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Lecturer of Accounting and Finance

Chapter
1-1
Accounting in
Business

Chapter
1-2
Study 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
1-3
Accounting in Action

The Building The Basic Using the


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
1-4
What is Accounting?

The purpose of accounting is to:


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

Chapter
1-5 SO 1 Explain what accounting is.
What is Accounting?

Three Activities
Illustration 1-1
Accounting process

The accounting process includes


the bookkeeping function.

Chapter
1-6 SO 1 Explain what accounting is.
Who Uses Accounting Data?
Internal Users
Management IRS

Human Investors
Resources
There are two broad
groups of users of Labor
financial information: Unions
Finance
internal users and
external users. Creditors
Marketing
SEC
Customers External
Users
Chapter
1-7 SO 2 Identify the users and uses of accounting.
Who Uses Accounting 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 SO 2 Identify the users and uses of accounting.
Who Uses Accounting Data?

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

See notes page for discussion


SO 3 Understand why ethics is a fundamental business concept.
Chapter
1-9
The Building Blocks of 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 sound


ethical behavior.

SO 3 Understand why ethics is a fundamental business concept.


Chapter
1-10
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.

SO 3 Understand why ethics is a fundamental business concept.


Chapter
1-11
The Building Blocks of 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 profession


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

Chapter
1-12 SO 4 Explain generally accepted accounting principles and the cost principle.
The Building Blocks of Accounting

Organizations Involved in Standard Setting:

Securities and Exchange Commission (SEC)


http://www.sec.gov/

Financial Accounting Standards Board (FASB)


http://www.fasb.org/

International Accounting Standards Board


(IASB) http://www.iasb.org/

Chapter
1-13 SO 4 Explain generally accepted accounting principles and the cost principle.
The Building Blocks of 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 SO 4 Explain generally accepted accounting principles and the cost principle.
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 Ownership
Corporation.
Chapter SO 5 Explain the monetary unit assumption
1-15
and the economic entity assumption.
Forms of Business Ownership

Proprietorship Partnership Corporation

Generally owned Owned by two or Ownership


by one person. more persons. divided into
Often small shares of stock
Often retail and
service-type service-type Separate legal
businesses businesses entity organized
Owner receives under state
Generally
any profits, corporation law
unlimited
suffers any personal liability Limited liability
losses, and is
Partnership
personally liable
agreement
for all debts.
Chapter SO 5 Explain the monetary unit assumption
1-16
and the economic entity assumption.
Chapter
1-17 SO 5 Explain the monetary unit assumption and the economic entity assumption.
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 SO 5 Explain the monetary unit assumption


1-18
and the economic entity assumption.
Forms of Business 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 SO 5 Explain the monetary unit assumption


1-19
and the economic entity assumption.
The Basic Accounting 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 SO 6 State the accounting equation, and define


1-20
its components.
The Basic Accounting Equation

Owner’s
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 SO 6 State the accounting equation, and define
1-21
its components.
The Basic Accounting Equation

Owner’s
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 SO 6 State the accounting equation, and define
1-22
its components.
The Basic Accounting Equation

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
Partnership).
Chapter SO 6 State the accounting equation, and define
1-23
its components.
Owner’s 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 SO 6 State the accounting equation, and define


1-24
its components.
Owner’s 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 SO 6 State the accounting equation, and define


1-25
its components.
Using The Basic Accounting 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 SO 7 Analyze the effects of business transactions


1-26
on the accounting equation.
Transactions (Question?)

Q1-15: Are the following events recorded in the


accounting records? Owner
Supplies are An employee withdraws
Event purchased is hired. cash for
on account. personal use.

Criterion Is the financial position (assets, liabilities, or


owner’s equity) of the company changed?

Record/
Don’t Record

Chapter SO 7 Analyze the effects of business transactions


1-27
on the accounting equation.
Transactions

Discussion Question
Q1-18. In February 2010, 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?

See notes page for discussion


Chapter SO 7 Analyze the effects of business transactions
1-28
on the accounting equation.
Transactions (Problem)

P1-1A: Barone’s Repair Shop was started on May 1 by Nancy


Barone. 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 + Owners’ Equity
Accounts Accounts Barone, Barone,
Cash + Receivable + Equipment = Payable + Capital - Drawing + Revenues - Expenses

1. +10,000 +10,000

Chapter SO 7 Analyze the effects of business transactions


1-29
on the accounting equation.
Transactions (Problem)

2. Purchased equipment for $5,000 cash.


Assets = Liabilities + Owners’ Equity

Accounts Accounts Barone, Barone,


Cash + Receivable + Equipment = Payable + Capital - Drawing + Revenues - Expenses

1. +10,000 +10,000
2. -5,000 +5,000

3.

4.

5.
6.

7.

8.

9.

10.

Chapter SO 7 Analyze the effects of business transactions


1-30
on the accounting equation.
Transactions (Problem)

3. Paid $400 cash for May office rent.


Assets = Liabilities + Owners’ Equity

Accounts Accounts Barone, Barone,


Cash + Receivable + Equipment = Payable + Capital - Drawing + Revenues - Expenses

1. +10,000 +10,000
2. -5,000 +5,000

3. -400 -400

4.

