Topic

Accounting in Action

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Study Objectives
1. 2. 3. 4. 5. 6. 7. 8. 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.

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Accounting in Action

What is Accounting?

The Building Blocks of Accounting Ethics in financial reporting Accounting standards Assumptions

The Basic Accounting Equation Assets Liabilities Equity

Using the Accounting Equation Transaction analysis Summary of transactions

Financial Statements

Three activities Who uses accounting data?

Income statement Retained earnings statement Statement of financial position Statement of cash flows

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What is Accounting?
The purpose of accounting:
(1)

to identify record and communicate the economic identify, record, events of an

(2) (3)

organization to interested users.

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SO 1 Explain what accounting is.

What is Accounting?
Three Activities
Illustration 1-1 The activities of the accounting process

The accounting process includes the bookkeeping function.

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SO 1 Explain what accounting is.

What is Accounting?
Who Uses Accounting Data
Internal Users
Finance Management Customers Creditors Marketing Regulatory Agencies Human Resources Taxing Authorities Labor Unions

External Users

Investors

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SO 2 Identify the users and uses of accounting.

What is Accounting?
Common Questions Asked
1. Can we afford to give our employees a pay raise? 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? 6. Will the company be able to pay its debts?
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User Human Resources Investors Management Finance Marketing Creditors

SO 2 Identify the users and uses of accounting.

The Building Blocks of Accounting

Ethics In Financial Reporting
Standards of conduct by which ones 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.
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SO 3 Understand why ethics is a fundamental business concept.

The Building Blocks of Accounting

Ethics In Financial Reporting

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SO 3 Understand why ethics is a fundamental business concept.

The Building Blocks of Accounting

Review Question
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.

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Solution on notes page

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)

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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.

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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.

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SO 4 Explain accounting standards and the measurement principles.

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.
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Forms of Business Ownership

SO 5 Explain the monetary unit assumption and the economic entity assumption.

The Building Blocks of Accounting

Proprietorship
Generally owned by one person. Often small service-type businesses Owner receives any profits, suffers any losses, and is personally liable for all debts.
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Partnership
Owned by two or more persons. Often retail and service-type businesses Generally unlimited personal liability Partnership agreement

Corporation
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 Building Blocks of Accounting

Review Question
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.

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Solution on notes page

SO 5 Explain the monetary unit assumption and the economic entity assumption.

The Building Blocks of Accounting

Review Question
A business organized as a separate legal entity under state law having ownership divided into shares is a a. proprietorship. b. partnership. c. corporation. d. sole proprietorship.

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Solution on notes page

SO 5 Explain the monetary unit assumption and the economic entity assumption.

The Building Blocks of Accounting

Indicate whether each of the following statements presented below is true or false. 1. The three steps in the accounting process are identification, recording, and communication. 2. The two most common types of external users are investors and company officers. 3. Shareholders in a corporation enjoy limited legal liability as compared to partners in a partnership.

True False True

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Solution on notes page

SO 5 Explain the monetary unit assumption and the economic entity assumption.

The Building Blocks of Accounting

Indicate whether each of the following statements presented below is true or false. 4. The primary accounting standard-setting body outside the United States is the International Accounting Standards Board (IASB). 5. The cost principle dictates that companies record assets at their cost. In later periods, however, the fair value of the asset must be used if fair value is higher than its cost.

True

False

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Solution on notes page

SO 5 Explain the monetary unit assumption and the economic entity assumption.

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Answer on notes page

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.

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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.
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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.
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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.
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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.
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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.
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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

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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 1. Rent expense 2. Service revenue 3. Dividends 4. Salaries expense
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Effect on Equity Decrease Increase Decrease Decrease

Expense Revenue Dividends Expense

SO 6

State the accounting equation, and define its components.

Using The Accounting Equation

Transactions are a businesss 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.

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SO 7

Analyze the effects of business transactions on the accounting equation.

Using The Accounting Equation

Illustration: Are the following events recorded in the accounting records? Illustration 1-8 Event
Purchase computer. Discuss product design with customer. Pay rent.

Criterion

Is the financial position (assets, liabilities, or equity) of the company changed?

Record/ Dont Record

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SO 7

Analyze the effects of business transactions on the accounting equation.

Using The Accounting Equation

Transaction Analysis

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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:

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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)].

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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.

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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

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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

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SO 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.

Solution on notes page Slide 1-44

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. Illustration 1-11 Financial statements and Net loss expenses exceed revenues. their interrelationships
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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

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SO 8

Financial Statements

Retained Earnings Statement

Statement indicates the reasons why retained earnings has increased or decreased during the period.

Illustration 1-11 Financial statements and their interrelationships

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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 Slide 1-48

SO 8 Understand the four financial statements and how they are prepared.

Financial Statements

Balance Sheet

Illustration 1-11 Financial statements and their interrelationships

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SO 8 Understand the four financial statements and how they are prepared.

Financial Statements

Illustration 1-11 Financial statements and their interrelationships

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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?

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SO 8 Understand the four financial statements and how they are prepared.

Financial Statements

Statement of Cash Flows

Illustration 1-11 Financial statements and their interrelationships

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SO 8 Understand the four financial statements and how they are prepared.

Answer on notes page Slide 1-53

SO 8 Understand the four financial statements and how they are prepared.

Financial Statements

Review Question
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.

Solution on notes page. Slide 1-54

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.
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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.

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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.

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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.

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Career Opportunities
Public accounting Private accounting Show me the Money

APPENDIX
Government Forensic accounting

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SO 9 Explain the career opportunities in accounting.