Accounting In Action

Accounting In Action

Chapter 1-1

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 stockholders’ 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 in Action

What is Accounting? Three activities Who uses accounting data

Chapter 1-3

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

The Basic Accounting Equation Assets Liabilities Stockholders' equity

Using the Basic Accounting Equation Transaction analysis Summary of transactions

Financial Statements Income statement Statement of retained earnings Balance sheet Statement of cash flows

What is Accounting? The purpose of accounting is to: •

identify, identify record, record and communicate the economic events of an

•

organization to

•

interested users.

Chapter 1-4

SO 1 Explain what accounting is.

What is Accounting? Three Activities

Illustration 1-1 Accounting process

The accounting process includes the bookkeeping function. Chapter 1-5

SO 1 Explain what accounting is.

Who Uses Accounting Data? Internal Users

Management

IRS Investors

Human Resources Finance

Common Questions

Creditors

Marketing Customers Chapter 1-6

Labor Unions

SEC

External Users

SO 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?

User Human Resources

2. Did the company earn a satisfactory income?

Investors

3. Do we need to borrow in the near future? 4. Is cash sufficient to pay dividends to the stockholders?

Management 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

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 Chapter 1-8

SO 3 Understand why ethics is a fundamental business concept.

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.

Chapter 1-9

•

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.

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

SO 3 Understand why ethics is a fundamental business concept.

The Building Blocks of 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 Retained Earnings Statement Statement of Cash Flows Note Disclosure

Generally Accepted Accounting Principles (GAAP)

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

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 1-13

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. Partnership.

Forms of Business Ownership

Corporation. Chapter 1-14

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

Forms of Business 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 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 1-16

SO 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. Chapter 1-17

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

The Basic Accounting Equation Assets

=

Liabilities

+

Stockholders’ 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

SO 6 State the accounting equation, and define assets, liabilities, and stockholders’ equity.

The Basic Accounting Equation Assets

=

Liabilities

+

Stockholders’ 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

SO 6 State the accounting equation, and define assets, liabilities, and stockholders’ equity.

The Basic Accounting Equation Assets

=

Liabilities

+

Stockholders’ 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

SO 6 State the accounting equation, and define assets, liabilities, and stockholders’ equity.

The Basic Accounting Equation Assets

=

Liabilities

+

Stockholders’ Equity

Provides the underlying framework for recording and summarizing economic events. Stockholders’ Equity Ownership claim on total assets. Referred to as residual equity. Paid-in Capital, Retained Earnings (Corporation). Chapter 1-21

SO 6 State the accounting equation, and define assets, liabilities, and stockholders’ equity.

Stockholders’ 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

SO 6 State the accounting equation, and define assets, liabilities, and stockholders’ equity.

Stockholders’ 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

SO 6 State the accounting equation, and define assets, liabilities, and stockholders’ equity.

Stockholders’ Equity Illustration 1-6

Dividends are the distribution of cash or other assets to stockholders. Dividends reduce retained earnings, however dividends are not an expense. Chapter 1-24

SO 6 State the accounting equation, and define assets, liabilities, and stockholders’ equity.

Using The Basic Accounting Equation Transactions are a business’s economic events recorded by accountants.

Chapter 1-25

•

May be external or internal.

•

Not all activities represent transactions.

•

Each transaction has a dual effect on the accounting equation.

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

Transactions Question: Are the following events recorded in the accounting records? An employee is hired.

Dividends are paid to stockholders’.

Event

Supplies are purchased on account.

Criterion

Is the financial position (assets, liabilities, or stockholders’ equity) of the company changed?

Record/ Don’t Record Chapter 1-26

SO 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 Hardy Company. Hardy’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 1-27

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

Transactions (Problem) P1-1A: Barone’s Repair Shop was started on May. Prepare a tabular analysis of the following transactions for the month of May. 1. Stockholders invested $10,000 cash to start the repair shop. Assets Cash 1. +10,000

Chapter 1-28

Liabilities

Stockholders’ Equity

Accounts Accounts Common + Receivable + Equipment = Payable + Stock +10,000

Investment

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

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

Assets Cash

Accounts Accounts Common + Receivable + Equipment = Payable + Stock

1. +10,000 2.

-5,000

Chapter 1-29

Stockholders’ Equity

+10,000

Investment

+5,000

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

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

Assets Cash

Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings

1. +10,000 2.

-5,000

3.

-400

Chapter 1-30

Stockholders’ Equity

+10,000 +5,000 -400 Expense

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

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

Assets Cash

Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings

1. +10,000 2.

-5,000

3. 4.

-400 +5,100

Chapter 1-31

Stockholders’ Equity

+10,000 +5,000 -400 +5,100 Revenue

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

Transactions (Problem) 5. Paid dividends of $1,000 cash. Liabilities

Assets Cash

Stockholders’ Equity

Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings

1. +10,000

+10,000

2.

-5,000

3. 4.

-400 +5,100

-400 +5,100

5.

-1,000

-1,000

Chapter 1-32

+5,000

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

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

Assets Cash

Stockholders’ Equity

Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings

1. +10,000

+10,000

2.

-5,000

+5,000

3. 4.

-400 +5,100

-400 +5,100

5. 6.

-1,000 -2,000

-1,000 -2,000 Expense

Chapter 1-33

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

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

Assets Cash

Stockholders’ Equity

Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings

1. +10,000

+10,000

2.

-5,000

3. 4.

-400 +5,100

-400 +5,100

5. 6.

-1,000 -2,000

-1,000 -2,000

7.

Chapter 1-34

+5,000

+250

-250 Expense

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

Transactions (Problem) 8. Provided repair services on account to customers $750. Liabilities

Assets Cash

Stockholders’ Equity

Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings

1. +10,000

+10,000

2.

