Chapter 1

Accounting Principles
Thirteenth Edition
Weygandt Kimmel Kieso
Chapter 1
Accounting in Action
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
Chapter 1
Accounting in Action
Chapter Outline
Learning Objectives
LO 1 Identify the activities and users associated with
accounting.
LO 2 Explain the building blocks of accounting: ethics,
principles, and assumptions.
LO 3 State the accounting equation, and define its
components.
LO 4 Analyze the effects of business transactions on the
accounting equation.
LO 5 Describe the four financial statements and how they
are prepared.
Copyright ©2019 John Wiley & Son, Inc. 3
Accounting Activities and Users
Accounting consists of three activities
1. Identification – Select economic events
(transactions)
2. Recording - Record, classify, and summarize
3. Communication
• Prepare accounting reports
• Analyze and interpret for users
LO 1 Copyright ©2019 John Wiley & Son, Inc. 4

Who Uses Accounting Data
Internal Users
• Finance - Is cash sufficient to pay dividends to SAP
shareholders?
• Marketing – What price should Nokia charge for a cell
phone to maximize the company's net income?
• Human Resources – Can Toyota afford to give its
employees pay raises this year?
• Management - Which PepsiCo product line is the most
profitable? Should any product lines be eliminated?
Who Uses Accounting Data
External Users
• Investors
 Is Lenovo earning satisfactory income?
 How does Disney compare in size and profitability
with Time Warner?
• Creditors – Will Singapore Airlines be able to pay its
debts as they come due?

DO IT! 1 Basic Concepts
Indicate whether each of the statements is true or false. indicate
how to correct the statement.
1. The three steps in the accounting process are identification,
recording, and communication.
2. Bookkeeping encompasses all steps in the accounting process.
3. Accountants prepare, but do not interpret, financial reports.
4. The two most common types of external users are investors
and company officers.
5. Managerial accounting focuses on reports for internal users.
Solution: 1. True2. False 3. False 4. False 5. True

The Building Blocks of Accounting
Ethics in Financial Reporting
• Financial scandals include: Satyam Computer Services (IND),
Toshiba (JPN), Pou Sheng International (HKG), Siwei (CHN),
and other companies
• Effective financial reporting depends on sound ethical
behavior

Ethics in Financial Reporting
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

Generally Accepted Accounting
Principles
Standards that are generally accepted and universally
practiced. These standards indicate how to report
economic events.
Standard-setting bodies:
a. Financial Accounting Standards Board (FASB)
b. International Accounting Standards Board (IASB)

Measurement Principles
Historical Cost Principle (or cost principle)
Record assets at their cost.
Fair Value Principle
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.
Assumptions
Monetary Unit Assumption
Include in accounting records only transaction data
that can be expressed in terms of money
Economic Entity Assumption
Activities of entity be kept separate and distinct
from activities of its owner and all other entities
 Proprietorship
Forms of Business
 Partnership Ownership
 Corporation
Forms of Business Ownership
Proprietorship Partnership Corporation
• Owned by one • Owned by two or • Ownership divided
person more persons into shares
• Owner is often • Often retail and • Separate legal
manager/operator service-type entity organized
businesses under state
• Owner receives any corporation law
profits, suffers any • Generally
losses, and is unlimited personal • Limited liability
personally liable for liability
all debts
• Partnership
agreement

Assumptions
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.

Assumptions
A business organized as a separate legal entity under
jurisdiction corporation law having ownership divided
into shares of stock is a
a. proprietorship
b. partnership
c. corporation
d. sole proprietorship

DO IT! 2 Building Blocks of Accounting
Indicate whether each of the statements is true or false.
1. Convergence refers to efforts to reduce differences between
IFRS and U.S. GAAP.
2. The primary accounting standard-setting body headquartered
in London is the International Accounting Standards Board
(IASB).
3. The historical 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.
Solution: 1. True2. True3. False

