fundamental financial accounting chapter 1

Chapter 1-1

Chapter 1-2

Accounting In Action

Accounting In Action

Financial Accounting, Sixth Edition

Chapter Chapter 11Chapter Chapter 11

Chapter 1-3

1. Explain what accounting is.

2. Identify the users and uses of accounting.

3. Understand why ethics is a fundamental business concept.

4. Explain generally accepted accounting principles and the cost principle.

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

6. State the accounting equation, and define assets, liabilities, and stockholders’ equity.

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

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

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Chapter 1-4

Accounting in ActionAccounting in ActionAccounting in ActionAccounting in Action

Ethics in Ethics in financial financial reportingreporting

Generally Generally accepted accepted accounting accounting principlesprinciples

AssumptionsAssumptions

What is What is

Accounting?Accounting?What is What is

Accounting?Accounting?

The Building The Building

Blocks of Blocks of

AccountingAccounting

The Building The Building

Blocks of Blocks of

AccountingAccounting

The Basic The Basic

Accounting Accounting

EquationEquation

The Basic The Basic

Accounting Accounting

EquationEquation

Using the Using the Basic Basic

Accounting Accounting EquationEquation

Using the Using the Basic Basic

Accounting Accounting EquationEquation

Financial Financial

StatementsStatementsFinancial Financial

StatementsStatements

Three Three activitiesactivities

Who uses Who uses accounting accounting datadata

AssetsAssets

LiabilitiesLiabilities

Stockholders' Stockholders' equityequity

Transaction Transaction analysisanalysis

Summary of Summary of transactionstransactions

Income Income statementstatement

Statement of Statement of retained retained earningsearnings

Balance Balance sheetsheet

Statement of Statement of cash flowscash flows

Chapter 1-5

What is Accounting?What is Accounting?What is Accounting?What is Accounting?

SO 1 Explain what accounting is.SO 1 Explain what accounting is.

The purpose of accounting is to:

(1)(1) identifyidentify, recordrecord, and communicatecommunicate the economic events of an

(2) organization to

(3) interested users.

Chapter 1-6

Three Activities

What is Accounting?What is Accounting?What is Accounting?What is Accounting?

SO 1 Explain what accounting is.SO 1 Explain what accounting is.

Illustration 1-1Accounting process

The accounting process includes the bookkeeping function.

Chapter 1-7

Management

Common Questions

Human Resources

IRS

Labor Unions

SEC

Marketing

Finance

Investors

Creditors

Who Uses Accounting Data?Who Uses Accounting Data?Who Uses Accounting Data?Who Uses Accounting Data?

SO 2 Identify the users and uses of accounting.SO 2 Identify the users and uses of accounting.

Customers

Internal Users

External Users

Chapter 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. Do we need to borrow in the near future?

4. Is cash sufficient to pay dividends to the stockholders?

5. What price for our product will maximize net income?


SO 2 Identify the users and uses of accounting.SO 2 Identify the users and uses of accounting.

6. Will the company be able to pay its short-term debts?

Investors

Management

Finance

Marketing

Creditors

Chapter 1-9

Discussion Question

SO 3 Understand why ethics is a fundamental business conceptSO 3 Understand why ethics is a fundamental business concept.

Q1. “Accounting is ingrained in our society and it is vital to our economic system.” Do you agree? Explain.

See notes page for discussion


Chapter 1-10

The Building Blocks of AccountingThe Building Blocks of AccountingThe Building Blocks of AccountingThe 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.

Recent financial scandals include: Enron, WorldCom, HealthSouth, AIG, and others.

Congress passed Sarbanes-Oxley Act of 2002.

Effective financial reporting depends on sound ethical behavior.

Chapter 1-11

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 QuestionReview Question

EthicsEthicsEthicsEthics


Chapter 1-12

Various users need financial information

Various users need financial information

The accounting profession has

attempted to develop a set of standards that are generally accepted and universally practiced.

Financial StatementsBalance SheetIncome StatementRetained Earnings StatementStatement of Cash FlowsNote Disclosure

Financial StatementsBalance SheetIncome StatementRetained Earnings StatementStatement of Cash FlowsNote Disclosure

Generally Generally Accepted Accepted

Accounting Accounting Principles Principles

(GAAP)(GAAP)

Generally Generally Accepted Accepted

Accounting Accounting Principles Principles

(GAAP)(GAAP)


SO 4 Explain generally accepted accounting principles and the SO 4 Explain generally accepted accounting principles and the cost principle.cost principle.

