Accounting

Principles

Second Canadian Edition

Weygandt Kieso Kimmel Trenholm

Source and Adapted from

Carole Bowman, Sheridan College

CHAPTER

1
ACCOUNTING IN ACTION

ILLUSTRATION 1-1

THE ACCOUNTING PROCESS

Communication
Identification

Recording

Accounting
Reports

Prepare
accounting reports
SOFTBYTE

Select economic events

(transactions)

Record, classify,
and summarize

Annual Report

Analyse and interpret

for users

USERS OF
ACCOUNTING INFORMATION
Internal Users
Includes Marketing, Human Resources, Production,
Senior Management
Used for planning, organizing and running the business
External Users
Investors, Creditors, Labour Unions, Customers,
Regulators and other authorities
Used for decisions of ownership, credit, lending, assess
compliance, performance

ILLUSTRATION 1-2

QUESTIONS ASKED BY INTERNAL USERS

Is cash sufficient to pay bills?

Can we afford to give employees

pay raises this year?

What is the cost of manufacturing

each unit of product?

Which product line is the most

profitable?

ILLUSTRATION 1-3

QUESTIONS ASKED BY EXTERNAL USERS

Is the company earning

satisfactory income?

How does the company compare in

size and profitability with its
competitors?
What do we
do if they
catch us?

Will the company be able to pay its debts as they come due?

BOOKKEEPING DISTINGUISHED
FROM ACCOUNTING
Accounting
1. Includes bookkeeping
2. Also includes much more
Bookkeeping
1. Involves only the recording of economic events
2. Is just one part of accounting

THE ACCOUNTING PROFESSION

Public accountants offer their expertise to the general

public through the services they perform.

Private accountants are employees of individual
companies and are involved in a number of activities,
including cost and tax accounting, systems, and internal
auditing.
Not-for-profit accounting includes reporting and control
for government units, foundations, hospitals, labour
unions, colleges/universities, and charities.

ILLUSTRATION 1-4

ETHICS
Ethics

Standards of conduct

To Solve Ethical Dilemma

1. Recognize situation
and ethical issues
involved
2. Identify and analyse
elements
3. Identify at least two
alternatives and
weigh effects (costs
and benefits) on
stakeholders
4. Select the most
ethical alternative
and justify

GAAP
Generally Accepted Accounting Principles
Common set of accounting standards
Developed by the Canadian Institute of Chartered
Accountants (CICA)
Consult with organizations and individuals
Authority through Canadian and provincial
business and securities statutes
Moving towards international financial reporting
standards (IFRS)

GAAP
Generally Accepted Accounting Principles
Primarily established by the Canadian Institute of
Chartered Accountants
Cost Principle
The cost principle dictates that assets are
recorded at their cost.
Cost is the value exchanged at the time something
is acquired.
Cost is used because it is both relevant and
reliable.

GAAP
1. Objectivity Principle
The accounting for a business should be recorded
on the basis of objective evidence (i.e., source
documents) which includes complete details of
each transaction.
2. Cost Principle
Accounting for purchases should be recorded at
their original cost (purchase price) to the
purchaser.
The cost price of an asset in the books does not
change over time.

GAAP
3. Going Concern Principle
One should assume that a business will continue
to operate indefinitely unless there is clear
evidence to the contrary.
Assets should be listed at their cost price (and not
their liquidation value) in the books.
4. Business Entity Principle
The accounting for a business should be kept
separate and apart from the personal accounting
of the owner, or any other business organization.

GAAP
5. Principle of Conservatism
The accounting for a business should be fair and
reasonable. Neither profits nor equity should be
overstated or understated.
Practice follows the Lower of Cost or Net
Realizable Market [LCM] Principle
Merchandise inventory should be valued at the
lower of its cost (purchase) or net realizable
market value (current replacement/resale value
minus costs of disposition).

GAAP
6. Revenue Recognition Principle
Under the accrual basis of accounting, revenues
should be recognized (or recorded) in the fiscal
period in which the transaction is completed
i.e., when goods/services are, and/or the bill is
delivered to the customer and not necessarily
when payment is ultimately received.
7. Time Period Principle
Accounting takes place over specified time
periods known as fiscal periods. These periods
should be of equal length when used to measure
the financial progress of the business.

GAAP
8. Matching Principle

Under the accrual basis of accounting, expenses

should be recorded in the same fiscal period as

the revenues they helped to earn.
i.e., when expenses were incurred and/or the
bill is received) and not necessarily when
payment is ultimately delivered.
9. Consistency Principle
A business should use the same accounting
methods and procedures from period to period.
Any necessary legitimate changes should be
clearly disclosed in the financial statements or
the notes to those statements.

