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Chapter 1

Accounting as a Form of
Communication

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
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Learning Objectives
LO1 Explain what business is about.
LO2 Distinguish among the forms of organization.
LO3 Describe the various types of business activities.
LO4 Define accounting and identify the primary users of
accounting information and their needs.
LO5 Explain the purpose of each of the financial statements and
the relationships among them and prepare a set of simple
statements.
LO6 Identify and explain the primary assumptions made in
preparing financial statements.

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
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Learning Objectives (continued)
LO7 Identify the various groups involved in setting accounting
standards and the role of auditors in determining whether
the standards are followed.
LO8 Explain the critical role that ethics plays in providing useful
financial information.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Module 1 The Nature of Business
Business consists of all activities necessary to
provide members of an economic system with
goods and services

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Types of Businesses
Certainbusiness activities focus on providing
goods or products
Companies can:
produce or manufacture the products
distribute the products
sell directly to the consumer

Suppliers, manufacturers, wholesalers, and


retailers are examples of product companies

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 1: LO 1
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Exhibit 1-1Types of Businesses

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 1: LO 1
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Business Entities
Business Entity: organization operated to earn a profit
Sole Proprietorships: organization with a single owner
Partnerships: business owned by two or more
individuals
Often used by accounting firms and law firms
Corporations: entity organized under the laws of a
particular state
Ownership is established by acquiring shares of stock

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 1: LO 2
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Exhibit 1-2Forms of Organization

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Nonbusiness Entities
Organizations operated for some purpose other
than to earn a profit
Do not have an identifiable owner
Fund accounting is used by nonbusiness entities

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Organizations and Social
Responsibility
U.S. business entities recognize the societal
aspects of their overall mission and have
established programs to meet these
responsibilities

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 1: LO 2
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
The Nature of Business Activity
All business activities can be categorized as
operating, investing, or financing activities
Financing activities: raising money from owners
contributions as well as obtaining loans from
outsiders
Investing activities: investing the amounts raised
from financing activities in various types of assets
Operating activities: providing goods and services to
customers

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Exhibit 1-3A Model of Business
Activities

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Module 2 Accounting and Financial
Statements
The primary users of financial statements
depend on the economic information conveyed
in those statements to make decisions
Accounting: the process of identifying,
measuring, and communicating economic
information to various users to permit informed
judgments and decisions

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Users of Accounting Information
Primary users may be broadly classified as
internal and external users
Internal users are usually managers of a company
External users include stockholders, investors,
creditors, and government agencies

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 2: LO 4
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Management and Financial
Accounting
Management accounting: the branch of
accounting concerned with providing internal
users with information to facilitate planning and
control
Financial accounting: the branch of accounting
concerned with the preparation of financial
statements for external users

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Exhibit 1-4Users of Accounting
Information

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 2: LO 4
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Financial Decision Framework
1. Formulate the question
2. Gather information from the financial
statements and other sources
3. Analyze the information gathered
4. Make the decision
5. Monitor your decision

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The Accounting Equation
Assets = Liabilities + Owners Equity
Left side: valuable economic resources that will
provide future benefit to the company
Right side: indicates who provided, or has a
claim to, the assets
Stockholders equity, or shareholders equity:
used to refer to the owners equity of a
corporation

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 2: LO 5
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Stockholders Equity
Created when a company issues stock to an
investor
Retained earnings: earnings accumulated or
retained by the company

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 2: LO 5
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The Balance Sheet
Financial statement that summarizes the assets,
liabilities, and owners equity of a company
Sometimes called the statement of financial
position
At any point in time, assets must equal liabilities
and owners equity

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 2: LO 5
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Example 1-4Preparing a Balance
Sheet

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 2: LO 5
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Exhibit 1-5The Accounting
Equation and the Balance Sheet

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
The Income Statement
Summarizes the revenues and expenses of a
company for a period of time

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 2: LO 5
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Example 1-5Preparing an Income
Statement

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 2: LO 5
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
The Statement of Retained Earnings
Summarizes the income earned and dividends
paid over the life of a business
Dividends: Distribution of the net income of a
business to its owners

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 2: LO 5
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
The Statement of Cash Flows
Summarizes a companys cash receipts and cash
payments during the period from operating,
investing, and financing activities

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Exhibit 1-6Relationships Among
the Financial Statements

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Module 3 Conceptual Framework of
Accounting
The usefulness of accounting information is
enhanced through the various assumptions set
forth in the conceptual framework developed by
the accounting profession
This conceptual framework is the foundation for
the methods, rules, and practices that make up
generally accepted accounting principles (GAAP)

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 3
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Conceptual Framework for
Accounting
Important assumptions in the conceptual
framework are as follows:
Economic entity concept
Cost principle
Going concern
Monetary unit
Time period

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
Module 3: LO 6
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Economic Entity Concept
Single, identifiable unit must be accounted for
in all situations
Specific entity be the subject of a set of financial
statements
Does not intermingle the personal assets and
liabilities of the employees or any of the other
stockholders

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
Module 3: LO 6
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Cost Principle
Assets are recorded at the cost to acquire them
Original cost or historical costuntil the company
disposes them
More objective than market value

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Going Concern
Assume entity will continue indefinitely into the
future
Justifies use of historical cost

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 3: LO 6
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Monetary Unit
Yardstick used to measure amounts in financial
statements
The dollar is used because it is the recognized
medium of exchange in the United States
Assumes monetary unit is relatively stable; no
adjustment for inflation made in financial
statements

