Accounting in Action Chapter 1 PDF

CHAPTER 1 AL RI...

CHAPTER 1 AL RI TE MA D Erik Isakson/Tetra Images/AGE Fotostock TE Accounting in Action GH Tetra Images/SUPERSTOCK RI PY The Chapter Preview describes the purpose of the chapter and highlights major topics. Chapter Preview CO The following Feature Story highlights the importance of having good financial information and knowing how to use it to make effective business decisions. Whatever your pursuits or occupation, the need for financial information is inescapable. You cannot earn a living, spend money, buy on credit, make an investment, or pay taxes without receiving, using, or dispensing financial information. Good decision-making depends on good information. The Feature Story helps you picture how the chapter topic relates to the real world of accounting and business. Feature Story ­ arold Geneen, the former chairman of a major interna- H tional ­company: “To be good at your ­business, you have to know the numbers—cold.” Knowing the Numbers Success in any business comes back to the numbers. You Many students who take this course do not plan to be will rely on them to make decisions, and managers will use ­accountants. If you are in that group, you might be thinking, them to evaluate your performance. That is true whether “If I’m not going to be an accountant, why do I need to your job involves marketing, production, management, or know accounting?” In response, consider the quote from ­information systems. 1-1 1-2 CH A PT E R 1 Accounting in Action In business, accounting is the means for communicating ­ tandards (IFRS): Taiwan Semiconductor Manufactur- S the numbers. If you don’t know how to read financial state- ing ­Company (TSMC) Ltd. (TWN), Nestlé SA (CHE), and ments, you cannot really know your business. Delfi Limited (SGP). Throughout this text, we increase your Many companies spend significant resources teaching ­familiarity with financial reporting by providing numerous their employees basic accounting so that they can read finan- references, questions, and exercises that encourage you to cial statements and understand how their actions affect the explore these financial statements. In addition, we encour- company’s financial results. Employers need managers in all age you to visit each company’s website where you can view areas of the company to be “financially literate.” its complete annual report. Taking this course will go a long way to making you Even though these three companies are based in three financially literate. In this text, you will learn how to read and different countries, they all follow IFRS. This means they all prepare financial statements, and how to use basic tools to follow the same basic accounting principles. As a result, their evaluate financial results. financial statements are very similar. Therefore, by learning Appendices A, B, and C of this text provide real finan- these basic principles as presented in this text, you will be well cial statements of three companies from different coun- equipped to begin understanding the financial results of com- tries that report using International Financial Reporting panies around the world. The Chapter Outline presents the chapter’s topics and subtopics, as well as practice opportunities. Chapter Outline LEARNING OBJECTIVES REVIEW PRACTIC E LO 1 Identify the activities and Who uses accounting data DO IT! 1 Basic Concepts users associated with accounting. Data analytics LO 2 Explain the building blocks of Ethics in financial reporting DO IT! 2 B  uilding Blocks of accounting: ethics, principles, and Accounting standards ­Accounting assumptions. Measurement principles Assumptions LO 3 State the accounting Assets DO IT! 3 E  quity Effects equation, and define its Liabilities components. Equity LO 4 Analyze the effects of business Accounting transactions DO IT! 4 Tabular Analysis transactions on the accounting Transaction analysis equation. Summary of transactions LO 5 Describe the five financial Income statement DO IT! 5 Financial Statement statements and how they are Retained earnings statement Items prepared. Statement of financial position Statement of cash flows Comprehensive income statement Go to the Review and Practice section at the end of the chapter for a targeted summary and practice applications with solutions. Additional tutorials and practice opportunities are available in the Wiley online course.  1.1 Accounting Activities and Users 1-3 1.1 Accounting Activities and Users LEARNING OBJECTIVE 1 Identify the activities and users associated with accounting. What consistently ranks as one of the top career opportunities in business? What frequently rates among the most popular majors on campus? Accounting.1 Why do people choose accounting? They want to acquire the skills needed to understand what is happening finan- cially inside an organization. Accounting is the financial information system that provides these insights. In short, to understand your organization, you have to know the numbers. Accounting consists of three basic activities—it identifies, records, and communi- Essential terms are printed in cates the economic events of an organization to interested users. blue when they first appear, and are defined in the end-of-chapter 1. As a starting point to the accounting process, a company identifies the economic events Glossary Review. relevant to its business. Examples of economic events are the sale of food and snacks by Unilever (GBR), the providing of telephone services by Chunghwa Telecom (TWN), and the manufacture of motor vehicles by Tata Motors (IND). 2. Once a company like Unilever identifies economic events, it records those events in or- der to provide a history of its financial activities. Recording consists of keeping a sys- tematic, chronological diary of events, measured in monetary units. In recording, Unilever also classifies and summarizes economic events. 3. Finally, Unilever communicates the collected information to interested users by means of accounting reports. The most common of these reports are called financial ­statements. To make the reported financial information meaningful, Unilever reports the recorded data in a standardized way. It accumulates information resulting from similar transactions. For exam- ple, Unilever accumulates all sales transactions over a certain period of time and reports the data as one amount in the company’s financial statements. Such data are said to be reported in the aggregate. By presenting the recorded data in the aggregate, the accounting process simplifies a multitude of transactions and makes a series of activities understandable and meaningful. A vital element in communicating economic events is the accountant’s ability to ana- lyze and interpret the reported information. A  nalysis involves use of ratios, percentages, graphs, and charts to highlight significant financial trends and relationships. I nterpretation involves explaining the uses, meaning, and limitations of reported data. Appendix A of this text shows the financial statements of Taiwan Semiconductor Manu- facturing Company (TSMC) Ltd. (TWN). Appendix B illustrates the financial statements of Nestlé SA (CHE), and Appendix C includes the financial statements of Delfi ­Limited (SGP). We refer to these statements at various places throughout the text. (In addition, in the A Look at U.S. GAAP section at the end of each chapter, the U.S. company Apple Inc. is analyzed.) At this point, these financial statements probably strike you as complex and confusing. By the end of this course, you’ll be surprised at your ability to understand, analyze, and interpret them. 1 The appendix to this chapter describes job opportunities for accounting majors and explains why accounting is such a popular major. 