DO IT! 2 Building Blocks of Accounting
Indicate whether each of the statements is true or false.
4. Relevance means that financial information matches what
really happened; the information is factual.
5. A business owner’s personal expenses must be separated from
expenses of the business to comply with accounting’s economic
entity assumption.
Solution: 1. True2. True3. False 4. False 5. True

The Accounting Equation
Assets = Liabilities + Owner's Equity
Basic Accounting Equation

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

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

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

The Accounting Equation ILLUSTRATION 1.6
Expanded accounting equation
Equation Assets = Liabilities + Owner's Equity

Expanded Assets = Liabilities + Owner's - Owner's + Revenues - Expenses
Equation Capital Drawings
Increase in Owner’s Equity

Investment by Owner. Assets the owner puts into
the business
Revenues. Increases in assets or decreases in
liabilities resulting from sale of goods or
performance of services in normal course of
LO 3 business Copyright ©2019 John Wiley & Son, Inc. 22
The Accounting Equation ILLUSTRATION 1.6
Expanded accounting equation
Equation Assets = Liabilities + Owner's Equity

Expanded Assets = Liabilities + Owner's - Owner's + Revenues - Expenses
Equation Capital Drawings
Decrease in Owner’s Equity

Drawings. A withdraw of cash or other assets for
personal use
Expenses. Cost of assets consumed or services used
in the process of earning revenue

DO IT! 3 Owner’s Equity Effects
Classify the following items as investment by owner, owner’s
drawings, revenues, or expenses. Then indicate whether each
item increases or decreases owner’s equity.
Effect
Classification on Equity
1. Rent Expense Expense Decrease
2. Service Revenue Revenue Increase
Owner’s
3. Drawings Decrease
Drawings
4. Salaries and Wages Expense Expense Decrease

Analyzing Business Transactions
Transactions are a business’s economic events recorded by
accountants.
a. May be external or internal
b. Not all activities represent transactions
c. Have a dual effect on the accounting equation
Analyze
Trial Adjusting
business Journalize Post
Balance Entries
transactions
Adjusted
Financial Closing Post-Closing
Trial
Balance Statements Entries Trial Balance

Analyzing Business Transactions
Illustration: Are the following events recorded in the
accounting records?
Discuss product ILLUSTRATION 1.7
Transaction
design with identification process
Purchase potential
Event
computer customer Pay rent
Criterion Is the financial position (assets, liabilities, or

owner’s equity) of the company changed?
Record/
Don’t Record Yes No Yes

Transaction Analysis
Transaction 1. Ray Neal decides to start a smartphone app development
company which he names Softbyte. On September 1, 2020, 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

Accounts Accounts Owner's Owner's
No. Cash + Receivable + Supplies + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€15,000 +€15,000
2
3

Transaction 2. Softbyte purchases computer equipment for €7,000 cash.

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 -600 -600
-900 -900
-200 -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

Transaction 3. 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.
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 -600 -600
-900 -900
-200 -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

Transaction 4. Softbyte receives €1,200 cash from customers for app
development services it has performed.

1 +€15,000 +€15,000
2 -7,000 +€7,000
3 +€1,600 +€1,600
4 +1,200 Service Revenue +€1,200
5 +250 -€250
6 +1,500 +€2,000 +3,500
7 -600 -600
-900 -900
-200 -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

Transaction 5. Softbyte Inc. receives a bill for €250 from the Daily News
for advertising on its online website but postpones payment until a later
date.
1 +€15,000 +€15,000
2 -7,000 +€7,000
3 +€1,600 +€1,600
4 +1,200 +€1,200
5 +250 Advertising Expense -€250
6 +1,500 +€2,000 +3,500
7 -600 -600
-900 -900
-200 -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

Transaction 6. 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.
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 Service Revenue +3,500
7 -600 -600
-900 -900
-200 -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

Transaction 7. Softbyte pays the following expenses in cash for
September: office rent €600, salaries and wages of employees €900, and
utilities €200.
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 -600 Rent Expense -600
-900 Salaries and Wage Expense -900
-200 Utilities Expense -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

Transaction 8. Softbyte pays its €250 Daily News bill in cash. The
company previously (in Transaction 5) recorded the bill as an increase in
Accounts Payable.
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 -600 -600
-900 -900
-200 -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

Transaction 9. Softbyte receives €600 in cash from customers who had
been billed for services (in Transaction 6).

