Financial accounting

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

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

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1-4
Ethics in
financial
reporting
Accounting
standards
Assumptions
What is
Accounting?
The Building
Blocks of
Accounting
The Basic
Accounting
Equation
Using the
Accounting
Equation
Financial
Statements
Three
activities
Who uses
accounting
data?
Assets
Liabilities
Equity
Transaction
analysis
Summary of
transactions
Income
statement
Retained
earnings
statement
Statement of
financial
position
Statement of
cash flows
Accounting in Action

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1-5
What is Accounting?
SO 1 Explain what accounting is.
The purpose of accounting:
(1) to identify, record, and communicate the economic
events of an
(2) organization to
(3) interested users.

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

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1-7
Management
Human
Resources
Taxing
Authorities
Labor
Unions
Regulatory
Agencies
Marketing
Finance
Investors
Creditors
SO 2 Identify the users and uses of accounting.
Customers
Internal
Users
External
Users
What is Accounting?
Who Uses Accounting Data

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1-8
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?
3. Should any product lines be
eliminated?
4. Is cash sufficient to pay
dividends to shareholders?
5. What price for our product will
maximize net income?
What is Accounting?
SO 2 Identify the users and uses of accounting.
6. Will the company be able to
pay its debts?
Investors
Management
Finance
Marketing
Creditors

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1-9
The Building Blocks of Accounting
Ethics In Financial Reporting
SO 3 Understand why ethics is a fundamental business concept.
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).
Effective financial reporting depends on sound ethical
behavior.

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1-10
The Building Blocks of Accounting
Ethics In Financial Reporting
SO 3 Understand why ethics is a fundamental business concept.

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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.
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.
Review Question
SO 3 Understand why ethics is a fundamental business concept.
Solution on
notes page
The Building Blocks of Accounting

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1-12
International Financial Reporting Standards (IFRS)
SO 4 Explain accounting standards and the measurement principles.
Financial Accounting Standards Board (FASB)
http://www.fasb.org/
International Accounting Standards Board (IASB)
http://www.iasb.org/
Generally Accepted Accounting Principles (GAAP)
The Building Blocks of Accounting
Accounting Standards

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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.
The Building Blocks of Accounting
Measurement Principles
SO 4 Explain accounting standards and the measurement principles.

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1-14
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.
The Building Blocks of Accounting
Measurement Principles
SO 4 Explain accounting standards and the measurement principles.

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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
Assumptions
The Building Blocks of Accounting
SO 5 Explain the monetary unit assumption and the economic entity assumption.

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1-16
Proprietorship Partnership Corporation
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
Generally owned
by one person.
Often small
service-type
businesses
Owner receives
any profits, suffers
any losses, and is
personally liable for
all debts.
SO 5 Explain the monetary unit assumption and the economic entity assumption.
The Building Blocks of Accounting

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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.
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.
Review Question
SO 5 Explain the monetary unit assumption
and the economic entity assumption.
The Building Blocks of Accounting
Solution on
notes page

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1-18
Assets Liabilities Equity
= +
Provides the underlying framework for recording and
summarizing economic events.
Applies to all economic entities regardless of size.
The Basic Accounting Equation
SO 6 State the accounting equation, and define its components.

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1-19
Assets
Provides the underlying framework for recording and
summarizing economic events.
The Basic Accounting Equation
Resources a business owns.
Provide future services or benefits.
Cash, Inventory, Equipment, etc.
Assets
Liabilities Equity
= +
SO 6 State the accounting equation, and define its components.

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1-20
Provides the underlying framework for recording and
summarizing economic events.
The Basic Accounting Equation
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.
Liabilities
Assets Liabilities
= + Equity

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1-21
Provides the underlying framework for recording and
summarizing economic events.
The Basic Accounting Equation
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.
Equity
Assets Liabilities Equity
= +

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

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1-23
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.
Illustration 1-7
SO 6 State the accounting equation, and define its components.
The Basic Accounting Equation

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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
Illustration 1-7

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

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

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

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1-28 SO 7 Analyze the effects of business transactions on the accounting equation.
Using The Accounting Equation
Transaction Analysis

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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:
Transactions Analysis
Solution on
notes page
SO 7 Analyze the effects of business transactions
on the accounting equation.

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1-30
Transaction (2). Purchase of Equipment for Cash. Softbyte
purchases computer equipment for $7,000 cash.
Transactions Analysis
Solution on
notes page
SO 7 Analyze the effects of business transactions
on the accounting equation.

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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.

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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.

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1-33
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.

34. Slide
1-34
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.

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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.

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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.

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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.

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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.

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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.

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Companies prepare four financial statements from the
summarized accounting data:
Statement
of Financial
Position
Income
Statement
Statement
of Cash
Flows
Retained
Earnings
Statement
Financial Statements
SO 8 Understand the four financial statements and how they are prepared.

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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.
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.
Financial Statements
Review Question
Solution on
notes page
SO 8 Understand the four financial statements and how they are prepared.

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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.

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

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

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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.

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

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Financial
Statements
Illustration 1-11
Financial statements and
their interrelationships

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Financial Statements
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?
Statement of Cash Flows
SO 8 Understand the four financial statements and how they are prepared.

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1-49
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.

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1-50 SO 8 Understand the four financial statements and how they are prepared.
Answer on
notes page

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

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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.
Accounting in Action
Understanding U.S. GAAP
Key Differences

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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.
Accounting in Action
Understanding U.S. GAAP
Key Differences

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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.
Accounting in Action
Understanding U.S. GAAP
Key Differences

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Looking to the Future
Understanding U.S. GAAP
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.

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

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