Financial Accounting, IFRS Edition Chapter 1 Accounting in Action Financial Accounting, IFRS Edition Weygandt Kimmel Kieso

Study Objectives Explain what accounting is. Identify the users and uses of accounting. Understand why ethics is a fundamental business concept. Explain accounting standards and the measurement principles. Explain the monetary unit assumption and the economic entity assumption. State the accounting equation, and define its components. Analyze the effects of business transactions on the accounting equation. Understand the four financial statements and how they are prepared.

Accounting in Action What is Accounting? The Building Blocks of Accounting The Basic Accounting Equation Using the Accounting Equation Financial Statements Three activities Who uses accounting data? Ethics in financial reporting Accounting standards Assumptions Assets Liabilities Equity Transaction analysis Summary of transactions Income statement Retained earnings statement Statement of financial position Statement of cash flows

What is Accounting? The purpose of accounting: to identify, record, and communicate the economic events of an organization to interested users. SO 1 Explain what accounting is.

What is Accounting? Three Activities The accounting process includes Illustration 1-1 The activities of the accounting process Three Activities The accounting process includes the bookkeeping function. SO 1 Explain what accounting is.

What is Accounting? Who Uses Accounting Data External Users Internal Users Human Resources Taxing Authorities Labor Unions Finance Management Customers Creditors Marketing Regulatory Agencies Investors SO 2 Identify the users and uses of accounting.

What is Accounting? Common Questions Asked User Human Resources 1. Can we afford to give our employees a pay raise? Human Resources 2. Did the company earn a satisfactory income? Investors Should any product lines be eliminated? Management 4. Is cash sufficient to pay dividends to shareholders? Finance 5. What price for our product will maximize net income? Marketing 6. Will the company be able to pay its debts? Creditors SO 2 Identify the users and uses of accounting.

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. Recent financial scandals include: Enron (USA), Parmalat (ITA), Satyam Computer Services (IND), AIG (USA), and others. Effective financial reporting depends on sound ethical behavior. SO 3 Understand why ethics is a fundamental business concept.

The Building Blocks of Accounting Accounting Standards International Accounting Standards Board (IASB) http://www.iasb.org/ International Financial Reporting Standards (IFRS) Financial Accounting Standards Board (FASB) http://www.fasb.org/ Generally Accepted Accounting Principles (GAAP) SO 4 Explain accounting standards and the measurement principles.

The Building Blocks of Accounting Measurement Principles 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, market value is often subjective. Fair value information may be more useful. SO 4 Explain accounting standards and the measurement principles.

The Building Blocks of Accounting Measurement Principles Fair Value Principle – indicates that assets and liabilities should be reported at fair value. In determining which measurement principle to use, companies weigh the factual nature of cost figures versus the relevance of fair value. Only in situations where assets are actively traded, such as investment securities, is the fair value principle applied. SO 4 Explain accounting standards and the measurement principles.

Forms of Business Ownership The Building Blocks of Accounting 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. Corporation. Forms of Business Ownership SO 5 Explain the monetary unit assumption and the economic entity assumption.

The Building Blocks of Accounting Proprietorship Partnership Corporation Generally owned by one person. Often small service-type businesses Owner receives any profits, suffers any losses, and is personally liable for all debts. Owned by two or more persons. Often retail and service-type businesses Generally unlimited personal liability Partnership agreement Ownership divided into shares Separate legal entity organized under state corporation law Limited liability SO 5 Explain the monetary unit assumption and the economic entity assumption.

The Basic Accounting Equation Assets Liabilities Equity = + Provides the underlying framework for recording and summarizing economic events. Applies to all economic entities regardless of size. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation Assets Liabilities Equity = + Provides the underlying framework for recording and summarizing economic events. Assets Resources a business owns. Provide future services or benefits. Cash, Inventory, Equipment, etc. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation 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. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation Assets Liabilities Equity = + Provides the underlying framework for recording and summarizing economic events. Equity Ownership claim on total assets. Referred to as residual equity. Share capital and retained earnings. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation Illustration 1-7 Revenues result from business activities entered into for the purpose of earning income. Generally results from selling merchandise, performing services, renting property, and lending money. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation Illustration 1-7 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. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation Illustration 1-7 Dividends are the distribution of cash or other assets to shareholders. Reduce retained earnings Not an expense SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation Classify the following items as issuance of shares, dividends, revenues, or expenses. Then indicate whether each item increases or decreases equity. Classification Effect on Equity Rent expense Service revenue Dividends Salaries expense Expense Decrease Revenue Increase Dividends Decrease Expense Decrease Solution on notes page SO 6 State the accounting equation, and define its components.

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

Discuss product design with customer. Using The Accounting Equation Illustration: Are the following events recorded in the accounting records? Discuss product design with customer. Illustration 1-8 Purchase computer. Event Pay rent. Is the financial position (assets, liabilities, or equity) of the company changed? Criterion Record/ Don’t Record SO 7 Analyze the effects of business transactions on the accounting equation.

