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Chapter 1 Accounting in ActionLearning Objectives
After studying this ch apter, you should b e 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 entityassumption.
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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1-4 LO 1 Explain what accounting is.
Accountingconsists of three basic activities - it
identifies,
records, and
communicates
the economic events of an organization to interested users.
What is Accounting?
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Three Activities
Illustration 1-1
The activities of the
accounting process
The accounting process includes
the bookkeepingfunction.
What is Accounting?
LO 1 Explain what accounting is.
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Management
Human
ResourcesTaxing
Authorities
Labor
Unions
RegulatoryAgencies
Marketing
Finance
Investors
Creditors
Customers
Internal
Users
ExternalUsers
Who Uses Accounting Data
LO 2 Identify the users and uses of accounting.
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Common Questions Asked User1. Can we afford to give our
employees a pay raise? Human Resources
2. Did the company earn a
satisfactory income?
3. Should any product lines beeliminated?
4. Is cash sufficient to pay dividendsto shareholders?
5. What price for our product willmaximize net income?
6. Will the company be able to payits debts?
Investors
Management
Finance
Marketing
Creditors
Who Uses Accounting Data
LO 2 Identify the users and uses of accounting.
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Ethics In Financial Reporting
LO 3 Understand why ethics is a fundamental business concept.
Standards of conduct by which ones 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.
The Building Blocks of Accounting
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The Building Blocks of Accounting
Ethics In Financial Reporting Illustration 1-4Steps in analyzing ethics cases
and situations
LO 3 Understand why ethics is a fundamental business concept.
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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.
Question
LO 3 Understand why ethics is a fundamental business concept.
Ethics in Financial Reporting
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International Financial Reporting Standards (IFRS)
LO 4 Explain accounting standards and the measurement principles.
Financial Accounting Standards Board (FASB)http://www.fasb.org/
International Accounting Standards Board (IASB)
http://www.iasb.org/
Generally Accepted Accounting Principles (GAAP)
The Building Blocks of Accounting
Accounting Standards
http://www.fasb.org/http://www.iasb.org/http://www.iasb.org/http://www.fasb.org/8/10/2019 Financiall Accounting IFRS Edition CH1
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Cost Principleor historical cost principle, dictates that
companies record assets at their cost.
Fair Value Principlestates that assets and liabilities
should be reported at fair value (the price received to sell an
asset or settle a liability).
Measurement Principles
The Building Blocks of Accounting
LO 4 Explain accounting standards and the measurement principles.
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Monetary Unitinclude in the accounting records only
transaction data that can be expressed in money terms.
Economic Entityrequires that activities of the entity be
kept separate and distinct from the activities of its owner and
all other economic entities.
Proprietorship. Partnership.
Corporation.
LO 5 Explain the monetary unit assumptionand the economic entity assumption.
Forms of Business
Ownership
Assumptions
The Building Blocks of Accounting
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Proprietorship Partnership Corporation
Owned by two or
more persons
Often retail andservice-type
businesses
Generally
unlimited
personal liability
Partnership
agreement
Ownership
divided into
shares Separate legal
entity organized
under corporation
law
Limited liability
Generally owned
by one person
Often smallservice-type
businesses
Owner receives
any profits,
suffers any
losses, and is
personally liable
for all debts
LO 5 Explain the monetary unit assumptionand the economic entity assumption.
Forms of Business Ownership
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Indicate whether each of the following statements presented belowis trueor false.
LO 5 Explain the monetary unit assumptionand the economic entity assumption.
1. The three steps in the accounting process are
identification, recording, and communication.
2. The two most common types of external users are
investors and company officers.
3. Shareholders in a corporation enjoy limited legal
liability as compared to partners in a partnership.
True
False
True
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False
True
LO 5 Explain the monetary unit assumptionand the economic entity assumption.
4. The primary accounting standard-setting body outside
the United States is the International Accounting
Standards Board (IASB).
5. The 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.
Indicate whether each of the following statements presented belowis trueor false.
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QuestionCombining 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 assumptionand the economic entity assumption.
The Building Blocks of Accounting
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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 assumptionand the economic entity assumption.
Question
Forms of Business Ownership
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Assets Liabilities Equity= +
Provides the underlying frameworkfor recording andsummarizing economic events.
Applies to all economic entities regardless of size.
The Basic Accounting Equation
LO 6 State the accounting equation, and define its components.
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Assets
Provides the underlying frameworkfor recording andsummarizing economic events.
Resources a business owns. Provide future services or benefits.
Cash, Inventory, Equipment, etc.
Assets
Liabilities Equity= +
LO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
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Provides the underlying frameworkfor recording andsummarizing economic events.
Liabilities
Assets Liabilities= + Equity
LO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
Claims against assets (debts and obligations). Creditors - party to whom money is owed.
Accounts payable, Notes payable, etc.
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Provides the underlying frameworkfor recording andsummarizing economic events.
Ownership claim on total assets. Referred to as residual equity.
Share capital-ordinary and retained earnings.
Equity
Assets Liabilities Equity= +
LO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
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Revenuesresult from business activities entered into for the purpose
of earning income.
Generally results from selling merchandise, performing services,
renting property, and lending money.
Illustration 1-7
LO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
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Expensesare 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.
Illustration 1-7
LO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
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Dividends are the distribution of cash or other assets to shareholders.