1-4 CH A PT ER 1 Accounting in Action Illustration 1.1 summarizes the activities of the accounting process. ILLUSTRATION 1.1 The activities of the accounting process Communication Identification Recording CHIP CITY Prepare accounting reports Select economic events (transactions) Record, classify, and summarize Analyze and interpret for users You should understand that the accounting process includes the bookkeeping function. Bookkeeping usually involves only the recording of economic events. It is therefore just one part of the accounting process. In total, accounting involves the entire process of identifying, recording, and communi- cating economic events.2 Who Uses Accounting Data The financial information that users need depends upon the kinds of decisions they make. There are two broad groups of users of financial information: internal users and external users. Internal Users Internal users of accounting information are managers who plan, organize, and run the business. These include marketing managers, production supervisors, finance directors, and company officers. In running a business, internal users must answer many important ques- tions, as shown in Illustration 1.2. ILLUSTRATION 1.2 Questions that internal users ask Questions Asked by Internal Users ON ON STRIKE ONSTRIKE STRIKE COLA Snack chips Beverages Finance Marketing Human Resources Management Is cash sufficient to pay What price should Nokia charge Can Toyota afford Which PepsiCo product line is dividends to for a cell phone to maximize the to give its employees pay the most profitable? Should any SAP shareholders? company's net income? raises this year? product lines be eliminated? 2 The origins of accounting are generally attributed to the work of Luca Pacioli, an Italian Renaissance mathematician. Pacioli was a close friend and tutor to Leonardo da Vinci and a contemporary of Christopher Columbus. In his 1494 text Summa de Arithmetica, Geometria, Proportione et Proportionalite, Pacioli described a system to ensure that financial information was recorded efficiently and accurately.  1.1 Accounting Activities and Users 1-5 To answer these and other questions, internal users need detailed information on a timely basis. Managerial accounting provides internal reports to help users make decisions about their companies. 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 informa- tion about the company. The two most common types of external users are investors and creditors. Investors (owners) use accounting information to decide whether 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. Illustration 1.3 shows some questions that investors and creditors may ask. ILLUSTRATION 1.3 Questions that external users ask Questions Asked by External Users Yeah! What do we do if they catch us? Bills Investors Investors Creditors Is Lenovo earning How does Disney compare in size Will Singapore Airlines be able satisfactory income? and profitability with Time Warner? to pay its debts as they come due? Financial accounting answers these questions. It provides economic and financial information for investors, creditors, and other external users. The information needs of exter- nal users vary considerably. Taxing authorities, such as the State Administration of Taxation in the People’s Republic of China (CHN), want to know whether the company complies with tax laws. Regulatory agencies, such as the Financial Services Authority of Indonesia (IDN), want to know whether the company is operating within prescribed rules. Customers are interested in whether a company like Tesla Motors, Inc. (USA) will continue to honor product warranties and support its product lines. Labor unions, such as the Indian National Trade Union Congress (IND), want to know whether companies have the ability to pay increased wages and benefits to union members. Data Analytics Accounting software systems collect vast amounts of data about a company’s economic events as well as its suppliers and customers. Business decision-makers take advantage of this wealth of data by using data analytics to gain insights and therefore make more informed business decisions. Helpful Hints further clarify concepts being discussed. Data analytics involves analyzing data, often employing both software and statistics, to draw inferences. As both data access and analytical software improve, the use of data analytics to sup- HELPFUL HINT port decisions is becoming increasingly common at virtually all types of companies (see Throughout this text, we Helpful Hint). will highlight examples where accounting informa- Illustration 1.4 shows the four most common types of data analytics that help answer ques- tion is used to support busi- tions ranging from what happened and why did it happen, to what is likely to happen and ness decisions using data what should we do about it? Analytics range from simple analysis that can be performed using analytics. spreadsheets with tools like pivot tables and graphs, to complex statistical software and even artificial intelligence. More complex analysis provides greater value to the business. 1-6 CH A PT ER 1 Accounting in Action ILLUSTRATION 1.4 Four Types of Data Analytics Future Four types of data analytics Prescriptive Greater What should we Predictive do about it? Past What is likely to happen? Diagnostic Value Why did it happen? Descriptive Foresight What happened? Insight Hindsight Less Less Greater Complexity Insight boxes provide examples of business situations from various perspectives—ethics; investor, global; environmental, social, and governance; and data analytics. Data Analytics Insight Netflix Using Data Science to Create Art ­ roductions, such as filming locations and production ­schedules, p Netflix can more precisely estimate costs for future productions. Technology provides decision-makers and Further, consider that the production of a TV show or film problem-solvers with access to a large vol- involves hundreds of tasks. Here again, Netflix uses data science, ume of information called “big data.” And in this case to visualize where bottlenecks might occur or where UnSplash Netflix (USA), the world’s leading sub- opportunities might exist to increase the efficiency of the produc- scription streaming entertainment service, tion process. is tapping into this big data as part of its efforts to ramp up its Source: Based on Ritwik Kumar et al., “Data Science and the Art original content production. of Producing Entertainment at Netflix,” The Netflix Tech Blog In a recent year, Netflix planned to spend $8 billion on (March 26, 2018). content creation. Producing content involves a blend of crea- tivity, technology, and business decisions, all of which result How can “big data” improve decision-making? (Answer is in costs. And by analyzing the large amounts of data from past available near the end of the chapter.) The DO IT! exercises ask you to put newly acquired knowledge to work. They outline the Action Plan necessary to complete the exercise, and they show a Solution. ACTION PLAN DO IT! 1 Basic Concepts Review the basic concepts discussed. Indicate whether each of the five statements presented below is true or false. If false, indicate Develop an how to correct the statement. understanding 1. The three steps in the accounting process are identification, recording, and communication. of the key terms used. 2. Bookkeeping encompasses all steps in the accounting process. 3. Accountants prepare, but do not interpret, financial reports. 