CH 01

John Wiley & Sons, Inc.
Financial Accounting, 4e
Weygandt, Kieso, & Kimmel
Prepared by
Gregory K. Lowry
Mercer University
Marianne Bradford
The University of Tennessee
1 Explain the meaning of accounting.
2 Identify the 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.
After studying this chapter, you should be able to:
CHAPTER 1
ACCOUNTING
IN ACTION
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
stockholders 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.
After studying this chapter, you should be able to:
CHAPTER 1
ACCOUNTING
IN ACTION
Accounting
in Action
Ethics - a fundamental
business concept
Generally accepted
accounting principles
Assumptions
Basic accounting
equation
Transaction analysis
Summary of
transactions
Who uses accounting

data?
Brief history of
accounting
Bookkeeping and
accounting
Accounting and you
The accounting
profession
What is
Accounting?
PREVIEW OF CHAPTER 1
Financial
Statements
The Building
Blocks
of Accounting
Using the
Building
Blocks
Income statement
Retained Earnings
statement
Balance sheet
Statement of cash
flows
Accounting is a process of three activities:

1 Identifying
2 Recording
3 Communicating
WHAT IS ACCOUNTING?
Identification
Select economic events
(transactions)
Recording
Record, classify
and summarize
Accounting
Reports
SOFTBYTE
Annual Report
Prepare
accounting
reports
Analyze and interpret
for users
Communication
ILLUSTRATION 1-1
ACCOUNTING PROCESS
QUESTIONS ASKED BY
INTERNAL USERS

Is cash sufficient to pay bills?
Can we afford to give
employee pay raises this year?
What is the cost of
manufacturing each unit of
product?
Which product line is the most
profitable?

QUESTIONS ASKED BY
EXTERNAL USERS
Is the company earning
satisfactory income?
Will the company be
able to pay its debts as
they come due?
How does the company
compare in size and
profitability with
competitors?
BOOKKEEPING DISTINGUISHED
FROM ACCOUNTING
Accounting
1 Includes bookkeeping
2 Also includes much more

Bookkeeping
1 Involves only the recording of economic events
2 Is just one part of accounting
Ethics - standards of conduct by which ones
actions are judged as right or wrong, honest or
dishonest.
Generally Accepted Accounting Principles -
primarily established by the Financial
Accounting Standards Board and the Securities
and Exchange Commission.
Assumptions:
1 Monetary unit - only transaction data that
can be expressed in terms of money is
included in the accounting records.
2 Economic entity - includes any
organization or unit in society.
THE BUILDING BLOCKS
OF ACCOUNTING
1. Recognize an ethical situation and the ethical
issues involved.
Use your personal ethics to identify ethical
situations and issues. Some businesses and
professional organizations provide written codes
of ethics for guidance in some business situations.
ILLUSTRATION 1-4
STEPS IN ANALYZING ETHICS CASES
SOLVING AN ETHICAL DILEMMA
ALT #1
ALT #2
2. Identify and analyze the principal elements in
the situation.
Identify the stakeholders - persons or groups who
may be harmed or benefited. Ask the question:
What are the responsibilities and obligations of
the parties involved?
ILLUSTRATION 1-4
ALT #1
ALT #2
3. Identify the alternatives, and weigh the impact
of each alternative on various stakeholders.
Select the most ethical alternative, considering all
the consequences. Sometimes there will be one
right answer. Other situations involve more than
one right solution; these situations require an
evaluation of each and a selection of the best
alternative.
ILLUSTRATION 1-4
ALT #1
ALT #2
BUSINESS ENTERPRISES
A business owned by one person is generally a
proprietorship.
A business owned by two or more persons
associated as partners is a partnership.
A business organized as a separate legal entity
under state corporation law and having
ownership divided into transferable shares of
stock is called a corporation.
The Basic Accounting Equation
ILLUSTRATION 1-5
THE BASIC ACCOUNTING EQUATION
Assets = Liabilities + Stockholders
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, consumption and
exchange.
The common characteristics possessed by all
assets is the capacity to provide future services
or benefits to the entities that use them.
LIABILITIES AS A
BUILDING BLOCK
Liabilities are claims against assets.
They are existing debts and obligations.
Most claims of creditors attach to total
enterprise assets rather than to the
specific assets provided by the creditor.
STOCKHOLDERS EQUITY
AS A BUILDING BLOCK
The ownership claim on total assets is
known as stockholders equity.
It is equal to total assets minus total
liabilities.
The stockholders equity section of a
corporations balance sheet consists of:
1 Paid-in (contributed) capital
2 Retained earnings

