2. Financial Accounting, Seventh Edition
Accounting in Action
Financial Accounting, Seventh Edition

3. 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.

4. 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

5. 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.

6. 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.

7. 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.

8. 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.

9. 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.

10. 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.

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

12. 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.

13. 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.

14. The Building Blocks of Accounting
Organizations Involved in Standard Setting:
Securities and Exchange Commission (SEC)
Public Company Accounting Oversight Board (PCAOB)
Securities and Exchange Commission (SEC)
International Accounting Standards Board (IASB)
SO 4

15. 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.

16. 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.

17. 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.

18. 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.

19. 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.

20. 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.

21. 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.

22. 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.

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

24. 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.

25. 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.

26. 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.

27. 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.

28. 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.

29. 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.

30. 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.

31. 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.

32. 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.

33. 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.

34. Discussion Question Using The Accounting Equation
Q 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.

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

36. 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.

37. 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.

38. 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.

39. 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.

40. 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.

41. 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.

42. 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.

43. 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.

44. 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.

45. 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.

46. 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.

47. 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.

48. 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.

49. 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.

50. Financial Statements
Net income is needed to determine the ending balance in retained earnings.
Illustration 1-10
Financial statements and
their interrelationships
SO 8

51. 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.

52. 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.

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

54. Financial Statements Illustration 1-10 Financial statements and
their interrelationships

55. 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.

56. 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.

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

58. 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.

59. 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.

60. 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.

61. 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.

63. 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.

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

65. Copyright
Copyright © 2010 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.