Using The Accounting Equation Transaction Analysis SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Transaction (1). Investment by Shareholders. Ray and Barbara Neal decides to open a computer programming service which he names Softbyte. On September 1, 2011, they invest $15,000 cash in exchange for capital shares. The effect of this transaction on the basic equation is: Solution on notes page SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Transaction (2). Purchase of Equipment for Cash. Softbyte purchases computer equipment for $7,000 cash. Solution on notes page SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Transaction (3). Purchase of Supplies on Credit. Softbyte purchases for $1,600 from Acme Supply Company computer paper and other supplies expected to last several months. Solution on notes page SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Transaction (4). Services Provided for Cash. Softbyte receives $1,200 cash from customers for programming services it has provided. Solution on notes page SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Transaction (5). Purchase of Advertising on Credit. Softbyte receives a bill for $250 from the Daily News for advertising but postpones payment until a later date. Solution on notes page SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Transaction (6). Services Provided for Cash and Credit. 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. Solution on notes page SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Transaction (7). Payment of Expenses. Softbyte pays the following Expenses in cash for September: store rent $600, salaries of employees $900, and utilities $200. Solution on notes page SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Transaction (8). Payment of Accounts Payable. Softbyte pays its $250 Daily News bill in cash. Solution on notes page SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Transaction (9). Receipt of Cash on Account. Softbyte receives $600 in cash from customers who had been billed for services [in Transaction (6)]. Solution on notes page SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Transaction (10). Dividends. The corporation pays a dividend of $1,300 in cash. Solution on notes page SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Summary of Transactions Illustration 1-10 Tabular summary of Softbyte transactions 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 Retained Earnings Statement Statement of Financial Position Statement of Cash Flows SO 8 Understand the four financial statements and how they are prepared.

Financial Statements Income Statement Reports the revenues and expenses for a specific period of time. Net income – revenues exceed expenses. Net loss – expenses exceed revenues. Illustration 1-11 Financial statements and their interrelationships SO 8 Understand the four financial statements and how they are prepared.

Financial Statements Net income is needed to determine the ending balance in retained earnings. Illustration 1-11 Financial statements and their interrelationships SO 8

Retained Earnings Statement Financial Statements Statement indicates the reasons why retained earnings has increased or decreased during the period. Illustration 1-11 Financial statements and their interrelationships SO 8 Understand the four financial statements and how they are prepared.

Financial Statements The ending balance in retained earnings is needed in preparing the statement of financial position Illustration 1-11 Financial statements and their interrelationships SO 8 Understand the four financial statements and how they are prepared.

Financial Statements Balance Sheet Illustration 1-11 Financial statements and their interrelationships SO 8 Understand the four financial statements and how they are prepared.

Financial Statements Illustration 1-11 Financial statements and their interrelationships

Statement of Cash Flows Financial Statements Statement of Cash Flows Illustration 1-11 Financial statements and their interrelationships SO 8 Understand the four financial statements and how they are prepared.

Review Question Financial Statements Which of the following financial statements is prepared as of a specific date? Balance sheet. Income statement. Retained earnings statement. Statement of cash flows. Which of the following financial statements is prepared as of a specific date? Balance sheet. Income statement. Retained earnings statement. Statement of cash flows. Solution on notes page. SO 8 Understand the four financial statements and how they are prepared.

Understanding U.S. GAAP Key Differences Accounting in Action In 2002, the U.S. Congress issued the Sarbanes-Oxley Act (SOX), which mandated certain internal controls for large public companies listed on U.S. exchanges. Debate about international companies (non-U.S.) adopting SOX-type standards centers on whether the benefits exceed the costs. The concern is that the higher costs of SOX compliance are making the U.S. securities markets less competitive. Financial frauds have occurred at companies such as Satyam Computer Services (IND), Parmalat (ITA), and Royal Ahold (NLD). They have also occurred at large U.S. companies such as Enron, WorldCom, and AIG.

Understanding U.S. GAAP Key Differences Accounting in Action IFRS tends to be less detailed in its accounting and disclosure requirements than GAAP. This difference in approach has resulted in a debate about the merits of “principles-based” (IFRS) versus “rules-based” (GAAP) standards. U.S. regulators have recently eliminated the need for foreign companies that trade shares in U.S. markets to reconcile their accounting with GAAP. GAAP is based on a conceptual framework that is similar to that used to develop IFRS.

Understanding U.S. GAAP Key Differences Accounting in Action The three common forms of business organization that are presented in the chapter, proprietorships, partnerships, and corporations, are also found in the United States. Because the choice of business organization is influenced by factors such as legal environment, tax rates and regulations, and degree of entrepreneurism, the relative use of each form will vary across countries. Transaction analysis is basically the same under IFRS and GAAP but, as you will see in later chapters, the different standards may impact how transactions are recorded.

Understanding U.S. GAAP Looking to the Future Accounting in Action Both the IASB and the FASB are hard at work developing standards that will lead to the elimination of major differences in the way certain transactions are accounted for and reported. Consider, for example, that as a result of a joint project on the conceptual framework, the definitions of the most fundamental elements (assets, liabilities, equity, revenues, and expenses) may actually change. However, whether the IASB adopts internal control provisions similar to those in SOX remains to be seen.

Career Opportunities APPENDIX Public accounting Private accounting Government Forensic accounting “Show me the Money” SO 9 Explain the career opportunities in accounting.

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