Financial Accounting and Accounting Standards

[Audio] WILEY IFRS EDITION Prepared by Coby Harmon University of California, Santa Barbara Westmont College.

[Audio] PREVIEW OF CHAPTER 1 Financial Accounting IFRS 3rd Edition Weygandt ● Kimmel ● Kieso.

[Audio] CHAPTER Accounting in Action 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 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 five financial statements and how they are prepared..

[Audio] What is Accounting? Learning Objective 1 Explain what accounting is. Accounting consists of three basic activities—it identifies, records, and communicates the economic events of an organization to interested users. LO 1.

[Audio] Three Activities Illustration 1-1 The activities of the accounting process The accounting process includes the bookkeeping function..

[Audio] Assumptions Review Question Which of the following is not a step in the accounting process? Identification. Recording. Economic entity. Communication.

[Audio] Who Uses Accounting Data? INTERNAL USERS Illustration 1-2 Questions that internal users ask.

[Audio] Learning Objective 2 Identify the users and uses of accounting. EXTERNALUSERS Illustration 1-3 Questions that external users ask LO 2.

[Audio] > DO IT! Indicate whether the following statements are true or false. The three steps in the accounting process are identification, recording, and communication. Bookkeeping encompasses all steps in the accounting process. Accountants prepare, but do not interpret, financial reports. The two most common types of external users are investors and company officers. Managerial accounting activities focus on reports for internal users. True False False False True Solution: 1. 2. 3. 4. 5..

[Audio] The Building Blocks of Accounting Learning Objective 3 Understand why ethics is a fundamental business concept. Ethics in Financial Reporting Standards of conduct by which one’s actions are judged as right or wrong, honest or dishonest, fair or not fair, are ethics. Recent financial scandals include: Enron (USA), Parmalat (ITA), Satyam Computer Services (IND), AIG (USA), and others. Effective financial reporting depends on sound ethical behavior. LO 3.

[Audio] Ethics in Financial Reporting Illustration 1-4 Steps in analyzing ethics cases and situations.

[Audio] Ethics Insight Dewey & LeBoeuf (USA) I Felt the Pressure—Would You? “I felt the pressure.” That’s what some of the employees of the now-defunct law firm of Dewey & LeBoeuf LLP (USA) indicated when they helped to overstate revenue and use accounting tricks to hide losses and cover up cash shortages. These employees worked for the former finance director and former chief financial officer (CFO) of the firm. Here are some of their comments: • “I was instructed by the CFO to create invoices, knowing they would not be sent to clients. When I created these invoices, I knew that it was inappropriate.” • “I intentionally gave the auditors incorrect information in the course of the audit.” (continued) LO 3.

[Audio] I Felt the Pressure—Would You? What happened here is that a small group of lower-level employees over a period of years carried out the instructions of their bosses. Their bosses, however, seemed to have no concern as evidenced by various e-mails with one another in which they referred to their financial manipulations as accounting tricks, cooking the books, and fake income. Source: Ashby Jones, “Guilty Pleas of Dewey Staff Detail the Alleged Fraud,” Wall Street Journal (March 28, 2014). LO 3.

[Audio] Accounting Standards Learning Objective 4 Explain accounting standards and the measurement principles. International Accounting Standards Board (IASB) http://www.iasb.org/ International Financial Reporting Standards Financial Accounting Standards Board (FASB) http://www.fasb.org/ Generally Accepted Accounting Principles (GAAP) LO 4.

[Audio] Measurement Principles HISTORICAL COST PRINCIPLE (or cost principle) dictates that companies record assets at their cost. 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)..

[Audio] Global Insight 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). LO 4.

[Audio] Assumptions Learning Objective 5 Explain the monetary unit assumption and the economic entity assumption. MONETARY UNIT ASSUMPTION requires that companies 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. Proprietorship Partnership Corporation Forms of Business Ownership LO 5.

[Audio] Forms of Business Ownership Proprietorship Partnership Corporation Owned by one person Owner is often manager/operator Owner receives any profits, suffers any losses, and is personally liable for all debts Owned by two or more persons Often retail and service-type businesses Generally unlimited personal liability Partnership agreement Ownership divided into shares Separate legal entity organized under corporation law Limited liability.

[Audio] Assumptions Review Question The historical cost principle states that: assets should be initially recorded at cost and adjusted when the fair value changes. activities of an entity are to be kept separate and distinct from its owner. assets should be recorded at their cost. only transaction data capable of being expressed in terms of money be included in the accounting records..