4. The two most common types of external users are investors and company officers. 5. Managerial accounting activities focus on reports for internal users.  1.2 The Building Blocks of Accounting 1-7 Solution 1. True 2. False. Bookkeeping involves only the recording step. 3. False. Accountants analyze and interpret information in reports as part of the communication step. 4. False. The two most common types of external users are investors and creditors. 5. True. Related exercise material: DO IT! 1.1, E1.1, and E1.2. 1.2 The Building Blocks of Accounting LEARNING OBJECTIVE 2 Explain the building blocks of accounting: ethics, principles, and assumptions. A doctor follows certain protocols in treating a patient’s illness. An architect follows certain structural guidelines in designing a building. Similarly, an accountant follows certain stan- dards in reporting financial information. These standards are based on specific principles and assumptions. For these standards to work, however, a fundamental business concept must be present—ethical behavior. Ethics in Financial Reporting People won’t gamble in a casino if they think it is “rigged.” Similarly, people won’t invest in the securities market if they think share prices are rigged. In recent years, the financial press has been full of articles about financial scandals at Mahindra Satyam (IND), Toshiba (JPN), Pou Sheng International (HKG), Siwei (CHN), and other companies. As the scandals came to light, mistrust of financial reporting in general grew. One article in the financial press noted that “repeated disclosures about questionable accounting prac- tices have bruised investors’ faith in the reliability of earnings reports, which in turn has sent share prices tumbling.” Imagine trying to carry on a business or invest money if you could not depend on the financial statements to be honestly prepared. Information would have no cred- ibility. There is no doubt that a sound, well-functioning economy depends on accurate and dependable financial r­ eporting. The standards of conduct by which actions are judged as right or wrong, honest or dis- honest, fair or not fair, are ethics. Effective financial reporting depends on sound ethical behavior. To sensitize you to ethical situations in business and to give you practice at solving ethical dilemmas, we address ethics in a number of ways in this text: 1. A number of the Feature Stories and other parts of the text discuss the central importance of ethical behavior to financial reporting. 2. Ethics Insight boxes and marginal Ethics Notes highlight ethics situations and issues in actual business settings. 3. Many of the Environmental, Social, and Governance Insight boxes focus on ethical issues that companies face in measuring and reporting social and environmental issues. 4. At the end of the chapter, an Ethics Case simulates a business situation and asks you to put yourself in the position of a decision-maker in that case. When analyzing these various ethics cases, as well as experiences in your own life, it is useful to apply the three steps outlined in Illustration 1.5. 1-8 CH A PT ER 1 Accounting in Action ILLUSTRATION 1.5 Steps in analyzing ethics cases and situations 1. Recognize an ethical 2. Identify and analyze 3. Identify the alternatives, situation and the ethical the principal elements and weigh the impact of issues involved. in the situation. each alternative on various Use your personal ethics to Identify the stakeholders— stakeholders. identify ethical situations and persons or groups who may Select the most ethical issues. Some businesses and be harmed or benefited. Ask alternative, considering all the #1 #2 professional organizations the question: What are the consequences. Sometimes there ALT ALT provide written codes of responsibilities and obligations will be one right answer. Other ethics for guidance in some of the parties involved? situations involve more than business situations. one right solution; these situations require an evaluation of each and a selection of the best alternative. Ethics Insight Toshiba Loyalty to Your Employer Is In response to these events, company leadership began to Great, Until It Is Not pressure divisional and mid-level managers to achieve unrea- sonable financial goals. These managers, unable to meet the un- A common attribute of Japanese em- reasonably high performance expectations and influenced by a ployees is a culture of strong loyalty to strong culture of loyalty and respect, were left with little choice nmann77/Adobe Stock their employer. This loyalty arises out of but to create profits where there were none. They committed a a common practice of lifetime employ- number of financial frauds, including unreasonable estimates ment combined with a general cultural value of respect. While and improper recording of transactions with suppliers. strong loyalty is a positive in many respects, it can create chal- In 2015, when these matters came to light, it was determined lenges in some circumstances. that reported revenues during this period had been overstated by For example, Toshiba (JPN), like many Japanese busi- ¥129 million and profits for the period has been overstated by nesses, was severely affected by a series of events in the early ¥477 million. 2000s. First, the company, along with the rest of the world, ex- Source: Based on Dennis Caplan, Saurav Dutta, and David Marchinko, perienced the financial crisis and subsequent global recession “Unmasking the Fraud at Toshiba,” Issues in Accounting Education, in 2008 and 2009. Next, in 2011, an earthquake and subsequent Vol. 34, No. 3 (August 2019). tsunami in northern Japan triggered a significant recession in Japan. The company experienced a 14% decline in revenue from What would you do if your company asked you to misreport 2007 to 2013, and a 90% decline in profits over the same period. an item? (Answer is available near the end of the chapter.) Accounting Standards In order to ensure high-quality financial reporting, accountants present financial statements in conformity with accounting standards that are issued by standard-setting bodies. Presently, there are two primary accounting standard-setting ­bodies—the International Accounting Stan- dards Board (IASB) and the Financial Accounting Standards Board (FASB). M  ore than 150 countries follow standards referred to as International Financial Reporting Standards (IFRS). I FRSs are determined by the IASB. The IASB is headquartered in ­London, with its board members drawn from around the world. M  ost companies in the United States follow standards issued by the FASB, referred to as generally accepted accounting principles (GAAP). As markets become more global, it is often desirable to compare the results of companies from different countries that report using different accounting standards. We provide at the end of each chapter a section called A Look at U.S. GAAP, to provide a comparison with IFRS.  1.2 The Building Blocks of Accounting 1-9 Global Insight The Korean Discount This change was motivated by a desire to “make the country’s businesses more transparent” in order to build investor confidence If you think that accounting standards and spur economic growth. Many other Asian countries, including don’t matter, consider these events in South China, India, Japan, and Hong Kong, have also decided either to ­Korea. For many years, international inves- adopt international standards or to create standards that are based Toru-Hanai/Pool/ tors complained that the financial reports of Getty Images on the international standards. South