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 3: LO 6
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Time Period Assumption
Artificialsegment on the calendar used as the
basis for preparing financial statements
Accountants assume that it is possible to
prepare an income statement that accurately
reflects net income or earnings for a specific
time period

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 3: LO 6
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Setting Accounting Standards
Financial statements are the responsibility of
management. Various groups are involved in
setting the standards that are used in preparing
the statements
Although the SEC has the ultimate authority to
determine the rules, the FASB currently sets the
standards in the United States

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 3: LO 7
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Setting Accounting Standards
Generally accepted accounting principles
(GAAP)
Various methods, rules, practices, and other
procedurespreparing financial statements
Securities and Exchange Commission (SEC)
Federal agency with ultimate authority to determine
the rules for preparing statements
Financial Accounting Standards Board (FASB)
Authority to set accounting standards
2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 3: LO 7
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Setting Accounting Standards
(continued)
American Institute of Certified Public
Accountants (AICPA)
Professional organization of Certified Public
Accountants (CPAs)
Public Company Accounting Oversight Board
(PCAOB)
Five-member body created by an act of Congress in
2002 to set auditing standards
International Accounting Standards Board
(IASB)
Develop worldwide accounting standards
2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 3: LO 7
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
The Audit of Financial Statements
Most stockholders are not actively involved in
the daily affairs of the business
Auditing: examining whether financial
statements are fairly presented
External auditor performs various tests and
procedures to render an opinion as to whether the
financial statements of a company are fairly
presented
Auditors report is an opinion, not a statement of
fact
2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 3: LO 7
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Introduction to Ethics in Accounting
Ethics plays a critical role in providing useful
financial information
Investors and other users must have confidence
in a company, its accountants, and its outside
auditors that the information presented in
financial statements is relevant, complete,
neutral, and free from error

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 3: LO 8
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Why Should Accountants Be
Concerned with Ethics?
Moral and social ethical behavior must be
considered while decision making
Recent news of questionable accounting practices has placed
increased scrutiny on the accounting profession
Professional judgment is often needed to arrive at
appropriate decisions when some question arises about the
application of GAAP

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 3: LO 8
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Exhibit 1-9Ethics and Accounting:
A Decision-Making Model

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as Module 3: LO 8
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Review
LO1 Explain what business is about.
Business consists of all activities necessary to provide members of an
economic system with goods and services. Suppliers, manufacturers,
wholesalers, and retailers are examples of product companies.
LO2 Distinguish among the forms of organization.
Some entities are organized to earn a profit, while others are
organized to serve various segments of society.
The three forms of business entities are sole proprietorships,
partnerships, and corporations.

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Review
LO3 Describe the various types of business activities.
All business activities can be categorized as operating, investing, or
financing activities.
Financing activities involve raising money from contributions made by
the owners of a business as well as obtaining loans from outsiders.
Companies invest the amounts raised from financing activities in
various types of assets, such as inventories, buildings, and
equipment.
Once funds are obtained and investments are made in productive
assets, a business can begin operations. Operating activities involve
providing goods and services to customers.

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Review
LO4 Define accounting and identify the primary users of
accounting information and their needs.
The primary users of financial statements depend on the economic
information conveyed in those statements to make decisions. Primary
users may be broadly classified as internal and external users.
Internal users are usually managers of a company.
External users include stockholders, investors, creditors, and
government agencies.

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Review
LO5 Explain the purpose of each of the financial statements and
the relationships among them and prepare a set of simple
statements.
Four major financial statements are covered in this chapter: balance sheet, income
statement, statement of retained earnings, and statement of cash flows.
The balance sheet is a snapshot of a companys financial position at the end of the
period. It reflects the assets, liabilities, and stockholders equity accounts.
The income statement summarizes the financial activity for a period of time. Items of
revenues, expenses, gains, and losses are reflected on the income statement.
Ultimately, all net income (loss) and dividends are reflected in retained earnings on the
balance sheet. The statement of retained earnings links the income statement to the
balance sheet by showing how net income (loss) and dividends affect the Retained
Earnings account.
The statement of cash flows summarizes the cash flow effects of a companys
operating, investing, and financing activities.

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Review
LO6 Identify and explain the primary assumptions made in
preparing financial statements.
The usefulness of accounting information is enhanced through the
various assumptions set forth in the conceptual framework
developed by the accounting profession. This conceptual framework
is the foundation for the methods, rules, and practices that make up
generally accepted accounting principles (GAAP).
Important assumptions in the conceptual framework are as follows:
Economic entity concept
Cost principle
Going concern
Monetary unit
Time period

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Review
LO7 Identify the various groups involved in setting accounting
standards and the role of auditors in determining whether
the standards are followed.
Financial statements are the responsibility of management. Various groups are involved
in setting the standards that are used in preparing the statements. Although the SEC
has the ultimate authority to determine the rules, the FASB currently sets the
standards in the United States.
The role of the external auditor is to perform various tests and procedures to render an
opinion as to whether the financial statements of a company are fairly presented.

LO8 Explain the critical role that ethics plays in providing useful
financial information.
All decision makers must consider the moral and social implications of their decisions.
Recent news of questionable accounting practices has placed increased scrutiny on the
accounting profession. Professional judgment is often needed to arrive at appropriate
decisions when some question arises about the application of GAAP.

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
End of Chapter 1

2017 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

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