ACN 201 Chapter 1 PDF

ACN 201 Chapter 1 Accounting in Action Reference: Financial Accounting, Kieso, Kimmel & Waygandt, 4th Edition (IFRS), Chapter 1 Learning Objectives 1. Define Accounting. 2. Identify the activities and users associated with accounting. 3. Explain the building blocks...

ACN 201 Chapter 1 Accounting in Action Reference: Financial Accounting, Kieso, Kimmel & Waygandt, 4th Edition (IFRS), Chapter 1 Learning Objectives 1. Define Accounting. 2. Identify the activities and users associated with accounting. 3. Explain the building blocks of accounting: ethics, principles, and assumptions. 4. State the accounting equation, and define its components 5. Analyze the effects of business transactions on the accounting equation. 6. Describe the financial statements and how they are prepared. Learning Objectives 1 Define Accounting  Definition of Accounting Accounting is a process that identifies, records, and communicates the economic events of an organization to interested users for decision making purposes.  Learning Objectives 2 Identify the activities and users associated with accounting. Identify the activities of accounting Accounting consists of three basic activities—it  identifies,  records, and  communicates the economic events of an organization to interested users Three Activities The accounting process includes the bookkeeping function. INTERNAL USERS  EXTERNAL USERS 1. Present & Potential Investors 2. Present & Potential Creditors 3. Suppliers 4. Customers 5. Regulatory Authorities 6. General Public Accounting Across the Organization One question that students frequently ask is, “How will the study of accounting help me?” A working knowledge of accounting is desirable for virtually every field of endeavor. Some examples of how accounting is used in other careers include: General management: Imagine running Volkswagen (DEU), Saudi Telecom (SAU), a Subway (USA) franchise, or a Fuji (JPN) bike shop. All general managers need to understand where the company’s cash comes from and where it goes in order to make wise business decisions. Marketing: Marketing specialists at a company like Hyundai Motor (KOR) develop strategies to help the sales force be successful. But making a sale is meaningless unless it is profitable. Marketing people must be sensitive Finance: Do you want to be a banker for Société Générale (FRA) or a financial analyst for ICBC (CHN)? These fields rely heavily on accounting. In all of them, you will regularly examine and analyze financial statements. In fact, it is difficult to get a good finance job without two or three courses in accounting. Real estate: Are you interested in being a real estate broker for Sotheby’s International Realty (GBR)? Because a third party—the bank—is almost always involved in financing a real estate transaction, brokers must understand the numbers involved: Can the buyer afford to make the payments to the bank? Does the cash flow from an industrial property justify the purchase price? What are the tax benefits of the purchase?  DO IT! Basic Concepts Indicate whether the following statements are true or false. 1. The three steps in the accounting process are identification, recording, and communication. 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.  Learning Objectives 3 Explain the building blocks of accounting: ethics, principles, and assumptions. Ethics in Financial Reporting  Recent financial scandals include: Enron, WorldCom, HealthSouth, AIG, and other companies.  Regulators and lawmakers concerned that economy would suffer if investors lost confidence in corporate accounting. In response, ► Congress passed Sarbanes-Oxley Act (SOX).  