Preview of Chapter 1: Financial Accounting

Preview of Chapter 1
Financial Accounting
Ninth Edition
Weygandt Kimmel Kieso
1-1
1 Accounting in Action
Accounting in Action
Learning Objectives
After studying this chapter, you should be able to:
[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.
[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.
1-2
What is Accounting?
Accounting consists of three basic activities—it
 identifies,
 records, and
 communicates
the economic events of an organization to interested users.
1-3 LO 1
What is Accounting?
Illustration 1-1
Three Activities The activities of the

accounting process
The accounting process includes

the bookkeeping function.
1-4 LO 1
Learning Objectives
[1] Explain what accounting is.

1-5
Who Uses Accounting Data
Internal
Users
Illustration 1-2
Questions that internal
users ask
1-6 LO 2
1-7 LO 2
Who Uses Accounting Data
External
Users
Illustration 1-3
Questions that external
users ask
1-8 LO 2
Learning Objectives

1-9
The Building Blocks of Accounting
Ethics In Financial Reporting

United States regulators and lawmakers were very concerned
that the economy would suffer if investors lost confidence in
corporate accounting because of unethical financial reporting.
 Recent financial scandals include: Enron, WorldCom,

HealthSouth, AIG, and others.
 Congress passed Sarbanes-Oxley Act of (SOX).
 Effective financial reporting depends on sound ethical

behavior.
1-10 LO 3
The Building Blocks of Accounting
Ethics In Financial Reporting Illustration 1-4

Steps in analyzing ethics cases
and situations
1-11 LO 3
Ethics in Financial Reporting
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.
1-12 LO 3
1-13 LO 3
Learning Objectives

1-14
Generally Accepted Accounting Principles
Financial Statements
Various users  Balance Sheet
need financial  Income Statement
 Statement of Stockholders’ Equity
information  Statement of Cash Flows
 Note Disclosure
The accounting profession

has attempted to develop a
Generally Accepted
set of standards that are Accounting
generally accepted and Principles (GAAP)
universally practiced.
1-15 LO 4
Generally Accepted Accounting Principles (GAAP) –

Standards that are generally accepted and universally practiced.
These standards indicate how to report economic events.
Standard-setting bodies:
► Financial Accounting Standards
Board (FASB)
► Securities and Exchange Commission
(SEC)
► International Accounting Standards
Board (IASB)
1-16 LO 4
Measurement Principles
Historical Cost Principle (or cost principle) dictates that

companies record assets at their cost.
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).
Selection of which principle to follow

generally relates to trade-offs
between relevance and faithful
representation.
1-17 LO 4
1-18 LO 4
Learning Objectives

[5] Explain the monetary unit assumption and the economic entity
assumption.
1-19
Assumptions
Monetary Unit Assumption requires that companies
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 Business
 Partnership. Ownership
 Corporation.
1-20 LO 5
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.
1-21 LO 5
Indicate whether each of the following statements presented below
is true or false.
1. The three steps in the accounting process are

identification, recording, and communication. True
2. The two most common types of external users are

investors and company officers. False
3. Congress passed the Sarbanes-Oxley Act to reduce

unethical behavior and decrease the likelihood of True
future corporate scandals.
1-22 Advance slide in presentation mode to reveal answers. LO 5

Indicate whether each of the following statements presented below
is true or false.
4. The primary accounting standard-setting body in the

United States is the Financial Accounting Standards True
Board (FASB).
5. The cost principle dictates that companies record

assets at their cost. In later periods, however, the fair False
value of the asset must be used if fair value is higher
than its cost.

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.

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.

