Accounting Principles

Thirteenth Edition
Weygandt Kimmel Kieso

Chapter 1 (Chapter 1 in ACT3112)

Accounting in Action
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
Chapter Outline
Learning Objectives
LO 1 Identify the activities and users associated with
accounting.
LO 2 Explain the building blocks of accounting: ethics,
principles, and assumptions.
LO 3 State the accounting equation, and define its
components.
LO 4 Analyze the effects of business transactions on the
accounting equation.
LO 5 Describe the four financial statements and how they
are prepared.
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 Accounting Activities and Users
Accounting consists of three activities
1. Identification – Select economic events
(transactions)
2. Recording - Record, classify, and summarize
3. Communication
• Prepare accounting reports
• Analyze and interpret for users

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 Who Uses Accounting Data
Internal Users
• Finance - Is cash sufficient to pay dividends to
Microsoft stockholders?
• Marketing – What price should Apple charge for an
iPad to maximize net income?
• Human Resources – Can General Motors afford to
give its employees pay raises?
• Management - Which PepsiCo product line is most
profitable? Should any products be eliminated?
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 Who Uses Accounting Data
External Users
• Investors
 Is General Electric earning satisfactory income?
 How does Disney compare in size and profitability
with Time Warner?
• Creditors – Will United Airlines be able to pay its
debts as they come due?

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 DO IT! 1 Basic Concepts
Indicate whether each of the statements is 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 focuses on reports for internal users.

Solution: 1. True 2. False 3. False 4. False 5. True

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 The Building Blocks of Accounting
Ethics in Financial Reporting
• 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
 Congress passed Sarbanes-Oxley Act (SOX)
• Effective financial reporting depends on sound ethical
behavior

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 Ethics in Financial Reporting
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

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 Generally Accepted Accounting
Principles Financial Statements
 Balance Sheet
Various users need  Income Statement
financial  Owner's Equity Statement
information  Statement of Cash Flows
 Note Disclosure

The accounting profession has

Generally Accepted
developed standards that are
Accounting Principles
generally accepted and
(GAAP)
universally practiced.

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 Generally Accepted Accounting
Principles
Standards that are generally accepted and universally
practiced. These standards indicate how to report
economic events.
Standard-setting bodies:
• Financial Accounting Standards Board (FASB)
• Securities and Exchange Commission (SEC)
• International Accounting Standards Board (IASB)

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 Measurement Principles
Historical Cost Principle (or cost principle)
• Record assets at their cost.
Fair Value Principle
• Assets and liabilities should be reported at fair value
(the price received to sell an asset or settle a liability)
Selection of which principle to follow generally relates to
trade-offs between relevance and faithful
representation.

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 Assumptions
Monetary Unit Assumption
• Include in accounting records only transaction data
that can be expressed in terms of money
Economic Entity Assumption
• Activities of entity be kept separate and distinct from
activities of its owner and all other entities
 Proprietorship
Forms of Business
 Partnership Ownership
 Corporation
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 Forms of Business Ownership
Proprietorship Partnership Corporation
• Owned by one • Owned by two or • Ownership divided
person more persons into shares of stock
• Owner is often • Often retail and • Separate legal
manager/operator service-type entity organized
• Owner receives any businesses under state
profits, suffers any • Generally corporation law
losses, and is unlimited personal • Limited liability
personally liable for liability
all debts • Partnership
agreement

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 Assumptions
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.

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 Assumptions
A business organized as a separate legal entity under
state law having ownership divided into shares of stock
is a
a. proprietorship
b. partnership
c. porporation
d. sole proprietorship

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 DO IT! 2 Building Blocks of Accounting
Indicate whether each of the statements is true or false.
1. Congress passed the Sarbanes-Oxley Act to reduce unethical
behavior and decrease the likelihood of future corporate
scandals.
2. The primary accounting standard-setting body in the United
States is the Financial Accounting Standards Board (FASB).
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.

Solution: 1. True 2. True 3. False

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 DO IT! 2 Building Blocks of Accounting
Indicate whether each of the statements 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.

