Accounting Principles

Second Canadian Edition

Weygandt Kieso Kimmel Trenholm

Carole Bowman, Sheridan College

Prepared by:

CHAPTER

1
ACCOUNTING IN ACTION

ILLUSTRATION 1-1

THE ACCOUNTING PROCESS

Communication Identification Recording
Account ing Reports

Prepare accounting reports

Select economic events (transactions)

Record, classify, and summarize

SOFTBYTE
Annual Report

Analyse and interpret for users

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 employees 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?

How does the company compare in size and profitability with its competitors?
What do we do if they catch us?

Will the company be able to pay its debts as they come due?

BOOKKEEPING DISTINGUISHED FROM ACCOUNTING

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

THE ACCOUNTING PROFESSION

Public accountants offer their expertise 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, labour unions, colleges/universities, and charities.

ILLUSTRATION 1-4

ETHICS
Ethics

Standards of conduct

To Solve Ethical Dilemma 1. Recognize situation and ethical issues involved 2. Identify and analyse elements 3. Identify alternatives and weigh effects on stakeholders

GAAP
Generally Accepted Accounting Principles Primarily established by the Canadian Institute of Chartered Accountants Cost Principle The cost principle dictates that assets are recorded at their cost. Cost is the value exchanged at the time something is acquired. Cost is used because it is both relevant and reliable.

ASSUMPTIONS
1. Going Concern - assumes organization will

continue into foreseeable future. 2. Monetary Unit - only transaction data that can be expressed in terms of money is included in the accounting records. 3. Economic Entity - includes any organization or unit in society.

BUSINESS ENTERPRISES

A business owned by one person is generally a proprietorship (owners equity). A business owned by two or more persons associated as partners is a partnership (partners equity). A business organized as a separate legal entity under corporation law and having ownership divided into transferable shares is called a corporation (shareholders equity).

ILLUSTRATION 1-5

BASIC ACCOUNTING EQUATION

The Basic Accounting Equation

Assets

Liabilities

Owners Equity

ASSETS AS A BUILDING BLOCK

Assets are resources owned by a business. They are things of value used in carrying out such activities as production and exchange.

LIABILITIES AS A BUILDING BLOCK

Liabilities are claims against assets. They are existing debts and obligations.

OWNERS EQUITY AS A BUILDING BLOCK

Owners Equity is equal to total assets minus total liabilities. Owners Equity represents the ownership claim on total assets. Subdivisions of Owners Equity: 1. Capital 2. Drawings 3. Revenues 4. Expenses

INVESTMENTS BY OWNERS AS A BUILDING BLOCK

Investments by owner are the assets put into the business by the owner. These investments in the business increase owners equity.

DRAWINGS AS A BUILDING BLOCK

Drawings are withdrawals of cash or other assets by the owner for personal use. Drawings decrease total owners equity.

REVENUES AS A BUILDING BLOCK

Revenues are the gross increases in owners 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 owners equity that result from operating the business. Expenses are the cost of assets consumed or services used in the process of earning revenue. Examples of expenses include utility expense, rent expense, and supplies expense.

ILLUSTRATION 1-6

INCREASES AND DECREASES IN OWNERS EQUITY

INCREASES
Investments by Owner

DECREASES
Owners Equity
Withdrawals by Owner

Revenues

Expenses

TRANSACTION ANALYSIS
Marc Doucet decides to open a computer programming service.

BANK

Softbyt e

TRANSACTION ANALYSIS

TRANSACTION 1
On September 1, he invests $15,000 cash in the business, which he names Softbyte.
Trans. # Cash 15,000 Assets Supplies = Liabilities + Owner's Equity Accounts M. Doucet, Equipment Payable Capital = 15,000 Investment

(1)

There is an increase in the asset Cash, $15,000, and an equal increase in the owners equity, M. Doucet, Capital, $15,000.

TRANSACTION ANALYSIS

TRANSACTION 2
Softbyte purchases computer equipment for $7,000 cash.
Trans. # Assets Cash Supplies 15,000 (7,000) 8,000 + = Liabilities + Owner's Equity Accounts M. Doucet, Equipment Payable Capital 15,000 Investment 7,000 7,000 = 15,000

(2) Balance

Cash is decreased $7,000, and the asset Equipment is increased $7,000.

