Accounting Principles 7/e Ch/1

CH 1 : ACCOUNTING IN ACTION

After studying this chapter, you should be able to:

• Explain what accounting is.
• Identify users and uses of accounting.
• Understand why ethics is a fundamental business concept.
• Explain the meaning of generally accepted accounting principles and the cost principle.
• Explain the meaning of the monetary unit assumption and the economic entity assumption.
• State the basic accounting equation and explain the meaning of assets, liabilities, and owner’s equity.
• Analyze the effect of business transactions on the basic accounting equation.
• Understand what the four financial statements are and how they are prepared.

• 1 Explain what accounting is. • 2 Identify users and uses of accounting. • 3 Understand why ethics is a fundamental business concept. • 4 Explain the meaning of generally accepted accounting principles and the cost principle. • 5 Explain the meaning of the monetary unit assumption and the economic entity assumption. • 6 State the basic accounting equation and explain the meaning of assets, liabilities, and owner’s equity. • 7 Analyze the effect of business transactions on the basic accounting equation. • 8 Understand what the four financial statements are and how they are prepared. • Accounting is an information system that • Identifies • Records • Communicates the economic events of an organization to interested users • Accounting Includes bookkeeping Also includes much more • Bookkeeping The recording of economic events One part of accounting • Public Accountants Service to the general public through the services they perform. • Private Accountants Individuals in companies involved in activities including cost and tax accounting, systems, and internal auditing. • Not For Profit Accountants Reporting and control for government units, foundations, hospitals, labor unions, colleges/universities, and charities. • Ethics Standards by which actions are judged as right or wrong, honest or dishonest. • Generally Accepted Accounting Principles Established by the F.A.S.B and the S.E.C. • Assumptions – Monetary Unit Only data that can be expressed in terms of money is included in the accounting records. – Economic Entity Includes any organization or unit in society. • Proprietorship Owned by one person. • Partnership Owned by two or more persons. • Corporation Organized as a separate legal entity under state corporation law and having ownership divided into transferable shares of stock. The accounting process is correctly sequenced as • identification, communication, recording. • recording, communication, identification. • identification, recording, communication. • communication, recording, identification. The accounting process is correctly sequenced as • identification, communication, recording. • recording, communication, identification. • identification, recording, communication. • communication, recording, identification. • Liabilities • are creditor claims against assets • are existing debts and obligations • Owner’s Equity = total assets minus total liabilities. (A - L = O.E.) • Owner’s Equity represents the ownership claim to total assets. • Subdivisions of Owner’s Equity: 1 Capital or Investments by Owner (+) 2 Drawing (-) 3 Revenues (+) 4 Expenses (-) • Investments • are the assets the owner puts in the business • increase owner’s equity • Drawings • are withdrawals of cash or other assets by the owner for personal use • decrease owner’s equity • Revenues • gross increases in owner’s equity from business activities entered into for the purpose of earning income • may result from sale of merchandise, services, rental of property, or lending money • usually result in an increase in an asset Expenses • decreases in owner’s equity that result from operating the business • cost of assets consumed or services used in the process of earning revenue • examples: utility expense, rent expense, supplies expense, and tax expense • INCREASES DECREASES • Ray Neal decides to open a computer programming service. • On September 1, he invests $15,000 cash in the business, which he names Softbyte. TRANSACTION ANALYSIS TRANSACTION 1 SOLUTION • Assets = Liabilities + Owner’s Equity Cash R. Neal, Capital + 15,000 Investment + 15,000 $15,000 = $15,000 • Softbyte purchases computer equipment for $7,000 cash. TRANSACTION ANALYSIS TRANSACTION 2 SOLUTION • Assets = Liabilities + Owner’s Equity • Cash + Equipment = + R. Neal, Capital • Old • $15,000 = $15,000 • (2) - 7,000 + 7,000______________________________ • New • $ 8,000 + $7,000 = $15,000 • Softbyte purchases