ACCOUNTING IN ACTION

Learning Objectives
After studying this chapter, you should be able to:
[1] Explain the measurement principles.
[2] Explain the monetary unit assumption and the economic entity assumption.
[3] State the accounting equation, and define its components.

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 Measurement Principles
Learning
Objective 1
Explain the
HISTORICAL COST PRINCIPLE (or cost principle) Measurement
Dictates that companies record assets at their cost. principles.
.

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).

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 Assumptions
Learning
MONETARY UNIT ASSUMPTION Objective 2
Explain the
requires that companies include in the monetary unit
assumption and
accounting records only transaction data that the economic
can be expressed in terms of money. entity assumption.

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 ◆ Often retail and shares
manager/operator service-type ◆ Separate legal
◆ Owner receives businesses entity organized
any profits, suffers ◆ Generally under corporation
any losses, and is unlimited law
personally liable personal liability ◆ Limited liability
for all debts
◆ Partnership ◆ Shares are
◆ Beauty Saloon, agreement transferable
Retail Store
◆ Lawyer, doctor, ◆ Unlimited life
architects, CA
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 Assumptions

Review Question
The historical cost principle states that:
a. assets should be initially recorded at cost and
adjusted when the fair value changes.
b. activities of an entity are to be kept separate and
distinct from its owner.
c. assets should be recorded at their cost.
d. only transaction data capable of being expressed in
terms of money be included in the accounting
records.
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 Accounting Equation
Accounting Equation is the mathematical Learning
Objective 3
expression of total accounting system. State the
accounting
Basic Accounting Equation equation, and
define its
components.
◆ Provides the underlying framework for recording and
summarizing economic events.
◆ Assets must equal the sum of liabilities and equity.
◆ Liabilities and owners equity are the rights or claims
against these resources

Assets = Liabilities + Equity

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 Basic Accounting Equation

Assets = Liabilities + Equity

Assets
◆ Resources a business owns.
◆ Production and Sales
◆ Provide future services or benefits.
◆ Cash, Inventory, Equipment, etc.
◆ Pizza hut

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 Basic Accounting Equation

Assets = Liabilities + Equity

Liabilities
◆ Claims against assets (debts and obligations).
◆ Creditors (party to whom money is owed).
◆ Accounts Payable, Notes Payable, Salaries and Wages
Payable, Tax payable etc.
◆ Creditors can legally force the liquidation of a business

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 Basic Accounting Equation

Assets = Liabilities + Equity

Equity
◆ Ownership claim on total assets.
◆ Referred to as residual equity.
◆ Share Capital—Ordinary and Retained Earnings.
◆ Ordinary share capital is the sum of money raised by a corporate
from private and public sources through the issue of its
common shares

◆ Retained earnings (RE) is the amount of net income left

over for the business after it has paid out dividends to its
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shareholders LO 6
 Equity Illustration 1-7
Increases and
decreases in equity

Investments by shareholders represent the total amount paid

in by shareholders for the ordinary shares they purchase.

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 Stockholders’ Equity Illustration 1-7
Increases and
decreases in 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.

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 Stockholders’ Equity Illustration 1-7
Increases and
decreases in 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, property tax expense, etc.

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 Stockholders’ Equity Illustration 1-7
Increases and
decreases in equity

Dividends are the distribution of cash or other assets to

shareholders.
Dividends reduce retained earnings. However, dividends are not
expenses.

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 > DO IT!

Classify the following items as issuance of stock, dividends,

revenues, or expenses. Then indicate whether each item
increases or decreases stockholders’ equity.

Classification Effect on Equity

1. Rent Expense Expense Decrease

2. Service Revenue Revenue Increase

3. Dividends Dividends Decrease
4. Salaries and Wages
Expense Expense Decrease

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 The Basic Accounting Equation

Basic Accounting Equation

◆ Provides the underlying framework for
recording and summarizing economic
events.
◆ Assets must equal the sum of liabilities
and equity.

Assets = Liabilities + Equity

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 Basic Accounting Equation

Assets = Liabilities + Equity

Assets
◆ Resources a business owns.
◆ Provide future services or benefits.
◆ Cash, Inventory, Equipment, etc.

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 Basic Accounting Equation

Assets = Liabilities + Equity

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

1-17 LO 6
 Basic Accounting Equation

Assets = Liabilities + Equity

Equity
◆ Ownership claim on total assets.
◆ Referred to as residual equity.
◆ Share Capital—Ordinary and Retained Earnings.

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 Equity Illustration 1-7
Increases and
decreases in equity

Investments by shareholders represent the total amount paid

in by shareholders for the ordinary shares they purchase.

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 Stockholders’ Equity Illustration 1-7
Increases and
decreases in 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.

1-20 LO 6
 Stockholders’ Equity Illustration 1-7
Increases and
decreases in 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, property tax expense, etc.

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 QUESTION

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