 1, Shareholders invested $10,000,000 in cash in exchange for ordinary shares of Legal Services Company Ltd. 2. Paid $800,000 for July rent on office space. 3, Purchased office equipment on account $3,000,000. 4, Performed legal services for clients for cash $1,500,000. 5, Borrowed $700,000 cash from a bank on a note payable. 6. Performed legal services for a client on account $2,000,000. 7. Paid monthly expenses: salaries $500,000, utilities $300,000, and advertising $100,000. Instructions ) Prepore a tabular summary of the transactions, (Prepare using $ in thousands) b) Prepare the income statement, retained earnings statement, and statement of financial position at July 31 for Legal Services Company Ltd. (Prepare using $ in thousands.)Problem 3 On April 1, Holly Dahl established Holiday Travel Agency Ltd, The following transactions were completed during the month, 1. Shareholders invested €12,000 cash in the business In exchange for ordinary shares. 2. Paid €400 cash for April office rent. 5, Purchased office equipment for €5,500 cash, 4. Incurred €300 of advertising costs in a local newspaper, on account. 5, Pald €600 cash for office supplies 6. Performed services worth €8,500: €2,000 cash is received from customers, and the balance of €6,500 is billed to customers on account 7. Declared and paid 0 €200 cash dividend. 8, Paid the local newspaper amount due in transaction (4) 9, Paid employees’ solaries €2,200. 10, Received €5,700 in cash from customers billed previously in the transaction (6) Instructions (o) Prepare a tabular analysis of the transactions using the following column headings: Cash, Accounts Receivable, Supplies, Equipment, Accounts Payable, Share Capital, and Retained Earnings (with separate columns for Revenue: Expenses, and Dividends). Include margin explanation for any changes in Retained Earnings. (b) From an analysis of the Retained Earnings columns, compute the net income or net loss for April