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Chapter 1 Accounting in Action

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. Understand why ethics is a fundamental business concept.
4. Explain accounting standards and the measurement principles.
5. Explain the monetary unit assumption and the economic entity
assumption.
6. State the accounting equation, and define its components.
7. Analyze the effects of business transactions on the accounting equation.
8. Understand the four financial statements and how they are prepared.

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 Preview of Chapter 1

Financial Accounting
IFRS Second Edition
Weygandt Kimmel Kieso
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 What is Accounting?

Accounting consists of three basic activities - it

 identifies,
 records, and
 communicates

the economic events of an organization to interested users.

1-4 LO 1 Explain what accounting is.

 What is Accounting?
Illustration 1-1

Three Activities The activities of the

accounting process

The accounting process includes

the bookkeeping function.

1-5 LO 1 Explain what accounting is.

 Who Uses Accounting Data

External
Internal Users
Human Taxing
Users
Resources Authorities
Labor
Unions
Finance
Management Customers

Creditors
Marketing Regulatory
Agencies
Investors

1-6 LO 2 Identify the users and uses of accounting.

 Who Uses Accounting Data

Common Questions Asked User

1. Can we afford to give our
employees a pay raise? Human Resources
2. Did the company earn a
satisfactory income? Investors
3. Should any product lines be
eliminated? Management
4. Is cash sufficient to pay dividends
to shareholders? Finance
5. What price for our product will
maximize net income? Marketing
6. Will the company be able to pay
its debts? Creditors
1-7 LO 2 Identify the users and uses of accounting.
 The Building Blocks of Accounting

Ethics In Financial Reporting

Standards of conduct by which one’s actions are judged as
right or wrong, honest or dishonest, fair or not fair, are
ethics.
 Recent financial scandals include: Enron (USA),
Parmalat (ITA), Satyam Computer Services (IND), AIG
(USA), and others.
 Effective financial reporting depends on sound ethical
behavior.

1-8 LO 3 Understand why ethics is a fundamental business concept.

 The Building Blocks of Accounting

Ethics In Financial Reporting

Illustration 1-4
Steps in analyzing ethics cases
and situations

1-9 LO 3 Understand why ethics is a fundamental business concept.

 Ethics in Financial Reporting

Question
Ethics are the standards of conduct by which one's actions are
judged as:
a. right or wrong.
b. honest or dishonest.
c. fair or not fair.
d. all of these options.

1-10 LO 3 Understand why ethics is a fundamental business concept.

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 The Building Blocks of Accounting

Accounting Standards

International Accounting Standards Board (IASB)

http://www.iasb.org/

International Financial Reporting Standards (IFRS)

Financial Accounting Standards Board (FASB)

http://www.fasb.org/

Generally Accepted Accounting Principles (GAAP)

1-12 LO 4 Explain accounting standards and the measurement principles.

 The Building Blocks of Accounting

Measurement Principles
Cost Principle – or historical 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).

1-13 LO 4 Explain accounting standards and the measurement principles.

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 The Building Blocks of Accounting

Assumptions
Monetary Unit – include in the accounting records only
transaction data that can be expressed in money terms.

Economic Entity – requires that activities of the entity be

kept separate and distinct from the activities of its owner and
all other economic entities.
 Proprietorship.
 Partnership. Forms of Business
Ownership
 Corporation.

LO 5 Explain the monetary unit assumption

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and the economic entity assumption.
 Forms of Business Ownership

Proprietorship Partnership Corporation

 Generally owned  Owned by two or  Ownership

by one person more persons divided into
 Often small  Often retail and shares
service-type service-type  Separate legal
businesses businesses entity organized
 Owner receives  Generally under corporation
any profits, unlimited law
suffers any personal liability  Limited liability
losses, and is  Partnership
personally liable
agreement
for all debts

LO 5 Explain the monetary unit assumption

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and the economic entity assumption.
 Indicate whether each of the following statements presented below
is true or false.

