Principles Of Accounting

Chapter 1
Basic Accounting

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 1 Accounting in Action

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

Explain the building blocks of accounting: ethics, principles, and

2 assumptions.

3 State the accounting equation, and define its components.

Analyze the effects of business transactions on the accounting

4 equation.

Describe the four financial statements and how they are

5 prepared.
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 What is Accounting
 The process or work of keeping financial
records.
 Is a systematic process of identifying ,
recording, measuring, classifying, verifying,
summarizing, and communicating financial
information.
 It reveals profit or loss for a given period ,
the value & nature of a firm’s asset , liability
& owner’s equity.

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LEARNING Identify the activities and users
1
OBJECTIVE associated with accounting.

Accounting consists of three basic activities—it

 identifies,

 records, and

 communicates

the economic events of an organization to interested users.

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 Three Activities
Illustration 1-1
The activities of the accounting process

The accounting process includes

the bookkeeping function.

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 Who Uses Accounting Data

INTERNAL
USERS

Illustration 1-2
Questions that internal
users ask

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 Who Uses Accounting Data

EXTERNAL
USERS

Illustration 1-3
Questions that external
users ask
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 Generally Accepted Accounting Principles

Financial Statements
Various users 
 Balance
Balance Sheet
Sheet
need financial 
 Income
Income Statement
Statement

 Statement
Statement of
of Owner's
Owner's Equity
Equity
information 
 Statement
Statement of
of Cash
Cash Flows
Flows

 Note
Note Disclosure
Disclosure

The accounting profession

has developed standards
Generally Accepted
Accounting
that are generally accepted
Principles (GAAP)
and universally practiced.

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 Generally Accepted Accounting Principles

Generally Accepted Accounting Principles (GAAP) – Standards

that are generally accepted and universally practiced. These
standards indicate how to report economic events.

Standard-setting bodies:
► Financial Accounting Standards
Board (FASB)
► Securities and Exchange
Commission (SEC)
► International Accounting
Standards Board (IASB)

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 Measurement Principles

HISTORICAL COST PRINCIPLE (or cost principle) dictates

that companies record assets at their cost.

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).

Selection of which principle to follow

generally relates to trade-offs
between relevance and faithful
representation.

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 Assumptions

MONETARY UNIT ASSUMPTION requires that companies

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
Forms of Business
 Partnership
Ownership
 Corporation

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 Forms of Business Ownership

Proprietorship Partnership Corporation

 Owned by one  Owned by two or  Ownership

person more persons divided into
 Owner is often  Often retail and shares of stock
manager/operator service-type  Separate legal
 Owner receives businesses entity organized
any profits, suffers  Generally under state
any losses, and is unlimited corporation law
personally liable personal liability  Limited liability
for all debts  Partnership
agreement

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 Assumptions

Question
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.

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 Assumptions

Question
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.

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LEARNING State the accounting equation, and define
3
OBJECTIVE its components.

Owner's
Assets = Liabilities +
Equity

Basic Accounting Equation

 Provides the underlying framework for recording and
summarizing economic events.
 Assets are claimed by either creditors or owners.
 If a business is liquidated, claims of creditors must be paid
before ownership claims.

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 Basic Accounting Equation

Owner's
Assets = Liabilities +
Equity

Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Supplies, Equipment, etc.

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 Basic Accounting Equation

Owner's
Assets = Liabilities +
Equity

Liabilities
 Claims against assets (debts and obligations).
 Creditors (party to whom money is owed).
 Accounts Payable, Notes Payable, Salaries and Wages
Payable, etc.

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 Basic Accounting Equation

Owner's
Assets = Liabilities +
Equity

Owner's Equity
 Ownership claim on total assets.
 Referred to as residual equity.
 Investment by owners and revenues (+)
 Drawings and expenses (-).

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 Owner’s Equity Illustration 1-6
Expanded accounting
equation

Increases in Owner’s Equity

 Investments by owner are the assets the owner puts into the
business.
 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.

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 Owner’s Equity Illustration 1-6
Expanded accounting
equation

Decreases in Owner’s Equity

 Drawings An owner may withdraw cash or other assets for
personal use.
 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.

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LEARNING Analyze the effects of business transactions
4
OBJECTIVE on 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.

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 Transaction Analysis

Illustration: Are the following events recorded in the accounting

records?
Illustration 1-7
Discuss product
Purchase
Event design with Pay rent
computer
potential customer

Criterion Is the financial position (assets, liabilities, or

owner’s equity) of the company changed?

