CHAPTER 1
ACCOUNTING IN ACTION
LEARNING OBJECTIVES
1. IDENTIFY THE ACTIVITIES AND USERS ASSOCIATED
WITH ACCOUNTING.
2. EXPLAIN THE BUILDING BLOCKS OF ACCOUNTING:
ETHICS, PRINCIPLES, AND ASSUMPTIONS.
CHAPTER REVIEW
Accounting Defined
1. (L.O. 1) Accounting is an information system that identifies, records, and communicates the
economic events of an organization to interested users.
a. The first part of the process, identifying, involves selecting those events that are considered
evidence of economic activity relevant to a particular business organization.
b. Recording is the keeping of a chronological diary of events, measured in dollars and cents.
c. Communication occurs through the preparation and distribution of accounting reports.
2. The accounting process consists of:
and customers.
Ethics
5. (L.O. 2) The standards of conduct by which one’s actions are judged as right or wrong, honest
or dishonest, fair or not fair, are ethics. The process of analyzing ethics cases and situations is to
recognize an ethical situation and the ethical issues involved, identify and analyze the principal
elements in the situation (especially those harmed or benefited), identify the alternatives and
weigh the impact of each alternative on various stakeholders, then select the most ethical
alternative.
GAAP and Measurement Principles
6. Generally accepted accounting principles (GAAP) are a common set of guidelines (standards)
used by accountants.
7. The Securities and Exchange Commission (SEC) is the agency of the United States
government that oversees U.S financial markets and accounting standard-setting bodies.
The Monetary Unit and Economic Entity Assumptions
10. The accounting profession has developed certain assumptions that serve as guidelines for the
accounting process.
a. The monetary unit assumption requires that only transaction data that can be expressed in
money terms be included in the accounting records.
Business Enterprises
11. Three types of business enterprises are proprietorships, partnerships, and corporations.
a. A proprietorship is a business owned by one person.
The Accounting Equation
12. (L.O. 3) The basic accounting equation is:
Assets = Liabilities + Owner’s Equity.
The accounting equation applies to all economic entities regardless of size, nature of business, or
form of business organization.
13. The key components of the basic accounting equation are:
a. Assets are resources owned.
b. Liabilities are claims against assets.
c. Owner’s equity is the claims of owners.
14. In proprietorships, there are four subdivisions of owner’s equity:
a. Investments by Owner are the assets put in the business by the owner.
b. Revenues are the gross increase in owner’s equity resulting from business activities entered
Transactions
16. (L.O. 4) Transactions are the economic events of the business recorded by accountants.
Transactions may be identified as either external or internal transactions.
17. Each transaction must be analyzed in terms of its effect on the components of the basic
accounting equation. The analysis must also identify the specific items affected and the amount of
the change in each item.
18. Each transaction has a dual effect on the equation. For example, if an individual asset is
increased, there must be a corresponding:
a. decrease in another asset, or
b. increase in a specific liability, or
c. increase in owner’s equity.
The Financial Statements
20. (L.O. 5) Four financial statements are prepared from the summarized accounting data:
a. An income statement presents the revenues and expenses and resulting net income or net
loss of a company for a specific period of time.
b. An owner’s equity statement summarizes the changes in owner’s equity for a specific
period of time.
c. A balance sheet reports the assets, liabilities, and owner’s equity at a specific date.
d. A statement of cash flows summarizes information concerning the cash inflows (receipts)
and outflows (payments) for a specific period of time.
21. The financial statements are interrelated because:
a. Net income (or net loss) shown on the income statement is added (subtracted) to (from) the
beginning balance of owner’s capital in the owner’s equity statement.
b. Owner’s capital at the end of the reporting period shown in the owner’s equity statement is
reported in the balance sheet.
25. The statement of cash flows reports the sources, uses, and net increase or decrease in cash.
Chapter 17 will examine in detail how the statement is prepared.