Korean companies were inadequate and inaccurate. Accounting practices there often resulted in huge dif- ferences between stated revenues and actual revenues. Because in- Source: Based on Evan Ramstad, “End to ‘Korea Discount’?” Wall vestors did not have faith in the accuracy of the numbers, they were Street Journal (March 16, 2007). unwilling to pay as much for the shares of these companies relative to shares of comparable companies in different countries. This dif- What is meant by the phrase “make the country’s business- ference in share price was often referred to as the “Korean discount.” es more transparent”? Why would increasing transparency In response, Korean regulators decided that companies spur economic growth? (Answer is available at the end of would have to comply with international accounting standards. the ­chapter.) Measurement Principles IFRS uses one of two measurement bases, the historical cost basis or the current value basis. HELPFUL HINT Selection of which basis to use is generally determined by considering the qualitative charac- Relevance and faithful rep- teristics of useful information, including relevance and faithful representation (see Helpful resentation are two pri- Hint). Relevance means that financial information is capable of making a difference in a mary qualities that make decision. Faithful representation means that the numbers and descriptions match what ­accounting information really existed or happened—they are factual. useful for decision-making. Historical Cost The historical cost basis records and reports assets at their cost. This is true not only at the time the asset is purchased, but also over the time the asset is held. For example, if Great Wall Manufacturing purchases land for ¥300,000 (amounts in thousands), the company initially reports it in its accounting records at ¥300,000. But what does Great Wall do if, by the end of the next year, the current value of the land has increased to ¥400,000? Under the historical cost basis, it continues to report the land at ¥300,000. Current Value The current value basis records and reports assets and other accounts at current value. Depending on the nature of the item being reported, current value is determined based on the item’s fair value (the price received to sell an asset or settle a liability), value in use (the present value of the future cash flows associated with the item), or current cost (the current replace- ment cost of the item). Current value information may be more useful than historical cost for certain types of assets and liabilities. For example, certain investment securities are reported at current value because market value information is usually readily available for these types of assets. I n determining which measurement basis to use, companies weigh the factual nature of historical cost figures versus the relevance of current value. I n general, even though IFRS allows companies to revalue property, plant, and equip- ment and other long-lived assets to current value, most companies choose to use cost. Only in situations where assets are actively traded, such as investment securities, do companies apply the current value extensively. Assumptions Assumptions provide a foundation for the accounting process. Two main assumptions are the monetary unit assumption and the economic entity assumption. 1-10 C H A PTE R 1 Accounting in Action Monetary Unit Assumption The monetary unit assumption requires that companies include in the accounting records only transaction data that can be expressed in money terms. This assumption enables account- ing to quantify (measure) economic events. The monetary unit assumption is vital to using the historical cost basis. This assumption prevents the inclusion of some relevant information in the accounting records. For example, the health of a company’s owner, the quality of service, and the morale of employees are not included. The reason: Companies cannot quantify this information in money terms. Though this information is important, companies record only events that can be measured in money. Throughout this text, we use a variety of currencies in our examples and end-of-chapter materials, such as the following. Australia, dollar $ Russia, ruble P Brazil, real R$ South Africa, rand R China, yuan renminbi ¥ South Korea, won W Europe, euro € Switzerland, Swiss franc CHF Hong Kong, dollar HK$ Taiwan, new dollar NT$ India, rupee Turkey, lira Indonesia, rupia Rp United Kingdom, pound £ Japan, yen ¥ United States, dollar $ ETHICS NOTE Economic Entity Assumption The importance of the eco- An economic entity can be any organization or unit in society. It may be a company nomic entity assumption is (such as Maruti Suzuki (IND)), a governmental unit (the Indonesian province of Papua), illustrated by scandals in- a municipality (Beijing), or a temple (the Temple of the Six Banyan Trees). The economic volving Adelphia (USA). In entity assumption requires that the activities of the entity be kept separate and distinct from this case, senior company the activities of its owner and all other economic entities. To illustrate, Barb Su, owner of em­ployees entered into Barb’s Bike Shop, must keep her personal living costs separate from the expenses of the busi- transactions that blurred the ness. Similarly, Maxway Cycles Co. (TWN) and Asia Bicycle Trading Company (TWN) line between the employees’ financial interests and those are segregated into separate economic entities for accounting purposes (see Ethics Note). of the company. For exam- Proprietorship A business owned by one person is generally a proprietorship. The ple, Adelphia guaranteed owner is often the manager/operator of the business. Small service-type businesses (plumb- over $2 ­billion of loans to the ing companies, beauty salons, and auto repair shops), farms, and small retail stores (antique founding family. shops, clothing stores, and used-book stores) are often proprietorships. Ethics Notes help sensitize you U  sually, only a relatively small amount of money (capital) is necessary to start in business to some of the ethical issues in as a proprietorship. accounting. T  he owner (proprietor) receives any profits, suffers any losses, and is personally liable for all debts of the business. There is no legal distinction between the business as an economic unit and the owner, but the accounting records of the business activities are kept separate from the personal records and activities of the owner. Partnership A business owned by two or more persons associated as partners is a part- nership. In most respects a partnership is like a proprietorship except that more than one owner is involved. T  ypically, a partnership agreement (written or oral) sets forth such terms as initial invest- ment, duties of each partner, division of net income (or net loss), and settlement to be made upon death or withdrawal of a partner. Each partner generally has unlimited personal liability for the debts of the partnership. L  ike a proprietorship, for accounting purposes the partnership transactions must be kept separate from the personal activities of the partners. Partnerships are often used to organize retail and service-type businesses, including profes- sional practices (lawyers, doctors, architects, and accountants).  