STUDY GUIDE FOR TEST #1
*BESIDES THIS STUDY GUIDE, YOU SHOULD REVIEW YOUR NOTES,
HOMEWORKS, PRACTICE PROBLEMS, REVIEW SHEET, AND QUIZZES. YOU
SHOULD ALSO REVIEW TEXTBOOK CHAPTERS 3, 4, AND 5.*
Accounting in the Business World
Types of Business Operations:
- Service - provides a needed service for a fee (travel agencies, hair & nail salons,
movers, repair shops, real estate, medical centers)
- Merchandising - buys finished products and resells them to individuals or other
businesses (department stores, car dealers, supermarkets, drugstores,
florists)
- Manufacturing - buys raw materials like wood or iron and transforms them into finished
products through the use of labor and capital, and sells them to
individuals or other businesses (bakery, shipbuilders)
Forms of Business Organizations:
- Sole Proprietorship - a business owned by 1 person; easiest to set up; success or failure
depends heavily on the effort and talents of the owner
Advantages: easy to set up, all profits go to owner, owner has total control, few
regulations to follow
Disadvantages: limited expertise, hard to raise money, owner assumes all the
risks, hard to attract talented employees
- Partnership - a business owned by two or more people called partners who agree to
operate the business as co-owners; partners enter into a written legal
agreement that specifies how much money or property is invested by each
partner, the responsibilities of each partner, and how profits/losses are
divided
Advantages: easy to start, skills and talents are pooled together, more money
available
Disadvantages: conflicts between partners, profits must be shared, owners share
all risks
- Corporation - a business organization that is recognized by law to have a life of its own;
it must get permission from the state to operate called a charter (gives a
corporation certain rights and privileges and spells out the rules the
corporation operates under)
- corporations often start out as a sole proprietorship or partnership and the
owners may choose to "incorporate" to gain additional money needed to
expand; to raise this money, shares of stock are sold as investments in the
corporation (shareholders/stockholders)
Advantages: easier to raise money, easy to expand, easy to transfer ownership,
losses limited to amount of investment
Disadvantages: costs more to start up, complex to organize, more regulations,
higher taxes
Business Transactions & the Accounting Equation
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Financial Accounting - focuses on reporting information to external users not directly
involved in the day-to-day operations of the business
Managerial Accounting - focuses on reporting information to management and to those
involved in making day-to-day operating decisions like purchasing, hiring, production,
payments, sales, and collections
Generally Accepted Accounting Principles (GAAP) - used by all accountants, these
provide a way to communicate financial information in a form understood by those who
are interested in the operations and financial condition of a business
There are 3 major assumptions all accounts make under GAAP:
1) Business is a separate entity called a business entity which exists
independently of its owner's personal holdings. Accounting records are
maintained separately and contain financial information only related to the
business.
2) Accounting Period - a period of time covered by an accounting report
- Most common: 1 month, quarterly (3 month), yearly
3) Unless there is any evidence that says otherwise, accountants will assume that a
business has the ability to survive and operate indefinitely. In other words, a
business is expected to continue as a going concern. Accountants will assume a
business will continue to operate unless it becomes clear it can't survive.
The Accounting Equation
ASSETS
=
LIABILITIES
+
OWNER'S EQUITY
Asset - property or items of value owned by a business
- examples: cash, equipment, buildings, land
- Equity - the financial claim to an asset
- Investments - long-term assets not intended to be converted into cash or used in
normal business operations in the next accounting period
Liabilities - a creditor's claim to the assets of a business (the debts of a business)
- Creditor - any person or business which money is owed to
Owner's Equity - the owner's claim to the assets of the business which is measured by
the dollar amount of the owner's claims to the total assets of the business
Business Transaction - an economic event that causes a positive or negative change in
assets, liabilities, or owner's equity
- all transaction are recorded in specific accounts which shows the
balance for the specific item such as cash and equipment
- depending on the type of business, there can be only a few
accounts or hundreds of accounts which are all classified as either
A, L, or OE
A/R - the total amount of money owed to a business; a claim to the assets of other people
or businesses
A/P - the amount of money owed to the creditors of a business
Capital - the dollar value of assets contributed to the business

