Chapter

1-1
 CHAPTER 1

ACCOUNTING IN
ACTION

Accounting Principles, Eighth Edition

Chapter
1-2
 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 assets,
liabilities, and owner’s equity.
7. Analyze the effects of business transactions on the
accounting equation.
8. Understand the four financial statements and how they
are prepared.
Chapter
1-3
 Accounting
Accounting in
in Action
Action

Using
Using the
the
The
The Building
Building The
The Basic
Basic
What
What is
is Basic
Basic Financial
Financial
Blocks
Blocks of
of Accounting
Accounting
Accounting?
Accounting? Accounting
Accounting Statements
Statements
Accounting
Accounting Equation
Equation 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
1-4
 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
1-5 LO 1 Explain what accounting is.
 What
What is
is Accounting?
Accounting?
Illustration 1-1
Three Activities Accounting
process

The accounting process includes

the bookkeeping function.

Chapter
1-6 LO 1 Explain what accounting is.
 Who
Who Uses
Uses Accounting
Accounting Data?
Data?
Internal
Users Manageme IRS
nt Investors
Human
Resources

Labor
Unions
Finance Common Questions

Creditor
Marketin s
g SEC
Customer Externa
s l Users
Chapter
1-7 LO 2 Identify the users and uses of accounting.
 Who
Who Uses
Uses Accounting
Accounting Data?
Data?
Common Questions Asked User
1. Can we afford to give our
employees a pay raise? Human 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 stockholders? Finance

5. What price for our product

will maximize net income? Marketing

6. Will the company be able to

pay its short-term debts? Creditors
Chapter
1-8 LO 2 Identify the users and uses of accounting.
 Who
Who Uses
Uses Accounting
Accounting Data?
Data?

Discussion Question
Q1. “Accounting is ingrained in our society and it
is vital to our economic system.” Do you agree?
Explain.

Chapter
1-9See notes
LO 3 page why ethics is a fundamental business concept .
for discussion
Understand
 The
The Building
Building Blocks
Blocks of
of Accounting
Accounting

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.

Recent financial scandals include: Enron,

WorldCom, HealthSouth, AIG, and others.

Congress passed Sarbanes-Oxley Act of

2002.

Effective financial reporting depends on

Chapter
sound ethical behavior.
1-10 LO 3 Understand why ethics is a fundamental business concept .
 Ethics
Ethics
Review Question
Ethics are the standards of conduct by which
one's actions are judged as:
a. right or wrong.
b. honest or dishonest.
c. fair or not fair.
d. all of these options.

Chapter
1-11 LO 3 Understand why ethics is a fundamental business concept .
 The
The Building
Building Blocks
Blocks of
of Accounting
Accounting

Financial Statements
Various users Balance Sheet
need financial Income Statement
Statement of Owners’ 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
1-12 LO 4 Explain generally accepted accounting principles and the
 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
1-13 (IASB)
LO 4 Explain generally accepted accounting principles and the
 The
The Building
Building Blocks
Blocks of
of Accounting
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.

Chapter
1-14 LO 4 Explain generally accepted accounting principles and the
 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 LO 5 Explain the monetary unit
1-15
assumption and the economic
 Forms
Forms of
of Business
Business Ownership
Ownership
Proprietorshi
Partnership Corporation
p
Generally owned Owned by two Ownership
by one person. or more divided into
Often small persons. shares of stock
service-type Often retail and Separate legal
businesses service-type entity
Owner receives businesses organized
any profits, Generally under state
suffers any unlimited corporation law
losses, and is personal liability Limited liability
personally liable
for all debts. Partnership
agreement
Chapter LO 5 Explain the monetary unit
1-16
assumption and the economic
 Assumptions
Assumptions
Review 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.

Chapter LO 5 Explain the monetary unit

1-17
assumption and the economic
 Forms
Forms of
of Business
Business Ownership
Ownership
Review 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.

