Introduction to Accounting and Business

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Introduction to Accounting and Business
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After studying this chapter, you should be able
to

• Describe the nature of a business and the role of
  ethics and accounting in business.

• Summarize the development of accounting
  principles and relate them to practice.
• State the accounting equation and define each
  element of the equation.

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After studying this chapter, you should be able
to

• Describe and illustrate how business transactions
  can be recorded in terms of the resulting change
  in the basic elements of the accounting equation.

• Describe the financial statements of a
  proprietorship and explain how they interrelate.

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Objective 1
Describe the nature of a business and the role of
ethics and accounting in business.
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Types of Businesses
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Types of Businesses
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Types of Businesses
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Common Forms of Business Organizations

• Proprietorship
• Partnership
• Corporation
• Limited liability company

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A proprietorship is owned by one individual and

• Comprises 70 of business organizations in the
  United States.
• Requires low cost of organizing.
• Is limited to financial resources of the owner.
• Is used by small businesses.

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A partnership is similar to a proprietorship
except that it is owned by two or more
individuals and

• Comprises 10 of business organizations in the
  United States.
• Combines the skills and resources of more than
  one person.

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A corporation is organized under state or federal
statues as a separate legal taxable entity and

• Generates 90 of the total dollars of business
  receipts received.
• Comprises 20 of the businesses.

Continued
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• Includes ownership divided into shares of stock,
  sold to shareholders (stockholders).

• Is able to obtain large amounts of resources by
  issuing stock.
• Is used by large businesses.

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A limited liability company (LLC) combines
attributes of a partnership and a corporation in
that it is organized as a corporation. However,
a limited liability corporation can elect to be
taxed as a partnership and

• Is a popular alternative to a partnership.
• Has tax and liability advantages to the owners.

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A business stakeholder is a person or entity
having an interest in the economic performance
and well-being of a business.
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Capital market stakeholders provide the major
financing for the business in order for the
business to begin and continue its operations.
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Product or service market stakeholders include
customers who purchase the businesss products or
services as well as the vendors who supply inputs
to the business.
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Government stakeholders have an interest in the
economic performance of a business. City,
county, state, and federal governments collect
taxes from businesses within their jurisdiction.
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Internal stakeholders include individuals
employed by the business. Managers have an
incentive to maximize the economic value of the
business. Employees have an interest because
their jobs depend on it.
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The moral principles that guide the conduct of
individuals are called ethics.
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The answer to What went wrong for these
companies? (Exhibit 2) involves three factors.

• 1. Individual character
• 2. Firm culture
• 3. Laws and enforcement

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Accounting can be defined as an information
system that provides reports to stakeholders
about the economic activities and condition of a
business.
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The process by which accounting provides
information to business stakeholders is as
follows

• Identify stakeholders.
• Assess stakeholders information needs.
• Design the accounting information system to meet
  stakeholders needs.
• Record economic data about business activities
  and events.
• Prepare accounting reports for stakeholders.

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Financial accounting is primarily concerned with
the recording and reporting of economic data and
activities for a business.
Managerial accounting uses both financial
accounting and estimated data to aid management
in running day-to-day operations and in planning
future operations.
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Accountants employed by a business firm or a
not-for-profit organization are said to be
employed in private accounting.
Accountants and their staff who provide services
on a fee basis are said to be employed in public
accounting.
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Objective 2
Summarize the development of accounting
principles and relate them to practice.
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The business entity concept limits the economic
data in the accounting system to data related
directly to the activities of the business.
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The cost concept is the basis for entering the
exchange price, or cost of an acquisition in the
accounting records.
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The objectivity concept requires that the
accounting records and reports be based upon
objective evidence.
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The unit of measure concept requires that
economic data be recorded in dollars.
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On August 25, Gallatin Repair Service extended an
offer of 125,000 for land that had been priced
for sale at 150,000. On September 3, Gallatin
Repair Service accepted the sellers counteroffer
of 137,000. On October 20, the land was
assessed at a value of 98,000 for property tax
purposes. On December 4, Gallatin Repair Service
was offered 160,000 for the land by a national
retail chain. At what value should the land be
recorded in Gallatin Repair Services records?
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Objective 3
State the accounting equation and define each
element of the equation.
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The Accounting Equation
Assets Liabilities Owners Equity
The resources owned by a business
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The Accounting Equation
Assets Liabilities Owners Equity
The rights of the creditors, which represent
debts of the business
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The Accounting Equation
Assets Liabilities Owners Equity
The rights of the owners
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John Joos is the owner and operator of Youre A
Star, a motivational consulting business. At the
end of its accounting period, December 31, 2007,
Youre A Star has assets of 800,000 and
liabilities of 350,000. Using the accounting
equation, determine the following amounts
The following accounts appear in the adjusted
trial balance of Hindsight Consulting. Indicate
whether each account would be reported in the (a)
current asset (b) property, plant, and
equipment (c) current liability, (d) long-term
liability or (e) owners equity section of the
December 31, 2007, balance sheet of Hindsight
Consulting.