[Audio] Accounting Across the Organization Spinning the Career Wheel One question that students frequently ask is, “How will the study of accounting help me?” 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), Saudi Telecom (SAU), a Subway (USA) franchise, or a Fuji (JPN) bike shop. All general managers need to understand where the company’s cash comes from and where it goes in order to make wise business decisions. Marketing: Marketing specialists at a company like Hyundai Motor (KOR) develop strategies to help the sales force be successful. But making a sale is meaningless unless it is profitable. Marketing people must be sensitive to costs and benefits, which accounting helps them quantify and understand. (continued) LO 5.

[Audio] Spinning the Career Wheel Finance: Do you want to be a banker for Société Générale (FRA) or a financial analyst for ICBC (CHN)? 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 Sotheby’s International Realty (GBR)? 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? LO 5.

[Audio] > DO IT! Indicate whether each of the following statements presented below is true or false. Convergence refers to efforts to reduce differences between IFRS and U.S. GAAP. The primary accounting standard-setting body headquartered in London is the International Accounting Standards Board (IASB). The historical cost principle dictates that companies record assets at their cost. In later periods, however, the fair value of the asset must be used if fair value is higher than its cost. True True False.

[Audio] Relevance means that financial information matches what really happened; the information is factual. A business owner’s personal expenses must be separated from expenses of the business to comply with accounting’s economic entity assumption. False True.

[Audio] The Basic Accounting Equation Learning Objective 6 State the accounting equation, and define its components. Basic Accounting Equation Provides the underlying framework for recording and summarizing economic events. Assets must equal the sum of liabilities and equity. Assets Liabilities Equity = + LO 6.

[Audio] Basic Accounting Equation Assets Liabilities Equity = + Assets Resources a business owns. Provide future services or benefits. Cash, Inventory, Equipment, etc..

[Audio] Liabilities Claims against assets (debts and obligations). Creditors (party to whom money is owed). Accounts Payable, Notes Payable, Salaries and Wages Payable, etc..

[Audio] Equity Ownership claim on total assets. Referred to as residual equity. Share Capital—Ordinary and Retained Earnings..

[Audio] Equity Illustration 1-7 Increases and decreases in equity Investments by shareholders represent the total amount paid in by shareholders for the ordinary shares they purchase..

[Audio] Stockholders’ Equity Revenues result from business activities entered into for the purpose of earning income. Common sources of revenue are: sales, fees, services, commissions, interest, dividends, royalties, and rent..

[Audio] Expenses are the cost of assets consumed or services used in the process of earning revenue. Common expenses are: salaries expense, rent expense, utilities expense, property tax expense, etc..

[Audio] Dividends are the distribution of cash or other assets to shareholders. Dividends reduce retained earnings. However, dividends are not expenses..

[Audio] > DO IT! Classify the following items as issuance of stock, dividends, revenues, or expenses. Then indicate whether each item increases or decreases stockholders’ equity. Classification Effect on Equity Expense Decrease Rent Expense Service Revenue Dividends Salaries and Wages Expense Revenue Increase Dividends Decrease Expense Decrease.

[Audio] The Basic Accounting Equation Learning Objective 7 Analyze the effects of business transactions on the accounting equation. Transactions are a business’s economic events recorded by accountants. May be external or internal. Not all activities represent transactions. Each transaction has a dual effect on the accounting equation. LO 7.

[Audio] Transaction Analysis Illustration: Are the following events recorded in the accounting records? Discuss product design with potential customer Purchase computer Event Pay rent Is the financial position (assets, liabilities, or stockholder’s equity) of the company changed? Criterion Record/ Don’t Record Illustration 1-8 Transaction-identification process.

[Audio] Illustration 1-9 Expanded accounting equation.

[Audio] TRANSACTION 1. INVESTMENT BY STOCKHOLDERS Ray and Barbara Neal decide to start a smartphone app development company that they incorporate as Softbyte SA. On September 1, 2017, 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 SA. This transaction results in an equal increase in both assets and equity. Illustration 1-10 Assets = Liabilities + Equity + + + + + Trans- action Cash Accounts Receivable Supplies Equipment Accounts Payable Share Capital Retained Earnings Rev. – Exp. – Div. = 1. +15,000 +15,000.