1-26 LO 5
Learning Objectives

1-27
The Basic Accounting Equation
Stockholder’s
Assets = Liabilities +
Equity
Provides the underlying framework for recording and

summarizing economic events.
Assets must equal the sum of liabilities and stockholders’

equity.
Claims of creditors (liabilities) must be paid before ownership

claims (stockholders’ equity).
1-28 LO 6
Stockholder’s
Equity
Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Supplies, Equipment, etc.
1-29 LO 6
Stockholder’s
Equity
Liabilities
 Claims against assets (debts and obligations).
 Creditors - party to whom money is owed.
 Accounts payable, Notes payable, etc.
1-30 LO 6
Stockholder’s
Equity
Stockholders’ Equity
 Ownership claim on total assets.
 Referred to as residual equity.
 Common stock and retained earnings.
1-31 LO 6
Illustration 1-6
Investments by stockholders represent the total amount paid in by

stockholders for the shares they purchase.
1-32 LO 6
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.
1-33 LO 6
Illustration 1-6
Dividends are the distribution of cash or other assets to stockholders.

Dividends reduce retained earnings. However, dividends are not an
expense.
1-34 LO 6
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.
1-35 LO 6
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 Equity Decrease
4. Salaries and Wages

Expense Decrease
expense
Learning Objectives

[7] Analyze the effects of business transactions on the accounting
equation.
1-37
Using the 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.
1-38 LO 7
Illustration: Are the following events recorded in the accounting

records?
Illustration 1-7
Discuss product
Purchase
Event design with Pay rent.
computer.
potential customer.
Criterion Is the financial position (assets, liabilities, or

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

Illustration 1-8
Expanded accounting equation
1-40 LO 7
Transaction Analysis
Transaction (1). Investment by Stockholders. Ray and Barbara
Neal decides to open a computer programming service which he
names Softbyte. On September 1, 2015, they invest $15,000 cash
in exchange for common stock. Illustration 1-9

Transaction (2). Purchase of Equipment for Cash. Softbyte
purchases computer equipment for $7,000 cash.
Illustration 1-9
1-42
LO 7
Transaction (3). Purchase of Supplies on Credit. Softbyte
purchases for $1,600 from Acme Supply Company computer paper
and other supplies expected to last several months.
Illustration 1-9
1-43
LO 7
Transaction (4). Services Provided for Cash. Softbyte receives
$1,200 cash from customers for programming services it has
provided.
Illustration 1-9
1-44
LO 7
Transaction (5). Purchase of Advertising on Credit. Softbyte
receives a bill for $250 from the Daily News for advertising but
postpones payment until a later date.
Illustration 1-9
1-45
LO 7
Transaction (6). Services Provided for Cash and Credit. Softbyte
provides $3,500 of programming services for customers. The
company receives cash of $1,500 from customers, and it bills the
balance of $2,000 on account. Illustration 1-9
1-46
LO 7
Transaction (7). Payment of Expenses. Softbyte pays the
following expenses in cash for September: store rent $600, salaries
and wages of employees $900, and utilities $200.
Illustration 1-9
1-47
LO 7
Transaction (8). Payment of Accounts Payable. Softbyte pays its
$250 Daily News bill in cash.
Illustration 1-9
1-48
LO 7
Transaction (9). Receipt of Cash on Account. Softbyte receives
$600 in cash from customers who had been billed for services [in
Transaction (6)].
Illustration 1-9
1-49
LO 7
Transaction (10). Dividends. The corporation pays a dividend of
$1,300 in cash.
Illustration 1-9
1-50
LO 7
Learning Objectives

1-51
Companies prepare four financial statements :
Retained Statement
Income Balance
Earnings of Cash
Statement Sheet
Statement Flows
1-52 LO 8
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.