5.
6.

7.

8.

9.

10.

Chapter SO 7 Analyze the effects of business transactions


1-31
on the accounting equation.
Transactions (Problem)

4. Incurred $250 of advertising costs, on account.


Assets = Liabilities + Owners’ Equity

Accounts Accounts Barone, Barone,


Cash + Receivable + Equipment = Payable + Capital - Drawing + Revenues - Expenses

1. +10,000 +10,000
2. -5,000 +5,000

3. -400 -400

4. +250 -250

5.
6.

7.

8.

9.

10.

Chapter SO 7 Analyze the effects of business transactions


1-32
on the accounting equation.
Transactions (Problem)

5. Received $5,100 from customers for repair service.


Assets = Liabilities + Owners’ Equity

Accounts Accounts Barone, Barone,


Cash + Receivable + Equipment = Payable + Capital - Drawing + Revenues - Expenses

1. +10,000 +10,000
2. -5,000 +5,000

3. -400 -400

4. +250 -250

5. +5,100 +5,100
6.

7.

8.

9.

10.

Chapter SO 7 Analyze the effects of business transactions


1-33
on the accounting equation.
Transactions (Problem)

6. Withdrew $1,000 cash for personal use.


Assets = Liabilities + Owners’ Equity

Accounts Accounts Barone, Barone,


Cash + Receivable + Equipment = Payable + Capital - Drawing + Revenues - Expenses

1. +10,000 +10,000
2. -5,000 +5,000

3. -400 -400

4. +250 -250

5. +5,100 +5,100
6. -1,000 -1,000

7.

8.

9.

10.

Chapter SO 7 Analyze the effects of business transactions


1-34
on the accounting equation.
Transactions (Problem)

7. Paid part-time employee salaries of $2,000.


Assets = Liabilities + Owners’ Equity

Accounts Accounts Barone, Barone,


Cash + Receivable + Equipment = Payable + Capital - Drawing + Revenues - Expenses

1. +10,000 +10,000
2. -5,000 +5,000

3. -400 -400

4. +250 -250

5. +5,100 +5,100
6. -1,000 -1,000

7. -2,000 -2,000

8.

9.

10.

Chapter SO 7 Analyze the effects of business transactions


1-35
on the accounting equation.
Transactions (Problem)

8. Paid utility bills $140.


Assets = Liabilities + Owners’ Equity

Accounts Accounts Barone, Barone,


Cash + Receivable + Equipment = Payable + Capital - Drawing + Revenues - Expenses

1. +10,000 +10,000
2. -5,000 +5,000

3. -400 -400

4. +250 -250

5. +5,100 +5,100
6. -1,000 -1,000

7. -2,000 -2,000

8. -140 -140

9.

10.

Chapter SO 7 Analyze the effects of business transactions


1-36
on the accounting equation.
Transactions (Problem)

9. Provided $750 of repair services on account.


Assets = Liabilities + Owners’ Equity

Accounts Accounts Barone, Barone,


Cash + Receivable + Equipment = Payable + Capital - Drawing + Revenues - Expenses

1. +10,000 +10,000
2. -5,000 +5,000

3. -400 -400

4. +250 -250

5. +5,100 +5,100
6. -1,000 -1,000

7. -2,000 -2,000

8. -140 -140

9. +750 +750

10.

Chapter SO 7 Analyze the effects of business transactions


1-37
on the accounting equation.
Transactions (Problem)

10. Collected $120 cash for services previously billed.


Assets = Liabilities + Owners’ Equity

Accounts Accounts Barone, Barone,


Cash + Receivable + Equipment = Payable + Capital - Drawing + Revenues - Expenses

1. +10,000 +10,000
2. -5,000 +5,000

3. -400 -400

4. +250 -250

5. +5,100 +5,100
6. -1,000 -1,000

7. -2,000 -2,000

8. -140 -140

9. +750 +750

10. +120 -120

Chapter
1-38
Transactions (Problem)

10. Collected $120 cash for services previously billed.


Assets = Liabilities + Owners’ Equity

Accounts Accounts Barone, Barone,


Cash + Receivable + Equipment = Payable + Capital - Drawing + Revenues - Expenses

1. +10,000 +10,000
2. -5,000 +5,000

3. -400 -400

4. +250 -250

5. +5,100 +5,100
6. -1,000 -1,000

7. -2,000 -2,000

8. -140 -140

9. +750 +750

10. +120 -120

+6,680 +630 +5,000 = +250 +10,000 -1,000 +5,850 -2,790

Chapter $12,310 $12,310


1-39
Financial Statements

Companies prepare four financial statements from


the summarized accounting data:

Owner’s Statement
Income Balance
Equity of Cash
Statement Sheet
Statement Flows

Chapter
1-40 SO 8 Understand the four financial statements and how they are prepared.
Financial 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
1-41 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements

