1/3/2022

Financial Accounting Chapter Outline

IFRS 4th Edition
Weygandt ● Kimmel ● Kieso

Chapter 1

Accounting in Action
Copyright ©2019 John Wiley & Son, Inc. 2

Chapter Preview

Good decision-making depends on good information. Learning Objective 1

Whatever your pursuits or occupation, the need for financial Identify the activities and users
information is inescapable. You cannot earn a living, spend money,
buy on credit, make an investment, or pay taxes without receiving, associated with accounting.
using, or dispensing financial information. Good decision-making
depends on good information.

Copyright ©2019 John Wiley & Son, Inc. 3 LO 1 Copyright ©2019 John Wiley & Sons, Inc. 4

Accounting Activities and Users Accounting Activities and Users

Three Activities Internal Users

LO 1 Copyright ©2019 John Wiley & Son, Inc. 5 LO 1 Copyright ©2019 John Wiley & Son, Inc. 6

1
 1/3/2022

Accounting Activities and Users Accounting Activities and Users

External Users (1/2) External Users (2/2)

Taxing authorities: Does the company comply with the tax laws?
Regulatory agencies: Is the company operating within prescribed rules?
Labor unions: Does the company have the ability to pay increased wages and
benefits to union members?

LO 1 Copyright ©2019 John Wiley & Son, Inc. 7 LO 1 Copyright ©2019 John Wiley & Son, Inc. 8

DO IT! Basic Concepts

Learning Objective 2
Explain the building blocks of
accounting: ethics, principles, and
assumptions.
ACTION PLAN
• Review the basic concepts discussed.
• Develop an understanding of the key terms used.

LO 4 Copyright ©2019 John Wiley & Son, Inc. 9 LO 1 Copyright ©2019 John Wiley & Sons, Inc. 10

The Building Blocks of Accounting The Building Blocks of Accounting

Ethics in Financial Reporting Accounting Standards
Ensure high-quality financial reporting.

Primary accounting standard-setting bodies:

International Accounting Standards Board (IASB)
• Determines International Financial Reporting Standards (IFRS)
• Used in 130 countries
Financial Accounting Standards Board (FASB)
• Determines generally accepted accounting principles (GAAP)
• Used by most companies in the U.S.

LO 2 Copyright ©2019 John Wiley & Son, Inc. 11 LO 2 Copyright ©2019 John Wiley & Son, Inc. 12

2
 1/3/2022

The Building Blocks of Accounting The Building Blocks of Accounting

Measurement Principles Selecting Measurement Principles
IFRS generally uses one of two measurement principles, the historical cost Selection of which principle to follow generally relates to trade-offs between
principle or the fair value principle. relevance and faithful representation.

Historical cost principle (or cost principle): dictates that companies Relevance means that financial information is capable of making a
record assets at their cost. This is true not only at the time the difference in a decision.
asset is purchased, but also over the time the asset is held. Faithful representation means that the numbers and descriptions
match what really existed or happened—they are factual.
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).

LO 2 Copyright ©2019 John Wiley & Son, Inc. 13 LO 2 Copyright ©2019 John Wiley & Son, Inc. 14

The Building Blocks of Accounting DO IT! Building Blocks of Accounting

Assumptions
Assumptions provide a foundation for the accounting process. Two main
assumptions are the monetary unit assumption and the economic entity
assumption.

Monetary unit assumption: requires that companies include in the

accounting records only transaction data that can be expressed in
money terms.
Economic Entity Assumption: requires that the activities of the
entity be kept separate and distinct from the activities of its owner ACTION PLAN
and all other economic entities. Typical entity forms are • Review the discussion of ethics and financial reporting standards.
proprietorship, partnership, corporation. • Develop an understanding of the key terms used.

LO 2 Copyright ©2019 John Wiley & Son, Inc. 15 LO 4 Copyright ©2019 John Wiley & Son, Inc. 16

The Accounting Equation

The Basic Accounting Equation
Learning Objective 3
State the accounting equation, and
define its components.
Assets: resources a business owns.
Liabilities: claims against assets, i.e. existing debts and obligations.
Equity: the ownership claim on a company’s total assets.