• Owners equity, as of December 31, 2007.
• b. Owners equity, as of December 31, 2008,
  assuming that assets increased by 130,000 and
  liabilities decreased by 25,000 during 2008.

• A L OE
• 800,000 350,000 OE
• OE 450,000

• A L OE
• 130,000 25,000 OE
  OE 155,000
• OE on Dec. 31, 2008
• 605,000 (450,000 155,000)

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Objective 4
Describe and illustrate how business transactions
can be recorded in terms of the resulting change
in the basic elements of the accounting equation.
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A business transaction is an economic event or
condition that directly changes an entitys
financial condition or directly affects its
results of operations.
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On November 1, 2007, Chris Clark begins a
business that will be known as NetSolutions.
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Chris Clark, Capital 25,000 Investment by Chris
Clark
a. Chris Clark deposits 25,000 in a bank
account in the name of NetSolutions.
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Assets
Owners Equity

Chris Clark, Capital 25,000
Cash Land 25,000
Bal.

b. 20,000 20,000
b. NetSolutions exchanged 20,000 for land.
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Owners Liabilities
Equity
Assets


Accounts Chris Clark, Cash
Supplies Land Payable
Capital

Bal.
5,000 20,000 25,000
c. During the month, NetSolutions purchased
supplies for 1,350 and agreed to pay the
supplier in the near future (on account).
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Beginning with entry (d) the asset section will
be shown first, then the liabilities and owners
equity will be shown in the following slide.
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Assets

Cash Supplies Land

Bal.
5,000 1,350 20,000
d. NetSolutions provided services to customers,
earning fees of 7,500 and received the amount in
cash.
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Liabilities Owners Equity
Accounts Chris Clark, Fees
Payable Capital Earned

Bal.
1,350 25,000
d. NetSolutions provided services to customers,
earning fees of 7,500 and received the amount in
cash.
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Expenses
The amounts used in earning revenue are called
expenses. Adding expenses to the owners equity
section results in a space problem. To adjust
for these added headings, the word Bal. has
been omitted from Slides 48, 50, 52, and 54. The
bottom row in these four slides provides the
balances after each transaction.
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Assets
Cash Supplies
Land
Bal. 12,500 1,350 20,000
e. 3,650
e. NetSolutions paid the following expenses
wages, 2,125 rent, 800 utilities, 450 and
miscellaneous, 275.
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Liabilities
Owners Equity
Accounts Chris Clark, Fees
Wages Rent Utilities Misc.
Payable Capital Earned
Expense Expense Expense Expense
1,350 25,000 7,500
e. NetSolutions paid the following expenses
wages, 2,125 rent, 800 utilities, 450 and
miscellaneous, 275.
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Assets
Cash Supplies
Land
Bal. 8,850 1,350 20,000
f. 950
f. NetSolutions paid 950 to creditors during
the month.
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Liabilities
Owners Equity
Accounts Chris Clark, Fees
Wages Rent Utilities Misc.
Payable Capital Earned
Expense Expense Expense Expense
2,125 800 450 275
1,350 25,000 7,500
f. NetSolutions paid 950 to creditors during
the month.
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Assets
Cash Supplies
Land
Bal. 7,900 1,350 20,000
g. 800
g. At the end of the month, the cost of supplies
on hand is 550, so 800 of supplies were used.
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Liabilities
Owners Equity
Accounts Chris Clark, Fees Wages
Rent Supplies Util. Misc. Payable
Capital Earned Exp. Exp.
Exp. Exp. Exp.
400 25,000 7,500 2,125 800 450 275
g. At the end of the month, the cost of supplies
on hand is 550, so 800 of supplies were used.
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Assets
Cash Supplies
Land
Bal. 7,900 550 20,000
h. 2,000
h. At the end of the month, Chris withdrew
2,000 in cash from the business for personal use.
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Liabilities Owners
Equity
Accounts Chris Clark, Chris Clark Fees
Wages Rent Supplies Util. Misc.
Payable Capital Drawing Earned
Exp. Exp. Exp. Exp. Exp.
400 25,000 7,500 2,125 800 800 450 275