1. The three steps in the accounting process are

identification, recording, and communication. True

2. The two most common types of external users are

investors and company officers. False
3. Shareholders in a corporation enjoy limited legal
liability as compared to partners in a partnership. True

LO 5 Explain the monetary unit assumption

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and the economic entity assumption.
 Indicate whether each of the following statements presented below
is true or false.

4. The primary accounting standard-setting body outside

the United States is the International Accounting True
Standards Board (IASB).

5. The cost principle dictates that companies record

assets at their cost. In later periods, however, the fair False
value of the asset must be used if fair value is higher
than its cost.

LO 5 Explain the monetary unit assumption

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and the economic entity assumption.
 The Building Blocks of Accounting

Question
Combining the activities of Kellogg and General Mills would
violate the
a. cost principle.
b. economic entity assumption.
c. monetary unit assumption.
d. ethics principle.

LO 5 Explain the monetary unit assumption

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and the economic entity assumption.
 Forms of Business Ownership

Question
A business organized as a separate legal entity under law
having ownership divided into ordinary shares is a
a. proprietorship.
b. partnership.
c. corporation.
d. sole proprietorship.

LO 5 Explain the monetary unit assumption

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and the economic entity assumption.
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 The Basic Accounting Equation

Assets = Liabilities + Equity

Provides the underlying framework for recording and

summarizing economic events.

Applies to all economic entities regardless of size.

1-22 LO 6 State the accounting equation, and define its components.

 The Basic Accounting Equation

Assets = Liabilities + Equity

Provides the underlying framework for recording and

summarizing economic events.

Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Inventory, Equipment, etc.

1-23 LO 6 State the accounting equation, and define its components.

 The Basic Accounting Equation

Assets = Liabilities + Equity

Provides the underlying framework for recording and

summarizing economic events.

Liabilities
 Claims against assets (debts and obligations).
 Creditors - party to whom money is owed.
 Accounts payable, Notes payable, etc.

1-24 LO 6 State the accounting equation, and define its components.

 The Basic Accounting Equation

Assets = Liabilities + Equity

Provides the underlying framework for recording and

summarizing economic events.

Equity
 Ownership claim on total assets.
 Referred to as residual equity.
 Share capital-ordinary and retained earnings.

1-25 LO 6 State the accounting equation, and define its components.

 The Basic Accounting Equation
Illustration 1-7

Revenues result from business activities entered into for the purpose
of earning income.
Generally results from selling merchandise, performing services,
renting property, and lending money.

1-26 LO 6 State the accounting equation, and define its components.

 The Basic Accounting Equation
Illustration 1-7

Expenses are the cost of assets consumed or services used in the

process of earning revenue.
Common expenses are salaries expense, rent expense, interest
expense, property tax expense, etc.

1-27 LO 6 State the accounting equation, and define its components.

 The Basic Accounting Equation
Illustration 1-7

Dividends are the distribution of cash or other assets to shareholders.

 Reduce retained earnings
 Not an expense

1-28 LO 6 State the accounting equation, and define its components.

 Classify the following items as issuance of shares, dividends,
revenues, or expenses. Then indicate whether each item
increases or decreases equity.

Classification Effect on Equity

1. Rent expense Expense Decrease

2. Service revenue Revenue Increase

3. Dividends Equity Decrease

4. Salaries expense Expense Decrease

1-29 LO 6 State the accounting equation, and define its components.

 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.

1-30 LO 7 Analyze the effects of business transactions on the accounting equation.

 Using the Accounting Equation

Illustration: Are the following events recorded in the accounting

records?
Illustration 1-8
Discuss
Purchase product
Event Pay rent.
computer. design with
customer.

Criterion Is the financial position (assets, liabilities, or equity)

of the company changed?

Record/
Don’t Record

1-31 LO 7 Analyze the effects of business transactions on the accounting equation.