*Careers in Accounting
*26. (L.O. 6) Public accounting provides the services of auditing, taxation, and management
consulting.
a. Auditing involves examining financial statements of companies and expressing an opinion
as to the fairness of their presentation.
*27. Private accounting involves the employment of accountants within individual companies. The
private accountant performs a wide variety of duties such as general accounting, cost accounting,
budgeting, accounting information systems, tax accounting, and internal auditing.
LECTURE OUTLINE
A. What Accounting Is.
1. Accounting consists of three basic activities—it identifies, records, and
communicates the economic events of an organization to interested
users.
2. Once a company identifies economic events, it records those events in
order to provide a history of its financial activities. Recording consists of
keeping a systematic, chronological diary of events, measured in dollars
and cents.
5. Bookkeeping usually involves only the recording of economic events and is
therefore just one part of the accounting process. Accounting involves the
entire process of identifying, recording, and communicating economic events.
B. Users and Uses of Accounting.
1. Internal users of accounting information are managers who plan,
2. External users are individuals and organizations outside of a company
who are either:
a. Investors or creditors: Investors (owners) use accounting information
to make decisions to buy, hold, or sell ownership shares of a
company. Creditors (suppliers and bankers) use accounting
information to evaluate the risks of granting credit or lending
money.
ACCOUNTING ACROSS THE ORGANIZATION
Accounting can serve as a useful recruiting tool even for the human resources
department. One company’s website includes the following: “operating results
are posted and monthly group meetings inform all employees about what’s
happening in the company.”
What are the benefits to the company and to the employees of making the
financial statements available to all employees?
Answer: If employees can read and use financial reports, a company will benefit
in the following ways. The marketing department will make better
decisions about products to offer and prices to charge. The finance
C. Ethics in Financial Reporting.
1. Ethics are the standards of conduct by which one’s actions are judged
as right or wrong, honest or dishonest, fair or not fair. Effective financial
reporting depends on sound ethical behavior.
2. In the process of analyzing ethics cases and situations, the following
steps should be applied:
a. Recognize an ethical situation and the ethical issues involved.
D. Generally Accepted Accounting Principles.
1. Generally accepted accounting principles are a common set of
standards used by accountants.
2. Two organizations are primarily responsible for establishing generally
accepted accounting principles.
a. The Financial Accounting Standards Board (FASB) is the primary
accounting standard–setting body in the United States.
3. The historical cost principle (or cost principle) dictates that companies
should record assets at their cost. This is also true over the time the
asset is held.
E. Assumptions.
1. Monetary unit assumption.
a. Requires that companies include in the accounting records only trans-
action data that can be expressed in money terms. This assumption
enables accounting to quantify (measure) economic events.
2. Economic entity assumption requires that the activities of the entity be kept
separate and distinct from the activities of its owner and all other economic
entities.
a. A business owned by one person is generally a proprietorship.
ACCOUNTING ACROSS THE ORGANIZATION
The study of accounting should help students a great deal, because a working
knowledge of accounting is desirable for virtually every field of business.
How might accounting help a student?
Answer: You will need to understand financial reports in any enterprise with
which you are associated. Whether you become a manager, a doctor,
F. The Basic Accounting Equation.
1. Assets = Liabilities + Owner’s Equity.
2. Equality of the equation must be preserved.
3. The expanded accounting equation is:
G. Assets, Liabilities, and Owner’s Equity.
1. Assets are resources a business owns. The business uses its assets in
carrying out such activities as production and sales.
2. Liabilities are claims against assets. They are existing debts and obligations.
3. Owner’s equity is equal to total assets minus total liabilities; owner’s
equity represents the ownership claim on total assets. The principal subdi-
visions of owner’s equity are capital, drawings, revenues, and expenses.
4. Revenues are the gross increase in owner’s equity resulting from business
activities entered into for the purpose of earning income.
5. Expenses are the cost of assets consumed or services used in the process
of earning revenue.
H. Using the Accounting Equation.
1. External transactions are economic events between the company and
some outside enterprise.
