Accounting Principles

10th Edition
Weygandt Kieso Kimmel Trenholm

CHAPTER

1
ACCOUNTING IN ACTION

THE ACCOUNTING PROCESS

BOOKKEEPING DISTINGUISHED FROM ACCOUNTING

Accounting 1. Includes bookkeeping 2. Includes much more such as the entire process of identifying, recording, and communicating economic events. Bookkeeping 1. Involves only the recording of economic events 2. Is just one part of accounting

Users of Accounting Information

Internal Users External Users

QUESTIONS ASKED BY INTERNAL USERS (Management)

Is cash sufficient to pay bills?

What is the cost of manufacturing each unit of product?

Can we afford to give employees pay raises this year?

Which product line is the most profitable?

Management Accounting
Management accounting provides internal decision makers (management), who are charged with achieving the goals of profitability and liquidity, with information about operating, investing, and financing activities. Examples are financial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year.

External users
External users are individuals and organizations outside a company who want financial information about the company. The two most common types of external users are investors and creditors. Investors (owners) use accounting information to make decisions to buy, hold, or sell ownership shares of a company. Creditors (such as suppliers and bankers) use accounting information to evaluate the risks of granting credit or lending money.

QUESTIONS ASKED BY EXTERNAL USERS

Is the company earning satisfactory income?

How does the company compare in size and profitability with its competitors?
What do we do if they catch us?

Will the company be able to pay its debts as they come due?

Financial Accounting
Financial accounting generates reports and communicates them to external decision makers so they can evaluate how well the business has achieved its goals. These reports are called financial statements. Financial statements report directly on the goals of profitability and liquidity and are used extensively both inside and outside a business to evaluate the businesss success. It varies according to the requirement of user.

BUSINESS ENTERPRISES
A business owned by one person is generally a proprietorship (owners equity). A business owned by two or more persons associated as partners is a partnership (partners equity). A business organized as a separate legal entity under corporation law and having ownership divided into transferable shares is called a corporation (shareholders equity).

BASIC ACCOUNTING EQUATION

The Basic Accounting Equation

Assets

Liabilities

Owners Equity

ASSETS AS A BUILDING BLOCK

Assets are resources owned by a business. They are things of value used in carrying out such activities as production and exchange.

LIABILITIES AS A BUILDING BLOCK

Liabilities are claims against assets. They are existing debts and obligations.

OWNERS EQUITY
Owners Equity is equal to total assets minus

total liabilities. Owners Equity represents the ownership claim on total assets. It is often referred to as residual equity. Subdivisions of Owners Equity: 1. Investments by Owner 2. Drawings 3. Revenues 4. Expenses

Increase in Owners Equity

Investments by owner are the assets put into the business by the owner. These investments in the business increase owners equity.

Increase in Owners Equity

Revenues are the gross increases in owners equity resulting from business activities entered into for the purpose of earning income. Revenues may result from sale of merchandise, performance of services, rental of property, or lending of money. Revenues usually result in an increase in an asset.

Decrease in Owners Equity

Drawings are withdrawals of cash or other assets by the owner for personal use. Drawings decrease total owners equity.

Decrease in Owners Equity

Expenses are the decreases in owners equity that result from operating the business. Expenses are the cost of assets consumed or services used in the process of earning revenue. Examples of expenses include utility expense, rent expense, and supplies expense.

INCREASES AND DECREASES IN OWNERS EQUITY

INCREASES
Investments by Owner

DECREASES
Withdrawals by Owner

Owners Equity
Revenues

Expenses

Expanded accounting equation

TRANSACTION ANALYSIS
Marc Doucet decides to open a computer programming service.

BANK

Softbyt e

TRANSACTION ANALYSIS

TRANSACTION 1

TRANSACTION ANALYSIS

TRANSACTION 2

TRANSACTION ANALYSIS

TRANSACTION 3

TRANSACTION ANALYSIS

TRANSACTION 4

TRANSACTION ANALYSIS

TRANSACTION 5

TRANSACTION ANALYSIS

TRANSACTION 6

Softbyte provides $3,500 of programming services for customers. The company receives cash of $1,500 from customers, and it bills the balance of $2,000 on account.

TRANSACTION ANALYSIS

TRANSACTION 7

Softbyte pays the following expenses in cash for September: store rent $600, salaries and wages of employees $900, and utilities $200. These payments result in an equal decrease in assets and expenses. Cash decreases $1,700, and the specific expense categories (Rent Expense, Salaries and Wages Expense, and Utilities Expense) decrease owners equity by the same amount.

TRANSACTION ANALYSIS

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 and a decrease in owners equity.

TRANSACTION ANALYSIS

TRANSACTION 9

Softbyte receives $600 in cash from customers who had been billed for services [in Transaction (6)].

TRANSACTION ANALYSIS

TRANSACTION 10

Summary of Transaction

Numerical

Solution

FINANCIAL STATEMENTS
After transactions are identified, recorded, and summarized, four financial statements are prepared from the summarized accounting data: 1. An income statement presents the revenues and expenses and resulting net income or net loss of a company for a specific period of time. 2. A statement of owners equity summarizes the changes in owners equity for a specific period of time.

FINANCIAL STATEMENTS
In addition to the income statement and statement of owners equity, two additional statements are prepared: 3. A balance sheet reports the assets, liabilities, and owners equity of a business enterprise at a specific date. 4. A cash flow statement summarizes information concerning the cash inflows (receipts) and outflows (payments) for a specific period of time. These statements provide relevant financial data for internal and external users.

Numerical