Accounting Principles

Thirteenth Edition
Weygandt Kimmel Kieso

Chapter 1

Accounting in Action
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
Accounting in Action Preview

What is The Building The Basic Using the Financial

Accounting? Blocks of Accounting Accounting Statements
• Three activities Accounting Equation Equation • Income
• Who uses • Ethics in • Assets • Transaction Statement
accounting data financial • Liabilities analysis • Owner’s Equity
reporting • Owner’s equity • Summary of statement
• Generally Transactions • Balance Sheet
accepted • Statement of
accounting Cash Flows
principles
• Measurement
principles
• Assumptions

Copyright ©2018 John Wiley & Son, Inc. 2

Chapter Outline
Learning Objectives
LO 1 Identify the activities and users associated with
accounting.
LO 2 Explain the building blocks of accounting: ethics,
principles, and assumptions.
LO 3 State the accounting equation, and define its
components.
LO 4 Analyze the effects of business transactions on the
accounting equation.
LO 5 Describe the four financial statements and how they
are prepared.
Copyright ©2018 John Wiley & Son, Inc. 3
 Accounting Activities and Users
Accounting consists of three activities
1. Identification – Select economic events
(transactions)
2. Recording - Record, classify, and summarize
3. Communication
• Prepare accounting reports
• Analyze and interpret for users

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 Who Uses Accounting Data
Internal Users
• Finance - Is cash sufficient to pay dividends to
Microsoft stockholders?
• Marketing – What price should Apple charge for an
iPad to maximize net income?
• Human Resources – Can General Motors afford to
give its employees pay raises?
• Management - Which PepsiCo product line is most
profitable? Should any products be eliminated?
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 Who Uses Accounting Data
External Users
• Investors
 Is General Electric earning satisfactory income?
 How does Disney compare in size and profitability
with Time Warner?
• Creditors – Will United Airlines be able to pay its
debts as they come due?

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 DO IT! 1 Basic Concepts
Indicate whether each of the statements is true or false.
1. The three steps in the accounting process are identification,
recording, and communication.
2. Bookkeeping encompasses all steps in the accounting
process.
3. Accountants prepare, but do not interpret, financial reports.
4. The two most common types of external users are investors
and company officers.
5. Managerial accounting focuses on reports for internal users.

Solution: 1. True2. False 3. False 4. False 5.

True
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 The Building Blocks of Accounting
Ethics in Financial Reporting
• Financial scandals include: Enron, WorldCom,
HealthSouth, AIG, and other companies
• Regulators and lawmakers concerned that economy
would suffer if investors lost confidence in corporate
accounting
 Congress passed Sarbanes-Oxley Act (SOX)
• Effective financial reporting depends on sound ethical
behavior

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 Ethics in Financial Reporting
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

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 Generally Accepted Accounting
Principles Financial Statements

 Balance
Balance Sheet
Sheet
Various users need 
 Income
Income Statement
Statement
financial 
 Owner's
Owner's Equity
Equity Statement
Statement
information 
 Statement
Statement of
of Cash
Cash Flows
Flows

 Note
Note Disclosure
Disclosure

The accounting profession has

Generally Accepted
developed standards that are
Accounting Principles
generally accepted and
(GAAP)
universally practiced.

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 Generally Accepted Accounting
Principles
Standards that are generally accepted and universally
practiced. These standards indicate how to report
economic events.
Standard-setting bodies:
a. Financial Accounting Standards Board (FASB)
b. Securities and Exchange Commission (SEC)
c. International Accounting Standards Board (IASB)

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 Measurement Principles
Historical Cost Principle (or cost principle)
Record assets at their cost.
Fair Value Principle
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.
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 Assumptions
Monetary Unit Assumption
Include in accounting records only transaction data
that can be expressed in terms of money
Economic Entity Assumption
Activities of entity be kept separate and distinct
from activities of its owner and all other entities
 Proprietorship
Forms of Business
 Partnership Ownership
 Corporation
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 Forms of Business Ownership
Proprietorship Partnership Corporation
• Owned by one • Owned by two or • Ownership divided
person more persons into shares of stock
• Owner is often • Often retail and • Separate legal
manager/operator service-type entity organized
businesses under state
• Owner receives any corporation law
profits, suffers any • Generally
losses, and is unlimited personal • Limited liability
personally liable for liability
all debts
• Partnership
agreement

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 Assumptions
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.

