Financial Accounting, Seventh Edition Accounting in Action Financial Accounting, Seventh Edition

Study Objectives Explain what accounting is. Identify the users and uses of accounting. Understand why ethics is a fundamental business concept. Explain generally accepted accounting principles and the measurement principle. 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.

Accounting in Action What is Accounting? The Building Blocks of Accounting The Basic Accounting Equation Using the Accounting Equation Financial Statements Three activities Who uses accounting data Ethics in financial reporting Generally accepted accounting principles Assumptions Assets Liabilities Stockholders’ equity Transaction analysis Summary of transactions Income statement Retained earnings statement Balance sheet Statement of cash flows

The purpose of accounting is to: What is Accounting? The purpose of accounting is to: identify, record, and communicate the economic events of an organization to interested users. SO 1 Explain what accounting is.

Three Activities What is Accounting? The accounting process includes Illustration 1-1 The activities of the accounting process Three Activities The accounting process includes the bookkeeping function. SO 1 Explain what accounting is.

Who Uses Accounting Data Internal Users IRS Management Investors Human Resources There are two broad groups of users of financial information: internal users and external users. Labor Unions Finance Creditors Marketing SEC Customers External Users SO 2 Identify the users and uses of accounting.

Who Uses Accounting Data 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? Investors 3. Do we need to borrow in the near future? Management 4. Is cash sufficient to pay dividends to the stockholders? Finance 5. What price for our product will maximize net income? Marketing 6. Will the company be able to pay its short-term debts? Creditors SO 2 Identify the users and uses of accounting.

Who Uses Accounting Data Discussion Question Q1. “Accounting is ingrained in our society and it is vital to our economic system.” Do you agree? Explain. Question 1 (textbook) Yes, this is correct. Virtually every organization and person in our society uses accounting information. Businesses, investors, creditors, government agencies, and not-for-profit organizations must use accounting information to operate effectively. Solution on notes page SO 3 Understand why ethics is a fundamental business concept.

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

The Building Blocks of Accounting Ethics In Financial Reporting SO 3 Understand why ethics is a fundamental business concept.

Review Question The Building Blocks of Accounting Ethics are the standards of conduct by which one's actions are judged as: right or wrong. honest or dishonest. fair or not fair. all of these options. Ethics are the standards of conduct by which one's actions are judged as: right or wrong. honest or dishonest. fair or not fair. all of these options. Solution on notes page SO 3 Understand why ethics is a fundamental business concept.

The Building Blocks of Accounting Financial Statements Balance Sheet Income Statement Statement of Owner’s Equity Statement of Cash Flows Note Disclosure Various users need financial information The accounting profession has attempted to develop a set of standards that are generally accepted and universally practiced. Generally Accepted Accounting Principles (GAAP) SO 4 Explain generally accepted accounting principles and the measurement principle.

The Building Blocks of Accounting Organizations Involved in Standard Setting: Securities and Exchange Commission (SEC) http://www.sec.gov/ Public Company Accounting Oversight Board (PCAOB) http://www.pcaobus.org/ Securities and Exchange Commission (SEC) http://www.fasb.org/ International Accounting Standards Board (IASB) http://www.iasb.org/ SO 4

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, whereas market value is often subjective. Fair value information may be more useful. SO 4 Explain generally accepted accounting principles and the measurement principle.

The Building Blocks of Accounting Measurement Principles 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). FASB indicates that most assets must follow the cost principle because market values are not representationally faithful. Only in situations where assets are actively traded, such as investment securities, is the fair value principle applied. SO 4 Explain generally accepted accounting principles and the measurement principle.

Forms of Business Ownership 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. Forms of Business Ownership SO 5 Explain the monetary unit assumption and the economic entity assumption.

Forms of Business Ownership Proprietorship Partnership Corporation Generally owned by one person. Often small service-type businesses Owner receives any profits, suffers any losses, and is personally liable for all debts. Owned by two or more persons. Often retail and service-type businesses Generally unlimited personal liability Partnership agreement Ownership divided into shares of stock Separate legal entity organized under state corporation law Limited liability SO 5 Explain the monetary unit assumption and the economic entity assumption.

Review Question The Building Blocks of Accounting Combining the activities of Kellogg and General Mills would violate the cost principle. economic entity assumption. monetary unit assumption. ethics principle. Combining the activities of Kellogg and General Mills would violate the cost principle. economic entity assumption. monetary unit assumption. ethics principle. Solution on notes page SO 5 Explain the monetary unit assumption and the economic entity assumption.

Review Question The Building Blocks of Accounting A business organized as a separate legal entity under state law having ownership divided into shares of stock is a proprietorship. partnership. corporation. sole proprietorship. A business organized as a separate legal entity under state law having ownership divided into shares of stock is a proprietorship. partnership. corporation. sole proprietorship. 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. The three steps in the accounting process are identification, recording, and communication. The two most common types of external users are investors and company officers. Congress passed the Sarbanes-Oxley Act of 2002 to reduce unethical behavior and decrease the likelihood of future corporate scandals. True False True 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. The primary accounting standard-setting body in the United States is the Financial Accounting Standards Board (FASB). 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 Solution on notes page SO 5 Explain the monetary unit assumption and the economic entity assumption.

