Lecture 01
1 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
Preview of Chapter 1
Accounting Principles
1-3
What is Accounting?
Purpose of accounting is to:
1. identify,
2. record, and
3. communicate
the economic events of an organization to interested users.
1-4 LO 1 Explain what accounting is.
What is Accounting?
Illustration 1-1
Three Activities Accounting process
The accounting process includes
the bookkeeping function.
1-5 LO 1 Explain what accounting is.
Who Uses Accounting Data
Internal
Users
Illustration 1-2
Questions that internal
users ask
1-6 LO 2
Who Uses Accounting Data
External
Users
Illustration 1-3
Questions that external
users ask
1-7 LO 2
Forms of Business Ownership
Proprietorship Partnership Corporation
◆ Generally owned ◆ Owned by two or ◆ Ownership
by one person. more persons. divided into
◆ Often small ◆ Often retail and shares of stock
service-type service-type ◆ Separate legal
businesses businesses entity organized
◆ Owner receives ◆ Generally under state
any profits, unlimited corporation law
suffers any personal liability ◆ Limited liability
losses, and is
◆ Partnership
personally liable
agreement
for all debts.
LO 5 Explain the monetary unit assumption
1-8
and the economic entity assumption.
The Basic Accounting Equation
Assets Liabilities Owner’s
= + 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.
1-9 LO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
Assets
◆ Resources a business owns.
◆ Provide future services or benefits.
◆ Cash, Supplies, Equipment, etc.
Assets Liabilities Owner’s
= + Equity
1-10 LO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
Liabilities
◆ Claims against assets (debts and obligations).
◆ Creditors - party to whom money is owed.
◆ Accounts payable, Notes payable, etc.
Assets Liabilities Owner’s
= + Equity
1-11 LO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
Owner’s Equity
◆ Ownership claim on total assets.
◆ Referred to as residual equity.
◆ Investment by owners and revenues (+)
◆ Drawings and expenses (-).
Assets Liabilities Owner’s
= + Equity
1-12 LO 6 State the accounting equation, and define its components.
Owner’s Equity
Illustration 1-6
Increases in Owner’s Equity
♦ Investments by owner are the assets the owner puts into the
business.
♦ 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.
1-13 LO 6 State the accounting equation, and define its components.
Problem 01
1. At the beginning of the year, Ortiz Company had total assets
of $900,000 and total liabilities of $440,000. Answer the
following questions.
a) If total assets decreased $100,000 during the year and
total liabilities increased $80,000 during the year, what is
the amount of owner’s equity at the end of the year?
b) During the year, total liabilities decreased $100,000 and
owner’s equity increased $200,000. What is the amount of
total assets at the end of the year?
c) If total assets increased $50,000 during the year and
owner’s equity increased $60,000 during the year, what is
the amount of total liabilities at the end of the year?
Owner’s Equity
Illustration 1-6
Decreases in Owner’s Equity
♦ Drawings An owner may withdraw cash or other assets for
personal use.
♦ 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.
1-15 LO 6 State the accounting equation, and define its components.
Building Block
• Assets are resources owned by a business.
• They are used in carrying out such activities as
production, consumption and exchange.
● Liabilities
• are creditor claims against assets
• are existing debts and obligations
1-16
Building Block
● Investments/Capital
• are the assets the owner puts in the
business
• increase owner’s equity
● Drawings
• are withdrawals of cash or other assets by the
owner for personal use
• decrease owner’s equity
1-17
Building Block
● Revenues
• gross increases in owner’s equity from business activities
entered into for the purpose of earning income
• may result from sale of merchandise, services, rental of
property, or lending money
• usually result in an increase in an asset
Expenses
• decreases in owner’s equity that result from
operating the business
• cost of assets consumed or services used in the
process of earning revenue
• examples: utility expense, rent expense, supplies
expense, and tax expense
1-18
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.
1-19 LO 7 Analyze the effects of business transactions on the accounting equation.
Using the Accounting Equation
Illustration: Are the following events recorded in the accounting
records?
Discuss
Purchase guided trip
Event computer options with Pay rent
customer
Criterion Is the financial position (assets, liabilities, or
owner’s equity) of the company changed?
Record/
Don’t Record
1-20 LO 7 Analyze the effects of business transactions on the accounting equation.
Lecture 02
Transaction Analysis
Transaction (1): Ray Neal decides to open a computer programming
service which he names Softbyte. On September 1, 2014, Ray Neal
invests $15,000 cash in the business.
1-22
LO 7
Transaction Analysis
Transaction (2): Purchase of Equipment for Cash. Softbyte purchases
computer equipment for $7,000 cash.
1-23
LO 7
Transaction Analysis
Transaction (3): Softbyte purchases for $1,600 from Acme Supply
Company computer paper and other supplies expected to last several
months. The purchase is made on account.
1-24
LO 7
Transaction Analysis
Transaction (4): Softbyte receives $1,200 cash from customers for
programming services it has provided.
1-25
LO 7
Transaction Analysis
Transaction (5): Softbyte receives a bill for $250 from the Daily News
for advertising but postpones payment until a later date.
1-26
LO 7
Transaction Analysis
Transaction (6): 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.
1-27
LO 7
Transaction Analysis
Transaction (7): Softbyte pays the following expenses in cash for
September: store rent $600, salaries of employees $900, and utilities
$200.
1-28
LO 7
Transaction Analysis
Transaction (8): Softbyte pays its $250 Daily News bill in cash.
1-29
LO 7
Transaction Analysis
Transaction (9): Softbyte receives $600 in cash from customers who
had been billed for services [in Transaction (6)].
1-30
LO 7
Transaction Analysis
Transaction (10): Ray Neal withdraws $1,300 in cash from the
business for his personal use.
Illustration 1-8
Tabular summary of
Softbyte transactions
1-31
LO 7
Financial Statements
Companies prepare four financial statements :
Owner’s Statement
Income Balance
Equity of Cash
Statement Sheet
Statement Flows
1-32 LO 8 Understand the four financial statements and how they are prepared.
Financial Statements
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.
1-33 LO 8 Understand the four financial statements and how they are prepared.
Net income is needed to determine the
Financial Statements ending balance in owner’s equity.
Illustration 1-9
Financial statements and
their interrelationships
1-34 LO 8
The ending balance in owner’s equity is
Financial Statements needed in preparing the balance sheet
Illustration 1-9
1-35 LO 8
The balance sheet and income statement are
Financial Statements needed to prepare statement of cash flows.
Illustration 1-9
1-36 LO 8
Financial Statements
Income Statement
◆ Reports the revenues and expenses for a specific period
of time.
◆ Lists revenues first, followed by expenses.
◆ Shows net income (or net loss).
1-37 LO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Owner’s Equity Statement
◆ Reports the changes in owner’s equity for a specific
period of time.
◆ The time period is the same as that covered by the
income statement.
1-38 LO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Balance Sheet
◆ Reports the assets, liabilities, and owner’s equity at a
specific date.
◆ Lists assets at the top, followed by liabilities and owner’s
equity.
◆ Total assets must equal total liabilities and owner’s equity.
◆ Is a snapshot of the company’s financial condition at a
specific moment in time (usually the month-end or
year-end).
1-39 LO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Statement of Cash Flows
◆ 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?
1-40 LO 8 Understand the four financial statements and how they are prepared.
Financial Statements
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.
1-41 LO 8 Understand the four financial statements and how they are prepared.
Exercise: 01
Answer to Exercise 01:
Problem 01