GAAP
10. Materiality Principle
Any material (significant) information that has
an immediate impact upon a companys
accounts should be included with that
companys financial statements.
11. Full Disclosure Principle
Any information that one day may have an
impact upon a companys financial
performance should be included with that
company's financial statements or the notes to
those statements.

ASSUMPTIONS
1. Going Concern - assumes organization will

continue into foreseeable future.

2. Monetary Unit - only transaction data that can
be expressed in terms of money is included in
the accounting records.
3. Economic Entity - includes any business
enterprise where the owners personal affairs
are kept separate from the company affairs.

GAAP CHALLENGE
1. The owner of a sole proprietorship lists his
family vehicle under the assets section of the
companys balance sheet.
2. The owner of a small clothing outlet lists the
value of the company car at its current resale
value because he assumes the business is about
to close once Wal-Mart moves into the
neighbourhood the following year.

GAAP CHALLENGE
3. An accountant alternates between using a oneyear fiscal period and a three-month fiscal period
for her business.
4. A large, multinational corporation issues an
amended balance sheet which features restated
values for Office Supplies due to the omission of
$16 worth of elastic bands.

GAAP CHALLENGE
5. The purchase of a new computer was recorded at
its retail value (sticker price) of $600 even
though the company had negotiated a good deal
and paid only $400 for the item.
6. A corporation fails to disclose in its annual
report that it is the defendant in a $3 million
class action lawsuit recently launched by
disgruntled shareholders.

GAAP CHALLENGE
7. A bookkeeper records a credit sale in the books
of the company on March 14 because that was
the day that payment of the account was finally
received.
8. A telephone bill is recorded in the books on the
day it was finally paid even though the bill had
arrived three weeks earlier.

GAAP CHALLENGE
9. The CEO of a large company encourages her
department to work from memory and not spend
too much time worrying about the maintenance
of source documents.
10.An accountant ignores the gradual loss in market
value of the firms merchandise inventory in
order to improve the equity position of the
company.

GAAP CHALLENGE
11.An accountant alternates between the straightline and declining-balance methods of
depreciation on the company building in order to
lower expenses and increase profits.
12.Computers costing less than $1,000 are
immediately expensed even though their useful
life is three years.

BUSINESS ENTERPRISES
A business owned by one person is generally a

proprietorship (owners equity).

A business owned by two or more persons associated as
partners is a partnership (partners equity).
A business organized as a separate legal entity under
corporation law and having ownership divided into
transferable shares is called a corporation (shareholders
equity).

ILLUSTRATION 1-5

BASIC ACCOUNTING EQUATION

The Basic Accounting Equation

Assets

Liabilities

Owners Equity

ASSETS AS A BUILDING BLOCK

Assets are resources owned by a business.
They are things of value used in carrying
out such activities as production and
exchange.

LIABILITIES AS A BUILDING BLOCK

Liabilities are claims against assets.
They are existing debts and obligations.

OWNERS EQUITY AS
A BUILDING BLOCK
Owners

Equity is equal to total assets minus

total liabilities.
Owners Equity represents the ownership claim
on total assets.
Subdivisions of Owners Equity:
1. Capital
2. Drawings
3. Revenues
4. Expenses

INVESTMENTS BY OWNERS
AS A BUILDING BLOCK
Investments by owner are the assets put into

the business by the owner.

These investments in the business increase
owners equity.

DRAWINGS AS A
BUILDING BLOCK
Drawings are withdrawals of cash or other

assets by the owner for personal use.

Drawings decrease total owners equity.

REVENUES AS A
BUILDING BLOCK
Revenues are the gross increases in owners equity

resulting from business activities entered into for

the purpose of earning income.
Revenues may result from sale of merchandise,
performance of services, rental of property, or
lending of money.
Revenues usually result in an increase in an asset.

EXPENSES AS A
BUILDING BLOCK
Expenses are the decreases in owners equity that

result from operating the business.

Expenses are the cost of assets consumed or
services used in the process of earning revenue.
Examples of expenses include utility expense, rent
expense, and supplies expense.

ILLUSTRATION 1-6

INCREASES AND DECREASES IN

OWNERS EQUITY
INCREASES
Investments
by Owner

Revenues

DECREASES
Owners
Equity

Withdrawals
by Owner

Expenses

TRANSACTION ANALYSIS
Marc Doucet decides to open a computer
programming service.

