Accounting in Action

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Chapter 1

• Accounting in Action

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Chapter 1Accounting in Action

• Remember these are mini-lectures intended to
  supplement the text, not replace it. Have you
  read the chapter yet?

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Chapter 1Accounting in Action

• Define accounting, its users (internal and
  external)
• Differentiate between bookkeeping and accounting
• Explain some careers in accounting
• Differentiate between public, private, and
  not-for-profit accounting and the activities
  under each

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The Building Blocks of Accounting

• Ethics
• Generally Accepted Accounting Principles
• Assumptions
• Basic Accounting Equation

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Ethics

• Moral principles that guide the conduct of
  individuals
• Crucial to the conduct of business the public
  demands high ethical standards for accountants
  and public figures

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Ethics

• When faced with a decision think Whatever I do
  today will be published on the front page of
  tomorrows national newspapers. My parents,
  spouse, children, and religious leader will all
  see my decision. How do I feel about that?

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Ethics

• Good ethics is good business. Many companies
  gain business due to their ethical handling of
  situations (Tylenol)

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Generally Accepted Accounting Principles

• The law of accounting
• The rules accountants must follow when they
  prepare financial statements

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Generally Accepted Accounting Principles

• GAAP is written by FASB - the Financial
  Accounting Standards Board
• FASB is a private organization that determines
  how accounting is practiced in the U.S.

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Generally Accepted Accounting Principles

• FASB works with the SEC - Securities and Exchange
  Commission
• SEC is a federal agency which requires businesses
  to disclose certain financial information to the
  public

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Cost Principle

• The Cost Principle states that assets should be
  recorded at their cost
• WHAT DID YOU ACTUALLY PAY FOR THIS ASSET?
• Asking price, initial offer, appraisal value,
  fair market value none of these matter
• All that matters is what you paid out of your
  pocket

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Cost Principle

• Cost is usually the most objective measurement
  available. As accountants, we need to use
  objective measurements rather than subjective
  ones (like market value)

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Monetary Unit Assumption

• The Monetary Unit Assumption states that we only
  record those things that can be quantified
  (measured) in terms of dollars (money)
• If its not a matter of money, we dont care
  about it

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Stable Monetary Unit Assumption

• Goes hand-in-hand with the Monetary Unit
  Assumption
• Ignores the effect of inflation in the accounting
  records
• Assumes that the dollars purchasing power is
  relatively stable
• This makes our lives easierone less thing to
  worry about!

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Economic Entity Assumption

• The Economic Entity Assumption states that an
  entity is an organization or a section of an
  organization that for accounting purposes stands
  apart from other organizations and individuals as
  a separate economic unit.

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Economic Entity Assumption

• WE HAVE TO KNOW WHERE OUR BUSINESS STARTS AND
  ENDS IN ORDER TO KNOW WHAT TO RECORD ON ITS BEHALF

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Economic Entity Assumption

• The entity could be an individual, a
  not-for-profit organization (church), or a profit
  enterprise
• Profit-making businesses are normally organized
  as a sole proprietorship, partnership, or
  corporation. Lets define these...

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Economic Entity Assumption

• Sole Proprietorship - owned by one person or a
  married couple
• The life of a sole proprietorship is limited by
  the owners choice or death
• The owner is personally liable for the business
  debts
• Most businesses are sole proprietorships

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Economic Entity Assumption

• Partnership - owned by two or more partners
• The life of a partnership is limited by the
  owners choice or death
• The partners are personally liable for the
  business debts

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Economic Entity Assumption

• Corporation - owned by the shareholders (there
  are generally many of these)
• The life of a corporation is indefinite (not
  dependent on who is a shareholder).

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Economic Entity Assumption

• Corporation - The shareholders are not personally
  liable for the business debts.
• Corporations account for the greatest amount of
  revenue.

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Basic Accounting Equation

• The most basic tool of accounting
• We will use this all semester know it, live it,
  breathe it!