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

The Basic Accounting Equation Assets Liabilities Stockholder’s 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. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation Assets Liabilities Stockholder’s Equity = + Provides the underlying framework for recording and summarizing economic events. Assets Resources a business owns. Provide future services or benefits. Cash, Supplies, Equipment, etc. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation Assets Liabilities Stockholder’s 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. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation Assets Liabilities Stockholder’s Equity = + Provides the underlying framework for recording and summarizing economic events. Stockholders’ Equity Ownership claim on total assets. Referred to as residual equity. Common stock and retained earnings. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation 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. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation 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. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation Illustration 1-6 Dividends are the distribution of cash or other assets to stockholders. Dividends reduce retained earnings. However, dividends are not an expense. SO 6 State the accounting equation, and define its components.

The Basic Accounting Equation Classify the following items as issuance of stock, dividends, revenues, or expenses. Then indicate whether each item increases or decreases stockholders’ equity. Effect on Equity Classification Rent expense Service revenue Dividends Salaries expense Expense Decrease Revenue Increase Dividends Decrease Expense Decrease Solution on notes page SO 6 State the accounting equation, and define its components.

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

Discuss product design with customer. Using The Accounting Equation Illustration: Are the following events recorded in the accounting records? Discuss product design with customer. Illustration 1-7 Purchase computer. Event Pay rent. Is the financial position (assets, liabilities, or owner’s equity) of the company changed? Criterion Record/ Don’t Record SO 7 Analyze the effects of business transactions on the accounting equation.

Discussion Question Using The Accounting Equation Q1-19. In February 2011, 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? Question 19 (Chapter 1) No, this treatment is not proper. While the transactions does involve a receipt of cash, it does not represent revenues. Revenues are the gross increase in stockholder’s equity resulting from business activities entered into for the purpose of earning income. This transactions is simply an additional investment made by the owner in the business. Solution on notes page SO 7 Analyze the effects of business transactions on the accounting equation.

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

Transactions Analysis Transaction (1). Investment by Stockholders. 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 common stock. The effect of this transaction on the basic equation is: 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. 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. 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. 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. 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. 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. 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. 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)]. 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. SO 7 Analyze the effects of business transactions on the accounting equation.

Transactions Analysis Illustration 1-9 Tabular summary of Softbyte transactions Summary of Transactions 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 Balance Sheet Statement of Cash Flows SO 8 Understand the four financial statements and how they are prepared.

Review Question Financial Statements Net income will result during a time period when: assets exceed liabilities. assets exceed revenues. expenses exceed revenues. revenues exceed expenses. Net income will result during a time period when: assets exceed liabilities. assets exceed revenues. expenses exceed revenues. revenues exceed expenses. Solution on notes page 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. Net loss – expenses exceed revenues. Illustration 1-10 Financial statements and their interrelationships 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 1-10 Financial statements and their interrelationships SO 8

Retained Earnings Statement Financial Statements Statement indicates the reasons why retained earnings has increased or decreased during the period. Illustration 1-10 Financial statements and their interrelationships 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 balance sheet Illustration 1-10 Financial statements and their interrelationships SO 8 Understand the four financial statements and how they are prepared.

Financial Statements Balance Sheet Illustration 1-10 Financial statements and their interrelationships SO 8 Understand the four financial statements and how they are prepared.

Financial Statements Illustration 1-10 Financial statements and their interrelationships

Statement of Cash Flows Financial Statements Statement of Cash Flows Information for a specific period of time. Answers the following: Where did cash come from? What was cash used for? What was the change in the cash balance? SO 8 Understand the four financial statements and how they are prepared.

Statement of Cash Flows Financial Statements Statement of Cash Flows Illustration 1-10 Financial statements and their interrelationships SO 8 Understand the four financial statements and how they are prepared.

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

Review Question Financial Statements Which of the following financial statements is prepared as of a specific date? Balance sheet. Income statement. Owner's equity statement. Statement of cash flows. Which of the following financial statements is prepared as of a specific date? Balance sheet. Income statement. Owner's equity statement. Statement of cash flows. Solution on notes page. SO 8 Understand the four financial statements and how they are prepared.

Discussion Question Financial Statements Q1-20. “A company’s net income appears directly on the income statement and the retained earnings, and it is included indirectly in the company’s balance sheet.” Do you agree? Explain. Question 20 (textbook) Y e s . Net income does appear on the income statement — it is the result of subtracting expenses from revenues. In addition, net income appears in the retained earning statement — it is shown as an addition to the beginning balance. Indirectly, the net income of a company is also included in the balance sheet. Solution on notes page SO 8 Understand the four financial statements and how they are prepared.

Ethics: Managing Personal Financial Reporting 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, according to an analysis of data from the Department of Education’s National Postsecondary Student Aid Study. That does not include any debt that their parents might incur.

Colleges are required to audit the FAFSA forms of at least one-third of their students; some audit 100%. (Compare that to the IRS, which audits a very small percentage of tax returns.) Thus, if you lie on your financial aid forms, there’s a very good chance you’ll get caught.

Consider the following and decide what action you would take: Suppose you have $4,000 in cash and $4,000 in credit card bills. The more cash and other assets that you have, the less likely you are to get financial aid. Also, if you have a lot of consumer debt (credit card bills), schools are not more likely to loan you money. To increase your chances of receiving aid, should you use the cash to pay off your credit card bills, and therefore make yourself look “worse off” to the financial aid decision makers? YES: You are playing within the rules. You are not hiding assets. You are restructuring your assets and liabilities to best conform with the preferences that are built into the federal aid formulas. NO: You are engaging in a transaction solely to take advantage of a loophole in the federal aid rules. You are potentially depriving someone who is actually worse off than you from receiving aid.

Career Opportunities APPENDIX Public accounting Private accounting Government Forensic accounting “Show me the Money” SO 9 Explain the career opportunities in accounting.

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