1 1 Introduction to Accounting and Business. 2 2. Summarize the development of accounting principles...

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1Introduction to Introduction to

Accounting Accounting and Businessand Business

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2. Summarize the development of accounting principles and relate them to practice.3. State the accounting equation and define each element of the equation.

After studying this chapter, you should be able to:

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

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

After studying this chapter, you should be able to:

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

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

Objective 1Objective 1Objective 1Objective 1

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ServiceService BusinessBusiness ServiceService ServiceService BusinessBusiness ServiceService

The Walt Disney Company EntertainmentDelta Air Lines TransportationMarriott International Hotels Hospitality and

lodgingBank of America Corporation Financial servicesXM Satellite Radio Satellite radio

The Walt Disney Company EntertainmentDelta Air Lines TransportationMarriott International Hotels Hospitality and

lodgingBank of America Corporation Financial servicesXM Satellite Radio Satellite radio

1-1Types of Businesses

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Merchandising BusinessMerchandising Business ProductProductMerchandising BusinessMerchandising Business ProductProduct

Wal-Mart General merchandiseGameStop Corporation Video games and accessoriesBest Buy Consumer electronicsGap Inc. ApparelAmazon.com Internet books, music, video

Wal-Mart General merchandiseGameStop Corporation Video games and accessoriesBest Buy Consumer electronicsGap Inc. ApparelAmazon.com Internet books, music, video

Types of Businesses 1-1

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Manufacturing BusinessManufacturing Business ProductProductManufacturing BusinessManufacturing Business ProductProduct

General Motors Corp. Cars, trucks, vansSamsung Cell phonesDell Inc. Personal computersNike Athletic shoes and apparelThe Coca-Cola Company BeveragesSony Corporation Stereos and televisions

General Motors Corp. Cars, trucks, vansSamsung Cell phonesDell Inc. Personal computersNike Athletic shoes and apparelThe Coca-Cola Company BeveragesSony Corporation Stereos and televisions

Types of Businesses 1-1

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Proprietorship Partnership Corporation Limited liability company

Common Forms of Business Organizations 1-1

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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.

A proprietorship is owned by one individual and—

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Comprises 10% of business organizations in the United States.

Combines the skills and resources of more than one person.

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

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Generates 90% of the total dollars of business receipts received.

Comprises 20% of the businesses.

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

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

owners.

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—

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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 business’s 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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1. Individual character

2. Firm culture3. Laws and

enforcement

The answer to “What went

wrong for these companies?”

(Exhibit 2) involves three

factors.

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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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Summarize the development of accounting principles and

relate them to practice.

Objective 2Objective 2Objective 2Objective 2

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The The business entity concept limits the economic data in limits the economic data in the accounting system to the accounting system to

data related directly to the data related directly to the activities of the business.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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Example Exercise 1-1

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 seller’s 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 Service’s records?

Follow My Example 1-1

$137,000. Under the cost concept, the land should be recorded at the cost to Gallatin Repair Service.

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State the accounting equation and define each element of the equation.

Objective 3Objective 3Objective 3Objective 3

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Assets = Liabilities + Owner’s Equity

The resources owned by a

business

The Accounting Equation 1-3

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The rights of the creditors, which represent debts of the business

Assets = Liabilities + Owner’s Equity

The Accounting Equation 1-3

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The rights of the owners

Assets = Liabilities + Owner’s Equity

The Accounting Equation 1-3

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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) owner’s equity section of the December 31, 2007, balance sheet of Hindsight Consulting.

Example Exercise 1-2

John Joos is the owner and operator of You’re A Star, a motivational consulting business. At the end of its accounting period, December 31, 2007, You’re A Star has assets of $800,000 and liabilities of $350,000. Using the accounting equation, determine the following amounts:

a. Owner’s equity, as of December 31, 2007.

b. Owner’s equity, as of December 31, 2008, assuming that assets increased by $130,000 and liabilities decreased by $25,000 during 2008.

Follow My Example 1-2a. A = L + OE $800,000 = $350,000 + OE OE = $450,000

b. 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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Describe and illustrate how business transactions can be

recorded in terms of the resulting change in the basic elements of the

accounting equation.

Objective 4Objective 4Objective 4Objective 4

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A business transaction is an economic event or condition that

directly changes an entity’s 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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a. Chris Clark deposits $25,000 in a bank account in the name of NetSolutions.

Chris Clark, Capital25,000 Investment

by Chris Clark

Cash25,000 a.

=

Assets Owner’s Equity=

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b. NetSolutions exchanged $20,000 for land.

