RMIT Classification: Trusted
Financial Accounting
IFRS 4th Edition
Weygandt ● Kimmel ● Kieso
Chapter 1
Accounting in Action
RMIT Classification: Trusted
CHAPTER PREVIEW
Good decision-making depends on good information.
Whatever your pursuits or occupation, the need for
financial information is inescapable. You cannot earn a
living, spend money, buy on credit, make an investment,
or pay taxes without receiving, using, or dispensing
financial information. Good decision-making depends on
good information.
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CHAPTER OUTLINE
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Chapter Outline
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Learning Objective 1
LO 1 Identify the activities and users associated with
accounting.
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Accounting Activities and Users
• Three Activities
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Accounting Activities and Users
• Internal Users
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Accounting Activities and Users
• External Users
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?
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DO IT! Basic Concepts
ACTION PLAN
Review the basic concepts discussed.
Develop an understanding of the key terms used.
ACTION PLAN
• Review the basic concepts discussed.
• Develop an understanding of the key terms used.
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Learning Objective 2
LO 2 Explain the building blocks of accounting: ethics,
principles, and assumptions.
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The Building Blocks of Accounting
Ethics in Financial Reporting
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The Building Blocks of Accounting
Accounting Standards
Ensure high-quality financial reporting.
Primary accounting standard-setting bodies:
International Accounting Standards Board (IASB)
• Determines IFRS: Used in 130 countries.
Financial Accounting Standards Board (FASB)
• Determines GAAP: Used by most companies in the
U.S.
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The Building Blocks of Accounting
Measurement Principles
Historical cost principle (or cost principle):
Assets & liabilities should be recorded at their cost.
This is true not only at the time the asset is purchased,
but also over the time the asset is held.
Fair value principles
Assets and liabilities should be reported at fair value -
the price received to sell an asset or settle a liability.
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The Building Blocks of Accounting
Selecting Measurement Principles
Selection of which principle to follow generally relates to
trade-offs between relevance & faithful representation.
• Relevance means that financial information is
capable of making a difference in a decision.
• Faithful representation means that the numbers and
descriptions match what really existed or
happened—they are factual.
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The Building Blocks of Accounting
Assumptions
Monetary unit: requires that companies include in the
accounting records only transaction data that can be
expressed in money terms.
Economic Entity: requires that the activities of the
entity be kept separate and distinct from the
activities of its owner and all other economic
entities.
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DO IT! Building Blocks of Accounting
ACTION PLAN
• Review the discussion of ethics & financial reporting standards.
• Develop an understanding of the key terms used.
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Learning Objective 3
LO 3 State the accounting equation and define its
components.
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The Accounting Equation
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.
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The Accounting Equation
Equity
Share capital—ordinary: describes the amounts paid in
by shareholders for the ordinary shares they purchase.
Dividends: are distribution of cash or other assets to
shareholders. They are not an expense.
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The Accounting Equation
Equity
Revenues: are the gross increases in equity resulting from
business activities entered into for the purpose of earning
income. Revenues usually result in an increase in an asset.
Expenses: are the cost of assets consumed or services used in
the process of earning revenue.
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DO IT! Equity Effects
a. Rent Expense c. Dividends
b. Service Revenue d. Salaries and Wage
Expense
ACTION PLAN
• Understand the sources of revenue.
• Understand what causes expenses.
• Review the rules for changes in equity: Investments and revenues
increase equity. Expenses and dividends decrease equity.
• Recognize that dividends are distributions of earnings to shareholders.
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Learning Objective 4
LO 4 Analyze the effects of business transactions on
the accounting equation.
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Analyzing Business Transactions
Accounting Information System:
The system of collecting and processing transaction
data and communicating financial information to
decision-makers.
The steps companies follow each period to record
transactions and eventually prepare FS:
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Analyzing Business Transactions
Identifying Accounting Transactions
•
•
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Analyzing Business Transactions
Expanding the Balance Sheet Equation for analysis
•
•
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1. Investment by Shareholders
Ray & Barbara Neal decide to start a smartphone app
development company that they incorporate as Softbyte SA.
On Sep 1, 2020, they invest €15,000 cash in the business in
exchange for €15,000 of ordinary shares.
Observe that the equality of the basic equation has been maintained. Note also
that the source of the increase in equity (in this case, issued shares) is indicated.
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2. Purchase of Equipment for Cash
Softbyte SA purchases computer equipment for €7,000
cash.
•
•
This transaction results in an equal increase and decrease in total assets,
though the composition of assets changes.
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3. Purchase of Supplies on Credit
Softbyte SA purchases headsets (expected to last several
months) for €1,600 from Mobile Solutions, payable in Oct.
This transaction is a purchase on account (a credit purchase).
Assets increase because of the expected future benefits of using the headsets and
computer accessories, and liabilities increase by the amount due Mobile Solutions.