supplies expected to last for several months for $1,600 from Acme Supply Company. • Acme agrees to allow Softbyte to pay this bill next month, in October. • This transaction is referred to as a purchase on account or a credit purchase. TRANSACTION ANALYSIS TRANSACTION 3 SOLUTION • Assets = Liabilities + Owner’s Equity • Cash + Supplies + Equip. = Accts. Pay. + R. Neal, Capital • Old $8,000 + $7,000 = $15,000 • (3) _____ + $1,600 _______ + $1,600 ________ • New $8,000 + $1,600 + $7,000 = + $1,600 + $15,000 • • $16,600 $16,600 • Softbyte receives $1,200 cash from customers for programming services it has provided. • This transaction represents the Softbyte’s principal revenue-producing activity. TRANSACTION ANALYSIS TRANSACTION 4 SOLUTION • Assets = Liabilities + Owner’s Equity • Cash + Supplies + Equip. = Accts. Pay. + R. Neal, Capital • Old $8,000 + $1,600 + $7,000 = $1,600 + $15,000 • (4) + 1,200 _____ _____ _______________ + 1,200 • New $9,200 + $1,600 + $7,000 = $1,600 $16,200 • $17,800 $17,800 • Softbyte receives a bill for $250 from the Daily News for advertising but postpones payment of the bill until a later date. TRANSACTION ANALYSIS TRANSACTION 5 SOLUTION • Assets = Liabilities + Owner’s Equity • Cash + Supplies + Equip. = Accts. Pay. + R. Neal, Capital • Old $9,200 + $1,600 + $7,000 = $1,600 + $16,200 • (5) ___Advertising Expense__ + 250 _- 250 • New $9,200 + $1,600 + $7,000 = $1,850 + $15,950 • $17,800 $17,800 • Softbyte provides $3,500 of programming services for customers. • Cash of $1,500 is received from customers, and the balance of $2,000 is billed on account. TRANSACTION ANALYSIS TRANSACTION 6 SOLUTION • Assets = Liabilities + Owner’s Equity • Cash + Accts. Rec. + Supplies + Equip. = Accts. Pay. + R. Neal, Capital • Old • $ 9,200 + $1,600 + $7,000 = $1,850 + $15,950 • (6) • + 1,500 + 2,000 + 3,500 • New • $10,700 + $2,000 + $1,600 + $7,000 = $1,850 + $19,450 • $21,300 $21,300 • Expenses paid in cash for September are store rent, $600; employees’ salaries, $900; and utilities, $200. TRANSACTION ANALYSIS TRANSACTION 7 SOLUTION • Assets = Liabilities + Owner’s Equity • Cash + Accts. Rec. + Supplies + Equip. = Accts. Pay. + R. Neal, Capital • Old • $10,700 + $2,000 + $1,600 + $7,000 = $1,850 + $19,450 • (7) • - 1,700 Rent Expense - 600 • Salaries Expense - 900 • Utilities Expense - 200 • New • $ 9,000 + $2,000 + $1,600 + $7,000 = $1,850 + $17,750 • $19,600 $19,600 • Softbyte pays its $250 Daily News advertising bill in cash. TRANSACTION ANALYSIS TRANSACTION 8 SOLUTION • Assets = Liabilities + Owner’s Equity • Cash + Accts. Rec. + Supplies + Equip. = Accts. Pay. + R. Neal, Capital • Old • $9,000 + $2,000 + $1,600 + $7,000 = $1,850 + $17,750 • (8)- 250 - 250 . • New • $8,750 + $2,000 + $1,600 + $7,000 = $1,600 + $17,750 • $19,350 $19,350 • The sum of $600 in cash is received from customers who have previously been billed for services (in Transaction 6). TRANSACTION ANALYSIS TRANSACTION 9 SOLUTION • Assets = Liabilities + Owner’s Equity • Cash + Accts. Rec. + Supplies + Equip. = Accts. Pay. + R. Neal, Capital • Old • $8,750 + $2,000 + $1,600 + $7,000 = $1,600 + $17,750 • (9) + 600 - 600 . • New • $9,350 + $1,400 + $1,600 + $7,000 = $1,600 + $17,750 • • $19,350 $19,350 • Ray Neal withdraws $1,300 in cash from the business for his personal use. TRANSACTION ANALYSIS TRANSACTION 10 SOLUTION • Assets = Liabilities + Owner’s Equity • Cash + Accts. Rec. + Supplies + Equip = Accts. Pay. + R. Neal, Capital • Old • $9,350 + $1,400 + $1,600 + $7,000 = $1,600 + $17,750 • (10) • - 1,300 Drawing - 1,300 • New • $8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $16,450 • $18,050 $18,050 • Four financial statements are prepared from the summarized accounting data: • Income Statement revenues and expenses and resulting net income or net loss for a specific period of time • Owner’s Equity Statement changes in owner’s equity for a specific period of time • Balance Sheet assets, liabilities, and owner’s equity at a specific date • Statement of Cash Flows cash inflows (receipts) and outflows (payments) for a specific period of time • $ 2,750 • $16,450 • 16,450 • $ 8,050 • $ 8,050 Which of the following is not an advantage of the corporate form of business organization? • Limited liability of stockholders • Transferability of ownership • Unlimited personal liability for stockholders • Unlimited life Which of the following is not an advantage of the corporate form of business organization? • Limited liability of stockholders • Transferability of ownership • Unlimited personal liability for stockholders • Unlimited life