Chris Clark, Capital25,000

Cash + Land 25,000 Bal.

Assets Owner’s Equity=

=b. –20,000 +20,000Bal. 5,000 20,000 25,000

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Accounts Chris Clark, Cash + Supplies + Land Payable Capital

Assets

c. During the month, NetSolutions purchased supplies for $1,350 and agreed to pay the supplier in the near future (on account).

Owner’s Liabilities + Equity=

5,000 20,000 25,000=

+1,350 +1,350c.Bal.

5,000 1,350 20,000 1,350 25,000Bal.

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Beginning with entry (d) the asset section will be shown first, then the liabilities and

owner’s equity will be shown in the following slide.

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Cash + Supplies + Land

Assets

5,000 1,350 20,000

d. NetSolutions provided services to customers, earning fees of $7,500 and received the amount in cash.

Bal.

12,500 1,350 20,000+7,500d.

Bal.

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d. NetSolutions provided services to customers, earning fees of $7,500 and received the amount in cash.

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Liabilities + Owner’s Equity Accounts Chris Clark, Fees

Payable Capital + Earned 1,350 25,000 Bal.

+7,500 d.

+

25,000 7,500 Bal.1,350

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The amounts used in earning revenue are called expenses. Adding expenses to the owner’s 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.

Expenses

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Cash + Supplies + Land

Assets

e. NetSolutions paid the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.

Bal. 12,500 1,350 20,000

Bal. 8,850 1,350 20,000 e. –3,650

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Accounts Chris Clark, Fees Wages Rent Utilities Misc. Payable + Capital + Earned Expense Expense Expense Expense

Liabilities + Owner’s Equity

1,350 25,000 7,500

–2,125 –800 –450 –275 e.

1,350 25,000 7,500 –2,125 –800 –450 –275

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e. NetSolutions paid the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.

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f. NetSolutions paid $950 to creditors during the month.

Cash + Supplies + Land

Assets

Bal. 8,850 1,350 20,000

Bal. 7,900 1,350 20,000 f. –950

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Accounts Chris Clark, Fees Wages Rent Utilities Misc. Payable + Capital + Earned Expense Expense Expense Expense

Liabilities + Owner’s Equity

1,350 25,000 7,500 –2,125 –800 –450 –275

400 25,000 7,500 –2,125 –800 –450 –275

f. NetSolutions paid $950 to creditors during the month.

f.–950

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g. At the end of the month, the cost of supplies on hand is $550, so $800 of supplies were used.

Cash + Supplies + Land

Assets

Bal. 7,900 1,350 20,000

Bal. 7,900 550 20,000 g. –800

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Accounts Chris Clark, Fees Wages Rent Supplies Util. Misc. Payable + Capital + Earned Exp. Exp. Exp. Exp. Exp.

Liabilities + Owner’s Equity

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.

g. –800

400 25,000 7,500 –2,125 –800 –800 –450 –275

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Cash + Supplies + Land

Assets

Bal. 7,900 550 20,000

Bal. 5,900 550 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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Accounts Chris Clark, Chris Clark Fees Wages Rent Supplies Util. Misc. Payable + Capital + Drawing Earned Exp. Exp. Exp. Exp. Exp.

Liabilities + Owner’s Equity

400 25,000 7,500 –2,125 –800 –800 –450 –275 h. –2,000

h. At the end of the month, Chris withdrew $2,000 in cash from the business for personal use.

400 25,000 –2,000 7,500 –2,125 –800 –800 –450 –275

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Owner’s withdrawals

Expenses

Decreased byDecreased by

Owner’s Equity

Increased byIncreased by

Owner’s investments

Revenues

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Example Exercise 1-3

Salvo Delivery Service is owned and operated by Joel Salvo. The following selected transactions were completed by Salvo Delivery Service during February:

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1. Received cash from owner as additional investment, $35,000.

2. Paid creditors on account, $1,800.

3. Billed customers for delivery services on account, $11,250.

4. Received cash from customers on account, $6,740.

5. Paid cash to owners for personal use, $1,000.

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Continued

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Example Exercise 1-3

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Indicate the effect of each transaction on the accounting equation elements (Assets, Liabilities, Owner’s 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; Owner’s Equity (Joel Salvo, Capital) increases by $35,000.

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Follow My Example 1-3

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(2) Asset (Cash) decreases by $1,800; Liability (Accounts Payable) decreases by $1,800.

For Practice: PE 1-3A, PE 1-3B

(3) Asset (Accounts Receivable) increases by $11,250; Revenue (Delivery Service Fees) increases by $11,250.