TRANSACTION ANALYSIS

TRANSACTION 3
Softbyte purchases computer paper and supplies expected to last several months from Chuah Supply Company for $1,600 on account.
Trans. # = Liabilities + Owner's Equity = Liabilities + Owner's Accounts M. Doucet, Accounts M. Cash Supplies Equipment Payable Capital Equipment 8,000 7,000 15,000 8,000 7,000 15,000 1,600 1,600 8,000 + 1,600 + 7,000 = 1,600 + 15,000 Assets

Balance (3) Balance

The asset Supplies is increased $1,600, and the liability Accounts Payable is increased by the same amount.

TRANSACTION ANALYSIS

TRANSACTION 4
Softbyte receives $1,200 cash from customers for programming services it has provided.
Trans. # = Liabilities + Owner's Equity Accounts M. Doucet, Cash Supplies Equipment Payable Capital 8,000 1,600 7,000 1,600 15,000 1,200 1,200 Service Revenue 9,200 + 1,600 + 7,000 = 1,600 + 16,200 Assets

Balance (4) Balance

Cash is increased $1,200, and M. Doucet, Capital is increased $1,200.

TRANSACTION ANALYSIS

TRANSACTION 5
Softbyte receives a bill for $250 for advertising its business but pays the bill on a later date.
Trans. #
= Liabilities + Owner's Equity Owner's Accounts M. Doucet, Cash Supplies Equipment Payable Capital 9,200 + 1,600 + 7,000 = 1,600 + 16,200 1,600 7,000 1,600 16,200 250 (250) Advertising Expense 9,200 1,600 7,000 1,850 15,950 Assets

Balance (5) Balance

Accounts Payable is increased $250, and M. Doucet, Capital is decreased $250.

TRANSACTION ANALYSIS

TRANSACTION 6
Softbyte provides programming services of $3,500 for customers and receives cash of $1,500, with the balance payable on account.
Trans. # # Cash 9,200 9,200 1,500 10,700 Assets = Liabilities + = Liabilities + Owner's Equity Owner's Account Account Accounts Accounts M. Doucet, M. Doucet, Receivable Supplies Receivable Supplies Equipment Equipment Payable Payable Capital Capital + + 0 + 0 + 1,600 + 1,600 + 7,000 = 7,000 = 1,850 1,850 15,950 15,950 2,000 3,500 Service Revenue 2,000 1,600 7,000 1,850 19,450

Balance Balance (6) Balance

Cash is increased $1,500; Accounts Receivable is increased $2,000; and M. Doucet, Capital is increased $3,500.

TRANSACTION ANALYSIS

TRANSACTION 7
Expenses paid in cash for September are store rent, $600, salaries of employees, $900, and utilities, $200.
Trans. # Cash 10,700 (600) (900) (200) 9,000 + Assets Account Receivable Supplies 2,000 1,600 = Liabilities + Owner's Equity Accounts M. Doucet, Equipment Payable Capital 7,000 1,850 19,450 (600) Rent Exp. (900) Salaries Exp. (200) Utilities Exp. 1,600 + 7,000 = 1,850 + 17,750

Balance (7)

Balance

2,000 +

Cash is decreased $1,700 and M. Doucet, Capital is decreased the same amount.

TRANSACTION ANALYSIS

TRANSACTION 8
Softbyte pays its advertising bill of $250 in cash.

Trans. # Balance Balance (8) Balance Cash Cash 9,000 9,000 (250) 8,750 +

AccountAssets Account Receivable Supplies Receivable Supplies 2,000 1,600 2,000 1,600 2,000 + 1,600 +

Equipment Equipment 7,000 7,000 7,000

= Liabilities + M. Doucet, Owner's Equity Accounts Accounts M.Capital Doucet, Payable Payable Capital 1,850 17,750 1,850 17,750 (250) = 1,600 + 17,750

Cash is decreased $250 and Accounts Payable is decreased the same amount.

