Financial Accounting

IFRS 5th Edition

Weygandt ● Kimmel

Chapter 1

Accounting in Action
This slide deck contains animations. Please disable animations if they cause issues with your device.

Copyright © John Wiley & Sons, Inc.

Learning Objective 1
Identify the activities and users
associated with accounting.

Copyright © John Wiley & Sons, Inc. LO 1

What is Accounting?
The information system of collecting and processing
transaction data and communicating financial
information to decision-makers.

The steps companies follow each period to record transactions

and eventually prepare financial statements:

Copyright © John Wiley & Sons, Inc. LO 4

Accounting Activities Illustrated
Three Activities

Illustration 1.1: The activities of the accounting process.

Copyright © John Wiley & Sons, Inc. LO 1

Financial Information User Groups
• Internal: Managers who plan, organize, and run the
business.
o Rely on managerial accounting for decision-making.
o Examples: Marketing, production, finance managers.

• External: Users outside of the organization.

o Rely on financial accounting for decision-making.
o Examples: Investors, creditors, taxing authorities,
and regulators, etc.

Copyright © John Wiley & Sons, Inc. LO 1

Learning Objective 2
Explain the building blocks of
accounting: ethics, principles, and
assumptions.

Copyright © John Wiley & Sons, Inc. LO 2

Accounting Standards
Ensure high-quality financial reporting.
Primary accounting standard-setting bodies:
• International Accounting Standards Board (IASB)
o Determines International Financial Reporting Standards (IFRS)
o Used in more than 150 countries

• Financial Accounting Standards Board (FASB)

o Determines generally accepted accounting principles (GAAP)
o Used by most companies in the U.S.

Copyright © John Wiley & Sons, Inc. LO 2

Selecting Measurement Principles
• Selection of which principle to follow generally relates
to trade-offs between relevance and faithful
representation.

• Relevance means that financial information is capable

of making a difference in a decision.
• Faithful representation means that the numbers and
descriptions match what really existed or happened—
they are factual.

Copyright © John Wiley & Sons, Inc. LO 2

Measurement Principles
• IFRS generally uses one of two measurement principles,
the historical cost principle or the fair value principle.
• Historical cost principle (or cost principle): dictates that
companies record assets at their cost. This is true not
only at the time the asset is purchased, but also over
the time the asset is held.
• Fair value principle: states that assets and liabilities
should be reported at fair value (the price received to
sell an asset or settle a liability), value in use (present
value of future cash flows), or current cost
(replacement cost).
Copyright © John Wiley & Sons, Inc. LO 2
Learning Objective 3
State the accounting equation, and
define its components.

Copyright © John Wiley & Sons, Inc. LO 3

The Accounting Equation
The Basic Accounting Equation
Assets = Liabilities + Equity

Illustration 1.6: The basic accounting equation.

Assets: resources expected to produce future benefits.

Liabilities: claims against assets, i.e. existing debts and obligations.
Equity: the ownership (stockholders’) claim on a company’s assets.

Copyright © John Wiley & Sons, Inc. LO 3

Assets
• Cash: Money including bank account balances, paper
currency, certificates of deposits, and checks.
• Accounts Receivable: Promise for future cash for goods
or services.
• Inventory: Raw materials used in production as well as
the goods produced that are available for sale
• Supplies: Items the company uses to run its business
and drive revenue.
• Property, Plant, and Equipment: Land, buildings, and
equipment owned by a company.

Copyright © John Wiley & Sons, Inc. LO 3

Liabilities
• Accounts Payable: The amounts owed by a company to
its suppliers for goods or services the company received
on credit
• Notes Payable: Signed notes promising to pay a future
amount
• Accrued Liabilities: Expenses that have been incurred
by a company, but the amounts have not yet been paid

Copyright © John Wiley & Sons, Inc. LO 3

Equity
• Share Capital: The amounts paid in by shareholders for
the shares they purchase.
• Retained Earnings: Cumulative net income (i.e., profit)
minus dividends over the company’s life

Revenues
− Expenses
Net Income
Investors
(= shareholders)

Retained Earnings
Copyright © John Wiley & Sons, Inc. LO 3
 Equity
• Share Capital: The amounts paid in by shareholders for
the shares they purchase.
• Retained Earnings: Cumulative net income (i.e., profit)
minus dividends over the company’s life
increase ▪ Revenues: Gross increases in equity resulting from
equity
business activities entered into for the purpose of earning
income.
▪ Expenses: The cost of assets consumed or services used in
decrease the process of earning revenue.
equity
▪ Dividends: Distribution of cash or other assets to
shareholders. They are NOT expenses.
Copyright © John Wiley & Sons, Inc. LO 3
DO IT! 3: Equity Effects

Classify the following items as issuance of shares (I),

dividends (D), revenues (R), or expenses (E). Then indicate
whether each item increases or decreases equity.

a. Rent Expense is an expense (E); it decreases equity.

b. Service Revenue is a revenue (R); it increases equity.
c. Dividends is a distribution to shareholders (D); it
decreases equity.
d. Salaries and Wages Expense is an expense (E); it
decreases equity.