Chapter 1-13

Organizations Involved in Standard Setting:

Securities and Exchange Commission (SEC)

Financial Accounting Standards Board (FASB)

International Accounting Standards Board (IASB)SO 4 Explain generally accepted accounting principles and the SO 4 Explain generally accepted accounting principles and the

cost principle.cost principle.


http://www.fasb.org/

http://www.sec.gov/

http://www.iasb.org/

Chapter 1-14

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, whereas market value is often subjective.

Fair value information may be more useful.


SO 4 Explain generally accepted accounting principles and the SO 4 Explain generally accepted accounting principles and the cost principle.cost principle.

Chapter 1-15

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.

AssumptionsAssumptionsAssumptionsAssumptions

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

Forms of Business

Ownership

Chapter 1-16

Proprietorship

Partnership Corporation

Owned by two Owned by two or more or more persons.persons.

Often retail and Often retail and service-type service-type businessesbusinesses

Generally Generally unlimited unlimited personal liabilitypersonal liability

Partnership Partnership agreementagreement

Ownership Ownership divided into divided into shares of stockshares of stock

Separate legal Separate legal entity entity organized organized under state under state corporation lawcorporation law

Limited liabilityLimited liability

Forms of Business OwnershipForms of Business OwnershipForms of Business OwnershipForms of Business Ownership

Generally owned Generally owned by one person.by one person.

Often small Often small service-type service-type businessesbusinesses

Owner receives Owner receives any profits, any profits, suffers any suffers any losses, and is losses, and is personally liable personally liable for all debts.for all debts.


Chapter 1-17

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.

AssumptionsAssumptionsAssumptionsAssumptions



Chapter 1-18

A business organized as a separate legal entity under state law having ownership divided into shares of stock is a

a. proprietorship.

b. partnership.

c. corporation.

d. sole proprietorship.


Forms of Business OwnershipForms of Business OwnershipForms of Business OwnershipForms of Business Ownership


Chapter 1-19

AssetsAssetsAssetsAssets LiabilitiesLiabilitiesLiabilitiesLiabilitiesStockholdeStockholders’ Equityrs’ Equity

StockholdeStockholders’ Equityrs’ Equity

= +

Provides the underlying framework for recording and summarizing economic events.

Assets are claimed by either creditors or owners.

Claims of creditors must be paid before ownership claims.

The Basic Accounting EquationThe Basic Accounting EquationThe Basic Accounting EquationThe Basic Accounting Equation

SO 6 SO 6 State the accounting equation, and State the accounting equation, and define assets, liabilities, and define assets, liabilities, and stockholders’ equity.stockholders’ equity.

Chapter 1-20



Resources a business owns.

Provide future services or benefits.

Cash, Supplies, Equipment, etc.

AssetsAssetsAssetsAssets



= +


Chapter 1-21



Claims against assets (debts and obligations).

Creditors - party to whom money is owed.

Accounts payable, Notes payable, etc.

LiabilitiesLiabilitiesLiabilitiesLiabilities



= +


Chapter 1-22



Ownership claim on total assets.

Referred to as residual equity.

Paid-in Capital, Retained Earnings (Corporation).

Stockholders’ EquityStockholders’ EquityStockholders’ EquityStockholders’ Equity



= +


Chapter 1-23


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.

Illustration 1-6


Chapter 1-24

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 1-6


Chapter 1-25

Dividends are the distribution of cash or other assets to stockholders.

Dividends reduce retained earnings, however dividends are not an expense.


Illustration 1-6


Chapter 1-26

Using The Basic Accounting Using The Basic Accounting EquationEquationUsing The Basic Accounting Using The Basic Accounting EquationEquation

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

Chapter 1-27

Question:Question: Are the following events recorded in the accounting records?

Event

Supplies are

purchased on account.

Criterion

Is the financial position (assets, liabilities, or stockholders’ equity) of the company

changed?


An employee is hired.

Dividends are paid to

stockholders’.