(4) Asset (Cash) increases by $6,740; Asset (Accounts Receivable) decreases by $6,740.

(5) Asset (Cash) decreases by $1,000; Owner’s Equity (Joel Salvo, Drawing) increases by $1,000.

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Describe the financial statements of a proprietorship

and explain how they interrelate.

Objective 5Objective 5Objective 5Objective 5

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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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Net income is carried to the

statement of owner’s equity

Income Statement

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A statement of owner’s equity is a summary of the changes

in the owner’s equity that have occurred during a specific

period of time.

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From the income statement

To the balance sheet

Statement of Owner’s Equity

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A balance sheet is a list of the assets, liabilities, and

owner’s equity as of a specific date.

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This amount is compared to the net cash flow on the statement of cash flows

From the statement of owner’s equity

Balance Sheet

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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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This amount should match Cash on the balance sheet.

Statement of Cash Flows 1-5

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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.

1-5Income Statement

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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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Example Exercise 1-4

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.

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Accounts payable $ 12,200 Miscellaneous expense $ 12,950Accounts receivable 31,350 Office expense 63,000Cash 53,050 Supplies 3,350Fees earned 263,200 Wages expense 131,700Land 80,000

Prepare an income statement for the current year ended April 30, 2008.

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Follow My Example 1-4

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CHICKADEE TRAVEL SERVICEINCOME STATEMENT

For the Year Ended April 30, 2008

Fees earned $263,200Expenses:

Wages expense $131,700Office expense 63,000Miscellaneous expense 12,950 Total expenses 207,650

Net income $ 55,550

For practice: PE 1-4A, PE 1-4B

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The statement of owner’s equity reports the changes in

the owner’s equity for a period of time. It is prepared after the

income statement.

1-5Statement of Owner’s Equity

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Example Exercise 1-5

Using the data for Chickadee Travel Service shown in Example Exercise 1-4, prepare a statement of owner’s 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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Follow My Example 1-5

CHICKADEE TRAVEL SERVICESTATEMENT OF OWNER’S EQUITY

For the Year Ended April 30, 2008

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Adam Cellini, capital, May 1, 2007 $ 80,000Additional investment by owner during year $ 50,000Net income for the year 55,550

$105,550Less withdrawals 30,000Increase in owner’s equity 75,550Adam Cellini, capital, April 30, 2008 $155,550

For Practice: PE 1-5A, PE 1-5B

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The balance sheet reports the amounts of a firm’s assets, liabilities, and

owner’s equity at the end of a specific period.

1-5Balance Sheet

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The account form of balance sheet lists the assets on the left and the liabilities and owner’s equity on the right—similar to

design of an account.

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The report form of balance sheet presents the liabilities and owner’s equity sections

below the assets section.

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Example Exercise 1-6

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.

79For Practice: PE 1-6A, PE 1-6B

Follow My Example 1-6

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CHICKADEE TRAVEL SERVICEBALANCE SHEET

April 30, 2008 Assets Liabilities

Cash $ 53,050 Accounts payable $12,200Accounts receivable 31,350Supplies 3,350 Owner’s EquityLand 80,000 Adam Cellini, capital 155,550Total assets $167,750 Total liab. & owner’s eq. $167,750

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The statement of cash flows consists of three sections:

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(1) Operating activities

(2) Investing activities

(3) Financing activities

Statement of Cash Flows

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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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Example Exercise 1-7

A summary of cash flows for Chickadee Travel Service for the year ended April 30, 2008, is shown below.

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Cash receipts:Cash received from customers $251,000Cash received from additional investment of owner 50,000

Cash payments:Cash paid for expenses 210,000Cash paid for land 80,000Cash 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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Follow My Example 1-7

For Practice: PE 1-7A, PE 1-7B

CHICKADEE TRAVEL SERVICESTATEMENT OF CASH FLOWSFor the Year Ended April 30, 2008

Cash flows from operating activities:Cash received from customers $251,000Deduct cash payments for expenses 210,000Net 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 $ 50,000Deduct cash withdrawals by owner 30,000Net cash flows from financing activities 20,000

Net decrease in cash during year $(19,000)Cash as of May 1, 2007 72,050Cash as of April 30, 2008 $ 53,050

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The income statement and the statement of owner’s equity are interrelated.

Net income or net loss appears on both statements.

1-5Interrelationships Among Financial Statements

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The statement of owner’s equity and the balance sheet are interrelated.

The owner’s capital at the end of the period on the statement of owner’s equity also appears on the balance

sheet as owner’s 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.

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