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 -600 -600
-900 -900
-200 -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

Transaction 10. Ray Neal withdraws €1,300 in cash from the business for
his personal use.

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 -600 -600
-900 -900
-200 -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
€18,050 €18,050

Summary of Transactions
1. Each transaction analyzed in terms of effect on:
a. Three components of basic accounting
equation
• Assets
• Liabilities
• Owner’s equity
b. Specific types of items, such as Cash
2. Two sides of equation must always be equal

DO IT! 4 Tabular Analysis
Transactions made by Virmari SA, a public accounting firm, for the
month of August are shown below. Prepare a tabular analysis
which shows the effects of these transactions on the expanded
accounting equation, similar to that shown in Illustration 1.8.
1. The owner invested €25,000 cash in the business.
2. The company purchased €7,000 of office equipment on credit.
3. The company received €8,000 cash in exchange for services
performed.
4. The company paid €850 for this month’s rent.
5. The owner withdrew €1,000 cash for personal use.

Transaction 1. The owner invested €25,000 cash in the
business.
Accounts Owner's Owner's
No. Cash + Equipment = Payable + Capital - Drawings + Revenue - Expense
1 +€25,000 +€25,000
2
3
4
5

Transaction 2. The company purchased €7,000 of office
equipment on credit.
1 +€25,000 +€25,000
2 +€7,000 +€7,000
3
4
5

Transaction 3. The company received €8,000 cash in
exchange for services performed.
1 +€25,000 +€25,000
2 +€7,000 +€7,000
3 +8,000 Service Revenue +€8,000
4
5

Transaction 4. The company paid €850 for this month’s
rent.
1 +€25,000 +€25,000
2 +€7,000 +€7,000
3 +8,000 +€8,000
4 -850 Rent Expense -€850
5

Transaction 5. The owner withdrew €1,000 cash for
personal use.
1 +€25,000 +€25,000
2 +€7,000 +€7,000
3 +8,000 +€8,000
4 -850 -€850
5 -1,000 -€1,000
€ 31,150 + €7,000 = €7,000 + €25,000 - €1,000 + €8,000 - €850
€38,150 €38,150

The Four Financial Statements
Companies prepare four financial statements:
Owner's Statement Statement

Income
Statement Equity of Financial of Cash
Statement Position Flows

Financial Statements
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

Income Statement
Financial Revenues €4,700
Service revenue
Statements Expenses
Salaries and wages expense 900
Softbyte Rent expense 600
Advertising expense 250
statements for Utilities expense 200
the Month Total expenses 1,950
Net income €2,750
Ended
September 30, Owner’s Equity Statement
2020 Owner’s capital, September 1 € 0
Add: Investments 15,000
Add: Net income 2,750
ILLUSTRATION 1.9
Financial statements and
Less: Drawings 1,300
their interrelationships Owner’s capital, September 30 $16,450

Owner’s Equity Statement
Financial Owner’s capital, September 1

Add: Investments
€ 0
15,000
Statements Add: Net income
Less: Drawings
2,750
1,300
Owner’s capital, September 30 €16,450
Softbyte
statements for Statement of Financial Position
Assets
the Month
Cash € 8,050
Ended Accounts receivable 1,400
September 30, Supplies 1,600
Equipment 7,000
2020 Total assets €18,050
Owner’s Equity and Liabilities
ILLUSTRATION 1.9
Accounts payable € 1,600
Financial statements and Owner’s capital 16,450
their interrelationships
Total owner’s equity and liabilities €18,050
Statement of Financial Position (partial)
Assets
Financial Cash
Accounts receivable
€ 8,050
1,400
Statements Supplies 1,600
Statement of Cash Flows
Softbyte Cash flows from operating activities
Cash receipts from revenues 3,300
statements for Cash payments from expenses (1,950)
the Month Net cash from operating activities 1,350
Cash flows from investing activities
Ended Purchase of equipment (7,000)
September 30, Cash flows from financing activities
Investments by owner 15,000
2020 Drawings by owner (1,300)
Net cash from financing activities 13,700
ILLUSTRATION 1.9
Net increase in cash 8,050
Financial statements and Cash at beginning of period 0
their interrelationships
Cash at end of period € 8,050
Income Statement
• Reports 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 owner and business in
measuring net income

