1 Accounting in Action

Learning Objectives

1 Identify the activities and users associated with accounting.

Explain the building blocks of accounting: ethics, principles, and

2 assumptions.

3 State the accounting equation, and define its components.

Analyze the effects of business transactions on the accounting

4 equation.

Describe the four financial statements and how they are

5 prepared.
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LEARNING Identify the activities and users

1
OBJECTIVE associated with accounting.

Accounting consists of three basic activities—it

 identifies,

 records, and

 communicates

the economic events of an organization to interested users.

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 Three Activities
Illustration 1-1
The activities of the accounting process

The accounting process includes

the bookkeeping function.

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Who Uses Accounting Data

INTERNAL
USERS

Illustration 1-2
Questions that internal
users ask

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 Who Uses Accounting Data

EXTERNAL
USERS

Illustration 1-3
Questions that external
users ask
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Nature of Business:

Trading /
Service Manufacturing
Merchandising
 Provides  Goods are  Raw material is
intangible benefits purchased for converted into
to clients. the purpose of finished goods
 Professional skills resale without and then sold to
are required. changing its customers.
form or creating
 Examples are,  Examples are,
additional value.
accounting and sugar mills,
consultancy firms,  Examples are, cement,
law firms, Retailers, beverages etc.
hospitals, banks distributors etc.
etc.
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 Forms of Business Ownership

Proprietorship Partnership Corporation

 Owned by one  Owned by two or  Ownership

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

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LEARNING State the accounting equation, and define

3
OBJECTIVE its components.

Owner's
Assets = Liabilities +
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.

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 Basic Accounting Equation

Owner's
Assets = Liabilities +
Equity

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

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Basic Accounting Equation

Owner's
Assets = Liabilities +
Equity

Liabilities
 Claims against assets (debts and obligations).

 Creditors (party to whom money is owed).

 Accounts Payable, Notes Payable, Salaries and Wages

Payable, etc.

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 Basic Accounting Equation

Owner's
Assets = Liabilities +
Equity

Owner's Equity
 Ownership claim on total assets.

 Referred to as residual equity.

 Investment by owners and revenues (+)
 Drawings and expenses (-).

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Owner’s Equity Illustration 1-6

Expanded accounting
equation

Increases in Owner’s Equity

 Investments by owner are the assets the owner puts into the
business.
 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.

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 Owner’s Equity Illustration 1-6
Expanded accounting
equation

Decreases in Owner’s Equity

 Drawings An owner may withdraw cash or other assets for
personal use.
 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, tax expense, etc.

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LEARNING Analyze the effects of business transactions

4
OBJECTIVE 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.

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 Transaction Analysis

Illustration: Are the following events recorded in the accounting

records?
Illustration 1-7
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

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Transaction Analysis

TRANSACTION 1. INVESTMENT BY OWNER Ray Neal decides to start

a smartphone app development company which he names Softbyte. On
September 1, 2017, he invests $15,000 cash in the business. This
transaction results in an equal increase in assets and owner’s equity.

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

1. +15,000 +15,000

Illustration 1-8
Tabular summary of
Softbyte transactions

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 TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH Softbyte
Inc. purchases computer equipment for $7,000 cash.
Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

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

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TRANSACTION 3. PURCHASE OF SUPPLIES ON CREDIT Softbyte Inc.

purchases for $1,600 headsets and other accessories expected to last
several months. The supplier allows Softbyte to pay this bill in October.
Illustration 1-8 Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

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

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 TRANSACTION 4. SERVICES PERFORMED FOR CASH Softbyte Inc.
receives $1,200 cash from customers for app development services it has
performed. Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

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

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TRANSACTION 5. PURCHASE OF ADVERTISING ON CREDIT Softbyte

Inc. receives a bill for $250 from the Daily News for advertising on its
online website but postpones payment until a later date. Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

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

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 TRANSACTION 6. SERVICES PERFORMED FOR CASH AND CREDIT.
Softbyte performs $3,500 of services. The company receives cash of
$1,500 from customers, and it bills the balance of $2,000 on account.
Illustration 1-8 Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

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

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TRANSACTION 7. PAYMENT OF EXPENSES Softbyte Inc. pays the

following expenses in cash for September: office rent $600, salaries and
wages of employees $900, and utilities $200. Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

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

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 TRANSACTION 8. PAYMENT OF ACCOUNTS PAYABLE Softbyte Inc.
pays its $250 Daily News bill in cash. The company previously (in
Transaction 5) recorded the bill as an increase in Accounts Payable.
Illustration 1-8 Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

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

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TRANSACTION 9. RECEIPT OF CASH ON ACCOUNT Softbyte Inc.

receives $600 in cash from customers who had been billed for services
(in Transaction 6). Illustration 1-8

Assets = Liabilities + Owner's Equity

Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

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

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 TRANSACTION 10. WITHDRAWAL OF CASH BY OWNER Ray Neal
withdraws $1,300 in cash in cash from the business for his personal use.
Illustration 1-8
Assets = Liabilities + Owner's Equity
Trans- Accounts Accounts Owner's Owner's
Cash + + Supplies + Equipment = + - + Rev. - Exp.
action Receivable Payable Capital Drawings

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 - $1,300 + $4,700 - $1,950

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LEARNING Describe the four financial statements

5
OBJECTIVE and how they are prepared.

Companies prepare four financial statements :

Owner’s Statement
Income Balance
Equity of Cash
Statement Sheet
Statement Flows

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 Net income is needed to determine the
Financial Statements ending balance in owner’s equity.

SOFTBYTE
Income Statement
For the Month Ended September 30, 2017

Illustration 1-9
Financial statements and
their interrelationships

SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017

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SOFTBYTE
Owner’s Equity Statement
For the Month Ended September 30, 2017

Illustration 1-9
The ending
balance in SOFTBYTE
owner’s equity Balance Sheet
is needed in September 30, 2017
preparing the
balance sheet.

Illustration 1-9
Financial statements
and their
interrelationships

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 SOFTBYTE
Financial Balance Sheet
September 30, 2017

Statements

Balance sheet and

income statement
are needed to
prepare statement of
cash flows.
SOFTBYTE
Statement of Cash Flows
For the Month Ended September 30, 2017

Illustration 1-9
Financial statements
and their
interrelationships

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Income Statement

 Reports the revenues and expenses for a specific

period of time.

 Lists revenues first, followed by expenses.

 Shows net income (or net loss).

 Does not include
investment and
withdrawal transactions
between the owner and
the business in
measuring net income.

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 Owner’s Equity Statement

 Reports the changes in owner’s equity for a specific

period of time.

 The time period is the same as that covered by the

income statement.

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Balance Sheet

 Reports the assets, liabilities, and owner's equity at a

specific date.

 Lists assets at the top, followed by liabilities and owner’s

equity.

 Total assets must equal total liabilities and owner's

equity.

 Is a snapshot of the company’s financial condition at a

specific moment in time (usually the month-end or year-
end).

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 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 balance?

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End of Chapter 01

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