Chapter 1 | Accounting in Action |
The Navigator is a learning system designed to prompt you to use the learning aids in the chapter and set priorities as you study.
Learning Objectives give you a framework for learning the specific concepts covered in the chapter.
Learning Objectives
After studying this chapter, you should be 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 entity assumption.
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.
Feature Story
Many students who take this course do not plan to be accountants. If you are in that group, you might be thinking, “If I'm not going to be an accountant, why do I need to know accounting?” In response, consider the quote from Harold Geneen, the former chairman of a major international company: “To be good at your business, you have to know the numbers—cold.”
Success in any business comes back to the numbers. You will rely on them to make decisions, and managers will use them to evaluate your performance. That is true whether your job involves marketing, production, management, or information systems.
In business, accounting is the means for communicating the numbers. If you don't know how to read financial statements, you can't really know your business.
Many companies spend significant resources teaching their employees basic accounting so that they can read financial statements and understand how their actions affect the company's financial results. Employers need managers in all areas of the company to be “financially literate.”
Taking this course will go a long way to making you financially literate. In this book, you will learn how to read and prepare financial statements, and how to use basic tools to evaluate financial results.
Appendices A, B, and C of this textbook provide real financial statements of three companies from different countries that report under International Financial Reporting Standards (IFRS): Samsung Electronics Co., Ltd. (KOR), Nestlé S.A. (CHE), and Zetar plc (GBR). Throughout this textbook, we increase your familiarity with financial reporting by providing numerous references, questions, and exercises that encourage you to explore these financial statements. In addition, we encourage you to visit each company's website where you can view its complete annual report. In examining the financial reports of these three companies, you will see that the accounting practices of companies in specific countries that follow IFRS sometimes differ with regard to particular details. However, more importantly, you will find that the basic accounting principles are the same. As a result, by learning these basic principles, as presented in this textbook, you will be well equipped to begin understanding the financial results of companies around the world.
The Feature Story helps you picture how the chapter topic relates to the real world of accounting and business. You will find references to the story throughout the chapter.
Preview of Chapter 1
The Feature Story highlights the importance of having good financial information and knowing how to use it to make effective business decisions. 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.
The purpose of this chapter is to show you that accounting is the system used to provide useful financial information. The content and organization of Chapter 1 are as follows.
The Preview describes and outlines the major topics and subtopics you will see in the chapter.
LEARNING OBJECTIVE 1
Explain what accounting is.
What consistently ranks as one of the top career opportunities in business? What frequently rates among the most popular majors on campus? Accounting.1 Why do people choose accounting? They want to acquire the skills needed to understand what is happening financially inside a company. Accounting is the financial information system that provides these insights. In short, to understand an organization of any type, you have to know the numbers.
Essential terms are printed in blue when they first appear, and are defined in the end-of-chapter glossary.
Accounting consists of three basic activities—it identifies, records, and communicates the economic events of an organization to interested users. Let's take a c loser look at these three activities.
As a starting point to the accounting process, a company identifies the economic events relevant to its business. Examples of economic events are the sale of food and snacks by Unilever (GBR and NLD), the providing of telephone services by Chunghwa Telecom (TWN), and the manufacture of motor vehicles by Tata Motors (IND).
Once a company like Unilever identifies economic events, it records those events in order to provide a history of its financial activities. Recording consists of keeping a systematic, chronological diary of events, measured in monetary units. In recording, Unilever also classifies and summarizes economic events.
Finally, Unilever communicates the collected information to interested users by means of accounting reports. The most common of these reports are called financial statements. To make the reported financial information meaningful, Unilever reports the recorded data in a standardized way. It accumulates information resulting from similar transactions. For example, Unilever accumulates all sales transactions over a certain period of time and reports the data as one amount in the company's financial statements. Such data are said to be reported in the aggregate. By presenting the recorded data in the aggregate, the accounting process simplifies a multitude of transactions and makes a series of activities understandable and meaningful.
A vital element in communicating economic events is the accountant's ability to analyze and interpret the reported information. Analysis involves use of ratios, percentages, graphs, and charts to highlight significant financial trends and relationships. Interpretation involves explaining the uses, meaning, and limitations of reported data. Appendix A of this textbook shows the financial statements of Samsung Electronics (KOR). Appendix B illustrates the financial statements of Nestlé (CHE), and Appendix C includes the financial statements of Zetar (GBR). We refer to these statements at various places throughout the textbook. (In addition, in the Another Perspective section at the end of each chapter, the U.S. company Tootsie Roll Industries is analyzed.) At this point, these financial statements probably strike you as complex and confusing. By the end of this course, you'll be surprised at your ability to understand, analyze, and interpret them.
Illustration 1-1 summarizes the activities of the accounting process.
You should understand that the accounting process includes the bookkeeping function. Bookkeeping usually involves only the recording of economic events. It is therefore just one part of the accounting process. In total, accounting involves the entire process of identifying, recording, and communicating economic events.2
LEARNING OBJECTIVE 2
Identify the users and uses of accounting.
The specific financial information that a user needs depends upon the kinds of decisions the user makes. There are two broad groups of users of financial information: internal users and external users.
Internal users of accounting information are managers who plan, organize, and run the business. These include marketing managers, production supervisors, finance directors, and company officers. In running a business, internal users must answer many important questions, as shown in Illustration 1-2.
To answer these and other questions, internal users need detailed information on a timely basis. Managerial accounting provides internal reports to help users make decisions about their companies. Examples are financial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year.
External users are individuals and organizations outside a company who want financial information about the company. The two most common types of external users are investors and creditors. Investors (owners) use accounting information to make decisions to buy, hold, or sell ownership shares of a company. Creditors (such as suppliers and bankers) use accounting information to evaluate the risks of granting credit or lending money. Illustration 1-3 shows some questions that investors and creditors may ask.
Financial accounting answers these questions. It provides economic and financial information for investors, creditors, and other external users. The information needs of external users vary considerably. Taxing authorities, such as the State Administration of Taxation in the People's Republic of China (CHN), want to know whether the company complies with tax laws. Regulatory agencies, such as the Autorité des Marchés Financiers (FRA) or the Federal Trade Commission (USA), want to know whether the company is operating within prescribed rules. Customers are interested in whether a company like General Motors (USA) will continue to honor product warranties and support its product lines. Labor unions, such as the German Confederation of Trade Unions (DEU), want to know whether the companies have the ability to pay increased wages and benefits to union members.
A doctor follows certain standards in treating a patient's illness. An architect follows certain standards in designing a building. An accountant follows certain standards in reporting financial information. For these standards to work, a fundamental business concept must be at work—ethical behavior.
LEARNING OBJECTIVE 3
Understand why ethics is a fundamental business concept.
People won't gamble in a casino if they think it is “rigged.” Similarly, people won't play the securities market if they think share prices are rigged. In recent years, the financial press has been full of articles about financial scandals at Enron (USA), Parmalat (ITA), Satyam Computer Services (IND), AIG (USA), and others. As the scandals came to light, mistrust of financial reporting in general grew. One article in the financial press noted that “repeated disclosures about questionable accounting practices have bruised investors' faith in the reliability of earnings reports, which in turn has sent share prices tumbling.” Imagine trying to carry on a business or invest money if you could not depend on the financial statements to be honestly prepared. Information would have no credibility. There is no doubt that a sound, well-functioning economy depends on accurate and dependable financial reporting.
The standards of conduct by which one's actions are judged as right or wrong, honest or dishonest, fair or not fair, are ethics. Effective financial reporting depends on sound ethical behavior. To sensitize you to ethical situations in business and to give you practice at solving ethical dilemmas, we address ethics in a number of ways in this book:
When analyzing these various ethics cases, as well as experiences in your own life, it is useful to apply the three steps outlined in Illustration 1-4.
Insights provide examples of business situations from various perspectives—ethics, investor, international, and corporate social responsibility.
ETHICS INSIGHT
The Numbers Behind Not-for-Profit Organizations
Accounting plays an important role for a wide range of business organizations worldwide. Just as the integrity of the numbers matters for business, it matters at least as much for not-for-profit organizations. Proper control and reporting help ensure that money is used the way donors intended. Donors are less inclined to give to an organization if they think the organization is subject to waste or theft. The accounting challenges of some large international not-for-profits rival those of the world's largest businesses. For example, after the Haitian earthquake, the Haitian-born musician Wyclef Jean was criticized for the poor accounting controls in a relief fund that he founded. Since then, he has hired a new accountant and improved the transparency regarding funds raised and spent.
What benefits does a sound accounting system provide to a not-for-profit organization? (See page 46.)
LEARNING OBJECTIVE 4
Explain accounting standards and the measurement principles.
In order to ensure high-quality financial reporting, accountants present financial statements in conformity with accounting standards that are issued by standard-setting bodies. Presently, there are two primary accounting standard-setting bodies—the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB). More than 130 countries follow standards referred to as International Financial Reporting Standards (IFRS). IFRSs are determined by the IASB. The IASB is headquartered in London, with its 15 board members drawn from around the world. Most companies in the United States follow standards issued by the FASB, referred to as generally accepted accounting principles (GAAP).
As markets become more global, it is often desirable to compare the results of companies from different countries that report using different accounting standards. In order to increase comparability, in recent years the two standard-setting bodies have made efforts to reduce the differences between IFRS and U.S. GAAP. This process is referred to as convergence. As a result of these convergence efforts, it is likely that someday there will be a single set of high-quality accounting standards that are used by companies around the world. Because convergence is such an important issue, we provide at the end of each chapter a section called Another Perspective, to provide a comparison with IFRS.
Helpful Hint
Relevance and faithful representation are two primary qualities that make accounting information useful for decision-making.
IFRS generally uses one of two measurement principles, the historical cost principle or the fair value principle. Selection of which principle to follow generally relates to trade-offs between relevance and 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.
Helpful Hints further clarify concepts being discussed.
The historical cost principle (or cost principle) dictates that companies record assets at their cost. This is true not only at the time the asset is purchased, but also over the time the asset is held. For example, if Gazprom (RUS) purchases land for 300,000, the company initially reports it in its accounting records at 300,000. But what does Gazprom do if, by the end of the next year, the fair value of the land has increased to 400,000? Under the historical cost principle, it continues to report the land at 300,000.