Record/ Don’t Record

TransactionsTransactionsTransactionsTransactions

Chapter 1-28

Discussion Question

Q18. In February 2008, Paula King invested

an additional $10,000 in Hardy Company.

Hardy’s accountant, Lance Jones, recorded

this receipt as an increase in cash and

revenues. Is this treatment appropriate?

Why or why not?


TransactionsTransactionsTransactionsTransactions


Chapter 1-29

Stockholders’ Equity

P1-1A:P1-1A: Barone’s Repair Shop was started on May. Prepare a tabular analysis of the following transactions for the month of May.

Transactions (Problem)Transactions (Problem)Transactions (Problem)Transactions (Problem)

+10,000

1. +10,000

CashAccounts

Receivable Equipment

Accounts Payable

Common Stock


+ + = +

1. Stockholders invested $10,000 cash to start the repair shop.

Investment

Assets Liabilities

Chapter 1-30


+10,000

1. +10,000


2. Purchased equipment for $5,000 cash.

-5,0002. +5,000

Investment


CashAccounts


Accounts Payable

Common Stock+ + = +

Assets Liabilities

Chapter 1-31


+10,000

1. +10,000


3. Paid $400 cash for May office rent.

-5,0002. +5,000

-4003. -400


CashAccounts


Accounts Payable

Common Stock+ + = +

Assets Liabilities

Retained Earnings

Expense

+

Chapter 1-32


+10,000

1. +10,000


-5,0002. +5,000

-4003. -400


CashAccounts


Accounts Payable

Common Stock+ + = +

Assets Liabilities

Retained Earnings

+5,1004. +5,100

4. Received $5,100 from customers for repair service.

Revenue

+

Chapter 1-33


+10,000

1. +10,000


-5,0002. +5,000

-4003. -400


CashAccounts


Accounts Payable

Common Stock+ + = +

Assets Liabilities

Retained Earnings

+5,1004. +5,100

5. Paid dividends of $1,000 cash.

-1,0005. -1,000

+

Chapter 1-34


+10,000

1. +10,000


-5,0002. +5,000

-4003. -400


CashAccounts


Accounts Payable

Common Stock+ + = +

Assets Liabilities

Retained Earnings

+5,1004. +5,100

-1,0005. -1,000

6. Paid part-time employee salaries of $2,000.

-2,0006. -2,000

Expense

+

Chapter 1-35


+10,000

1. +10,000


-5,0002. +5,000

-4003. -400


CashAccounts


Accounts Payable

Common Stock+ + = +

Assets Liabilities

Retained Earnings

+5,1004. +5,100

-1,0005. -1,000

-2,0006. -2,000

Expense

7. Incurred $250 of advertising costs, on account.

+250 -2507.

+

Chapter 1-36


+10,000

1. +10,000


-5,0002. +5,000

-4003. -400


CashAccounts


Accounts Payable

Common Stock+ + = +

Assets Liabilities

Retained Earnings

+5,1004. +5,100

-1,0005. -1,000

-2,0006. -2,000

Revenue

+250 -2507.

8. Provided repair services on account to customers $750.

+7508. +750

+

Chapter 1-37

6,820 + 630 + 5,000 = 250 + 10,000 +2,200


+10,000

1. +10,000


-5,0002. +5,000

-4003. -400


CashAccounts


Accounts Payable

Common Stock+ + = +

Assets Liabilities

Retained Earnings

+5,1004. +5,100

-1,0005. -1,000

-2,0006. -2,000

+250 -2507.

+7508. +750

9. Collected $120 cash for services previously billed.

+1209. -120

+

Chapter 1-38

Companies prepare four financial statements from the summarized accounting data:Companies prepare four financial statements from the summarized accounting data:

Balance Sheet

Income Statemen

t

Statement of Cash

Flows

Retained Earnings Statemen

t

Financial StatementsFinancial StatementsFinancial StatementsFinancial Statements

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

Chapter 1-39

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.




Chapter 1-40

Income Statement



Reports the revenues and expenses for a specific period of time.

Net income – revenues exceed expenses.

Net loss – expenses exceed revenues.

