Chapter 1: Accounting in action
LO 1: Identify the activities and users associated with accounting.
Accounting consists of 3 basic activities: it identifies, records, and communicates the economic events of
an organization to interested users.
Identifying: identifies the economic events relevant to its business.
Recording: consists of keeping a systematic, chronological diary of events.
Communicating: communicates information to interested users by means of accounting reports.
Bookkeeping: involves only the recording of economic events (just one part of the accounting process)
Who uses Accounting Data?
1. Internal users: managers who plan, organize, and run a business.
To answer these questions, internal users need detailed information on a timely basis.
Managerial accounting provides internal reports to help users make decisions about their companies.
2. External users: individuals/organizations outside company who want financial info about the company.
The 2 most common types of external users are investors (owners) and creditors (bank).
Financial accounting provides economic/financial information for investors/creditors/external users.
LO 2: Explain the building blocks of accounting: ethics, principles, and assumptions.
An accountant follows certain standards in reporting financial information (based on principles/assumptions)
Ethics in financial reporting
Sarbanes-Oxley Act (SOX): reduce unethical corporate behavior and decrease the likelihood of future
corporate scandals. As a result, top management must now certify the accuracy of financial information.
Effective financial reporting depends on sound ethical behavior -> Preventing fraud
Generally accepted Accounting principles
Generally accepted accounting principles (GAAP): common set of standards that indicate how to report
economic events. In Europe we use International Financial Reporting Standards (IFRS).
In order to increase comparability, the two standard-setting bodies have made efforts to reduce the
differences between U.S. GAAP and IFRS = This process is referred to as convergence.
Measurement Principles
GAAP uses one of two measurement principles, the historical cost principle, or the fair value principle.
1. Historical cost principle: companies must record assets at their cost -> always report the historical price.
2. Fair value principle: assets and liabilities should be reported at fair value
Selection of which principle to follow relates to trade-offs between relevance/faithful representation.
- Relevance: financial information is capable of making a difference in a decision.
- Faithful representation: numbers/descriptions match what really existed or happened—they are factual.
Assumptions
The 2 main assumptions are the monetary unit assumption and the economic entity assumption:
1. Monetary unit assumption: companies include only transaction data that can be expressed in money terms.
2. Economic Entity Assumption: The activities of the entity must be kept separate and distinct from the
activities of its owner and all other economic entities -> Economic entity = any organization or unit in society.
- Proprietorship: business owned by one person -> The owner (proprietor) receives any profits, suffers any
losses, and is personally liable for all debts of the business -> Accounting records must be kept separately.
- Partnership: business owned by 2 or more persons associated as partners -> for accounting purposes the
partnership transactions must be kept separate from the personal activities of the partners.
- Corporation: business organized as a separate legal entity under state corporation law and having
ownership divided into transferable shares of stock -> holders have limited liability (not personal)
LO 3: State the accounting equation, and define its components.
,Basic accounting equation:
- Assets (activa): resources a
business owns -> The capacity to provide future services or benefits.
- Liabilities (crediteuren): claims against assets = existing debts and obligations -> be paid before owners.
- Stockholders’ equity (EV): ownership claim on a corporation’s total assets -> consists of common stock
(total amount paid by stockholders for the shares) and retained earnings (revenues/expenses/dividends).
Revenues: increases in assets or decreases in liabilities resulting from the sale of goods or the
performance of services in the normal course of business.
Expenses: cost of assets consumed/services used in generating revenue. They are decreases in equity
that result from operating the business.
Dividends: The distribution of cash or other assets to stockholders -> dividends are not an expense.
LO 4: Analyze the effects of business transactions on the accounting equation
Transactions (business transactions) are a business’s economic events recorded by accountants.
- Internal: economic events that occur entirely within one company
- External: economic events between the company and some outside enterprise
Each transaction must have a dual effect on the accounting equation (assets/liabilities/equity)
Transaction analysis (Expanded accounting equation)
Summary of transactions
- Each transaction must be analyzed in terms of its effect on:
The three components of the basic accounting equation (assets, liabilities, and stockholders’ equity).
Specific types (kinds) of items within each component (such as the asset Cash).
- The two sides of the equation must always be equal.
- Common Stock/Retained Earnings indicate causes of each change in the stockholders’ claim on assets.
LO 5: Describe the 4 financial statements and how they are prepared.
Companies prepare 4 financial statements from the summarized accounting data:
1. Income statement: presents the revenues/expenses/resulting net income/loss for a specific period of time.
2. Retained earnings statement: summarizes the changes in retained earnings for a specific period of time.
3. Balance sheet: reports the assets, liabilities, and stockholders’ equity of a company at a specific date.
4. Statement of cash flows: summarizes info about cash inflows (receipts) and outflows (payments)
The income statement, retained earnings statement, and statement of cash flows are all for a period of
time, whereas the balance sheet is for a point in time.
1. Income Statement
Income statement reports the success/profitability of the company’s operations
over a specific period of time => Profit/loss
The income statement lists revenues first, followed by expenses. Finally, the
statement shows net income.
