Basic Accounting

CHAPTER 1
ACCOUNTING IN
ACTION
Chapter
1-1
History of Accounting
Ancient history :
o Accountancy is a very old concept. Its inception was
during the age of human agriculture and civilization.
(the Sumerians* in Mesopotamia, and the Egyptian Old
Kingdom) Ancient economic thinking facilitated the
creation of accurate records of the quantities and
relative values of agricultural products, methods that
were formalized in trading and monetary systems by
2000 BC.
* (late 6th millennium BC to 4th millennium
BC))
Chapter
1-2
Painting of Luca Pacioli (The father of Accounting)
Chapter
1-3
 Luca Pacioli (1445 - 1517), also known as Friar Luca dal
Borgo, is credited for the "birth" of accounting.
His Summa de arithmetica, geometrica, proportioni et
proportionalita (Summa on arithmetic, geometry,
proportions and proportionality, Venice 1494), was a
textbook for use in the abbaco schools of northern Italy,
where the sons of merchants and craftsmen were
educated.
Chapter
1-4
 It includes the first printed description of the method of
keeping accounts that merchants used at that time,
known as the double-entry accounting system.
 Pacioli actually codified rather than invented this system.

As The system he published included most of the
accounting cycle as we know it today, so he is widely
regarded as the "Father of Accounting".
 He described the use of journals and ledgers, and

warned that a person should not go to sleep at night until
the debits equal the credits!
Chapter
1-5
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 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
1-6
Accounting in Action
The Building The Basic Using

What is Basic Financial
the Blocks of Accounting
Accounting? Accounting Statements
Accounting Equation Equation
Three Ethics in Assets Transaction Income

activities financial Liabilities analysis statement
Who uses Owner’s Summary of Owner’s
accounting reporting equity
equity
data Generally transactions statement
accepted Balance
accounting sheet
principles
Statement of
Assumptio cash flows
ns
Chapter
1-7
What is Accounting?
Three Activities
Illustration 1-1
Accounting process
The accounting process includes

the bookkeeping function.
Chapter
1-8 LO 1 Explain what accounting is.
Who Uses Accounting Data?
Internal Users
Management
Human Resources Investors
There are two broad

groups of users of Labor Unions
Finance
financial information:
internal users and
external users.
Creditors
Marketing
SEC
Customers External
Users
Chapter
1-9 LO 2 Identify the users and uses of accounting.
Who Uses Accounting Data?
Common Questions Asked User
1. Can we afford to give our

Human Resources
employees a pay raise?
2. Did the company earn a
Investors
satisfactory income?
3. Do we need to borrow in the
Management
near future?
4. Is cash sufficient to pay
Finance
dividends to the stockholders?
5. What price for our product
Marketing
will maximize net income?
6. Will the company be able to
Creditors
pay its short-term debts?
Chapter
1-10 LO 2 Identify the users and uses of accounting.
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.
Effective financial reporting depends on sound

ethical behavior.
LO 3 Understand why ethics is a fundamental business concept.

Chapter
1-11
GAAP
 The common set of accounting principles,
standards and procedures that companies use
to compile their financial statements. GAAP
are a combination of authoritative standards
(set by policy boards) and simply the
commonly accepted ways of recording and
reporting accounting information.
Source: [http://www.investopedia.com/terms/g/gaap.asp]
Chapter
1-12
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 LO 4 Explain generally accepted accounting principles and the cost principle.
FASB
 Since 1973 the FASB has been the
organization designated to establish
authoritative financial accounting and
reporting standards (Statements of Financial
Accounting Standards, SFAS) for business
and other private-sector entities. Its mission
is to be responsive to the entire economic
community and to operate in full view of the
entire community through a due-process
system.
Chapter
1-14
IASB
 Formed in January 2001. IASB is structured similarly
to the FASB. It is currently the focus of the IASB,
in collaboration with the FASB and other accounting
focused organizations, to "meet" standards and
develop a single, universally accepted set of biding
international accounting standards. The IASC, and
now IASB, issue a series of standards known as
International Financial Reporting Standards (IFRS),
formerly called International Accounting Standards
(IAS).
Chapter
1-15
Financial Statements
Various users Balance Sheet
need Income Statement
Statement of Owner’s Equity
financial Statement of Cash Flows
information Note Disclosure
The accounting profession

has attempted to develop
Generally Accepted
a set of standards that Accounting Principles
are generally accepted (GAAP)
and universally practiced.
Chapter
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.
e.g. XYZ corp. purchased a car for $200,000 in the year of 2006. But, the car’s
current market price is $150,000. Still, the historic cost principle says
that the book value (recorded value) of the asset should portray the
historic cost meaning $200,000 for the car.
Chapter
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
Corporation. Business Ownership
Chapter LO 5 Explain the monetary unit assumption

1-18
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 LO 5 Explain the monetary unit assumption
1-19
and the economic entity assumption.
The Basic Accounting Equation
Owner’s Equity
Assets = Liabilities +
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 define

1-20
assets, liabilities, and owner’s equity.
Owner’s Equity

economic events.
Assets
Resources a business owns.

