Giáo trình financial accounting IFRS edtion 3e by kieso

Normal Account Title Classifi cation Financial Statement Balance A Accounts Payable Current Liability Statement of Financial Position CreditAccounts Receivable Current Asset Statement of

Donald E Kieso PhD, CPA

Northern Illinois University DeKalb, Illinois

Normal Account Title Classifi cation Financial Statement Balance

A

Accounts Payable Current Liability Statement of Financial Position CreditAccounts Receivable Current Asset Statement of Financial Position DebitAccumulated Depreciation— Plant Asset—Contra Statement of Financial Position CreditBuildings

Accumulated Depreciation— Plant Asset—Contra Statement of Financial Position CreditEquipment

Allowance for Doubtful Accounts Current Asset—Contra Statement of Financial Position Credit

B

Bonds Payable Non-Current Liability Statement of Financial Position Credit

C

D

Debt Investments Current Asset/Long-Term Statement of Financial Position Debit Investment

to Retained Earnings StatementDividends Payable Current Liability Statement of Financial Position Credit

Gain on Disposal of Plant Assets Other Income and Expense Income Statement Credit

I

to Retained Earnings

Income Taxes Payable Current Liability Statement of Financial Position Credit

Interest Payable Current Liability Statement of Financial Position CreditInterest Receivable Current Asset Statement of Financial Position Debit

Account Title Classifi cation Financial Statement Balance

L

Loss on Disposal of Plant Assets Other Income and Expense Income Statement Debit

R

Research and Development Expense Operating Expense Income Statement Debit

and Retained Earnings Statement

S

Salaries and Wages Payable Current Liability Statement of Financial Position Credit

Share Investments Current Asset/Long-Term Statement of Financial Position Debit Investment

T

U

Unearned Service Revenue Current Liability Statement of Financial Position Credit

(1) The normal balance for Income Summary will be credit when there is a net income, debit when there is a net loss The Income Summary account does not appear on any fi nancial statement

(2) If a periodic system is used, Inventory also appears on the income statement in the calculation of cost of goods sold

this textbook but rather those accounts that are commonly used This sample chart of accounts is for a company that generates both service revenue as well as sales revenue It uses the perpetual approach to inventory If a periodic system was used, the following temporary accounts would be needed to record inventory purchases: Purchases, Freight-In, Purchase Returns and Allowances, and Purchase Discounts.

AdministrativeExpensesAmortizationExpenseBad Debt ExpenseCost of Goods SoldDepreciationExpenseFreight-OutIncome TaxExpenseInsurance Expense Interest ExpenseLoss on Disposal ofPlant AssetsMaintenance andRepairs ExpenseRent ExpenseSalaries and WagesExpense

Selling ExpensesSupplies ExpenseUtilities Expense

Service RevenueSales RevenueSales DiscountsSales Returns and AllowancesInterest RevenueGain on Disposal

of Plant Assets

Share Capital—

PreferenceShare Capital—

OrdinaryShare Premium—

PreferenceShare Premium—

OrdinaryRetained EarningsTreasury SharesDividendsIncome Summary

Notes PayableAccounts PayableUnearned ServiceRevenueSalaries andWages PayableInterest PayableDividends PayableIncome TaxesPayableBonds PayableMortgage Payable

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ISBN-13 978-1-118-97808-5

The inside back cover will contain printing identifi cation and country of origin if omitted from this page In addition, if

the ISBN on the back cover differs from the ISBN on this page, the one on the back cover is correct.

1 Accounting 2 Accounting—Standards 3 International business

enterprises—Accounting—Standards I Kimmel, Paul D II Kieso, Donald E

III Title

HF5635.W52423 2015

657.02’18—dc23

2015022964

1 Accounting in Action 2

2 The Recording Process 52

3 Adjusting the Accounts 100

4 Completing the Accounting Cycle 160

5 Accounting for Merchandising Operations 218

6 Inventories 276

7 Fraud, Internal Control, and Cash 328

8 Accounting for Receivables 382

9 Plant Assets, Natural Resources,

and Intangible Assets 426

10 Liabilities 480

11 Corporations: Organization, Share Transactions,

Dividends, and Retained Earnings 536

12 Investments 598

13 Statement of Cash Flows 644

14 Financial Statement Analysis 710

APPENDICES

A Specimen Financial Statements: TSMC, Ltd A-1

B Specimen Financial Statements: Nestlé SA B-1

C Specimen Financial Statements: Petra Foods Limited C-1

D Specimen Financial Statements: Apple Inc D-1

E Time Value of Money E-1

F Accounting for Partnerships F-1

*G Subsidiary Ledgers and Special Journals G-1

*H Other Significant Liabilities H-1

* I Payroll Accounting I-1

*Available at the book's companion website, www.wiley.com/college/

weygandt.

iii

Dear Student,

Why This Course? Remember your biology course in high school? Did you have one

of those “invisible man” models (or maybe something more high-tech than that) that

gave you the opportunity to look “inside” the human body? This accounting course

offers something similar To understand a business, you have to understand the financial

insides of a business organization An accounting course will help you understand

the essential financial components of businesses Whether you are looking at a large

or coffee shop, knowing the fundamentals of accounting will help you understand

what is happening As an employee, a manager, an investor, a business owner, or a

director of your own personal finances—any of

which roles you will have at some point in your

life—you will make better decisions for having

taken this course.

Why This Book? Thousands of students have

used this textbook Your instructor has chosen it

for you because of its trusted reputation The

authors have worked hard to keep the book fresh,

timely, and accurate.

How to Succeed? We've asked many students and many instructors whether there is

a secret for success in this course The nearly unanimous answer turns out to be not

much of a secret: “Do the homework.” This is one course where doing is learning The

more time you spend on the homework assignments—using the various tools that this

textbook provides—the more likely you are to learn the essential concepts, techniques,

and methods of accounting Besides the textbook itself, WileyPLUS and the book's

companion website also offers various support resources.

Good luck in this course We hope you enjoy the experience and that you put to good

use throughout a lifetime of success the knowledge you obtain in this course We are

sure you will not be disappointed.