When revenues exceed expenses, net income results
When expenses exceed revenues, net loss results.
2. Retained earnings statement
,Reports the changes in retained earnings for a specific period of time. The first line of the statement shows the
beginning retained earnings amount. Then come net income and dividends. The retained earnings ending
balance is the final amount on the statement.
3. Balance sheet
Reports the assets/liabilities/stockholders’ equity at a specific date. Observe that the balance sheet lists assets
at the top, followed by liabilities and stockholders’ equity -> Total assets = liabilities + stockholders’ equity.
4. Statement of Cash Flows
The primary purpose of a statement of cash flows is to provide financial information about the cash receipts
and cash payments of a company for a specific period of time.
To help investors/creditors, the statement of cash flows reports the cash effects of a company’s operating,
investing, and financing activities. In addition, the statement shows the net increase or decrease in cash
during the period, and the amount of cash at the end of the period.
, Chapter 2: The recording process
LO 1: Describe how accounts, debits, and credits are used to record business transactions.
Account: an individual accounting record of increases/decreases in a
specific asset, liability, or stockholders’ equity item -> T-Account
An account consists of 3 parts: (1) a title, (2) a left or debit side
(DR.), and (3) a right or credit side (CR.).
Debit and credit procedure
Double-entry system: The equality of debits/credits, the dual (two-sided) effect of each transaction.
DR./CR. Procedures for assets and liabilities
Increases/decreases in liabilities have to be recorded
opposite from increases/decreases in assets.
Stockholders’ equity
The 5 subdivisions of stockholders’ equity: common stock/retained earnings/dividends/revenues/expenses
1. Common stock: Companies issue common stock in exchange for the owners’
investment paid into the corporation.
2. Retained earnings: Net income that is kept in the business. It represents the
portion of stockholders’ equity that the company has accumulated through the
profitable operation of the business. Credits (net income) increase the Retained
Earnings account, and debits (dividends or net losses) decrease it.
3. Dividends: A company’s distribution to its stockholders on a pro rata basis.
Dividends reduce the stockholders’ claims on retained earnings.
4 and 5. Revenues and Expenses: The purpose of earning
revenues is to benefit the stockholders of the business. When a
company recognizes revenues, stockholders’ equity increases.
Stockholders’ equity relationships
Companies report the subdivisions of stockholders’ equity in
various places in the financial statements:
- Common stock and retained earnings in the stockholders’
equity section of the balance sheet.
- Dividends on the retained earnings statement.
- Revenues and expenses on the income statement.
LO 2: Indicate how a journal is used in the recording process.
LO 1: Identify the activities and users associated with accounting.
Accounting consists of 3 basic activities: it identifies, records, and communicates the economic events of
an organization to interested users.
Identifying: identifies the economic events relevant to its business.
Recording: consists of keeping a systematic, chronological diary of events.
Communicating: communicates information to interested users by means of accounting reports.
Bookkeeping: involves only the recording of economic events (just one part of the accounting process)
Who uses Accounting Data?
1. Internal users: managers who plan, organize, and run a business.
To answer these questions, internal users need detailed information on a timely basis.
Managerial accounting provides internal reports to help users make decisions about their companies.
2. External users: individuals/organizations outside company who want financial info about the company.
The 2 most common types of external users are investors (owners) and creditors (bank).
Financial accounting provides economic/financial information for investors/creditors/external users.
LO 2: Explain the building blocks of accounting: ethics, principles, and assumptions.
An accountant follows certain standards in reporting financial information (based on principles/assumptions)
Ethics in financial reporting
Sarbanes-Oxley Act (SOX): reduce unethical corporate behavior and decrease the likelihood of future
corporate scandals. As a result, top management must now certify the accuracy of financial information.
Effective financial reporting depends on sound ethical behavior -> Preventing fraud
Generally accepted Accounting principles
Generally accepted accounting principles (GAAP): common set of standards that indicate how to report
economic events. In Europe we use International Financial Reporting Standards (IFRS).
In order to increase comparability, the two standard-setting bodies have made efforts to reduce the
differences between U.S. GAAP and IFRS = This process is referred to as convergence.
Measurement Principles
GAAP uses one of two measurement principles, the historical cost principle, or the fair value principle.
1. Historical cost principle: companies must record assets at their cost -> always report the historical price.
2. Fair value principle: assets and liabilities should be reported at fair value
Selection of which principle to follow relates to trade-offs between relevance/faithful representation.
- Relevance: financial information is capable of making a difference in a decision.
- Faithful representation: numbers/descriptions match what really existed or happened—they are factual.
Assumptions
The 2 main assumptions are the monetary unit assumption and the economic entity assumption:
1. Monetary unit assumption: companies include only transaction data that can be expressed in money terms.
2. Economic Entity Assumption: The activities of the entity must be kept separate and distinct from the
activities of its owner and all other economic entities -> Economic entity = any organization or unit in society.
- Proprietorship: business owned by one person -> The owner (proprietor) receives any profits, suffers any
losses, and is personally liable for all debts of the business -> Accounting records must be kept separately.