1.2 The Building Blocks of Accounting 1-11 Corporation A business organized as a separate legal entity under jurisdiction corporation law and having ownership divided into transferable shares is a corporation. T  he holders of the shares (shareholders) enjoy limited liability; that is, they are not per- sonally liable for the debts of the corporate entity. S  hareholders may transfer all or part of their ownership shares to other investors at any time (i.e., sell their shares). The ease with which ownership can change adds to the at- tractiveness of investing in a corporation. B  ecause ownership can be transferred without dissolving the corporation, the corpora- tion enjoys an unlimited life. Although the combined number of proprietorships and partnerships in the world significantly exceeds the number of corporations, the revenue produced by corporations is much greater. Most of the largest companies in the world—for example, ING (NLD), Royal Dutch Shell (GBR and NLD), Apple Inc. (USA), Fortis (BEL), and Toyota (JPN)—are corporations. Accounting Across the Organization Spinning the Career Wheel Marketing people must be sensitive to costs and benefits, which accounting helps them quantify and understand. One question that students frequently ask is, “How will the study of accounting help Finance: Do you want to be a banker for Shanghai Commer- me?” A working knowledge of account- cial and Savings Bank (TWN) or a financial analyst for ICBC ing is desirable for virtually every field (CHN)? These fields rely heavily on accounting. In all of them, of ­endeavor. Some examples of how ac- you will regularly examine and analyze financial statements. In counting is used in other careers include fact, it is difficult to get a good finance job without two or three the ­following. courses in accounting. blublaf/E+/Getty General management: Imagine run- Real estate: Are you interested in being a real estate broker for Images ning Volkswagen (DEU), Saudi Tele- Hong Kong Property Services (HKG)? Because a third party— com (SAU), a Subway (USA) franchise, or a Fuji (JPN) bike shop. the bank—is almost always involved in financing a real estate All general managers need to understand where the company’s transaction, brokers must understand the numbers involved: Can cash comes from and where it goes in order to make wise business the buyer afford to make the payments to the bank? Does the cash ­decisions. flow from an industrial property justify the purchase price? What are the tax benefits of the purchase? Marketing: Marketing specialists at a company like Hyundai ­Motor (KOR) develop strategies to help the sales force be How might accounting help you? (Answer is available near ­successful. But making a sale is meaningless unless it is profitable. the end of the chapter.) DO IT! 2 Building Blocks of Accounting ACTION PLAN Review the discussion Indicate whether each of the five statements presented below is true or false. If false, indicate of ethics and financial how to correct the statement. reporting standards. 1. Ethics are the standards of conduct by which actions are judged as right or wrong, honest or Develop an dishonest, fair or not fair. understanding of the key terms used. 2. The primary accounting standard-setting body headquartered in London is the International Accounting Standards Board (IASB). 3. A  n asset recorded using the historical cost basis results in recording assets at their cost. In later periods, however, the current value of the asset must be used if current value is higher than its cost. 4. Relevance means that financial information matches what really happened; the information is factual. 5. A business owner’s personal expenses must be separated from expenses of the business to comply with accounting’s economic entity assumption. 1-12 C H A PT E R 1 Accounting in Action Solution 1. True. 2. True. 3. False. Assets recorded using the historical cost basis are not adjusted in later periods to current value. They remain at their original cost. 4. False. Faithful repre- sentation means that financial information matches what really happened; the information is factual. 5. True. Related exercise material: DO IT! 1.2, E1.3, and E1.4. 1.3 The Accounting Equation LEARNING OBJECTIVE 3 State the accounting equation, and define its components. The two basic elements of a business are what it owns and what it owes. A  ssets are the resources a business owns. For example, adidas (DEU) has total assets of approximately €15,176 billion. Liabilities and equity are the rights or claims against these resources. Thus, adidas has €15,176 billion of claims against its €15,176 billion of assets. Claims of those to whom the company owes money (creditors) are called liabilities. C  laims of owners are called equity. adidas has liabilities of €8,721 billion and equity of €6,455 billion. We can express the relationship of assets, liabilities, and equity as an equation, as shown in Illustration 1.6. ILLUSTRATION 1.6 Assets    =    Liabilities    +    Equity The basic accounting equation This relationship is the basic accounting equation. Assets must equal the sum of liabilities and equity. L  iabilities appear before equity in the basic accounting equation because they are paid first if a business is liquidated. The accounting equation applies to all economic entities regardless of size, nature of busi- ness, or form of business organization. It applies to a small proprietorship such as a corner grocery store as well as to a giant corporation such as adidas. The equation provides the underlying framework for recording and summarizing economic events. Let’s look in more detail at the categories in the basic accounting equation. Assets As noted previously, assets are resources a business owns. The business uses its assets in carry- ing out such activities as production and sales. T  he common characteristic possessed by all assets is the capacity to provide future services or benefits. I n a business, that service potential or future economic benefit eventually results in cash inflows (receipts). For example, consider Taipei Pizza, a local restaurant. It owns a delivery truck that provides ­economic benefits from delivering pizzas. Other assets of Taipei Pizza are tables, chairs, sound system, cash register, oven, tableware, and, of course, cash.  1.3 The Accounting Equation 1-13 Liabilities Liabilities are claims against assets—that is, existing debts and obligations. Businesses of all sizes usually borrow money and purchase merchandise on credit. These economic activities result in payables of various sorts: T  aipei Pizza, for instance, purchases cheese, sausage, flour, and beverages on credit from suppliers. These obligations are called accounts payable. T  aipei Pizza also has a note payable to First Bank for the money borrowed to purchase the delivery truck. T  aipei Pizza may also have salaries and wages payable to employees and sales and real estate taxes payable to the local government. All of these persons or entities to whom Taipei Pizza owes money are its creditors. Creditors may legally force the liquidation of a business that does not pay its debts. In that case, the law requires that creditor claims be paid before ownership claims. Equity The ownership claim on a company’s total assets is equity. It is equal to total assets minus total liabilities. Here is why. T  he assets of a business are claimed by either creditors or shareholders. To find out what belongs to shareholders, we subtract creditors’ claims (the liabilities) from the assets. T  he remainder is the shareholders’ claim on the assets—equity. It is often referred to as residual equity—that is, the equity “left over” after creditors’ claims are s­ atisfied. Equity generally consists of (1) share capital—ordinary and (2) retained earnings. Share Capital—Ordinary A company may obtain funds by selling ordinary shares to investors. Share capital— ordinary is the