The 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). Fair value information may be more useful than historical cost for certain types of assets and liabilities. For example, certain investment securities are reported at fair value because market value information is usually readily available for these types of assets. In determining which measurement principle to use, companies weigh the factual nature of cost figures versus the relevance of fair value. In general, even though IFRS allows companies to revalue property, plant, and equipment and other long-lived assets to fair value, most companies choose to use cost. Only in situations where assets are actively traded, such as investment securities, do companies apply the fair value principle extensively.
The Korean Discount
If you think that accounting standards don't matter, consider recent events in South Korea. International investors expressed concerns that the financial reports of some South Korean companies were inaccurate. Accounting practices sometimes resulted in differences between stated revenues and actual revenues. Because investors did not have complete faith in the accuracy of the numbers, they were unwilling to pay as much for the shares of these companies relative to shares of comparable companies in different countries. This difference in share price was referred to as the “Korean discount.”
In response, Korean regulators decided to require companies to comply with international accounting standards. This change was motivated by a desire to “make the country's businesses more transparent” in order to build investor confidence and spur economic growth. Many other Asian countries, including China, India, Japan, and Hong Kong, have also decided either to adopt international standards or to create standards that are based on the international standards.
Source: Evan Ramstad, “ End to ‘Korea Discount'?” Wall Street Journal (March 16, 2007).
What is meant by the phrase “make the country's businesses more transparent”?
Why would increasing transparency spur economic growth? (See page 46.)
LEARNING OBJECTIVE 5
Explain the monetary unit assumption and the economic entity assumption.
Assumptions provide a foundation for the accounting process. Two main assumptions are the monetary unit assumption and the economic entity assumption.
The monetary unit assumption requires that companies include in the accounting records only transaction data that can be expressed in money terms. This assumption enables accounting to quantify (measure) economic events. The monetary unit assumption is vital to applying the historical cost principle.
This assumption prevents the inclusion of some relevant information in the accounting records. For example, the health of a company's owner, the quality of service, and the morale of employees are not included. The reason: Companies cannot quantify this information in money terms. Though this information is important, companies record only events that can be measured in money. Throughout this textbook, we use a variety of currencies in our examples and end-of-chapter materials. The currencies and the associated country or region are shown in Illustration 1-5.
Ethics Notes help sensitize you to some of the ethical issues in accounting.
An economic entity can be any organization or unit in society. It may be a company [such as Telefónica (ESP)], a governmental unit (the city-state of Singapore), a municipality (Toronto, Canada), a school district (St. Louis District 48), or a church (Southern Baptist). The economic entity assumption requires that the activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities. To illustrate, Sally Rider, owner of Sally's Boutique, must keep her personal living costs separate from the expenses of the boutique. Similarly, Metro (DEU) and Coca-Cola (USA) are segregated into separate economic entities for accounting purposes.
Ethics Note
The importance of the economic entity assumption is illustrated by scandals involving Adelphia (USA). In this case, senior company employees entered into transactions that blurred the line between the employees' financial interests and those of the company. For example, Adelphia guaranteed over $2 billion of loans to the founding family.
PROPRIETORSHIP A business owned by one person is generally a proprietorship. The owner is often the manager/operator of the business. Small service-type businesses (plumbing companies, beauty salons, and auto repair shops), farms, and small retail stores (antique shops, clothing stores, and used-book stores) are often proprietorships. Usually only a relatively small amount of money (capital) is necessary to start in business as a proprietorship. The owner (proprietor) receives any profits, suffers any losses, and is personally liable for all debts of the business. There is no legal distinction between the business as an economic unit and the owner, but the accounting records of the business activities are kept separate from the personal records and activities of the owner.
PARTNERSHIP A business owned by two or more persons associated as partners is a partnership. In most respects a partnership is like a proprietorship except that more than one owner is involved. Typically a partnership agreement (written or oral) sets forth such terms as initial investment, duties of each partner, division of net income (or net loss), and settlement to be made upon death or withdrawal of a partner. Each partner generally has unlimited personal liability for the debts of the partnership. Like a proprietorship, for accounting purposes the partnership transactions must be kept separate from the personal activities of the partners. Partnerships are often used to organize retail and service-type businesses, including professional practices (lawyers, doctors, architects, and chartered public accountants).
CORPORATION A business organized as a separate legal entity under corporation law and having ownership divided into transferable shares is a corporation. The holders of the shares (shareholders) enjoy limited liability; that is, they are not personally liable for the debts of the corporate entity. Shareholders may transfer all or part of their ownership shares to other investors at any time (i.e., sell their shares). The ease with which ownership can change adds to the attractiveness of investing in a corporation. Because ownership can be transferred without dissolving the corporation, the corporation enjoys an unlimited life.
Although the combined number of proprietorships and partnerships in the world significantly exceeds the number of corporations, the revenue produced by corporations is much greater. Most of the largest companies in the world—for example, ING (NLD), Royal Dutch Shell (GBR and NLD), Wal-Mart Stores Inc. (USA), Fortis (BEL), and Toyota (JPN)—are corporations.
Basic Concepts
Indicate whether each of the five statements presented below is true or false.
The DO IT! exercises ask you to put newly acquired knowledge to work. They outline the Action Plan necessary to complete the exercise, and they show a Solution.
Action Plan
Solution
1. True 2. False. The two most common types of external users are investors and creditors. 3. True. 4. True. 5. False. The historical cost principle dictates that companies record assets at their cost. Under the historical cost principle, the company must also use cost in later periods.
Related exercise material: E1-1, E1-2, E1-3, E1-4, and 1-1.
ACCOUNTING ACROSS THE ORGANIZATION
Spinning the Career Wheel
One question that students frequently ask is, “How will the study of accounting help me?” It should help you a great deal because a working knowledge of accounting is desirable for virtually every field of endeavor. Some examples of how accounting is used in other careers include:
General management: Imagine running Volkswagen (DEU), Massachusetts General Hospital (USA), a Subway (USA) franchise, or a Fuji (JPN) bike shop. All general managers need to understand where the enterprise's cash comes from and where it goes in order to make wise business decisions.
Marketing: A marketing specialist at a company like Hyundai Motor (KOR) develops strategies to help the sales force be successful. But making a sale is meaningless unless it is a profitable sale. Marketing people must be sensitive to costs and benefits, which accounting helps them quantify and understand.
Finance: Do you want to be a banker for Société Générale (FRA) or an investment analyst for Goldman Sachs (USA)? These fields rely heavily on accounting. In all of them, you will regularly examine and analyze financial statements. In fact, it is difficult to get a good finance job without two or three courses in accounting.
Real estate: Are you interested in being a real estate broker for Prudential Real Estate (USA)? Because a third party—the bank—is almost always involved in financing a real estate transaction, brokers must understand the numbers involved: Can the buyer afford to make the payments to the bank? Does the cash flow from an industrial property justify the purchase price? What are the tax benefits of the purchase?
How might accounting help you? (See page 47.)
LEARNING OBJECTIVE 6
State the accounting equation, and define its components.
The two basic elements of a business are what it owns and what it owes. Assets are the resources a business owns. For example, adidas (DEU) has total assets of approximately €10.6 billion. Liabilities and owner's equity are the rights or claims against these resources. Thus, adidas has €10.6 billion of claims against its €10.6 billion of assets. Claims of those to whom the company owes money (creditors) are called liabilities. Claims of owners are called equity. adidas has liabilities of €6.0 billion and equity of €4.6 billion.
We can express the relationship of assets, liabilities, and equity as an equation, as shown in Illustration 1-6.
This relationship is the basic accounting equation. Assets must equal the sum of liabilities and equity.
The accounting equation applies to all economic entities regardless of size, nature of business, or form of business organization. It applies to a small proprietorship such as a corner grocery store as well as to a giant corporation such as adidas. The equation provides the underlying framework for recording and summarizing economic events.
Let's look in more detail at the categories in the basic accounting equation.
As noted above, assets are resources a business owns. The business uses its assets in carrying out such activities as production and sales. The common characteristic possessed by all assets is the capacity to provide future services or benefits. In a business, that service potential or future economic benefit eventually results in cash inflows (receipts). For example, consider Campus Pizza, a local restaurant. It owns a delivery truck that provides economic benefits from delivering pizzas. Other assets of Campus Pizza are tables, chairs, jukebox, cash register, oven, tableware, and, of course, cash.
Liabilities are claims against assets—that is, existing debts and obligations. Businesses of all sizes usually borrow money and purchase merchandise on credit. These economic activities result in payables of various sorts:
All of these persons or entities to whom Campus Pizza owes money are its creditors.
Creditors may legally force the liquidation of a business that does not pay its debts. In that case, the law requires that creditor claims be paid before ownership claims.
The ownership claim on total assets is equity. It is equal to total assets minus total liabilities. Here is why: The assets of a business are claimed by either creditors or shareholders. To find out what belongs to shareholders, we subtract creditors' claims (the liabilities) from the assets. The remainder is the shareholders' claim on the assets—equity. It is often referred to as residual equity—that is, the equity “left over” after creditors' claims are satisfied.
Equity generally consists of (1) share capital—ordinary and (2) retained earnings.
A corporation may obtain funds by selling ordinary shares to investors. Share capital—ordinary is the term used to describe the amounts paid in by shareholders for the ordinary shares they purchase.
Retained earnings is determined by three items: revenues, expenses, and dividends.
Helpful Hint
The effect of revenues is positive—an increase in equity coupled with an increase in assets or a decrease in liabilities.
REVENUES Revenues are the gross increases in equity resulting from business activities entered into for the purpose of earning income. Generally, revenues result from selling merchandise, performing services, renting property, and lending money.
Revenues usually result in an increase in an asset. They may arise from different sources and are called various names depending on the nature of the business. Campus Pizza, for instance, has two categories of sales revenues—pizza sales and beverage sales. Other titles for and sources of revenue common to many businesses are sales, fees, services, commissions, interest, dividends, royalties, and rent.
Helpful Hint
The effect of expenses is negative—a decrease in equity coupled with a decrease in assets or an increase in liabilities.
EXPENSES Expenses are the cost of assets consumed or services used in the process of earning revenue. They are decreases in equity that result from operating the business. Like revenues, expenses take many forms and are called various names depending on the type of asset consumed or service used. For example, Campus Pizza recognizes the following types of expenses: cost of ingredients (flour, cheese, tomato paste, meat, mushrooms, etc.); cost of beverages; wages expense; utilities expense (electric, gas, and water expense); telephone expense; delivery expense (gasoline, repairs, licenses, etc.); supplies expense (napkins, detergents, aprons, etc.); rent expense; interest expense; and property tax expense.
