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CHAPTER 1

Accounting: An
Overview and
Analysis
Accounting Principles, Eighth Edition
Chapter
1-1

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 owners equity.

7.

Analyze the effects of business transactions on the


accounting equation.

8.

Understand the four financial statements and how they are


prepared.

Chapter
1-2

Accounting
Accounting in
in Action
Action

What
What is
is
Accounting?
Three
activities
Who uses
accounting
data

Chapter
1-3

The
The Building
Building
Blocks
Blocks of
of
Accounting
Accounting
Ethics in
financial
reporting
Generally
accepted
accounting
principles
Assumptions

The
The Basic
Basic
Accounting
Accounting
Equation
Equation
Assets
Liabilities
Owners
equity

Using
Using the
the
Basic
Basic
Accounting
Accounting
Equation
Equation
Transaction
analysis
Summary of
transactions

Financial
Financial
Statements
Income
statement
Owners
equity
statement
Balance
sheet
Statement of
cash flows

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

LO 1 Explain what accounting is.

What
What is
is Accounting?
Accounting?
Three Activities

Illustration 1-1
Accounting process

The accounting process includes


the bookkeeping function.
Chapter
1-5

LO 1 Explain what accounting is.

Who
Who Uses
Uses Accounting
Accounting Data?
Data?
Internal Users

Management

IRS
Investors

Human
Resources
Finance

Common Questions

Creditors

Marketing
Customers
Chapter
1-6

Labor
Unions

SEC

External
Users

LO 2 Identify the users and uses of accounting.

Who
Who Uses
Uses Accounting
Accounting Data?
Data?
Common Questions Asked
1. Can we afford to give our
employees a pay raise?

User
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
1-7

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.

See notes page for discussion


Chapter
1-8

LO 3 Understand why ethics is a fundamental business concept .

The
The Building
Building Blocks
Blocks of
of Accounting
Accounting
Ethics In Financial Reporting
Standards of conduct by which ones 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.
Chapter
1-9

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:

Chapter
1-10

a.

right or wrong.

b.

honest or dishonest.

c.

fair or not fair.

d.

all of these options.

LO 3 Understand why ethics is a fundamental business concept .

The
The Building
Building Blocks
Blocks of
of Accounting
Accounting
Various users
need financial
information

The accounting profession


has attempted to develop
a set of standards that
are generally accepted
and universally practiced.
Chapter
1-11

Financial Statements
Balance Sheet
Income Statement
Statement of Owners Equity
Statement of Cash Flows
Note Disclosure

Generally Accepted
Accounting
Principles (GAAP)

LO 4 Explain generally accepted accounting principles and the cost principle.

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 (FASB)


http://www.fasb.org/

International Accounting Standards Board


(IASB)
http://www.iasb.org/
Chapter
1-12

LO 4 Explain generally accepted accounting principles and the cost principle.

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
1-13

LO 4 Explain generally accepted accounting principles and the cost principle.

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.
Partnership.

Forms of
Business Ownership

Corporation.
Chapter
1-14

LO 5 Explain the monetary unit assumption


and the economic entity assumption.

Forms
Forms of
of Business
Business Ownership
Ownership
Proprietorship

Chapter
1-15

Partnership

Corporation

Generally owned
by one person.

Owned by two or
more persons.

Often small
service-type
businesses

Often retail and


service-type
businesses

Ownership
divided into
shares of stock

Owner receives
any profits,
suffers any
losses, and is
personally liable
for all debts.

Generally
unlimited
personal liability

Separate legal
entity organized
under state
corporation law
Limited liability

Partnership
agreement
LO 5 Explain the monetary unit assumption
and the economic entity assumption.

Assumptions
Assumptions
Review Question

Combining the activities of Kellogg and General


Mills would violate the

Chapter
1-16

a.

cost principle.

b.

economic entity assumption.

c.

monetary unit assumption.

d.

ethics principle.

LO 5 Explain the monetary unit assumption


and the economic entity assumption.

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

Chapter
1-17

a.

proprietorship.

b.

partnership.

c.

corporation.

d.

sole proprietorship.
LO 5 Explain the monetary unit assumption
and the economic entity assumption.