Effective financial reporting depends on sound ethical behavior. Ethics in Financial Reporting Accounting Standards International Accounting Standards Board (IASB) http://www.iasb.org/ International Financial Reporting Standards Financial Accounting Standards Board (FASB) http://www.fasb.org/ Generally Accepted Accounting Principles (GAAP) Measurement Principles HISTORICAL COST PRINCIPLE (or cost principle) dictates that companies record assets at their cost. FAIR VALUE PRINCIPLE states that assets and liabilities should be reported at fair value (the price received to sell an asset or settle a liability). Assumptions MONETARY UNIT ASSUMPTION requires that companies include in the accounting records only transaction data that can be expressed in terms of money. ECONOMIC ENTITY ASSUMPTION requires that activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities. Forms of Business  Ownership Proprietorship  Partnership  Corporation Forms of Business Ownership Proprietorship Partnership Corporation  Owned by two or more  Ownership divided into  Owned by one person persons shares  Owner is often  Often retail and service-  Separate legal entity manager/operator type businesses organized under  Owner receives any  Generally unlimited corporation law profits, suffers any losses, and is personally personal liability  Limited liability liable for all debts  Partnership agreement  Learning Objectives 4 State the accounting equation, and define its components  = Liabilitie Owner's Assets + s Equity Basic Accounting Equation  Provides the underlying framework for recording and summarizing economic events.  Assets are claimed by either creditors or owners.  If a business is liquidated, claims of creditors must be paid before ownership claims. Assets  Resources a business owns.  Provide future services or benefits.  Cash, Supplies, Equipment, etc. Liabilities  Claims against assets (debts and obligations).  Creditors (party to whom money is owed).  Accounts Payable, Notes Payable, Salaries and Wages Payable, etc. Owner's Equity  Ownership claim on total assets.  Referred to as residual equity.  Share Capital—Ordinary and Retained Earnings. Equity Investments by shareholders represent the total amount paid in by shareholders for the ordinary shares they purchase. Stockholders’ Equity Revenues result from business activities entered into for the purpose of earning income. Common sources of revenue are: sales, fees, services, commissions, interest, dividends, royalties, and rent. Stockholders’ Equity Expenses are the cost of assets consumed or services used in the process of earning revenue. Common expenses are: salaries expense, rent expense, utilities expense, property tax expense, etc. Stockholders’ Equity Dividends are the distribution of cash or other assets to shareholders. Dividends reduce retained earnings. However, dividends are not expenses. Elements of Financial Statements A resource controlled by the entity as a result of Asset past events and from which future economic benefits are expected to flow to the entity. Liability Equity Income Expenses Elements of Financial Statements Asset A present obligation of the entity arising from past events, Liability the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Equity Income Expenses Elements of Financial Statements Asset Liability Equity The residual interest in the assets of the entity after deducting all its liabilities. Income Expenses Elements of Financial Statements Asset Liability Equity Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of Income liabilities that result in increases in equity, other than those relating to contributions from equity participants. Expenses Elements of Financial Statements Asset Liability Equity Income Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of Expenses liabilities that result in decreases in equity, other than those relating to distributions to equity participants.  Learning Objectives 5 Analyze the effects of business transactions on the accounting equation  Analyze the effects of business transactions on the accounting equation. Transactions are a business’s economic events recorded by accountants.  May be external or internal.  Not all activities represent transactions.  Each transaction has a dual effect on the accounting equation.  