DIVIDENDS Net income represents an increase in net assets which is then available to distribute to shareholders. The distribution of cash or other assets to shareholders is called a dividend. Dividends reduce retained earnings. However, dividends are not an expense. A corporation first determines its revenues and expenses and then computes net income or net loss. If it has net income, and decides it has no better use for that income, a corporation may decide to distribute a dividend to its owners (the shareholders).
In summary, the principal sources (increases) of equity are investments by shareholders and revenues from business operations. In contrast, reductions (decreases) in equity result from expenses and dividends. These relationships are shown in Illustration 1-7 (page 14).
DO IT!
Equity Effects
Classify the following items as issuance of shares (I), dividends (D), revenues (R), or expenses (E). Then indicate whether each item increases or decreases equity.
(1) Rent Expense
(2) Service Revenue
(3) Dividends
(4) Salaries and Wages Expense
Action Plan
Solution
1. Rent Expense is an expense (E); it decreases equity. 2. Service Revenue is a revenue (R); it increases equity. 3. Dividends is a distribution to shareholders (D); it decreases equity. 4. Salaries and Wages Expense is an expense (E); it decreases equity.
Related exercise material: BE1-1, BE1-2, BE1-3, BE1-4, BE1-5, BE1-8, BE1-9, E1-5, E1-6, E1-7, and 1-2.
LEARNING OBJECTIVE 7
Analyze the effects of business transactions on the accounting equation.
Transactions (business transactions) are a business's economic events recorded by accountants. Transactions may be external or internal. External transactions involve economic events between the company and some outside enterprise. For example, Campus Pizza's purchase of cooking equipment from a supplier, payment of monthly rent to the landlord, and sale of pizzas to customers are external transactions. Internal transactions are economic events that occur entirely within one company. The use of cooking and cleaning supplies are internal transactions for Campus Pizza.
Companies carry on many activities that do not represent business transactions. Examples are hiring employees, answering the telephone, talking with customers, and placing merchandise orders. Some of these activities may lead to business transactions: Employees will earn wages, and suppliers will deliver ordered merchandise. The company must analyze each event to find out if it affects the components of the accounting equation. If it does, the company will record the transaction. Illustration 1-8 demonstrates the transaction-identification process.
Each transaction must have a dual effect on the accounting equation. For example, if an asset is increased, there must be a corresponding (1) decrease in another asset, (2) increase in a specific liability, or (3) increase in equity.
Two or more items could be affected. For example, as one asset is increased $10,000, another asset could decrease $6,000 and a liability could increase $4,000. Any change in a liability or ownership claim is subject to similar analysis.
In order to analyze transactions, we will examine a computer programming business (Softbyte Inc.) during its first month of operations. As part of this analysis, we will expand the basic accounting equation. This will allow us to better illustrate the impact of transactions on equity. Recall that equity is comprised of two parts: share capital—ordinary and retained earnings. Share capital—ordinary is affected when the company issues new ordinary shares in exchange for cash. Retained earnings is affected when the company earns revenue, incurs expenses, or pays dividends. Illustration 1-9 (page 16) shows the expanded accounting equation.
If you are tempted to skip ahead after you've read a few of the following transaction analyses, don't do it. Each has something unique to teach, something you'll need later. (We assure you that we've kept them to the minimum needed!)
Helpful Hint
You will want to study these transactions until you are sure you understand them. They are not difficult, but understanding them is important to your success in this course. The ability to analyze transactions in terms of the basic accounting equation is essential in accounting.
TRANSACTION 1. INVESTMENT BY SHAREHOLDERS Ray and Barbara Neal decide to open a computer programming company that they incorporate as Softbyte Inc. On September 1, 2014, they invest €15,000 cash in the business in exchange for €15,000 of ordinary shares. The ordinary shares indicates the ownership interest that the Neals have in Softbyte Inc. This transaction results in an equal increase in both assets and equity.3
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. Why does this matter? Because investments by shareholders do not represent revenues, and they are excluded in determining net income. Therefore, it is necessary to make clear that the increase is an investment rather than revenue from operations. Additional investments (i.e., investments made by shareholders after the corporation has been initially formed) have the same effect on equity as the initial investment.
TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH Softbyte Inc. 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. Observe that total assets are still €15,000. Share Capital—Ordinary also remains at €15,000, the amount of the original investment.
TRANSACTION 3. PURCHASE OF SUPPLIES ON CREDIT Softbyte Inc. purchases for €1,600 from Acme Supply Company computer paper and other supplies expected to last several months. Acme agrees to allow Softbyte to pay this bill in October. This transaction is a purchase on account (a credit purchase). Assets increase because of the expected future benefits of using the paper and supplies, and liabilities increase by the amount due Acme Company.
Total assets are now €16,600. This total is matched by a €1,600 creditor's claim and a €15,000 ownership claim.
TRANSACTION 4. SERVICES PROVIDED FOR CASH Softbyte Inc. receives €1,200 cash from customers for programming services it has provided. This transaction represents Softbyte's principal revenue-producing activity. Recall that revenue increases equity.
The two sides of the equation balance at €17,800. Service Revenue is included in determining Softbyte's net income.
Note that we do not have room to give details for each individual revenue and expense account in this illustration. Thus, revenues (and expenses when we get to them) are summarized under one column heading for Revenues and one for Expenses. However, it is important to keep track of the category (account) titles affected (e.g., Service Revenue) as they will be needed when we prepare financial statements later in the chapter.
TRANSACTION 5. PURCHASE OF ADVERTISING ON CREDIT Softbyte receives a bill for €250 from the Daily News for advertising but postpones payment until a later date. This transaction results in an increase in liabilities and a decrease in equity.
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 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.
TRANSACTION 6. SERVICES PROVIDED FOR CASH AND CREDIT Softbyte Inc. 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. This transaction results in an equal increase in assets and equity.
Softbyte earns revenues when it provides the service, and therefore it recognizes €3,500 in revenue. In exchange for this service, it received €1,500 in Cash and Accounts Receivable of €2,000. This Accounts Receivable represents customers' promise to pay €2,000 to Softbyte in the future. When it later receives collections on account, Softbyte will increase Cash and will decrease Accounts Receivable (see Transaction 9).
TRANSACTION 7. PAYMENT OF EXPENSES Softbyte pays the following expenses in cash for September: store rent €600, salaries and wages of employees €900, and utilities €200. These payments result in an equal decrease in assets and expenses.
The two sides of the equation now balance at €19,600. Three lines are required in the analysis to indicate the different types of expenses that have been incurred.
TRANSACTION 8. PAYMENT OF ACCOUNTS PAYABLE Softbyte pays its €250 Daily News bill in cash. The company previously (in Transaction 5) recorded the bill as an increase in Accounts Payable and a decrease in 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.
TRANSACTION 9. RECEIPT OF CASH ON ACCOUNT Softbyte receives €600 in cash from customers who had been billed for services (in Transaction 6). This transaction 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.
TRANSACTION 10. DIVIDENDS The corporation pays a dividend of €1,300 in cash to Ray and Barbara Neal, the shareholders of Softbyte Inc. This transaction results in an equal decrease in assets and equity.
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.
Illustration 1-10 summarizes the September transactions of Softbyte Inc. to show their cumulative effect on the basic accounting equation. It also indicates the transaction number and the specific effects of each transaction. Finally, Illustration 1-10 demonstrates a number of significant facts:
(a) The three components of the basic accounting equation.
(b) Specific types (kinds) of items within each component.
There! You made it through transaction analysis. If you feel a bit shaky on any of the transactions, it might be a good idea at this point to get up, take a short break, and come back again for a brief (10- to 15-minute) review of the transactions, to make sure you understand them before you go on to the next section.
DO IT!
Tabular Analysis
Transactions made by Virmari & Co., a public accounting firm in France, for the month of August are shown below. Prepare a tabular analysis which shows the effects of these transactions on the expanded accounting equation, similar to that shown in Illustration 1-10.
Action Plan
Solution
Related exercise material: BE1-6, BE1-7, E1-6, E1-7, E1-8, and 1-3.
LEARNING OBJECTIVE 8
Understand the four financial statements and how they are prepared.
Companies prepare four financial statements from the summarized accounting data:
These statements provide relevant financial data for internal and external users. Illustration 1-11 shows the financial statements of Softbyte Inc. Note that the statements shown in Illustration 1-11 are interrelated:
Helpful Hint
The income statement, retained earnings statement, and statement of cash flows are all for a period of time, whereas the statement of financial position is for a point in time.
Also, explanatory notes and supporting schedules are an integral part of every set of financial statements. We illustrate these notes and schedules in later chapters of this textbook.
Be sure to carefully examine the format and content of each statement in Illustration 1-11. We describe the essential features of each in the following sections.
Alternative Terminology
The income statement is sometimes referred to as the statement of operations, earnings statement, or profit and loss statement.
The income statement reports the success or profitability of the company's operations over a specific period of time. For example, Softbyte Inc.'s income statement is dated “For the Month Ended September 30, 2014.” It is prepared from the data appearing in the revenue and expense columns of Illustration 1-10 (page 21). The heading of the statement identifies the company, the type of statement, and the time period covered by the statement.
The income statement lists revenues first, followed by expenses. Finally, the statement shows net income (or net loss). When revenues exceed expenses, net income results. When expenses exceed revenues, a net loss results.
Alternative Terminology notes present synonymous terms that you may come across in practice.
Although practice varies, we have chosen to list expenses in order of magnitude in our illustrations. (We will consider alternative formats for the income statement in later chapters.)
Note that the income statement does not include investment and dividend transactions between the shareholders and the business in measuring net income. For example, as explained earlier, the cash dividend from Softbyte Inc. was not regarded as a business expense. This type of transaction is considered a reduction of retained earnings, which causes a decrease in equity.
Softbyte Inc.'s retained earnings statement reports the changes in retained earnings for a specific period of time. The time period is the same as that covered by the income statement (“For the Month Ended September 30, 2014”). Data for the preparation of the retained earnings statement come from the retained earnings columns of the tabular summary (Illustration 1-10) and from the income statement (Illustration 1-11).
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. The information provided by this statement indicates the reasons why retained earnings increased or decreased during the period. If there is a net loss, it is deducted with dividends in the retained earnings statement.
Softbyte Inc.'s statement of financial position reports the assets, liabilities, and equity at a specific date (September 30, 2014). The company prepares the statement of financial position from the column headings and the month-end data shown in the last line of the tabular summary (Illustration 1-10).