 Using the Accounting Equation

Transaction Analysis
Illustration 1-9
Expanded accounting equation

1-32 LO 7 Analyze the effects of business transactions on the accounting equation.

 Transaction Analysis
Transaction (1). Investment by Shareholders. Ray and Barbara Neal
decides to open a computer programming service which he names
Softbyte. On September 1, 2014, they invest €15,000 cash in exchange for
€15,000 of ordinary shares. Illustration 1-10

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 Transaction Analysis
Transaction (2). Purchase of Equipment for Cash. Softbyte purchases
computer equipment for €7,000 cash.

Illustration 1-10

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 Transaction Analysis
Transaction (3). Purchase of Supplies on Credit. Softbyte purchases for
€1,600 from Acme Supply Company computer paper and other supplies
expected to last several months. The purchase is on account.
Illustration 1-10

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 Transaction Analysis
Transaction (4). Services Provided for Cash. Softbyte receives €1,200
cash from customers for programming services it has provided.

Illustration 1-10

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 Transaction Analysis
Transaction (5). Purchase of Advertising on Credit. Softbyte receives a
bill for €250 from the Daily News for advertising but postpones payment
until a later date.

Illustration 1-10

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 Transaction Analysis
Transaction (6). Services Provided for Cash and Credit. Softbyte
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.
Illustration 1-10

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 Transaction Analysis
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.

Illustration 1-10

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 Transaction Analysis
Transaction (8). Payment of Accounts Payable. Softbyte pays its €250
Daily News bill in cash.

Illustration 1-10

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 Transaction Analysis
Transaction (9). Receipt of Cash on Account. Softbyte receives €600 in
cash from customers who had been billed for services [in Transaction (6)].

Illustration 1-10

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 Transaction Analysis
Transaction (10). Dividends. The corporation pays a dividend of €1,300 in
cash.

Illustration 1-10

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 Financial Statements

Companies prepare four financial statements :

Retained Statement Statement

Income
Earnings of Financial of Cash
Statement
Statement Position Flows

1-49 LO 8 Understand the four financial statements and how they are prepared.
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 Financial Statements

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.

1-51 LO 8 Understand the four financial statements and how they are prepared.
 Net income is needed to determine the
Financial Statements ending balance in retained earnings.

Illustration 1-11
Financial statements and
their interrelationships

1-52 LO 8
 The ending balance in retained earnings is
Financial Statements needed in preparing the balance sheet

Illustration 1-11

1-53 LO 8
 The balance sheet and income statement are
Financial Statements needed to prepare statement of cash flows.

Illustration 1-11

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 Financial Statements

Question
Which of the following financial statements is prepared as
of a specific date?
a. Statement of financial position.
b. Income statement.
c. Retained earnings statement.
d. Statement of cash flows.

1-55 LO 8 Understand the four financial statements and how they are prepared.
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 APPENDIX 1A ACCOUNTING CAREER OPPORTUNITIES

Public Accounting Private Accounting

Careers in auditing, taxation, Careers in industry working in
and management consulting cost accounting, budgeting,
serving the general public. accounting information
systems, and taxation.

Government Forensic Accounting

Careers with the tax Uses accounting, auditing, and
authorities, law enforcement investigative skills to conduct
agencies, and corporate investigations into theft and
regulators. fraud.

1-57 LO 9 Explain the career opportunities in accounting.

 APPENDIX 1A ACCOUNTING CAREER OPPORTUNITIES

“Show Me the Money”

Salary estimates for jobs in public and corporate accounting Illustration 1A-1

Upper-level management salaries in corporate accounting Illustration 1A-2

1-58 LO 9 Explain the career opportunities in accounting.

