Chapter

1-1
 CHAPTER 1

ACCOUNTING IN
ACTION

Accounting Principles, Eighth Edition

Chapter
1-2
 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 owner’s equity.
7. Analyze the effects of business transactions on the
accounting equation.
8. Understand the four financial statements and how they are
prepared.
Chapter
1-3
 Accounting in Action

Using the
The Building The Basic
What is Basic Financial
Blocks of Accounting
Accounting? Accounting Statements
Accounting Equation Equation

Three Ethics in Assets Transaction Income

activities financial Liabilities analysis statement
Who uses reporting Summary of Owner’s
Owner’s
accounting Generally equity transactions equity
data accepted statement
accounting Balance
principles sheet
Assumptions Statement of
cash flows

Chapter
1-4
 What is Accounting?

The purpose of accounting is to:

(1) identify,
identify record,
record and communicate the
economic events of an
(2) organization to
(3) interested users.

Chapter
1-5 LO 1 Explain what accounting is.
 What is Accounting?
Illustration 1-1
Three Activities Accounting process

The accounting process includes

the bookkeeping function.

Chapter
1-6 LO 1 Explain what accounting is.
 Who Uses Accounting Data?
Internal Users
Management IRS
Human Investors
Resources
There are two broad
groups of users of Labor
financial information: Unions
Finance
internal users and
external users. Creditors
Marketing
SEC
Customers External
Users
Chapter
1-7 LO 2 Identify the users and uses of accounting.
 Who Uses Accounting Data?
Common Questions Asked User
1. Can we afford to give our
employees a pay raise? Human Resources
2. Did the company earn a
satisfactory income? Investors
3. Do we need to borrow in the
near future? Management
4. Is cash sufficient to pay
dividends to the stockholders? 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
1-8 LO 2 Identify the users and uses of accounting.
 The Building Blocks of Accounting

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

The accounting profession

has attempted to develop Generally Accepted
a set of standards that
Accounting
are generally accepted
and universally practiced.
Principles (GAAP)

Chapter
1-9 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
1-10 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
1-11 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.
Forms of
Partnership. Business Ownership
Corporation.
Chapter LO 5 Explain the monetary unit assumption
1-12
and the economic entity assumption.
 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
for all debts.
Chapter LO 5 Explain the monetary unit assumption
1-13
and the economic entity assumption.
 The Basic Accounting Equation

Owner’s
Assets = Liabilities +
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 LO 6 State the accounting equation, and define

1-14
assets, liabilities, and owner’s equity.
 The Basic Accounting Equation

Owner’s
Assets = Liabilities +
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 LO 6 State the accounting equation, and define
1-15
assets, liabilities, and owner’s equity.
 The Basic Accounting Equation

Owner’s
Assets = Liabilities +
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 LO 6 State the accounting equation, and define
1-16
assets, liabilities, and owner’s equity.
 The Basic Accounting Equation

Owner’s
Assets = Liabilities +
Equity

Provides the underlying framework for recording and

summarizing economic events.
Owner’s Equity

Ownership claim on total assets.

Referred to as residual equity.
Capital, Drawings, etc. (Proprietorship or
Partnership).
Chapter LO 6 State the accounting equation, and define
1-17
assets, liabilities, and owner’s equity.
 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 LO 6 State the accounting equation, and define
1-18
assets, liabilities, and owner’s 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 LO 6 State the accounting equation, and define
1-19
assets, liabilities, and owner’s equity.
 Using The Basic 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.

Chapter LO 7 Analyze the effects of business transactions

1-20
on the accounting equation.
 Transactions (Question?)
Q1-15: Are the following events recorded in the
accounting records? Owner
Supplies are An employee withdraws
Event purchased is hired. cash for
on account. personal use.

Criterion Is the financial position (assets, liabilities, or

owner’s equity) of the company changed?

