CHAPTER1

Accounting in
Action

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Chapter 1: Accounting in action
What is accounting?

The building blocks of accounting

The basic accounting equation

Using the accounting equation

Financial Statements

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What is Accounting?

The Three basic activities of accounting &

The Purpose of accounting is to:
1. identify,
2. record, and
3. communicate
the economic events of an organization to interested users.

SO 1 Explain what accounting is.3

What is accounting?

Identify Record Communicate

 Relevant to  Bookkeeping  Financial
business Statements

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 What is accounting?
Illustration 1-1
Three Activities Accounting process

The accounting process includes

the bookkeeping function.

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 Who Uses Accounting Data?

Various Department:
Finance, Marketing,
Internal User
Human resource, Top
management
Users of accounting
data

Investors, Creditors, Tax

External User authorities, Customers,
Labor Unions, SEC

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 Who Uses Accounting Data?
Common Questions Asked User

1. Can we afford to give our

Human Resources
employees a pay raise?
2. Did the company earn a
Investors
satisfactory income?
3. Do we need to borrow in the
Management
near future?
4. Is cash sufficient to pay
Finance
dividends to the stockholders?
5. What price for our product
Marketing
will maximize net income?
6. Will the company be able to
Creditors
pay its short-term debts?

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Building blocks of accounting

Ethics in Financial Generally Accepted

reporting Accounting Principles
- Sarbanes-Oxley Act - Standard setting bodies
2002 - Measurement Principles

Assumptions
- Forms of business
ownerships

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 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.

 Congress passed Sarbanes-Oxley Act of 2002.

 Effective financial reporting depends on sound ethical

behavior.

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Building blocks of accounting
Sarbanes-Oxley Act 2002
 Reduce unethical behavior

 Top management has to certify accuracy of

financial information

 Severe penalties for fraud

 Increased independence of outside auditors

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 Building blocks of accounting
Generally Accepted Accounting Principles (GAAP) - A set of
rules and practices, that the accounting profession recognizes as a
general guide for financial reporting purposes.

Which is generally accepted & universally practiced.

Standard-setting bodies determine these guidelines:

► Securities and Exchange Commission (SEC)

► Financial Accounting Standards Board (FASB)

► International Accounting Standards Board (IASB)

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 Building blocks of accounting
Measurement Principles

Cost Principle – Or historical cost principle, dictates that

companies record assets at their cost.

Fair Value Principle – Indicates that assets and liabilities

should be reported at fair value (the price received to sell an
asset or settle a liability).

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 Building blocks of accounting
Assumptions
Monetary Unit – include in the accounting records only
transaction data that can be expressed in terms of money.

Economic Entity – requires that activities of the entity be

kept separate and distinct from the activities of its owner and
all other economic entities.
 Proprietorship.
Forms of Business
 Partnership.
Ownership
 Corporation.

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 Building blocks of accounting
Forms of business ownership
Proprietorship Partnership Corporation

 Generally owned by  Owned by two or more  Ownership divided into

one person. persons. shares of stock

 Often small service-  Separate legal entity

 Often retail and service-
organized under state
type businesses type businesses corporation law
 Owner receives any  Generally unlimited  Limited liability of
profits, suffers any personal liability shareholders
losses, and is  Transferrable ownership
 Partnership agreement
personally liable for
 Ex- retail and service  Unlimited life of
all debts.
corporation.
type, including
 Ex-Small service-  Ex- large enterprises
professional practices
type businesses like-General Motors,
(lawyers, doctors,
(beauty salons), and Wal-Mart, Citigroup, and
architects, and certified
small retail stores Microsoft 14
public accountants).
Basic accounting Equation
Owner’s Equity
Assets = Liabilities +

The accounting equation Provides the underlying framework for recording

and summarizing economic events.

The two basic elements of a business are what it owns and what it owes.

In essence, a business uses liabilities and shareholders' equity to obtain

sufficient funding for the assets its needs to operate.

Assets are claimed by either creditors or owners.

Claims of creditors must be paid before ownership claims.

 The basic accounting formula must balance at all times. If not, then a
transaction was entered incorrectly, and must be corrected before
financial statements can be issued. 15
Basic accounting Equation
Owner’s Equity
Assets = Liabilities +

Provides the underlying framework for recording and summarizing

economic events.

Assets

Resources a business owns.

Provide future services or benefits.
Cash, Supplies, Accounts receivable, inventory, and fixed assets
(Furniture, Equipment, Land) etc.

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Basic accounting Equation
Owner’s Equity
Assets = Liabilities +

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(An example of a accounts payable is- the due
amount of any purchase that must be paid to the supplier),
Notes payable (An example of a notes payable is- a loan issued to a
company by a bank.(interest involved)), etc.
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Basic accounting Equation
Owner’s Equity
Assets = Liabilities +

Provides the underlying framework for recording and summarizing

economic events.

Owner’s Equity

Ownership claim on total assets.

Referred to as residual equity.
Capital (investments), Drawings, etc.