Net income is needed to determine the
Financial Statements ending balance in retained earnings.
Illustration 1-10
Financial statements and
their interrelationships
1-54 LO 8
The ending balance in retained earnings
Financial Statements is needed in preparing the balance sheet.
Illustration 1-10
1-55 LO 8
Balance sheet and income statement are
Financial Statements needed to prepare statement of cash flows.
Illustration 1-10
1-56 LO 8
Income Statement
 Reports the profitability of the company’s operations over
a specific period of time.
 Lists revenues first, followed by expenses.
 Shows net income (or net loss).
1-57 LO 8
Retained Earnings Statement

 Reports the changes in retained earnings for a specific
period of time.
 The time period is the same as that covered by the

income statement.
1-58 LO 8
Balance Sheet
 Reports the assets, liabilities, and stockholders’ equity at
a specific date.
 Lists assets at the top, followed by liabilities and

stockholder’s equity.
 Total assets must equal total liabilities and stockholder’s

equity.
 Is a snapshot of the company’s financial condition at a

specific moment in time (usually the month-end or year-
end).
1-59 LO 8
Statement of Cash Flows

 Information on the cash receipts and
payments 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?
1-60 LO 8
Question
Which of the following financial statements is prepared as of
a specific date?
a. Balance sheet.
b. Income statement.
c. Retained earnings statement.
d. Statement of cash flows.
1-61 LO 8
1-62 LO 8
APPENDIX 1A Accounting Career Opportunities
Public Accounting Private Accounting

Careers in auditing, taxation, Careers in industry working in
and management consulting cost accounting, budgeting,
serving the general public. accounting information
systems, and taxation.
Governmental Accounting Forensic Accounting

Careers with the IRS, the FBI, Uses accounting, auditing, and
the SEC, and in public investigative skills to conduct
colleges and universities. investigations into theft and
fraud.
1-63 LO 9 Explain the career opportunities in accounting.

APPENDIX 1A Accounting Career Opportunities
“Show Me the Money”

Salary estimates for jobs in public and corporate accounting Illustration 1A-1
Upper-level management salaries in corporate accounting Illustration 1A-2
1-64 LO 9
Key Points
 International standards are referred to as International Financial
Reporting Standards (IFRS), developed by the International
Accounting Standards Board (IASB).
 Much of the world has voted for the standards issued by the IASB.
Over 115 countries require or permit use of IFRS.
 The fact that there are differences between what is in this textbook
(which is based on U.S. standards) and IFRS should not be surprising
because the FASB and IASB have responded to different user
needs.
1-65 LO 10
Key Points
 Debate about international companies (non-U.S.) adopting SOX-type
standards centers on whether the benefits exceed the costs. The
concern is that the higher costs of SOX compliance are making the
U.S. securities markets less competitive.
 The textbook mentions a number of ethics violations, such as Enron,
WorldCom, and AIG. These problems have also occurred
internationally, for example, at Satyam Computer Services (India),
Parmalat (Italy), and Royal Ahold (the Netherlands).
1-66 LO 10
Key Points
 IFRS tends to be simpler in its accounting and disclosure
requirements; some people say more “principles-based.” GAAP is
more detailed; some people say it is more “rules-based.”
 U.S. regulators have recently eliminated the need for foreign
companies that trade shares in U.S. markets to reconcile their
accounting with GAAP.
 Because the choice of business organization is influenced by factors
such as legal environment, tax rates and regulations, and degree of
entrepreneurism, the relative use of each form will vary across
countries.
 The conceptual framework that underlies IFRS is very similar to that
used to develop GAAP.
1-67 LO 10
Key Points
 The more substantive definitions, using the IASB definitional
structure, are as follows.
► Assets. A resource controlled by the entity as a result of past
events and from which future economic benefits are expected to
flow to the entity.
► Liabilities. A present obligation of the entity arising from past
events, the settlement of which is expected to result in an
outflow from the entity of resources embodying economic
benefits. Liabilities may be legally enforceable via a contract or
law, but need not be, i.e., they can arise due to normal business
practice or customs.
1-68 LO 10
Key Points
 The more substantive definitions, using the IASB definitional
structure, are as follows.
► Equity. A residual interest in the assets of the entity after
deducting all its liabilities.
► Income. Increases in economic benefits that result in increases
in equity (other than those related to contributions from
shareholders). Income includes both revenues (resulting from
ordinary activities) and gains.
► Expenses. Decreases in economic benefits that result in
decreases in equity (other than those related to distributions to
shareholders). Expenses includes losses that are not the result
of ordinary activities.
1-69 LO 10
Looking to the Future
Both the IASB and the FASB are hard at work developing standards that will
lead to the elimination of major differences in the way certain transactions
are accounted for and reported. In fact, at one time the IASB stated that no
new major standards would become effective until 2011. The major reason
for this policy was to provide companies the time to translate and implement
IFRS into practice, as much has happened in a very short period of time.
1-70 LO 10
A Look at IFRS
IFRS Practice
Which of the following is not a reason why a single set of high-
quality international accounting standards would be beneficial?
a) Mergers and acquisition activity.
b) Financial markets.
c) Multinational corporations.
d) GAAP is widely considered to be a superior reporting system.
1-71 LO 10
A Look at IFRS
IFRS Practice
The Sarbanes-Oxley Act determines:
a) international tax regulations.
b) internal control standards as enforced by the IASB.
c) internal control standards of U.S. publicly traded companies.
d) U.S. tax regulations.
1-72 LO 10
A Look at IFRS
IFRS Practice
IFRS is considered to be more:
a) principles-based and less rules-based than GAAP.
b) rules-based and less principles-based than GAAP.
c) detailed than GAAP.
d) None of the above.
1-73 LO 10
Copyright
“Copyright © 2013 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser may
make back-up copies for his/her own use only and not for distribution
or resale. The Publisher assumes no responsibility for errors,
omissions, or damages, caused by the use of these programs or from
the use of the information contained herein.”
1-74