Observe that the statement of financial position lists assets at the top, followed by equity and then liabilities. Total assets must equal total equity and liabilities. Softbyte Inc. reports only one liability, Accounts Payable, on its statement of financial position. In most cases, there will be more than one liability. When two or more liabilities are involved, a customary way of listing is as shown in Illustration 1-12.
The statement of financial position is like a snapshot of the company's financial condition at a specific moment in time (usually the month-end or year-end).
ACCOUNTING ACROSS THE ORGANIZATION
What Do Vodafone, Walt Disney, and JJB Sports Have in Common?
Not every company uses December 31 as the accounting year-end. Some companies whose year-ends differ from December 31 are Vodafone Group (GBR), March 31; Walt Disney Productions (USA), September 30; and JJB Sports (GBR), the Sunday that falls before, but closest to, January 31. Why do companies choose the particular year-ends that they do? Many choose to end the accounting year when inventory or operations are at a low. Compiling accounting information requires much time and effort by managers, so companies would rather do it when they aren't as busy operating the business. Also, inventory is easier and less costly to count when it is low.
What year-end would you likely use if you owned a ski resort and ski rental business? What if you owned a college bookstore? Why choose those year-ends? (See page 47.)
Helpful Hint
Investing activities pertain to investments made by the company, not investments made by the owners.
The statement of cash flows provides information on the cash receipts and payments for a specific period of time. The statement of cash flows reports (1) the cash effects of a company's operations during a period, (2) its investing transactions, (3) its financing transactions, (4) the net increase or decrease in cash during the period, and (5) the cash amount at the end of the period.
Reporting the sources, uses, and change in cash is useful because investors, creditors, and others want to know what is happening to a company's most liquid resource. The statement of cash flows provides answers to the following simple but important questions.
As shown in Softbyte Inc.'s statement of cash flows in Illustration 1-11, cash increased €8,050 during the period. Net cash flow provided from operating activities increased cash €1,350. Cash flow from investing transactions decreased cash €7,000. And cash flow from financing transactions increased cash €13,700. At this time, you need not be concerned with how these amounts are determined. Chapter 13 will examine in detail how the statement is prepared.
PEOPLE, PLANET, AND PROFIT INSIGHT
Beyond Financial Statements
Should we expand our financial statements beyond the income statement, retained earnings statement, statement of financial position, and statement of cash flows? Some believe we should take into account ecological and social performance, in addition to financial results, in evaluating a company. The argument is that a company's responsibility lies with anyone who is influenced by its actions. In other words, a company should be interested in benefiting many different parties, instead of only maximizing shareholders' interests.
A socially responsible business does not exploit or endanger any group of individuals. It follows fair trade practices, provides safe environments for workers, and bears responsibility for environmental damage. Granted, measurement of these factors is difficult. How to report this information is also controversial. But, many interesting and useful efforts are underway. Throughout this textbook, we provide additional insights into how companies are attempting to meet the challenge of measuring and reporting their contributions to society, as well as their financial results, to shareholders.
Why might a company's shareholders be interested in its environmental and social performance? (See page 47.)
DO IT!
Financial Statement Items
Presented below is selected information related to Flanagan Company at December 31, 2014. Flanagan reports financial information monthly.
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 |
Salaries and Wages Expense | 7,000 |
Notes Payable | 16,500 |
Dividends | 5,000 |
(a) Determine the total assets of Flanagan at December 31, 2014.
(b) Determine the net income that Flanagan reported for December 2014.
(c) Determine the equity of Flanagan at December 31, 2014.
Action Plan
Solution
(a) The total assets are £27,000, comprised of Equipment £10,000, Accounts Receivable £9,000, and Cash £8,000.
(b) Net income is £14,000, computed as follows.
(c) The ending equity of Flanagan is £8,500. By rewriting the accounting equation, we can compute equity as assets minus liabilities, as follows.
Note that it is not possible to determine the company's equity in any other way, because the beginning total for equity is not provided.
Related exercise material: BE1-10, BE1-11, E1-9, E1-12, E1-13, E1-14, E1-15, E1-16, and 1-4.
Comprehensive DO IT!
Legal Services Company was incorporated on July 1, 2014. During the first month of operations, the following transactions occurred.
The Comprehensive DO IT! is a final review of the chapter. The Action Plan gives tips about how to approach the problem, and the Solution demonstrates both the form and content of complete answers.
Instructions
(a) Prepare a tabular summary of the transactions. (Present using NT$ in thousands.)
(b) Prepare the income statement, retained earnings statement, and statement of financial position at July 31 for Legal Services Company. (Present using NT$ in thousands.)
Solution to Comprehensive
(a)
(b)
SUMMARY OF LEARNING OBJECTIVES
1 Explain what accounting is. Accounting is an information system that identifies, records, and communicates the economic events of an organization to interested users.
2 Identify the users and uses of accounting. The major users and uses of accounting are as follows. (a) Management uses accounting information to plan, organize, and run the business. (b) Investors (owners) decide whether to buy, hold, or sell their financial interests on the basis of accounting data. (c) Creditors (suppliers and bankers) evaluate the risks of granting credit or lending money on the basis of accounting information. Other groups that use accounting information are taxing authorities, regulatory agencies, customers, labor unions, and economic planners.
3 Understand why ethics is a fundamental business concept. Ethics are the standards of conduct by which actions are judged as right or wrong. Effective financial reporting depends on sound ethical behavior.
4 Explain accounting standards and the measurement principles. Accounting is based on standards, such as International Financial Reporting Standards (IFRS). IFRS generally uses one of two measurement principles, the historical cost principle or the fair value principle. Selection of which principle to follow generally relates to trade-offs between relevance and faithful representation.
5 Explain the monetary unit assumption and the economic entity assumption. The monetary unit assumption requires that companies include in the accounting records only transaction data that can be expressed in terms of money. The economic entity assumption requires that the activities of each economic entity be kept separate from the activities of its owner(s) and other economic entities.
6 State the accounting equation, and define its components. The basic accounting equation is:
Assets = Liabilities + Equity
Assets are resources a business owns. Liabilities are creditor' claims on total assets. Equity is the ownership claim on total assets.
The expanded accounting equation is:
Assets = Liabilities + Share Capital—Ordinary + Revenues − Expenses − Dividends
Share capital—ordinary is affected when the company issues new ordinary shares in exchange for cash. Revenues are increases in assets resulting from income-earning activities. Expenses are the costs of assets consumed or services used in the process of earning revenue. Dividends are payments the company makes to its shareholders.
7 Analyze the effects of business transactions on the accounting equation. Each business transaction must have a dual effect on the accounting equation. For example, if an individual asset increases, there must be a corresponding (1) decrease in another asset, or (2) increase in a specific liability, or (3) increase in equity.
8 Understand the four financial statements and how they are prepared. An income statement presents the revenues and expenses, and resulting net income or net loss, for a specific period of time. A retained earnings statement summarizes the changes in retained earnings for a specific period of time. A statement of financial position reports the assets, liabilities, and 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.
GLOSSARY
Accounting The information system that identifies, records, and communicates the economic events of an organization to interested users. (p. 4).
Assets Resources a business owns. (p. 12).
Basic accounting equation Assets = Liabilities + Equity. (p. 12).
Bookkeeping A part of accounting that involves only the recording of economic events. (p. 5).
Convergence Effort to reduce differences between U.S. GAAP and IFRS to enhance comparability. (p. 8).
Corporation A business organized as a separate legal entity under corporation law, having ownership divided into transferable shares. (p. 10).
Dividend A distribution of cash or other assets by a corporation to its shareholders. (p. 13).
Economic entity assumption An assumption that requires that the activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities. (p. 10).
Equity The ownership claim on a corporation's total assets. (p. 13).
Ethics The standards of conduct by which one's actions are judged as right or wrong, honest or dishonest, fair or not fair. (p. 7).
Expanded accounting equation Assets = Liabilities + Share Capital—Ordinary + Revenues − Expenses − Dividends. (p. 15).
Expenses The cost of assets consumed or services used in the process of earning revenue. (p. 13).
Fair value principle An accounting principle stating that assets and liabilities should be reported at fair value (the price received to sell an asset or settle a liability). (p. 8).
Faithful representation Numbers and descriptions match what really existed or happened—they are factual. (p. 8).
Financial accounting The field of accounting that provides economic and financial information for investors, creditors, and other external users. (p. 6).
Financial Accounting Standards Board (FASB) An organization that establishes generally accepted accounting principles in the United States (GAAP). (p. 8).
Generally accepted accounting principles (GAAP) Accounting standards issued in the United States by the Financial Accounting Standards Board. (p. 8).
Historical cost principle (cost principle) An accounting principle that states that companies should record assets at their cost. (p. 8).
Income statement A financial statement that presents the revenues and expenses and resulting net income or net loss of a company for a specific period of time. (p. 22).
International Accounting Standards Board (IASB) An accounting standard-setting body that issues standards adopted by many countries outside of the United States. (p. 8).
International Financial Reporting Standards (IFRS) International accounting standards set by the International Accounting Standards Board (IASB). (p. 8).
Liabilities Creditor claims on total assets. (p. 12).
Managerial accounting The field of accounting that provides internal reports to help users make decisions about their companies. (p. 6).
Monetary unit assumption An assumption stating that companies include in the accounting records only transaction data that can be expressed in terms of money. (p. 9).
Net income The amount by which revenues exceed expenses. (p. 22).
Net loss The amount by which expenses exceed revenues. (p. 22).
Partnership A business owned by two or more persons associated as partners. (p. 10).
Proprietorship A business owned by one person. (p. 10).
Relevance Financial information that is capable of making a difference in a decision. (p. 8).
Retained earnings statement A financial statement that summarizes the changes in retained earnings for a specific period of time. (p. 22).
Revenues The gross increase in equity resulting from business activities entered into for the purpose of earning income. (p. 13).
Share capital—ordinary Amounts paid in by shareholders for the ordinary shares they purchase. (p. 13).
Statement of cash flows A financial statement that summarizes information about the cash inflows (receipts) and cash outflows (payments) for a specific period of time. (p. 22).
Statement of financial position (balance sheet) A financial statement that reports the assets, liabilities, and equity of a company at a specific date. (p. 22).
Transactions The economic events of a business that are recorded by accountants. (p. 14).
LEARNING OBJECTIVE 9
Explain the career opportunities in accounting.