Jerry J Weygandt Paul D Kimmel Donald E Kieso

“Whether you are looking at a large multinational company like TSMC

or Apple or a single-owner software consulting business or coffee shop, knowing the fundamentals of accounting will help you understand what is happening.”

iv

Jerry Weygandt

JERRY J WEYGANDT, PhD, CPA, is Arthur

Andersen Alumni Emeritus Professor of

Accounting at the University of Wisconsin—

Madison He holds a Ph.D in accounting from

the University of Illinois Articles by Professor

Weygandt have appeared in the Accounting

Review, Journal of Accounting Research,

Accounting Horizons, Journal of Accountancy,

and other academic and professional journals

These articles have examined such fi nancial

reporting issues as accounting for price-level

adjustments, pensions, convertible securities,

stock option contracts, and interim reports

Professor Weygandt is author of other

ac-counting and fi nancial reporting books and

is a member of the American Accounting

Association, the American Institute of Certifi ed

Public Accountants, and the Wisconsin Society

of Certifi ed Public Accountants He has served

on numerous committees of the American

Accounting Association and as a member of

the editorial board of the Accounting Review;

he also has served as President and

Secretary-Treasurer of the American Accounting

Associa-tion In addition, he has been actively involved

with the American Institute of Certifi ed Public

Accountants and has been a member of the

Accounting Standards Executive Committee

(AcSEC) of that organization He has served on

the FASB task force that examined the

report-ing issues related to accountreport-ing for income

taxes and served as a trustee of the Financial

Accounting Foundation Professor Weygandt

has received the Chancellor's Award for

Excel-lence in Teaching and the Beta Gamma Sigma

Dean's Teaching Award He is on the board of

directors of M & I Bank of Southern Wisconsin

He is the recipient of the Wisconsin Institute of

CPA's Outstanding Educator's Award and the

Lifetime Achievement Award In 2001 he

re-ceived the American Accounting Association's

Outstanding Educator Award

PAUL D KIMMEL, PhD, CPA, received his bachelor's degree from the University of Minnesota and his doctorate in accounting from the University of Wisconsin He is an Associate Professor at the University of Wisconsin—Milwaukee, and has public accounting experience with Deloitte & Touche (Minneapolis) He was the recipient of the UWM School of Business Advisory Council Teaching Award, the Reggie Taite Excellence

in Teaching Award and a three-time winner of the Outstanding Teaching Assistant Award

at the University of Wisconsin He is also a recipient of the Elijah Watts Sells Award for Honorary Distinction for his results on the CPA exam He is a member of the American Accounting Association and the Institute of Management Accountants and has published

articles in Accounting Review, Accounting Horizons, Advances in Management Accounting, Managerial Finance, Issues in Accounting Education, Journal of Accounting Education,

as well as other journals His research interests include accounting for fi nancial instruments and innovation in accounting education He has published papers and given numerous talks on incorporating critical thinking into accounting education, and helped prepare a catalog of critical thinking resources for the Federated Schools of Accountancy

DONALD E KIESO, PhD, CPA, received his bachelor's degree from Aurora University and his doctorate in accounting from the University of Illinois He has served as chairman

of the Department of Accountancy and is currently the KPMG Emeritus Professor of Accountancy at Northern Illinois University

He has public accounting experience with Price Waterhouse & Co (San Francisco and Chicago) and Arthur Andersen & Co (Chicago) and research experience with the Research Division of the American Institute

of Certifi ed Public Accountants (New York)

He has done post doctorate work as a Visiting Scholar at the University of California at Berkeley and is a recipient of NIU's Teaching Excellence Award and four Golden Apple Teaching Awards Professor Kieso is the author of other accounting and business books and is a member of the American Accounting Association, the American Institute of Certifi ed Public Accountants, and the Illinois CPA Society He has served as a member of the Board of Directors of the Illinois CPA Society, then AACSB's Accounting Accreditation Committees, the State of Illinois Comptroller's Commission, as Secretary-Treasurer of the Federation of Schools of Accountancy, and as Secretary-Treasurer of the American Accounting Association Professor Kieso is currently serving on the Board of Trustees and Executive Committee of Aurora University, as a member of the Board of Directors of Kishwaukee Community Hospital, and as Treasurer and Director of Valley West Community Hospital From 1989 to 1993 he served as a charter member of the national Accounting Education Change Commission

He is the recipient of the Outstanding Accounting Educator Award from the Illinois CPA Society, the FSA’s Joseph A Silvoso Award

of Merit, the NIU Foundation’s Humanitarian Award for Service to Higher Education, a Distinguished Service Award from the Illinois CPA Society, and in 2003 an honorary doctorate from Aurora University

Practice Made Simple

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giving students endless opportunities for practice throughout the course.

The Team for Success is focused on helping students get the most out of their

accounting course by making practice simple Both in the printed text and the

online environment of WileyPLUS, new opportunities for self-guided practice

allow students to check their knowledge of accounting concepts, skills, and problem-solving techniques as they receive individual feedback at the question, learning objective, and course level.

In WileyPLUS, the new practice assignments

include several Do It! Reviews, Brief Exercises, Exercises, and Problems, giving students the opportunity to check their work or see the answer and solution after their fi nal attempt.

In the text, the new Review and Practice

• Practice Exercises and Solutions

• Practice Problem and Solution

Review and Practice

A new section in the text and in WileyPLUS offers students more opportunities for self-guided practice.

1 (a) Dec 31 Bad Debt Expense 1,500 Accounts Receivable—M Jack 1,500 (b) (1) Dec 31 Bad Debt Expense

[($850,000 − $30,000) × 1.5%] 12,300 Allowance for Doubtful

(2) Dec 31 Bad Debt Expense 12,600 Allowance for Doubtful Accounts

[($150,000 × 10%) − $2,400] 12,600 (c) (1) Dec 31 Bad Debt Expense

[($850,000 − $30,000) × 0.75%] 6,150 Allowance for Doubtful

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[($150,000 × 6%) + $200] 9,200

WileyPLUS with ORION

Several thousand new questions are available for practice and review WileyPLUS with Orion is an adaptive study and practice tool that helps students build profi ciency in course topics

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We scrutinized all chapter material to fi nd new ways to engage students and help them learn accounting concepts Homework problems were updated in all chapters

The learning objective structure helps students practice their understanding of concepts with DO IT! exercises before they move on to different topics in other learning objectives Coupled with a new interior design and revised infographics, the outcomes-oriented approach motivates students and helps them make the best use of their time

Student Practice and Solutions

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Real World Context

We expanded our practice of using numerous examples of real companies throughout the textbook New fi nancial reporting problems in each chapter require students to analyze the fi nancial statements of TSMC, Nestlé, Petra Foods, and Apple In WileyPLUS, real-world Insight boxes now have questions that can be assigned as homework

A Look at U.S GAAP

This end-of-chapter section offers Key Points, Similarities, and Differences to help students compare IFRS with U.S GAAP Assessment material is also provided to test students’ understanding

Excel

New Excel skill videos help students understand Excel features they can apply in their accounting studies

