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CHAPTER 1

Accounting: An Overview and Analysis


Accounting Principles, Eighth Edition
Chapter 1-1

Study Objectives
1. 2. 3. 4. 5. 6. 7. 8.
Chapter 1-2

Explain what accounting is. Identify the users and uses of accounting. Understand why ethics is a fundamental business concept. Explain generally accepted accounting principles and the cost principle. Explain the monetary unit assumption and the economic entity assumption. State the accounting equation, and define assets, liabilities, and owners equity. Analyze the effects of business transactions on the accounting equation. Understand the four financial statements and how they are prepared.

Accounting in Action

What is Accounting?

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

The Basic Accounting Equation Assets Liabilities Owners equity

Using the Basic Accounting Equation Transaction analysis Summary of transactions

Financial Statements

Three activities Who uses accounting data

Income statement Owners equity statement Balance sheet

Assumptions

Statement of cash flows

Chapter 1-3

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 1-4

LO 1 Explain what accounting is.

What is 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 Uses Accounting Data?


Internal Users Management IRS

Human Resources
Finance

Investors
Labor Unions Creditors Customers SEC External Users

Common Questions

Marketing

Chapter 1-6

LO 2 Identify the users and uses of accounting.

Who Uses Accounting Data?


Common Questions Asked
1. Can we afford to give our employees a pay raise? 2. Did the company earn a satisfactory income? 3. Do we need to borrow in the near future? 4. Is cash sufficient to pay dividends to the stockholders? 5. What price for our product will maximize net income? 6. Will the company be able to pay its short-term debts?
Chapter 1-7

User

Human Resources
Investors

Management
Finance

Marketing
Creditors

LO 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


Chapter 1-8

LO 3 Understand why ethics is a fundamental business concept.

The Building Blocks of 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

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.

Chapter 1-10

LO 3 Understand why ethics is a fundamental business concept.

The Building Blocks of Accounting


Various users need financial information Financial Statements
Balance Sheet Income Statement Statement of Owners Equity Statement of Cash Flows Note Disclosure

The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced.

Generally Accepted Accounting Principles (GAAP)

Chapter 1-11

LO 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 1-12

LO 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 1-13

LO 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.

Partnership.
Corporation.
Chapter 1-14

Forms of Business Ownership


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

Forms of Business Ownership


Proprietorship
Generally owned by one person. Often small service-type businesses Owner receives any profits, suffers any losses, and is personally liable for all debts.
Chapter 1-15

Partnership
Owned by two or more persons. Often retail and service-type businesses

Corporation
Ownership divided into shares of stock Separate legal entity organized under state corporation law Limited liability

Generally unlimited personal liability


Partnership agreement

LO 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 1-16

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

Chapter 1-17

The Basic Accounting 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 Basic Accounting 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 Basic Accounting 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 Basic Accounting 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.


Capital, Drawings, etc. (Proprietorship or Partnership).
LO 6 State the accounting equation, and define assets, liabilities, and owners equity.

Chapter 1-21

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.
Chapter 1-22

LO 6 State the accounting equation, and define assets, liabilities, and owners equity.

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.
Chapter 1-23

LO 6 State the accounting equation, and define assets, liabilities, and owners equity.

Using The Basic Accounting 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 (Question?)
Q1-15: Are the following events recorded in the accounting records? Owner Event
Supplies are purchased on account. An employee is hired.

withdraws cash for personal use.

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

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

1. +10,000

+10,000

Investment

Chapter 1-27

LO 7 Analyze the effects of business transactions on the accounting equation.

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

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

Accounts Accounts Barone, + Receivable + Equipment = Payable + Capital

+10,000
+5,000

Investment

Chapter 1-28

LO 7 Analyze the effects of business transactions on the accounting equation.

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

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

Accounts Accounts Barone, + Receivable + Equipment = Payable + Capital

+10,000
+5,000

Investment

3.

-400

-400

Expense

Chapter 1-29

LO 7 Analyze the effects of business transactions on the accounting equation.

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

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

Accounts Accounts Barone, + Receivable + Equipment = Payable + Capital

+10,000
+5,000

Investment

3. 4.

-400 +5,100

-400 +5,100

Expense Revenue

Chapter 1-30

LO 7 Analyze the effects of business transactions on the accounting equation.

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

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

Accounts Accounts Barone, + Receivable + Equipment = Payable + Capital

+10,000
+5,000

Investment

3. 4.
5.

-400 +5,100
-1,000

-400 +5,100
-1,000

Expense Revenue
Drawings

Chapter 1-31

LO 7 Analyze the effects of business transactions on the accounting equation.