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Basic Accounting Equation

• ASSETS LIABILITIES OWNERS EQUITY

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Basic Accounting Equation

• ASSETS LIABILITIES OWNERS EQUITY

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Basic Accounting Equation

• ASSETSLIABILITIESOWNERS EQUITY

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Basic Accounting Equation

• Assets what the business OWNS (our resources)
• Liabilities Owners Equity who has claims on
  our resources

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Assets

• Assets - Economic resources expected to benefit
  the business in the future

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Assets

• Examples
• Cash
• Office Supplies
• Merchandise
• Land
• Buildings
• Equipment
• Accounts Receivable

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Assets

• Accounts Receivable money that someone
  (typically a customer) owes us
• Anything receivable is money we have the right to
  RECEIVE and is therefore always an asset

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Basic Accounting Equation

• ASSETS LIABILITIES OWNERS EQUITY

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Liabilities

• What the business OWES
• Claims that creditors have on our resources
• A debt or obligation the business must pay to its
  creditors

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Liabilities

• Examples
• Accounts Payable
• Notes Payable
• anything payable means we must PAY it to someone
  else

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Basic Accounting Equation

• ASSETSLIABILITIESOWNERS EQUITY

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Owners Equity

• The claim of a business owner to the assets of
  the business
• The part of our assets that we ACTUALLY OWN

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Owners Equity

• Example You have a 100,000 home with a 60,000
  mortgage payable to the bank
• Assets Liabilities Owners Equity
• 100,000 60,000 40,000

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Basic Accounting Equation

• ASSETSLIABILITIES OWNERS EQUITY

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Basic Accounting Equation

• Assets 95,000
• Liabilities 35,000
• Owners Equity ?

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Basic Accounting Equation

• Assets 95,000
• Liabilities 35,000
• Owners Equity 60,000

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Basic Accounting Equation

• Assets 54,000
• Liabilities ?
• Owners Equity 12,000

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Basic Accounting Equation

• Assets 54,000
• Liabilities 42,000
• Owners Equity 12,000

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Basic Accounting Equation

• The equation must always balance!
• ASSETSLIABILITIESOWNERS EQUITY

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Owners Equity

• Two things INCREASE our equity
• Owner Investments in the business
• (the owner gives the business money)
• Revenues the business generates
• (the business earns money by selling a product or
  service)

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Owners Equity

• Two things INCREASE our equity
• Owner Investments (Hurray! We get money from the
  big guy!)
• Revenues (Hurray! We get money from our
  customers!)

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Owners Equity

• Two things DECREASE our equity
• Owner Withdrawals from the business
• (the owner takes money from the business for
  personal use)
• Expenses the business incurs
• (the business must spend money to make money)
• (examples include rent, payroll, taxes,
  insurance, advertising, utilities)

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Basic Accounting Equation

• Remember the equation must always...

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Basic Accounting Equation

• BALANCE

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Using the Building Blocks

• So, how do we USE the basic accounting equation?
• We use it to record transactions

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Using the Building Blocks

• Are all economic events affecting a business
  recorded in an accounting system? NO
• For example, a change in a businesss credit
  rating by Dun Bradstreet is not recorded

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Using the Building Blocks

• We only record business transactions
• What is a business transaction? An economic
  event or condition that directly changes the
  businesss financial position

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Business transactions

• Examples
• Paying a monthly bill
• Purchasing merchandise on credit
• Collecting a fee
• Selling a product

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Business transactions

• Every business transaction can be stated in terms
  of changes in the three elements (Assets,
  Liabilities, and Owners Equity) of the basic
  accounting equation
• The equation must always BALANCE

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Transaction Analysis

• For the following analyses, assume the following
• On November 1, 1999, Peg Kline, an engineer,
  begins a sole proprietorship. Using Pegs
  knowledge, the business will offer consulting
  services for a fee.

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Transaction Analysis

• 1 Investment by the Owner
• Peg deposits 15,000 in a bank account in the
  name of Kline Consulting.