More information about the Third Edition is available on the book’s website at www.wiley.com/college/weygandt

viii

Who Uses Accounting Data? 5

The Building Blocks of Accounting 7

Ethics in Financial Reporting 7

Retained Earnings Statement 24

Statement of Financial Position 24

Statement of Cash Flows 25

Comprehensive Income Statement 25

APPENDIX 1A: Accounting Career Opportunities 27

Summary of Debit/Credit Rules 58

Steps in the Recording Process 59

The Journal 60

The Ledger 62

Posting 63

The Recording Process Illustrated 65

Summary Illustration of Journalizing and

Posting 71

The Trial Balance 72

Limitations of a Trial Balance 73

Locating Errors 73

Currency Signs and Underlining 74

A Look at U.S GAAP 97

Chapter 3

What Was Your Profit? 100

Timing Issues 102

Fiscal and Calendar Years 102 Accrual- versus Cash-Basis Accounting 102 Recognizing Revenues and Expenses 103

The Basics of Adjusting Entries 104

Types of Adjusting Entries 105 Adjusting Entries for Deferrals 106 Adjusting Entries for Accruals 113 Summary of Basic Relationships 118

The Adjusted Trial Balance and Financial Statements 121

Preparing the Adjusted Trial Balance 121 Preparing Financial Statements 122 APPENDIX 3A: Alternative Treatment of Prepaid Expenses and Unearned Revenues 124

Prepaid Expenses 125 Unearned Revenues 126 Summary of Additional Adjustment Relationships 127

APPENDIX 3B: Concepts in Action 128

Qualities of Useful Information 128 Assumptions in Financial Reporting 128 Principles in Financial Reporting 129 Cost Constraint 130

A Look at U.S GAAP 157

Chapter 4

Speaking the Same Language 160

Using a Worksheet 162

Steps in Preparing a Worksheet 163 Preparing Financial Statements from

a Worksheet 165 Preparing Adjusting Entries from a Worksheet 167

Closing the Books 167

Preparing Closing Entries 168 Posting Closing Entries 170 Preparing a Post-Closing Trial Balance 171

Summary of the Accounting Cycle 174

Reversing Entries—An Optional Step 175 Correcting Entries—An Avoidable Step 175

The Classified Statement of Financial Position 178

Intangible Assets 178 Property, Plant, and Equipment 180 Long-Term Investments 180

ix

Equity 182

Non-Current Liabilities 182

Current Liabilities 182

APPENDIX 4A: Reversing Entries 184

Reversing Entries Example 184

A Look at U.S GAAP 214

Summary of Purchasing Transactions 227

Recording Sales of Merchandise 228

Sales Returns and Allowances 229

Sales Discounts 230

Completing the Accounting Cycle 231

Adjusting Entries 232

Closing Entries 232

Summary of Merchandising Entries 233

Forms of Financial Statements 234

Income Statement 234

Income Statement Presentation of Sales 234

Inventory Presentation in the Classified Statement

of Financial Position 238

APPENDIX 5A: Worksheet for a Merchandising

Company 240

Using a Worksheet 240

APPENDIX 5B: Periodic Inventory System 241

Determining Cost of Goods Sold Under

a Periodic System 241

Recording Merchandise Transactions 242

Recording Purchases of Merchandise 243

Recording Sales of Merchandise 244

Journalizing and Posting Closing Entries 244

Determining Inventory Quantities 279

Taking a Physical Inventory 279

Determining Ownership of Goods 280

Inventory Costing 282

Specific Identification 283

Cost Flow Assumptions 283

Cost Flow Methods 287 Using Inventory Cost Flow Methods Consistently 288

Lower-of-Cost-or-Net Realizable Value 289

in Perpetual Inventory Systems 294

First-In, First-Out (FIFO) 295 Average-Cost 295

APPENDIX 6B: Estimating Inventories 296

Gross Profit Method 296 Retail Inventory Method 297 APPENDIX 6C: LIFO Inventory Method 298

A Look at U.S GAAP 325

Chapter 7

Minding the Money at Nick's 328

Fraud and Internal Control 330

Fraud 330 Internal Control 330 Principles of Internal Control Activities 331 Limitations of Internal Control 338

Cash Controls 339

Cash Receipts Controls 339 Cash Disbursements Controls 342 Petty Cash Fund Controls 343

Control Features: Use of a Bank 347

Making Bank Deposits 347 Writing Checks 347 Bank Statements 348 Reconciling the Bank Account 350 Electronic Funds Transfer (EFT) System 353

Reporting Cash 354

Cash Equivalents 355 Restricted Cash 355

A Look at U.S GAAP 379

Chapter 8

Are You Going to Pay Me—or Not? 382

Types of Receivables 384 Accounts Receivable 384

Recognizing Accounts Receivable 384 Valuing Accounts Receivable 386 Disposing of Accounts Receivable 393

Notes Receivable 395

Determining the Maturity Date 396 Computing Interest 397

x

Valuing Notes Receivable 397

Disposing of Notes Receivable 398

Statement Presentation and Analysis 401

Revaluation of Plant Assets 439

Expenditures During Useful Life 441

Plant Asset Disposals 441

Extractable Natural Resources 444

Intangible Assets 446

Accounting for Intangible Assets 446

Research and Development Costs 449

Statement Presentation and Analysis 450

Current Maturities of Long-Term Debt 484

Statement Presentation and Analysis 485

Non-Current Liabilities 486

Bond Basics 487

Determining the Market Price of a Bond 490

Accounting for Bond Issues 491

Accounting for Bond Redemptions 496

Accounting for Long-Term Notes

Payable 497

Statement Presentation and Analysis 499

APPENDIX 10A: Effective-Interest Method

of Bond Amortization 502

Amortizing Bond Discount 502

Amortizing Bond Premium 504

APPENDIX 10B: Straight-Line Amortization 505

Amortizing Bond Discount 505

Amortizing Bond Premium 507

Payroll Deductions 508 Profit-Sharing and Bonus Plans 509

A Look at U.S GAAP 532

Chapter 11

Corporations: Organization, Share Transactions, Dividends, and Retained

To the Victor Go the Spoils 536

The Corporate Form of Organization 538

Characteristics of a Corporation 538 Forming a Corporation 541

Ownership Rights of Shareholders 541 Share Issue Considerations 541 Corporate Capital 545

Accounting for Share Transactions 547

Accounting for Ordinary Share Issues 547 Accounting for Treasury Shares 550 Accounting for Preference Shares 553

Dividends 555

Cash Dividends 555 Share Dividends 558 Share Splits 560

Retained Earnings 562

Retained Earnings Restrictions 563 Prior Period Adjustments 564 Retained Earnings Statement 564

Statement Presentation and Analysis 566

Presentation 566 Analysis 567 APPENDIX 11A: Statement of Changes

Playing for Fun and Profit 598

Why Corporations Invest 600 Accounting for Debt Investments 601

Recording Acquisition of Bonds 601 Recording Bond Interest 601 Recording Sale of Bonds 602