term used to describe the amounts paid in by shareholders for the ordinary shares they purchase. Retained Earnings Retained earnings is determined by three items: revenues, expenses, and dividends. Revenues Revenues are the gross increases in equity resulting from business HELPFUL HINT ­ ctivities entered into for the purpose of earning income (see Helpful Hint).3 Gen- a The effect of revenues is erally, revenues ­result from selling merchandise, performing services, renting property, and positive—an increase in eq- lending money. uity coupled with an increase Revenues usually result in an increase in an asset. They may arise from different sources in assets or a decrease in and are called various names depending on the nature of the business. Taipai Pizza, for liabilities. instance, has two categories of sales revenues—pizza sales and beverage sales. Other titles for and sources of revenue common to many businesses are sales, fees, services, commissions, interest, dividends, royalties, and rent. Expenses Expenses are the cost of assets consumed or services used in the process of HELPFUL HINT earning revenue. They are decreases in equity that result from operating the business The effect of expenses (see Helpful Hint). Like revenues, expenses take many forms and are called various names is negative—a decrease depending on the type of asset consumed or service used. in equity coupled with a For example, Taipai Pizza recognizes the following types of expenses: cost of ingredi- ­decrease in assets or an ents (flour, cheese, tomato paste, meat, mushrooms, etc.), cost of beverages, wages expense, ­increase in liabilities. 3 IFRS uses both the term income and the term revenue to refer to the increase in equity resulting from business activities entered into for the purpose of earning income. To avoid confusion, we will use the term revenue consistently in this text. 1-14 C H A PT E R 1 Accounting in Action utilities expense (electric, gas, and water expense), telephone expense, delivery expense (gaso- line, repairs, licenses, etc.), supplies expense (napkins, detergents, aprons, etc.), rent expense, interest expense, and property tax expense. Dividends Net income represents an increase in net assets which is then available to distrib- ute to shareholders. The distribution of cash or other assets to shareholders is called a dividend. Dividends reduce retained earnings. However, dividends are not expenses. A corporation first determines its revenues and expenses and then computes net income or net loss. If it has net income, and decides it has no better use for that income, a corporation may decide to distribute a dividend to its owners (the shareholders). In summary, the principal sources (increases) of equity are investments by shareholders and revenues from business operations. In contrast, reductions (decreases) in equity result from expenses and dividends. These relationships are shown in Illustration 1.7. ILLUSTRATION 1.7 Increases and decreases in equity INCREASES DECREASES Investments by shareholders Dividends to shareholders Equity Revenues Expenses ACTION PLAN DO IT! 3 Equity Effects Understand the sources of revenue. Classify the following items as issuance of shares (I), dividends (D), revenues (R), or expenses (E). Understand what causes Then indicate whether each item increases or decreases equity. expenses. a. Rent Expense. c. Dividends. Review the rules for b. Service Revenue. d. Salaries and Wages Expense. changes in equity: Investments and revenues increase equity. Solution Expenses and dividends decrease equity. a. Rent Expense is an expense (E); it decreases equity. b. Service Revenue is a revenue (R); it increases equity. c. Dividends is a distribution to shareholders (D); it decreases equity. Recognize that dividends d. Salaries and Wages Expense is an expense (E); it decreases equity. are distributions of cash or other assets to Related exercise material: BE1.1, BE1.2, BE1.3, BE1.4, BE1.5, BE1.6, DO IT! 1.3, and E1.5. shareholders. 1.4 Analyzing Business Transactions LEARNING OBJECTIVE 4 Analyze the effects of business transactions on the accounting equation.  1.4 Analyzing Business Transactions 1-15 Analyze ADJUSTED TRIAL ADJUSTING FINANCIAL CLOSING POST-CLOSING business JOURNALIZE POST TRIAL BALANCE ENTRIES STATEMENTS ENTRIES TRIAL BALANCE transactions BALANCE The system of collecting and processing transaction data and communicating financial infor- This accounting cycle graphic mation to decision-makers is known as the accounting information system. Factors that illustrates the steps companies shape an accounting information system include the nature of the company’s business, the follow each period to record types of transactions, the size of the company, the volume of data, and the information transactions and eventually demands of management and others. prepare financial statements. Most businesses use computerized accounting systems—sometimes referred to as elec- tronic data processing (EDP) systems. These systems handle all the steps involved in the recording process, from initial data entry to preparation of the financial statements. Many companies upgraded their accounting information systems to prevent cybersecurity attacks. In addition, companies are utilizing new technologies. Cloud-based storage permits employees to access records from different locations. Data automation and analytics tools help companies interpret large volumes of data to support enhanced decision-making and automating routine processes. In order to remain competitive, companies continually improve their accounting systems to provide accurate and timely data for decision-making. For example, in a recent annual report, Tootsie Roll (USA) stated, “We also invested in additional processing and data storage hard- ware during the year. We view information technology as a key strategic tool, and are commit- ted to deploying leading edge technology in this area.” Accounting information systems rely on a process referred to as the accounting cycle. As you can see from the graphic, the accounting cycle begins with the analysis of business transactions and ends with the preparation of a post-closing trial balance. We explain each of the steps, starting in this chapter and continuing in Chapters 2–4. In this text, in order to emphasize the underlying concepts and principles, we focus on a manual accounting system. The accounting concepts and principles do not change whether a system is computerized or manual. Accounting Transactions Transactions (business transactions) are a business’s economic events recorded by accountants. Transactions may be external or internal. External transactions involve economic events between the company and some outside enterprise. For example, Taipai Pizza’s purchase of cooking equipment from a supplier, payment of monthly rent to the landlord, and sale of pizzas to customers are external transactions. Internal transactions are economic events that occur entirely within one company. The use of cooking and cleaning supplies are internal transactions for Taipai Pizza. Companies carry on many activities that do not represent business transactions. Examples are hiring employees, responding to e-mails, talking with customers, and placing merchandise orders. Some of these activities may lead to business transactions. Employees will earn wages, and suppliers will deliver ordered merchandise. A company must analyze each event to find out if it affects the components of the accounting equation. If it does, the company will record the transaction. Illustration 1.8 demonstrates the transaction identification process. Each transaction must have a dual effect on the accounting equation. For example, if an asset is increased, there must be a corresponding: Decrease in another asset, or Increase in a specific liability, or Increase in equity. 