BANK

Softbyt
e

TRANSACTION ANALYSIS

TRANSACTION 1
On September 1, he invests $15,000 cash in the
business, which he names Softbyte.
Trans. #

(1)

Assets
Cash
15,000

Supplies

= Liabilities +
Owner's Equity
Accounts
M. Doucet,
Equipment
Payable
Capital
=
15,000 Investment

There is an increase in the asset Cash, $15,000, and

an equal increase in the owners equity, M. Doucet,
Capital, $15,000.

TRANSACTION ANALYSIS

TRANSACTION 2
Softbyte purchases computer equipment for $7,000 cash.
Trans. #

(2)
Balance

Assets
Cash
Supplies
15,000
(7,000)
8,000 +

= Liabilities +
Owner's Equity
Accounts
M. Doucet,
Equipment
Payable
Capital
15,000 Investment
7,000
7,000 =
15,000

Cash is decreased $7,000, and the asset

Equipment is increased $7,000.

TRANSACTION ANALYSIS

TRANSACTION 3
Softbyte purchases computer paper and supplies expected to last
several months from Chuah Supply Company for $1,600 on account.
Trans. #

Balance
(3)
Balance

Assets

== Liabilities
Owner's
Liabilities ++
Owner's Equity
Accounts
M.
Accounts
M. Doucet,
Cash
Supplies
Equipment
Payable
Capital
Equipment
8,000
7,000
15,000
8,000
7,000
15,000
1,600
1,600
8,000 +
1,600 +
7,000 =
1,600 +
15,000

The asset Supplies is increased $1,600, and the liability

Accounts Payable is increased by the same amount.

TRANSACTION ANALYSIS

TRANSACTION 4
Softbyte receives $1,200 cash from customers for
programming services it has provided.
Trans. #

Balance
(4)
Balance

Assets

= Liabilities +
Owner's Equity
Accounts
M. Doucet,
Cash
Payable
Capital
Supplies
Equipment
1,600
7,000
1,600
8,000
15,000
1,200
1,200 Service Revenue
9,200 +
1,600 +
7,000 =
1,600 +
16,200

Cash is increased $1,200, and

M. Doucet, Capital is increased $1,200.

TRANSACTION ANALYSIS

TRANSACTION 5
Softbyte receives a bill for $250 for advertising its business
but pays the bill on a later date.
Trans. #

Balance
(5)
Balance

Assets

= Liabilities +
Owner's
Owner's Equity
Accounts
M. Doucet,
Cash
Supplies
Equipment
Payable
Capital
9,200 +
1,600
7,000
1,600
16,200
1,600 +
7,000 =
1,600 +
16,200
250
(250) Advertising Expense
9,200
1,600
7,000
1,850
15,950

Accounts Payable is increased $250, and M.

Doucet, Capital is decreased $250.

TRANSACTION ANALYSIS

TRANSACTION 6
Softbyte provides programming services of $3,500 for
customers and receives cash of $1,500, with the balance
payable on account.
Trans. ##

Balance
Balance
(6)
Balance

Cash
9,200
9,200
1,500
10,700

Assets
== Liabilities
Liabilities ++
Owner's
Owner's Equity
Account
Account
Accounts
Accounts
M.
M. Doucet,
Doucet,
Receivable
Receivable Supplies
Supplies Equipment
Equipment
Payable
Payable
Capital
Capital
++
00 ++ 1,600
1,600 ++
7,000
7,000 ==
1,850
1,850
15,950
15,950
2,000
3,500 Service Revenue
2,000
1,600
7,000
1,850
19,450

Cash is increased $1,500; Accounts Receivable is

increased $2,000; and M. Doucet, Capital is
increased $3,500.

TRANSACTION ANALYSIS

TRANSACTION 7
Expenses paid in cash for September are store rent,
$600, salaries of employees, $900, and utilities, $200.
Trans. #

Balance
(7)

Balance

Cash
10,700
(600)
(900)
(200)
9,000 +

Assets
Account
Receivable
Supplies
2,000
1,600

2,000 +

= Liabilities +
Owner's Equity
Accounts
M. Doucet,
Equipment
Payable
Capital
7,000
1,850
19,450
(600) Rent Exp.
(900) Salaries Exp.
(200) Utilities Exp.
1,600 +
7,000 =
1,850 +
17,750

Cash is decreased $1,700 and M. Doucet,

Capital is decreased the same amount.

TRANSACTION ANALYSIS

TRANSACTION 8
Softbyte pays its advertising bill of $250 in cash.

Trans. #
Balance
Balance
(8)
Balance

Cash
Cash
9,000
9,000
(250)
8,750 +

AccountAssets
Account
Receivable
Supplies
Receivable
Supplies
2,000
1,600
2,000
1,600
2,000 +

1,600 +

Equipment
Equipment
7,000
7,000
7,000

= Liabilities
Owner's Equity
Accounts + M. Doucet,
Accounts
M.Capital
Doucet,
Payable
Payable
Capital
1,850
17,750
1,850
17,750
(250)
=
1,600 +
17,750

Cash is decreased $250 and Accounts

Payable is decreased the same amount.

