Accounting

Principles

Weygandt · Kieso · Kimmel

Prepared by:
Carole Bowman, Sheridan College
 CHAPTER

ACCOUNTING IN ACTION
 Definition of Accounting
Accounting is a financial information system that
identifies, records and communicates the economic
activities/events of a business organization to the
interested users

The basic activities of Accounting:

1. To identify the economic activities/ events of a
business org.
2. To record the economic activities/events of the
business organization in the accounting system
3. To communicate the accounting data with the users
 The users of accounting data

1. Internal users: Managers, CEO, Engineers

2. External Users: Govt, Creditors, Suppliers,

Banks, Customers, students, Academicians
 ILLUSTRATION 1-1
THE ACCOUNTING PROCESS
Communication
Identification Recording Account
ing
Reports
Ge
r
7 M a ld T r
e
Fre acCau nholm
de r l
icto y Driv
nN e
B

200
0

Prepare
accounting reports
SOFTBYTE
Select economic events Record, classify, Annual Report

(transactions) and summarize

Analyse and interpret

for users
 ILLUSTRATION 1-2
QUESTIONS ASKED BY INTERNAL USERS

What is the cost of manufacturing

Is cash sufficient to pay bills? each unit of product?

Can we afford to give employees Which product line is the most

pay raises this year? profitable?
 ILLUSTRATION 1-3
QUESTIONS ASKED BY EXTERNAL USERS

How does the company compare in

Is the company earning size and profitability with its
satisfactory income? 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
 GAAP
Generally Accepted Accounting Principles
 Primarily established by the FASB and SEC of
USA
Historical 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.
2. Revenue recognition Principle: Revenue is
recognized when it is earned no matter
whether cash has been received.
3. Matching principle/ Expense recognition:
An expense is recognized and recorded when
it makes its contribution for earning revenues
no matter whether cash has been paid.
4. Full Disclosure Principle: All important
information should be disclosed with the
users.
 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.
4. Time period: Total life of the business is
divided into small parts.
 ILLUSTRATION 1-5
BASIC ACCOUNTING EQUATION

The Basic Accounting Equation

Assets = Liabilities + Owner’s 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.
 OWNER’S EQUITY AS
A BUILDING BLOCK
 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
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
owner’s equity.
 DRAWINGS AS A
BUILDING BLOCK

 Drawings are withdrawals of cash or other

assets by the owner for personal use.
 Drawings decrease total owner’s equity.
 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.
 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
OWNER’S EQUITY

INCREASES DECREASES
Investments
Investments Withdrawals
Withdrawals
by
byOwner
Owner by
byOwner
Owner
Owner’s
Equity
Revenues
Revenues Expenses
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. # Assets = Liabilities + Owner's Equity

Accounts M. Doucet,
Cash Supplies Equipment Payable Capital
(1) 15,000 = 15,000 Investment

There
There isis an
an increase
increase inin the
the asset
asset Cash,
Cash, $15,000,
$15,000, and
and
an
an equal
equal increase
increase in
in the
the owner’s
owner’s equity,
equity, M.
M. Doucet,
Doucet,
Capital,
Capital, $15,000.
$15,000.
 TRANSACTION ANALYSIS
TRANSACTION 2

Softbyte purchases computer equipment for $7,000 cash.

Trans. # Assets = Liabilities + Owner's Equity

Accounts M. Doucet,
Cash Supplies Equipment Payable Capital
15,000 15,000 Investment
(2) (7,000) 7,000
Balance 8,000 + 7,000 = 15,000

Cash
Cash isis decreased
decreased $7,000,
$7,000, and
and the
the asset
asset
Equipment
Equipment isis increased
increased $7,000.
$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. # Assets == Liabilities

Liabilities ++ Owner's
Owner's Equity
Accounts
Accounts M.
M. Doucet,
Cash Supplies Equipment
Equipment Payable Capital
Balance 8,000
8,000 7,000
7,000 15,000
15,000
(3) 1,600 1,600
Balance 8,000 + 1,600 + 7,000 = 1,600 + 15,000

The
The asset
asset Supplies
Supplies isis increased
increased $1,600,
$1,600, and
and the
the liability
liability
Accounts
Accounts Payable
Payable isis increased
increased by
by the
the same
same amount.
amount.
 TRANSACTION ANALYSIS
TRANSACTION 4
Softbyte receives $1,200 cash from customers for
programming services it has provided.