1-16 C H A PTE R 1 Accounting in Action ILLUSTRATION 1.8 Transaction identification process CHIP CITY Events Purchase computer Discuss product design with Pay rent potential customer Criterion Is the financial position (assets, liabilities, or equity) of the company changed? Yes No Yes Record/ Don’t Record Two or more items could be affected. For example, as one asset is increased €10,000, another asset could decrease €6,000 and a liability could increase €4,000. Any change in a liability or ownership claim is subject to similar analysis. Transaction Analysis To demonstrate how to analyze transactions in terms of the accounting equation, we will review the business activities of Softbyte SA. As part of this analysis, we will expand the basic accounting equation. This will allow us to better illustrate the impact of transactions on equity. Recall that equity is comprised of two parts: share capital—ordinary and retained earnings. Share capital—ordinary is affected when the company issues new ordinary shares in exchange for cash. Retained earnings is affected when the company earns revenue, incurs expenses, or pays dividends. Illustration 1.9 shows the expanded accounting equation. ILLUSTRATION 1.9 Expanded accounting equation Assets = Liabilities + Equity Share + Retained Earnings Capital—Ordinary Revenues – Expenses – Dividends  1.4 Analyzing Business Transactions 1-17 If you are tempted to skip ahead after you’ve read a few of the following transaction analy- HELPFUL HINT ses, don’t do it. Each has something unique to teach, something you’ll need later (see Helpful You will want to study these Hint). (We assure you that we’ve kept them to the minimum needed!) transactions until you are sure you understand them. Transaction (1). Investment by Shareholders Ray and Barbara Neal decide to start They are not difficult, but un- a smartphone app development company that they incorporate as Softbyte SA. On September derstanding them is impor- 1, 2025, they invest €15,000 cash in the business in exchange for €15,000 of ordinary shares. tant to your success in this The ordinary shares indicates the ownership interest that the Neals have in Softbyte SA. This course. The ability to analyze transaction results in an equal increase in both assets and equity.4 transactions in terms of the basic accounting equation is ­essential in accounting. Basic The asset Cash increases 15,000, and equity identified as Share Capital—Ordinary Analysis increases 15,000. Assets = Liabilities + Equity Equation Cash = Share Capital Analysis (1) +€15,000 = +€15,000 Issued Shares Observe that the equality of the basic equation has been maintained. Note also that the source of the increase in equity (in this case, issued shares) is indicated. Why does this matter? Because investments by shareholders do not represent revenues, and they are excluded in determining net income. Therefore, it is necessary to make clear that the increase is an investment rather than revenue from operations. Additional investments (i.e., investments made by shareholders after the corporation has been initially formed) have the same effect on equity as the initial investment. Transaction (2). Purchase of Equipment for Cash Softbyte SA purchases computer equipment for €7,000 cash. This transaction results in an equal increase and decrease in total assets, though the composition of assets changes. Basic The asset Cash decreases €7,000, and the asset Equipment increases €7,000. Analysis Assets = Liabilities + Equity Cash + Equipment = Share Capital Equation €15,000 €15,000 Analysis (2) −7,000 +€7,000 € 8,000 + €7,000 = €15,000 €15,000 Observe that total assets are still €15,000. Share Capital—Ordinary also remains at €15,000, the amount of the original investment. Transaction (3). Purchase of Supplies on Credit Softbyte SA purchases headsets (and other computer accessories expected to last several months) for €1,600 from Mobile Solu- tions. Mobile Solutions agrees to allow Softbyte to pay this bill in October. This transaction is a purchase on account (a credit purchase). A  ssets increase because of the expected future benefits of using the headsets and com- puter accessories, and liabilities increase by the amount due Mobile Solutions. 4 For the illustrative equations that follow, we use the general account title “Share Capital” instead of “Share Capital—Ordinary” for space considerations. 1-18 C H A PT E R 1 Accounting in Action Basic The asset Supplies increases €1,600, and the liability Accounts Payable increases €1,600. Analysis Assets = Liabilities + Equity Accounts Share Cash + Supplies + Equipment = Payable + Capital Equation €8,000 €7,000 €15,000 Analysis (3) +€1,600 +€1,600 €8,000 + €1,600 + €7,000 = €1,600 + €15,000 €16,600 €16,600 Total assets are now €16,600. This total is matched by a €1,600 creditor’s claim and a €15,000 ownership claim. Transaction (4). Services Performed for Cash Softbyte SA receives €1,200 cash from customers for app development services it has performed. This transaction represents Softbyte’s principal revenue-producing activity. Recall that revenue increases equity. Basic The asset Cash increases €1,200, and equity increases €1,200 due to Service Revenue. Analysis Assets = Liabilities + Equity Accounts Share Retained Earnings Cash + Supplies + Equipment = Payable + Capital + Rev. − Exp. − Div. Equation €8,000 €1,600 €7,000 €1,600 €15,000 Analysis (4) +1,200 +€1,200 Service Revenue €9,200 + €1,600 + €7,000 = €1,600 + €15,000 + €1,200 €17,800 €17,800 The two sides of the equation balance at €17,800. Service Revenue is included in determining Softbyte’s net income. N  ote that we do not have room to give details for each individual revenue and expense account in this illustration. Thus, revenues (and expenses when we get to them) are sum- marized under one column heading for Revenues and one for Expenses. H  owever, it is important to keep track of the category (account) titles affected (e.g., ­Service Revenue) as they will be needed when we prepare financial statements later in the chapter. Transaction (5). Purchase of Advertising on Credit Softbyte SA receives a bill for €250 from Programming News for advertising on its website but postpones payment until a later date. This transaction results in an increase in liabilities and a decrease in equity. Basic The liability Accounts Payable increases €250, and equity decreases €250 due to Advertising Expense. Analysis Assets = Liabilities + Equity Accounts Share Retained Earnings Cash + Supplies + Equipment = Payable + Capital + Rev. – Exp. – Div. Equation €9,200 €1,600 €7,000 €1,600 €15,000 €1,200 Analysis Advertising (5) +250 −€250 €9,200 + €1,600 + €7,000 = €1,850 + €15,000 + €1,200 – €  250 Expense €17,800 €17,800  1.4 Analyzing Business Transactions 1-19 The two sides of the equation still balance at €17,800. Retained Earnings decreases when Soft- byte incurs the expense. Expenses do not have to be paid in cash at the time they are incurred. W  hen Softbyte pays at a later date, the liability Accounts Payable will decrease and the asset Cash will decrease [see Transaction (8)]. The cost of advertising is an expense (rather than an asset) because Softbyte has used the ben- efits. Advertising Expense is included in determining net income. Transaction (6). Services Performed for Cash and Credit ­Softbyte SA performs €3,500 of app development