Transaction Analysis Illustration: Are the following events recorded in the accounting records? Discuss product Purchase Event design with Pay rent computer potential customer Criterion Is the financial position (assets, liabilities, or owner’s equity) of the company changed? Record/ Don’t Record Transaction Analysis Transaction Analysis TRANSACTION 1. INVESTMENT BY STOCKHOLDERS Ray and Barbara Neal decide to start a smartphone app development company that they incorporate as Softbyte SA. On September 1, 2017, they invest €15,000 cash in the business in exchange for €15,000 of ordinary shares. The ordinary shares indicates the ownership interest that the Neals have in Softbyte SA. This transaction results in an equal increase in both assets and equity. Illustration 1-10 Assets = Liabilities + Equity Accounts Retained Earnings Trans- Supplie Accounts Share Cash + Receivabl + +Equipment= + + Rev. – Exp. – action s Payable Capital e Div. 1. +15,000 +15,000  TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH Softbyte SA purchases computer equipment for €7,000 cash. Illustration 1-10 Assets = Liabilities + Equity Accounts Retained Earnings Trans- Supplie Accounts Share Cash + Receivabl + +Equipment= + + Rev. – Exp. – action s Payable Capital e Div. 1. +15,000 +15,000 2. -7,000 +7,000 3. +1,600 +1,600 4. +1,200 +1,200 5. +250 -250 6. +1,500 +2,000 +3,500 7. -1,700 -600 -900 -200 8. -250 -250 9. +600 -600 10. -1,300 -1,300 $8,050 + $1,400 +$1,600 + $7,000 = $1,600 + $15,000 + $4,700 -$1,950 $1,300 -  TRANSACTION 3. PURCHASE OF SUPPLIES ON CREDIT Softbyte SA purchases for €1,600 headsets and other accessories expected to last several months. The supplier allows Softbyte Illustration 1- to pay this bill in October. Assets = Liabilities + Equity 10 Accounts Retained Earnings Trans- Supplie Accounts Share Cash + Receivabl + +Equipment= + + Rev. – Exp. – action s Payable Capital e Div. 1. +15,000 +15,000 2. -7,000 +7,000 3. +1,600 +1,600 4. +1,200 +1,200 5. +250 -250 6. +1,500 +2,000 +3,500 7. -1,700 -600 -900 -200 8. -250 -250 9. +600 -600 10. -1,300 -1,300 $8,050 + $1,400 +$1,600 + $7,000 = $1,600 + $15,000 + $4,700 -$1,950 $1,300 -  TRANSACTION 4. SERVICES PERFORMED FOR CASH Softbyte SA receives €1,200 cash from customers for app development services it has performed. Illustration 1-10 Assets = Liabilities + Equity Trans- Accounts Accounts Share Retained Earnings Cash + + Supplies +Equipment = + + action Receivable Payable Capital Rev. – Exp. – Div. 1. +15,000 +15,000 2. -7,000 +7,000 3. +1,600 +1,600 4. +1,200 +1,200 5. +250 -250 6. +1,500 +2,000 +3,500 7. -1,700 -600 -900 -200 8. -250 -250 9. +600 -600 10. -1,300 -1,300 $8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300  TRANSACTION 5. PURCHASE OF ADVERTISING ON CREDIT Softbyte SA receives a bill for €250 from the Programming News for advertising on its website but postpones payment until a later date. Illustration 1-10 Assets = Liabilities + Equity Trans- Accounts Accounts Share Retained Earnings Cash + + Supplies +Equipment = + + action Receivable Payable Capital Rev. – Exp. – Div. 1. +15,000 +15,000 2. -7,000 +7,000 3. +1,600 +1,600 4. +1,200 +1,200 5. +250 -250 6. +1,500 +2,000 +3,500 7. -1,700 -600 -900 -200 8. -250 -250 9. +600 -600 10. -1,300 -1,300 $8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300  TRANSACTION 6. SERVICES PROVIDED FOR CASH AND CREDIT. Softbyte provides €3,500 of services. The company receives cash of €1,500 from customers, and it bills the balance of €2,000 on account. Illustration 1-10 Assets = Liabilities + Equity Trans- Accounts Accounts Share Retained Earnings Cash + + Supplies +Equipment = + + action Receivable Payable Capital Rev. – Exp. – Div. 1. +15,000 +15,000 2. -7,000 +7,000 3. +1,600 +1,600 4. +1,200 +1,200 5. +250 -250 6. +1,500 +2,000 +3,500 7. -1,700 -600 -900 -200 8. -250 -250 9. +600 -600 10. -1,300 -1,300 $8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300  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. Illustration 1-10 Assets = Liabilities + Equity Trans- Accounts Accounts Share Retained Earnings Cash + + Supplies +Equipment = + + action Receivable Payable Capital Rev. – Exp. – Div. 1. +15,000 +15,000 2. -7,000 +7,000 3. +1,600 +1,600 4. +1,200 +1,200 5. +250 -250 6. +1,500 +2,000 +3,500 7. -1,700 -600 -900 -200 8. -250 -250 9. +600 -600 10. -1,300 -1,300 $8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300  