Accounting for Share Investments 603

Holdings of Less than 20% 604 Holdings Between 20% and 50% 605 Holdings of More than 50% 606

Valuing and Reporting Investments 608

Categories of Securities 608 Statement of Financial Position Presentation 614

xi

Loss 615

Classified Statement of Financial Position 616

APPENDIX 12A: Preparing Consolidated Financial

Statements 618

Consolidated Statement of Financial Position 618

Consolidated Income Statement 621

A Look at U.S GAAP 641

Chapter 13

What Should We Do with This Cash? 644

Statement of Cash Flows: Usefulness

and Format 646

Usefulness of the Statement of Cash Flows 646

Classification of Cash Flows 646

Significant Non-Cash Activities 648

Format of the Statement of Cash Flows 648

Preparing the Statement of Cash Flows 650

Indirect and Direct Methods 651

Preparing the Statement of Cash Flows—

Indirect Method 651

Step 1: Operating Activities 652

Summary of Conversion to Net Cash Provided

by Operating Activities—Indirect Method 656

Step 2: Investing and Financing Activities 658

Step 3: Net Change in Cash 659

Using Cash Flows to Evaluate a Company 662

Free Cash Flow 662

APPENDIX 13A: Statement of Cash Flows—

Direct Method 664

Step 1: Operating Activities 665

Step 2: Investing and Financing Activities 669

Step 3: Net Change in Cash 671

APPENDIX 13B: Using a Worksheet to Prepare the

Statement of Cash Flows—Indirect Method 671

Preparing the Worksheet 672

APPENDIX 13C: Statement of Cash Flows—

T-Account Approach 677

A Look at U.S GAAP 707

Chapter 14

Making Money the Old-Fashioned Way 710

Basics of Financial Statement Analysis 712

Need for Comparative Analysis 712

Earning Power and Unusual Items 730

Discontinued Operations 731 Changes in Accounting Principle 732 Comprehensive Income 732

Quality of Earnings 734

Alternative Accounting Methods 734 Pro Forma Income 735

Improper Recognition 735

A Look at U.S GAAP 759

Nature of Interest E-1

Simple Interest E-1 Compound Interest E-2

Future Value Concepts E-3

Future Value of a Single Amount E-3 Future Value of an Annuity E-4

Present Value Concepts E-7

Present Value Variables E-7 Present Value of a Single Amount E-7 Present Value of an Annuity E-9 Time Periods and Discounting E-11 Computing the Present Value of a Long-Term Note or Bond E-11 Computing the Present Values in a Capital Budgeting Decision E-14

Using Financial Calculators E-16

Present Value of a Single Sum E-16 Present Value of an Annuity E-17 Useful Applications of the Financial Calculator E-18

Partnership Form of Organization F-1

Characteristics of Partnerships F-1

xii

Advantages and Disadvantages of

Partnerships F-3

The Partnership Agreement F-4

Basic Partnership Accounting F-4

Forming a Partnership F-4

Dividing Net Income or Net Loss F-6

Partnership Financial Statements F-9

Admission and Withdrawal of Partners F-9

Liquidation of a Partnership F-10

No Capital Deficiency F-10

Capital Deficiency F-12

Journals G-1 (available at www.wiley.com/

college/weygandt)

Expanding the Ledger—Subsidiary

Ledgers G-1

Subsidiary Ledger Example G-2

Advantages of Subsidiary Ledgers G-3

Expanding the Journal—Special Journals G-3

Sales Journal G-4

Cash Receipts Journal G-7

Purchases Journal G-11

Cash Payments Journal G-13

Effects of Special Journals on the General

Journal G-15

Cyber Security: A Final Comment G-17

Liabilities H-1 (available at www.wiley.com/

college/weygandt)

Provisions and Contingent Liabilities H-1

Recording a Provision H-1 Disclosure of Contingent Liabilities H-2

Lease Liabilities H-3

Operating Leases H-3 Finance Leases H-4

Additional Liabilities for Employee Fringe Benefits H-5

Paid Absences H-5 Postretirement Benefits H-6

(available at www.wiley.com/college/

weygandt)

Accounting for Payroll I-1

Determining the Payroll I-1 Recording the Payroll I-5

Employer Payroll Taxes I-8

FICA Taxes I-8 Federal Unemployment Taxes I-8 State Unemployment Taxes I-8 Recording Employer Payroll Taxes I-9 Filing and Remitting Payroll Taxes I-9

Internal Control for Payroll I-10

xiii

Financial Accounting, IFRS Third Edition, has benefited greatly from the input of focus group

participants, manuscript reviewers, those who have sent comments by letter or e-mail, ancillary

authors, and proofers We greatly appreciate the constructive suggestions and innovative ideas

of reviewers and the creativity and accuracy of the ancillary authors and checkers.

Clare Yu-Shun Hung

Fu Jen Catholic University

We appreciate the exemplary support and commitment

given to us by executive editor Michael McDonald, senior

marketing manager Karolina Zarychta Honsa, senior

devel-opment editor Ed Brislin, associate develdevel-opment editor

Courtney Luzzi, editorial assistant Elizabeth Kearns,

devel-opment editors Terry Ann Tatro and Margaret Thompson,

senior product designer Allie Morris, product designer Matt

Origoni, designers Maureen Eide and Kristine Carney, photo

editor Mary Ann Price, indexer Steve Ingle, and Dennis Free

at Aptara All of these professionals provided innumerable

services that helped the textbook take shape

Finally, our thanks to Susan Elbe, George Hoffman, Tim Stookesberry, Douglas Reiner, Brent Gordon, Joe Heider, and Steve Smith for their support and leadership in Wiley's Global Education We will appreciate suggestions and com-ments from users—instructors and students alike You can send your thoughts and ideas about the textbook to us via

email at: AccountingAuthors@yahoo.com.

Jerry J Weygandt Paul D Kimmel Donald E Kieso

Madison, Wisconsin Milwaukee, Wisconsin DeKalb, Illinois

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

manag-ers 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 fi nancial

statements, you cannot really know your business.

Many companies spend signifi cant resources teaching their

employees basic accounting so that they can read fi nancial

statements and understand how their actions affect the

company’s fi nancial results Employers need managers in

all areas of the company to be “fi nancially literate.”

Taking this course will go a long way to making you

fi nancially literate In this book, you will learn how to

read and prepare fi nancial statements, and how to use

basic tools to evaluate fi nancial results.