Solution: 1. True 2. True 3. False 4. False 5. True

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 The Four Financial Statements
Companies prepare four financial statements:

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

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 Financial Statements
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

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 Income Statement
Financial Revenues $4,700
Service revenue
Statements Expenses
Salaries and wages expense 900
Softbyte Rent expense 600
statements for Advertising expense 250
Utilities expense 200
the Month Ended Total expenses 1,950
September 30, Net income $2,750
2020
Owner’s Equity Statement
Owner’s capital, September 1 $ 0
Add: Investments 15,000
Add: Net income 2,750
ILLUSTRATION 1.9
Financial statements and
Less: Drawings 1,300
their interrelationships Owner’s capital, September 30 $16,450

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 Owner’s Equity Statement

Financial Owner’s capital, September 1

Add: Investments
$ 0
15,000
Statements Add: Net income
Less: Drawings
2,750
1,300
Owner’s capital, September 30 $16,450
Softbyte
statements for Balance Sheet
Assets
the Month Ended
Cash $ 8,050
September 30, Accounts receivable 1,400
2020 Supplies 1,600
Equipment 7,000
Total assets $18,050
Liabilities and Owner’s Equity
Accounts payable $ 1,600
ILLUSTRATION 1.9
Financial statements and Owner’s capital 16,450
their interrelationships
Total liabilities and equity $18,050

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 Balance Sheet (partial)
Assets
Financial Cash
Accounts receivable
$ 8,050
1,400
Statements Supplies 1,600
Statement of Cash Flows
Softbyte Cash flows from operating activities
Cash receipts from revenues 3,300
statements for Cash payments from expenses (1,950)
the Month Ended Net cash from operating activities 1,350
September 30, Cash flows from investing activities
Purchase of equipment (7,000)
2020 Cash flows from financing activities
Investments by owner 15,000
Drawings by owner (1,300)
Net cash from financing activities 13,700
Net increase in cash 8,050
ILLUSTRATION 1.9
Financial statements and Cash at beginning of period 0
their interrelationships
Cash at end of period $ 8,050

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 Income Statement
• Reports 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 owner and business in
measuring net income

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 Owner’s Equity Statement
• Reports changes in owner’s equity for a specific
period of time
• Time period is the same as that covered by the
income statement

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 Balance Sheet
• Reports assets, liabilities, and owner's equity at a
specific date
• Lists assets at top, followed by liabilities and owner’s
equity
• Total assets must equal total liabilities and owner's
equity
• Snapshot of company’s financial condition at a
specific moment in time (usually month-end or year-
end)

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 Statement of Cash Flows
• Information on 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 change in cash balance?

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 Financial Statements
Which of the following financial statements is prepared
as of a specific date?
a. Balance sheet
b. Income statement
c. Owner's equity statement
d. Statement of cash flows

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 DO IT! 5 Financial Statement Items
Presented below is selected information related to Flanagan
Company at December 31, 2020. 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 Owner’s Drawings 5,000
a. Determine the total assets of at December 31, 2020.
b. Determine the net income reported for December 2020.
c. Determine the owner’s equity at December 31, 2020.

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 DO IT! 5 Financial Statement Items
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 Owner’s Drawings 5,000
a. Determine the total assets of at December 31, 2020.
Cash $ 8,000
Accounts receivable 9,000
Equipment 10,000
Total assets $27,000

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 DO IT! 5 Financial Statement Items
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 Owner’s Drawings 5,000
b. Determine the net income reported for December 2020.
Service revenue $36,000
Rent expense 11,000
Salaries and wages expense 7,000
Utilities expense 4,000
Net income $14,000
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 DO IT! 5 Financial Statement Items
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 Owner’s Drawings 5,000
c. Determine the owner’s equity at December 31, 2020.
Total assets $27,000
Less: Notes payable expense 16,500
Less: Accounts payable 2,000
Owner’s equity $ 8,500

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 Managerial Accounting Basics
Provides economic and financial information for
managers and other internal users.
Comparing Managerial and Financial Accounting
Similarities and differences:
• Each field deals with economic events of a business
• Both require that economic events be quantified and
communicated to interested parties

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 Comparing Managerial and Financial
Feature Financial Accounting Managerial Accounting
Primary Users External users: stockholders, Internal users: officers and
of Reports creditors, and regulators. managers.
Types and Frequency Financial statements. Internal reports.
of Reports Quarterly and annually. As frequently as needed.
Purpose of Reports General-purpose. Special-purpose for
specific decisions.
Content of Reports Pertains to business as a whole. Pertains to subunits of the
Highly aggregated (condensed). business.
Limited to double-entry Very detailed.
accounting and cost data. Extends beyond double-entry
Generally accepted accounting to any relevant data.
accounting principles. Evaluated based on relevance to
decisions.
Verification Process Audited by CPA. No independent audits.
ILLUSTRATION 19.1
Differences between financial and managerial accounting
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 Management Functions
Planning Directing Controlling
• Maximize short-term • Coordinate diverse • Keeping activities on
profit and market activities and human track
share resources
• Determine whether
• Commit to • Implement planned goals are met
environmental objectives
• Decide changes
protection and social
• Provide incentives to needed to get back
programs
motivate employees on track
• Add value to the
• Hire and train • May use an informal
business
employees or formal system of
evaluations
• Produce a smooth-
running operation

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