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 Assumptions
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. porporation
d. sole proprietorship

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 DO IT! 2 Building Blocks of Accounting
Indicate whether each of the statements is true or false.
1. Congress passed the Sarbanes-Oxley Act to reduce unethical
behavior and decrease the likelihood of future corporate
scandals.
2. The primary accounting standard-setting body in the United
States is the Financial Accounting Standards Board (FASB).
3. The historical cost principle dictates that companies record
assets at their cost. In later periods, however, the fair value
of the asset must be used if fair value is higher than its cost.

Solution: 1. True2. True3. False

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 DO IT! 2 Building Blocks of Accounting
Indicate whether each of the statements is true or false.
4. Relevance means that financial information matches what
really happened; the information is factual.
5. A business owner’s personal expenses must be separated from
expenses of the business to comply with accounting’s economic
entity assumption.

Solution: 1. True2. True3. False 4. False 5. True

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 The Accounting Equation
Assets = Liabilities + Owner's Equity

Basic Accounting Equation

Provides underlying framework for recording and
summarizing economic events
Assets are claimed by either creditors or owners
If a business is liquidated, claims of creditors must
be paid before ownership claims
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 The Accounting Equation
Assets = Liabilities + Owner's Equity

Assets
Resources a business owns
Provide future services or benefits
Cash, Supplies, Equipment, etc.

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 The Accounting Equation
Assets = Liabilities + Owner's Equity

Liabilities
Claims against assets (debts and obligations)
Creditors (party to whom money is owed)
Accounts Payable, Notes Payable, Salaries and Wages
Payable, etc.

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 The Accounting Equation
Assets = Liabilities + Owner's Equity

Owner’s Equity
Ownership claim on total assets
Referred to as residual equity
Investment by owners and revenues (+)
Drawings and expenses (-)

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 The Accounting Equation ILLUSTRATION 1.6
Expanded accounting equation

Equation Assets = Liabilities + Owner's Equity

Expanded Owner's Owner's
Equation Assets = Liabilities + Capital - Drawings + Revenues - Expenses

Increase in Owner’s Equity

Investment by Owner. Assets the owner puts into
the business
Revenues. Increases in assets or decreases in
liabilities resulting from sale of goods or
performance of services in normal course of
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 The Accounting Equation ILLUSTRATION 1.6
Expanded accounting equation

Equation Assets = Liabilities + Owner's Equity

Expanded Owner's Owner's
Equation Assets = Liabilities + Capital - Drawings + Revenues - Expenses

Decrease in Owner’s Equity

Drawings. A withdraw of cash or other assets for
personal use
Expenses. Cost of assets consumed or services used
in the process of earning revenue

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 DO IT! 3 Owner’s Equity Effects
Classify the following items as investment by owner, owner’s
drawings, revenues, or expenses. Then indicate whether each
item increases or decreases owner’s equity.
Effect
Classification on Equity
1. Rent Expense Expense Decrease
2. Service Revenue Revenue Increase
Owner’s
3. Drawings Decrease
Drawings
4. Salaries and Wages Expense Expense Decrease

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 Analyzing Business Transactions
Transactions are a business’s economic events recorded by
accountants.
a. May be external or internal
b. Not all activities represent transactions
c. Have a dual effect on the accounting equation

Analyze
Journaliz Trial Adjusting
business Post
e Balance Entries
transactions

Adjusted
Financial Closing Post-Closing
Trial
Balance Statements Entries Trial Balance

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 Analyzing Business Transactions
Illustration: Are the following events recorded in the
accounting records?
Discuss product ILLUSTRATION 1.7
Transaction
design with identification process

Purchase potential
Event
computer customer Pay rent

Criterion Is the financial position (assets, liabilities, or

owner’s equity) of the company changed?