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 17 LO 3 Copyright ©2019 John Wiley & Son, Inc. 18

3
 1/3/2022

The Accounting Equation DO IT! Equity Effects

Equity
a. Rent Expense
b. Service Revenue
c. Dividends
d. Salaries and Wage Expense

ACTION PLAN
Share capital—ordinary: describes the amounts paid in by shareholders for the ordinary
shares they purchase.
• Understand the sources of revenue.
Revenues: are the gross increases in equity resulting from business activities entered into for • Understand what causes expenses.
the purpose of earning income. Revenues usually result in an increase in an asset. • Review the rules for changes in equity: Investments and revenues
Expenses: are the cost of assets consumed or services used in the process of earning increase equity. Expenses and dividends decrease equity.
revenue. • Recognize that dividends are distributions of cash or other assets to
Dividends: are distribution of cash or other assets to shareholders. They are not an expense. shareholders.

LO 3 Copyright ©2019 John Wiley & Son, Inc. 19 LO 4 Copyright ©2019 John Wiley & Son, Inc. 20

Analyzing Business Transactions

Learning Objective 4 Accounting Information System:
The system of collecting and processing transaction data and
Analyze the effects of business communicating financial information to decision-makers.
transactions on the accounting The steps companies follow each period to record transactions and eventually prepare
equation. financial statements:

LO 4 Copyright ©2019 John Wiley & Sons, Inc. 21 LO 4 Copyright ©2019 John Wiley & Son, Inc. 22

Analyzing Business Transactions Analyzing Business Transactions

Identifying Accounting Transactions
Expanding the Balance Sheet Equation for analysis

LO 4 Copyright ©2019 John Wiley & Son, Inc. 23 LO 4 Copyright ©2019 John Wiley & Son, Inc. 24

4
 1/3/2022

Transaction (1). Investment by Shareholders. Transaction(2). Purchase of Equipment for Cash.

Assume: Ray and Barbara Neal decide to start a smartphone app Assume: Softbyte SA purchases computer equipment for €7,000 cash.
development company that they incorporate as Softbyte SA. On September 1,
2020, they invest €15,000 cash in the business in exchange for €15,000 of Demonstrate: Basic and equation analysis of this transaction.
ordinary shares. The ordinary shares indicates the ownership interest that the
Neals have in Softbyte SA.
Demonstrate: Basic and equation analysis of this transaction.

Observe that the equality of the basic equation has been maintained. Note also that the This transaction results in an equal increase and decrease in total assets, though
source of the increase in equity (in this case, issued shares) is indicated. the composition of assets changes.

LO 4 Copyright ©2019 John Wiley & Son, Inc. 25 LO 4 Copyright ©2019 John Wiley & Son, Inc. 26

Transaction(3). Purchase of Supplies on Credit. Transaction (4). Services Performed for Cash.
Assume: Softbyte SA purchases headsets (and other computer accessories expected Assume: Softbyte SA receives €1,200 cash from customers for app
to last several months) for €1,600 from Mobile Solutions. Mobile Solutions agrees to development services it has performed. This transaction represents Softbyte’s
allow Softbyte to pay this bill in October. This transaction is a purchase on account (a principal revenue-producing activity. Recall that revenue increases equity.
credit purchase). Demonstrate: Basic and equation analysis of this transaction.
Demonstrate: Basic and equation analysis of this transaction.

Recall that revenue increases equity.

Assets increase because of the expected future benefits of using the headsets and computer accessories, and
liabilities increase by the amount due Mobile Solutions.

LO 4 Copyright ©2019 John Wiley & Son, Inc. 27 LO 4 Copyright ©2019 John Wiley & Son, Inc. 28

Transaction (5). Purchase of Advertising on Credit. Transaction (6).

Services Performed for Cash & Credit.
Assume: Softbyte SA receives a bill for €250 from Programming News for
advertising on its website but postpones payment until a later date. Assume: Softbyte SA performs €3,500 of app development services for
Demonstrate: Basic and equation analysis of this transaction. customers. The company receives cash of €1,500 from customers, and it bills
the balance of €2,000 on account.
Demonstrate: Basic and equation analysis of this transaction.