TRANSACTION ANALYSIS

TRANSACTION 9
The sum of $600 in cash is received from customers who
have previously been billed for services in Transaction 6.
Trans. #

Balance
(9)
Balance

Assets
= Liabilities +
Owner's Equity
Account
Accounts
M. Doucet,
Cash
Receivable
Supplies
Payable
Capital
Equipment
8,750 +
2,000 +
1,600 +
7,000 =
1,600 +
17,750
600
(600)
9,350 +
1,400 +
1,600 +
7,000 =
1,600 +
17,750

Cash is increased $600 and Accounts

Receivable is decreased by the same amount.

TRANSACTION ANALYSIS

TRANSACTION 10
Marc Doucet withdraws $1,300 in cash from
the business for his personal use.
Trans. #

Balance
(10)
Balance

Assets

Cash
9,350
(1,300)
8,050

= Liabilities
Owner's
Liabilities ++
Owner's Equity
Account
Accounts
M.
Accounts
M. Doucet,
Doucet,
Receivable Supplies
Equipment
Payable
Capital
Equipment
Payable
Capital
1,400
1,600
7,000
1,600
17,750
1,600
7,000
1,600
17,750
(1,300) Doucet, Drawings
+
1,400 +
1,600 +
7,000 =
1,600 +
16,450

Cash is decreased $1,300 and M. Doucet,

Capital is decreased by the same amount.

FINANCIAL STATEMENTS
After transactions are identified, recorded, and
summarized, four financial statements are
prepared from the summarized accounting data:
1. An income statement presents the revenues
and expenses and resulting net income or net
loss of a company for a specific period of time.
2. A statement of owners equity summarizes the
changes in owners equity for a specific period
of time.

FINANCIAL STATEMENTS
In addition to the income statement and statement of
owners equity, two additional statements are
prepared:
3. A balance sheet reports the assets, liabilities, and
owners equity of a business enterprise at a
specific date.
4. A cash flow statement summarizes information
concerning the cash inflows (receipts) and
outflows (payments) for a specific period of time.
The notes are an integral part of the financial
statements.

ILLUSTRATION 1-10
FINANCIAL STATEMENTS AND THEIR
INTERRELATIONSHIPS
SOFTBYTE
Income Statement
For the Month Ended September 30, 2002
Revenues
Service revenue
$
4,700
Expenses
Salaries expense
$
900
Rent expense
600
Advertising expense
250
Utilities expense
200
Total expenses
1,950
Net income
$
2,750

Net income of $2,750 shown on the income statement is added to the

beginning balance of owners capital in the statement of owners equity.

ILLUSTRATION 1-10

FINANCIAL STATEMENTS AND THEIR

INTERRELATIONSHIPS
SOFTBYTE
Statement of Owner's Equity
For the Month Ended September 30, 2002
M. Doucet, Capital, September 1
Add: Investments
Net income
Less: Drawings
M. Doucet, Capital September 30

$
$ 15,000
2,750

17,750
$ 17,750
1,300
$ 16,450

Net income of $2,750 is carried forward from the income statement to

the statement of owners equity. The owners capital of $16,450 at the
end of the reporting period is shown as the final total of the owners
equity column of the Summary of Transactions (Illustration 1-9 in text).

ILLUSTRATION 1-10

FINANCIAL STATEMENTS AND THEIR

INTERRELATIONSHIPS
Owners
capital of
$16,450 at the
end of the
reporting
period shown
in the
statement of
owners equity
is also shown
on the balance
sheet. Cash of
$8,050 on the
balance sheet is
reported on the
cash flow
statement.

SOFTBYTE
Balance Sheet
September 30, 2002
Assets
Cash
Accounts receivable
Supplies
Equipment
Total assets

8,050
1,400
1,600
7,000
$ 18,050

Liabilities and Owner's Equity

Liabilities
Accounts payable
Owner's Equity
M. Doucet, Capital
Total liabilities and owner's equity

1,600

16,450
$ 18,050

ILLUSTRATION 1-10

FINANCIAL STATEMENTS AND THEIR

INTERRELATIONSHIPS
Cash of
$8,050 on the
balance sheet
and cash flow
statement is
shown as the
final total of
the cash
column of the
Summary of
Transactions
(Illustration
1-9 in text).

USING THE INFORMATION IN THE

FINANCIAL STATEMENTS

Annual Reports
Non-financial

information
Financial

information