Income Statement

Barone’s Repair Shop Reports the revenues


Income Statement
For the Month Ended May 31, 2010
and expenses for a
Revenues:
specific period of time.
Service revenue $ 5,850
Expenses: Net income – revenues
Salary expense 2,000 exceed expenses.
Rent expense 400
Utility expense 140
Advertising expense 250
Net loss – expenses
Total expenses 2,790 exceed revenues.
Net income $ 3,060

Chapter
1-42 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements

Income Statement Owner’s Equity Statement

Barone’s Repair Shop Barone’s Repair Shop


Income Statement Owner's Equity Statement
For the Month Ended May 31, 2010 For the Month Ended May 31, 2010

Revenues: Barone's, Capital May 1 $ -


Service revenue $ 5,850 Add: Investment 10,000
Expenses: Net income 3,060
Salary expense 2,000 13,060
Rent expense 400 Less: Drawings 0
Utility expense 140 Barone's, Capital May 31 $13,060
Advertising expense 250
Total expenses 2,790
Net income $ 3,060
Net income is needed to determine
the ending balance in owner’s equity.
Chapter
1-43 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements

Owner’s Equity Statement

Statement indicates the Barone’s Repair Shop


reasons why owner’s Owner's Equity Statement

equity has increased or For the Month Ended May 31, 2010

decreased during the Barone's, Capital May 1


Add: Investment
$ -
10,000
period. Net income 3,060
13,060
Less: Drawings 1,000
Barone's, Capital May 31 $12,060

Chapter
1-44 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements

Balance Sheet Owner’s Equity Statement


Barone’s Repair Shop
Balance Sheet Barone’s Repair Shop
May 31, 2010 Owner's Equity Statement
Assets For the Month Ended May 31, 2010

Cash $ 7,680 Barone's, Capital May 1 $ -


Accounts receivable 630 Add: Investment 10,000
Equipment 5,000 Net income 3,060
Total assets $ 13,310 13,060
Liabilities Less: Drawings 0
Accounts payable $ 250 Barone's, Capital May 31 $ 13,060
Owner's Equity
Barone's, capital 13,060
Total liab. & equity $ 13,310 The ending balance in owner’s equity is
needed in preparing the balance sheet
Chapter
1-45 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements

Balance Sheet
Barone’s Repair Shop Reports the assets,
Balance Sheet liabilities, and owner’s
May 31, 2010
Assets
equity at a specific date.
Cash $ 7,680
Accounts receivable 630 Assets listed at the top,
Equipment 5,000 followed by liabilities
Total assets $ 13,310
Liabilities
and owner’s equity.
Accounts payable $ 250
Owner's Equity Total assets must equal
Barone's, capital 13,060 total liabilities and
Total liab. & equity $ 13,310
owner’s equity.
Chapter
1-46 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements

Balance Sheet Statement of Cash Flows


Barone’s Repair Shop Barone’s Repair Shop
Balance Sheet Statement of Cash Flows
May 31, 2010 For the Month Ended May 31, 2010
Assets Cash flow from operating activities
Cash $ 7,680 Cash receipts from revenues $ 5,220
Accounts receivable 630 Cash paid for expenses (2,540)
Equipment 5,000 Cash provided by operations 2,680
Total assets $ 13,310 Cash flow from investing activitites
Liabilities Purchase of equipment (5,000)
Accounts payable $ 250 Cash flow from financing activities
Owner's Equity Investment by owners 10,000
Barone's, capital 13,060 Cash provided by financing 10,000
Total liab. & equity $ 13,310 Net increase in cash 7,680
Cash balance, May 1 -
Cash balance, May 31 $ 7,680
Chapter
1-47
Financial Statements

Information for a Statement of Cash Flows


specific period of time.
Barone’s Repair Shop
Statement of Cash Flows
Answers the following: For the Month Ended May 31, 2010
Cash flow from operating activities
1. Where did cash come
Cash receipts from revenues $ 5,220
from? Cash paid for expenses (2,540)
Cash provided by operations 2,680
2. What was cash used Cash flow from investing activitites
for? Purchase of equipment (5,000)
Cash flow from financing activities
3. What was the change Investment by owners 10,000
Cash provided by financing 10,000
in the cash balance?
Net increase in cash 7,680
Cash balance, May 1 -
Cash balance, May 31 $ 7,680
Chapter
1-48 SO 8 Understand the four financial statements and how they are prepared.
Chapter
1-49 SO 8 Understand the four financial statements and how they are prepared.
Financial 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
1-50 SO 8 Understand the four financial statements and how they are prepared.
Financial Statements

Discussion Question
Q1-19. “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 page for discussion

Chapter
1-51 SO 8 Understand the four financial statements and how they are prepared.
Accounting Career Opportunities

Public Accounting
Careers in auditing and taxation serving the general public.

Private Accounting
Careers in industry working in cost accounting, budgeting,
accounting information systems, and taxation.

Opportunities in Government
Careers with the IRS, the FBI, the SEC, and in public
colleges and universities.

Forensic Accounting
Careers with insurance companies and law offices to conduct
investigations into theft and fraud.
Chapter
1-52 SO 9 Explain the career opportunities in accounting.