Appendices A, B, and C of this textbook provide real

fi nancial statements of three companies from different countries that report using International Financial Reporting Standards (IFRS): Taiwan Semiconductor Manufacturing Company (TSMC) Ltd (TWN), Nestlé SA

(CHE), and Petra Foods Ltd (SGP) Throughout this book, we increase your familiarity with fi nancial report- ing by providing numerous references, questions, and exercises that encourage you to explore these fi nancial statements In addition, we encourage you to visit each company’s website where you can view its complete annual report In examining the fi nancial reports of these three companies, you will see that the accounting practices of companies in specifi c countries that follow IFRS sometimes differ with regard to particular details However, more importantly, you will fi nd that the basic accounting principles are the same As a result, by learning these basic principles as presented in this text- book, you will be well equipped to begin understanding the fi nancial results of companies around the world ■

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 defi ne its components.

7 Analyze the effects of business transactions on the accounting equation.

8 Understand the fi ve fi nancial statements and how they are prepared.

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 specifi c concepts covered in the chapter.

basic tools to evaluate fi nancial results.

h

Th N i i ll i d d i d

Scan Learning Objectives

Read Feature Story

Review and Practice pp 28–34

• Reviews of Learning Objectives and Glossary

• Answer Practice Multiple-Choice Questions, Exercises, and Problem

Complete Assignments

Watch WileyPLUS Chapter Reviews

Read A Look at U.S GAAP

✔ The Navigator

The Feature Story helps you picture how

the chapter topic relates to the real world

of accounting and business You will fi nd references to the story throughout the chapter.

The Feature Story highlights the importance of having good fi nancial information and knowing how to use it

to make effective business decisions Whatever your pursuits or occupation, the need for fi nancial information

is inescapable You cannot earn a living, spend money, buy on credit, make an investment, or pay taxes without receiving, using, or dispensing fi nancial 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 fi nancial information The content and organization of Chapter 1 are as follows.

• Accounting standards

• Measurement principles

• Transaction analysis

• Summary of transactions

• Income statement

• Retained earnings statement

Using the Accounting Equation Financial Statements

The Preview describes and outlines the major topics and

subtopics you will see in the chapter.

✔ The Navigator

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 stand what is happening fi nancially inside a company Accounting is the fi nancial information system that provides these insights In short, to understand an orga- nization of any type, you have to know the numbers.

Accounting consists of three basic activities—it identifi es, records, and

communicates the economic events of an organization to interested users Let’s

take a closer look at these three activities.

Three Activities

As a starting point to the accounting process, a company identifi es 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 identifi es economic events, it records those

events in order to provide a history of its fi nancial activities Recording

con-sists of keeping a systematic, chronological diary of events, measured in

monetary units In recording, Unilever also classifi es and summarizes nomic events.

eco-Finally, Unilever communicates the collected information to interested users

by means of accounting reports The most common of these reports are called

fi nancial statements To make the reported fi nancial information meaningful,

Unilever reports the recorded data in a standardized way It accumulates mation 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 fi nancial statements Such data are said to be reported

infor-in the aggregate By presentinfor-ing the recorded data infor-in the aggregate, the

account-ing process simplifi es a multitude of transactions and makes a series of activities understandable and meaningful.

A vital element in communicating economic events is the accountant’s

abil-ity to analyze and interpret the reported information Analysis involves use of

ratios, percentages, graphs, and charts to highlight signifi cant fi nancial trends

and relationships Interpretation involves explaining the uses, meaning, and

limitations of reported data Appendix A of this textbook shows the fi nancial

statements of Taiwan Semiconductor Manufacturing Company (TSMC) Ltd

(TWN) Appendix B illustrates the fi nancial statements of Nestlé SA (CHE), and Appendix C includes the fi nancial statements of Petra Foods Ltd (SGP) We refer to these statements at various places throughout the textbook (In addition,

in the A Look at U.S GAAP section at the end of each chapter, the U.S company

Apple Inc is analyzed.) At this point, these fi nancial 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

bookkeep-ing function Bookkeeping usually involves only the recording of economic

events It is therefore just one part of the accounting process In total, accounting

Essential terms are

printed in blue when they

fi rst appear, and are defi ned

in the end-of-chapter

Glossary Review.

1The appendix to this chapter describes job opportunities for accounting majors and explains why accounting is such a popular major

involves the entire process of identifying, recording, and communicating

economic events.2

Who Uses Accounting Data?

The specifi c fi nancial information that a user needs depends upon the kinds of

decisions the user makes There are two broad groups of users of fi nancial

infor-mation: internal users and external users.

INTERNAL USERS

Internal users of accounting information are managers who plan, organize, and

run the business These include marketing managers, production supervisors,

fi nance directors, and company offi cers In running a business, internal users

must answer many important questions, as shown in Illustration 1-2.

Learning Objective 2

Identify the users and uses

of accounting.

Communication

Select economic events (transactions) Record, classify, and summarize

Prepare accounting reports

Analyze and interpret for users

CHIP CITY

DELL

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

Chris-topher Columbus In his 1494 text Summa de Arithmetica, Geometria, Proportione et Proportionalite,

Pacioli described a system to ensure that fi nancial information was recorded effi ciently and accurately

Questions Asked by Internal Users

Is cash sufficient to pay

Human Resources

Which PepsiCo product line is the most profitable? Should anyproduct lines be eliminated?

Management

What price for a Nokia cell phonewill maximize the company'snet income?

Marketing

SHARES

ON STRIKE

ON STRIKE

ON STRIKE

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 fi nancial comparisons of

operating alternatives, projections of income from new sales campaigns, and casts of cash needs for the next year.

fore-EXTERNAL USERS

External users are individuals and organizations outside a company who want

fi nancial information about the company The two most common types of

exter-nal users are investors and creditors Investors (owners) use accounting

infor-mation to make decisions to buy, hold, or sell ownership shares of a company

Creditors (such as suppliers and bankers) use accounting information to

evalu-ate 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 fi cial information for investors, creditors, and other external users The information

nan-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 Tesla Motors, Inc (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 nies have the ability to pay increased wages and benefi ts to union members.

Yeah!

Questions Asked by External Users

Is Royal Dutch Shell earning

Will Singapore Airlines be able

to pay its debts as they come due?

Creditors

1 True 2 False Bookkeeping involves only the recording step 3 False Accountants analyze and interpret information in reports as part of the communication step 4 False The two most common types of external users are investors and creditors 5 True

Indicate whether each of the fi ve statements presented below is true or false If false, indicate how to correct the statement

1 The three steps in the accounting process are identifi cation, recording, and

com-munication

2 Bookkeeping encompasses all steps in the accounting process.

3 Accountants prepare, but do not interpret, fi nancial reports.

4 The two most common types of external users are investors and company offi cers.

5 Managerial accounting activities focus on reports for internal users.

Related exercise material: E1-1, E1-2, and DO IT! 1-1.

