Accounting in

Action

Chapter
1-1 Accounting Principles
 Study
Study Objectives
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 its components.
7. Analyze the effects of business transactions on the
accounting equation.
8. Understand the four financial statements and how they
are prepared.
Chapter
1-2
 Accounting
Accounting in
in Action
Action

Using the
The Building The Basic
What is Basic Financial
Blocks of Accounting Accounting
Accounting? Statements
Accounting Equation 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
1-3
 What
What is
is Accounting?
Accounting?

The purpose of accounting is to:

(1) identify,
identify record,
record and communicate
the economic events of an
(2) organization to
(3) interested users.

Chapter
1-4
 What
What is
is Accounting?
Accounting?
Illustration 1-1
Three Activities Accounting
process

The accounting process includes

the bookkeeping function.

Chapter
1-5
 Who
Who Uses
Uses Accounting
Accounting Data?
Data?
Internal
Users Manageme IRS
nt Investors
Human
Resources
There are two broad
groups of users of Labor
financial information: Unions
Finance
internal users and
external users. Creditor
Marketin s
g SEC
Customer Externa
s l Users
Chapter
1-6
 Who
Who Uses
Uses Accounting
Accounting Data?
Data?
Common Questions Asked User
1. Can we afford to give
our employees a pay Human
raise? 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 Finance
stockholders?
5. What price for our product
will maximize net income? Marketing
6. Will the company be able
to pay its short-term Creditors
debts?
Chapter
1-7
 The
The Building
Building Blocks
Blocks of
of Accounting
Accounting

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

The accounting Generally

profession has Accepted
attempted to develop a
Accounting
set of standards that are
generally accepted and
Principles
universally practiced. (GAAP)

Chapter
1-8 .
 The
The Building
Building Blocks
Blocks of
of Accounting
Accounting

Organizations Involved in Standard

Setting:

Securities and Exchange Commission (SEC)

http://www.sec.gov/

Financial Accounting Standards Board

http://www.fasb.org/
(FASB)

http://www.iasb.org/

International Accounting Standards Board

Chapter
1-9 (IASB)
 Generally Accepted Accounting Principles
(GAAP)
The accounting profession has attempted to
develop a set of standards that are generally
accepted and universally practiced. The common
set of standards is called GAAP developed by
FASB (USA standard-setting body) which public
companies must follow. Outside the USA, IFRS
(International Financial Reporting Standards)
developed by IASB (International Accounting
Standards Board) adopted by the public
companies.

Chapter
1-10
 The
The Building
Building Blocks
Blocks of
of Accounting
Accounting

Cost Principle (Historical Cost) – 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
1-11
 Assumptions
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
Corporation. Ownership
Chapter
1-12
 Assumptions
Assumptions (continued)
(continued)

Periodicity Assumption – Financial

statements are prepared for a specific
accounting or business period generally
one year.

Chapter
1-13
 Forms
Forms of
of Business
Business Ownership
Ownership

Proprietorsh
Partnership Corporation
ip
Generally Owned by two Ownership
owned by one or more divided into
person. persons. shares of stock
Often small Often retail and Separate legal
service-type service-type entity
businesses businesses organized
Owner receives under state
Generally
any profits, corporation law
unlimited
suffers any personal Limited liability
losses, and is liability
personally
Chapter Partnership
1-14 liable for all
agreement
 The
The Basic
Basic Accounting
Accounting Equation
Equation

Owner’s
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
1-15
 The
The Basic
Basic Accounting
Accounting Equation
Equation
(continued)
(continued)
Owner’s
Assets = Liabilities +
Equity

Provides the underlying framework for

recording and summarizing economic events.
Asset
s
Resources a business owns.
Provide future services or benefits.
Cash, Supplies, Equipment, etc.
Chapter
1-16
 The
The Basic
Basic Accounting
Accounting Equation
Equation
(continued)
(continued)
Owner’s
Assets = Liabilities +
Equity

Provides the underlying framework for

recording and summarizing economic events.
Liabiliti
es
Claims against assets (debts and obligations).
Creditors - party to whom money is owed.
Accounts payable, Notes payable, etc.
Chapter
1-17
 The
The Basic
Basic Accounting
Accounting Equation
Equation
(continued)
(continued)
Owner’s
Assets = Liabilities +
Equity

Provides the underlying framework for

recording and summarizing economic events.
Owner’s
Equity
Ownership claim on total assets.
Referred to as residual equity.
Capital, Drawings, etc. (Proprietorship or
Chapter
Partnership).
1-18
 Owners’
Owners’ Equity
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
1-19
 Owners’
Owners’ Equity
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
1-20
 Recording Basis of Accounting

There are two recording basis of

Accounting:
1.Cash Basis: Only cash transactions are
recorded
2.Accrual Basis: Whether cash paid or not
nor cash received or not transactions of a
particular period is recorded.

