Chapter

One to
Introduction
Accounting
LEARNING OBJECTIVES
After studying this chapter, you should be
able to:
1 Explain what accounting is.
2 Identify the users and uses of accounting.
3 Explain accounting standards and measurement
principles.
4 Explain the monetary unit assumption
and the economic entity assumption.
5 Explain the career opportunities in accounting.
6 State the accounting equation, and define its
components.
7 Analyze effects of business transactions
on the accounting equation.
 1.1. What is Accounting?
Accounting consists of three basic activities—
it

 identifies,

 records, and

 communicates

the economic events of an

organization to
interested users.
 Cont’d
o As a starting point to the accounting process, a company
identifies the economic events relevant to its
business. Examples of economic events are the sale of
goods, the providing of telephone services …
o Once a company identifies economic events, it records
those
events in order to provide a history of its financial
activities.
o Recording consists of keeping a systematic,
chronological
diary of events, measured in monetary units.
o In recording, the company also classifies and summarizes
economic events.
o Finally, the company communicates the collected
Three Activities
Illustration 1-1
The activities of the accounting process

The accounting process

includes the
bookkeeping function.
Who U ses Accounting
Data?
o There are two broad groups of users of financial
information: internal users and external users.
1) INTERNAL USERS
o 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.
o Managerial Accounting provides internal reports to
help users make decisions about their companies.
o Examples are financial comparisons of operating
alternatives, projections of income from new sales
campaigns, & forecasts of cash needs for the next year.
 Cont’d

IN TERN
AL
USERS

Illustration 1-2
Questions that internal
users ask
 Cont’d
2) EXTERNAL USERS
o External users are individuals and organizations
outside a company who want financial information about
the company.
o The two most common types of external users are
investors
and creditors.
o Investors (owners) use accounting information to
make decisions to buy, hold, or sell ownership shares of
a company.
o Creditors (such as suppliers & bankers) use
accounting information to evaluate the risks of granting
credit or lending money.
 Cont’d

EXTERN
AL
USERS

Illustration 1-3
Questions that external users ask
 > D O IT!

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.
5. Managerial accounting activities focus on reports for
internal
 1.2. Accounting Standards, Measurement Principles
& Assumptions
Accounting Standards
o In order to ensure high-quality financial reporting,
accountants present FS’s in conformity with
accounting standards that are issued by standard
setting bodies.
o Presently, there are two primary accounting
standard- setting bodies—the IASB and FASB.
o More than 140 countries follow standards referred
to
IFRS.
o IFRS’s are determined by the IASB. The IASB is
headquartered in London, with its 15 board
 Cont’d
o Most companies in the US follow standards issued by
the
FASB, referred to as GAAP.
o As markets become more global, it is often desirable
to compare the results of companies from different
countries that report using different accounting
standards.
o In order to increase comparability, in recent years the
two standard-setting bodies have made efforts to
reduce the differences between IFRS and U.S. GAAP.
o This process is referred to as convergence.
o As a result of these convergence efforts, it is likely
that someday there will be a single set of high-quality
 Cont’d

International Accounting Standards Board

(IASB) http://www.iasb.org/

International
Financial
Reporting
Financial Accounting
Standards Standards Board
(FASB) http://www.fasb.org/

Generally Accepted Accounting Principles

(GAAP)
Measurement
Principles
o IFRS generally uses one of two measurement
principles, the historical cost principle or the
fair value principle.
o The selection of which principle to follow generally
relates to trade-offs between relevance & faithful
representation.
o Relevance means that financial information is
capable of making a difference in a decision.
o Faithful representation means that the numbers
and descriptions match what really existed or
happened— they are factual.
 Cont’d
1) HISTORICAL COST PRINCIPLE (or Cost
Principle)
o It dictates that companies record assets at
their cost.

o This is true not only at the time the asset

is purchased, but also over the time the
asset is held.

2) FAIR VALUE PRINCIPLE

o It states that assets and liabilities should be
reported at fair value (the price received to
sell an asset or settle a liability).
 C ont’
o d HC
Fair value information may be more useful than
for
certain types of assets and liabilities.

o For example, certain investment securities are

reported at FV because market value information is
usually readily available for these types of assets.

o In determining which measurement principle to

use, companies weigh the factual nature of cost
figures versus the relevance of fair value.

o In general, even though IFRS allows companies to

revalue PPE and other long-lived assets to FV, most
companies choose to use cost. Only in situations
where assets are actively traded, such as
investment securities, do companies apply the FV
Assumptions
o Assumptions provide a foundation for the
accounting
process.
o Two main assumptions are the monetary unit
assumption
and the economic entity assumption.