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

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

Accounts Accounts Barone, + Receivable + Equipment = Payable + Capital

+10,000
+5,000

Investment

3. 4.

-400 +5,100

-400 +5,100
-1,000 -2,000

Expense Revenue
Drawings Expense

5. -1,000 6. -2,000

Chapter 1-32

LO 7 Analyze the effects of business transactions on the accounting equation.

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

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

Accounts Accounts Barone, + Receivable + Equipment = Payable + Capital

+10,000
+5,000

Investment

3. 4.

-400 +5,100

-400 +5,100
-1,000 -2,000 +250 -250

Expense Revenue
Drawings Expense

5. -1,000 6. -2,000 7.

Expense

Chapter 1-33

LO 7 Analyze the effects of business transactions on the accounting equation.

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

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

Accounts Accounts Barone, + Receivable + Equipment = Payable + Capital

+10,000
+5,000

Investment

3. 4.

-400 +5,100

-400 +5,100
-1,000 -2,000 +250 +750 -250 +750

Expense Revenue
Drawings Expense

5. -1,000 6. -2,000 7. 8.

Expense Revenue

Chapter 1-34

LO 7 Analyze the effects of business transactions on the accounting equation.

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

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

Accounts Accounts Barone, + Receivable + Equipment = Payable + Capital

+10,000
+5,000

Investment

3. 4.

-400 +5,100

-400 +5,100
-1,000 -2,000 +250 +750 -250 +750 12,200

Expense Revenue
Drawings Expense

5. -1,000 6. -2,000 7. 8. 9.
Chapter 1-35

Expense Revenue

+120 6,820 +

-120 630 +

5,000 =

250 +

LO 7 Analyze the effects of business transactions on the accounting equation.

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

Income Statement

Owners Equity Statement

Balance Sheet

Statement of Cash Flows

Chapter 1-36

LO 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 1-37

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

Financial 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 $ 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.

Chapter 1-38

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

Financial 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 $ 5,850 2,000 400 250 2,650 3,200

Owners Equity Statement


Barones Repair Shop Owners' Equity Statement For the Month Ended May 31, 2007 Barone's, Capital May 1 Add: Investment Net income Less: Drawings Barone's, Capital May 31 $ 10,000 3,200 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 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 Add: Investment Net income Less: Drawings Barone's, Capital May 31 $ 10,000 3,200 13,200 1,000 12,200

Chapter 1-40

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

Financial Statements
Balance Sheet
Barones Repair Shop Balance Sheet May 31, 2007 Assets Cash Accounts receivable Equipment Total assets Liabilities Accounts payable Owners' Equity Barone's, capital Total liab. & equity $ 6,820 630 5,000 12,450 250

Owners Equity Statement


Barones Repair Shop Owners' Equity Statement For the Month Ended May 31, 2007 Barone's, Capital May 1 Add: Investment Net income Less: Drawings Barone's, Capital May 31 $ 10,000 3,200 13,200 1,000 $ 12,200

$ $

12,200 $ 12,450

The ending balance in owners equity is needed in preparing the balance sheet

Chapter 1-41

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

Financial Statements
Balance Sheet
Barones Repair Shop Balance Sheet May 31, 2007 Assets Cash Accounts receivable Equipment Total assets Liabilities Accounts payable Owners' Equity Barone's, capital Total liab. & equity $ 6,820 630 5,000 12,450 250 12,200 12,450

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.

$ $

Chapter 1-42

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

Financial Statements
Balance Sheet
Barones Repair Shop Balance Sheet May 31, 2007 Assets Cash Accounts receivable Equipment Total assets Liabilities Accounts payable Owners' Equity Barone's, capital Total liab. & equity $ 6,820 630 5,000 12,450 250 12,200 12,450

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 Purchase of equipment Cash flow from Financing Investment by owners Drawings by owners Cash provided by financing Net increase in cash Cash balance, May 1 Cash balance, May 31 $ $ 5,220 (2,400) 2,820 (5,000) 10,000 (1,000) 9,000 6,820 6,820

$ $

Chapter 1-43

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

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

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 Purchase of equipment Cash flow from Financing Investment by owners Drawings by owners Cash provided by financing Net increase in cash Cash balance, May 1 Cash balance, May 31 $ $ 5,220 (2,400) 2,820 (5,000) 10,000 (1,000) 9,000 6,820 6,820

from?
for?

2. What was cash used 3. What was the change

in the cash balance?

Chapter 1-44

LO 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 1-45

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

Financial 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
Copyright 2006 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.

Chapter 1-47