Record/
Don’t Record

Chapter LO 7 Analyze the effects of business transactions

1-21
on the accounting equation.
 Transactions

Discussion Question
Q18. In February 2008, Paula King invested an
additional $10,000 in her business, King’s
Pharmacy, which is organized as a proprietorship.
King’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 LO 7 Analyze the effects of business transactions
1-22
on the accounting equation.
 Transactions (Problem)
P1-1A: Barone’s 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 Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment

Chapter LO 7 Analyze the effects of business transactions

1-23
on the accounting equation.
 Transactions (Problem)
2. Purchased equipment for $5,000 cash.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000

Chapter LO 7 Analyze the effects of business transactions

1-24
on the accounting equation.
 Transactions (Problem)
3. Paid $400 cash for May office rent.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense

Chapter LO 7 Analyze the effects of business transactions

1-25
on the accounting equation.
 Transactions (Problem)
4. Received $5,100 from customers for repair service.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue

Chapter LO 7 Analyze the effects of business transactions

1-26
on the accounting equation.
 Transactions (Problem)
5. Withdrew $1,000 cash for personal use.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings

Chapter LO 7 Analyze the effects of business transactions

1-27
on the accounting equation.
 Transactions (Problem)
6. Paid part-time employee salaries of $2,000.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense

Chapter LO 7 Analyze the effects of business transactions

1-28
on the accounting equation.
 Transactions (Problem)
7. Incurred $250 of advertising costs, on account.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense
7. +250 -250 Expense

Chapter LO 7 Analyze the effects of business transactions

1-29
on the accounting equation.
 Transactions (Problem)
8. Provided $750 of repair services on account.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense
7. +250 -250 Expense
8. +750 +750 Revenue

Chapter LO 7 Analyze the effects of business transactions

1-30
on the accounting equation.
 Transactions (Problem)
9. Collected $120 cash for services previously billed.
Assets Liabilities Equity
Accounts Accounts Barone,
Cash + Receivable + Equipment = Payable + Capital
1. +10,000 +10,000 Investment
2. -5,000 +5,000
3. -400 -400 Expense
4. +5,100 +5,100 Revenue
5. -1,000 -1,000 Drawings
6. -2,000 -2,000 Expense
7. +250 -250 Expense
8. +750 +750 Revenue
9. +120 -120
6,820 + 630 + 5,000 = 250 + 12,200
Chapter LO 7 Analyze the effects of business transactions
1-31
on the accounting equation.
 Financial Statements

Companies prepare four financial statements from

the summarized accounting data:

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

Chapter
1-32 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
1-33 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements

Income Statement
Ba rone ’s Re pa ir S hop
Reports the revenues
Incom e S ta te m e nt
For th e M o nth Ended M ay 31, 2008 and expenses for a
Re ve nue s: specific period of time.
S ervice revenue $ 5 ,8 5 0
Expe nse s: Net income – revenues
S alary expense 2 ,0 0 0
exceed expenses.
Rent expense 400
Advertising expense 250
T otal expenses 2 ,6 5 0 Net loss – expenses
N e t inc om e $ 3 ,2 0 0 exceed revenues.

Chapter
1-34 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Owner’s Equity
Income Statement Statement
B a rone ’s Re pa ir S hop Ba rone’s Repa ir Shop
Incom e Sta te m e nt O wner's Equity Sta tem ent
For th e M on th End ed M ay 31, 2008 F or the M onth Ended M ay 3 1, 200 8

Re ve nue s: Ba rone's, C apita l M a y 1 $ -

Service revenue $ 5 ,8 5 0 Add: Investm ent 10 ,0 0 0
E xpe nse s: N et incom e 3 ,2 0 0
Sa lary expense 2 ,0 0 0 13 ,2 0 0
Rent expense 400 Less: D raw ings 1,0 0 0
Advertising expense 250 Ba rone's, C apita l M a y 3 1 $ 12 ,2 0 0
T otal expenses 2 ,6 5 0
N e t incom e $ 3 ,2 0 0
Net income is needed to determine
the ending balance in owner’s equity.
Chapter
1-35 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Owner’s Equity
Statement
Statement indicates the Barone ’s Re pair Shop
O wner's E quity Sta tem e nt
reasons why owner’s
F or the M ont h Ended M ay 31, 200 8
equity has increased or
Barone 's, C a pita l M a y 1 $ -
decreased during the Add: Investm ent 10 ,0 0 0
period. N et incom e 3 ,2 0 0
13 ,2 0 0
Less: D raw ings 1,0 0 0
Barone 's, C a pita l M a y 3 1 $ 12 ,2 0 0