h. At the end of the month, Chris withdrew
2,000 in cash from the business for personal use.
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Owners Equity
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Salvo Delivery Service is owned and operated by
Joel Salvo. The following selected transactions
were completed by Salvo Delivery Service during
February

• Received cash from owner as additional
  investment, 35,000.
• Paid creditors on account, 1,800.
• Billed customers for delivery services on
  account, 11,250.
• Received cash from customers on account, 6,740.
• Paid cash to owners for personal use, 1,000.

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Continued
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Indicate the effect of each transaction on the
accounting equation elements (Assets,
Liabilities, Owners Equity, Drawing, Revenue,
and Expense) by listing the numbers identifying
the transactions, (1) through (5). Also,
indicate the specific item within the accounting
equation element that is affected. To
illustrate, the answer to (1) is shown below.
(1) Asset (Cash) increases by 35,000 Owners
Equity (Joel Salvo, Capital) increases by 35,000.
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• Asset (Cash) decreases by 1,800 Liability
  (Accounts Payable) decreases by 1,800.

• Asset (Accounts Receivable) increases by 11,250
  Revenue (Delivery Service Fees) increases by
  11,250.
• Asset (Cash) increases by 6,740 Asset (Accounts
  Receivable) decreases by 6,740.
• Asset (Cash) decreases by 1,000 Owners Equity
  (Joel Salvo, Drawing) increases by 1,000.

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For Practice PE 1-3A, PE 1-3B
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Objective 5
Describe the financial statements of a
proprietorship and explain how they interrelate.
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Accounting reports, called financial statements,
provide summarized information to the owner.
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• The income statement is a summary of the revenue
  and expenses for a specific period of time, such
  as a month or a year.