The
The Basic
Basic Accounting
Accounting Equation
Equation
Assets

Liabilities

Owners
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
1-18

LO 6 State the accounting equation, and define


assets, liabilities, and owners equity.

The
The Basic
Basic Accounting
Accounting Equation
Equation
Assets

Liabilities

Owners
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
1-19

LO 6 State the accounting equation, and define


assets, liabilities, and owners equity.

The
The Basic
Basic Accounting
Accounting Equation
Equation
Assets

Liabilities

Owners
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
1-20

LO 6 State the accounting equation, and define


assets, liabilities, and owners equity.

The
The Basic
Basic Accounting
Accounting Equation
Equation
Assets

Liabilities

Owners
Equity

Provides the underlying framework for recording and


summarizing economic events.
Owners Equity

Ownership claim on total assets.


Referred to as residual equity.

Chapter
1-21

Capital, Drawings, etc. (Proprietorship or


Partnership).

LO 6 State the accounting equation, and define


assets, liabilities, and owners equity.

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
1-22

LO 6 State the accounting equation, and define


assets, liabilities, and owners equity.

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
1-23

LO 6 State the accounting equation, and define


assets, liabilities, and owners equity.

Using
Using The
The Basic
Basic Accounting
Accounting Equation
Equation
Transactions are a businesss 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
1-24

LO 7 Analyze the effects of business transactions


on the accounting equation.

Transactions
Transactions (Question?)
(Question?)
Q1-15: Are the following events recorded in the
accounting records?
Owner
An employee
is hired.

withdraws
cash for
personal use.

Event

Supplies are
purchased
on account.

Criterion

Is the financial position (assets, liabilities, or


owners equity) of the company changed?

Record/
Dont Record
Chapter
1-25

LO 7 Analyze the effects of business transactions


on the accounting equation.

Transactions
Transactions

Discussion Question
Q18. In February 2008, Paula King invested an
additional $10,000 in her business, Kings
Pharmacy, which is organized as a proprietorship.
Kings 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
1-26

LO 7 Analyze the effects of business transactions


on the accounting equation.

Transactions
Transactions (Problem)
(Problem)
P1-1A: Barones 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.

Cash
1. +10,000

Chapter
1-27

Liabilities
Equity
Assets
Accounts
Accounts
Barone,
+ Receivable + Equipment = Payable + Capital
+10,000

Investment

LO 7 Analyze the effects of business transactions


on the accounting equation.

Transactions
Transactions (Problem)
(Problem)
2. Purchased equipment for $5,000 cash.

Cash

Liabilities
Equity
Assets
Accounts
Accounts
Barone,
+ Receivable + Equipment = Payable + Capital

1. +10,000
2.

-5,000

Chapter
1-28

+10,000

Investment

+5,000

LO 7 Analyze the effects of business transactions


on the accounting equation.

Transactions
Transactions (Problem)
(Problem)
3. Paid $400 cash for May office rent.

Cash

Liabilities
Equity
Assets
Accounts
Accounts
Barone,
+ Receivable + Equipment = Payable + Capital

1. +10,000
2.

-5,000

3.

-400

Chapter
1-29

+10,000

Investment

+5,000
-400

Expense

LO 7 Analyze the effects of business transactions


on the accounting equation.

Transactions
Transactions (Problem)
(Problem)
4. Received $5,100 from customers for repair service.

Cash

Liabilities
Equity
Assets
Accounts
Accounts
Barone,
+ Receivable + Equipment = Payable + Capital

1. +10,000
2.

-5,000

3.
4.

-400
+5,100

Chapter
1-30

+10,000

Investment

+5,000
-400
+5,100

Expense
Revenue

LO 7 Analyze the effects of business transactions


on the accounting equation.

Transactions
Transactions (Problem)
(Problem)
5. Withdrew $1,000 cash for personal use.

Cash

Liabilities
Equity
Assets
Accounts
Accounts
Barone,
+ Receivable + Equipment = Payable + Capital

1. +10,000

+10,000

Investment

2.

-5,000

3.
4.

-400
+5,100

-400
+5,100

Expense
Revenue

5.

-1,000

-1,000

Drawings

Chapter
1-31

+5,000

LO 7 Analyze the effects of business transactions


on the accounting equation.

