c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objectives
1.
2.
3.
4.
5.
6.
Describe the nature of a business and the role of
accounting and ethics in business.
Summarize the development of accounting principles and
relate them to practice.
State the accounting equation and define each element of
the equation.
Describe and illustrate how business transactions can be
recorded in terms of the resulting change in the elements
of the accounting equation.
Describe the financial statements of a proprietorship and
explain how they interrelate.
Describe and illustrate the use of the ratio of liabilities to
owner’s equity in evaluating a company’s financial
condition.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Nature of Business and Accounting
o
A business is an organization in which basic
resources (inputs), such as materials and
labor, are assembled and processed to
provide goods or services (outputs) to
customers.
Nature of Business and Accounting
o The objective of most businesses is to earn a
profit.
o Profit is the difference between the amounts
received from customers for goods or services
and the amounts paid for the inputs used to
provide the goods or services.
Types of Businesses
Service Businesses
Service
Delta Air Lines
Transportation services
The Walt Disney Company
Entertainment services
Merchandising Businesses
Product
WalMart
General merchandise
Amazon.com
Internet books, music, videos
Manufacturing Businesses
Product
Ford Motor Company
Cars, trucks, vans
Dell Inc.
Personal computers
The Role of Accounting in Business
o
Accounting can be defined as an information
system that provides reports to users about
the economic activities and condition of a
business.
The Role of Accounting in Business
o The process by which accounting provides
information to users is as follows:
 Identify users.
 Assess users’ information needs.
 Design the accounting information system to meet
users’ needs.
 Record economic data about business activities and
events.
 Prepare accounting reports for users.
THE ROLE OF
ACCOUNTING IN
BUSINESS
Managerial Accounting
o
The area of accounting that provides internal
users with information is called managerial
accounting or management accounting.
o
Managerial accountants employed by a
business are employed in private accounting.
Financial Accounting
o
The area of accounting that provides external
users with information is called financial
accounting.
o
The objective of financial accounting is to
provide relevant and timely information for
the decision-making needs of users outside of
the business.
o
General-purpose financial statements are one
type of financial accounting report that is
distributed to external users.
Role of Ethics in Accounting and Business
o The objective of accounting is to provide
relevant, timely information for user decision
making.
o Accountants must behave in an ethical manner
so that the information they provide users will
be trustworthy and, thus, useful for decision
making.
o Ethics are moral principles that guide the
conduct of individuals.
Role of Ethics in Accounting and Business
Role of Ethics in Accounting and Business
The answer to …

Failure of individual
character
“What went wrong for
these companies?” …

Firm culture of greed
and ethical
indifference
involves one or both of
these factors. (Exhibit 2)
Role of Ethics in Accounting and Business
Opportunities for Accountants
o
Accountants and their staff who provide
services on a fee basis are said to be
employed in public accounting.
o
Accountants employed by a business firm,
government, or a not-for-profit organization
are said to be employed in private accounting.
o Public accountants who have met a state’s
education, experience, and examination
requirements may become Certified Public
Accountants (CPAs).
Opportunities for Accountants
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Generally Accepted Accounting Principles
o
Financial accountants follow generally
accepted accounting principles (GAAP) in
preparing reports.
o
Within the U.S., the Financial Accounting
Standards Board (FASB) has the primary
responsibility for developing accounting
principles.
Generally Accepted Accounting Principles
o The Securities and Exchange Commission
(SEC), an agency of the U.S. government, has
authority over the accounting and financial
disclosures for companies whose shares of
ownership (stock) are traded and sold to the
public.
o Many countries outside the United States use
generally accepted accounting principles
adopted by the International Accounting
Standards Board (IASB).
Business Entity Concept
o
Under the business entity concept, the
activities of a business are recorded
separately from the activities of its owners,
creditors, or other businesses.
PROPRIETORSHIP
A proprietorship is
owned by one
individual.

70% of business
entities in the U.S. are
proprietorships.

They are easy and
cheap to organize.

Resources are limited
to those of the owner.

Used by small
businesses.
PARTNERSHIP
A partnership is
similar to a
proprietorship
except that it is
owned by two or
more individuals.


10% of business
organizations in the
U.S. (combined
with limited
liability
companies) are
partnerships.
Combines the skills
and resources of
more than one
person.
CORPORATION
A corporation is
organized under
state or federal
statutes as a
separate legal
taxable entity.





Generates 90% of
business revenues.
20% of the business
organizations in the U.S.
Ownership is divided
into shares, called
stock.
Can obtain large
amounts of resources
by issuing stock.
Used by large
businesses.
LIMITED LIABILITY COMPANY (LLC)
A limited liability
company (LLC)
combines the
attributes of a
partnership and a
corporation.

10% of business
organizations in the
U.S. (combined
with partnerships).

Often used as an
alternative to a
partnership.