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Income Statement
Net income is carried to the statement of owners
equity
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A statement of owners equity is a summary of the
changes in the owners equity that have occurred
during a specific period of time.
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Statement of Owners Equity
From the income statement
To the balance sheet
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A balance sheet is a list of the assets,
liabilities, and owners equity as of a specific
date.
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Balance Sheet
This amount is compared to the net cash flow on
the statement of cash flows
From the statement of owners equity
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A statement of cash flows is a summary of the
cash receipts and payments for a specific period
of time.
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Statement of Cash Flows
This amount should match Cash on the balance
sheet.
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Income Statement
The income statement reports the revenues and
expenses for a period of time based on the
matching concept. This concept is applied by
matching the expenses with the revenue generated
during a period by those expenses.
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The excess of revenue over the expenses is called
net income or net profit. If the expenses exceed
the revenue, the excess is a net loss.
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The assets and liabilities of Chickadee Travel
Service at April 30, 2008, the end of the current
year, and its revenue and expenses for the year
are listed below. The capital of the owner, Adam
Cellini, was 80,000 at May 1, 2007, the
beginning of the current year.
Accounts payable 12,200 Miscellaneous
expense 12,950 Accounts receivable 31,350 Offic
e expense 63,000 Cash 53,050 Supplies 3,350 Fees
earned 263,200 Wages expense 131,700 Land 80,000
Prepare an income statement for the current year
ended April 30, 2008.
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CHICKADEE TRAVEL SERVICE INCOME STATEMENT For the
Year Ended April 30, 2008
Fees earned 263,200 Expenses Wages
expense 131,700 Office expense 63,000 Miscellan
eous expense 12,950 Total expenses
207,650 Net income 55,550
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For practice PE 1-4A, PE 1-4B
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Statement of Owners Equity
The statement of owners equity reports the
changes in the owners equity for a period of
time. It is prepared after the income statement.
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Using the data for Chickadee Travel Service shown
in Example Exercise 1-4, prepare a statement of
owners equity for the current year ended April
30, 2008. Adam Cellini invested an additional
50,000 in the business during the year and
withdrew cash of 30,000 for personal use.
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CHICKADEE TRAVEL SERVICE STATEMENT OF OWNERS
EQUITY For the Year Ended April 30, 2008
Adam Cellini, capital, May 1, 2007
80,000 Additional investment by owner during
year 50,000 Net income for the year
55,550 105,550 Less withdrawals
30,000 Increase in owners equity
75,550 Adam Cellini, capital, April 30,
2008 155,550
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For Practice PE 1-5A, PE 1-5B
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Balance Sheet
The balance sheet reports the amounts of a firms
assets, liabilities, and owners equity at the
end of a specific period.
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The account form of balance sheet lists the
assets on the left and the liabilities and
owners equity on the rightsimilar to design of
an account.
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The report form of balance sheet presents the
liabilities and owners equity sections below the
assets section.
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Using the data for Chickadee Travel Service shown
in Example Exercise 1-4 and 1-5, prepare the
balance sheet as of April 30, 2008.
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For Practice PE 1-6A, PE 1-6B
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Statement of Cash Flows
The statement of cash flows consists of three
sections

• Operating activities
• Investing activities
• Financing activities

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The cash flows from operating activities section
reports a summary of cash receipts and cash
payments from operations.
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The cash flows from investing activities section
reports the cash transactions for the acquisition
and sale of relatively permanent assets.
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The cash flows from financing activities section
reports the cash transactions related to cash
investments by the owner, borrowings, and cash
withdrawals by the owner.
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A summary of cash flows for Chickadee Travel
Service for the year ended April 30, 2008, is
shown below.
Cash receipts Cash received from
customers 251,000 Cash received from
additional investment of owner 50,000 Cash
payments Cash paid for expenses 210,000 Cash
paid for land 80,000 Cash paid to owner for
personal use 30,000
The cash balance as of May 1, 2007, was 72,050.
Prepare a statement of cash flows for Chickadee
Travel Service for the year ended April 30. 2008.
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CHICKADEE TRAVEL SERVICE STATEMENT OF CASH
FLOWS For the Year Ended April 30, 2008
Cash flows from operating activities Cash
received from customers 251,000 Deduct cash
payments for expenses 210,000 Net cash flows
from operating activities 41,000 Cash flows
from investing activities Cash payments for
purchase of land (80,000) Cash flows from
financing activities Cash received from owner
as investment 50,000 Deduct cash withdrawals
by owner 30,000 Net cash flows from financing
activities 20,000 Net decrease in cash during
year (19,000) Cash as of May 1, 2007
72,050 Cash as of April 30, 2008 53,050
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For Practice PE 1-7A, PE 1-7B
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Interrelationships Among Financial Statements

• The income statement and the statement of owners
  equity are interrelated.

Net income or net loss appears on both statements.
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• The statement of owners equity and the balance
  sheet are interrelated.

The owners capital at the end of the period on
the statement of owners equity also appears on
the balance sheet as owners capital.
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• The balance sheet and the statement of cash flows
  are interrelated.

The cash on the balance sheet also appears as the
end-of-period cash on the statement of cash flows.