PAID-IN CAPITAL AS
A BUILDING BLOCK
Paid-in capital is the term used to describe
the total amount paid in by stockholders.
The principal source of paid-in-capital is
the investment of cash and other assets in
the corporation by stockholders in
exchange for capital stock.
The retained earnings section of the balance
sheet is determined by three items:
1 Revenues
2 Expenses
3 Dividends
RETAINED EARNINGS AS
A BUILDING BLOCK
REVENUES AS A
BUILDING BLOCK
Revenues are the gross increases in
stockholders equity that result from
operating the business.
Generally, revenues result from the sale
of merchandise, the performance of
services, the rental of property, or the
lending of money.
Revenues usually result in an increase in
an asset.
EXPENSES AS A
BUILDING BLOCK
Expenses are the decreases in stockholders
equity that result from operating the business.
They are the cost of assets consumed or
services used in the process of earning revenue.
Examples of expenses include utility expense,
rent expense, supplies expense, and tax
expense.
When revenues exceed expenses, net income
results.
When expenses exceed revenues, a net loss
results.
DIVIDENDS
Net income represents an increase in net
assets which then become available for
distribution to stockholders.
Cash or other assets that are distributed
to stockholders are called dividends.
Dividends reduce retained earnings but
are not corporate expenses.
A corporation decides whether or not to
distribute a dividend after determining its
net income or net loss.
INCREASE DECREASE
Investments by
Stockholders
Revenues
Stockholders
Equity
Dividends to
Stockholders
Expenses
ILLUSTRATION 1-6
INCREASES AND DECREASES IN
STOCKHOLDERS EQUITY
Transactions are the economic events of the
enterprise.
They may be identified as external or internal.
1 External transactions involve economic events
between the company and some outside
enterprise or party.
2 Internal transactions are economic events that
occur entirely within one company.
USING THE BUILDING BLOCKS
TRANSACTION ANALYSIS
We need ten
cases by
Friday
My division
needs 2,500
pounds from
your division
Ray and Barbara Neal decide to open a computer
programming company to be incorporated as
Softbyte, Inc.
They invest $15,000 cash in exchange for $15,000
of common stock.
TRANSACTION 1
There is an increase in the asset Cash, $15,000,
and an equal increase in the stockholders
equity, Common Stock, $15,000.
TRANSACTION 1 SOLUTION
(1) +15,000 = +15,000 Investment
Assets = Liabilities + Stockholders Equity
Common
Cash Stock
TRANSACTION 2
Softbyte purchases computer equipment for $7,000 cash.
Cash is decreased $7,000 and the asset
Equipment is increased $7,000.
= Stock
+ $7,000 =
(2) -7,000 +$7,000
Assets = Liabilities +
Stockholders
Common
Cash + Equipment
Old Bal. $15,000 $15,000
New Bal. $ 8,000 $15,000
$15,000
Equity
Softbyte purchases computer paper and other
supplies expected to last several months from
Acme Supply Company for $1,600.
Acme Supply Company agrees to allow Softbyte
to pay this bill in October, a month later.
This transaction is often referred to as a purchase
on account or a credit purchase.
TRANSACTION 3
Acme Supply Company
Softbyte, Inc.
The asset Supplies is increased $1,600 and the liability
Accounts Payable is increased by the same amount.
+ = +
$16,600
(3) +$1,600 +$1,600
Assets = Liabilities + Equity
Accounts Common
Cash + Supplies + Equipment = Payable + Stock
Old Bal. $8,000 $7,000 $15,000
New Bal. $8,000 $1,600 + $7,000 $1,600 $15,000
$16,600
Stockholders
Softbyte receives $1,200 cash from customers for
programming services it has provided.
This transaction represents the principal
revenue-producing activity of Softbyte.