Revenues:

Service revenue 5,850$

Expenses:

Salary expense 2,000

Rent expense 400

Advertising expense 250

Total expenses 2,650

Net income 3,200$

Barone’s Repair Shop

Income Statement

For the Month Ended May 31, 2007

Chapter 1-41

Revenues:

Service revenue 5,850$

Expenses:

Salary expense 2,000

Rent expense 400

Advertising expense 250

Total expenses 2,650

Net income 3,200$


Income Statement


Income Statement



Retained Earnings Statement

Net income is needed to determine the ending balance

in retained earnings.

Retained earnings, May 1 -$

Add: Net income 3,200

Less: Dividends (1,000)

Retained earnings, May 31 2,200$




Chapter 1-42




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








Chapter 1-43



Assets

Cash 6,820$

Accounts receivable 630

Equipment 5,000

Total assets 12,450$

Liabilities

Accounts payable 250$

Stockholders' Equity

Common stock 10,000

Retained earnings 2,200

Total liab. & equity 12,450$

Balance Sheet


May 31, 2007

Balance Sheet Retained Earnings Statement

The ending balance in retained earnings is needed in preparing the

balance sheet.








Chapter 1-44



Reports the assets, liabilities, and stockholders’ equity at a specific date.

Assets listed at the top, followed by liabilities and stockholders’ equity.

Total assets must equal total liabilities and stockholders’ equity.

Assets

Cash 6,820$


Equipment 5,000


Liabilities



Common stock 10,000



Balance Sheet


May 31, 2007

Balance Sheet

Chapter 1-45



Cash flow from Operations

Cash receipts f rom customers 5,220$ Cash paid f or expenses (2,400) Cash provided by operations 2,820

Cash flow from I nvesting

Purchase of equipment (5,000) Cash flow from Financing

I nvestment by owners 10,000 Drawings by owners (1,000) Cash provided by financing 9,000

Net increase in cash 6,820

Cash balance, May 1 -

Cash balance, May 31 6,820$

Statement of Cash Flows




Assets

Cash 6,820$


Equipment 5,000


Liabilities



Common stock 10,000



Balance Sheet


May 31, 2007

Balance Sheet

Chapter 1-46



Cash flow from Operations

Cash receipts f rom customers 5,220$ Cash paid f or expenses (2,400) Cash provided by operations 2,820

Cash flow from I nvesting

Purchase of equipment (5,000) Cash flow from Financing

I nvestment by owners 10,000 Drawings by owners (1,000) Cash provided by financing 9,000

Net increase in cash 6,820

Cash balance, May 1 -

Cash balance, May 31 6,820$





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?

Chapter 1-47

Which of the following financial statements is prepared as of a specific date?

a. Balance sheet.

b. Income statement.

c. Statement of stockholders’ equity.

d. Statement of cash flows.




Chapter 1-48

Discussion Question

Q19. “A company’s net income appears

directly on the income statement and the

retained earnings statement, and it is

included indirectly in the company’s balance

sheet.” Do you agree? Explain.




Chapter 1-49

Ethics: Managing Personal Financial ReportingWhen students need money for school, they often apply for financial aid. Why do the Department of Education and your school want this information?

Bottom line: The worse off you look financially, the more likely you are to get money.

Question: Should you intentionally make yourself look worse off than you are?

All About YouAll About YouAll About YouAll About You

Chapter 1-50

Some Facts:

After adjusting for inflation, private-college tuition and fees have increased 37% over the past decade; public-college tuition has risen 54%.

Two-thirds (65.6%) of undergraduate students graduate with some debt.

Among graduating seniors, the average debt load is $19,202.


Chapter 1-51


Source: College Board, Princeton Review, as reported in “College Admissions: Is Gate Open or Closed?,” Wall Street Journal, March 25, 2006, p. A7.

Chapter 1-52

To increase your chances of receiving aid, should you use available cash to pay off your credit card bills, and therefore make yourself look “worse off” to the financial aid decision makers?


What Do You Think?What Do You Think?

YES: You are simply restructuring your assets and liabilities to best conform with the preferencesthat are built into the federal aid formulas.

NO: You are taking advantage of a loophole in the federal aid rules and potentially depriving someone who is actually worse off than you from receiving aid.

Chapter 1-53

Copyright © 2008 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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fundamental financial accounting chapter 1

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