Owner’s Equity Statement
• Reports changes in owner’s equity for a specific
period of time
• Time period is the same as that covered by the
income statement

Statement of Financial Position
• Reports assets, liabilities, and owner's equity at a
specific date
• Lists assets at top, followed by liabilities and owner’s
equity
• Total assets must equal total owner’s equity and
liabilities
• Snapshot of company’s financial condition at a
specific moment in time (usually month-end or year-
end)

Statement of Cash Flows
• Information on 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 change in cash balance?

Financial Statements
Which of the following financial statements is prepared as
of a specific date?
a. Statement of financial position
b. Income statement
c. Owner's equity statement
d. Statement of cash flows

DO IT! 5 Financial Statement Items
Presented below is selected information related to Li Fashions at
December 31, 2020. Li reports financial information monthly.
Equipment HK$10,000 Utilities Expense HK$4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Owner’s Drawings 5,000
a. Determine the total assets at December 31, 2020.
b. Determine the net income reported for December 2020.
c. Determine the owner’s equity at December 31, 2020.

Li reports financial information monthly.
a. Determine the total assets at December 31, 2020.
Cash $ 8,000
Accounts receivable 9,000
Equipment 10,000
Total assets $27,000

b. Determine the net income reported for December 2020.
Service revenue $36,000
Rent expense 11,000
Salaries and wages expense 7,000
Utilities expense 4,000
Net income $14,000

c. Determine the owner’s equity at December 31, 2020.
Total assets $27,000

Less: Notes payable expense 16,500
Less: Accounts payable 2,000
Owner’s equity $ 8,500

Appendix 1A
Career Opportunities in Accounting
Public Accounting Private Accounting
Careers in auditing, taxation, Careers in industry working in
and management consulting cost accounting, budgeting,
serving the general public. accounting information
systems, and taxation.
Governmental Accounting Forensic Accounting

Careers with tax authorities, Uses accounting, auditing,
law enforcement agencies, and investigative skills to
company regulators, public conduct investigations into
colleges and universities, and theft and fraud.
in local governments.

Copyright
Copyright © 2019 John Wiley & Sons, Inc.
All rights reserved. Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States 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.
Copyright ©2019 John Wiley & Son, Inc. 59

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Accounting Principles

LO 1 Copyright ©2019 John Wiley & Son, Inc. 4

LO 1 Copyright ©2019 John Wiley & Son, Inc. 6

Solution: 1. True2. False 3. False 4. False 5. True

LO 1 Copyright ©2019 John Wiley & Son, Inc. 7

LO 2 Copyright ©2019 John Wiley & Son, Inc. 8

LO 2 Copyright ©2019 John Wiley & Son, Inc. 9

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LO 2 Copyright ©2019 John Wiley & Son, Inc. 13

LO 2 Copyright ©2019 John Wiley & Son, Inc. 14

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Solution: 1. True2. True3. False

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Solution: 1. True2. True3. False 4. False 5. True

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Basic Accounting Equation

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LO 3 Copyright ©2019 John Wiley & Son, Inc. 20

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Equation Assets = Liabilities + Owner's Equity

Increase in Owner’s Equity

Equation Assets = Liabilities + Owner's Equity

Decrease in Owner’s Equity

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Criterion Is the financial position (assets, liabilities, or

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Assets Liabilities Owner’s Equity

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Assets Liabilities Owner’s Equity

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Assets Liabilities Owner’s Equity

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Assets Liabilities Owner’s Equity

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Assets Liabilities Owner’s Equity

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Owner's Statement Statement

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Financial Owner’s capital, September 1

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