-5,000

3. 4.

-400 +5,100

-400 +5,100

5. 6.

-1,000 -2,000

-1,000 -2,000

7. 8.

+5,000

+250 +750

-250 +750 Revenue

Chapter 1-35

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

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

Assets Cash

Stockholders’ Equity

Accounts Accounts Common Retained + Receivable + Equipment = Payable + Stock + Earnings

1. +10,000

+10,000

2.

-5,000

3. 4.

-400 +5,100

-400 +5,100

5. 6.

-1,000 -2,000

-1,000 -2,000

7. 8. 9. Chapter 1-36

+5,000

+250

-250 +750

+750 +120 6,820 +

-120 630 +

5,000 =

250 +

10,000 +

2,200

SO 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

Chapter 1-37

Retained Earnings Statement

Balance Sheet

Statement of Cash Flows

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 1-38

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

Financial Statements Income Statement Barone’s Repair Shop Income Statement For the Month Ended May 31, 2007 Revenues: Service revenue

$

5,850

Expenses: Salary expense

2,000

Rent expense

400

Advertising expense

250

Total expenses Net income Chapter 1-39

2,650 $

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

3,200

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

Financial Statements Income Statement

Retained Earnings Statement

Barone’s Repair Shop

Barone’s Repair Shop

Income Statement

Retained Earnings Statement

For the Month Ended May 31, 2007

For the Month Ended May 31, 2007 Retained earnings, May 1

Revenues: Service revenue

$

5,850

Expenses: Salary expense

2,000

Rent expense

400

Advertising expense

250

Total expenses Net income Chapter 1-40

2,650 $

3,200

$

-

Add: Net income

3,200

Less: Dividends

(1,000)

Retained earnings, May 31 $

2,200

Net income is needed to determine the ending balance in retained earnings.

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

Financial Statements Retained Earnings Statement Statement indicates the reasons why retained earnings has increased or decreased during the period.

Chapter 1-41

Barone’s Repair Shop Retained Earnings Statement For the Month Ended May 31, 2007 Retained earnings, May 1

$

-

Add: Net income

3,200

Less: Dividends

(1,000)

Retained earnings, May 31 $

2,200

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

Financial Statements Retained Earnings Statement

Balance Sheet Barone’s Repair Shop Balance Sheet

Barone’s Repair Shop

May 31, 2007

Retained Earnings Statement

Assets Cash

$

Accounts receivable

630

Equipment Total assets

6,820 5,000

$ 12,450

Liabilities Accounts payable

$

250

For the Month Ended May 31, 2007 Retained earnings, May 1

$

-

Add: Net income

3,200

Less: Dividends

(1,000)

Retained earnings, May 31 $

2,200

Stockholders' Equity Common stock

10,000

Retained earnings

2,200

Total liab. & equity Chapter 1-42

$ 12,450

The ending balance in retained earnings is needed in preparing the balance sheet.

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

Financial Statements Balance Sheet Barone’s Repair Shop Balance Sheet May 31, 2007 Assets Cash

$

Accounts receivable

630

Equipment Total assets

6,820 5,000

$ 12,450

Liabilities Accounts payable

$

250

Stockholders' Equity Common stock

10,000

Retained earnings

2,200

Total liab. & equity Chapter 1-43

$ 12,450

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

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, 2007

For the Month Ended May 31, 2007 Cash flow from Operations

Assets Cash

$

Accounts receivable

630

Equipment Total assets

6,820 5,000

$ 12,450

Liabilities

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

(5,000) 10,000 (1,000) 9,000 6,820 6,820

Common stock

10,000

Retained earnings

2,200

Cash balance, May 1

$

250

Stockholders' Equity

Total liab. & equity Chapter 1-44

$ 12,450

5,220 (2,400) 2,820

Purchase of equipment Cash flow from Financing Investment by owners Drawings by owners Cash provided by financing Net increase in cash

Accounts payable

$

Cash balance, May 31

$

SO 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

from?

2. What was cash used

for?

3. What was the change

in the cash balance?

Statement of Cash Flows Barone’s 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 1-45

$

$

6,820

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. Statement of stockholders’ equity. d. Statement of cash flows.

Chapter 1-46

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

Financial Statements

Discussion Question Q19. “A company’s net income appears directly on the income statement and the retained earnings statement, and it is included indirectly in the company’s balance sheet.” Do you agree? Explain.

See notes page for discussion Chapter 1-47

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

All About You Ethics: Managing Personal Financial Reporting When students need money for school, they often apply for financial aid. Why do the Department of Education and your school want this information? Bottom line: The worse off you look financially, the more likely you are to get money. Question: Should you intentionally make yourself look worse off than you are? Chapter 1-48

All About You Some Facts: After adjusting for inflation, private-college tuition and fees have increased 37% over the past decade; public-college tuition has risen 54%. Two-thirds (65.6%) of undergraduate students graduate with some debt. Among graduating seniors, the average debt load is $19,202.

Chapter 1-49

All About You

Source: College Board, Princeton Review, as reported in “College Admissions: Is Gate Open or Closed?,” Wall Street Journal, March 25, 2006, p. A7. Chapter 1-50

All About You What Do You Think? To increase your chances of receiving aid, should you use available cash to pay off your credit card bills, and therefore make yourself look “worse off” to the financial aid decision makers? YES: You are simply restructuring your assets and liabilities to best conform with the preferences that are built into the federal aid formulas.

Chapter 1-51

NO: You are taking advantage of a loophole in the federal aid rules and potentially depriving someone who is actually worse off than you from receiving aid.

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Chapter 1-52