CHAPTER 1 ACCOUNTING IN ACTION CHAPTER LEARNING OBJECTIVES 1. Identify the activities and users associated with accounting. Accounting is an information system that identifies, records, and communicates the economic events of an organization to interested users. The major users and uses of accounting are as follows: (a) Management uses accounting information to plan, organize, and run the business. (b) Investors (owners) decide whether to buy, hold, or sell their financial interests on the basis of accounting data. (c) Creditors (suppliers and bankers) evaluate the risks of granting credit or lending money on the basis of accounting information. Other groups that use accounting information are taxing authorities, regulatory agencies, customers, and labor unions. 2. Explain the building blocks of accounting: ethics, principles, and assumptions. Ethics are the standards of conduct by which actions are judged as right or wrong. Effective financial reporting depends on sound ethical behavior. Generally accepted accounting principles are a common set of standards used by accountants. The primary accounting standard-setting body in the United States is the Financial Accounting Standards Board. 3. State the accounting equation, and define its components. The basic accounting equation is: Assets = Liabilities + Owner's Equity Assets are resources a business owns. Liabilities are creditorship claims on total assets. Owner's equity is the ownership claim on total assets. The expanded accounting equation is: Assets  Liabilities + Owner's Capital  Owner's Drawings + Revenues  Expenses Investments by owners (assets the owner puts into the business) are recorded in a category called owner‘s capital. Owner‘s drawings are the withdrawal of assets by the owner for personal use. Revenues are the gross increase in owner‘s equity from business activities for the purpose of earning income. Expenses are the costs of assets consumed or services used in the process of earning revenue. Owner‘s equity is increased by an owner‘s investments and by revenues from business operations. Owner‘s equity is decreased by an owner‘s withdrawals of assets and by expenses. 4. Analyze the effects of business transactions on the accounting equation. Each business transaction must have a dual effect on the accounting equation. For example, if an individual asset increases, there must be a corresponding (1) decrease in another asset, or (2) increase in a specific liability, or (3) increase in owner's equity. 5. Describe the four financial statements and how they are prepared. An income statement presents the revenues and expenses, and resulting net income or net loss for a specific period of time. An owner's equity statement summarizes the changes in owner's equity for a specific period of time. A balance sheet reports the assets, liabilities, and owner's equity at a specific date. A statement of cash flows summarizes information about the cash inflows (receipts) and outflows (payments) for a specific period of time.