Provide future services or benefits.
Cash, Supplies, Equipment, inventory, Car, trucks, machines, etc.

1-21
Owner’s Equity

economic events.
Liabilities
Claims against assets (debts and obligations).

Creditors - party to whom money is owed.
Accounts payable, Notes payable, etc.

1-22
Owner’s Equity

economic events.
Owner’s Equity
Ownership claim on total assets.

Referred to as residual equity.
Capital, Drawings, etc.
(Proprietorship or Partnership).

1-23
Owners’ 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.

1-24
Owners’ 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.

1-25
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 LO 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 cash for
purchased is hired.
for cash. personal use.
Criterion Is the financial position (assets, liabilities, or

owner’s equity) of the company changed?
Record/ Don’t
Record

1-27
Accrual Basis Accounting – An intro
Accrual Basis accounting is one of the most important accounting

concept that is being followed by most of the organizations. As per the
“Matching principle” it is binding that the revenues and the expenses of
any specific period must be reported in that period. So, sometimes
this very criterion pushes the firms to follow the accrual basis
accounting.
Chapter
1-28
Accounts Payable
 To run the business sometimes it is required to purchase
several products or to receive services on credit. This is
an obligation that the company needs to pay and these
obligations are called as Accounts Payables.
 In a similar manner if any company borrows any amount
of money with formal instruments as proof of debt, then it
is an obligation that is needed to be paid. Then it is
called Notes Payable.
 All these PAYABLES are LIABILITIES.
Chapter
1-29
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?

1-30
Answer
 Question 18 (Chapter 1) No, this treatment is not
proper. While the transactions does involve a receipt
of cash, it does not represent revenues. Revenues are
the gross increase in owner’s equity resulting from
business activities entered into for the purpose of
earning income. This transactions is simply an
additional investment made by the owner in the
business.
Chapter
1-31
Transactions (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
Accounts
Liabilities Barone,
Equity
Cash Accounts + Capital
+ Receivable + Equipment = Payable
1. +10,000 +10,000 Investment

1-32
2. Purchased equipment for $5,000 cash.
Assets Equity
Accounts Barone,
Cash Accounts
Liabilities + Capital
1. +10,000 +10,000 Investment
2. - +5,000
5,000

1-33
3. Paid $400 cash for May office rent.
Assets Equity
Accounts Barone,
Cash Accounts
Liabilities + Capital
1. +10,000 +10,000 Investment
2. - +5,000
5,000 -400 Expense
3. -400

1-34
4. Received $5,100 from customers for repair service.
Assets LiabilitiesEquity Accounts Accounts
Cash Barone,
+ Equipment Payable
+ Receivable = + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue

1-35
5. Withdrew $1,000 cash for personal use.
Assets Equity
Barone,
Cash Liabilities +
+ Receivable Equipment = Payable + Capital
Accounts
1. +10,000 +10,000 Investment
2. -5,000 Accounts +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings

1-36
6. Paid part-time employee salaries of $2,000.
Assets Equity
Barone,
Cash Liabilities +
+ Receivable Equipment = Payable + Capital
Accounts
1. +10,000 +10,000 Investment
2. -5,000 Accounts +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense

1-37
7. Incurred $250 of advertising costs, on account.
Cash Barone, Equipment = Payable

+
+ Receivable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense
7. +250 -250 Expense

1-38
Receivables
 The term receivables refers to amount due from
individuals and other companies. Receivables are
claims that are expected to be collected in cash.
Examples can be 1) Accounts receivables, 2)
Notes Receivables , etc.
1) Accounts receivables: Amount owed by customers
on account. They result from sale of goods and
services. Companies generally expects to collect these
receivables within 30 to 60 days.
2) Notes receivables: Claims for which formal instrument
of credit are issued as proof of debt. It requires the
debtor to pay interest.
All these Receivables are ASSETS.
Chapter
1-39
8. Provided $750 of repair services on account.
Assets Equity
Barone,
Cash Equipment = Payable
+
Liabilities
+ Receivable + Capital
Accounts
1. +10,000 +10,000 Investment
2. -5,000 Accounts +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense
7. +250 -250 Expense
8. +750 +750 Revenue