Chapter LO 5 Explain the monetary unit

1-18
assumption and the economic
 The
The Basic
Basic Accounting
Accounting Equation
Equation

Owners’
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 LO 6 State the accounting equation, and

1-19
define assets, liabilities, and owner’s
 The
The Basic
Basic Accounting
Accounting Equation
Equation

Owners’
Assets = Liabilities +
Equity

Provides the underlying framework for

recording and summarizing economic events.
Assets

Resources a business owns.

Provide future services or benefits.
Cash, Supplies, Equipment, etc.
Chapter LO 6 State the accounting equation, and
1-20
define assets, liabilities, and owner’s
 The
The Basic
Basic Accounting
Accounting Equation
Equation

Owners’
Assets = Liabilities +
Equity

Provides the underlying framework for

recording and summarizing economic events.
Liabilities

Claims against assets (debts and obligations).

Creditors - party to whom money is owed.
Accounts payable, Notes payable, etc.
Chapter LO 6 State the accounting equation, and
1-21
define assets, liabilities, and owner’s
 The
The Basic
Basic Accounting
Accounting Equation
Equation

Owners’
Assets = Liabilities +
Equity

Provides the underlying framework for

recording and summarizing economic events.
Owners’ Equity

Ownership claim on total assets.

Referred to as residual equity.
Capital, Drawings, etc. (Proprietorship or
Partnership).
Chapter LO 6 State the accounting equation, and
1-22
define assets, liabilities, and owner’s
 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
Chapter rent. LO 6 State the accounting equation, and
1-23
define assets, liabilities, and owner’s
 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 LO 6 State the accounting equation, and
1-24
define assets, liabilities, and owner’s
 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 LO 7 Analyze the effects of business

1-25
transactions on the accounting
 Transactions
Transactions (Question?)
(Question?)
Q1-15: Are the following events recorded in the
accounting records? Owner
Supplies An withdraws
Even are employee cash for
t purchased is hired. personal use.
on account.

Criterio Is the financial position (assets, liabilities,

n or owner’s equity) of the company
changed?

Record/
Don’t
Record
Chapter LO 7 Analyze the effects of business
1-26
transactions on the accounting
 Transactions
Transactions

Discussion Question
Q18. In February 2008, Paula King invested
an additional $10,000 in her business, King’s
Pharmacy, which is organized as a
proprietorship. King’s accountant, Lance
Jones, recorded this receipt as an increase in
cash and revenues. Is this treatment
appropriate? Why or why not?

Chapter LO 7 Analyze the effects of business

1-27See notes page for discussion
transactions on the accounting
transactions on the accounting
 Transactions
Transactions (Problem)
(Problem)
P1-1A: Barone’s Repair Shop was started on May 1
by Nancy. Prepare a tabular analysis of the
following transactions for the month of May.

1. Invested $10,000 cash to start the repair

shop.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipme = Payable + Capital
nt
1. +10,00 +10,00 Investme
0 0 nt

Chapter LO 7 Analyze the effects of business

1-28
transactions on the accounting
 Transactions
Transactions (Problem)
(Problem)
2. Purchased equipment for $5,000 cash.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipme = Payable + Capital
nt
1. +10,00 +10,00 Investme
0
2. -5,000 +5,000 0 nt

Chapter LO 7 Analyze the effects of business

1-29
transactions on the accounting
 Transactions
Transactions (Problem)
(Problem)
3. Paid $400 cash for May office rent.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipme = Payable + Capital
nt
1. +10,00 +10,00 Investme
0
2. -5,000 +5,000 0 nt
3. -400 -400 Expense

Chapter LO 7 Analyze the effects of business

1-30
transactions on the accounting
 Transactions
Transactions (Problem)
(Problem)
4. Received $5,100 from customers for repair
service. Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipme = Payable + Capital
nt
1. +10,00 +10,00 Investme
0
2. -5,000 +5,000 0 nt
3. -400 -400 Expense
4. +5,100 +5,100 Revenu
e

Chapter LO 7 Analyze the effects of business

1-31
transactions on the accounting
 Transactions
Transactions (Problem)
(Problem)
5. Withdrew $1,000 cash for personal use.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipme = Payable + Capital
nt
1. +10,00 +10,00 Investme
0
2. -5,000 +5,000 0 nt
3. -400 -400 Expense
4. +5,100 +5,100 Revenu
5. -1,000 -1,000 e
Drawing
s

