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Financial Accounting
IFRS 4th Edition

Weygandt ● Kimmel ● Kieso
Chapter 1
Accounting in Action
Chapter Preview
Good decision-making depends on good information.

Whatever your pursuits or occupation, the need for financial
information is inescapable. You cannot earn a living, spend money,
buy on credit, make an investment, or pay taxes without receiving,
using, or dispensing financial information. Good decision-making
depends on good information.
Employers need managers in all areas of the company

to be “financially literate.”
Copyright ©2019 John Wiley & Son, Inc. 2

Chapter Outline
• LO 1: Identify the activities and users associated with accounting
• LO 2: Explain the building blocks of accounting: ethics, principles,

and assumptions
• LO 3: State the accounting equation and define its components
• LO 4: Analyze the effects of business transactions on the

accounting equation
• LO 5: Describe the five financial statements and how they are

prepared
Learning Objective 1
Identify the activities and users
associated with accounting.
LO 1 Copyright ©2019 John Wiley & Sons, Inc. 4

Accounting Activities and Users
Three Activities
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Internal Users

External Users (1/2)

External Users (2/2)
Taxing authorities: Does the company comply with the tax laws?
Regulatory agencies: Is the company operating within prescribed rules?
Labor unions: Does the company have the ability to pay increased wages and
benefits to union members?

Explain the building blocks of
accounting: ethics, principles, and
assumptions.

The Building Blocks of Accounting
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),

Toshiba (JPN), Parmalat (ITA), Satyam Computer
Services (IND), Siwei (CHN), Pou Sheng
International (HKG) and others.
◆ Effective financial reporting depends on sound ethical

behavior.
LO 3
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
Ethics Insight Dewey & LeBoeuf (USA)
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
Ethics Insight: Toshiba
Loyalty to Your Employer Is Great, Until It Is Not
Toshiba (JPN), like many Japanese businesses, was severely affected by a series
of events in the early 2000s. First, the company, along with the rest of the world,
experienced the financial crisis and subsequent global recession in 2008 and
2009. Next, in 2011, an earthquake and subsequent tsunami in northern Japan
triggered a significant recession in Japan. The company experienced a 14%
decline in revenue from 2007 to 2013 and a 90% decline in profits over the same
period.
In response to these events, company leadership began to pressure divisional
and mid-level managers to achieve unreasonable financial goals. These
managers, unable to meet the unreasonably high-performance expectations and
influenced by a strong culture of loyalty and respect, were left with little choice
but to create profits where there were none. They committed a number of
financial frauds, including unreasonable estimates and improper recording of
transactions with suppliers.
Ethics Insight: Toshiba
In 2015, when these matters came to light, it was determined that reported
revenues during this period had been overstated by ¥129 million and profits for
the period has been overstated by ¥477 million.
Source: Based on Dennis Caplan, Saurav Dutta, and David Marchinko,

“Unmasking the Fraud at Toshiba,” Issues in Accounting Education, Vol. 34, No. 3
(August 2019).

Accounting Standards
Ensure high-quality financial reporting.
Primary accounting standard-setting bodies:

International Accounting Standards Board (IASB)
• Determines International Financial Reporting Standards (IFRS)
• Used in 130 countries
Financial Accounting Standards Board (FASB)
• Determines generally accepted accounting principles (GAAP)
• Used by most companies in the U.S.
Accounting Standards Board Japan (ASBJ)
• Development of accounting standards in Japan
• Japanese GAAP is equivalent to IFRS

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
Measurement Principles
IFRS generally uses one of two measurement principles, the historical cost
principle or the fair value principle.
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.
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).

Selecting Measurement Principles
Selection of which principle to follow generally relates to trade-offs between
relevance and faithful representation.
Relevance means that financial 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.

Assumptions
Assumptions provide a foundation for the accounting process.
Monetary Unit Assumption: requires that companies include in the
accounting records only transaction data that can be expressed in
money terms.
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. Typical entity forms are
proprietorship, partnership, corporation.
Going Concern Assumption: most accounting methods rely on the
going concern assumption—that the company will have a long life.

DO IT! Building Blocks of Accounting
ACTION PLAN
• Review the discussion of ethics and financial reporting standards.
• Develop an understanding of the key terms used.

DO IT! Building Blocks of Accounting
Solution
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 financial information matches what really
happened; the information is factual.
5. True.

State the accounting equation and
define its components.

The Accounting Equation
The Basic Accounting Equation
Assets: resources a business owns.