TRANSACTION 4
Softbyte, Inc.
Cash is increased $1,200 and Retained
Earnings is increased $1,200.
Assets = Liabilities + Stockholders Equity
Accounts Common
Cash + Supplies + Equipment = Payable + Stock
Old Bal. $8,000 $1,600 $7,000 $1,600 $15,000
New Bal. $9,200 + $1,600 + $7,000 = $1,600 + $15,000
$17,800 $17,800
Retained
Earnings
$1,200
(4) +1,200 +1,200 Service
Revenue
Softbyte receives a bill for $250 from the Daily News
for advertising the opening of its business but
postpones payment of the bill until a later date.
Softbyte, Inc.
Daily
New
s
Bill
TRANSACTION 5
Accounts Payable is increased $250, and
Retained Earnings is decreased $250.
Assets = Liabilities +
Accounts
Cash + Supplies + Equipment = Payable +
Old Bal. $9,200 $1,600 $7,000 $1,600 $15,000
New Bal. $9,200 + $1,600 + $7,000 = $1,850 + $15,000
$17,800
$17,800
Stockholders Equity
Common
Stock
Retained
Earnings
$ 950
$1,200
(5) +250 -250 Advertising
Expense
Softbyte provides programming services of $3,500
for customers.
Cash amounting to $1,500 is received from
customers, and the balance of $2,000 is billed to
customers on account.
Softbyte, Inc.
Bill
TRANSACTION 6
Accounts Accounts Common Retained
Cash + Receivable + Supplies + Equipment = Payable + Stock + Earnings
Old Bal. $ 9,200 $1,600 $7,000 $1,850 $15,000 $ 950
New Bal. $10,700 + $2,000 + $1,600 + $7,000 = $1,850 + $15,000 + $4,450
(6) +1,500 +2,000 +3,500 Service
Revenue
Cash is increased $1,500; Accounts Receivable is increased
$2,000; and Retained Earnings is increased $3,500.
Stockholders Equity Assets = Liabilities +
$21,300 $21,300
Expenses paid in cash for September are store rent,
$600, salaries of employees, $900, and utilities, $200.
Softbyte, Inc.
$600
$900
$200
TRANSACTION 7
Old Bal. $10,700 $2,000 $1,600 $7,000 $1,850 $15,000 $4,450
New Bal. $ 9,000 + $2,000 + $1,600 + $7,000 = $1,850 + $15,000 + $2,750
(7) -1,700 -600 Rent
-900 Salaries
-200 Utilities
Cash is decreased $1,700 and Retained Earnings
is decreased by $1,700.
$19,600 $19,600
Softbyte pays its Daily News advertising bill of $250
in cash.
Softbyte, Inc.
Daily
New
s
TRANSACTION 8
(8) -250 -250
Old Bal. $9,000 $2,000 $1,600 $7,000 $1,850 $15,000 $2,750
New Bal. $8,750 + $2,000 + $1,600 + $7,000 = $1,600 + $15,000 + $2,750
Cash is decreased $250 and Accounts Payable is decreased
by $250.
$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 9
Softbyte, Inc.
(9) +600 -600
Old Bal. $8,750 $2,000 $1,600 $7,000 $1,600 $15,000 $2,750
New Bal. $9,350 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $2,750
Cash is increased $600 and Accounts Receivable
is decreased by the same amount.
$19,350 $19,350
The corporation pays a dividend of $1,300 in
cash to Ray and Barbara Neal, the stockholders
of Softbyte, Inc.
Softbyte, Inc.
$1,300
TRANSACTION 10
Cash is decreased $1,300 and Stockholders Equity is
decreased by the same amount.
Old Bal. $9,350 $1,400 $1,600 $7,000 $1,600 $15,000 $2,750
New Bal. $8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $1,450
$18,050 $18,050
(10) -1,300 -1,300 Dividends
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 retained earnings statement summarizes the changes in
retained earnings for a specific period of time.
3 A balance sheet reports the assets, liabilities, and
stockholdersequity of a business enterprise at a specific
date.
4 A statement of cash flows summarizes information
concerning the cash inflows (receipts) and outflows
(payments) for a specific period of time.
SOFTBYTE, INC.
Income Statement
For the Month Ended September 30, 2002
Revenues
Service revenue $ 4,700
Expenses
Salaries expense $ 900
Rent expense 600
Advertising expense 250
Utilities expense 200
Total expenses 1,950