Reduce retained earnings
Not an expense
Illustration 1-7
LO 6 State the accounting equation, and define its components.
The Basic Accounting Equation
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Classification
Classify the following items as issuance of shares, dividends,revenues, or expenses. Then indicate whether each item
increases or decreases equity.
1. Rent expense
2. Service revenue
3. Dividends
4. Salaries expense
LO 6 State the accounting equation, and define its components.
Effect on EquityExpense Decrease
Revenue Increase
Equity Decrease
Expense Decrease
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Transactionsare a businesss economic events recordedby accountants.
May be externalor internal.
Not all activities represent transactions.
Each transaction has a dual effect on the accounting
equation.
LO 7 Analyze the effects of business transactions on the accounting equation.
Using the Accounting Equation
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Illustration:Are the following events recorded in the accountingrecords?
EventPurchase
computer.
Criterion Is the financial position (assets, liabilities, or equity)of the company changed?
Discuss
product
design with
customer.
Pay rent.
Record/
Dont Record
LO 7 Analyze the effects of business transactions on the accounting equation.
Using the Accounting Equation
Illustration 1-8
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1-32 LO 7 Analyze the effects of business transactions on the accounting equation.
Using the Accounting Equation
Illustration 1-9
Expanded accounting equation
Transaction Analysis
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1-33LO 7
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 invest15,000 cash in exchange for
15,000 of ordinary shares.Illustration 1-10
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Transaction Analysis
Illustration 1-10
Transaction (2). Purchase of Equipment for Cash. Softbyte purchases
computer equipment for7,000 cash.
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Transaction Analysis
Illustration 1-10
Transaction (3). Purchase of Supplies on Credit. Softbyte purchases
for1,600 from Acme Supply Company computer paper and other supplies
expected to last several months. The purchase is on account.
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Transaction Analysis
Illustration 1-10
Transaction (4). Services Provided for Cash. Softbyte receives1,200
cash from customers for programming services it has provided.
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Transaction Analysis
Illustration 1-10
Transaction (5). Purchase of Advertising on Credit. Softbyte receives a
bill for250 from the Daily News for advertising but postpones paymentuntil a later date.
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Transaction Analysis
Illustration 1-10
Transaction (6). Services Provided for Cash and Credit.Softbyte
provides3,500 of programming services for customers. The companyreceives cash of1,500 from customers, and it bills the balance of2,000
on account.
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Transaction Analysis
Illustration 1-10
Transaction (7). Payment of Expenses. Softbyte pays the following
expenses in cash for September: store rent600, salaries and wages ofemployees900, and utilities200.
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Transaction Analysis
Illustration 1-10
Transaction (8). Payment of Accounts Payable.Softbyte pays its250
Daily News bill in cash.
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1-41 LO 7
Transaction Analysis
Illustration 1-10
Transaction (9). Receipt of Cash on Account.Softbyte receives600 in
cash from customers who had been billed for services [in Transaction (6)].
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Transaction Analysis
Illustration 1-10
Transaction (10). Dividends.The corporation pays a dividend of1,300
in cash.
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Companies prepare fourfinancial statements :
Statement
of Financial
Position
Income
Statement
Statement
of Cash
Flows
Retained
Earnings
Statement
LO 8 Understand the four financial statements and how they are prepared.
Financial Statements
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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.
LO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Question
Net income is needed to determine the
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Net income is needed to determine the
ending balance in retained earnings.Financial Statements
LO 8
Illustration 1-11
Financial statements and
their interrelationships
The ending balance in retained earnings is
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The ending balance in retained earnings is
needed in preparing the balance sheetFinancial Statements
Illustration 1-11
LO 8
The balance sheet and income statement are
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The balance sheet and income statement are
needed to prepare statement of cash flows.Financial Statements
Illustration 1-11
LO 8
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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.
LO 8 Understand the four financial statements and how they are prepared.
Financial Statements
Question
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Forensic Accounting
Uses accounting, auditing, and
investigative skills to conductinvestigations into theft and
fraud.
Government
Careers with the tax
authorities, law enforcementagencies, and corporate
regulators.
Private AccountingCareers in industry working in
cost accounting, budgeting,
accounting information
systems, and taxation.
LO 9 Explain the career opportunities in accounting.
Public AccountingCareers in auditing, taxation,
and management consulting
serving the general public.
APPENDIX 1A ACCOUNTING CAREER OPPORTUNITIES
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1-51 LO 9 Explain the career opportunities in accounting.
APPENDIX 1A ACCOUNTING CAREER OPPORTUNITIES
Show Me the MoneySalary estimates for jobs in public and corporate accounting Illustration 1A-1
Upper-level management salaries in corporate accounting Illustration 1A-2
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Key Points Most agree that there is a need for one set of international accounting
standards. Here is why:
Multinational corporations. Todays 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 individualsin 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.
Another Perspective
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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.
Another Perspective
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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.
Another Perspective
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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.
Another Perspective
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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.
Another Perspective
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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 entitys ongoing major or centraloperations.
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 entitys ongoing major or central operations.
Another Perspective
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Looking to the FutureBoth 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.
Another Perspective
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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.
GAAP Self-Test Questions
Another Perspective
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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.
GAAP Self-Test Questions
Another Perspective
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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.
GAAP Self-Test Questions
Another Perspective
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