Chapter 1

Accounting in Action

ACT 201 By: Ms. Adina

Malik

Who invented Accounting?

Luca Pacioli (1445-1517), widely regarded as the Father of Accounting Accounting was invented in Venice in 1494 A priest, teacher and mathematician Tutor to Leonardo Da Vinci.

Accounting
What is Accounting?
Accounting is an information system that identifies, records and communicates the economic events of an organization to interested users. Recording:
Systematic, chronological diary of events. Classifies and summarizes economic events.

Communication involves analyzing and interpreting the reported information. Analysis involves use of ratios, graph, charts, and percentages to highlight significant financial trends and relationships. Interpretation involves explaining the uses, meaning & limitations of the reported data.

The Activities of the Accounting Process

The Accounting Process involves the bookkeeping function

Users of Accounting Data

Internal: marketing managers, production supervisors, finance directors, company officers (more in Managerial Accounting) External: Investors, creditors, taxing authorities, regulatory agencies, labor unions, customers & so on.

Ethics in Financial Reporting

Recent financial scandals include: Enron, WorldCom, AIG, etc.

Ethics: The standards of conduct by which ones actions are judged as right or wrong, honest or dishonest, fair or not fair.
Congress passes the Sarbanes Oxley Act of 2002: To reduce unethical corporate behavior and decrease the likelihood of future corporate scandals. Effective financial reporting depends on sound ethical behavior.

GAAP (Generally Accepted Accounting Principles): Generally Accepted & Universally Practiced Common set of standards or general guide for financial reporting purpose E.g. historic cost principle

The Building Blocks of Accounting

Reporting Standards of Financial Information
FINANCIAL STATEMENTS: Balance Sheet Income Statement Statement of Retained Earnings Statement of Cash Flow Note Disclosure

GAAP (Generally Accepted Accounting Principles)

The Building Blocks of Accounting

Cost Principle (Historical)

It dictates that companies record assets at their cost.

Issues:
Reported at cost when purchased and also over the time the asset is held. Cost easily verified, whereas market value/fair value is often subjective.

Assumptions
Assumptions are foundation for the accounting process:

Monetary Unit Assumption include in the accounting

records only transaction data that can be expressed in terms of money.

Economic Entity Assumption requires that activities of

the entity be kept separate and distinct from the activities of its owner and all other economic entities. An economic entity can be any organization or unit in a society.

Proprietorship.
Partnership. Corporation.

Forms of Business Ownership

Forms of Business Ownership

Proprietorship
Generally owned by one person. Often small service-type businesses Owner receives any profits, suffers any losses, and is personally liable for all debts

Partnership
Owned by two or more persons. Often retail and service-type businesses Generally unlimited personal liability Partnership agreement

Corporation
Separate legal entity. Ownership divided into shares of stock Stockholders enjoy Limited liability Shares are transferrable Corporation enjoys an unlimited life.

The Basic Accounting Equation

Assets
Liabilities Owners Equity

The equation provides the underlying framework for recording and summarizing economic events Assets: Resources a business owns. E.g. Cash, Supplies, Equipment. The capacity to provide future services or benefits. They are claimed by either creditors or owners. Liabilities (debts & obligations): Claims against Assets Creditors: Party to whom money is owed E.g. accounts payable, note payable, wages payable, etc. Liabilities appear before owners equity because they are paid first if a business is liquidated.

Sample Short Questions

Q.1: The liabilities of McGlone Company are $ 50,000 & Assets are $ 90,000. What is the amount of owners equity?

Q.2: At the beginning of the year, Hernandez Company had total assets of $ 800,000 and total liabilities of $ 500,000.
If total assets increased by $ 150,000 and liabilities decreased by $ 80,000, what is the amount of owners equity at the end of the year? Q.3: Are the following events recorded in the accounting records? a. The owner of the company dies b. Supplies are purchased on account. c. An employee is fired d. Paid accounts payable in full.