Why is accounting such a popular major and career choice? First, there are a lot of jobs. In many cities in recent years, the demand for accountants exceeded the supply. Not only are there a lot of jobs, but there are a wide array of opportunities. As one accounting organization observed, “accounting is one degree with 360 degrees of opportunity.”
Accounting is also hot because it is obvious that accounting matters. Interest in accounting has increased, ironically, because of the attention caused by the turmoil over toxic (misstated) assets at many financial institutions. These widely publicized scandals revealed the important role that accounting plays in society. Most people want to make a difference, and an accounting career provides many opportunities to contribute to society. Finally, recent internal control requirements dramatically increased demand for professionals with accounting training.
Accountants are in such demand that it is not uncommon for accounting students to have accepted a job offer a year before graduation. As the following discussion reveals, the job options of people with accounting degrees are virtually unlimited.
Individuals in public accounting offer expert service to the general public, in much the same way that doctors serve patients and lawyers serve clients. A major portion of public accounting involves auditing. In auditing, an independent accountant, such as a chartered accountant (CA) or a certified public accountant (CPA), examines company financial statements and provides an opinion as to how accurately the financial statements present the company's results and financial position. Analysts, investors, and creditors rely heavily on these “audit opinions,” which CAs and CPAs have the exclusive authority to issue.
Taxation is another major area of public accounting. The work that tax specialists perform includes tax advice and planning, preparing tax returns, and representing clients before governmental agencies.
A third area in public accounting is management consulting. It ranges from installing basic accounting software or highly complex enterprise resource planning systems, to providing support services for major marketing projects and merger and acquisition activities.
Many accountants are entrepreneurs. They form small- or medium-sized practices that frequently specialize in tax or consulting services.
Instead of working in public accounting, you might choose to be an employee of a for-profit company such as Starbucks (USA), Nokia (FIN), or Samsung (KOR). In private (or managerial) accounting, you would be involved in activities such as cost accounting (finding the cost of producing specific products), budgeting, accounting information system design and support, and tax planning and preparation. You might also be a member of your company's internal audit team. In response to corporate failures, the internal auditors' job of reviewing the company's operations to ensure compliance with company policies and to increase efficiency has taken on increased importance.
Alternatively, many accountants work for not-for-profit organizations, such as the International Red Cross (CHE) or the Bill and Melinda Gates Foundation (USA), or for museums, libraries, or performing arts organizations.
Another option is to pursue one of the many accounting opportunities in governmental agencies. For example, tax authorities, law enforcement agencies, and corporate regulators all employ accountants. There is also a very high demand for accounting educators at colleges and universities and in governments.
Forensic accounting uses accounting, auditing, and investigative skills to conduct investigations into theft and fraud. It is listed among the top 20 career paths of the future. The job of forensic accountants is to catch the perpetrators of theft and fraud occurring at companies. This includes tracing money-laundering and identity-theft activities as well as tax evasion. Insurance companies hire forensic accountants to detect insurance frauds such as arson, and law offices employ forensic accountants to identify marital assets in divorces.
How much can a new accountant make? Take a look at the average salaries for college graduates in U.S. public and private accounting.4
Serious earning potential over time gives accountants great job security. Here are some examples of upper-level salaries for U.S. managers in corporate accounting.
For up-to-date salary estimates, as well as a wealth of additional information regarding accounting as a career, check out www.startheregoplaces.com.
SUMMARY OF LEARNING OBJECTIVE FOR APPENDIX 1A
9 Explain the career opportunities in accounting. Accounting offers many different jobs in fields such as public and private accounting, government, and forensic accounting. Accounting is a popular major because there are many different types of jobs, with unlimited potential for career advancement.
GLOSSARY FOR APPENDIX 1A
Auditing The examination of financial statements by an independent accountant in order to express an opinion as to the fairness of presentation. (p. 30).
Forensic accounting An area of accounting that uses accounting, auditing, and investigative skills to conduct investigations into theft and fraud. (p. 30).
Management consulting An area of public accounting ranging from development of accounting and computer systems to support services for marketing projects and merger and acquisition activities. (p. 30).
Private (or managerial) accounting An area of accounting within a company that involves such activities as cost accounting, budgeting, design and support of accounting information systems, and tax planning and preparation. (p. 30).
Public accounting An area of accounting in which the accountant offers expert service to the general public. (p. 30).
Taxation An area of public accounting involving tax advice, tax planning, preparing tax returns, and representing clients before governmental agencies. (p. 30).
Self-Test, Brief Exercises, Exercises, Problem Set A, and many more components are available for practice in WileyPLUS.
*Note: All asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.
SELF-TEST QUESTIONS
Answers are on page 47.
(a) Identification.
(b) Verification.
(c) Recording.
(d) Communication.
(a) Management is an internal user.
(b) Taxing authorities are external users.
(c) Present creditors are external users.
(d) Regulatory authorities are internal users.
(a) assets should be initially recorded at cost and adjusted when the fair value changes.
(b) activities of an entity are to be kept separate and distinct from its owner.
(c) assets should be recorded at their cost.
(d) only transaction data capable of being expressed in terms of money be included in the accounting records.
(a) Basic assumptions are the same as accounting principles.
(b) The economic entity assumption states that there should be a particular unit of accountability.
(c) The monetary unit assumption enables accounting to measure employee morale.
(d) Partnerships are not economic entities.
(a) proprietorships, small businesses, and partnerships.
(b) proprietorships, partnerships, and corporations.
(c) proprietorships, partnerships, and large businesses.
(d) financial, manufacturing, and service companies.
(a) assets exceed liabilities.
(b) assets exceed revenues.
(c) expenses exceed revenues.
(d) revenues exceed expenses.
(a) increase assets and decrease equity.
(b) increase assets and increase equity.
(c) increase assets and increase liabilities.
(d) increase liabilities and increase equity.
(a) €1,500.
(b) €1,000.
(c) €2,500.
(d) €2,000.
(a) Equipment is purchased on account.
(b) An employee is terminated.
(c) A cash investment is made into the business.
(d) The company pays a cash dividend.
(a) increased $40,000.
(b) decreased $140,000.
(c) decreased $40,000.
(d) increased $140,000.
(a) decreases equity and decreases liabilities.
(b) increases assets and decreases liabilities.
(c) decreases assets and increases equity.
(d) decreases assets and decreases liabilities.
(a) A statement of cash flows summarizes information about the cash inflows (receipts) and outflows (payments) for a specific period of time.
(b) A statement of financial position reports the assets, liabilities, and equity at a specific date.
(c) An income statement presents the revenues, expenses, changes in equity, and resulting net income or net loss for a specific period of time.
(d) A retained earnings statement summarizes the changes in retained earnings for a specific period of time.
(a) income statement only.
(b) statement of financial position only.
(c) income statement and retained earnings statement only.
(d) income statement, retained earnings statement, and statement of financial position.
(a) income statement.
(b) retained earnings statement.
(c) statement of financial position.
(d) statement of cash flows.
(a) auditing, taxation, and management consulting.
(b) auditing, budgeting, and management consulting.
(c) auditing, budgeting, and cost accounting.
(d) internal auditing, budgeting, and management consulting.
Go to the book's companion website, www.wiley.com/college/weygandt, for additional Self-Test Questions.
(a) Who are internal users of accounting data?
(b) How does accounting provide relevant data to these users?
(a) Define the terms assets, liabilities, and equity.
(b) What items affect equity?
(a) Cash.
(b) Accounts payable.
(c) Dividends.
(d) Accounts receivable.
(e) Supplies.
(f) Equipment.
(g) Salaries and wages payable.
(h) Service revenue.
(i) Rent expense.
(a) The president of the company dies.
(b) Supplies are purchased on account.
(c) An employee is fired.
(a) Paid cash for janitorial services.
(b) Purchased equipment for cash.
(c) Received cash in exchange for ordinary shares.
(d) Paid accounts payable in full.
(a) Service revenue.
(b) Equipment.
(c) Advertising expense.
(d) Accounts receivable.
(e) Retained earnings.
(f) Salaries and wages payable.
(a) Assuming no additional investment or distributions during the period, what is the net income for the period?
(b) Assuming an additional investment of $13,000 but no distributions during the period, what is the net income for the period?
Revenues earned: for cash £30,000; on account £70,000.
Expenses incurred: for cash £26,000; on account £40,000.
Indicate for H. J. Oslo Co. (a) the total revenues, (b) the total expenses, and (c) net income for the month of July.
BRIEF EXERCISES
Use basic accounting equation. (LO 6)
BE1-1 Presented below is the basic accounting equation (in thousands). Determine the missing amounts.
BE1-2 Given the accounting equation, answer each of the following questions.
(a) The liabilities of Shumway Company are $120,000 and the equity is $232,000. What is the amount of Shumway Company's total assets?
(b) The total assets of Shumway Company are $190,000 and its equity is $80,000. What is the amount of its total liabilities?
(c) The total assets of Shumway Company are $600,000 and its liabilities are equal to one half of its total assets. What is the amount of Shumway Company's equity?
Use basic accounting equation. (LO 6)
BE1-3 At the beginning of the year, Gonzales Company had total assets of €870,000 and total liabilities of €500,000. Answer the following questions.
(a) If total assets increased €150,000 during the year and total liabilities decreased €80,000, what is the amount of equity at the end of the year?
(b) During the year, total liabilities increased €100,000 and equity decreased €70,000. What is the amount of total assets at the end of the year?
(c) If total assets decreased €80,000 and equity increased €120,000 during the year, what is the amount of total liabilities at the end of the year?
Solve accounting equation. (LO 6)
BE1-4 Use the accounting equation to answer each of the following questions.
(a) The liabilities of Alli Company are £90,000. Share capital—ordinary is £150,000; dividends are £40,000; revenues, £450,000; and expenses, £320,000. What is the amount of Alli Company's total assets?
(b) The total assets of Planke Company are £57,000. Share capital—ordinary is £23,000; dividends are £7,000; revenues, £50,000; and expenses, £35,000. What is the amount of the company's total liabilities?
(c) The total assets of Thao Co. are £600,000 and its liabilities are equal to two-thirds of its total assets. What is the amount of Thao Co.'s equity?
Identify assets, liabilities, and equity. (LO 6)
BE1-5 Indicate whether each of the following items is an asset (A), liability (L), or part of equity (E).
Determine effect of transactions on basic accounting equation. (LO 7)
BE1-6 Presented below are three business transactions. On a sheet of paper, list the letters (a), (b), and (c) with columns for assets, liabilities, and equity. For each column, indicate whether the transactions increased (+), decreased (−), or had no effect (NE) on assets, liabilities, and equity.