Transactions
Transactions (Problem)
(Problem)
6. Paid part-time employee salaries of $2,000.

Cash

Liabilities
Equity
Assets
Accounts
Accounts
Barone,
+ Receivable + Equipment = Payable + Capital

1. +10,000

+10,000

Investment

2.

-5,000

3.
4.

-400
+5,100

-400
+5,100

Expense
Revenue

5.
6.

-1,000
-2,000

-1,000
-2,000

Drawings
Expense

Chapter
1-32

+5,000

LO 7 Analyze the effects of business transactions


on the accounting equation.

Transactions
Transactions (Problem)
(Problem)
7. Incurred $250 of advertising costs, on account.

Cash

Liabilities
Equity
Assets
Accounts
Accounts
Barone,
+ Receivable + Equipment = Payable + Capital

1. +10,000

+10,000

Investment

2.

-5,000

3.
4.

-400
+5,100

-400
+5,100

Expense
Revenue

5.
6.

-1,000
-2,000

-1,000
-2,000

Drawings
Expense

7.

Chapter
1-33

+5,000

+250

-250

Expense

LO 7 Analyze the effects of business transactions


on the accounting equation.

Transactions
Transactions (Problem)
(Problem)
8. Provided $750 of repair services on account.

Cash

Liabilities
Equity
Assets
Accounts
Accounts
Barone,
+ Receivable + Equipment = Payable + Capital

1. +10,000

+10,000

Investment

2.

-5,000

3.
4.

-400
+5,100

-400
+5,100

Expense
Revenue

5.
6.

-1,000
-2,000

-1,000
-2,000

Drawings
Expense

7.
8.

Chapter
1-34

+5,000

+250
+750

-250
+750

Expense
Revenue

LO 7 Analyze the effects of business transactions


on the accounting equation.

Transactions
Transactions (Problem)
(Problem)
9. Collected $120 cash for services previously billed.

Cash

Liabilities
Equity
Assets
Accounts
Accounts
Barone,
+ Receivable + Equipment = Payable + Capital

1. +10,000

+10,000

Investment

2.

-5,000

3.
4.

-400
+5,100

-400
+5,100

Expense
Revenue

5.
6.

-1,000
-2,000

-1,000
-2,000

Drawings
Expense

7.
8.
9.

+250
+750
+120
6,820 +

Chapter
1-35

+5,000

-120
630 +

5,000 =

250 +

-250
+750

Expense
Revenue

12,200

LO 7 Analyze the effects of business transactions


on the accounting equation.

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

Income
Statement

Chapter
1-36

Owners
Equity
Statement

Balance
Sheet

Statement
of Cash
Flows

LO 8 Understand the four financial statements and how they are prepared.

Financial
Financial Statements
Statements
Review Question

Net income will result during a time period when:

Chapter
1-37

a.

assets exceed liabilities.

b.

assets exceed revenues.

c.

expenses exceed revenues.

d.

revenues exceed expenses.

LO 8 Understand the four financial statements and how they are prepared.

Financial
Financial Statements
Statements
Income Statement
Barones Repair Shop
Income Statement
For the Month Ended May 31, 2007
Revenues:
Service revenue
Expenses:
Salary expense
Rent expense
Advertising expense
Total expenses
Net income

Chapter
1-38

5,850

2,000
400
250
2,650
3,200

Reports the revenues


and expenses for a
specific period of time.
Net income revenues
exceed expenses.
Net loss expenses
exceed revenues.

LO 8 Understand the four financial statements and how they are prepared.

Financial
Financial Statements
Statements
Income Statement

Owners Equity
Statement

Barones Repair Shop

Barones Repair Shop

Income Statement

Owners' Equity Statement

For the Month Ended May 31, 2007

For the Month Ended May 31, 2007

Revenues:
Service revenue
Expenses:
Salary expense
Rent expense
Advertising expense
Total expenses
Net income

5,850

2,000
400
250
2,650
3,200

Barone's, Capital May 1

Add: Investment
Net income

10,000
3,200

Less: Drawings
Barone's, Capital May 31

13,200
1,000
12,200

Net income is needed to determine


the ending balance in owners equity.
Chapter
1-39

LO 8 Understand the four financial statements and how they are prepared.