Q: 4 State which are Assets and Liabilities, from the items given below:
a. Cash b. Office Equipment c. Accounts Payable d. Supplies e. Notes Payable f. Accounts Receivable

Owners Equity
Increases By Owners Equity
Owners Capital Revenues

Decreases By
Owners Drawings Expenses

The ownership claim on Total Assets are called Owners Equity. Often referred to as Residual Equity. Owners Capital: Investments by owners/ assets that owners put into the business. Owners Drawings: Withdrawal of owner (cash/other assets) for personal use. Revenues: Resulting from business activities entered into for the purpose of earning income. E.g. sales, fees, services, commissions, etc. Expenses: the cost of assets consumed or services used in the process of earning revenue. E.g. utility expense, wages, telephone expense, delivery expense, rent expense, internet expense, etc.

Expanded Accounting Equation

Question
Presented below are selected information related to a company at Dec 31, 2010. Office Equipment $ 10,000 Cash $ 8,000 Service Revenue $ 36,000 Rent Expense $ 11,000 Accounts Payable $ 2,000 Utilities Expense $ 4,000 Accounts Receivable $ 9,000 Wages Expense $ 7,000 Notes Payable $ 16,000 Owners Drawings $ 5,000 Owners Capital $ 10,000

Find: Total Assets, Total Liabilities, Net Income & Owners Equity.

Transactions

Transactions are economic events of a business, recorded by Accountants. May be external or internal. Not all activities represent transactions. Note that Discussing about product design with potential customer is not a transaction. Is the financial position (assets, liabilities or owners equity) of the company changed? Each transaction must have a dual effect on the accounting equation.
An increase in asset must have a corresponding decrease in another asset, or an increase in liability or an increase in owners equity

Two or more items could be affected.

Transaction Analysis
Transaction (1): Ray Neal decides to open a computer

programming service which he names Softbyte. On September 1, 2011, Ray Neal invests $15,000 cash in the business.

SO 7

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

SO 7

Transaction Analysis
Transaction (3): Softbyte purchases for $1,600 from Acme Supply Company computer paper and other supplies expected to last several months. The purchase is made on account.

SO 7

Transaction Analysis
Transaction (4): Softbyte receives $1,200 cash from customers for programming services it has provided.

SO 7

Transaction Analysis
Transaction (5): Softbyte receives a bill for $250 from the Daily News for advertising but postpones payment until a later date.

SO 7

Transaction Analysis
Transaction (6): 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.

SO 7

Transaction Analysis
Transaction (7): Softbyte pays the following expenses in cash for September: store rent $600, salaries of employees $900, and utilities $200.

SO 7

Transaction Analysis
Transaction (8): Softbyte pays its $250 Daily News bill in cash.

SO 7

Transaction Analysis
Transaction (9): Softbyte receives $600 in cash from customers who had been billed for services [in Transaction (6)].

SO 7

Transaction Analysis
Transaction (10): Ray Neal withdraws $1,300 in cash from the business for his personal use.

SO 7

Financial Statements

An income statement presents the revenues and expenses and resulting net income or net loss for a specific period of time. An owners equity statement summarizes the changes in owners equity for a specific period of time. A balance sheet reports the assets, liabilities and owners equity at a specific date.

A statement of cash flows summarizes information about the cash inflows (receipts) and outflows (payments) for a specific period of time.

Question
Tina Brown opens her own law office on July 1, 2010. During the first month of operations, the following transactions occurred.

Tina invested $ 11,000 in cash in the law practice. Paid $ 800 for July rent on office space. Purchased Office Equipment on account $ 3,000.

Provided legal services to clients for cash $ 1,500.

Borrowed $ 700 cash from a bank on a note payable. Performed legal services to client on account $ 2,000. Paid monthly expenses: salaries $ 500; utilities $ 300 & telephone $ 100. Tina withdraws $ 1,000 cash for personal use.

Prepare a tabular summary of the transactions.