I. Financial Statements.
1. An income statement presents the revenues and expenses and resulting
net income or net loss for a specific period of time.
2. An owner’s equity statement summarizes the changes in owner’s equity
for a specific period of time.
*J. Accounting Career Opportunities.
1. Individuals in public accounting offer expert service to the general public
through the services they perform.
a. Auditing—A certified public accountant (CPA) examines company
financial statements and provides an opinion as to how accurately
the financial statements present the company’s results and financial
position.
2. Private accountants are employees of a for-profit company and are involved
in a number of activities including cost accounting, tax planning and prepa-
ration, accounting information system design and support, and internal
auditing.
IFRS
A Look at IFRS
Most agree that there is a need for one set of international accounting standards. Here is why:
Multinational corporations. Today’s companies view the entire world as their market. For
example, Coca-Cola, Intel, and McDonald’s generate more than 50% of their sales outside the
United States, and many foreign companies, such as Toyota, Nestlé, and Sony, find their
largest market to be the United States.
Mergers and acquisitions. The mergers between Fiat/Chrysler and Vodafone/Mannesmann
suggest that we will see even more such business combinations in the future.
KEY POINTS
Following are the key similarities and differences between GAAP and IRS as
related to accounting fundamentals.
• The basic techniques for recording business transactions are the same for U.S. and
international companies.
• Both international and U.S. accounting standards emphasize transparency in financial
reporting. Both sets of standards are primarily driven by meeting the needs of investors
and creditors.
• International standards are referred to as International Financial Reporting Standards
(IFRS), developed by the International Accounting Standards Board. Accounting
standards in the United States are referred to as generally accepted accounting
principles (GAAP), and are developed by the Financial Accounting Standards Board.
LOOKING TO THE FUTURE
Both the IASB and the FASB are hard at work developing standards that will lead to the
elimination of major differences in the way certain transactions are accounted for and reported.
20 MINUTE QUIZ
Circle the correct answer.
True/False
1. Accounting is the information system that identifies, records, and communicates the
economic events of an organization to interested users.
True False
2. Bookkeeping deals with the record-keeping process and is only one aspect of accounting.
True False
3. Internal users are those who manage the business.
True False
4. The Financial Accounting Standards Board is the primary accounting standard-setting
body in the United States.
True False
5. Net income is the excess of revenues over expenses for the accounting period.
True False
6. The economic entity assumption requires that the activities of the entity be kept sepa–
rate and distinct from the activities of its owner and all other economic entities.
True False
7. Collection of an accounts receivable will increase both cash and accounts receivable.
True False
8. An expense paid with cash would result in an equal decrease in liabilities and owner’s
equity.
True False
9. Liabilities represent the ownership claim on total assets.
True False
*10. Certified Public Accountants are only permitted to prepare audit reports and tax returns.
True False
Multiple Choice
1. All of the following are external users of accounting information except
a. labor unions.
b. taxing authorities.
c. regulatory agencies.
d. company officers.
2. Recording consists of
a. identifying and measuring economic events.
b. preparing and distributing accounting reports.
c. keeping a systematic, chronological diary of events, measured in dollars and cents.
d. identifying, measuring, receiving, and communicating economic events to interested
users.
3. The financial statement that summarizes information about the cash inflows and outflows
during a period is the
a. income statement.
b. owner’s equity statement.
c. balance sheet.
d. statement of cash flows.
4. Which of the following is not an acceptable statement of the basic accounting equation?
a. Assets – Liabilities = Owner’s equity
b. Assets = Liabilities – Owner’s equity
c. Assets = Liabilities + Owner’s equity
d. Assets – Owner’s equity = Liabilities
*5. Accountants involved with cost accounting, budgeting, and internal auditing are part of
which broad category within the accounting profession?
a. Governmental accounting
b. Management consulting
c. Public accounting
d. Private accounting
ANSWERS TO QUIZ
True/False
1. True 6. True
Multiple Choice
1. d.