Record/
Don’t Record Yes No Yes

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 Transaction Analysis
Transaction 1. Ray Neal decides to start a smartphone app development
company which he names Softbyte. On September 1, 2020, he invests
$15,000 cash in the business. This transaction results in an equal increase
in assets and owner’s equity.

Assets Liabilities Owner’s Equity

Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$15,000 +$15,000
2
3

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 Transaction 2. Softbyte purchases computer equipment for $7,000 cash.

Assets Liabilities Owner’s Equity

Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$15,000 +$15,000
2 -7,000 +$7,000
3 +$1,600 +$1,600
4 +1,200 +$1,200
5 +250 -$250
6 +1,500 +$2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -$1,300
$ 8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 - $1,300 + $4,700 - $1,950

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 Transaction 3. Softbyte Inc. purchases for $1,600 headsets and other
accessories expected to last several months. The supplier allows Softbyte
to pay this bill in October.
Assets Liabilities Owner’s Equity
Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$15,000 +$15,000
2 -7,000 +$7,000
3 +$1,600 +$1,600
4 +1,200 +$1,200
5 +250 -$250
6 +1,500 +$2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -$1,300
$ 8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 - $1,300 + $4,700 - $1,950

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 Transaction 4. Softbyte receives $1,200 cash from customers for app
development services it has performed.

Assets Liabilities Owner’s Equity

Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$15,000 +$15,000
2 -7,000 +$7,000
3 +$1,600 +$1,600
4 +1,200 Service Revenue +$1,200
5 +250 -$250
6 +1,500 +$2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -$1,300
$ 8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 - $1,300 + $4,700 - $1,950

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 Transaction 5. Softbyte Inc. receives a bill for $250 from the Daily News
for advertising on its online website but postpones payment until a later
date.
Assets Liabilities Owner’s Equity
Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$15,000 +$15,000
2 -7,000 +$7,000
3 +$1,600 +$1,600
4 +1,200 +$1,200
5 +250 Advertising Expense -$250
6 +1,500 +$2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -$1,300
$ 8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 - $1,300 + $4,700 - $1,950

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 Transaction 6. Softbyte performs $3,500 of services. The company
receives cash of $1,500 from customers, and it bills the balance of $2,000
on account.
Assets Liabilities Owner’s Equity
Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$15,000 +$15,000
2 -7,000 +$7,000
3 +$1,600 +$1,600
4 +1,200 +$1,200
5 +250 -$250
6 +1,500 +$2,000 Service Revenue +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -$1,300
$ 8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 - $1,300 + $4,700 - $1,950

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 Transaction 7. Softbyte pays the following expenses in cash for
September: office rent $600, salaries and wages of employees $900, and
utilities $200.
Assets Liabilities Owner’s Equity
Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$15,000 +$15,000
2 -7,000 +$7,000
3 +$1,600 +$1,600
4 +1,200 +$1,200
5 +250 -$250
6 +1,500 +$2,000 +3,500
7 -600 Rent Expense -600
-900 Salaries and Wage Expense -900
-200 Utilities Expense -200
8 -250 -250
9 +600 -600
10 -1,300 -$1,300
$ 8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 - $1,300 + $4,700 - $1,950

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 Transaction 8. Softbyte pays its $250 Daily News bill in cash. The company
previously (in Transaction 5) recorded the bill as an increase in Accounts
Payable.
Assets Liabilities Owner’s Equity
Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$15,000 +$15,000
2 -7,000 +$7,000
3 +$1,600 +$1,600
4 +1,200 +$1,200
5 +250 -$250
6 +1,500 +$2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -$1,300
$ 8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 - $1,300 + $4,700 - $1,950

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 Transaction 9. Softbyte receives $600 in cash from customers who had
been billed for services (in Transaction 6).