1-40
9. Collected $120 cash for services previously billed.
Cash Barone,
+ Equipment Payable
+ Receivable = + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense
7. +250 -250 Expense
8. +750 +750 Revenue
9. +120 -
120
6,820 + 630 + 5,000 = 250 + 12,200
1-41
List of Transactions for the months of December 2005
& January 2006
1. Marie Collins invested $100,000 of her own money
into her new pet shop on December 01, 2005. The
store will be named “Love thy Pet.”
2. On January 1, 2006, Marie paid $1,350 rent on the pet
shop which is the rent of December.
3. For January 2, 2006, Marie borrowed $50,000 by
signing a 4-month, 10% note payable.
4. For January 5, 2006, Marie purchased pet store
equipment for $7,500 in cash.
5. For January 6, 2006, Marie hired two salespeople to
begin work on the 9th of January in the store for a bi-
weekly wage of $800 each.
6. For January 8, 2006, Marie receives a cash advance
of $1,200 from a customer for an Irish sheep dog that
will not arrive from the breeder until March 7, 2006.
Chapter
1-42
List of Transactions for the months of December
2005 & January 2006
7. For January 10, 2006, Marie received $5,500
in cash for two bulldogs sold to a customer.
8. For January 14, 2006, Marie purchased 2-
months of pet supplies on account at a cost of
$500 from Morrison pet supply store.
9. For January 15, 2006, Marie declared and paid a
dividend to stockholders of $400.
10. For January 31, 2006 Marie purchased a 2-year
insurance policy costing $2,400 that will expire
on January 31 of 2008.
11. For January 31, 2006, Marie paid the
salespersons bi-weekly wages.
Chapter
1-43
Marie Collins invested $100,000 of her own
money into her new pet shop on January
1, 2006. The store will be named “Love
thy
Pet.”
Chapte
r1
-44
On January 1, 2006, Marie paid $1,350 rent
on the pet shop. (For December last year)
Chapter
1-45
For January 2, 2006, Marie borrowed
$50,000 by signing a 4-month, 10% note
payable.
Chapter
1-46
For January 5, 2006, Marie purchased
pet store equipment for $7,500 in cash.
Chapter
1-47
For January 6, 2006, Marie hired two salespeople
to begin work on the 9th of January in the shop for
a bi-weekly wage of $800 each.
This was not a transaction; therefore, it requires no journal

entries because assets were not exchanged at the time of
this event.
Chapte
r
1-48
For January 8, 2006, Marie receives a cash
advance of $1,200 from a customer for an Irish
sheep dog that will not arrive from the breeder
until March 7, 2006.
Chapter
1-49
For January 10, 2006, Marie received $5,500
in cash for two bulldogs sold to a customer.
Chapter
1-50
For January 14, 2006, Marie purchased 2-
months of pet supplies on account from
Morrison pet supply store for $500.
Chapter
1-51
For January 15,2006, Marie declared and
paid a dividend to stockholders of $400.
Chapter
1-52
For January 31, 2006 Marie purchased a 2-
year insurance policy costing $2,400 that
will expire on
January 31 of 2008.
Chapter
1-53
For January 31, 2006, Marie paid the
salespeople their bi-weekly wages.
Chapter
1-54
Chapter
1-55
Companies prepare four financial statements from the summarized

accounting data:
Owner’s
Income Statement of
Equity Balance Sheet
Statement Cash Flows
Statement
Chapter
1-56 LO 8 Understand the four financial statements and how they are prepared.
Income Statement
Barone’s Repair Shop Reports the revenues and
Income Statement expenses for a specific period of
For the Month Ended May 31, time.
2008
Revenues: Net income – revenues exceed