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1 Investment by the Owner

• This transaction will increase the asset (cash),
  on the left side of the equation, by 15,000.
• To balance the equation, the owners equity, on
  the right side of the equation, increased by the
  same amount.

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1 Investment by the Owner

• The equity of the owner is referred to by the
  owners name and Capital, such as Peg Kline,
  Capital.

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1 Investment by the Owner

• Assets Liabilities Owners Equity
• 15,000 X 15,000
• ? ?
• (Cash) (Owners Equity)
• 15,000 X 15,000 (running total)

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2 Purchase of Equipment for Cash

• Peg buys equipment for 10,000 cash to operate
  her business.

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2 Purchase of Equipment for Cash

• The purchase of the equipment changes the makeup
  of the assets but does not change the total
  assets.
• We are transferring our assets from cash to
  equipment.

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2 Purchase of Equipment for Cash

• Assets Liabilities OE
• -10,000 10,000
• ? ?
• (-Cash) (Equipment)
• 15,000 X 15,000
  (running total)

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3 Purchase of Supplies on Credit

• Peg buys supplies for 1,350, agreeing to pay the
  supplier in the near future.

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3 Purchase of Supplies on Credit

• The effect is to increase both assets and
  liabilities by 1,350.

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3 Purchase of Supplies on Credit

• This type of transaction (buy now, pay later) is
  called a purchase on account.
• The liability created is called an account
  payable.

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3 Purchase of Supplies on Credit

• Assets Liabilities OE
• 1,350 1,350
• ? ?
• (Supplies) (Account Payable)
• 16,350 1,350 15,000 (running total)

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4 Services Rendered for Cash

• During its first month of operations, CK earns
  fees of 7,500 and receives the amount in cash.
• These transactions increase cash and owners
  equity by 7,500.
• Remember revenue is 1 of the 4 things that
  affects owners equity. It increases it.

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4 Services Rendered for Cash

• This will increase cash and owners equity by
  7,500.
• Remember revenue is 1 of the 4 things that
  affects owners equity. It increases it.

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4 Services Rendered for Cash

• The amount charged to customers for services
  rendered is called revenue.
• Revenue from the sale of merchandise is called
  sales.
• Revenue from providing services is called fees
  earned.

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4 Services Rendered for Cash

• Assets Liabilities Owners Equity
• 7,500 7,500
• ? ?
• Cash Owners Equity
• 23,850 1,350 22,500 (running total)

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5 Purchase of Advertising on Credit

• CK receives a bill for 300 for radio
  advertising. CK will pay this bill at a later
  date.

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5 Purchase of Advertising on Credit

• This transaction increases a liability and
  decreases owners equity.
• Only one side of the equation is affected.
• Remember an expense is 1 of the 4 things that
  affects owners equity. It decreases it!

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5 Purchase of Advertising on Credit

• Assets Liabilities Owners Equity
• 300 -300
• ? ?
• Accounts Payable Owners Equity
• 23,850 1,650 22,200 (running total)

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6 Services Rendered for Cash and Credit

• CK earns fees of 12,000. CK receives 4,000 in
  cash and 8,000 is billed to customers on account.

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6 Services Rendered for Cash and Credit

• Although only 4,000 is received in cash, owners
  equity will increase for the entire 12,000. This
  is because the remaining 8,000 is an account
  receivable, which is still an asset.
• Remember revenue is 1 of the 4 things that
  affects owners equity. It increases it. This
  is true even if we are not paid cash for the
  revenue immediately.

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6 Services Rendered for Cash and Credit

• Assets Liabilities Owners Equity
• 4,0008,000 12,000
• ? ? ?
• Cash Accounts Receivable Owners Equity
• 35,850 1,650 34,200 (running total)

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7 Payment of Expenses

• CK pays expenses of 500 for rent, 200 for
  insurance, and 175 for utilities.