Analyzing Business Transactions
1) Identify the accounts affected
2) Classify the accounts affected
3) Determine the amount increase or decrease for each account affected (+/-)
4) Make sure the accounting equation remains in balance
TRANSACTIONS THAT AFFECT A, L, & OE

Accounts & the Double-Entry Accounting System
Account – a location within an accounting system in which the increases and
decreases in a specific A, L, or OE are recorded and stored
Ledger – where accounts are grouped together; “keeping the books”; when financial
statements are needed, the appropriate info is taken from the ledger and organized
into reports
Chart of Accounts – helps a business keep track of accounts by creating a list of all
accounts and their assigned account number
Double-Entry Accounting – a system of recordkeeping in which each business
transaction affects at least 2 accounts; necessary when a business has many accounts
and transactions to analyze

T Account – shows the dollar increase or decrease in an account that is caused by a
transaction
Top of T – Account name

-

1)
2)
3)
Left side – Debit
Right side – Credit
Rules of Debit and Credit
Debits and credits are used to show the increase or decrease of each account affected by a
business transaction
In double-entry accounting, for each debit made in an account, a credit of an equal
amount must be made in another account
Normal Balance – each account has a specific side that is used to record increases, the
balance of the increase side will be the Normal Balance of that account
Rules for Asset Accounts
Increased on the debit (left) side
Decreased on the credit (right) side
The normal balance for an asset account is the increase (debit, left) side. Assets normally
have debit balances

1)
2)
3)
Rules for Liability and Owner’s Equity Accounts
Increased on the credit (right) side
Decreased on the debit (left) side
The normal balance for a liability or OE account is the increased (credit, right) side.
Liability and OE accounts normally have credit balances.
Revenue, Expenses, & Withdrawals with T Accounts & Ledgers

Separate revenue and expense accounts will be set up to make things more clear and
easier to follow. This is useful because it can show a business owner which resources
earn the most money and which expenses need to be reduced to save money.

Revenue, expenses, and withdrawals are used to collect information for a single
accounting period. These accounts are called temporary capital accounts that start each
new accounting period with zero balances. They are not carried forward from one
accounting period to the next like most asset, liability, and owner's equity accounts.

At the end of the accounting period, the balances of temporary capital accounts are
transferred to the owner's capital account.

Each revenue, expense, and withdrawal account should be clearly and specifically labeled
like we have started doing with A/R and A/P accounts.

Permanent accounts - accounts that are continuous from one accounting period to the
next; the dollar balances at the end of one accounting period become the balances at the
beginning of the next accounting period

Rules of Debit and Credit for Temporary Capital Accounts
Revenue
Increase on the credit (right) side
Decrease on the debit (left) side
Normal balance on credit (right) side
Expenses
Increase on the debit (left) side
Decrease on the credit (right)
Normal balance on the debit (left) side
Withdrawal
Increase on the debit (left) side
Decrease on the credit (right) side
Normal balance on the debit (left) side
OTHER IMPORTANT THINGS TO REMEMBER
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Always make sure the accounting equation is in balance
Clearly label your accounts
Always show the balance of each account
Review how to input information into a balance sheet and a ledger using T Accounts
The +/- Chart for types of transactions (textbook p.61)
THE TEST WILL CONSIST OF:
10 MULTIPLE CHOICE (3 POINTS EACH)
=
30 POINTS
THE +/- CHART (10 POINTS)
=
10 POINTS
BALANCING A=L+OE WITH CHART
=
30 POINTS
BALANCING A=L+OE WITH T ACCOUNTS =
30 POINTS
(THE CHART AND T ACCOUNT PROBLEMS WILL USE SAME TRANSACTIONS)
YOU WILL HAVE A CHANCE FOR UP TO 10 BONUS POINTS (UP TO 5 FROM
REVIEW GAME AND UP TO 5 FROM BONUS QUESTIONS ON TEST)