Liabilities: claims against assets, i.e. existing debts and obligations.
Equity: the ownership claim on a company’s total assets.

The Accounting Equation
Equity
Share capital—ordinary: describes the amounts paid in by shareholders for the ordinary
shares they purchase.
Revenues: are the gross increases in equity resulting from business activities entered into for
the purpose of earning income. Revenues usually result in an increase in an asset.
Expenses: are the cost of assets consumed or services used in the process of earning
revenue.
Dividends: are distribution of cash or other assets to shareholders. They are not an expense.

Analyze the effects of business
transactions on the accounting
equation.

Analyzing Business Transactions
Accounting Information System:
The system of collecting and processing transaction data and
communicating financial information to decision-makers.
The steps companies follow each period to record transactions and eventually prepare
financial statements:

Identifying Accounting Transactions

Expanding the Balance Sheet Equation for analysis

Transaction (1). Investment by Shareholders.
Assume: Ray and Barbara Neal decide to start a smartphone app
development company that they incorporate as Softbyte SA. On September 1,
2020, 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.
Demonstrate: Basic and equation analysis of this transaction.
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.

Transaction(2). Purchase of Equipment for Cash.
Assume: 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.

Transaction(3). Purchase of Supplies on Credit.
Assume: Softbyte SA purchases headsets (and other computer accessories expected
to last several months) for €1,600 from Mobile Solutions. 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 benefits of using the headsets and computer accessories, and
liabilities increase by the amount due Mobile Solutions.

Transaction (4). Services Performed for Cash.
Assume: 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.
Recall that revenue increases equity.

Transaction (5). Purchase of Advertising on Credit.
Assume: Softbyte SA receives a bill for €250 from Programming News for
advertising on its website but postpones payment until a later date.
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 liability Accounts Payable will decrease and the asset Cash will decrease [see
Transaction (8)]. The cost of advertising is an expense (rather than an asset) because Softbyte has used the benefits.
Advertising Expense is included in determining net income.

Transaction (6).
Services Performed for Cash & Credit.
Assume: 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.

Transaction (7). Payment of Expenses.
Assume: Softbyte SA pays the following expenses in cash for September:
office rent €600, salaries and wages of employees €900, and utilities €200.
This transaction results in an equal decrease in assets and equity.

Transaction (8). Payment of Accounts Payable.
Assume: 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 Transaction (5)] and should not record it again.

Transaction (9). Receipt of Cash on Account.
Assume: 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 those assets.
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.
Assume: The company 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.
Transaction (9) does not change total assets, but it changes the composition of those assets.
Note that the dividend reduces retained earnings, which is part of equity. Dividends are not expenses.
Like shareholders’ investments, dividends are excluded in determining net income.

Softbyte SA: Tabular Analysis of Transactions

Key Points
1. Each transaction must be analyzed in terms of its effect on:
a. The three components of the basic accounting equation.
b. Specific 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.

Describe the five financial statements
and how they are prepared.

Financial Statements
Companies prepare five financial statements from the summarized accounting data.
1. Income statement presents the revenues and expenses and resulting net
income or net loss for a specific period of time.
2. Retained earnings statement summarizes the changes in retained earnings
for a specific period of time.
3. Statement of financial position reports the assets, liabilities, and equity of a
company at a specific date. (Sometimes referred to as a balance sheet.)
4. Statement of cash flows summarizes information about the cash inflows
(receipts) and outflows (payments) for a specific period of time.
5. Comprehensive income statement presents other comprehensive income
items that are not included in the determination of net income in 1.

Financial Statement Connections
Income Statement
Net income is computed first

and is needed to determine
Retained Earnings Statement the ending balance in retained
earnings.
Statement of Financial Position The ending balance in

retained earnings is needed in
preparing the statement of
financial position.
The cash shown on the

Statement of Cash Flows statement of financial position
is needed in preparing the
statement of cash flows.

LO 8
LO 8
LO 8
Income Statement
The income statement lists revenues first, followed by expenses.
Then, the statement shows net income (or net loss).
Structure:
• The income statement lists revenues first, 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.
• The income statement does not include investment and dividend
transactions between the shareholders and the business in
measuring net income.

Retained Earnings Statement
The information provided by this statement indicates the reasons why
retained earnings increased or decreased during the period. If there is
a net loss, it is deducted with dividends in the retained earnings
statement.
Structure:
• The first line of the statement shows the beginning retained
earnings amount.
• Then add net income (or subtract net loss) and subtract
dividends.
• The retained earnings ending balance is the final amount on the
statement.