TRANSACTION ANALYSIS

TRANSACTION 9
The sum of $600 in cash is received from customers who have previously been billed for services in Transaction 6.
Trans. # Assets = Liabilities + Owner's Equity Account Accounts M. Doucet, Cash Receivable Supplies Equipment Payable Capital 8,750 + 2,000 + 1,600 + 7,000 = 1,600 + 17,750 600 (600) 9,350 + 1,400 + 1,600 + 7,000 = 1,600 + 17,750

Balance (9) Balance

Cash is increased $600 and Accounts Receivable is decreased by the same amount.

TRANSACTION ANALYSIS

TRANSACTION 10
Marc Doucet withdraws $1,300 in cash from the business for his personal use.
Trans. # Cash 9,350 (1,300) 8,050 = Liabilities + Owner's Equity Liabilities + Owner's Account Accounts M. Doucet, Accounts M. Doucet, Receivable Supplies Equipment Payable Capital Equipment Payable Capital 1,400 1,600 7,000 1,600 17,750 1,600 7,000 1,600 17,750 (1,300) Doucet, Drawings + 1,400 + 1,600 + 7,000 = 1,600 + 16,450 Assets

Balance (10) Balance

Cash is decreased $1,300 and M. Doucet, Capital is decreased by the same amount.

FINANCIAL STATEMENTS
After transactions are identified, recorded, and summarized, four 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 of a company for a specific period of time. 2. A statement of owners equity summarizes the changes in owners equity for a specific period of time.

FINANCIAL STATEMENTS
In addition to the income statement and statement of owners equity, two additional statements are prepared: 3. A balance sheet reports the assets, liabilities, and owners equity of a business enterprise at a specific date. 4. A cash flow statement summarizes information concerning the cash inflows (receipts) and outflows (payments) for a specific period of time. The notes are an integral part of the financial statements.

ILLUSTRATION 1-10
FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS
SOFTBYTE Income Statement For the Month Ended September 30, 2002 Revenues Service revenue $ 4,700 Expenses Salaries expense $ 900 Rent expense 600 Advertising expense 250 Utilities expense 200 Total expenses 1,950 Net income $ 2,750

Net income of $2,750 shown on the income statement is added to the beginning balance of owners capital in the statement of owners equity.

ILLUSTRATION 1-10

FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

SOFTBYTE Statement of Owner's Equity For the Month Ended September 30, 2002 M. Doucet, Capital, September 1 Add: Investments Net income Less: Drawings M. Doucet, Capital September 30 $ $ 15,000 2,750 -

17,750 $ 17,750 1,300 $ 16,450

Net income of $2,750 is carried forward from the income statement to the statement of owners equity. The owners capital of $16,450 at the end of the reporting period is shown as the final total of the owners equity column of the Summary of Transactions (Illustration 1-9 in text).

ILLUSTRATION 1-10

FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

Owners capital of $16,450 at the end of the reporting period shown in the statement of owners equity is also shown on the balance sheet. Cash of $8,050 on the balance sheet is reported on the cash flow statement.
SOFTBYTE Balance Sheet September 30, 2002 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities and Owner's Equity Liabilities Accounts payable Owner's Equity M. Doucet, Capital Total liabilities and owner's equity $ 1,600 $ 8,050 1,400 1,600 7,000 $ 18,050

16,450 $ 18,050

ILLUSTRATION 1-10

FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS

Cash of $8,050 on the balance sheet and cash flow statement is shown as the final total of the cash column of the Summary of Transactions (Illustration 1-9 in text).
SOFTBYTE Cash Flow Statement For the Month Ended September 30, 2002 Cash flows from operating activities Cash receipts from customers $ 3,300 Cash payments to suppliers and employees (1,950) Net cash provided by operating activities Cash flows from investing activities Purchase of equipment $ (7,000) Net cash used by investing activities Cash flows from financing activities Investments by owner $ 15,000 Drawings by owner (1,300) Net cash provided by financing activities Net increase in cash Cash, September 1 Cash, September 30

$ 1,350

(7,000)

13,700 $ 8,050 $ 8,050

USING THE INFORMATION IN THE FINANCIAL STATEMENTS

Annual Reports

Non-financial information

Financial information

COPYRIGHT

Copyright 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.