[Audio] TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH Softbyte SA purchases computer equipment for €7,000 cash. Illustration 1-10 Assets = Liabilities + Equity + + + + + Trans- action Cash Accounts Receivable Supplies Equipment Accounts Payable Share Capital Retained Earnings Rev. – Exp. – Div. = 1. +15,000 +15,000 2. -7,000 +7,000 3. +1,600 +1,600 4. +1,200 +1,200 5. +250 -250 6. +1,500 +2,000 +3,500 7. -1,700 -600 -900 -200 8. -250 -250 9. +600 -600 10. -1,300 -1,300 + + + + + - - = $8,050 $1,400 $1,600 $7,000 $1,600 $15,000 $4,700 $1,950 $1,300.

[Audio] TRANSACTION 3. PURCHASE OF SUPPLIES ON CREDIT Softbyte SA purchases for €1,600 headsets and other accessories expected to last several months. The supplier allows Softbyte to pay this bill in October. Illustration 1-10 Trans- action.

[Audio] TRANSACTION 4. SERVICES PERFORMED FOR CASH Softbyte SA receives €1,200 cash from customers for app development services it has performed. Illustration 1-10 Trans- action 4. +1,200 +1,200.

[Audio] TRANSACTION 5. PURCHASE OF ADVERTISING ON CREDIT Softbyte SA receives a bill for €250 from the Programming News for advertising on its website but postpones payment until a later date. Illustration 1-10 5. +250 -250.

[Audio] TRANSACTION 6. SERVICES PROVIDED FOR CASH AND CREDIT. Softbyte provides €3,500 of services. The company receives cash of €1,500 from customers, and it bills the balance of €2,000 on account. Illustration 1-10 6. +1,500 +2,000 +3,500.

[Audio] TRANSACTION 7. PAYMENT OF EXPENSES Softbyte SA pays the following expenses in cash for September: office rent €600, salaries and wages of employees €900, and utilities €200. Illustration 1-10 7. -1,700 -600 -900 -200 LO 7.

[Audio] TRANSACTION 8. PAYMENT OF ACCOUNTS PAYABLE Softbyte SA pays its €250 Programming News bill in cash. The company previously (in Transaction 5) recorded the bill as an increase in Accounts Payable. Illustration 1-10.

[Audio] TRANSACTION 9. RECEIPT OF CASH ON ACCOUNT Softbyte SA receives €600 in cash from customers who had been billed for services (in Transaction 6). Illustration 1-10.

[Audio] TRANSACTION 10. DIVIDENDS The corporation pays a dividend of €1,300 in cash to Ray and Barbara Neal, the shareholders of Softbyte SA. Illustration 1-10 Assets = Liabilities + Equity + + + + + Trans- action Cash Accounts Receivable Supplies Equipment Accounts Payable Share Capital Retained Earnings Rev. – Exp. – Div. = 1. +15,000 +15,000 2. -7,000 +7,000 3. +1,600 +1,600 4. +1,200 +1,200 5. +250 -250 6. +1,500 +2,000 +3,500 7. -1,700 -600 -900 -200 8. -250 -250 9. +600 -600 10. -1,300 -1,300 + + + + + - - = €8,050 €1,400 €1,600 €7,000 €1,600 €15,000 €4,700 €1,950 €1,300 €18,050 €18,050.

[Audio] Summary of Transactions Each transaction must be analyzed in terms of its effect on: The three components of the basic accounting equation. Specific types (kinds) of items within each component. The two sides of the equation must always be equal. The Share Capital—Ordinary and Retained Earnings columns indicate the causes of each change in the shareholders’ claim on assets..

[Audio] > DO IT! Transactions made by Virmari & Co. SA, a public accounting firm, 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. The company issued ordinary shares for €25,000 cash. The company purchased €7,000 of office equipment on credit. The company received €8,000 cash in exchange for services performed. The company paid €850 for this month’s rent. The company paid a dividend of €1,000 in cash to shareholders..

[Audio] The company issued ordinary shares for €25,000 cash. Assets = Liabilities + Equity Trans- action Accounts Payable Share Capital Retained Earnings Rev. – Exp. – Div. Cash Equipment + + + = 1. +25,000 +25,000 2. +7,000 +7,000 3. +8,000 +8,000 4. -850 -850 5. -1,000 -1,000 + + + = - - $31,150 $7,000 $7,000 $25,000 $8,000 $850 $1,000 $18,050 $18,050.

[Audio] The company purchased €7,000 of office equipment on credit. 1. +25,000 +25,000 $18,050.

[Audio] The company received €8,000 cash in exchange for services performed. $18,050.