TRANSACTION 8. PAYMENT OF ACCOUNTS PAYABLE Softbyte SA pays its €250 Programming News bill in cash. The company previously (in Transaction 5) recorded the bill as an increase in Accounts Payable. Illustration 1-10 Assets = Liabilities + Equity Trans- Accounts Accounts Share Retained Earnings Cash + + Supplies +Equipment = + + action Receivable Payable Capital Rev. – Exp. – Div. 1. +15,000 +15,000 2. -7,000 +7,000 3. +1,600 +1,600 4. +1,200 +1,200 5. +250 -250 6. +1,500 +2,000 +3,500 7. -1,700 -600 -900 -200 8. -250 -250 9. +600 -600 10. -1,300 -1,300 $8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300  TRANSACTION 9. RECEIPT OF CASH ON ACCOUNT Softbyte SA receives €600 in cash from customers who had been billed for services (in Transaction 6). Illustration 1-10 Assets = Liabilities + Equity Trans- Accounts Accounts Share Retained Earnings Cash + + Supplies +Equipment = + + action Receivable Payable Capital Rev. – Exp. – Div. 1. +15,000 +15,000 2. -7,000 +7,000 3. +1,600 +1,600 4. +1,200 +1,200 5. +250 -250 6. +1,500 +2,000 +3,500 7. -1,700 -600 -900 -200 8. -250 -250 9. +600 -600 10. -1,300 -1,300 $8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300  TRANSACTION 10. DIVIDENDS The corporation pays a dividend of €1,300 in cash to Ray and Barbara Neal, the shareholders of Softbyte SA. Illustration 1-10 Assets = Liabilities + Equity Trans- Accounts Accounts Share Retained Earnings Cash + + Supplies +Equipment = + + action Receivable Payable Capital Rev. – Exp. – Div. 1. +15,000 +15,000 2. -7,000 +7,000 3. +1,600 +1,600 4. +1,200 +1,200 5. +250 -250 6. +1,500 +2,000 +3,500 7. -1,700 -600 -900 -200 8. -250 -250 9. +600 -600 10. -1,300 -1,300 €8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 + €4,700 - €1,950 - €1,300 €18,050 €18,050 Summary of Transactions 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.  > DO IT! Transactions made by Virmari & Co. SA, a public accounting firm, for the month of August are shown below. Prepare a tabular analysis which shows the effects of these transactions on the expanded accounting equation, similar to that shown in Illustration 1-10. 1. The company issued ordinary shares for €25,000 cash. 2. The company purchased €7,000 of office equipment on credit. 3. The company received €8,000 cash in exchange for services performed. 4. The company paid €850 for this month’s rent. 5. The company paid a dividend of €1,000 in cash to shareholders.  > DO IT! 1. The company issued ordinary shares for €25,000 cash. Assets = Liabilities + Equity Trans- Accounts Share Retained Earnings Cash + Equipment = + + action Payable Capital Rev. – Exp. – Div. 1. +25,000 +25,000 2. +7,000 +7,000 3. +8,000 +8,000 4. -850 -850 5. -1,000 -1,000 $31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000 $18,050 $18,050  > DO IT! 2. The company purchased €7,000 of office equipment on credit. Assets = Liabilities + Equity Trans- Accounts Share Retained Earnings Cash + Equipment = + + action Payable Capital Rev. – Exp. – Div. 1. +25,000 +25,000 2. +7,000 +7,000 3. +8,000 +8,000 4. -850 -850 5. -1,000 -1,000 $31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000 $18,050 $18,050  > DO IT! 3. The company received €8,000 cash in exchange for services performed. Assets = Liabilities + Equity Trans- Accounts Share Retained Earnings Cash + Equipment = + + action Payable Capital Rev. – Exp. – Div. 1. +25,000 +25,000 2. +7,000 +7,000 3. +8,000 +8,000 4. -850 -850 5. -1,000 -1,000 $31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000 $18,050 $18,050  > DO IT! 4. The company paid €850 for this month’s rent. Assets = Liabilities + Equity Trans- Accounts Share Retained Earnings Cash + Equipment = + + action Payable Capital Rev. – Exp. – Div. 1. +25,000 +25,000 2. +7,000 +7,000 3. +8,000 +8,000 4. -850 -850 5. -1,000 -1,000 $31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000 $18,050 $18,050  > DO IT! 5. The company paid a dividend of €1,000 in cash to shareholders. Assets = Liabilities + Equity Trans- Accounts Share Retained Earnings Cash + Equipment = + + action Payable Capital Rev. – Exp. – Div. 1. +25,000 +25,000 2. +7,000 +7,000 3. +8,000 +8,000 4. -850 -850 5. -1,000 -1,000 €31,150 + €7,000 = €7,000 + €25,000 + €8,000 - €850 - €1,000 €38,150 €38,150  Learning Objectives 6 Describe the financial statements and how they are prepared.  