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.

✔ The Navigator

Identify the stakeholders—

persons or groups who may

be harmed or benefited Askthe question: What are theresponsibilities and obligations

of the parties involved?

3 Identify the alternatives, and weigh the impact of each alternative on various stakeholders.

Select the most ethicalalternative, considering all theconsequences Sometimes therewill be one right answer Othersituations involve more thanone right solution; thesesituations require an evaluation

of each and a selection of thebest alternative

1 Recognize an ethical situation and the ethical issues involved.

Use your personal ethics toidentify ethical situations andissues Some businesses andprofessional organizationsprovide written codes ofethics for guidance in somebusiness situations

Illustration 1-4

Steps in analyzing ethics cases and situations

A doctor follows certain protocols in treating a patient’s illness An architect

follows certain structural guidelines in designing a building Similarly, an

accountant follows certain standards in reporting fi nancial information These

standards are based on specifi c principles and assumptions For these standards

to work, however, a fundamental business concept must be at work—ethical

behavior.

Ethics in Financial Reporting

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

fi nancial press has been full of articles about fi nancial scandals at Enron (USA),

Parmalat (ITA), Satyam Computer Services (IND), AIG (USA), and others As the

scandals came to light, mistrust of fi nancial reporting in general grew One article

in the fi nancial press noted that “repeated disclosures about questionable

account-ing practices have bruised investors’ faith in the reliability of earnaccount-ings reports,

which in turn has sent share prices tumbling.” Imagine trying to carry on a

busi-ness or invest money if you could not depend on the fi nancial 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 fi nancial

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 fi nancial reporting

depends on sound ethical behavior To sensitize you to ethical situations in

busi-ness and to give you practice at solving ethical dilemmas, we address ethics in a

number of ways in this textbook:

1 A number of the Feature Stories and other parts of the textbook discuss the

central importance of ethical behavior to fi nancial reporting.

2 Ethics Insight boxes and marginal Ethics Notes highlight ethics situations and

issues in actual business settings.

3 Many of the People, Planet, and Profi t Insight boxes focus on ethical issues

that companies face in measuring and reporting social and environmental

issues.

4 At the end of each chapter, an Ethics Case simulates a business situation and

asks you to put yourself in the position of a decision-maker in that case.

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.

Learning Objective 3

Understand why ethics

is a fundamental business concept.

The Building Blocks of Accounting

Accounting Standards

In order to ensure high-quality fi nancial reporting, accountants present fi nancial 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

fol-low standards referred to as International Financial Reporting Standards

London, with its 15 board members drawn from around the world Most nies in the United States follow standards issued by the FASB, referred to as

compa-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 made efforts to reduce the differences between IFRS and U.S GAAP This process is referred to as convergence Because convergence is such

an important issue, we provide at the end of each chapter a section called A Look

at U.S GAAP, to provide a comparison with IFRS.

Measurement Principles

IFRS generally uses one of two measurement principles, the historical cost ciple or the fair value principle Selection of which principle to follow generally

prin-relates to trade-offs between relevance and faithful representation Relevance

means that fi nancial 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.

HISTORICAL COST PRINCIPLE

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

two primary qualities

that make accounting

information useful for

decision-making

Why did these employees lie, and what do you believe should be their penalty for these lies?

(See page 49.)

Q

“I felt the pressure.” That’s what some of the employees of the now-defunct law fi rm of Dewey

when they helped to overstate revenue and use accounting tricks to hide losses and cover

up cash shortages These ployees worked for the former

em-fi nance director and former chief fi nancial offi cer (CFO) of the fi rm Here are some of their comments:

What happened here is that a small group of lower-level employees over a period of years carried out the instruc-tions 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 fi nancial 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).

© Alliance/Shutterstock

Insight boxes provide examples of business situations

from various perspectives—ethics, investor, global, and corporate social responsibility Guideline answers to the critical thinking questions are available near the end of the chapter.

Helpful Hints further

clarify concepts being

discussed.

• “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.”

land for P300,000, the company initially reports it in its accounting records at

P300,000 But what does Gazprom do if, by the end of the next year, the fair value

of the land has increased to P 400,000? Under the historical cost principle, it

con-tinues to report the land at P300,000.

FAIR VALUE PRINCIPLE

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

infor-mation 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 fi gures 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.

Assumptions

Assumptions provide a foundation for the accounting process Two main

assumptions are the monetary unit assumption and the economic entity

assumption.

MONETARY UNIT ASSUMPTION

The monetary unit assumption requires that companies include in the

account-ing 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

Learning Objective 5

Explain the monetary unit assumption and the economic entity assumption.

If you think that ing standards don’t mat-ter, consider recent events

account-in South Korea tional investors expressed concerns that the fi nan-cial reports of some South Korean companies were inaccurate Accounting practices sometimes re-sulted in differences be-tween stated revenues and actual revenues Be-cause investors did not have complete faith in the accuracy of the num-bers, they were unwill-ing to pay as much for the shares of these companies

Interna-relative to shares of comparable companies in different

SeongJoon Cho/Bloomberg/Getty

Images, Inc.

What is meant by the phrase “make the country’s businesses more transparent”? Why would increasing transparency spur economic growth? (See page 49.)

Q

countries This difference in share price was referred to

as the “Korean discount.”

In response, Korean regulators decided to require panies to comply with international accounting standards This change was motivated by a desire to “make the coun-try’s businesses more transparent” in order to build inves-tor confi dence 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

com-Source: Evan Ramstad, “End to ’Korea Discount’?” Wall Street Journal (March 16, 2007).

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, such as those shown in Illustration 1-5.

ECONOMIC ENTITY ASSUMPTION

An economic entity can be any organization or unit in society It may

be a company ( Telefónica (ESP)), a governmental unit (the city-state

of Singapore), a municipality (Toronto, Canada), a school district (St Louis District 48), or a church (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 sonal living costs separate from the expenses of the boutique Similarly,

per-Metro (DEU) and Coca-Cola (USA) are segregated into separate nomic entities for accounting purposes.

eco-PROPRIETORSHIP A business owned by one person is generally a prietorship 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, cloth-

pro-ing 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 profi ts, suffers any losses, and is personally liable for all debts of the busi- ness 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, sion of net income (or net loss), and settlement to be made upon death or with- drawal of a partner Each partner generally has unlimited personal liability for

divi-the debts of divi-the partnership Like a proprietorship, for accounting purposes

the partnership transactions must be kept separate from the personal ities of the partners Partnerships are often used to organize retail and service-

activ-type businesses, including professional practices (lawyers, doctors, architects, and chartered public accountants).

