A ccounting Principles, 6e Weygandt, Kieso, & Kimmel John Wiley & Sons, Inc. Prepared by Marianne Bradford, Ph. D. Bryant College

1 Explain what accounting is. 2 Identify the users and uses of accounting. 3 Understand why ethics is a fundamental business concept. 4 Explain the meaning of generally accepted accounting principles and the cost principle. After studying this chapter, you should be able to: CHAPTER 1 ACCOUNTING IN ACTION

5 Explain the meaning of the monetary unit assumption and the economic entity assumption. 6 State the basic accounting equation and explain the meaning of assets, liabilities, and owner’s equity. 7 Analyze the effect of business transactions on the basic accounting equation. 8 Understand what the four financial statements are and how they are prepared. CHAPTER 1 ACCOUNTING IN ACTION After studying this chapter, you should be able to:

PREVIEW OF CHAPTER 1 Accounting In Action What is Accounting? Who uses accounting data? Brief history of accounting Bookkeeping and accounting Accounting and you The accounting profession

PREVIEW OF CHAPTER 1 Accounting In Action The Building Blocks of Accounting Ethics - a fundamental business concept Generally accepted accounting principles Assumptions Basic accounting equation

PREVIEW OF CHAPTER 1 Accounting In Action Using the Building Blocks Transaction analysis Summary of transactions

PREVIEW OF CHAPTER 1 Accounting In Action Financial Statements Income Statement Owner’s Equity Statement Balance Sheet Statement of Cash Flows

STUDY OBJECTIVE 1 Explain what accounting is.

Accounting is an information system that 1) identifies, 2) records, and 3) communicates the economic events of an organization to interested users WHAT IS ACCOUNTING?

Identification Select economic events (transactions) Recording Record, classify and summarize Accounting Reports SOFTBYTE Annual Report Prepare accounting reports Analyze and interpret for users Communication ILLUSTRATION 1-1 THE ACCOUNTING PROCESS

STUDY OBJECTIVE 2 Identify the users and uses of accounting.

ILLUSTRATION 1-2 QUESTIONS ASKED BY INTERNAL USERS Is cash sufficient to pay bills? What is the cost of manufacturing each unit of product? Can we afford to give employee pay raises this year? Which product line is the most profitable?

ILLUSTRATION 1-3 QUESTIONS ASKED BY EXTERNAL USERS Is the company earning satisfactory income? Will the company be able to pay its debts as they come due? How does the company compare in size and profitability with its competitors? What do we do if they catch us?

Accounting 1 Includes bookkeeping 2 Also includes much more Bookkeeping 1 Involves only the recording of economic events 2 Is just one part of accounting BOOKKEEPING DISTINGUISHED FROM ACCOUNTING

THE ACCOUNTING PROFESSION Public accountants offer expert service to the general public through the services they perform. Private accountants are employees of individual companies and are involved in a number of activities including cost and tax accounting, systems, and internal auditing. Not for Profit accounting includes reporting and control for government units, foundations, hospitals, labor unions, colleges/universities, and charities.

ILLUSTRATION 1-4 ACCOUNTING CAREER LADDER 10+ years 6 to 8 years 2 to 4+ years Entry level Partner Public Accounting Audit Manager Senior Auditor Junior Auditor Private Accounting VP Finance and Chief Financial Officer Corporate Controller Senior Accountant Junior Accountant

STUDY OBJECTIVE 3 Understand why ethics is a fundamental business concept.

STUDY OBJECTIVE 4 Explain the meaning of generally accepted accounting principles and the cost principle.

STUDY OBJECTIVE 5 Explain the meaning of the monetary unit assumption and the economic entity assumption.

Ethics - standards of conduct by which one’s actions are judged as right or wrong, honest or dishonest. Generally Accepted Accounting Principles - primarily established by the Financial Accounting Standards Board and the Securities and Exchange Commission Assumptions 1 Monetary Unit - only transaction data that can be expressed in terms of money is included in the accounting records. 2 Economic Entity - includes any organization or unit in society. THE BUILDING BLOCKS OF ACCOUNTING

BUSINESS ENTERPRISES A business owned by one person is generally a proprietorship. A business owned by two or more persons associated as partners is a partnership. A business organized as a separate legal entity under state corporation law and having ownership divided into transferable shares of stock is a corporation.