Statement of Financial Position
The statement of financial position is like a snapshot of the company’s
financial condition at a specific moment in time (usually the month-end or
year-end).
Structure:
Lists assets at the top, followed by equity and then liabilities.
Total assets must equal total equity and liabilities.
When two or more liabilities are involved, a customary way of listing is as
shown as follows:

Statement of Cash Flows
The statement of cash flows provides information on the cash
receipts and payments for a specific period of time.
Structure:
The statement of cash flows reports
(1) the cash effects of a company’s operations during a period,
(2) its investing activities,
(3) its financing activities,
(4) the net increase or decrease in cash during the period, and
(5) the cash amount at the end of the period.

Comprehensive Income Statement
Other comprehensive income items are not part of net income but are
considered important enough to be reported separately.
This statement immediately follows the income statement.
IFRS Alternative:
IFRS allows an alternative statement format in which the
information contained in the income statement and the
comprehensive income statement are combined in a single
statement, referred to as a statement of comprehensive income.

A Look at U.S. GAAP
Key Points
Most agree that there is a need for one set of international accounting
standards. Here is why:
Multinational corporations. Today’s companies view the entire world as
their market. For example, large companies often generate more than 50% of
their sales outside their own boundaries.
Mergers and acquisitions. The mergers between Fiat/Chrysler and
Vodafone/Mannesmann suggest that we will see even more such business
combinations in the future.
Information technology. As communication barriers continue to topple
through advances in technology, companies and individuals in different
countries and markets are becoming more comfortable buying and selling
goods and services from one another.
LO 10
A Look at U.S. GAAP
Key Points
Financial markets. Financial markets are of international significance today.
Whether it is currency, equity securities (shares), bonds, or derivatives, there
are active markets throughout the world trading these types of instruments.
Similarities
● GAAP is based on a conceptual framework that is similar to that used to
develop IFRS.
● The three common forms of business organization that are presented in
the chapter, proprietorships, partnerships, and corporations, are also
found in the United States. Because the choice of business organization
is influenced by factors such as legal environment, tax rates and
regulations, and degree of entrepreneurism, the relative use of each
form will vary across countries.
LO 10
A Look at U.S. GAAP
Similarities
● Transaction analysis is basically the same under IFRS and GAAP but,
as you will see in later chapters, the different standards may impact how
transactions are recorded.
● Financial frauds have occurred at companies such as Satyam
Computer Services (IND), Parmalat (ITA), and Royal Ahold (NLD).
They have also occurred at large U.S. companies such as Enron,
WorldCom, and AIG.
LO 10
A Look at U.S. GAAP
Differences
● U.S. regulators have recently eliminated the need for foreign companies
that trade shares in U.S. markets to reconcile their accounting with
GAAP.
● IFRS tends to be less detailed in its accounting and disclosure
requirements than GAAP. This difference in approach has resulted in a
debate about the merits of “principles-based” (IFRS) versus “rules-
based” (GAAP) standards.
LO 10

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Financial Accounting

IFRS 4th Edition

Good decision-making depends on good information.

Employers need managers in all areas of the company

Copyright ©2019 John Wiley & Son, Inc. 2

• LO 2: Explain the building blocks of accounting: ethics, principles,

• LO 3: State the accounting equation and define its components

• LO 4: Analyze the effects of business transactions on the

• LO 5: Describe the five financial statements and how they are

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 4

LO 1 Copyright ©2019 John Wiley & Son, Inc. 5

LO 1 Copyright ©2019 John Wiley & Son, Inc. 6

LO 1 Copyright ©2019 John Wiley & Son, Inc. 7

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LO 1 Copyright ©2019 John Wiley & Sons, Inc. 9

◆ Recent financial scandals include: Enron (USA),

◆ Effective financial reporting depends on sound ethical

I Felt the Pressure—Would You?

I Felt the Pressure—Would You?

Source: Based on Dennis Caplan, Saurav Dutta, and David Marchinko,

Copyright ©2019 John Wiley & Son, Inc. 14

Primary accounting standard-setting bodies:

LO 2 Copyright ©2019 John Wiley & Son, Inc. 15

Historical cost principle (or cost principle): dictates that companies

Fair value principle: states that assets and liabilities should be

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Relevance means that financial information is capable of making a

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Assets: resources a business owns.

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Recall that revenue increases equity.

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This transaction results in an equal increase in assets and equity.

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

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Net income is computed first

Statement of Financial Position The ending balance in

The cash shown on the

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