Chapter
1-36 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Owners’ Equity
Balance Sheet Statement
Ba rone ’s Re pa ir Shop
B a rone ’s Re pa ir S h op
B a la nce S he e t
O w ne r's E qu ity S ta te m e nt
M ay 31, 2008
F or t he M ont h E nded M a y 3 1 , 2 0 0 8
A sse ts
Cash $ 6 ,8 2 0 Ba r one 's, C a p it al M a y 1 $ -
Accounts receivable 630 Add: Investm ent 1 0 ,0 0 0
E quipm ent 5 ,0 0 0 N et inc om e 3 ,2 0 0
T otal assets $ 12 ,4 5 0 1 3 ,2 0 0
Lia bilitie s Less: D ra w ings 1 ,0 0 0
Accounts payable $ 250 Ba r one 's, C a p it al M a y 3 1 $ 1 2 ,2 0 0
O w ne r's E quity
B arone's, capital 1 2 ,2 0 0
T otal liab. & equity $ 12 ,4 5 0 The ending balance in owner’s equity is
needed in preparing the balance sheet
Chapter
1-37 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements

Balance Sheet
Ba rone ’s Re pa ir Shop Reports the assets,
Ba la nce S hee t liabilities, and owner’s
M ay 31, 2008
equity at a specific date.
A sse ts
Cash $ 6 ,8 2 0
Accounts receivable 630 Assets listed at the top,
E quipm ent 5 ,0 0 0 followed by liabilities
T otal assets $ 12 ,4 5 0
and owner’s equity.
Lia bilitie s
Accounts payable $ 250
O w ne r's E quity Total assets must equal
Barone's, capital 12 ,2 0 0 total liabilities and
T otal liab. & equity $ 12 ,4 5 0
owner’s equity.
Chapter
1-38 LO 8 Understand the four financial statements and how they are prepared.
 Financial Statements
Statement of Cash Flows
Balance Sheet Ba rone ’s Re pa ir Shop
Sta te m e nt of C a sh F low s
B a rone ’s Re pa ir S hop
F or t he M onth E nded M ay 3 1 , 2 0 0 8
Ba la nce She e t
C a sh flow from ope ra ting a ctivitie s
M ay 31, 2008
Cash receipts from revenues $ 5 ,2 2 0
A sse ts
Cash pa id for expenses (2 ,4 0 0 )
Cash $ 6 ,8 2 0
Cash provided by operations 2 ,8 2 0
Accounts receivable 630 C a sh flow from inve sting a ctivitite s
E quipm ent 5 ,0 0 0 Purchase of equipm ent (5 ,0 0 0 )
T ota l assets $ 12 ,4 5 0 C a sh flow from fina ncing a ctivitie s
Lia bilitie s Investm ent by ow ners 10 ,0 0 0
Accounts payable $ 250 D raw ings by ow ners (1,0 0 0 )
O wne r's E quity Cash provided by financing 9 ,0 0 0
Barone's, capital 12 ,2 0 0 N e t incre a se in ca sh 6 ,8 2 0
T ota l liab. & equity $ 12 ,4 5 0 C a sh ba la nce , M a y 1 -
C a sh ba la nce , M a y 3 1 $ 6 ,8 2 0
Chapter
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?
Chapter
1-40 LO 8 Understand the four financial statements and how they are prepared.
B a rone ’s Re pa ir Shop
Sta te m e nt of C a sh F low s
F or the M onth E nde d M a y 3 1 , 2 0 0 8
C a sh flow f rom ope ra ting a ctivitie s
Cash receipts from custom ers $ 5 ,2 2 0
Cash pa id f or expenses (2 ,4 0 0 )
Cash provided by opera tions 2 ,8 2 0
C a sh flow f rom inve sting a ctivitie s
Purchase of equipm ent (5 ,0 0 0 )
C a sh flow f rom f ina ncing a c tivitie s
Investm ent by ow ners 10 ,0 0 0
D raw ings by ow ners (1,0 0 0 )
Cash provided by financing 9 ,0 0 0
N e t incre a se in ca sh 6 ,8 2 0
C a sh ba la nce , M a y 1 -
C a sh ba la nce , M a y 3 1 $ 6 ,8 2 0