CORPORATION A business organized as a separate legal entity under tion law and having ownership divided into transferable shares is a corporation

corpora-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

Switzerland, Swiss franc CHF

Turkey, lira

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’

fi nancial interests and those

of the company For example,

Adelphia guaranteed over

$2 billion of loans to the

founding family

Ethics Note

Ethics Notes help sensitize

you to some of the ethical

issues in accounting.

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

attractive-ness 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 signifi cantly 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), Apple Inc (USA),

Fortis (BEL), and Toyota (JPN)—are corporations.

How might accounting help you? (See page 49.)

for virtually every fi eld

of endeavor Some ples of how accounting

exam-is used in other careers include:

General ment: Imagine running

(USA) franchise, or a Fuji

(JPN) bike shop All eral managers need to understand where the company’s

gen-cash comes from and where it goes in order to make wise

business decisions

Marketing: Marketing specialists at a company like

force be successful But making a sale is meaningless unless it is profi table Marketing people must be sensi-tive to costs and benefi ts, which accounting helps them quantify and understand

Finance: Do you want to be a banker for Société

These fi elds rely heavily on accounting In all of them, you will regularly examine and analyze fi nancial statements

In fact, it is diffi cult to get a good fi nance 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

fi nancing a real estate transaction, brokers must stand the numbers involved: Can the buyer afford to make the payments to the bank? Does the cash fl ow from

under-an industrial property justify the purchase price? What are the tax benefi ts of the purchase?

© Josef Volavka/iStockphoto

Indicate whether each of the fi ve statements presented below is true or false If false, cate how to correct the statement

indi-1 Convergence refers to efforts to reduce differences between IFRS and U.S GAAP.

2 The primary accounting standard-setting body headquartered in London is the

Interna-tional Accounting Standards Board (IASB)

3 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

4 Relevance means that fi nancial information matches what really happened; the

infor-mation is factual

5 A business owner’s personal expenses must be separated from expenses of the business

to comply with accounting’s economic entity assumption

Building Blocks

of Accounting

Related exercise material: E1-3, E1-4, and DO IT! 1-2.

1 True 2 True 3 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 4 False Faithful representation means that fi nancial information matches what really happened; the information is factual 5 True

✔ The Navigator

Action Plan

✔ Review the discussion

of ethics and fi nancial

reporting standards.

✔ Develop an

under-standing of the key

terms used.

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 etorship such as a corner grocery store as well as to a giant corporation such as

propri-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.

Assets

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 char-

acteristic possessed by all assets is the capacity to provide future services or

benefi ts In a business, that service potential or future economic benefi t

eventu-ally results in cash infl ows (receipts) For example, consider Taipai Pizza, a local restaurant It owns a delivery truck that provides economic benefi ts from deliver- ing pizzas Other assets of Taipai Pizza are tables, chairs, cash register, oven, tableware, and, of course, cash.

Liabilities

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:

• Taipai Pizza, for instance, purchases cheese, sausage, fl our, and beverages

on credit from suppliers These obligations are called accounts payable.

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 €11.6 billion Liabilities and equity are the rights or claims against these resources Thus, adidas has €11.6 billion of claims against its €11.6 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

€6.1 billion and equity of €5.5 billion.

We can express the relationship of assets, liabilities, and equity as an equation,

as shown in Illustration 1-6.

Learning

Objective 6

State the accounting

equation, and defi ne

its components.

The Basic Accounting Equation

Illustration 1-6

The basic accounting equation

Assets ⫽ Liabilities ⫹ Equity

• Taipai Pizza also has a note payable to First National Bank for the money

borrowed to purchase the delivery truck.

• Taipai Pizza may also have salaries and wages payable to employees and

sales and real estate taxes payable to the local government.

All of these persons or entities to whom Taipai 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.

Equity

The ownership claim on a company’s 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.

SHARE CAPITAL—ORDINARY

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

share-holders for the ordinary shares they purchase.

RETAINED EARNINGS

Retained earnings is determined by three items: revenues, expenses, and

dividends.

REVENUES Revenues are the gross increases in equity resulting from

busi-ness 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

dif-ferent sources and are called various names depending on the nature of the

busi-ness Taipai 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.

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, Taipai Pizza recognizes the following types of expenses: cost of

ingredi-ents (fl our, 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

avail-able to distribute to shareholders The distribution of cash or other assets to

✔ The Navigator

shareholders is called a dividend Dividends reduce retained earnings However,

dividends are not expenses A corporation fi rst 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 distrib- ute 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.

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

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 (3) Dividends(2) Service Revenue (4) Salaries and Wages Expense

✔ Review the rules

for changes in equity:

Investments and

rev-enues increase equity

Expenses and dividends

decrease equity.

✔ Recognize that

divi-dends are distributions

of cash or other assets to

shareholders.

Solution

Related exercise material: BE1-1, BE1-2, BE1-3, BE1-4, BE1-5, BE1-8, BE1-9, E1-5, and DO IT! 1-3.

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, Taipai 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 actions for Taipai Pizza.

Companies carry on many activities that do not represent business

transac-tions Examples are hiring employees, answering the telephone, talking with

cus-tomers, 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 fi nd 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- identifi cation

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 specifi c liability, or (3) increase in equity.

Two or more items could be affected For example, as one asset is increased

NT$10,000, another asset could decrease NT$6,000 and a liability could increase

NT$4,000 Any change in a liability or ownership claim is subject to similar

analysis.

Transaction Analysis

To demonstrate how to analyze transactions in terms of the accounting

equa-tion, we will review the business activities of Softbyte SA As part of this

analy-sis, 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,

some-thing you’ll need later (We assure you that we’ve kept them to the minimum

needed!)

Illustration 1-8

Transaction-identifi cation process

RENT CHIP CITY

DELL

Yes No

with potential customerPurchase computer

Is the financial position (assets, liabilities, or equity) of the company changed?

TRANSACTION 1 INVESTMENT BY SHAREHOLDERS 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 own- ership interest that the Neals have in Softbyte SA This transaction results in an equal increase in both assets and equity.3

• HELPFUL HINT

You will want to study

these transactions until

you are sure you

under-stand them They are not

diffi cult, but understanding

them is important to your

success in this course The

ability to analyze

transac-tions in terms of the basic

accounting equation is

essential in accounting

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 nec- essary 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 SA 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.

Basic Analysis

The asset Cash increases €15,000, and equity identifi ed as Share Capital—Ordinary increases €15,000

Equation Analysis

Expanded accounting equation

3For the illustrative equations that follow, we use the general account title “Share Capital” instead of

“Share Capital—Ordinary” for space considerations

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 SA

pur-chases for €1,600 from Mobile Solutions Company headsets and other computer

accessories expected to last several months Mobile Solutions 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 benefi ts of

using the headsets and computer accessories, and liabilities increase by the

amount due Mobile Solutions.