Net income
SOFTBYTE, INC.
Retained Earnings Statement
Retained earnings, September 1 $ 0
Add: Net income
2,750
Less: Dividends 1,300
Retained earnings, September 30 $ 1,450
ILLUSTRATION 1-9 FINANCIAL
STATEMENTS AND THEIR INTERRELATIONSHIPS
Net
income of
$2,750
shown on
the
income
statement
is added
to the
beginning
balance of
retained
earnings
in the
retained
earnings
statement.
Net income
of $2,750 is
determined
from the
information
in the
retained
earnings
column of
the
Summary of
Transactions
(Illustration
1-8).
$ 2,750
2,750
SOFTBYTE, INC.
Retained Earnings Statement
Retained earnings, September 1 $ 0
Add: Net income 2,750
2,750
Less: Dividends 1,300
Retained earnings, September 30
SOFTBYTE, INC.
Balance Sheet
September 30, 2002
Assets
Cash $ 8,050
Accounts receivable 1,400
Supplies 1,600
Equipment 7,000
Total assets $ 18,050
Liabilities and Stockholders Equity
Liabilities
Accounts payable $ 1,600
Stockholders equity
Common stock $ 15,000
Retained earnings 16,450
Total liabilities and stockholders equity $ 18,050
Retained
earnings of
$1,450 at the
end of the
reporting
period
shown in the
retained
earnings
statement is
shown on
the balance
sheet.
The retained
earnings of
$1,450 at the
end of the
reporting period
is shown as the
final total of the
retained
earnings column
of the Summary
of Transactions
(Illustration
1-8).
$ 1,450
1,450
SOFTBYTE, INC.
Balance Sheet
September 30, 2002
Assets
Cash
Accounts receivable 1,400
Supplies 1,600
Equipment 7,000
Total assets $ 18,050
Liabilities and Stockholders Equity
Liabilities
Accounts payable $ 1,600
Stockholders equity
Common stock $ 15,000
Retained earnings 1,450 16,450
Total liabilities and stockholders equity $ 18,050
SOFTBYTE, INC.
Statement of Cash Flows
Cash flows from operating activities
Cash receipts from revenues $ 3,300
Cash payments for expenses (1,950)
Net cash provided by operating activities 1,350
Cash flows from investing activities
Purchase of equipment (7,000)
Cash flows from financing activities
Sale of common stock $ 15,000
Payment of cash dividends (1,300) 13,700
Net increase in cash 8,050
Cash at the beginning of the period 0
Cash at the end of the period
Cash of $8,050 on
the balance sheet
is reported on the
statement of cash
flows.
Cash of $8,050
on the balance
sheet and
statement of cash
flows is shown as
the final total of
the cash column
of the Summary
of Transactions
(Illustration 1-8).
$ 8,050
$8,050
APPENDIX A
THE ACCOUNTING PROFESSION
In public accounting, you would offer
expert service to the general public.
Areas of public accounting:
Auditing
Taxation
Management consulting

APPENDIX A
In private (managerial) accounting, you would
be involved in one of the following activities:
General accounting
Cost accounting
Budgeting
Accounting information systems
Tax accounting
Internal auditing
APPENDIX A
Not-for profit organizations also need
sound financial reporting and control.
Donors want information about how well
the organization has met its objectives and
whether continued support is justified.
Hospitals and colleges must make decisions
about the allocation of funds.
Governmental units must provide
information to citizens, employees,
creditors and legislators.
COPYRIGHT
Copyright 2003 John Wiley & Sons, Inc. All rights reserved. Reproduction or
translation of this work beyond that named in Section 117 of the 1976 United
States Copyright Act without the express written consent 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.
CHAPTER 1
ACCOUNTING IN ACTION

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Who uses accounting

Accounting is a process of three activities:

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