The two sides of the equation still balance at €17,800. Retained Earnings decreases when Softbyte incurs the expense.
Expenses do not have to be paid in cash at the time they are incurred.

When Softbyte pays at a later date, the liability Accounts Payable will decrease and the asset Cash will decrease [see This transaction results in an equal increase in assets and equity.
Transaction (8)]. The cost of advertising is an expense (rather than an asset) because Softbyte has used the benefits.
Advertising Expense is included in determining net income.

LO 4 Copyright ©2019 John Wiley & Son, Inc. 29 LO 4 Copyright ©2019 John Wiley & Son, Inc. 30

5
 1/3/2022

Transaction (7). Payment of Expenses. Transaction (8). Payment of Accounts Payable.

Assume: Softbyte SA pays the following expenses in cash for September: Assume: Softbyte SA pays its €250 Programming News bill in cash. The
office rent €600, salaries and wages of employees €900, and utilities €200. company previously [in Transaction (5)] recorded the bill as an increase in
Demonstrate: Basic and equation analysis of this transaction. Accounts Payable and a decrease in equity.
Demonstrate: Basic and equation analysis of this transaction.

This transaction results in an equal decrease in assets and equity. Observe that the payment of a liability related to an expense that has previously been recorded does not affect equity.
Softbyte recorded the expense [in Transaction (5)] and should not record it again.

LO 4 Copyright ©2019 John Wiley & Son, Inc. 31 LO 4 Copyright ©2019 John Wiley & Son, Inc. 32

Transaction (9). Receipt of Cash on Account. Transaction (10). Dividends.

Assume: Softbyte SA receives €600 in cash from customers who had been Assume: The company pays a dividend of €1,300 in cash to Ray and Barbara
billed for services [in Transaction (6)]. Neal, the shareholders of Softbyte SA. This transaction results in an equal
Demonstrate: Basic and equation analysis of this transaction. decrease in assets and equity.
Demonstrate: Basic and equation analysis of this transaction.

Transaction (9) does not change total assets, but it changes the composition of those assets. Transaction (9) does not change total assets, but it changes the composition of those assets.

Note that the collection of an account receivable for services previously billed and recorded does not affect equity. Note that the dividend reduces retained earnings, which is part of equity. Dividends are not expenses.
Softbyte already recorded this revenue [in Transaction (6)] and should not record it again. Like shareholders’ investments, dividends are excluded in determining net income.

LO 4 Copyright ©2019 John Wiley & Son, Inc. 33 LO 4 Copyright ©2019 John Wiley & Son, Inc. 34

Analyzing Business Transactions Analyzing Business Transactions

Softbyte SA: Tabular Analysis of Transactions Key Points
1. Each transaction must be analyzed in terms of its effect on:
a. The three components of the basic accounting equation.
b. Specific types (kinds) of items within each component.
2. The two sides of the equation must always be equal.
3. The Share Capital—Ordinary and Retained Earnings columns
indicate the causes of each change in the shareholders’ claim
on assets.

LO 4 Copyright ©2019 John Wiley & Son, Inc. 35 LO 4 Copyright ©2019 John Wiley & Son, Inc. 36

6
 1/3/2022

DO IT! Tabular Analysis

Learning Objective 5
Describe the five financial statements
and how they are prepared.

ACTION PLAN
• Analyze the effects of each transaction on the accounting equation.
• Use appropriate category names (not descriptions).
• Keep the accounting equation in balance.

LO 4 Copyright ©2019 John Wiley & Son, Inc. 37 LO 5 Copyright ©2019 John Wiley & Sons, Inc. 38

Financial Statements Financial Statement Connections

Companies prepare five financial statements from the summarized accounting data.
Income Statement

1. Income statement: presents the revenues and expenses and resulting net
Net income is computed first
income or net loss for a specific period of time. and is needed to determine
Retained Earnings Statement the ending balance in retained
2. Retained earnings statement: summarizes the changes in retained earnings
earnings.
for a specific period of time.
Statement of Financial Position The ending balance in
3. Statement of financial position: reports the assets, liabilities, and equity of
retained earnings is needed in
a company at a specific date. (Sometimes referred to as a balance sheet.) preparing the statement of
financial position.
4. Statement of cash flows: summarizes information about the cash inflows
(receipts) and outflows (payments) for a specific period of time. The cash shown on the
Statement of Cash Flows statement of financial position
5. Comprehensive income statement: presents other comprehensive income is needed in preparing the
items that are not included in the determination of net income in 1. statement of cash flows.