Companies prepare five financial statements : Statement of Profit & Loss Statement of Statement of Statement of and Other Changes in Financial Cash Flows Comprehensive Equity Position Income Notes & Disclosure Statement of Profit & Loss and Other Comprehensive Income  Reports the profitability of the company’s operations over a specific period of time.  Lists revenues first, followed by expenses.  Shows net income (or net loss).  Does not include investment and dividend transactions between the shareholders and the business. Financial Statements Review Question Net income will result during a time period when: a. assets exceed liabilities. b. assets exceed revenues. c. expenses exceed revenues. d. revenues exceed expenses. Statement of Changes in Equity  Reports the changes in Equity and retained earnings for a specific period of time.  The time period is the same as that covered by the income statement.  Information provided indicates the reasons why Share Capital & retained earnings increased or decreased during the period. Statement of Financial Position  Reports the assets, liabilities, and equity at a specific date.  Lists assets at the top, followed by liabilities and equity.  Total assets must equal total liabilities and equity.  Is a snapshot of the company’s financial condition at a specific moment in time (usually the month-end or year-end). Financial Statements Review Question The financial statement that reports assets, liabilities, and equity is the: a. income statement. b. retained earnings statement. c. statement of financial position. d. statement of cash flows. Statement of Cash Flows  Information on the cash receipts and payments for a specific period of time.  Answers the following: ► Where did cash come from? ► What was cash used for? HELPFUL HINT Investing activities ► What was the change in the pertain to investments cash balance? made by the company, not investments made by the owners.  > DO IT! Presented below is selected information related to Flanagan Group plc at December 31, 2017. Flanagan reports financial information monthly. Equipment £10,000 Utilities Expense £ 4,000 Cash 8,000 Accounts Receivable 9,000 Service Revenue 36,000 Salaries and Wages Expense 7,000 Rent Expense 11,000 Notes Payable 16,500 Accounts Payable 2,000 Dividends 5,000 (a) Determine the total assets of Flanagan at December 31, 2017. (b) Determine the net income that Flanagan reported for December 2017. (c) Determine the equity of Flanagan at December 31, 2017. Information related to Flanagan Group plc at December 31, 2017. Equipment £10,000 Utilities Expense £ 4,000 Cash 8,000 Accounts Receivable 9,000 Service Revenue 36,000 Salaries and Wages Expense 7,000 Rent Expense 11,000 Notes Payable 16,500 Accounts Payable 2,000 Dividends 5,000 (a) Determine the total assets of Flanagan at December 31, 2017. Equipment £10,000 Cash 8,000 Accounts Receivable 9,000 Total assets £27,000 Information related to Flanagan Group plc at December 31, 2017. Equipment £10,000 Utilities Expense £ 4,000 Cash 8,000 Accounts Receivable 9,000 Service Revenue 36,000 Salaries and Wages Expense 7,000 Rent Expense 11,000 Notes Payable 16,500 Accounts Payable 2,000 Dividends 5,000 (b) Determine the net income reported for December 2017. Revenues Service revenue £36,000 Expenses Rent expense £11,000 Salaries and wages expense 7,000 Utilities expense 4,000 Total expenses 22,000 Net income £14,000 Information related to Flanagan Group plc at December 31, 2017. Equipment £10,000 Utilities Expense £ 4,000 Cash 8,000 Accounts Receivable 9,000 Service Revenue 36,000 Salaries and Wages Expense 7,000 Rent Expense 11,000 Notes Payable 16,500 Accounts Payable 2,000 Dividends 5,000 (c) Determine the equity of Flanagan at December 31, 2017. Total assets [as computed in (a)] £27,000 Less: Liabilities Notes payable £16,500 Accounts payable 2,000 18,500 Equity £ 8,500 End of Chapter 1