(a) Purchased supplies on account.
(b) Received cash for providing a service.
(c) Paid expenses in cash.
Determine effect of transactions on accounting equation. (LO 7)
BE1-7 Follow the same format as BE1-6 above. Determine the effect on assets, liabilities, and equity of the following three transactions.
(a) Shareholders invested cash in the business for ordinary shares.
(b) Paid a cash dividend.
(c) Received cash from a customer who had previously been billed for services provided.
Classify items affecting equity. (LO 6)
BE1-8 Classify each of the following items as dividends (D), revenue (R), or expense (E).
Determine effect of transactions on equity. (LO 6)
BE1-9 Presented below are three transactions. Mark each transaction as affecting share capital—ordinary (SC), dividends (D), revenue (R), expense (E), or not affecting equity (NE).
Prepare a statement of financial position. (LO 8)
BE1-10 In alphabetical order below are statement of financial position items for Grande Company at December 31, 2014. Kit Grande is the owner of Grande Company. Prepare a statement of financial position, following the format of Illustration 1-11.
Accounts payable | $85,000 |
Accounts receivable | $72,500 |
Cash | $44,000 |
Share capital—ordinary | $31,500 |
BE1-11 Indicate whether the following items would appear on the income statement (IS), statement of financial position (FP), or retained earnings statement (RE).
DO IT! REVIEW
Review basic concepts. (LO 1, 2, 4)
1-1 Indicate whether each of the five statements presented below is true or false. If false, state why.
Evaluate effects of transactions on equity. (LO 6)
1-2 Classify the following items as issuance of shares (I), dividends (D), revenues (R), or expenses (E). Then indicate whether each item increases or decreases equity.
Prepare tabular analysis. (LO 7)
1-3 Transactions made by Callahan and Co., a law firm, for the month of March are shown below. Prepare a tabular analysis which shows the effects of these transactions on the accounting equation, similar to that shown in Illustration 1-10.
Calculate effects of transactions on financial statement items. (LO 8)
1-4 Presented below is selected information related to Rivera Company at December 31, 2014. Rivera reports financial information monthly.
Accounts Payable | R$ 3,000 |
Cash | 9,000 |
Advertising Expense | 6,000 |
Service Revenue | 54,000 |
Equipment | 29,000 |
Salaries and Wages Expense | R$16,500 |
Notes Payable | 25,000 |
Rent Expense | 9,800 |
Accounts Receivable | 13,500 |
Dividends | 7,500 |
(a) Determine the total assets of Rivera Company at December 31, 2014.
(b) Determine the net income that Rivera Company reported for December 2014.
(c) Determine the equity of Rivera Company at December 31, 2014.
EXERCISES
Classify the three activities of accounting. (LO 1)
E1-1 Sondgeroth Company performs the following accounting tasks during the year.
Accounting is “an information system that identifies, records, and communicates the economic events of an organization to interested users.”
Instructions
Categorize the accounting tasks performed by Sondgeroth as relating to either the identification (I), recording (R), or communication (C) aspects of accounting.
Identify users of accounting information. (LO 2)
E1-2 (a) The following are users of financial statements.
Instructions
Identify the users as being either external users (E) or internal users (I).
(b) The following questions could be asked by an internal user or an external user.
Instructions
Identify each of the questions as being more likely asked by an internal user (I) or an external user (E).
Discuss ethics and the historical cost principle. (LO 3)
E1-3 Leon Manternach, president of Manternach Company, has instructed Carla Ruden, the head of the accounting department for Manternach Company, to report the company's recently acquired land in the company's accounting reports at its fair value of $170,000 instead of its cost of $100,000. Manternach says, “I think we got a real deal on the purchase. It is probably worth $170,000. Showing the land at $170,000 will make our company look like a better investment when we try to attract new investors next month.”
Instructions
Explain the ethical situation involved for Carla Ruden, identifying the stakeholders and the alternatives.
Use accounting concepts. (LO 4, 5)
E1-4 The following situations involve accounting principles and assumptions.
Instructions
For each of the three situations, state if the accounting method used is correct or incorrect. If correct, identify which standard or assumption supports the method used. If incorrect, identify which standard or assumption has been violated.
Classify accounts as assets, liabilities, and equity. (LO 6)
E1-5 Robinson Cleaners has the following statement of financial position items.
Classify each item as an asset, liability, or equity.
Analyze the effect of transactions. (LO 6, 7)
E1-6 Selected transactions for Spring Green Lawn Care Company are listed below.
Instructions
List the numbers of the above transactions and describe the effect of each transaction on assets, liabilities, and equity. For example, the first answer is (1) Increase in assets and increase in equity.
Analyze the effect of transactions on assets, liabilities, and equity. (LO 6, 7)
E1-7 Collins Computer Timeshare Company entered into the following transactions during May 2014.
Instructions
Indicate with the appropriate letter whether each of the transactions above results in:
(a) An increase in assets and a decrease in assets.
(b) An increase in assets and an increase in equity.
(c) An increase in assets and an increase in liabilities.
(d) A decrease in assets and a decrease in equity.
(e) A decrease in assets and a decrease in liabilities.
(f) An increase in liabilities and a decrease in equity.
(g) An increase in equity and a decrease in liabilities.
Analyze transactions and compute net income. (LO 7, 8)
E1-8 An analysis of the transactions made by J. L. Kang & Co., a public accounting firm, for the month of August is shown below. Each increase and decrease in equity is explained.
Instructions
(a) Describe each transaction that occurred for the month.
(b) Determine how much equity increased for the month.
(c) Compute the amount of net income for the month.
E1-9 An analysis of transactions for J. L. Kang & Co. was presented in E1-8.
Instructions
Prepare an income statement and a retained earnings statement for August and a statement of financial position at August 31, 2014.
Determine net income (or loss). (LO 8)
E1-10 Kimmy Company had the following assets and liabilities on the dates indicated.
Kimmy began business on January 1, 2013, with an investment of 100,000 from shareholders.
Instructions
From an analysis of the change in equity during the year, compute the net income (or loss) for:
(a) 2013, assuming Kimmy paid 15,000 in dividends for the year.
(b) 2014, assuming shareholders made an additional investment of 50,000 and Kimmy paid no dividends in 2014.
(c) 2015, assuming shareholders made an additional investment of 15,000 and Kimmy paid dividends of 30,000 in 2015.
Analyze financial statements items. (LO 6, 7)
E1-11 Two items are omitted from each of the following summaries of statement of financial position and income statement data for two companies for the year 2014, Steven Craig and Georgia Enterprises.
Instructions
Determine the missing amounts.
Prepare income statement and retained earnings statement. (LO 8)
E1-12 The following information relates to Karen Weigel Co. for the year 2014.
Retained earnings, January 1, 2014 | $48,000 |
Dividends during 2014 | 5,000 |
Service revenue | 62,500 |
Salaries and wages expense | 28,000 |
Advertising expense | $ 1,800 |
Rent expense | 10,400 |
Utilities expense | 3,100 |
Instructions
After analyzing the data, prepare an income statement and a retained earnings statement for the year ending December 31, 2014.
Correct an incorrectly prepared statement of financial position. (LO 8)
E1-13 Lynn Dreise is the bookkeeper for Sanculi Company. Lynn has been trying to get the statement of financial position of Sanculi Company to balance. Sanculi's statement of financial position is shown on the next page.
Instructions
Prepare a correct statement of financial position.
Compute net income and prepare a statement of financial position. (LO 8)
E1-14 Bear Park, a public camping ground near the Lake Mead National Recreation Area, has compiled the following financial information as of December 31, 2014.
Revenues during 2014—camping fees | $140,000 |
Revenues during 2014—general store | 47,000 |
Accounts payable | 11,000 |
Cash on hand | 20,000 |
Original cost of equipment | 105,500 |
Fair value of equipment | 140,000 |
Notes payable | $ 60,000 |
Expenses during 2014 | 150,000 |
Supplies on hand | 2,500 |
Share capital—ordinary | 20,000 |
Retained earnings | ? |
Instructions
(a) Determine Bear Park's net income for 2014.
(b) Prepare a statement of financial position for Bear Park as of December 31, 2014.
Prepare an income statement. (LO 8)
E1-15 Presented below is financial information related to the 2014 operations of Delgado Cruise Company.
Maintenance and repairs expense | R$ 97,000 |
Utilities expense | 10,000 |
Salaries and wages expense | 142,000 |
Advertising expense | 3,500 |
Ticket revenue | 335,000 |
Instructions
Prepare the 2014 income statement for Delgado Cruise Company.
Prepare a retained earnings statement. (LO 8)
E1-16 Presented below is information related to Williams and Douglas, Attorneys at Law.
Retained earnings, January 1, 2014 | $ 23,000 |
Legal service revenue—2014 | 340,000 |
Total expenses—2014 | 211,000 |
Assets, January 1, 2014 | 85,000 |
Liabilities, January 1, 2014 | 62,000 |
Assets, December 31, 2014 | 168,000 |
Liabilities, December 31, 2014 | 80,000 |
Dividends—2014 | 64,000 |
Instructions
Prepare the 2014 retained earnings statement for Williams and Douglas, Attorneys at Law.
Prepare a cash flow statement. (LO 8)
E1-17 This information is for Java Company for the year ended December 31, 2014 (amounts in thousands).
Cash received from revenues from customers | Rp600,000 |
Cash received for issuance of ordinary shares | 280,000 |
Cash paid for new equipment | 100,000 |
Cash dividends paid | 20,000 |
Cash paid for expenses | 430,000 |
Cash balance 1/1/14 | 30,000 |
Instructions
Prepare the 2014 statement of cash flows for Java Company.
Analyze transactions and compute net income. (LO 6, 7)
P1-1A Kinney's Repair Ltd. was started on May 1. A summary of May transactions is presented below.
Check figures next to some Problems give you a key number, to let you know if you are on the right track with your solution.
Instructions
(a) Total assets £13,140
(a) Prepare a tabular analysis of the transactions, using the following column headings: Cash, Accounts Receivable, Supplies, Equipment, Accounts Payable, Share Capital, and Retained Earnings (with separate columns for Revenues, Expenses, and Dividends). Include margin explanations for any changes in Retained Earnings. Revenue is called Service Revenue.
(b) Net income £3,890
(b) From an analysis of the Retained Earnings columns, compute the net income or net loss for May.