services for customers. The company receives cash of €1,500 from customers, and it bills the balance of €2,000 on account. This transaction results in an equal increase in assets and equity. Basic Three specific items are affected: The asset Cash increases €1,500, the asset Accounts Receivable increases €2,000, Analysis and equity increases €3,500 due to Service Revenue. Assets = Liabilities + Equity Accounts Accounts Share Retained Earnings Cash + Receivable + Supplies + Equipment = Payable + Capital + Rev. − Exp. − Div. Equation € 9,200 €1,600 €7,000 €1,850 €15,000 €1,200 €250 Analysis Service (6) +1,500 +€2,000 +3,500 Revenue €10,700 + €2,000 + €1,600 + €7,000 = €1,850 + €15,000 + €4,700 − €250 €21,300 €21,300 Softbyte recognizes €3,500 in revenue when it performs the services. In exchange for these services, it received €1,500 in Cash and Accounts Receivable of €2,000. This Accounts Receiv- able represents customers’ promise to pay €2,000 to Softbyte in the future. When it later receives collections on account, Softbyte will increase Cash and will decrease Accounts Receivable [see Transaction (9)]. Transaction (7). Payment of Expenses Softbyte SA pays the following expenses in cash for September: office rent €600, salaries and wages of employees €900, and utilities €200. These payments result in an equal decrease in assets and equity. Basic The asset Cash decreases €1,700, and equity decreases €1,700 due to the following specific expenses: Analysis Rent Expense, Salaries and Wages Expense, and Utilities Expense. Assets = Liabilities + Equity Accounts Accounts Share Retained Earnings Cash + Receivable + Supplies + Equipment = Payable + Capital + Rev. − Exp. − Div. €10,700 €2,000 €1,600 €7,000 €1,850 €15,000 €4,700 € 250 Equation (7) −1,700 −600 Rent Exp. Analysis −900 Sal./Wages Exp. −200 Utilities Exp. € 9,000 + €2,000 + €1,600 + €7,000 = €1,850 + €15,000 + €4,700 − €1,950 €19,600 €19,600 The two sides of the equation now balance at €19,600. Three lines are required in the analysis to indicate the different types of expenses that have been incurred. Transaction (8). Payment of Accounts Payable Softbyte SA pays its €250 Program- ming News bill in cash. The company previously [in Transaction (5)] recorded the bill as an increase in Accounts Payable and a decrease in equity. 1-20 C H A PT E R 1 Accounting in Action Basic This cash payment “on account” decreases the asset Cash by €250 and also decreases the liability Accounts Analysis Payable by €250. Assets = Liabilities + Equity Accounts Accounts Share Retained Earnings Cash + Receivable + Supplies + Equipment = Payable + Capital + Rev. − Exp. − Div. Equation €9,000 €2,000 €1,600 €7,000 €1,850 €15,000 €4,700 €1,950 Analysis (8) −250 −250 €8,750 + €2,000 + €1,600 + €7,000 = €1,600 + €15,000 + €4,700 − €1,950 €19,350 €19,350 Observe that the payment of a liability related to an expense that has previously been recorded does not affect equity. Softbyte recorded the expense [in Transaction (5)] and should not record it again. Transaction (9). Receipt of Cash on Account Softbyte SA receives €600 in cash from customers who had been billed for services [in Transaction (6)]. Transaction (9) does not change total assets, but it changes the composition of those assets. Basic The asset Cash increases €600, and the asset Accounts Receivable decreases €600. Analysis Assets = Liabilities + Equity Accounts Accounts Share Retained Earnings Cash + Receivable + Supplies + Equipment = Payable + Capital + Rev. − Exp. − Div. Equation €8,750 €2,000 €1,600 €7,000 €1,600 €15,000 €4,700 €1,950 Analysis (9) +600 −600 €9,350 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 + €4,700 − €1,950 €19,350 €19,350 Note that the collection of an account receivable for services previously billed and recorded does not affect equity. Softbyte already recorded this revenue [in Transaction (6)] and should not record it again. Transaction (10). Dividends The company pays a dividend of €1,300 in cash to Ray and Barbara Neal, the shareholders of Softbyte SA. This transaction results in an equal de- crease in assets and equity. Basic The asset Cash decreases €1,300, and equity decreases €1,300 due to dividends. Analysis Assets = Liabilities + Equity Accounts Accounts Share Retained Earnings Cash + Receivable + Supplies + Equipment = Payable + Capital + Rev. − Exp. − Div. Equation €9,350 €1,400 €1,600 €7,000 €1,600 €15,000 €4,700 €1,950 Analysis (10) −1,300 −€1,300 Dividends €8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 + €4,700 − €1,950 − €1,300 €18,050 €18,050 Note that the dividend reduces retained earnings, which is part of equity. Dividends are not expenses. Like shareholders’ investments, dividends are excluded in determining net income.  1.4 Analyzing Business Transactions 1-21 Summary of Transactions Illustration 1.10 summarizes the September transactions of Softbyte SA to show their cumu- lative effect on the basic accounting equation. It also indicates the transaction number and the specific effects of each transaction. Finally, Illustration 1.10 demonstrates a number of signifi- cant facts: 1. Each transaction must be analyzed in terms of its effect on: a. The three components of the basic accounting equation. b. Specific types (kinds) of items within each component. 2. The two sides of the equation must always be equal. 3. The Share Capital—Ordinary and Retained Earnings columns indicate the causes of each change in the shareholders’ claim on assets. ILLUSTRATION 1.10 Tabular summary of Softbyte SA transactions Assets = Liabilities + Equity Trans- Accounts Accounts Share Retained Earnings action Cash + Receivable + Supplies + Equipment = Payable + Capital + Rev. – Exp. – Div. (1) +€15,000 + €15,000 Issued Shares (2)    –7,000 +€7,000 (3) +€1,600 +€1,600 (4)    +1,200 +€1,200 Service Revenue (5)    +250 –€250 Adver. Expense (6)    +1,500 +€2,000 +3,500 Service Revenue (7)     –1,700   –600 Rent Expense       –900 Sal./Wages Exp.       –200 Utilities Expense (8)     –250    –250 (9)     +600    –600 (10)    –1,300 –€1,300 Dividends   € 8,050 +   €1,400 + €1,600 + €7,000 = €1,600 + €15,000 +   €4,700 – €1,950 – €1,300 €18,050 €18,050 There! You made it through transaction analysis. If you feel a bit shaky on any of the transactions, it might be a good idea at this point to get up, take a short break, and come back again for a brief (10- to 15-minute) review of the transactions, to make sure you understand them before you go on to the next section. DO IT! 4 Tabular Analysis ACTION PLAN Analyze the effects of Transactions made by Virmari & Co., a public accounting firm in France, for the month of Au- each transaction on the gust are shown below. Prepare a tabular analysis which shows the effects of these transactions on accounting equation. the expanded accounting equation, similar to that shown in Illustration 1.10. Use appropriate 1. The company issued ordinary shares for €25,000 cash. category names (not descriptions). 2. The company purchased €7,000 of office equipment on credit. Keep the accounting 3. The company received €8,000 cash in exchange for services performed. equation in balance. 4. The company paid €850 for this month’s rent. 5. The company paid a dividend of €1,000 in cash to shareholders. 1-22 C H A PT E R 1 Accounting in Action Solution Assets = Liabilities + Equity Trans- Accounts Share Retained Earnings action Cash + Equipment = Payable + Capital + Rev. – Exp. – Div. (1) +€25,000 +€25,000 (2) +€7,000 +€7,000 (3) +8,000 +€8,000 Service Revenue (4) –850 –€850 Rent Expense (5) –1,000 –€1,000 Dividends €31,150 + €7,000 = €7,000 + €25,000 + €8,000 – €850 – €1,000