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4. Services Performed for Cash
Softbyte SA receives €1,200 cash from customers for app
development services it has performed. This transaction
represents Softbyte’s principal revenue-producing activity.
Recall that revenue increases equity.
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5. Purchase of Advertising on Credit
Softbyte SA receives a bill for €250 from Programming
News for advertising on its website but postpones payment
until a later date.
•
•
The two sides of the equation still balance at €17,800. RE 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 Transaction (8)]. The cost of advertising is an expense (rather than an
asset) because Softbyte has used the benefits & is included in determining net income.
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6. Services Performed for Cash & Credit
Softbyte SA performs €3,500 of app development services
for customers. The company receives cash of €1,500 from
customers, and it bills the balance of €2,000 on account.
This transaction results in an equal increase in assets and equity.
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7. Payment of Expenses
Softbyte SA pays the expenses in cash for Sep: office rent
€600, salaries & wages of employees €900, & utilities €200.
This transaction results in an equal decrease in assets and equity.
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8. Payment of Accounts Payable
Softbyte SA pays its €250 Programming News bill in cash
[refer to Transaction (5)].
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.
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9. Receipt of Cash on Account
Softbyte SA receives €600 in cash from customers wsho
had been billed for services [in Transaction (6)].
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.
Softbyte already recorded this revenue [in Transaction (6)] and should not record it again.
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10. Dividends
The company pays a dividend of €1,300 in cash to Ray &
Barbara Neal, the shareholders of Softbyte SA.
Transaction (9) does not change total assets, but it changes the composition of those assets.
Note that the dividend reduces retained earnings, which is part of equity.
Dividends are not expenses.
Like shareholders’ investments, dividends are excluded in determining net income.
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Analyzing Business Transactions
Tabular Analysis of Transactions
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Key Points
• Each transaction must be analyzed in terms of its
effect on:
• The three components of the basic accounting equation.
• Specific types (kinds) of items within each component.
• The two sides of the equation must always be equal.
• The Share Capital—Ordinary and Retained Earnings
columns indicate the causes of each change in the
shareholders’ claim on assets.
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DO IT! Tabular Analysis
ACTION PLAN
• Analyze the effects of each transaction on the accounting equation.
• Use appropriate category names (not descriptions).
• Keep the accounting equation in balance.
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Learning Objective 5
LO 5 Describe the five financial statements and how
they are prepared.
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Financial Statements
1. Income statement: presents the revenues and
expenses and resulting net income or net loss for a specific
period of time.
2. Retained earnings statement: summarizes the changes
in retained earnings for a specific period of time.
3. Statement of financial position: reports the assets,
liabilities, and equity of a company at a specific date.
(Sometimes referred to as a balance sheet.)
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5 Financial Statements
4. Statement of cash flows: summarizes information about
the cash inflows (receipts) and outflows (payments) for a
specific period of time.
5. Comprehensive income statement: presents other
comprehensive income items that are not included in the
determination of net income in 1.
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Financial Statement Connections
Income
Statement Net income is computed
first and is needed to
determine the ending
Retained Earnings balance in retained
Statement earnings.
The ending balance in
retained earnings is
Statement of Financial needed in preparing the
Position statement of financial
position.
The cash shown on the
Statement of Cash statement of financial
Flows position is needed in
preparing the statement of
cash flows.
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Income Statement
Structure:
• The income statement lists revenues first, followed by
expenses.
• Then, the statement shows net income (or net loss).
• When revenues exceed expenses, net income results.
• When expenses exceed revenues, a net loss results.
• The income statement does not include investment and
dividend transactions between the shareholders and
the business in measuring net income.
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Retained Earnings Statement
Structure:
• The first line of the statement shows the beginning
retained earnings amount.
• Then add net income (or subtract net loss) and
subtract dividends.
• The retained earnings ending balance is the final
amount on the statement.
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Statement of Financial Position
Structure:
• Lists assets at the top, followed by equity and then
liabilities.
• Total assets must equal total equity and liabilities.
• When two or more liabilities are involved, a customary
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Statement of Cash Flows
Structure:
The statement of cash flows reports
(1) The cash effects of a company’s operations during a
period.
(2) Its investing activities.
(3) Its financing activities.
(4) The net increase or decrease in cash during the
period.
(5) The cash amount at the end of the period.
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Comprehensive 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.
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DO IT! Financial Statement Items
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.
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Career Opportunities in Accounting
• Public Accounting: Auditing, taxation, management
consulting.
• Private Accounting: Cost accounting, budgeting,
accounting information system design and support,
tax planning and preparation, internal auditing.
• Governmental Accounting: Tax authorities, company
regulators, local governments, law enforcement
agencies.
• Forensic Accounting: Investigate theft and fraud
using accounting, auditing, and investigative skills.
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Copyright
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