Chapter 1

Subchapter 1
Accounting consists of three basic activities—it identifies, records, and communicates the
economic events of an organization to interested users.
Bookkeeping usually involves only the recording of economic events.
Internal users of accounting information are the managers who plan, organize, and run a
business.
Managerial accounting provides internal reports to help users make decisions about their
companies.
External users are individuals and organizations outside a company who want financial
information about the company.
Financial accounting answers these questions. It provides economic and financial information
for investors, creditors, and other external users.

DO IT! 1 Basic Concepts

Indicate whether each of the five statements presented below is true or false. If false, indicate
how to correct the statement.

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.

Solution
1. True.
2. False. Bookkeeping involves only the recording step.
3. False. Accountants analyzeand interpret information in reports as part of the communication
step.
4. False. The two most common types of external users are investors and creditors.
5. True.

Subchapter 2
The historical cost principle (or cost principle) dictates that companies record assets at their
cost.
The 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).

Two main assumptions are the monetary unit assumption and the economic entity assumption.
The monetary unit assumption requires that companies include in the accounting records only
transaction data that can be expressed in money terms.
The economic entity assumption requires that the activities of the entity be kept separate and
distinct from the activities of its owner and all other economic entities

A business owned by one person is generally a proprietorship.

A business owned by two or more persons associated as partners is a partnership.
A business organized as a separate legal entity under state corporation law and having
ownership divided into transferable shares of stock is a corporation.
DO IT! 2 Building Blocks of Accounting
Indicate whether each of the five statements presented below is true or false. If false, indicate
how to correct the statement.
1. Congress passed the Sarbanes-Oxley Act to reduce unethical behavior and decrease the
likelihood of future corporate scandals.
2. The primary accounting standard-setting body in the United States is the Financial
Accounting Standards Board (FASB).
3. The historical cost principle dictates 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.
4. Relevance means that financial information matches what really happened; the information
is factual.
5. A business owner’s personal expenses must be separated from expenses of the business
to comply with accounting’s economic entity assumption.

Solution
1. True.
2. True.
3. False. The historical cost principle dictates that companies record assets at their cost. Under
the historical cost principle, the company must also use cost in later periods.
4. False. Faithful representation, not relevance, means that financial information matches what
really happened; the information is factual.
5. True.

Subchapter 3
assets are resources a business owns.
Liabilities are claims against assets—that is, existing debts and obligations.
The ownership claim on a corporation’s total assets is stockholders’ equity.

DO IT! 3 Stockholders’ Equity Effects

Classify the following items as issuance of stock (I), dividends (D), revenues (R), or expenses
(E). Then indicate whether each item increases or decreases stockholders’ equity.

1. Rent Expense.
2. Service Revenue.
3. Dividends.
4. Salaries and Wages Expense.

Solution
1. Rent Expense is an expense (E); it decreases stockholders’ equity.
2. Service Revenue is revenue (R); it increases stockholders’ equity.
3. Dividends is a distribution to stockholders (D); it decreases stockholders’ equity.
4. Salaries and Wages Expense is an expense (E); it decreases stockholders’ equity.

Subchapter 4
Subchapter 5
1. An income statement presents the revenues and 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.
3. A balance sheet reports the assets, liabilities, and stockholders’ equity of a company at a
specific date.
4. A statement of cash flows summarizes information about the cash inflows (receipts) and
outflows (payments) for a specific period of time.
 Chapter 2
Subchapter 1
The term debit indicates the left side of an account, and credit indicates the right side.

Subchapter 2
Entering transaction data in the journal is known as journalizing. Companies make separate
journal entries for each transaction. A complete entry consists of
(1) the date of the transaction,
(2) the accounts and amounts to be debited and credited, and
(3) a brief explanation of the transaction.
Subchapter 3
The entire group of accounts maintained by a company is the ledger. The ledger provides the
balance in each of the accounts as well as keeps track of changes in these balances.
Companies may use various kinds of ledgers, but every company has a general ledger. A
general ledger contains all the asset, liability, and stockholders’ equity accounts
Subchapter 4
A trial balance is a list of accounts and their balances at a given time.
A trial balance does not guarantee freedom from recording errors, however. Numerous errors
may exist even though the totals of the trial balance columns agree. For example, the trial
balance may balance even when:
1. A transaction is not journalized.
2. A correct journal entry is not posted.
3. A journal entry is posted twice.
4. Incorrect accounts are used in journalizing or posting.
5. Off setting errors are made in recording the amount of a transaction.
As long as equal debits and credits are posted, even to the wrong account or in the wrong
amount, the total debits will equal the total credits. The trial balance does not prove that the
company has recorded all transactions or that the ledger is correct.
 Chapter 3
Subchapter 1
Using the accrual basis to determine net income means companies recognize revenues when
they perform services (rather than when they receive cash). It also means recognizing
expenses when incurred (rather than when paid).

Adjusting entries are classified as either deferrals or accruals.

Deferrals:

1. Prepaid expenses: Expenses paid in cash before they are used or consumed.
2. Unearned revenues: Cash received before services are performed.