Chapter LO 7 Analyze the effects of business

1-32
transactions on the accounting
 Transactions
Transactions (Problem)
(Problem)
6. Paid part-time employee salaries of
$2,000. Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipme = Payable + Capital
nt
1. +10,00 +10,00 Investme
0
2. -5,000 +5,000 0 nt
3. -400 -400 Expense
4. +5,100 +5,100 Revenu
5. -1,000 -1,000 e
Drawing
6. -2,000 -2,000 s
Expense

Chapter LO 7 Analyze the effects of business

1-33
transactions on the accounting
 Transactions
Transactions (Problem)
(Problem)
7. Incurred $250 of advertising costs, on
account. Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipme = Payable + Capital
nt
1. +10,00 +10,00 Investme
0
2. -5,000 +5,000 0 nt
3. -400 -400 Expense
4. +5,100 +5,100 Revenu
5. -1,000 -1,000 e
Drawing
6. -2,000 -2,000 s
Expense
7. +250 -250 Expense

Chapter LO 7 Analyze the effects of business

1-34
transactions on the accounting
 Transactions
Transactions (Problem)
(Problem)
8. Provided $750 of repair services on account.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipme = Payable + Capital
nt
1. +10,00 +10,00 Investme
0
2. -5,000 +5,000 0 nt
3. -400 -400 Expense
4. +5,100 +5,100 Revenu
5. -1,000 -1,000 e
Drawing
6. -2,000 -2,000 s
Expense
7. +250 -250 Expense
8. +750 +750 Revenu
e

Chapter LO 7 Analyze the effects of business

1-35
transactions on the accounting
 Transactions
Transactions (Problem)
(Problem)
9. Collected $120 cash for services previously
billed. Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipme = Payable + Capital
nt
1. +10,00 +10,00 Investme
0
2. -5,000 +5,000 0 nt
3. -400 -400 Expense
4. +5,100 +5,100 Revenu
5. -1,000 -1,000 e
Drawing
6. -2,000 -2,000 s
Expense
7. +250 -250 Expense
8. +750 +750 Revenu
9. +120 -120 e
6,820 + 630 + 5,000 = 250 +
12,200
Chapter LO 7 Analyze the effects of business
1-36
transactions on the accounting
 Financial
Financial Statements
Statements

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

Owners’
Income Statemen
Equity Balance
Statemen t of Cash
Statemen Sheet
t Flows
t

Chapter
1-37 LO 8 Understand the four financial statements and how they are
 Financial
Financial Statements
Statements
Review 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.

Chapter
1-38 LO 8 Understand the four financial statements and how they are
 Financial
Financial Statements
Statements

Income
Statement
Barone’s Repair Shop
Reports the revenues
I ncome Statement
For the Month Ended May 31, 2007 and expenses for a
Revenues: specific period of time.
Service revenue $ 5,850
Expenses: Net income – revenues
Salary expense 2,000
Rent expense 400
exceed expenses.
Advertising expense 250
Total expenses 2,650 Net loss – expenses
Net income $ 3,200
exceed revenues.

Chapter
1-39 LO 8 Understand the four financial statements and how they are
 Financial
Financial Statements
Statements
Owners’ Equity
Income Statement
Statement
Barone’s Repair Shop Barone’s Repair Shop
I ncome Statement Owners' Equity Statement
For the Month Ended May 31, 2007 For the Month Ended May 31, 2007

Revenues: Barone' s, Capital May 1 $ -

Service revenue $ 5,850 Add: I nvestment 10,000
Expenses: Net income 3,200
Salary expense 2,000 13,200
Rent expense 400 Less: Drawings 1,000
Advertising expense 250 Barone' s, Capital May 31 $ 12,200
Total expenses 2,650
Net income $ 3,200

Net income is needed to determine

the ending balance in owner’s
equity.
Chapter
1-40 LO 8 Understand the four financial statements and how they are
 Financial
Financial Statements
Statements
Owners’ Equity
Statement
Statement indicates Barone’s Repair Shop
Owners' Equity Statement
the reasons why
For the Month Ended May 31, 2007
owner’s equity has
Barone' s, Capital May 1 $ -
increased or decreased Add: I nvestment 10,000
during the period. Net income 3,200
13,200
Less: Drawings 1,000
Barone' s, Capital May 31 $ 12,200

