Chapter 1: Accounting in action

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What is accounting?

 Relevant to
 Bookkeeping  Financial
business Statements

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 What is accounting?
Illustration 1-1
Three Activities Accounting process

The accounting process includes

the bookkeeping function.

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What is accounting?

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Building blocks of accounting

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 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.
 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.

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Building blocks of accounting
Sarbanes-Oxley Act 2002
Reduce unethical behavior

Top management has to certify accuracy of

financial information

Severe penalties for fraud

Increased independence of outside auditors

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 Building blocks of accounting
Generally Accepted Accounting Principles (GAAP) - A set of
rules and practices, having substantial authoritative support, that
the accounting profession recognizes as a general guide for
financial reporting purposes.

Standard-setting bodies determine these guidelines:

► Securities and Exchange Commission (SEC)
► Financial Accounting Standards Board (FASB)
► International Accounting Standards Board (IASB)

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 Building blocks of accounting
Measurement Principles

Cost Principle – Or historical cost principle, dictates that

companies record assets at their cost.

Fair Value Principle – Indicates that assets and liabilities

should be reported at fair value (the price received to sell an
asset or settle a liability).

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 Building blocks of accounting
Assumptions
Monetary Unit – include in the accounting records only
transaction data that can be expressed in terms of money.

Economic Entity – 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.

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 Building blocks of accounting
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 NSU ACT 201: Adnan Habib (Anb)
for all debts.
Basic accounting Equation

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Basic accounting equation
Owner’s Equity increases with
◦ Investment (Capital): When owner puts in
cash in the business
◦ Revenues: Anything coming into the
business due to business activity.
Owner’s Equity decreases with
◦ Drawings: When owners withdraw cash
from business
◦ Expenses: Costs of assets and services
consumed or used

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 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.

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 Using the accounting equation
Transaction (1): Ray Neal decides to open a computer programming
service which he names Softbyte. On September 1, 2012, Ray Neal
invests $15,000 cash in the business.

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 Using the accounting equation
Transaction (2): Purchase of Equipment for Cash. Softbyte
purchases computer equipment for $7,000 cash.

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 Using the accounting equation
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.

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 Using the accounting equation
Transaction (4): Softbyte receives $1,200 cash from customers for
programming services it has provided.

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 Using the accounting equation
Transaction (5): Softbyte receives a bill for $250 from the Daily News
for advertising but postpones payment until a later date.

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 Using the accounting equation
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.

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 Using the accounting equation
Transaction (7): Softbyte pays the following expenses in cash for
September: store rent $600, salaries of employees $900, and utilities
$200.

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 Using the accounting equation
Transaction (8): Softbyte pays its $250 Daily News bill in cash.

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 Using the accounting equation
Transaction (9): Softbyte receives $600 in cash from customers who
had been billed for services [in Transaction (6)].

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 Using the accounting equation
Transaction (10): Ray Neal withdraws $1,300 in cash from the
business for his personal use.

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Using the accounting equation
Illustration 1-8
Tabular summary of
Softbyte transactions

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Using the accounting equation
Illustration 1-8
Tabular summary of
Softbyte transactions

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Using the accounting equation
Illustration 1-8
Tabular summary of
Softbyte transactions

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 Financial Statements

Companies prepare four financial statements :

Income Owner’s Equity Statement of

Balance Sheet
Statement Statement Cash Flows

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 Financial Statements
• Income Statement: Presents the revenues and expenses and resulting net
income or net loss for a specific period of time.
• Owner’s Equity Statement: Summarizes the changes in the owner’s equity for
a specific period of time.

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Financial Statements
• Balance Sheet: Reports the assets, liabilities, and owner’s equity at a specific
date. It ensures that the accounting equation is maintained.

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Financial Statements
Statement of Cash Flows: Summarizes
information about the cash inflows (receipts) and
outflows (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?

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