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[1] Explain what accounting is

Accounting consists of three basic activities—it

the economic events of an organization to interested users.

Three Activities The activities of the

The accounting process includes

[1] Explain what accounting is.

[1] Explain what accounting is.

Ethics In Financial Reporting

 Recent financial scandals include: Enron, WorldCom,

 Congress passed Sarbanes-Oxley Act of (SOX).

 Effective financial reporting depends on sound ethical

Ethics In Financial Reporting Illustration 1-4

c. fair or not fair.

d. all of these options.

[1] Explain what accounting is.

The accounting profession

Generally Accepted Accounting Principles (GAAP) –

Historical Cost Principle (or cost principle) dictates that

Fair Value Principle states that assets and liabilities should

Selection of which principle to follow

[1] Explain what accounting is.

Economic Entity Assumption requires that activities of the

Proprietorship Partnership Corporation

 Generally owned  Owned by two or  Ownership

1. The three steps in the accounting process are

2. The two most common types of external users are

3. Congress passed the Sarbanes-Oxley Act to reduce

1-22 Advance slide in presentation mode to reveal answers. LO 5

4. The primary accounting standard-setting body in the

5. The cost principle dictates that companies record

1-23 Advance slide in presentation mode to reveal answers. LO 5

b. economic entity assumption.

c. monetary unit assumption.

1-24 Advance slide in presentation mode to reveal answers. LO 5

A business organized as a separate legal entity under state law

1-25 Advance slide in presentation mode to reveal answers. LO 5

[1] Explain what accounting is.

Provides the underlying framework for recording and

Assets must equal the sum of liabilities and stockholders’

Claims of creditors (liabilities) must be paid before ownership

Investments by stockholders represent the total amount paid in by

Dividends are the distribution of cash or other assets to stockholders.

Expenses are the cost of assets consumed or services used in the

Classification Effect on Equity

1. Rent Expense Expense Decrease

2. Service Revenue Revenue Increase

3. Dividends Equity Decrease

4. Salaries and Wages

[1] Explain what accounting is.

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

Illustration: Are the following events recorded in the accounting

Criterion Is the financial position (assets, liabilities, or

1-39 Advance slide in presentation mode to reveal answers. LO 7

1-41 Advance slide in presentation mode to reveal answers. LO 7

[1] Explain what accounting is.

Companies prepare four financial statements :

a. assets exceed liabilities.

b. assets exceed revenues.

c. expenses exceed revenues.