Assets Liabilities Owner’s Equity

Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$15,000 +$15,000
2 -7,000 +$7,000
3 +$1,600 +$1,600
4 +1,200 +$1,200
5 +250 -$250
6 +1,500 +$2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -$1,300
$ 8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 - $1,300 + $4,700 - $1,950

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 Transaction 10. Ray Neal withdraws $1,300 in cash in cash from the
business for his personal use.

Assets Liabilities Owner’s Equity

Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$15,000 +$15,000
2 -7,000 +$7,000
3 +$1,600 +$1,600
4 +1,200 +$1,200
5 +250 -$250
6 +1,500 +$2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -$1,300
$ 8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 - $1,300 + $4,700 - $1,950

$18,050 $18,050

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 Summary of Transactions
1. Each transaction analyzed in terms of effect on:
a. Three components of basic accounting
equation
• Assets
• Liabilities
• Owner’s equity
b. Specific types of items, such as Cash
2. Two sides of equation must always be equal

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 DO IT! 4 Tabular Analysis
Transactions made by Virmari & Co., a public accounting firm, for
the month of August are shown below. Prepare a tabular analysis
which shows the effects of these transactions on the expanded
accounting equation, similar to that shown in Illustration 1.8.
1. The owner invested $25,000 cash in the business.
2. The company purchased $7,000 of office equipment on credit.
3. The company received $8,000 cash in exchange for services
performed.
4. The company paid $850 for this month’s rent.
5. The owner withdrew $1,000 cash for personal use.

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 DO IT! 4 Tabular Analysis
Transaction 1. The owner invested $25,000 cash in the
business.
Assets Liabilities Owner’s Equity
Accounts Owner's Owner's
No. Cash + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$25,000 +$25,000
2
3
4
5

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 DO IT! 4 Tabular Analysis
Transaction 2. The company purchased $7,000 of office
equipment on credit.
Assets Liabilities Owner’s Equity
Accounts Owner's Owner's
No. Cash + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$25,000 +$25,000
2 +$7,000 +$7,000
3
4
5

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 DO IT! 4 Tabular Analysis
Transaction 3. The company received $8,000 cash in
exchange for services performed.
Assets Liabilities Owner’s Equity
Accounts Owner's Owner's
No. Cash + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$25,000 +$25,000
2 +$7,000 +$7,000
3 +8,000 Service Revenue +$8,000
4
5

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 DO IT! 4 Tabular Analysis
Transaction 4. The company paid $850 for this month’s
rent.
Assets Liabilities Owner’s Equity
Accounts Owner's Owner's
No. Cash + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$25,000 +$25,000
2 +$7,000 +$7,000
3 +8,000 +$8,000
4 -850 Rent Expense -$850
5

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 DO IT! 4 Tabular Analysis
Transaction 5. The owner withdrew $1,000 cash for
personal use.
Assets Liabilities Owner’s Equity
Accounts Owner's Owner's
No. Cash + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +$25,000 +$25,000
2 +$7,000 +$7,000
3 +8,000 +$8,000
4 -850 -$850
5 -1,000 -$1,000
$ 31,150 + $7,000 = $7,000 + $25,000 - $1,000 + $8,000 - $850

$31,150 $31,150

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 The Four Financial Statements
Companies prepare four financial statements:

Owner's Statement
Income Balance
Equity of Cash
Statement Sheet
Statement Flows

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 Financial Statements
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

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 Income Statement
Financial Revenues $4,700

Statements Service revenue

Expenses
Salaries and wages expense 900
Softbyte Rent expense 600
Advertising expense 250
statements for Utilities expense 200
the Month Total expenses 1,950
Net income $2,750
Ended
September 30, Owner’s Equity Statement
2020 Owner’s capital, September 1 $ 0
Add: Investments 15,000
Add: Net income 2,750
ILLUSTRATION 1.9
Financial statements and
Less: Drawings 1,300
their interrelationships Owner’s capital, September 30 $16,450