Analyze transactions and prepare income statement, retained earnings statement, and statement of financial position. (LO 6, 7, 8)
P1-2A On August 31, the statement of financial position of Donahue Veterinary Clinic showed Cash $9,000, Accounts Receivable $1,700, Supplies $600, Equipment $6,000, Accounts Payable $3,600, Share Capital—Ordinary $13,000, and Retained Earnings $700. During September, the following transactions occurred.
Instructions
(a) Ending cash $15,900
(a) Prepare a tabular analysis of the September transactions beginning with August 31 balances. The column headings should be as follows: Cash + Accounts Receivable + Supplies + Equipment = Notes Payable + Accounts Payable + Share Capital + Retained Earnings + Revenues − Expenses − Dividends.
(b) Net income $4,330
Total assets $29,800
(b) Prepare an income statement for September, a retained earnings statement for September, and a statement of financial position at September 30.
Prepare income statement, retained earnings statement, and statement of financial position. (LO 8)
P1-3A On May 1, Park Flying School, a company that provides flying lessons, was started with an investment of 45,000 cash in the business. Following are the assets and liabilities of the company on May 31, 2014, and the revenues and expenses for the month of May (all amounts in thousands).
Cash | 4,500 |
Accounts Receivable | 7,200 |
Equipment | 64,000 |
Service Revenue | 6,800 |
Advertising Expense | 500 |
Accounts Payable | 1,400 |
Notes Payable | 28,000 |
Rent Expense | 1,200 |
Maintenance and Repairs Expense | 400 |
Gasoline Expense | 2,500 |
Utilities Expense | 400 |
No additional investments were made in May, but the company paid dividends of 500,000 during the month.
Instructions
(a) Net income 1,800
Total assets 75,700
(a) Prepare an income statement and a retained earnings statement for the month of May and a statement of financial position at May 31. (Show numbers in thousands.)
(b) Net income 1,200
(b) Prepare an income statement and a retained earnings statement for May assuming the following data are not included above: (1) 900,000 of revenue was earned and billed but not collected at May 31, and (2) 1,500,000 of gasoline expense was incurred but not paid.
Analyze transactions and prepare financial statements. (LO 6, 7, 8)
P1-4A Matt Stiner started a delivery service, Stiner Deliveries, on June 1, 2014. The following transactions occurred during the month of June.
June 1 | Shareholders invested $10,000 cash in the business in exchange for ordinary shares. |
2 | Purchased a used van for deliveries for $14,000. Matt paid $2,000 cash and signed a note payable for the remaining balance. |
3 | Paid $500 for office rent for the month. |
5 | Performed $4,800 of services on account. |
9 | Declared and paid $300 in cash dividends. |
12 | Purchased supplies for $150 on account. |
15 | Received a cash payment of $1,250 for services provided on June 5. |
17 | Purchased gasoline for $100 on account. |
20 | Received a cash payment of $1,500 for services provided. |
23 | Made a cash payment of $500 on the note payable. |
26 | Paid $250 for utilities. |
29 | Paid for the gasoline purchased on account on June 17. |
30 | Paid $1,000 for employee salaries. |
Instructions
(a) Total assets $25,800
(a) Show the effects of the previous transactions on the accounting equation using the following format.
Include margin explanations for any changes in the Retained Earnings account in your analysis.
(b) Net income $4,450
(b) Prepare an income statement for the month of June.
(c) Cash $8,100
(c) Prepare a statement of financial position at June 30, 2014.
Determine financial statement amounts and prepare retained earnings statement. (LO 7, 8)
P1-5A Financial statement information about four different companies is as follows.
(a) Determine the missing amounts. (Hint: For example, to solve for (a), Assets − Liabilities = Equity = $25,000.)
(b) Prepare the retained earnings statement for Stills Company. Assume beginning retained earnings was $20,000.
(c) Write a memorandum explaining the sequence for preparing financial statements and the interrelationship of the retained earnings statement to the income statement and statement of financial position.
PROBLEMS: SET B
Analyze transactions and compute net income. (LO 6, 7)
P1-1B On April 1, Holly Dahl established Holiday Travel Agency. The following transactions were completed during the month.
Instructions
(a) Ending cash €11,500
(a) Prepare a tabular analysis of the transactions using the following column headings: Cash, Accounts Receivable, Supplies, Equipment, Accounts Payable, Share Capital, and Retained Earnings (with separate columns for Revenues, Expenses, and Dividends). Include margin explanation for any changes in Retained Earnings.
(b) Net income €5,600
(b) From an analysis of the Retained Earnings columns, compute the net income or net loss for April.
Analyze transactions and prepare income statement, retained earnings statement, and statement of financial position. (LO 6, 7, 8)
P1-2B Mandy Arnold opened a law office, Mandy Arnold, Attorney at Law, on July 1, 2014. On July 31, the statement of financial position showed Cash $4,000, Accounts Receivable $1,500, Supplies $500, Equipment $5,000, Accounts Payable $4,200, Share Capital—Ordinary $6,000, and Retained Earnings $800. During August, the following transactions occurred.
Instructions
(a) Ending expenses $4,460
(a) Prepare a tabular analysis of the August transactions beginning with July 31 balances. The column headings should be as follows: Cash + Accounts Receivable + Supplies + Equipment = Notes Payable + Accounts Payable + Share Capital + Retained Earnings + Revenues − Expenses − Dividends.
(b) Net income $3,440
Total assets $14,100
(b) Prepare an income statement for August, a retained earnings statement for August, and a statement of financial position at August 31.
P1-3B Angelic Cosmetics Co., a company that provides individual skin care treatment, was started on June 1 with an investment of ¥25,000,000 cash. Following are the assets and liabilities of the company at June 30 and the revenues and expenses for the month of June (in thousands).
Cash | ¥10,000 |
Accounts Receivable | 4,000 |
Service Revenue | 5,500 |
Supplies | 2,000 |
Advertising Expense | 500 |
Equipment | 25,000 |
Notes Payable | ¥13,000 |
Accounts Payable | 1,400 |
Rent Expense | 1,600 |
Gasoline Expense | 600 |
Utilities Expense | 300 |
Shareholders made no additional investments in June. The company paid a cash dividend of ¥900,000 during the month.
Instructions
(a) Net income ¥2,500
Total assets ¥41,000
(a) Prepare an income statement and a retained earnings statement for the month of June and a statement of financial position at June 30, 2014. (Show numbers in thousands.)
(b) Net income ¥3,200
(b) Prepare an income statement and a retained earnings statement for June assuming the following data are not included above: (1) ¥800,000 of revenue was earned and billed but not collected at June 30, and (2) ¥100,000 of gasoline expense was incurred but not paid.
Analyze transactions and prepare financial statements. (LO 6, 7, 8)
P1-4B Jessi Paulis started a consulting firm, Paulis Consulting, on May 1, 2014. The following transactions occurred during the month of May.
May 1 | Paulis invested $8,000 cash in the business in exchange for shares. |
2 | Paid $800 for office rent for the month. |
3 | Purchased $500 of supplies on account. |
5 | Paid $50 to advertise in the County News. |
9 | Received $3,000 cash for services provided. |
12 | Declared and paid a $700 cash dividend. |
15 | Performed $3,300 of services on account. |
17 | Paid $2,100 for employee salaries. |
20 | Paid for the supplies purchased on account on May 3. |
23 | Received a cash payment of $2,000 for services provided on account on May 15. |
26 | Borrowed $5,000 from the bank on a note payable. |
29 | Purchased office equipment for $2,300 on account. |
30 | Paid $150 for utilities. |
Instructions
(a) Total assets $17,800
(a) Show the effects of the previous transactions on the accounting equation using the following format.
Include margin explanations for any changes in the Retained Earnings account in your analysis.
(b) Net income $3,200
(b) Prepare an income statement for the month of May.
(c) Cash $13,700
(c) Prepare a statement of financial position at May 31, 2014.
Determine financial statement amounts and prepare retained earnings statement. (LO 7, 8)
P1-5B Financial statement information about four different companies is shown on the next page.
Instructions
(a) Determine the missing amounts. (Hint: For example, to solve for (a), Assets − Liabilities = Equity = $28,000.)
(b) Prepare the retained earnings statement for John Company. Assume beginning retained earnings was $0.
(c) Write a memorandum explaining the sequence for preparing financial statements and the interrelationship of the retained earnings statement to the income statement and statement of financial position.
The Continuing Cookie Chronicle starts in this chapter and continues in every chapter. You also can find this problem at the book's companion website.
CCC1 Natalie Koebel spent much of her childhood learning the art of cookie-making from her grandmother. They passed many happy hours mastering every type of cookie imaginable and later creating new recipes that were both healthy and delicious. Now at the start of her second year in college, Natalie is investigating various possibilities for starting her own business as part of the requirements of the entrepreneurship program in which she is enrolled.
A long-time friend insists that Natalie has to somehow include cookies in her business plan. After a series of brainstorming sessions, Natalie settles on the idea of operating a cookie-making school. She will start on a part-time basis and offer her services in people's homes. Now that she has started thinking about it, the possibilities seem endless. During the fall, she will concentrate on holiday cookies. She will offer individual lessons and group sessions (which will probably be more entertainment than education for the participants). Natalie also decides to include children in her target market.
The first difficult decision is coming up with the perfect name for her business. In the end, she settles on “Cookie Creations” and then moves on to more important issues.
Instructions
(a) What form of business organization—proprietorship, partnership, or corporation—do you recommend that Natalie use for her business? Discuss the benefits and weaknesses of each form and give the reasons for your choice.
(b) Will Natalie need accounting information? If yes, what information will she need and why? How often will she need this information?
(c) Identify specific asset, liability, and equity accounts that Cookie Creations will likely use to record its business transactions.
(d) Should Natalie open a separate bank account for the business? Why or why not?
Broadening Your PERSPECTIVE
Financial Reporting and Analysis
Financial Reporting Problem: Samsung Electronics Co., Ltd.
BYP1-1 The actual financial statements of Samsung, as presented in the company's 2010 Annual Report, are contained in Appendix A (at the back of the textbook). The complete annual report, including the notes to the financial statements, is available in the Investor Relations section of the company's website, www.samsung.com.
Refer to Samsung's financial statements and answer the following questions. (Use amounts as reported in Korean won.)
(a) What were Samsung's total assets at December 31, 2010? At December 31, 2009?
(b) How much cash (and cash equivalents) did Samsung have on December 31, 2010?