LO 5 Copyright ©2019 John Wiley & Son, Inc. 39 LO 5 Copyright ©2019 John Wiley & Son, Inc. 40

Financial Statements Financial Statements

Income Statement Retained Earnings Statement
The income statement lists revenues first, followed by expenses. The information provided by this statement indicates the reasons why
Then, the statement shows net income (or net loss). retained earnings increased or decreased during the period. If there is
a net loss, it is deducted with dividends in the retained earnings
Structure: statement.
• The income statement lists revenues first, followed by expenses. Structure:
• Then, the statement shows net income (or net loss). • The first line of the statement shows the beginning retained
• When revenues exceed expenses, net income results. earnings amount.
• When expenses exceed revenues, a net loss results.
• Then add net income (or subtract net loss) and subtract
• The income statement does not include investment and dividend
transactions between the shareholders and the business in
dividends.
measuring net income. • The retained earnings ending balance is the final amount on the
statement.

LO 5 Copyright ©2019 John Wiley & Son, Inc. 41 LO 5 Copyright ©2019 John Wiley & Son, Inc. 42

7
 1/3/2022

Financial Statements Financial Statements

Statement of Financial Position Statement of Cash Flows
The statement of financial position is like a snapshot of the company’s The statement of cash flows provides information on the cash
financial condition at a specific moment in time (usually the month-end or receipts and payments for a specific period of time.
year-end).
Structure:
Structure:
Lists assets at the top, followed by equity and then liabilities.
The statement of cash flows reports
Total assets must equal total equity and liabilities. (1) the cash effects of a company’s operations during a period,
When two or more liabilities are involved, a customary way of listing is as (2) its investing activities,
shown as follows: (3) its financing activities,
(4) the net increase or decrease in cash during the period, and
(5) the cash amount at the end of the period.

LO 5 Copyright ©2019 John Wiley & Son, Inc. 43 LO 5 Copyright ©2019 John Wiley & Son, Inc. 44

Financial Statements DO IT! Financial Statement Items

Comprehensive Income Statement
Other comprehensive income items are not part of net income but are
considered important enough to be reported separately.
This statement immediately follows the income statement.

IFRS Alternative:
IFRS allows an alternative statement format in which the
information contained in the income statement and the
comprehensive income statement are combined in a single
statement, referred to as a statement of comprehensive income. ACTION PLAN
• Remember the basic accounting equation: assets must equal liabilities plus equity.
• Review previous financial statements to determine how total assets, net income,
and equity are computed.

LO 5 Copyright ©2019 John Wiley & Son, Inc. 45 LO 4 Copyright ©2019 John Wiley & Son, Inc. 46

Career Opportunities in Accounting

Copyright
Why is accounting such a popular major and career choice?

Public Accounting Copyright © 2019 John Wiley & Sons, Inc.

Individuals in public accounting offer expert service to the general public, in much the same
way that doctors serve patients and lawyers serve clients. All rights reserved. Reproduction or translation of this work beyond that permitted in
Choices: Auditing, taxation, management consulting
Section 117 of the 1976 United States Act without the express written permission of the
Private Accounting copyright owner is unlawful. Request for further information should be addressed to the
Individuals in private accounting are employees of for-profit companies and not-for-profit
organizations. Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up
Choices: Cost accounting, budgeting, accounting information system design and support,
tax planning and preparation, internal auditing copies for his/her own use only and not for distribution or resale. The Publisher assumes
no responsibility for errors, omissions, or damages, caused by the use of these programs
Governmental Accounting
Choices: Tax authorities, local governments, law enforcement agencies, company or from the use of the information contained herein.
regulators, accounting educators at public colleges and universities

Forensic Accounting
Choices: Investigate theft and fraud using accounting, auditing, and investigative skills

Copyright ©2019 John Wiley & Son, Inc. 47 Copyright ©2019 John Wiley & Son, Inc. 48