STUDY OBJECTIVE 6 State the basic accounting equation and explain the meaning of assets, liabilities, and owner’s equity.

Assets = Liabilities + Owner’s Equity ILLUSTRATION 1-6 BASIC ACCOUNTING EQUATION The Basic Accounting Equation

ASSETS AS A BUILDING BLOCK Assets are resources owned by a business. They are used in carrying out such activities as production, consumption and exchange.

LIABILITIES AS A BUILDING BLOCK Liabilities are claims against assets. They are existing debts and obligations.

Owner’s Equity is equal to total assets minus total liabilities. Owner’s Equity represents the ownership claim on total assets. Subdivisions of Owner’s Equity: 1 Capital or Investments by Owner 2 Drawing 3 Revenues 4 Expenses OWNER’S EQUITY AS A BUILDING BLOCK

INVESTMENTS BY OWNERS AS A BUILDING BLOCK Investments by Owner are the assets the owner puts in the business. These investments increase owner’s equity.

Drawings are withdrawals of cash or other assets by the owner for personal use. Drawings decrease owner’s equity. DRAWINGS AS A BUILDING BLOCK

REVENUES AS A BUILDING BLOCK Revenues are the gross increases in owner’s equity resulting from business activities entered into for the purpose of earning income. Revenues may result from sale of merchandise, performance of services, rental of property, or lending of money. Revenues usually result in an increase in an asset.

EXPENSES AS A BUILDING BLOCK Expenses are the decreases in owner’s equity that result from operating the business. They are the cost of assets consumed or services used in the process of earning revenue. Examples of expenses may be utility expense, rent expense, supplies expense, and tax expense.

ILLUSTRATION 1-7 INCREASES AND DECREASES IN OWNER’S EQUITY INCREASES DECREASES Investments by Owner Revenues Owner’s Equity Withdrawals by Owner Expenses

STUDY OBJECTIVE 7 Analyze the effect of business transactions on the basic accounting equation.

ILLUSTRATION 1-8 TRANSACTION IDENTIFICATION PROCESS Answer telephone Purchase computer Pay rent Is the financial position (assets, liabilities, and owner’s equity) of the company changed? YesNoYes Record Don’t Record Record

TRANSACTION ANALYSIS TRANSACTION 1 Ray Neal decides to open a computer programming service. On September 1, he invests $15,000 cash in the business, which he names Softbyte. BANK Softbyte

TRANSACTION ANALYSIS TRANSACTION 1 SOLUTION (1) +15,000 = +15,000 Investment There is an increase in the asset Cash, $15,000, and an equal increase in the owner’s equity, R. Neal, Capital, $15,000.

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

TRANSACTION ANALYSIS TRANSACTION 2 SOLUTION Cash is decreased $7,000, and the asset Equipment is increased $7,000. (2) -7,000 +$7,000

Softbyte purchases for $1,600 from Acme Supply Company computer paper and other supplies expected to last several months. Acme agrees to allow Softbyte to pay this bill next month, in October. This transaction is referred to as a purchase on account or a credit purchase. Softbyte Acme Supply Company TRANSACTION ANALYSIS TRANSACTION 3

TRANSACTION ANALYSIS TRANSACTION 3 SOLUTION The asset Supplies is increased $1,600, and the liability Accounts Payable is increased by the same amount. (3) +$1,600 +$1,600

Softbyte receives $1,200 cash from customers for programming services it has provided. This transaction represents the Softbyte’s principal revenue-producing activity. Softbyte TRANSACTION ANALYSIS TRANSACTION 4