Service revenue $ 5,850
expenses.
Expenses:
Salary expense 2,000 Net loss – expenses exceed
Rent expense 400 revenues.
Advertising expense
250 Total expenses
2,650
Net income $ 3,200
Chapter
Owner’s Equity
Income Statement Statement
Barone’s Repair Shop Barone’s Repair Shop
Income Statement Owner's Equity Statement
For the Month Ended May 31, For the Month Ended May 31,
2008 2008
Barone's, Capital May 1 $
Revenues:
Service revenue $ 5,850 Add: Investment -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
Owner’s Equity
Statement
Statement indicates the reasons Barone’s Repair Shop
why owner’s equity has Owner's Equity
increased or decreased during Statement
the period. For the Month Ended May 31,
Barone's, Capital2008
May $ -
1 10,000
Add: Investment 3,200
Net income 13,200
Less: Drawings 1,000
Barone's, Capital May $12,200
31
Chapter
Owners’ Equity
Balance Sheet Statement
Barone’s Repair Shop
Balance Sheet
Owner's Equity Statement
May 31, 2008
For the Month Ended May 31,
Assets 2008
Cash $ 6,820 Barone's, Capital May 1 $ -
Accounts receivable 630 Add: Investment 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
Owner's 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
Balance Sheet
Reports the assets, liabilities,
and owner’s equity at a specific
Balance Sheet
date.
May 31, 2008
Assets Assets listed at the top,
Cash $ 6,820 followed
Accounts receivable 630 by liabilities and owner’s
Equipment 5,000 equity.
Total assets $12,450
Liabilities
Total assets must equal total
Accounts payable $ 250
liabilities and owner’s
Owner's Equity equity.
Barone's, capital 12,200
Total liab. & equity $12,450
Chapter
Statement of Cash Flows
Balance Sheet Barone’s Repair Shop
For the Month Ended May 31,
Balance Sheet 2008
Cash flow from operating activities
May 31, 2008
Cash receipts from revenues $ 5,220
Cash paid for expenses (2,400)
Assets
Cash $ 6,820 Cash provided by operations 2,820
Accounts receivable 630 Cash flow from investing activitites
Equipment 5,000 Purchase of equipment
Total assets $12,450 (5,000)
Cash flow from financing activities
Liabilities Investment by owners 10,000
Accounts payable $ 250 Drawings by owners (1,000)
Owner's Equity Cash provided by 9,000
Barone's, capital 12,200 financing 6,820
Total liab. & equity $12,450 Net increase in cash -
Cash balance, May $ 6,820
Chapter 1
1-62 LO 8 Understand the four financial statements
Cash and how they are prepared.
balance, May
Information for a specific Statement of Cash Flows
period of time. Barone’s Repair Shop
Answers the following: For the Month Ended May 31, 2008
Cash flow from operating activities
Cash receipts from customers $5,220
1. Where did cash come Cash paid for expenses (2,400)
from? Cash provided by operations 2,820
Cash flow from investing activities
2. What was cash used Purchase of equipment
(5,000)
Cash flow from financing activities
for? Investment by owners 10,000
Drawings by owners (1,000)
3. What was the change Cash provided by 9,000
in the cash balance? financing 6,820
Net increase in cash -
Cash balance, May $6,820
Chapter 1
1-63 LO 8 Understand the four financial Cash
statements
balance,and how they are prepared.
May
End of the Chapter!
Chapter
1-64

Basic Accounting

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CHAPTER 1

 Pacioli actually codified rather than invented this system.

 He described the use of journals and ledgers, and

The Building The Basic Using

Three Ethics in Assets Transaction Income

The accounting process includes

Human Resources Investors

There are two broad

1. Can we afford to give our

Ethics In Financial Reporting

Recent financial scandals include: Enron,

Effective financial reporting depends on sound

LO 3 Understand why ethics is a fundamental business concept.

Organizations Involved in Standard Setting:

Securities and Exchange Commission (SEC)

Financial Accounting Standards Board (FASB)

International Accounting Standards Board

The accounting profession

Cost Principle (Historical) – dictates that companies record

Monetary Unit Assumption – include in the accounting

Economic Entity Assumption – requires that activities of

Chapter LO 5 Explain the monetary unit assumption

Proprietorship Partnership Corporation

Generally owned Owned by two or Ownership

Provides the underlying framework for recording and summarizing

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 define

Provides the underlying framework for recording and summarizing

Resources a business owns.

Chapter LO 6 State the accounting equation, and define

Provides the underlying framework for recording and summarizing

Claims against assets (debts and obligations).

Chapter LO 6 State the accounting equation, and define

Provides the underlying framework for recording and summarizing

Ownership claim on total assets.

Chapter LO 6 State the accounting equation, and define

Chapter LO 6 State the accounting equation, and define

Chapter LO 6 State the accounting equation, and define

Transactions are a business’s economic events recorded

May be external or internal.

Not all activities represent transactions.

Each transaction has a dual effect on the accounting

Chapter LO 7 Analyze the effects of business transactions

Criterion Is the financial position (assets, liabilities, or

Chapter LO 7 Analyze the effects of business transactions

Accrual Basis accounting is one of the most important accounting

 All these PAYABLES are LIABILITIES.

Chapter LO 7 Analyze the effects of business transactions

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

Chapter LO 7 Analyze the effects of business transactions

Chapter LO 7 Analyze the effects of business transactions

Chapter LO 7 Analyze the effects of business transactions

Assets LiabilitiesEquity Accounts Accounts

Chapter LO 7 Analyze the effects of business transactions

Chapter LO 7 Analyze the effects of business transactions

Chapter LO 7 Analyze the effects of business transactions

Assets LiabilitiesEquity Accounts Accounts

Cash Barone, Equipment = Payable

Chapter LO 7 Analyze the effects of business transactions

Chapter LO 7 Analyze the effects of business transactions

Assets LiabilitiesEquity Accounts Accounts

This was not a transaction; therefore, it requires no journal