Record/
Don’t Record

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 Transaction Analysis

TRANSACTION 1. INVESTMENT BY OWNER Ray Neal decides to start

a smartphone app development company which he names Softbyte. On
September 1, 2017, he invests $15,000 cash in the business. This
transaction results in an equal increase in assets and owner’s equity.

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000

Illustration 1-8
Tabular summary of
Softbyte transactions

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 TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH Softbyte
Inc. purchases computer equipment for $7,000 cash.
Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 3. PURCHASE OF SUPPLIES ON CREDIT Softbyte Inc.
purchases for $1,600 headsets and other accessories expected to last
several months. The supplier allows Softbyte to pay this bill in October.
Illustration 1-8 Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 4. SERVICES PERFORMED FOR CASH Softbyte Inc.
receives $1,200 cash from customers for app development services it has
performed. Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 5. PURCHASE OF ADVERTISING ON CREDIT Softbyte
Inc. receives a bill for $250 from the Daily News for advertising on its
online website but postpones payment until a later date. Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 6. SERVICES PERFORMED FOR CASH AND CREDIT.
Softbyte performs $3,500 of services. The company receives cash of
$1,500 from customers, and it bills the balance of $2,000 on account.
Illustration 1-8 Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 7. PAYMENT OF EXPENSES Softbyte Inc. pays the
following expenses in cash for September: office rent $600, salaries and
wages of employees $900, and utilities $200. Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 8. PAYMENT OF ACCOUNTS PAYABLE Softbyte Inc.
pays its $250 Daily News bill in cash. The company previously (in
Transaction 5) recorded the bill as an increase in Accounts Payable.
Illustration 1-8 Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 9. RECEIPT OF CASH ON ACCOUNT Softbyte Inc.
receives $600 in cash from customers who had been billed for services
(in Transaction 6). Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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 TRANSACTION 10. WITHDRAWAL OF CASH BY OWNER Ray Neal
withdraws $1,300 in cash in cash from the business for his personal use.
Illustration 1-8
Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 - $1,300 + $4,700 - $1,950

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LEARNING Describe the four financial statements
5
OBJECTIVE and how they are prepared.

Companies prepare four financial statements :

Owner’s Statement
Income Balance
Equity of Cash
Statement Sheet
Statement Flows

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 Net income is needed to determine the
Financial Statements ending balance in owner’s equity.

SOFTBYTE
Income Statement
For the Month Ended September 30, 2017

Illustration 1-9
Financial statements and
their interrelationships

SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017

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 SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017

Illustration 1-9
The ending
balance in SOFTBYTE
owner’s equity Balance Sheet
is needed in September 30, 2017
preparing the
balance sheet.

Illustration 1-9
Financial statements
and their
interrelationships

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 SOFTBYTE
Financial Balance Sheet
September 30, 2017

Statements

Balance sheet and

income statement
are needed to
prepare statement of
cash flows.
SOFTBYTE
Statement of Cash Flows
For the Month Ended September 30, 2017

Illustration 1-9
Financial statements
and their
interrelationships

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 Income Statement

 Reports the revenues and expenses for a specific

period of time.
 Lists revenues first, followed by expenses.
 Shows net income (or net loss).
 Does not include
investment and
withdrawal transactions
between the owner and
the business in
measuring net income.

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 Owner’s Equity Statement

 Reports the changes in owner’s equity for a specific

period of time.
 The time period is the same as that covered by the
income statement.

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 Balance Sheet

 Reports the assets, liabilities, and owner's equity at a

specific date.
 Lists assets at the top, followed by liabilities and owner’s
equity.
 Total assets must equal total liabilities and owner's
equity.
 Is a snapshot of the company’s financial condition at a
specific moment in time (usually the month-end or year-
end).

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 Statement of Cash Flows

 Information on the cash receipts and payments 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?

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 Quiz 1 :Xyz company performs the following accounting tasks during the
year:
1. Analyzing and interpreting information
2. Selecting economic activities relevant to the company
3. Measuring events in dollars and cents
4. Summarizing economic events
5. Preparing accounting reports
Identify whether the tasks relating to either the identification , recording
or communication
From the following lists try to identify the internal and
external user:
Customer, store manager, SEC, suppliers, production
supervisor

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 Quiz 1
 Identify each of the questions as being more likely asked by an
internal or external user
1. Which product should we emphasize?
2. Do we need to borrow in near future?
3. Did the company earn a satisfactory income?
4. Can we raise the salary of our employees?
5.What does it cost us to manufacture each unit produced?

What are the three basic activities of accounting , what

task they do?

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