Copyright © John Wiley & Sons, Inc. LO 3

Learning Objective 4
Analyze the effects of business
transactions on the accounting
equation.

Copyright © John Wiley & Sons, Inc. LO 4

Accounting Transactions

Illustration 1.8: The transaction identification process.

Copyright © John Wiley & Sons, Inc. LO 4

Transaction Analysis

Illustration 1.9: Expanded accounting equation.

Copyright © John Wiley & Sons, Inc. LO 4

Copyright © John Wiley & Sons, Inc. LO 4
Transaction (1). Investment by
Shareholders.
Assume: Ray and Barbara Neal decide to start a smartphone app
development company that they incorporate as Softbyte SA. On
September 1, 2025, they invest €15,000 cash in the business in
exchange for €15,000 of ordinary shares. The ordinary shares
indicates the ownership interest that the Neals have in Softbyte SA.
Demonstrate: Basic and equation analysis of this transaction.

Observe that the equality of the basic equation has been maintained.
Copyright © John Wiley & Sons, Inc. LO 4
Transaction (2). Purchase of
Equipment for Cash.
Assume: Softbyte SA purchases computer equipment for €7,000
cash.
Demonstrate: Basic and equation analysis of this transaction.

Changes to assets, liabilities, and equity are cumulative.

Copyright © John Wiley & Sons, Inc. LO 4
Transaction (3). Purchase of Supplies
on Credit.
Assume: Softbyte SA purchases headsets (and other computer
accessories expected to last several months) for €1,600 from Mobile
Solutions. Mobile Solutions agrees to allow Softbyte to pay this bill in
October. This transaction is a purchase on account (a credit
purchase).
Demonstrate: Basic and equation analysis of this transaction.

Assets increase because of the expected future benefits of using the headsets and
computer accessories, and liabilities increase by the amount due Mobile Solutions.
Copyright © John Wiley & Sons, Inc. LO 4
Transaction (4). Services Performed
for Cash.
Assume: Softbyte SA receives €1,200 cash from customers for
app development services it has performed. This transaction
represents Softbyte’s principal revenue-producing activity.
Recall that revenue increases equity.
Demonstrate: Basic and equation analysis of this transaction.

Recall that revenue increases equity.

Copyright © John Wiley & Sons, Inc. LO 4
Transaction (5). Purchase of Advertising
on Credit.
Assume: Softbyte SA receives a bill for €250 from Programming News for advertising
on its website but postpones payment until a later date.
Demonstrate: Basic and equation analysis of this transaction.

The two sides of the equation still balance at €17,800. Retained Earnings decreases
when Softbyte incurs the expense. Expenses do not have to be paid in cash at the time
they are incurred. When Softbyte pays at a later date, the liability Accounts Payable will
decrease and the asset Cash will decrease. The cost of advertising is an expense
because Softbyte has used the benefits. Advertising Expense is included in determining
net income.
Copyright © John Wiley & Sons, Inc. LO 4
Transaction (6). Services Performed
for Cash & Credit.
Assume: Softbyte SA performs €3,500 of app development services
for customers. The company receives cash of €1,500 from customers,
and it bills the balance of €2,000 on account.
Demonstrate: Basic and equation analysis of this transaction.

This transaction results in an equal increase in assets and equity.

Copyright © John Wiley & Sons, Inc. LO 4

Transaction (7). Payment of
Expenses.
Assume: Softbyte SA pays the following expenses in cash for
September: office rent €600, salaries and wages of employees €900,
and utilities €200.
Demonstrate: Basic and equation analysis of this transaction.

This transaction results in an equal decrease in assets and equity.

Copyright © John Wiley & Sons, Inc. LO 4

Transaction (8). Payment of Accounts
Payable.
Assume: Softbyte SA pays its €250 Programming News bill in cash.
The company previously [in Transaction (5)] recorded the bill as an
increase in Accounts Payable and a decrease in equity.
Demonstrate: Basic and equation analysis of this transaction.

Observe that the payment of a liability related to an expense that has

previously been recorded does not affect equity. Softbyte recorded the
expense [in Transaction (5)] and should not record it again.
Copyright © John Wiley & Sons, Inc. LO 4
Transaction (9). Receipt of Cash on
Account.
Assume: Softbyte SA receives €600 in cash from customers who
had been billed for services [in Transaction (6)].
Demonstrate: Basic and equation analysis of this transaction.

Transaction (9) does not change total assets, but it changes the composition of those assets.

Note that the collection of an account receivable for services previously billed and recorded does not affect equity.
Softbyte already recorded this revenue [in Transaction (6)] and should not record it again.

Copyright © John Wiley & Sons, Inc. LO 4

Transaction (10). Dividends.
Assume: The company pays a dividend of €1,300 in cash to Ray and
Barbara Neal, the shareholders of Softbyte SA. This transaction results
in an equal decrease in assets and equity.
Demonstrate: Basic and equation analysis of this transaction.

Total assets did not change, but the composition of those assets did. Note that
the dividend reduces retained earnings, which is part of equity. Dividends are
not expenses. Like shareholders’ investments, dividends are excluded in
determining net income.
Copyright © John Wiley & Sons, Inc. LO 4