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 Owner’s Equity Statement

Financial Owner’s capital, September 1

Add: Investments
$ 0
15,000
Statements Add: Net income
Less: Drawings
2,750
1,300
Owner’s capital, September 30 $16,450
Softbyte
Balance Sheet
statements for
Assets
the Month Cash $ 8,050
Ended Accounts receivable 1,400
Supplies 1,600
September 30, Equipment 7,000
2020 Total assets $18,050
Liabilities and Owner’s Equity
Accounts payable $ 1,600
ILLUSTRATION 1.9
Financial statements and Owner’s capital 16,450
their interrelationships
Total liabilities and equity $18,050

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 Balance Sheet (partial)
Assets
Financial Cash
Accounts receivable
$ 8,050
1,400
Statements Supplies 1,600
Statement of Cash Flows
Softbyte Cash flows from operating activities
Cash receipts from revenues 3,300
statements for Cash payments from expenses (1,950)
the Month Net cash from operating activities 1,350
Cash flows from investing activities
Ended Purchase of equipment (7,000)
September 30, Cash flows from financing activities
Investments by owner 15,000
2020 Drawings by owner (1,300)
Net cash from financing activities 13,700
Net increase in cash 8,050
ILLUSTRATION 1.9
Financial statements and Cash at beginning of period 0
their interrelationships
Cash at end of period $ 8,050

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 Income Statement
• Reports revenues and expenses for a specific period
of time
• Lists revenues first, followed by expenses
• Shows net income (or net loss)
• Does not include investment and withdrawal
transactions between owner and business in
measuring net income

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 Owner’s Equity Statement
• Reports changes in owner’s equity for a specific
period of time
• Time period is the same as that covered by the
income statement

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 Balance Sheet
• Reports assets, liabilities, and owner's equity at a
specific date
• Lists assets at top, followed by liabilities and owner’s
equity
• Total assets must equal total liabilities and owner's
equity
• Snapshot of company’s financial condition at a
specific moment in time (usually month-end or year-
end)

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 Statement of Cash Flows
• Information on cash receipts and payments for a
specific period of time
• Answers the following:
 Where did cash come from?
 What was cash used for?
 What was change in cash balance?

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 Financial Statements
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

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 DO IT! 5 Financial Statement Items
Presented below is selected information related to Flanagan
Company at December 31, 2020. Flanagan reports financial
information monthly.
Equipment 10,000 Utilities Expense 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000
a. Determine the total assets of at December 31, 2020.
b. Determine the net income reported for December 2020.
c. Determine the owner’s equity at December 31, 2020.

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 DO IT! 5 Financial Statement Items
Flanagan reports financial information monthly.
Equipment 10,000 Utilities Expense 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000
a. Determine the total assets of at December 31, 2020.

Cash $ 8,000
Accounts receivable 9,000
Equipment 10,000
Total assets $27,000

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 DO IT! 5 Financial Statement Items
Flanagan reports financial information monthly.
Equipment 10,000 Utilities Expense 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000
b. Determine the net income reported for December 2020.
Service revenue $36,000
Rent expense 11,000
Salaries and wages expense 7,000
Utilities expense 4,000
Net income $14,000

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 DO IT! 5 Financial Statement Items
Flanagan reports financial information monthly.
Equipment 10,000 Utilities Expense 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000
c. Determine the owner’s equity at December 31, 2020.
Total assets $27,000
Less: Notes payable expense 16,500
Less: Accounts payable 2,000
Owner’s equity $ 8,500

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 Appendix 1A
Career Opportunities in Accounting
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,
the SEC, public colleges and and investigative skills to
universities, and in state and conduct investigations into
local governments. theft and fraud.

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