(c) What amount of accounts (trade and other) payable did Samsung report on December 31, 2010? On December 31, 2009?
(d) What was Samsung's revenue in 2009? In 2010?
(e) What is the amount of the change in Samsung's net income from 2009 to 2010? (Hint: Use “Profit for the year”.)
Comparative Analysis Problem: Nestlé S.A. vs. Zetar plc
BYP1-2 Nestlé's financial statements are presented in Appendix C. Zetar's financial statements are presented in Appendix C.
Instructions
Refer to the financial statements and answer the following questions.
(a) Based on the information contained in these financial statements, determine the following for each company.
(1) Total assets at December 31, 2010, for Nestlé, and for Zetar at April 30, 2011.
(2) Accounts (trade) receivable, net at December 31, 2010, for Nestlé and at April 30, 2011, for Zetar.
(3) Net sales for year ended December 31, 2010, for Nestlé and April 30, 2011, for Zetar.
(4) Net income (profit) for year ended December 31, 2010, for Nestlé and April 30, 2011, for Zetar.
(b) What percentage do receivables represent of total assets for the two companies? What percentage does net income represent of sales (revenue) for the two companies?
Real-World Focus
BYP1-3 This exercise will familiarize you with skill requirements, job descriptions, and salaries for accounting careers.
Address: www.careers-in-accounting.com, or go to www.wiley.com/college/weygandt
Instructions
Go to the site shown above. Answer the following questions.
(a) What are the three broad areas of accounting (from “Skills and Talents Required”)?
(b) List eight skills required in accounting.
(c) How do the three accounting areas differ in terms of these eight required skills?
(d) Explain one of the key job alternatives in accounting.
(e) What is the salary range for a junior staff accountant to a Big 4 firm?
Critical Thinking
Decision-Making Across the Organization
BYP1-4 Lucy and Nick Lars, local golf stars, opened the Chip-Shot Driving Range Company on March 1, 2014. They invested $20,000 cash and received ordinary shares in exchange for their investment. A caddy shack was constructed for cash at a cost of $6,000, and $800 was spent on golf balls and golf clubs. The Lars leased five acres of land at a cost of $1,000 per month and paid the first month's rent. During the first month, advertising costs totaled $750, of which $150 was unpaid at March 31, and $400 was paid to members of the high school golf team for retrieving golf balls. All revenues from customers were deposited in the company's bank account. On March 15, Lucy and Nick received a dividend of $800. A $100 utility bill was received on March 31 but was not paid. On March 31, the balance in the company's bank account was $15,100.
Lucy and Nick thought they had a pretty good first month of operations. But, their estimates of profitability ranged from a loss of $4,900 to net income of $1,650.
With the class divided into groups, answer the following.
(a) How could the Lars have concluded that the business operated at a loss of $4,900? Was this a valid basis on which to determine net income?
(b) How could the Lars have concluded that the business operated at a net income of $1,650? (Hint: Prepare a statement of financial position at March 31.) Was this a valid basis on which to determine net income?
(c) Without preparing an income statement, determine the actual net income for March.
(d) What was the revenue earned in March?
Communication Activity
BYP1-5 Erin Danielle, the bookkeeper for Liverpool Company, has been trying to get the statement of financial position to balance. The company's statement of financial position is shown below.
Instructions
Explain to Erin Danielle in a memo why the original statement of financial position is incorrect, and what should be done to correct it.
Ethics Case
BYP1-6 After numerous campus interviews, Jeff Hunter, a senior at Great Northern College, received two office interview invitations from the Baltimore offices of two large firms. Both firms offered to cover his out-of-pocket expenses (travel, hotel, and meals). He scheduled the interviews for both firms on the same day, one in the morning and one in the afternoon. At the conclusion of each interview, he submitted to both firms his total out-of-pocket expenses for the trip to Baltimore: mileage $112 (280 miles at $0.40), hotel $130, meals $36, parking and tolls $18, for a total of $296. He believes this approach is appropriate. If he had made two trips, his cost would have been two times $296. He is also certain that neither firm knew he had visited the other on that same trip. Within 10 days, Jeff received two checks in the mail, each in the amount of $296.
Instructions
(a) Who are the stakeholders (affected parties) in this situation?
(b) What are the ethical issues in this case?
(c) What would you do in this situation?
Answers to Chapter Questions
Answers to Insight and Accounting Across the Organization Questions
p. 7 The Numbers Behind Not-for-Profit Organizations Q: What benefits does a sound accounting system provide to a not-for-profit organization? A: Accounting provides at least two benefits to not-for-profit organizations. First, it helps to ensure that money is used in the way that donors intended. Second, it assures donors that their money is not going to waste and thus increases the likelihood of future donations.
p. 9 The Korean Discount Q: What is meant by the phrase “make the country's businesses more transparent”? Why would increasing transparency spur economic growth? A: Transparency refers to the extent to which outsiders have knowledge regarding a company's financial performance and financial position. If a company lacks transparency, its financial reports do not adequately inform investors of critical information that is needed to make investment decisions. If corporate transparency is increased, investors will be more willing to supply the financial capital that businesses need in order to grow, which would spur the country's economic growth.
p. 11 Spinning the Career Wheel Q: How might accounting help you? A: You will need to understand financial reports in any enterprise with which you are associated. Whether you become a manager, a doctor, a lawyer, a social worker, a teacher, an engineer, an architect, or an entrepreneur, a working knowledge of accounting is relevant.
p. 24 What Do Vodafone, Walt Disney, and JJB Sports Have in Common? Q: What year-end would you likely use if you owned a ski resort and ski rental business? A: Probable choices for a ski resort would be between May 31 and August 31. Q: What if you owned a college bookstore? A: For a college bookstore, a likely year-end would be June 30. Q: Why choose those year-ends? A: The optimum accounting year-end, especially for seasonal businesses, is a point when inventory and activities are lowest.
p. 25 Beyond Financial Statements Q: Why might a company's shareholders be interested in its environmental and social performance? A: Many companies now recognize that being a socially responsible organization is not only the right thing to do, but it also is good for business. Many investment professionals understand, for example, that environmental, social, and proper corporate governance of companies affects the performance of their investment portfolios. For example, British Petroleum's (GBR) oil leak disaster is a classic example of the problems that can occur for a company and its shareholders. BP's share price was slashed, its dividend reduced, its executives replaced, and its reputation badly damaged. It is interesting that socially responsible investment funds are now gaining momentum in the marketplace such that companies now recognize this segment as an important investment group.
Answers to Self-Test Questions
1. b 2. d 3. c 4. b 5. b 6. d 7. b 8. a (€3,500 − €2,000) 9. b 10. a ($90,000 − $50,000) 11. d 12. c 13. b 14. c *15. a
As indicated in the chapter, IFRSs, which are issued by the IASB, are used by most countries in the world. However, another major standard-setter resides in the United States: the Financial Accounting Standards Board (FASB). Prior to the creation of IFRS, the U.S. accounting standards, referred to as generally accepted accounting principles (GAAP), were used by companies in many countries. Today, the IASB and the FASB are working jointly to achieve a single set of standards, although it may be five to ten years before a conversion to a single set of standards takes place. Until this happens, it is important for investors, accountants, and students to understand the key differences that exist between the standards.
Key Points
Multinational corporations. Today's companies view the entire world as their market. For example, large companies often generate more than 50% of their sales outside their own boundaries.
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 individuals in 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. Whether it is currency, equity securities (shares), bonds, or derivatives, there are active markets throughout the world trading these types of instruments.
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.
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 entity's ongoing major or central operations.
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 entity's ongoing major or central operations.
Looking to the Future
Both 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.
GAAP Practice
GAAP Self-Test Questions
(a) Mergers and acquisition activity.
(b) Financial markets.
(c) Multinational corporations.
(d) GAAP is widely considered to be a superior reporting system.
(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.
(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.
(a) GAAP is based on a conceptual framework that is similar to that used to develop IFRS.
(b) FASB and the IASB are working on a joint project related to the conceptual framework.
(c) Non-U.S. companies that trade shares in U.S. markets must reconcile their accounting with GAAP.
(d) Proprietorships, partnerships, and corporations are also found in countries that use IFRS.
(a) Financial frauds have not occurred in U.S. companies because GAAP has detailed accounting and disclosure requirements.
(b) Transaction analysis is basically the same under GAAP and IFRS.
(c) IFRS companies have agreed to adopt the Sarbanes-Oxley Act related to internal control in 2015.
(d) Equity is defined under GAAP as the residual interest in the liabilities of the company.
GAAP Exercises
GAAP1-1 Who are the two key international players in the development of international accounting standards? Explain their role.
GAAP1-2 What might explain the fact that different accounting standard-setters have developed accounting standards that are sometimes quite different in nature?
GAAP1-3 What is the benefit of a single set of high-quality accounting standards?
GAAP1-4 Discuss the potential advantages and disadvantages that countries outside the United States should consider before adopting regulations, such as those in the Sarbanes-Oxley Act, that increase corporate internal control requirements.
GAAP Financial Reporting Problem: Tootsie Roll Industries, Inc.
GAAP1-5 The financial statements of Tootsie Roll are presented in Appendix D. The company's complete annual report, including the notes to its financial statements, is available at www.tootsie.com.
Instructions
Refer to Tootsie Roll's financial statements to answer the following questions.
(a) What were Tootsie Roll's total assets at December 31, 2010? At December 31, 2009?
(b) How much cash did Tootsie Roll have on December 31, 2010?
(c) What amount of accounts payable did Tootsie Roll report on December 31, 2010? On December 31, 2009?
(d) What were Tootsie Roll's total revenues in 2010? In 2009?
(e) What is the amount of the change in Tootsie Roll's net income from 2009 to 2010?
Answers to GAAP Self-Test Questions
1. d 2. c 3. a 4. c 5. b
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1The appendix to this chapter describes job opportunities for accounting majors and explains why accounting is such a popular major.
2The origins of accounting are generally attributed to the work of Luca Pacioli, an Italian Renaissance mathematician. Pacioli was a close friend and tutor to Leonardo da Vinci and a contemporary of Christopher Columbus. In his 1494 text Summa de Arithmetica, Geometria, Proportione et Proportionalite, Pacioli described a system to ensure that financial information was recorded efficiently and accurately.
3For the illustrative equations that follow, we use the general account title “Share Capital” instead of “Share Capital—Ordinary” for space considerations.
4http://www.startheregoplaces.com/why-accounting/salary-and-demand/ (accessed April 24, 2011).