1) MONETARY UNIT ASSUMPTION

o The monetary unit assumption requires that
companies include in the accounting records only
transaction data that can be expressed in money terms.
o This assumption enables accounting to quantify
(measure) economic events.
o The monetary unit assumption is vital to applying
 Cont’d
o This assumption prevents the
inclusion of some relevant
information in the accounting records.
o For example, the health of a company’s owner, the
quality
of service, and the morale of employees are not
included.
o The reason: Companies cannot quantify this
information in money terms.
 Cont’d
2) ECONOMIC ENTITY ASSUMPTION
o It requires that activities of the entity be kept
separate and distinct from the activities of its
owner and all other economic entities.
 Proprietors
hip Forms of Business
 Partnership Ownership
 Corporatio
n
 Cont’d

Proprietorship Partnership Corporation

 Owned by  Owned by  Ownershi

one person two or more p divided
 persons into
Owner is
often  shares
Often retail
manager/ and service-  Separate legal
operator type entity
 Owner receives businesses organized
any profits,  under
Generally
suffers any corporation
unlimited
losses, and is law
personal
personally liability  Limited
 Cont’d
Question #1
The historical cost principle states that:
a. Assets should be initially recorded at cost and
adjusted when the fair value changes.
b. Activities of an entity are to be kept
separate and distinct from its owner.
c. Assets should be recorded at their cost.
d. Only transaction data capable of
being expressed in terms of
money be included in the accounting records.
 > D O IT!
Indicate whether each of the following
statements presented below is true or false.

1. Convergence refers to efforts to reduce differences

between IFRS and U.S. GAAP.

2. The primary accounting standard-setting body

headquartered in London is the International
Accounting Standards Board (IASB).

3. The historical cost principle dictates that companies

record assets at their cost. In later periods, however,
the fair value of the asset must be used if fair value
is higher than its cost.
 > D O IT!
Indicate whether each of the following
statements presented below is true or false.

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.
1.3. Accounting Career Opportunities
Public Accounting
Careers in auditing, Private Accounting
taxation, and Careers in industry
management consulting working in cost
serving the general accounting, budgeting,
Governmental Accounting
public.
Careers with the tax
accounting information
authorities, law systems, and taxation.
enforcement agencies, and
corporate regulators.

Forensic Accounting
Uses accounting, auditing, and investigative
skills to conduct investigations into theft and
 1.4. The Basic Accounting Equation

Basic Accounting Equation

 Provides the underlying framework for
recording and summarizing economic events.
 Assets must equal the sum of liabilities and
equity.

Asset = Liabiliti + Equit

s es y
 Cont’d

Asset = Liabiliti + Equit

s es y
Assets
 Resources a business owns.
 Provide future services or
benefits.
 Cash, Inventory, Equipment, etc.
 Cont’d

Asset = Liabiliti + Equit

s es y
Liabilities
 Claims against assets (debts and
obligations).
 Creditors (party to whom money is owed).
 Accounts Payable, Notes
Payable, Salaries and Wages
Payable, etc.
 Cont’d

Asset = Liabiliti + Equit

s es y
Equity
 Ownership claim on total assets.
 Referred to as residual equity.
 Share Capital—Ordinary and Retained
Earnings.
 Cont’d
Illustration 1-7: Increases and Decreases in Equity

Investments by shareholders represent the total

amount paid in by shareholders for the ordinary
shares they purchase.
 Cont’d
Illustration 1-7: Increases and Decreases in Equity

Revenues result from business

activitiesentered into for the purpose of
earning income.
Common sources of revenue are:
sales, fees, services, commissions, interest,
 Cont’d
Illustration 1-7: Increases and Decreases in 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,
 Cont’d
Illustration 1-7: Increases and Decreases in Equity

Dividends are the distribution of cash or other

assets to shareholders.
Dividends reduce retained earnings. However,
dividends are not expenses.
 > DO IT!
Classify the following items as issuance of stock,
dividends, revenues, or expenses. Then indicate
whether each item increases or decreases
stockholders’ equity.
Effect on
Classification Equity
1. Rent Expense

2. Service Revenue

3. Dividends

4. Salaries and Wages

Expense
 1.5. Using 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.
 Cont’d
Illustration: Are the following
events recorded in the
accounting records?
Discuss product
Purchas
Event design with Pay
e
potential rent
comput
customer
er
Criterion Is the financial position (assets,
liabilities, or stockholder’s equity) of the
company changed?