Accruals:

1. Accrued revenues: Revenues for services performed but not yet received in cash or
recorded.
2. Accrued expenses: Expenses incurred but not yet paid in cash or recorded.
Subchapter 2

Subchapter 3
Subchapter 4
 Chapter 4
Subchapter 3
Case 1
On May 10, Mercato Co. journalized and posted a $50 cash collection on account from a
customer as a debit to Cash $50 and a credit to Service Revenue $50 (see Illustration 4.12).
The company discovered the error on May 20, when the customer paid the remaining balance
in full.

Comparison of the incorrect entry with the correct entry reveals that the debit to Cash $50
is correct. However, the $50 credit to Service Revenue should have been credited to Accounts
Receivable. As a result, both Service Revenue and Accounts Receivable are overstated in the
ledger. Mercato makes the correcting entry shown in Illustration 4.13.

Case 2
On May 18, Mercato purchased on account equipment costing $450. The transaction was
journalized and posted as a debit to Equipment $45 and a credit to Accounts Payable $45
(see
Illustration 4.14). The error was discovered on June 3, when Mercato received the monthly
statement for May from the creditor.

Comparison of the two entries shows that two accounts are incorrect. Equipment is
understated
$405, and Accounts Payable is understated $405. Mercato makes the correcting entry
shown in Illustration 4.15.
Subchapter 4
 Chapter 5
Subchapter 1
Cost of goods sold is the total cost of merchandise sold during the period.

In a perpetual inventory system, companies keep detailed records of the cost of each
inventory purchase and sale
In a periodic inventory system, companies do not keep detailed inventory records of the
goods on hand throughout the period. Instead, they determine the cost of goods sold only at
the end of the accounting period
Subchapter 2

Subchapter 3

Subchapter 5
 Chapter 6
Subchapter 2
1. In a period of inflation, FIFO produces a higher net income because lower unit costs of the
first units purchased are matched against revenue.
2. In a period of inflation, LIFO produces a lower net income because higher unit costs of the
last goods purchased are matched against revenue.
3. If prices are falling, the results from the use of FIFO and LIFO are reversed. FIFO will report
the lowest net income and LIFO the highest.
4. Regardless of whether prices are rising or falling, average-cost produces net income
between FIFO and LIFO.
 Chapter 8
Subchapter 1

Subchapter 2
Under the direct write-off method, when a company determines a particular account to be
uncollectible, it charges the loss to Bad Debt Expense.

The allowance method of accounting for bad debts involves estimating uncollectible accounts
at the end of each period.
1. Companies estimate uncollectible accounts receivable. They match this estimated expense
against revenues in the same accounting period in which they record the revenues.
2. Companies debit estimated uncollectibles to Bad Debt Expense and credit them to
Allowance
for Doubtful Accounts through an adjusting entry at the end of each period.
Allowance for Doubtful Accounts is a contra account to Accounts Receivable.
3. When companies write off a specifi c account, they debit actual uncollectibles to Allowance
for Doubtful Accounts and credit that amount to Accounts Receivable.
 Chapter 9
Subchapter 2
Depreciation is generally computed using one of the following methods:
1. Straight-line
2. Units-of-activity
3. Declining-balance
 Chapter 12
Subchapter 1
1. Operating activities include the cash eff ects of transactions that create revenues and
expenses. They thus enter into the determination of net income.
2. Investing activities include (a) acquiring and disposing of investments and property,
plant, and equipment, and (b) lending money and collecting the loans.
3. Financing activities include (a) obtaining cash from issuing debt and repaying the
amounts borrowed, and (b) obtaining cash from stockholders, repurchasing shares, and
paying dividends.

Subchapter 2
The indirect method adjusts net income for items that do not aff ect cash.
The direct method shows operating cash receipts and payments. It is prepared by
adjusting each item in the income statement from the accrual basis to the cash basis.
\
Subchapter 3
Chapter 13
Subchapter 3
 Chapter 14
Subchapter 2
Subchapter 3
 Chapter 15
Subchapter 1

Subchapter 2
Subchapter 3

Subchapter 4
Subchapter 5
 Chapter 17
Subchapter 1

Subchapter 3

Subchapter 2
 Chapter 18
Subchapter 1

Subchapter 2
Subchapter 3
At the point where total contribution margin exactly equals fi xed costs, Vargo will report
net income of zero. At this point, referred to as the break-even point, total costs (variable plus
fi xed) exactly equal total revenue.
Subchapter 4

Subchapter 5
 Chapter 19
Subchapter 1
Subchapter 2
 Chapter 20
Subchapter 1

Subchapter 2
Subchapter 3
 Chapter 21
Subchapter 1

Subchapter 2
Subchapter 3
 Chapter 22
Subchapter 1
The primary benefi ts of budgeting are as follows.
1. It requires all levels of management to plan ahead and to formalize goals on a recurring
basis.
2. It provides defi nite objectives for evaluating performance at each level of responsibility.
3. It creates an early warning system for potential problems so that management can make
changes before things get out of hand.
4. It facilitates the coordination of activities within the business. It does this by correlating
the goals of each segment with overall company objectives. Thus, the company can integrate
production and sales promotion with expected sales.
5. It results in greater management awareness of the entity’s overall operations and the
impact on operations of external factors, such as economic trends.
6. It motivates personnel throughout the organization to meet planned objectives.
Subchapter 2
Subchapter 3
Subchapter 4
 Chapter 23
Subchapter 1
Subchapter 2
 Chapter 24
Subchapter 1

Subchapter 2
Subchapter 3
Subchapter 4