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7 Payment of Expenses

• This transaction will decrease cash and decrease
  owners equity.
• Remember an expense is 1 of the 4 things that
  affects owners equity. It decreases it!

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7 Payment of Expenses

• Assets Liabilities Owners Equity
• -875 - 500 - 200 - 175
• ? ? ?
  ?
• CashX-Rent Expense-Insurance Exp.-Utilities Exp.
• 34,975 1,650 33,325 (running total)

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8 Payment on Accounts Payable

• CK pays it advertising bill of 1,350 in cash.

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8 Payment on Accounts Payable

• This transaction will reduce cash and will reduce
  the liability account, accounts payable.

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8 Payment on Accounts Payable

• Assets Liabilities Owners Equity
• -1,350 -1,350
• ? ?
• Cash Accounts Payable
• 33,625 300 33,325 (running total)

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9 Receipt of Cash on Account

• CK receives 1,750 cash from customers on account.

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9 Receipt of Cash on Account

• The receipt of cash for a payment on an account
  receivable changes the makeup of the assets but
  does not change the total assets.
• We are transferring our assets from accounts
  receivable to cash.

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9 Receipt of Cash on Account

• Assets Liabilities Owners Equity
• 750 - 750
• ? ?
• Cash Accounts Receivable
• 33,625 300 33,325 (running total)

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10 Withdrawal of Cash by Owner

• Peg Kline withdraws 1,500 in cash from the
  business for her personal use.

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10 Withdrawal of Cash by Owner

• This transaction will reduce cash by 1,500 and
  will reduce owners equity by the same amount.
• Remember an owners withdrawal is 1 of the 4
  things that affects owners equity. It decreases
  it!

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10 Withdrawal of Cash by Owner

• Assets Liabilities Owners Equity
• -1,500 -1,500
• ? ?
• Cash Owners Equity
• 32,125 300 31,825 (running total)

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Financial Statements

• After transactions have been recorded and
  summarized, reports are prepared for users.
• The accounting reports that provide this
  information are called financial statements.

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Financial Statements

• The principal financial statements of a sole
  proprietorship are the income statement,
  statement of owners equity, balance sheet, and
  statement of cash flows.

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Income Statement

• Summarizes our revenue and expenses for a
  specific period of time (such as a month or year)

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Income Statement

• Revenue
• - Expenses
• Net Profit/Net Loss

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Income Statement

• If revenue gt expenses, we have a profit
  (hurray!)
• If expenses gt revenue, we have a loss (oops!)

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Statement of Owners Equity

• Summarizes the changes in the owners equity
  during a specific period of time (such as a month
  or a year)
• This statement links the income statement and the
  balance sheet.

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Statement of Owners Equity

• Remember, equity is INCREASED by owners
  investments and revenue
• Equity is DECREASED by owners withdrawals and
  expenses

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Statement of Owners Equity

• Beginning Capital Balance
• Owners Investments
• Net Income
• -Owners Withdrawals
• -Net Loss
• Ending Capital Balance

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Balance Sheet

• A list of our assets, liabilities, and owners
  equity as of a specific date, usually at the
  close of the last day of a month or year
• Since this statement deals with assets,
  liabilities, and owners equity, guess what?

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Balance Sheet

• It must always balance!

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Balance Sheet

• See page 24 in your text for a sample balance
  sheet.

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Statement of Cash Flows

• Summarizes the actual cash that came into and
  left our business for a specific period of time,
  such as a month or a year
• This is a crucial financial statement.
• Cash is critical to businesses.

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Statement of Cash Flows

• Did you know Most businesses that go out of
  businesses are actually profitable? They are
  just not receiving money (from their customers)
  in the time that they need it to pay their
  suppliers!

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Financial Statements

• Page 24 in your text is great for showing samples
  of these four statements and the relationship
  between them.
• We make a profit (income statement), which
  increases our equity (statement of owners
  equity). When we collect this profit from our
  customers, it also increases our cash (balance
  sheet and statement of cash flows).