Trans. # Assets = Liabilities + Owner's Equity

Accounts M. Doucet,
Cash Supplies Equipment Payable Capital
Balance 8,000 1,600 7,000 1,600 15,000
(4) 1,200 1,200 Service Revenue
Balance 9,200 + 1,600 + 7,000 = 1,600 + 16,200

Cash
Cash isis increased
increased $1,200,
$1,200, and
and
M.
M. Doucet,
Doucet, Capital
Capital isis increased
increased $1,200.
$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. # Assets = Liabilities + Owner's Equity

Owner's
Accounts M. Doucet,
Cash Supplies Equipment Payable Capital
Balance 9,200 + 1,600
1,600 + 7,000
7,000 = 1,600
1,600 + 16,200
16,200
(5) 250 (250) Advertising Expense
Balance 9,200 1,600 7,000 1,850 15,950

Accounts
Accounts Payable
Payable isis increased
increased $250,
$250, and
and M.
M.
Doucet,
Doucet, Capital
Capital isis decreased
decreased $250.
$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. ## Assets == Liabilities
Liabilities ++ Owner's
Owner's Equity
Account
Account Accounts
Accounts M.
M. Doucet,
Doucet,
Cash Receivable
Receivable Supplies
Supplies Equipment
Equipment Payable
Payable Capital
Capital
Balance
Balance 9,200
9,200 ++ 00 ++ 1,600
1,600 ++ 7,000
7,000 == 1,850
1,850 15,950
15,950
(6) 1,500 2,000 3,500 Service Revenue
Balance 10,700 2,000 1,600 7,000 1,850 19,450

Cash
Cash isis increased
increased $1,500;
$1,500; Accounts
Accounts Receivable
Receivable isis
increased
increased $2,000;
$2,000; and
and M.
M. Doucet,
Doucet, Capital
Capital isis
increased
increased $3,500.
$3,500.
 TRANSACTION ANALYSIS
TRANSACTION 7
Expenses paid in cash for September are store rent,
$600, salaries of employees, $900, and utilities, $200.

Trans. # Assets = Liabilities + Owner's Equity

Account Accounts M. Doucet,
Cash Receivable Supplies Equipment Payable Capital
Balance 10,700 2,000 1,600 7,000 1,850 19,450
(7) (600) (600) Rent Exp.
(900) (900) Salaries Exp.
(200) (200) Utilities Exp.
Balance 9,000 + 2,000 + 1,600 + 7,000 = 1,850 + 17,750

Cash
Cash isis decreased
decreased $1,700
$1,700 and
and M.
M. Doucet,
Doucet,
Capital
Capital isis decreased
decreased the
the same
same amount.
amount.
 TRANSACTION ANALYSIS
TRANSACTION 8
Softbyte pays its advertising bill of $250 in cash.

Trans. # AccountAssets = Liabilities

Accounts + M. Doucet,
Owner's Equity
Cash Account
Receivable Supplies Equipment Accounts
Payable M.Capital
Doucet,
Balance Cash
9,000 Receivable
2,000 Supplies
1,600 Equipment
7,000 Payable
1,850 Capital
17,750
Balance 9,000 2,000 1,600 7,000 1,850 17,750
(8) (250) (250)
Balance 8,750 + 2,000 + 1,600 + 7,000 = 1,600 + 17,750

Cash
Cash isis decreased
decreased $250
$250 and
and Accounts
Accounts
Payable
Payable isis decreased
decreased the
the same
same amount.
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
Balance 8,750 + 2,000 + 1,600 + 7,000 = 1,600 + 17,750
(9) 600 (600)
Balance 9,350 + 1,400 + 1,600 + 7,000 = 1,600 + 17,750

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

Cash
Cash isis decreased
decreased $1,300
$1,300 and
and M.
M. Doucet,
Doucet,
Capital
Capital isis decreased
decreased by
by the
the same
same amount.
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 owner’s equity summarizes the
changes in owner’s equity for a specific period
of time.
 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 owner’s capital in the statement of owner’s 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 $ 15,000
Net income 2,750 17,750
$ 17,750
Less: Drawings 1,300
M. Doucet, Capital September 30 $ 16,450

Net income of $2,750 is carried forward from the income statement to

the statement of owner’s equity. 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 1-9 in
 ILLUSTRATION 1-10
FINANCIAL STATEMENTS AND THEIR
INTERRELATIONSHIPS
Owner’s SOFTBYTE
capital of Balance Sheet
$16,450 at the September 30, 2002
end of the Assets
reporting Cash $ 8,050
period – shown Accounts receivable 1,400
in the Supplies 1,600
statement of Equipment 7,000
owner’s equity Total assets $ 18,050
– is also shown
on the balance Liabilities and Owner's Equity
sheet. Cash of Liabilities
$8,050 on the Accounts payable $ 1,600
balance sheet is Owner's Equity
reported on the M. Doucet, Capital 16,450
cash flow Total liabilities and owner's equity $ 18,050
statement.