Record/
Don’t Record

Illustration 1-8
Transaction-identification process
 Cont’d
Illustration 1-9
Expanded Accounting Equation
 Cont’d
TRANSACTION 1. INVESTMENT BY STOCKHOLDERS Ray and
Barbara
Neal decide to start a computer programming company that they
incorporate as Softbyte Inc. On September 1, 2014, 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.
Assets = Liabilities + Equity
Trans- Retained Earnings
Cash Accounts
+ Receivable + Supplies +Equipment =
Accounts +
Share + Rev. – Exp. –
action Payable Div.
1. +15,000
Capital
+15,000
TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH Softbyt
Inc. purchases computer equipment for €7,000 cash. e

Assets = Liabilities + Equity

Trans- Retained Earnings
Cash Accounts
+ Receivable + Supplies +Equipment =
Accounts +
Share + Rev. – Exp. –
action Payable Div.
1. +15,000
Capital
+15,000
-7,000 +7,000
2.
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
Inc.
purchases
several for €1,600
months. computer
The supplier paperSoftbyte
allows & othertosupplies
pay this expected
bill
to October.
in last
Assets = Liabilities + Equity
Trans- Retained Earnings
Cash Accounts
+ Receivable + Supplies +Equipment =
Accounts +
Share + Rev. – Exp. –
action Payable Div.
1. +15,000
Capital
+15,000
-7,000 +7,000
2.
+1,600 +1,600
3.
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
Inc.
receives€1,200 cash from customers
provided. for programming
services it has
Assets =
Liabilities + Equity
Trans- Cash Accounts + Supplies +Equipment = Accounts Share Retained Earnings
+ + + Rev. – Exp. –
action Payable Div.
1. +15,000
Receivable +
Capital
1
5
,
0
0
5. +250 0 -250
2.
6. -7,000
+1,500 +2,000 + +3,500
7
7. -1,700 , -600
0 -900
0 -200
0
8. -250 -250
3. + +
9. +600 -600 1 1
10. -1,300 , , -
1,300 6 6
$8,050 + $1,400 + $1,600
0 + $7,000 = 0$1,600 + $15,000 + $4,700 - $1,950 -
$1,300 0 0
4. +1,200 +
TRANSACTION 5. PURCHASE OF ADVERTISING ON CREDIT
Softbyte
receives
payment auntil
bill afor €250
later from the Daily News for advertising but
date.
postpones
Assets =
Liabilities + Equity
Trans- Cash Accounts + Supplies +Equipment = Accounts Share Retained Earnings
+ + + Rev. – Exp. –
action Payable Div.
1. +15,000
Receivable +
Capital
1
5
,
0
0
0
2.
6. -7,000
+1,500 +2,000 + +3,500
7
7. -1,700 , -600
0 -900
0 -200
0
8. -250 -250
3. + +
9. +600 -600 1 1
10. -1,300 , ,
-1,300 6 6
$8,050 $1,400 $1,600
0 $7,000 0 $1,600 $15,000 $4,700 $1,950 $1,300
+ 0 + 0+ = + +
- -
4. +1,200 +
TRANSACTION 6. SERVICES PROVIDED FOR CASH AND CREDIT.
Softbyte Inc provides €3,500 of programming services for
customers. The company receives cash of €1,500 from customers,
and it bills the balance of €2,000 on account.
Assets = Liabilities + Equity

Trans- Cash Accounts + Supplies +Equipment = Accounts Share Retained Earnings

+ + + Rev. – Exp. –
action Payable Div.
1. +15,000
Receivable +15,000
Capital

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 pays the
following expenses in cash for September: Store rent €600,
salaries and wages of employees €900, and utilities €200.
Assets = Liabilities + Equity

Trans- Cash Accounts + Supplies +Equipment = Accounts Share Retained Earnings

+ + + Rev. – Exp. –
action Payable Div.
1.
Receivable +15,000
Capital
+15,000
-7,000 +7,000
2.
+1,600 +1,600
3.
+1,200 +1,200
4.
+250 -250
5.
+1,500 +2,000 +3,500
6.
-1,700 -600
7. -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 pays
its
€250 Daily News bill in cash. The company previously (in Transaction
5) recorded the bill as an increase in Accounts Payable and a
decrease in equity.
Assets = Liabilities + Equity

Trans- Cash Accounts + Supplies +Equipment = Accounts Share Retained Earnings

+ + + Rev. – Exp. –
action Payable Div.
1.
Receivable +15,000
Capital
+15,000
-7,000 +7,000
2.
+1,600 +1,600
3.
+1,200 +1,200
4.
+250 -250
5.
+1,500 +2,000 +3,500
6.
-1,700 -600
7. -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
receives
services €600 in cash from
(in Transaction 6).customers who had been
billed for
Assets =
Liabilities + Equity
Trans- Cash Accounts + Supplies +Equipment = Accounts Share Retained Earnings
+ + + Rev. – Exp. –
action Payable Div.
1.
Receivable +15,000
Capital
+15,000
-7,000 +7,000
2.
+1,600 +1,600
3.
+1,200 +1,200
4.
+250 -250
5.
+1,500 +2,000 +3,500
6.
-1,700 -600
7. -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 Inc.
Assets = Liabilities + Equity
Trans- Retained Earnings
Cash Accounts
+ Receivable + Supplies +Equipment =
Accounts +
Share + Rev. – Exp. –
action Payable Div.
1. +15,000
Capital
+15,000
-7,000 +7,000
2.
+1,600 +1,600
3.
+1,200 +1,200
4.
+250 -250
5.
+1,500 +2,000 +3,500
6.
-1,700 -600
7. -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
Illustration 1.10: Tabular Summery of Softbyte Inc. Transactions