Chapter
1-21
 Using
Using The
The Basic
Basic Accounting
Accounting Equation
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
1-22
 Transactions
Transactions Analysis
Analysis

Transaction (1). Investment By Owner. Ray Neal

decides to open a computer programming service which
he names Softbyte. On September 1, 2010, he invests
$15,000 cash in the. The effect of this transaction on the
basic equation is:

Chapter
1-23
 Transactions
Transactions Analysis
Analysis

Transaction (2). Purchase of Equipment for Cash.

Softbyte purchases computer equipment for $7,000
cash.

Chapter
1-24
 Transactions
Transactions Analysis
Analysis

Transaction (3). Purchase of Supplies on Credit.

Softbyte purchases for $1,600 from Acme Supply
Company computer paper and other supplies expected
to last several months.

Chapter
1-25
 Transactions
Transactions Analysis
Analysis

Transaction (4). Services Provided for Cash.

Softbyte receives $1,200 cash from customers for
programming services it has provided.

Chapter
1-26
 Transactions
Transactions Analysis
Analysis

Transaction (5). Purchase of Advertising on Credit.

Softbyte receives a bill for $250 from the Daily News for
advertising but postpones payment until a later date.

Chapter
1-27
 Transactions
Transactions Analysis
Analysis

Transaction (6). Services Provided for Cash and

Credit. Softbyte provides $3,500 of programming
services for customers. The company receives cash of
$1,500 from customers, and it bills the balance of $2,000
on account.

Chapter
1-28
 Transactions
Transactions Analysis
Analysis

Transaction (7). Payment of Expenses. Softbyte

pays the following Expenses in cash for September: store
rent $600, salaries of employees $900, and utilities
$200.

Chapter
1-29
 Transactions
Transactions Analysis
Analysis

Transaction (8). Payment of Accounts Payable.

Softbyte pays its $250 Daily News bill in cash.

Chapter
1-30
 Transactions
Transactions Analysis
Analysis

Transaction (9). Receipt of Cash on Account.

Softbyte receives $600 in cash from customers who had
been billed for services [in Transaction (6)].

Chapter
1-31
 Transactions
Transactions Analysis
Analysis

Transaction (10). Withdrawal of Cash by Owner.

Ray Neal withdraws $1,300 in cash from the business for
his personal use.

Chapter
1-32
 Transactions
Transactions Analysis
Analysis
Illustration 1-8

Summary of Transactions Tabular summary of

Softbyte transactions

Chapter
1-33
 Financial
Financial Statements
Statements

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

Owner’s
Income Statemen
Equity Balance
Statemen t of Cash
Statemen Sheet
t Flows
t

Chapter
1-34 .
 Income Statement
 Income statement measures the “performance”
of a company over a period of time
 Also called the Statement of Earnings

Presents:
Revenues
Expenses
Net Income
Earnings Per Share
 Net income = Revenues – Expenses
 If Revenues > Expenses = Net income (Profit)
 If Revenues < Expenses = Net Loss (Loss)

Chapter
1-35
 Income Statement (continued)
Comes in two basic formats:

Multiple-step
Single-step

Chapter
1-36
 Income Statement (continued)

Multiple-step
Provides several intermediate profit
measures prior to the amount of net
earnings for the period:
 Gross profit
 Operating profit
 Earnings before income tax

Chapter
1-37
 Income Statement (continued)
Single-step
Groups all items of revenue together, then
deducts all categories of expense to arrive
at a figure for net income

Chapter
1-38
 Financial
Financial Statements
Statements Income Statement

Reports the revenues and expenses for a specific period of

time.
Net income – revenues exceed expenses.
Chapter
Net loss – expenses exceed revenues.
1-39
 Net income is needed to determine
Financial Statements
Financial Statementsthe ending balance in owner’s equity.

Illustration 1-9
Financial statements and
their interrelationships

Chapter
1-40
 Financial
Financial Statements
Statements Owner’s Equity
Statement

Statement indicates the reasons

why owner’s equity has increased
or decreased during the period.

Chapter
1-41
 Balance Sheet
Balance sheet is called the statement of
condition or statement of financial position

It shows the financial condition or financial

positions of a company on a particular
date

Assets = Liabilities + Stockholders’

equity

Chapter
1-42
 Balance Sheet (continued)
Balance sheet is prepared on a specific date
(end of accounting period): calendar year or
fiscal year or interim period
Balance Sheet comes in two form
 Classified Balance Sheet: Assets and
Liabilities are classified based on liquidity
 Comparative Balance Sheet: Balances for
end of previous year shown on balance
sheet

Chapter
1-43
 Financial
Financial Statements
Statements Balance
Sheet

Illustration 1-9
Financial statements and
their interrelationships

Chapter
1-44
 Financial
Financial Statements
Statements

Statement of Cash
Flows
Prepared in Cash Basis and provides
information about cash inflows and
outflows during an accounting period.
Can be developed from Balance Sheet
and Income Statement data.

Chapter
1-45
 Financial
Financial Statements
Statements Statement of Cash
Flows
Illustration 1-9
Financial statements and
their interrelationships

Chapter
1-46