Financial
Financial Statements
Statements
Owners Equity
Statement
Statement indicates the
reasons why owners
equity has increased or
decreased during the
period.

Barones Repair Shop


Owners' Equity Statement
For the Month Ended May 31, 2007
Barone's, Capital May 1

10,000
3,200
13,200
1,000
12,200

Add: Investment
Net income
Less: Drawings
Barone's, Capital May 31

Chapter
1-40

LO 8 Understand the four financial statements and how they are prepared.

Financial
Financial Statements
Statements
Balance Sheet
Barones Repair Shop

Barones Repair Shop

Balance Sheet

Owners' Equity Statement

May 31, 2007

For the Month Ended May 31, 2007

Assets
Cash
Accounts receivable
Equipment
Total assets

6,820
630
5,000
12,450

Liabilities
Accounts payable
Owners' Equity
Barone's, capital
Total liab. & equity

Chapter
1-41

Owners Equity
Statement

250

Barone's, Capital May 1

Add: Investment
Net income

10,000
3,200
13,200
1,000
$ 12,200

Less: Drawings
Barone's, Capital May 31

12,200
$

12,450

The ending balance in owners equity is


needed in preparing the balance sheet

LO 8 Understand the four financial statements and how they are prepared.

Financial
Financial Statements
Statements
Balance Sheet
Barones Repair Shop
Balance Sheet
May 31, 2007
Assets
Cash
Accounts receivable
Equipment
Total assets

6,820
630
5,000
12,450

250

12,200
12,450

Liabilities
Accounts payable
Owners' Equity
Barone's, capital
Total liab. & equity

Chapter
1-42

Reports the assets,


liabilities, and owners
equity at a specific date.
Assets listed at the top,
followed by liabilities
and owners equity.
Total assets must equal
total liabilities and
owners equity.

LO 8 Understand the four financial statements and how they are prepared.

Financial
Financial Statements
Statements
Balance Sheet

For the Month Ended May 31, 2007

Balance Sheet

Cash flow from Operations

May 31, 2007


Assets
$

6,820

630
5,000
12,450

Liabilities
Accounts payable
Owners' Equity
Barone's, capital
Total liab. & equity

Barones Repair Shop


Statement of Cash Flows

Barones Repair Shop

Cash
Accounts receivable
Equipment
Total assets

Statement of Cash Flows

250

12,200
12,450

Cash receipts from customers


Cash paid for expenses
Cash provided by operations
Cash flow from Investing

5,220
(2,400)
2,820

Purchase of equipment
Cash flow from Financing

(5,000)

Investment by owners
Drawings by owners
Cash provided by financing
Net increase in cash

10,000
(1,000)
9,000
6,820

Cash balance, May 1

6,820

Cash balance, May 31


Chapter
1-43

LO 8 Understand the four financial statements and how they are prepared.

Financial
Financial Statements
Statements
Information for a
specific period of time.
Answers the following:
1. Where did cash come

from?

2. What was cash used

for?

3. What was the change

in the cash balance?

Statement of Cash Flows


Barones Repair Shop
Statement of Cash Flows
For the Month Ended May 31, 2007
Cash flow from Operations
Cash receipts from customers
Cash paid for expenses
Cash provided by operations
Cash flow from Investing

5,220
(2,400)
2,820

Purchase of equipment
Cash flow from Financing

(5,000)

Investment by owners
Drawings by owners
Cash provided by financing
Net increase in cash

10,000
(1,000)
9,000
6,820

Cash balance, May 1


Cash balance, May 31

Chapter
1-44

6,820

LO 8 Understand the four financial statements and how they are prepared.

Financial
Financial Statements
Statements
Review Question

Which of the following financial statements is


prepared as of a specific date?

Chapter
1-45

a.

Balance sheet.

b.

Income statement.

c.

Owner's equity statement.

d.

Statement of cash flows.

LO 8 Understand the four financial statements and how they are prepared.

Financial
Financial Statements
Statements

Discussion Question
Q19. A companys net income appears directly
on the income statement and the owners equity
statement, and it is included indirectly in the
companys balance sheet. Do you agree? Explain.

See notes page for discussion


Chapter
1-46

LO 8 Understand the four financial statements and how they are prepared.

Copyright
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Copyright 2006 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
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Chapter
1-47