- Partnership: business owned by 2 or more persons associated as partners -> for accounting purposes the
partnership transactions must be kept separate from the personal activities of the partners.
- Corporation: business organized as a separate legal entity under state corporation law and having
ownership divided into transferable shares of stock -> holders have limited liability (not personal)
LO 3: State the accounting equation, and define its components.
,Basic accounting equation:
- Assets (activa): resources a
business owns -> The capacity to provide future services or benefits.
- Liabilities (crediteuren): claims against assets = existing debts and obligations -> be paid before owners.
- Stockholders’ equity (EV): ownership claim on a corporation’s total assets -> consists of common stock
(total amount paid by stockholders for the shares) and retained earnings (revenues/expenses/dividends).
Revenues: increases in assets or decreases in liabilities resulting from the sale of goods or the
performance of services in the normal course of business.
Expenses: cost of assets consumed/services used in generating revenue. They are decreases in equity
that result from operating the business.
Dividends: The distribution of cash or other assets to stockholders -> dividends are not an expense.
LO 4: Analyze the effects of business transactions on the accounting equation
Transactions (business transactions) are a business’s economic events recorded by accountants.
- Internal: economic events that occur entirely within one company
- External: economic events between the company and some outside enterprise
Each transaction must have a dual effect on the accounting equation (assets/liabilities/equity)
Transaction analysis (Expanded accounting equation)
Summary of transactions
- Each transaction must be analyzed in terms of its effect on:
The three components of the basic accounting equation (assets, liabilities, and stockholders’ equity).
Specific types (kinds) of items within each component (such as the asset Cash).
- The two sides of the equation must always be equal.
- Common Stock/Retained Earnings indicate causes of each change in the stockholders’ claim on assets.
LO 5: Describe the 4 financial statements and how they are prepared.
Companies prepare 4 financial statements from the summarized accounting data:
1. Income statement: presents the revenues/expenses/resulting net income/loss for a specific period of time.
2. Retained earnings statement: summarizes the changes in retained earnings for a specific period of time.
3. Balance sheet: reports the assets, liabilities, and stockholders’ equity of a company at a specific date.
4. Statement of cash flows: summarizes info about cash inflows (receipts) and outflows (payments)
The income statement, retained earnings statement, and statement of cash flows are all for a period of
time, whereas the balance sheet is for a point in time.
1. Income Statement
Income statement reports the success/profitability of the company’s operations
over a specific period of time => Profit/loss
The income statement lists revenues first, followed by expenses. Finally, the
statement shows net income.
When revenues exceed expenses, net income results
When expenses exceed revenues, net loss results.
2. Retained earnings statement
,Reports the changes in retained earnings for a specific period of time. The first line of the statement shows the
beginning retained earnings amount. Then come net income and dividends. The retained earnings ending
balance is the final amount on the statement.
3. Balance sheet
Reports the assets/liabilities/stockholders’ equity at a specific date. Observe that the balance sheet lists assets
at the top, followed by liabilities and stockholders’ equity -> Total assets = liabilities + stockholders’ equity.
4. Statement of Cash Flows
The primary purpose of a statement of cash flows is to provide financial information about the cash receipts
and cash payments of a company for a specific period of time.
To help investors/creditors, the statement of cash flows reports the cash effects of a company’s operating,
investing, and financing activities. In addition, the statement shows the net increase or decrease in cash
during the period, and the amount of cash at the end of the period.
, Chapter 2: The recording process
LO 1: Describe how accounts, debits, and credits are used to record business transactions.
Account: an individual accounting record of increases/decreases in a
specific asset, liability, or stockholders’ equity item -> T-Account
An account consists of 3 parts: (1) a title, (2) a left or debit side
(DR.), and (3) a right or credit side (CR.).
Debit and credit procedure
Double-entry system: The equality of debits/credits, the dual (two-sided) effect of each transaction.
DR./CR. Procedures for assets and liabilities
Increases/decreases in liabilities have to be recorded
opposite from increases/decreases in assets.
Stockholders’ equity
The 5 subdivisions of stockholders’ equity: common stock/retained earnings/dividends/revenues/expenses
1. Common stock: Companies issue common stock in exchange for the owners’
investment paid into the corporation.
2. Retained earnings: Net income that is kept in the business. It represents the
portion of stockholders’ equity that the company has accumulated through the
profitable operation of the business. Credits (net income) increase the Retained
Earnings account, and debits (dividends or net losses) decrease it.
3. Dividends: A company’s distribution to its stockholders on a pro rata basis.
Dividends reduce the stockholders’ claims on retained earnings.
4 and 5. Revenues and Expenses: The purpose of earning
revenues is to benefit the stockholders of the business. When a
company recognizes revenues, stockholders’ equity increases.
Stockholders’ equity relationships
Companies report the subdivisions of stockholders’ equity in
various places in the financial statements:
- Common stock and retained earnings in the stockholders’
equity section of the balance sheet.
- Dividends on the retained earnings statement.
- Revenues and expenses on the income statement.
LO 2: Indicate how a journal is used in the recording process.
