Chapter 1

1. Chapter 1 Accounting in Action ACT 201 By: Ms. Adina Malik (ALK)

2. Accounting What is Accounting? • Accounting is an information system that identifies, records and communicates the economic events of an organization to interested users. Economic Events? • Monetary transactions • For e.g. Cement bags sold by Crown Cement for Tk. 500,000. • For e.g. Payment of salaries to BRAC Bank employees.

3. Users of Accounting Data Internal • marketing managers, production supervisors, finance directors, company officers (more in Managerial Accounting) External • Investors, creditors, taxing authorities, regulatory agencies, labor unions, customers & so on. (in financial accounting)

4. What is Accounting? • Identification: • Of economic events • Recording: • Systematic, chronological diary of events. • Classifies and summarizes economic events. • Communication involves analyzing and interpreting the reported information. • Analysis involves use of ratios, graph, charts, and percentages to highlight significant financial trends and relationships. • Interpretation involves explaining the uses, meaning & limitations of the reported data.

5. The Activities of the Accounting Process The Accounting Process involves the bookkeeping function, another name for recording.

6. Ethics in Financial Reporting • Ethics:The standards of conduct by which one’s actions are judged as right or wrong, honest or dishonest, fair or not fair. • Recent financial scandals include: Enron, WorldCom, AIG, etc. • Enron: • American natural gas pipeline company, based in Texas • Company executives manipulated the earnings report-showed more profit, losses were hidden • Scandal was revealed in October 2001 • Losses exceeded $70 billion and the company went into bankruptcy • It led to the dissolution of the accounting firm, Arthur and Anderson

7. Ethics in Financial Reporting • Congress passes the Sarbanes Oxley Act of 2002: To reduce unethical corporate behavior and decrease the likelihood of future corporate scandals. • Top management has to certify the accuracy of the financial statements • Top management will face huge penalty for fraudulent financial activity • The accuracy of the financial statements are required to be reviewed by external auditor • The Board of Directors will have an oversight role • Effective financial reporting depends on sound ethical behavior. • GAAP (Generally Accepted Accounting Principles): • Generally Accepted & Universally Practiced • Common set of standards or general guide for financial reporting purpose

8. The Building Blocks of Accounting Reporting Standards of Financial Information • FINANCIAL STATEMENTS: • Income Statement • Statement of Retained Earnings/ Owner’s Equity Statement • Balance Sheet • Statement of Cash Flow • *Note Disclosure GAAP (Generally Accepted Accounting Principles)

9. The Building Blocks of Accounting • Cost Principle (Historical) • It dictates that companies record assets at their cost. • Issues: • Reported at cost when purchased and also over the time the asset is held. • Cost easily verified, whereas market value or fair value is often subjective.

10. Assumptions Assumptions are foundation for the accounting process: • Monetary Unit Assumption – include in the accounting records only transaction data that can be expressed in terms of money. • Economic Entity Assumption – requires that activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities. An economic entity can be any organization or unit in a society. • Proprietorship. • Partnership. • Corporation. Forms of Business Ownership

11. Forms of Business Ownership

12. The Basic Accounting Equation Assets Liabilities Owner’s Equity The equation provides the underlying framework for recording and summarizing economic events

13. The Basic Accounting Equation Assets: • Resources a business owns. E.g. Cash, Supplies, Equipment, Accounts Receivables, Inventories, Land, Building, etc. • The capacity to provide future services or benefits. • They are claimed by either creditors or owners.

14. The Basic Accounting Equation • Liabilities (debts & obligations): • Claims against Assets • Creditors: Party to whom money is owed • E.g. accounts payable, note payable, wages payable, etc. • Liabilities appear before owner’s equity because they are paid first if a business is liquidated.

15. The Basic Accounting Equation Owner’s Equity • The ownership claim on Total Assets are called Owner’s Equity. Often referred to as Residual Equity. • Owner’s Capital:Investments by owners or assets that owners put into the business. • Owner’s Drawings:Withdrawal of owner (cash/other assets) for personal use. • Revenues:Resulting from business activities entered into for the purpose of earning income. E.g. sales, fees, services, commissions, etc. • Expenses: the cost of assets consumed or services used in the process of earning revenue. E.g. utility expense, salaries and wages, telephone expense, travel expense, rent expense, internet expense, etc.

16. Expanded Accounting Equation Note: Revenue – Expenses=Net Income/Net Loss

17. Transactions • Transactions are economic events of a business, recorded by Accountants. • May be external or internal. • Not all activities represent transactions. Note that ‘Discussing about product design with potential customer’is not a transaction. • Is the financial position (assets, liabilities or owner’s equity) of the company changed? • Each transaction must have a dual effect on the accounting equation. • An increase in asset must have a corresponding decrease in another asset, or an increase in liability or an increase in owner’s equity • Two or more items could be affected.

18. Transaction Analysis Transaction (1):Ray Neal decides to open a computer programming service which he names Softbyte. On September 1, 2011, Ray Neal invests $15,000 cash in the business. SO 7

19. Transaction Analysis Transaction (2): Purchase of Equipment for Cash. Softbyte purchases computer equipment for $7,000 cash. SO 7

20. Transaction Analysis Transaction (3): Softbyte purchases for $1,600 from Acme Supply Company computer paper and other supplies expected to last several months. The purchase is made on account. SO 7

21. Transaction Analysis Transaction (4): Softbyte receives $1,200 cash from customers for programming services it has provided. SO 7

22. Transaction Analysis Transaction (5): Softbyte receives a bill for $250 from the Daily News for advertising but postpones payment until a later date. SO 7

23. Transaction Analysis Transaction (6): Softbyte 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. SO 7

24. Transaction Analysis Transaction (7):Softbyte pays the following expenses in cash for September: store rent $600, salaries of employees $900, and utilities $200. SO 7

25. Transaction Analysis Transaction (8): Softbyte pays its $250 Daily News bill in cash. SO 7

26. Transaction Analysis Transaction (9): Softbyte receives $600 in cash from customers who had been billed for services [in Transaction (6)]. SO 7

27. Transaction Analysis Transaction (10): Ray Neal withdraws $1,300 in cash from the business for his personal use. SO 7

28. Financial Statements • An income statement presents the revenues and expenses and resulting net income or net loss for a specific period of time. • An owner’s equity statement summarizes the changes in owner’s equity for a specific period of time. • A balance sheet reports the assets, liabilities and owner’s equity at a specific date. • A statement of cash flowssummarizes information about the cash inflows (receipts) and outflows (payments) for a specific period of time.