Assets = Liabilities + Equity

Trans- Retained Earnings
Cash Accounts
+ Receivable + Supplies +Equipment =
Accounts +
Share + Rev. – Exp. –
action Payable Div.
1. +15,000
Capital
+15,000
-7,000 +7,000
2.
+1,600 +1,600
3.
+1,200 +1,200
4.
+250 -250
5.
+1,500 +2,000 +3,500
6.
-1,700 -600
7. -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
 > DO IT!
Transactions made by Virmari & Co., 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 companyreceived €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!

Solutio
n:
Assets = Liabilities + Equity
Trans- Retained Earnings
Cash + Equipment Accounts
= Payable
Share
+ Capital +
action 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
1.6. Financial Statements
 Companies prepare four financial statements from
the summarized accounting data:
 An IS presents the revenues and expenses and resulting
Net Income or Net Loss for a specific period of time.
 A RE’s statement summarizes the changes in retained
earnings for a specific period of time.
 A SoFP (sometimes referred to as a balance sheet)
reports the
assets, liabilities, and equity of a company at a specific
date.
 A SCF summarizes information about the cash
inflows and
cash outflows for a specific period of time.
 Illustration 1-10
Financial statements
and their
interrelationships

Illustration 1-11: Financial Statements and their Interrelationships

SoFP & IS
are
needed
to
prepare
SCF.
Illustration 1-11:
FS’s and their
Interrelationship
s
Income Statement
 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.
 Cont’d
Question #2
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.

Retained Earnings Statement
 Reports the changes in 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
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).
 Cont’d
Question #3
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?
► What was the change in the
cash HELPFUL HINT
balance? Investing activities
pertain to investments
made by the company,
not investments made
by the owners.
 > DO IT!
Presented below is selected information related to
Flanagan Company at December 31, 2014. Flanagan
reports financial information monthly.
Equipment £10,000 Utilities Expense £
4,000
Cash 8,000 Accounts Receivable 9,000
Service 36,000 Salaries and Wages 7,000
Revenue Expense
Rent Expense 11,000 Notes Payable 16,500
Accounts 2,000 Dividends 5,000
Payable
(a) Determine the total assets of Flanagan at December 31,
Required:
2014.
(b) Determine the net income that Flanagan reported for
December 2014.
(c) Determine the equity of Flanagan at December 31, 2014.
Information related to Flanagan Company at December 31,
2014.
Equipment £10,000 Utilities Expense £
4,000
Cash 8,000 Accounts Receivable 9,000
Service 36,000 Salaries and Wages 7,000
Revenue Expense
Rent Expense 11,000 Notes Payable 16,500
Accounts 2,000
(a) Determine the total assets Dividends
of Flanagan at December 31, 5,000
Payable
2014.
Equipment £10,000
Cash 8,000
Accounts Receivable 9,000
Total assets £27,000
Information related to Flanagan Company at December 31,
2014.
Equipment £10,000 Utilities Expense £
4,000
Cash 8,000 Accounts Receivable 9,000
Service 36,000 Salaries and Wages 7,000
Revenue Expense
Rent Expense 11,000 Notes Payable 16,500
Accounts
(b) Determine the net2,000 Dividends
income reported for December 2014. 5,000
Payable
Revenues
S ervice revenue

£36,000
Rent expense £11,000
Expenses
Salaries and wages expense 7,000
Utilities expense 4,000
Total expenses 22,000
Net income £14,000
Information related to Flanagan Company at December 31,
2014.
Equipment £10,000 Utilities Expense £
4,000
Cash 8,000 Accounts Receivable 9,000
Service 36,000 Salaries and Wages 7,000
Revenue Expense
Rent Expense 11,000 Notes Payable 16,500
Accounts
(c) 2,000
Determine the equity Dividends
of Flanagan at December 31, 5,000
Payable
2014.
Total assets [as computed in (a)] £27,000
Less:
Liabilities £16,500
Notes
payable
Accounts payable 2,000 18,500
Equity £ 8,500
The End of Chapter
1

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