TRANSACTION ANALYSIS TRANSACTION 4 SOLUTION Cash is increased $1,200, and R. Neal, Capital is increased $1,200. Assets=Liabilities+Owner’s Equity AccountsR. Neal, Cash+Supplies+Equipment=Payable+Capital Old Bal.$8,000$1,600$7,000$1,600$15,000 New Bal.$9,200+$1,600+$7,000=$1,600+$16,200 $17,800 (4) +1,200 +1,200 Service Revenue

Softbyte receives a bill for $250 from the Daily News for advertising but postpones payment of the bill until a later date. Softbyte Daily News Bill TRANSACTION ANALYSIS TRANSACTION 5

TRANSACTION ANALYSIS TRANSACTION 5 SOLUTION Accounts Payable is increased $250, and R. Neal, Capital is decreased $250. (5) Advertising Expense

Softbyte provides $3,500 of programming services for customers. Cash of $1,500 is received from customers, and the balance of $2,000 is billed on account. Softbyte Bill TRANSACTION ANALYSIS TRANSACTION 6

TRANSACTION ANALYSIS TRANSACTION 6 SOLUTION Cash is increased $1,500; Accounts Receivable is increased $2,000; and R. Neal, Capital is increased $3,500. (6) +1,500 +2,000 +3,500 Service Revenue

Expenses paid in cash for September are store rent $600, salaries of employees $900, and utilities $200. Softbyte $600 $900 $200 TRANSACTION ANALYSIS TRANSACTION 7

TRANSACTION ANALYSIS TRANSACTION 7 SOLUTION Cash is decreased $1,700 and R. Neal, Capital is decreased by the same amount. (7) -1, Rent Exp Salaries Exp Salaries Exp.

Softbyte pays its $250 Daily News advertising bill in cash. TRANSACTION ANALYSIS TRANSACTION 8 Softbyte Daily News

TRANSACTION ANALYSIS TRANSACTION 8 SOLUTION Cash is decreased $250 and Accounts Payable is decreased by the same amount. (8)

The sum of $600 in cash is received from customers who have previously been billed for services (in Transaction 6). TRANSACTION ANALYSIS TRANSACTION 9 Softbyte

TRANSACTION ANALYSIS TRANSACTION 9 SOLUTION Cash is increased $600 and Accounts Receivable is decreased by the same amount. (9)

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

TRANSACTION ANALYSIS TRANSACTION 10 SOLUTION Cash is decreased $1,300 and R. Neal, Capital is decreased by the same amount. (10) -1,300 -1,300 Drawings

STUDY OBJECTIVE 8 Understand what the four financial statements are and how they are prepared.

FINANCIAL STATEMENTS After transactions are identified, recorded, and summarized, 4 financial statements are prepared from the summarized accounting data: 1 An income statement presents the revenues and expenses and resulting net income or net loss for a specific period of time. 2 An owner’s equity statement summarizes the changes in owner’s equity for a specific period of time. 3 A balance sheet reports the assets, liabilities, and owner’s equity at a specific date. 4 A statement of cash flows summarizes information about the cash inflows (receipts) and outflows (payments) for a specific period of time.

ILLUSTRATION 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS 2,750 Net income of $2,750 shown on the income statement is added to the beginning balance of owner’s capital in the owner’s equity statement.

ILLUSTRATION 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS 2,750 Net income of $2,750 is determined from the information in the owner’s equity column of the Summary of Transactions (Illustration 1-7).

ILLUSTRATION 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS $16,450 Net income of $2,750 carried forward from the income statement to the owner’s equity statement. The owner’s capital of $16,450 at the end of the reporting period is shown as the final total of the owner’s equity column of the Summary of Transactions (Illustration 1-7).

ILLUSTRATION 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS Owner’s capital of $16,450 at the end of the reporting period shown in the owner’s equity statement is shown on the balance sheet. 16,450

ILLUSTRATION 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS Cash of $8,050 on the balance sheet is reported on the statement of cash flows.

ILLUSTRATION 1-11 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS $ 8,050 Cash of $8,050 on the balance sheet and statement of cash flows is shown as the final total of the cash column of the Summary of Transactions (Illustration 1-7).

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CHAPTER 1 ACCOUNTING IN ACTION