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Basic accounting Equation
Liabilities:-
Outsider’s
claims against
assets;
borrowings;
payables Asset:-
Resources a
business owns
that have capacity
to provide future
services or
benefits
Owner’s
Equity:-
Owner’s claim
on assets

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Basic accounting equation
 Owner’s Equity increases with
◦ Investment (Capital): When owner puts in
cash in the business
◦ Revenues: Anything coming into the business
due to business activity.
 Owner’s Equity decreases with
◦ Drawings: When owners withdraw cash
from business
◦ Expenses: Costs of assets and services
consumed or used
Investment or
Capital
Liabilities – Drawings Assets
+ Revenues
- Expenses

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 Owners’ Equity
Illustration 1-6

Revenues result from business activities entered into for the purpose of
earning income.
Common sources of revenue are: sales, fees, services, commissions, interest,
dividends, royalties, and rent.

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 Owners’ Equity
Illustration 1-6

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.
Expenses - reduce net income, decrease equity
Revenues - increase net income, increase equity
Shareholder investments in capital stock - increase equity 22
 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.

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Transactions (Question?)
Q1-15: Are the following events recorded in the accounting records?

Owner
Supplies are An employee withdraws
Event cash for
purchased is hired.
on account. personal use.

Criterion Is the financial position (assets, liabilities, or

owner’s equity) of the company changed?

Record/ Don’t
Record

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 Using the accounting equation
Transaction (1): Ray Neal decides to open a computer programming
service which he names Softbyte. On September 1, 2012, Ray Neal
invests $15,000 cash in the business.

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 Using the accounting equation
Transaction (2): Purchase of Equipment for Cash. Softbyte purchases
computer equipment for $7,000 cash.

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 Using the accounting equation
Transaction (3): Softbyte purchases for $1,600 from Acme Supply
Company computer paper and other supplies expected to last several
months. The purchase is made on account.

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 Using the accounting equation
Transaction (4): Softbyte receives $1,200 cash from customers for
programming services it has provided.

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 Using the accounting equation
Transaction (5): Softbyte receives a bill for $250 from the Daily News
for advertising but postpones payment until a later date.

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 Using the accounting equation
Transaction (6): 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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 Using the accounting equation
Transaction (7): Softbyte pays the following expenses in cash for
September: store rent $600, salaries of employees $900, and utilities
$200.

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 Using the accounting equation
Transaction (8): Softbyte pays its $250 Daily News bill in cash.

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 Using the accounting equation
Transaction (9): Softbyte receives $600 in cash from customers who
had been billed for services [in Transaction (6)].

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 Using the accounting equation
Transaction (10): Ray Neal withdraws $1,300 in cash from the
business for his personal use.

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Using the accounting equation
Illustration 1-8
Tabular summary of
Softbyte transactions

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 Financial Statements

Companies prepare four financial statements :

Income Owner’s Equity Statement of

Balance Sheet
Statement Statement Cash Flows

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 Financial Statements
• Income Statement: Presents the revenues and expenses and resulting net
income or net loss for a specific period of time.
• Owner’s Equity Statement: Summarizes the changes in the owner’s equity
for a specific period of time.

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Financial Statements
• Balance Sheet: Reports the assets, liabilities, and owner’s equity at a specific
date. It ensures that the accounting equation is maintained.

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Financial Statements
Statement of Cash Flows: Summarizes
information about the cash inflows (receipts) and
outflows (payments) 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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Financial Statements
Statement of Cash Flows
Balance Sheet Barone’s Repair Shop
Statement of Cash Flows
Barone’s Repair Shop
For the Month Ended May 31, 2008
Balance Sheet
Cash flow from operating activities
May 31, 2008
Cash receipts from revenues $ 5,220
Assets
Cash paid for expenses (2,400)
Cash $ 6,820 Cash provided by operations 2,820
Accounts receivable 630 Cash flow from investing activitites
Equipment 5,000 Purchase of equipment (5,000)
Total assets $12,450 Cash flow from financing activities
Liabilities Investment by owners 10,000
Accounts payable $ 250 Drawings by owners (1,000)
Owner's Equity Cash provided by financing 9,000
Barone's, capital 12,200 Net increase in cash 6,820
Total liab. & equity $12,450 Cash balance, May 1 -
Cash balance, May 31 $ 6,820

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Financial Statements
Information for a specific Statement of Cash Flows
period of time. Barone’s Repair Shop
Statement of Cash Flows
Answers the following: For the Month Ended May 31, 2008
Cash flow from operating activities
Cash receipts from customers $ 5,220
1. Where did cash come Cash paid for expenses (2,400)
from? Cash provided by operations 2,820
Cash flow from investing activities
2. What was cash used Purchase of equipment (5,000)
Cash flow from financing activities
for? Investment by owners 10,000
Drawings by owners (1,000)
3. What was the change Cash provided by financing 9,000
in the cash balance? Net increase in cash 6,820
Cash balance, May 1 -
Cash balance, May 31 $ 6,820

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Financial Statements
Review Question
Which of the following financial statements is
prepared as of a specific date?
a. Balance sheet.
b. Income statement.
c. Owner's equity statement.
d. Statement of cash flows.

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