Chapter
1-41 LO 8 Understand the four financial statements and how they are
 Financial
Financial Statements
Statements
Owners’ Equity
Balance Sheet Statement
Barone’s Repair Shop
Barone’s Repair Shop
Balance Sheet
Owners' Equity Statement
May 31, 2007
For the Month Ended May 31, 2007
Assets
Cash $ 6,820 Barone' s, Capital May 1 $ -
Accounts receivable 630 Add: I nvestment 10,000
Equipment 5,000 Net income 3,200
Total assets $ 12,450 13,200
Liabilities Less: Drawings 1,000
Accounts payable $ 250 Barone' s, Capital May 31 $ 12,200
Owners' Equity
Barone' s, capital 12,200
Total liab. & equity $ 12,450
The ending balance in owner’s
equity is needed in preparing the
balance sheet
Chapter
1-42 LO 8 Understand the four financial statements and how they are
 Financial
Financial Statements
Statements

Balance Sheet
Barone’s Repair Shop
Reports the assets,
Balance Sheet liabilities, and owner’s
May 31, 2007
equity at a specific
Assets
Cash $ 6,820 date.
Accounts receivable 630
Equipment 5,000 Assets listed at the
Total assets $ 12,450
Liabilities top, followed by
Accounts payable $ 250 liabilities and owner’s
Owners' Equity
Barone' s, capital 12,200
equity.
Total liab. & equity $ 12,450
Total assets must
Chapter
equal total liabilities
LO 8 Understand the four financial statements and how they are
1-43
and owner’s equity.
 Financial
Financial Statements
Statements
Statement of Cash
Balance Sheet
Flows
Barone’s Repair Shop
Barone’s Repair Shop Statement of Cash Flows

Balance Sheet For the Month Ended May 31, 2007

Cash flow from Operations
May 31, 2007
Cash receipts f rom customers $ 5,220
Assets
Cash paid f or expenses (2,400)
Cash $ 6,820
Cash provided by operations 2,820
Accounts receivable 630
Cash flow from I nvesting
Equipment 5,000
Purchase of equipment (5,000)
Total assets $ 12,450
Cash flow from Financing
Liabilities
I nvestment by owners 10,000
Accounts payable $ 250 Drawings by owners (1,000)
Owners' Equity Cash provided by fi nancing 9,000
Barone' s, capital 12,200 Net increase in cash 6,820
Total liab. & equity $ 12,450 Cash balance, May 1 -
Cash balance, May 31 $ 6,820

Chapter
1-44 LO 8 Understand the four financial statements and how they are
 Financial
Financial Statements
Statements
Statement of Cash
Information for a
Flows
Barone’s Repair Shop
specific period of Statement of Cash Flows
time. For the Month Ended May 31, 2007
Cash flow from Operations
Cash receipts f rom customers $ 5,220
Answers
1. Where the
did cash Cash paid f or expenses (2,400)
following:
come from? Cash provided by operations 2,820
Cash flow from I nvesting
Purchase of equipment (5,000)
2. What was cash Cash flow from Financing
used for? I nvestment by owners 10,000
Drawings by owners (1,000)
3. What was the Cash provided by fi nancing 9,000
Net increase in cash 6,820
change in the cash Cash balance, May 1 -
balance? Cash balance, May 31 $ 6,820

Chapter
1-45 LO 8 Understand the four financial statements and how they are
 Financial
Financial Statements
Statements
Review 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.

Chapter
1-46 LO 8 Understand the four financial statements and how they are
 Financial
Financial Statements
Statements

Discussion Question
Q19. “A company’s net income appears
directly on the income statement and the
owner’s equity statement, and it is included
indirectly in the company’s balance sheet.”
Do you agree? Explain.

See notes
Chapter
1-47
page for discussion
LO 8 Understand the four financial statements and how they are
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Chapter
1-48