 Another Perspective

Key Points
 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.
► Mergers and acquisitions. The mergers between Fiat/Chrysler and
Vodafone/Mannesmann suggest that we will see even more such
business combinations in the future.
► Information technology. As communication barriers continue to
topple through advances in technology, companies and individuals
in different countries and markets are becoming more comfortable
buying and selling goods and services from one another.
► Financial markets. Financial markets are of international
significance today.
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 Another Perspective

Key Points
 In 2002, the U.S. Congress issued the Sarbanes-Oxley Act (SOX), which
mandated certain internal controls for large public companies listed on
U.S. exchanges. There is a continuing debate as to whether non-U.S.
companies should have to comply with this extra layer of regulation.
Debate about international companies (non-U.S.) adopting SOX-type
standards centers on whether the benefits exceed the costs. The
concern is that the higher costs of SOX compliance are making the U.S.
securities markets less competitive.
 Financial frauds have occurred at companies such as Satyam Computer
Services (IND), Parmalat (ITA), and Royal Ahold (NLD). They have also
occurred at large U.S. companies such as Enron, WorldCom, and AIG.

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 Another Perspective

Key Points
 IFRS tends to be less detailed in its accounting and disclosure
requirements than GAAP. This difference in approach has resulted in a
debate about the merits of “principles-based” (IFRS) versus “rules-
based” (GAAP) standards.
 U.S. regulators have recently eliminated the need for foreign companies
that trade shares in U.S. markets to reconcile their accounting with
GAAP.
 GAAP is based on a conceptual framework that is similar to that used to
develop IFRS.

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 Another Perspective

Key Points
 The three common forms of business organization that are presented in
the chapter, proprietorships, partnerships, and corporations, are also
found in the United States. Because the choice of business organization
is influenced by factors such as legal environment, tax rates and
regulations, and degree of entrepreneurism, the relative use of each
form will vary across countries.
 Transaction analysis is basically the same under IFRS and GAAP but, as
you will see in later chapters, the different standards may impact how
transactions are recorded.

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 Another Perspective

Key Points
 The basic definitions provided in this textbook for the key elements of
financial statements are simplified versions of the official definitions
provided by the IASB.
► Assets Probable future economic benefits obtained or controlled by
a particular entity as a result of past transactions or events.
► Liabilities Probable future sacrifices of economic benefits arising
from present obligations of a particular entity to transfer assets or
provide services to other entities in the future as a result of past
transactions or events.

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 Another Perspective

Key Points
 The basic definitions provided in this textbook for the key elements of
financial statements are simplified versions of the official definitions
provided by the IASB.
► Equity The residual interest in the assets of an entity that remains
after deducting its liabilities.
► Revenues Inflows or other enhancements of assets of an entity or
settlements of its liabilities (or a combination of both) from
delivering or producing goods, rendering services, or other
activities that constitute the entity’s ongoing major or central
operations.
► Expenses Outflows or other using up of assets or incurrences of
liabilities (or a combination of both) from delivering or producing
goods, rendering services, or carrying out other activities that
constitute the entity’s ongoing major or central operations.
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 Another Perspective

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. Consider, for example, that as a result of a
joint project on the conceptual framework, the definitions of the most
fundamental elements (assets, liabilities, equity, revenues, and expenses)
may actually change. However, whether the IASB adopts internal control
provisions similar to those in SOX remains to be seen.

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 Another Perspective

GAAP Self-Test Questions

Which of the following is not a reason why a single set of high-
quality international accounting standards would be beneficial?

a) Mergers and acquisition activity.

b) Financial markets.

c) Multinational corporations.

d) GAAP is widely considered to be a superior reporting system.

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 Another Perspective

GAAP Self-Test Questions

The Sarbanes-Oxley Act determines:

a) international tax regulations.

b) internal control standards as enforced by the IASB.

c) internal control standards of U.S. publicly traded companies.

d) U.S. tax regulations.

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 Another Perspective

GAAP Self-Test Questions

IFRS is considered to be more:

a) principles-based and less rules-based than GAAP.

b) rules-based and less principles-based than GAAP.

c) detailed than GAAP.

d) None of the above.

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