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 PERFORMED FOR CASH Softbyte SA receives

€1,200 cash from customers for app development services it has performed This

transaction represents Softbyte’s principal revenue-producing activity Recall

that revenue increases equity.

The asset Cash decreases €7,000, and the asset Equipment increases

Cash + Supplies + Equipment =

Payable + Capital + Rev −Exp − Div

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 fi nancial statements later in the chapter.

TRANSACTION 5 PURCHASE OF ADVERTISING ON CREDIT Softbyte SA receives a bill for €250 from Programming News for advertising on its website 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 liabil- ity Accounts Payable will decrease and the asset Cash will decrease (see Trans- action 8) The cost of advertising is an expense (rather than an asset) because Softbyte has used the benefi ts Advertising Expense is included in determining net income.

TRANSACTION 6 SERVICES PERFORMED FOR CASH AND CREDIT Softbyte

SA performs €3,500 of app development 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.

Three specifi c items are affected: The asset Cash increases €1,500, the asset Accounts Receivable increases €2,000, and equity increases €3,500 due to Service Revenue

Basic

Analysis

Equation

Analysis

Accounts Accounts Share Retained EarningsCash + Receivable + Supplies + Equipment = Payable + Capital + Rev − Exp − Div.

€ 9,200 €1,600 €7,000 €1,850 €15,000 €1,200 €250(6) +1,500 +€2,000 +3,500

€10,700 + € 2,000 + €1,600 + €7,000 = €1,850 + €15,000 + €4,700 − €250

Service Revenue

The liability Accounts Payable increases €250, and equity decreases €250 due to Advertising Expense

Basic

Analysis

Equation

Analysis

Cash + Supplies + Equipment = Payable + Capital + Rev − Exp − Div.

Softbyte recognizes €3,500 in revenue when it performs the services In

exchange for these services, 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 SA pays the following

expenses in cash for September: offi ce rent €600, salaries and wages of

employ-ees €900, and utilities €200 These payments result in an equal decrease in assets

and equity.

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 SA pays its

€250 Programming 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

Transac-tion 5) and should not record it again.

TRANSACTION 9 RECEIPT OF CASH ON ACCOUNT Softbyte SA receives

€600 in cash from customers who had been billed for services (in Transaction 6)

Transaction 9 does not change total assets, but it changes the composition of

Accounts Accounts Share Retained EarningsCash + Receivable + Supplies + Equipment = Payable + Capital + Rev − Exp − Div.

This cash payment “on account” decreases the asset Cash by €250 and also decreases the liability Accounts Payable by €250

Basic

Analysis

Equation

Analysis

Accounts Accounts Share Retained EarningsCash + Receivable + Supplies + Equipment = Payable + Capital + Rev − Exp − Div.

€9,000 €2,000 €1,600 €7,000 €1,850 €15,000 €4,700 €1,950

€8,750 + €2,000 + €1,600 + €7,000 = €1,600 + €15,000 + €4,700 − €1,950

€19,350 €19,350(8)

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 SA This transaction results in an equal decrease in assets and equity.

Note that the dividend reduces retained earnings, which is part of equity

Divi-dends are not expenses Like shareholders’ investments, diviDivi-dends are excluded

in determining net income.

Summary of Transactions

Illustration 1-10 summarizes the September transactions of Softbyte SA to show their cumulative effect on the basic accounting equation It also indicates the transaction number and the specifi c effects of each transaction Finally, Illustra- tion 1-10 demonstrates a number of signifi cant facts:

1 Each transaction must be analyzed in terms of its effect on:

(a) The three components of the basic accounting equation.

(b) Specifi c types (kinds) of items within each component.

2 The two sides of the equation must always be equal.

3 The Share Capital—Ordinary and Retained Earnings columns indicate the

causes of each change in the shareholders’ claim on assets.

The asset Cash increases €600, and the asset Accounts Receivable decreases €600

Basic

Analysis

Equation

Analysis

Accounts Accounts Share Retained EarningsCash + Receivable + Supplies + Equipment = Payable + Capital + Rev − Exp − Div.

Accounts Accounts Share Retained EarningsCash + Receivable + Supplies + Equipment = Payable + Capital + Rev − Exp − Div.

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

transac-tions, to make sure you understand them before you go on to the next section.

Trans- Accounts Accounts Share Retained Earnings

action Cash + Receivable + Supplies + Equipment = Payable + Capital + Rev − Exp − Div

Transactions made by Virmari & Co SA, a public accounting fi rm 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 Illustra-tion 1-10

Tabular Analysis

Action Plan

✔ Analyze the effects of

each transaction on the

Service Revenue Rent Expense Dividends

Companies prepare fi ve fi nancial statements from the summarized accounting data:

1 An income statement presents the revenues and expenses and resulting net income or net loss for a specifi c period of time.

2 A retained earnings statement summarizes the changes in retained earnings for a specifi c period of time.

3 A statement of fi nancial position (sometimes referred to as a balance sheet)

reports the assets, liabilities, and equity of a company at a specifi c date.

4 A statement of cash fl ows summarizes information about the cash infl ows

(receipts) and outfl ows (payments) for a specifi c period of time.

5 A comprehensive income statement presents other comprehensive income items that are not included in the determination of net income.

These statements provide relevant fi nancial data for internal and external users Illustration 1-11 shows the fi rst four fi nancial statements from the above list of Softbyte SA (Illustration 1-11 assumes Softbyte has no other comprehensive income items.) A comprehensive income statement is presented on page 25 for Softbyte Note that the statements shown in Illustration 1-11 are interrelated:

1 Net income of €2,750 on the income statement is added to the beginning balance of retained earnings in the retained earnings statement.

2 Retained earnings of €1,450 at the end of the reporting period shown in the

retained earnings statement is reported on the statement of fi nancial position.

3 Cash of €8,050 on the statement of fi nancial position is reported on the

statement of cash fl ows.

Also, explanatory notes and supporting schedules are an integral part of every set of fi nancial statements We illustrate these notes and schedules in later chap- ters 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.

The income statement lists revenues fi rst, followed by expenses Then, the

statement shows net income (or net loss) When revenues exceed expenses, net income results When expenses exceed revenues, a net loss results.

Although practice varies, we have chosen to list expenses in order of tude in our illustrations (We will consider alternative formats for the income statement in later chapters.)

magni-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 SA was not regarded as a business expense This type of transaction is considered a reduc- tion of retained earnings, which causes a decrease in equity.

statement are all for a

period of time, whereas

the statement of fi nancial

position is for a point in