Has tax and legal
liability advantages
for owners.
Cost Concept
o Under the cost concept, amounts are initially
recorded in the accounting records at their
cost or purchase price.
Cost Concept
o Aaron Publishers purchased a building on
February 20, 2012, for $150,000. Other amounts
related to this purchased are shown on the next
slide.
Cost Concept





Price listed by seller on Jan. 1, 2012
$160,000
Aaron Publishers’ initial offer to buy on Jan. 31, 2012
140,000
Purchase price on Feb. 20, 2012
150,000
Estimated selling price on Dec. 31, 2014
220,000
Assessed value for property taxes, Dec. 31, 2014
190,000
Under the cost concept, Aaron Publishers records the
purchase of the building on February 20, 2012, at the
purchase price of
$150,000.
The other amounts listed above have no effect on the
accounting records.
Objectivity Concept
o
The objectivity concept requires that the
amounts recorded in the accounting records
be based on objective evidence.
o
Only the final agreed-upon amount is
objective enough to be recorded in the
accounting records.
Unit of Measure Concept
o
The unit of measure concept requires that
economic data be recorded in dollars.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
The Accounting Equation
o
The resources owned by a business are its
assets.
o
The rights of creditors are the debts of the
business and are called liabilities.
o
The rights of the owners are called owner’s
equity.
o
The equation Assets = Liabilities + Owner’s
Equity is called the accounting equation.
THE ACCOUNTING
EQUATION
Assets = Liabilities + Owner’s Equity
The resources
owned by a
business
THE ACCOUNTING
EQUATION
Assets = Liabilities + Owner’s Equity
The rights of
creditors are the
debts of the
business
THE ACCOUNTING
EQUATION
Assets = Liabilities + Owner’s Equity
The rights of the
owners
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Business Transaction
o
A business transaction is an economic event or
condition that directly changes an entity’s
financial condition or its results of operations.
TRANSACTION A
On November 1, 2013, Chris Clark deposited
$25,000 in a bank account in the name of
NetSolutions.
TRANSACTION B
On November 5, 2013, NetSolutions paid
$20,000 for the purchase of land as a future
building site.
TRANSACTION C
On November 10, 2013, NetSolutions
purchased supplies for $1,350 and agreed to
pay the supplier in the near future.
Transaction C
o The liability created by a purchase on account
is called an account payable.
o Items such as supplies that will be used in the
business in the future are called prepaid
expenses, which are assets.
TRANSACTION D
On November 18, 2013, NetSolutions received cash of
$7,500 for providing services to customers. A business
earns money by selling goods or services to its
customers. This amount is called revenue.
Transaction D
o Revenue from providing services is recorded
as fees earned.
o Revenue from the sale of merchandise is
recorded as sales.
o Other examples of revenue include rent, which
is recorded as rent revenue, and interest, which
is recorded as interest revenue.
o An account receivable is a claim against a
customer, which is an asset.
TRANSACTION E
During the month, NetSolutions spent cash or
used up other assets in earning revenue.
Assets used in this process of earning revenue
are called expenses.
TRANSACTION E
On November 30, 2013, NetSolutions paid the
following expenses: wages, $2,125; rent, $800;
utilities, $450; and miscellaneous, $275.
TRANSACTION F
On November 30, 2013, NetSolutions paid
creditors on account, $950.
TRANSACTION G
On November 30, 2013, Chris Clark
determined that the cost of supplies on
hand at the end of the period was $550.
TRANSACTION H
On November 30, 2013, Chris Clark
withdrew $2,000 from NetSolutions for
personal use.
SUMMARY
Types of Transactions Affecting Owner’s Equity
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Financial Statements
o
After transactions have been recorded and
summarized, reports are prepared for users.
The accounting reports providing this
information are called financial statements.
FINANCIAL
STATEMENTS
Income Statement
o The income statement reports the revenues and
expenses for a period of time, based on the
matching concept.
o The matching concept is applied by “matching”
the expenses incurred during a period with the
revenue that those expenses generated.
o The excess of the revenue over the expenses is
called net income, net profit, or earnings. If
expenses exceed revenue, the excess is a net loss.
Statement of Owner’s Equity
o
The statement of owner’s equity reports the
changes in the owner’s equity for a period of
time.
o
It is prepared after the income statement
because the net income or net loss for the
period must be reported in this statement.
Financial Statements – Income Statement
Net income is carried to
the statement of
owner’s equity.
Financial Statements – Statement of Owner’s Equity
From the income statement
To the balance sheet
(continued)
Balance Sheet
o
A balance sheet is a list of the assets,
liabilities, and owner’s equity as of a specific
date.
Account Form
o
The account form of a balance sheet lists the
assets on the left and the liabilities and
owner’s equity on the right. It resembles the
basic format of the accounting equation.
Financial Statements – Balance Sheet
This amount is
compared to the
net cash flow on
the statement of
cash flows.
From the statement
of owner’s equity
(continued)
Statement of Cash Flows
o
A statement of cash flows is a summary of the
cash receipts and cash payments for a specific
period of time.
 It consists of three sections:
(1) operating activities
(2) investing activities
(3) financing activities
Financial Statements – Statement of Cash Flows
This amount should match
Cash on the balance sheet
(concluded)
Cash Flows from Operating Activities
o
The cash flows from operating activities
section reports a summary of cash receipts
and cash payments from operations.
Cash Flows from Investing Activities
o
The cash flows from investing activities section
reports the cash transactions for the
acquisition and sale of relatively permanent
assets.
Cash Flows from Financing Activities
o
The cash flows from financing activities
section reports the cash transactions related to
cash investments by the owner, borrowings,
and withdrawals by the owner.
INTERRELATIONSHIPS AMONG
FINANCIAL STATEMENTS
Income Statement and
Statement of
Owner’s Equity

Net income or net
loss reported on
the income
statement is also
reported on the
statement of
owner’s equity and
any additional
investments by the
owner during the
year.
Interrelationships Among Financial Statements
o In Exhibit 6, NetSolutions’ net income of $3,050
for November is added to Chris Clark’s
investment of $25,000 in the statement of
owner’s equity.
INTERRELATIONSHIPS AMONG
FINANCIAL STATEMENTS
Statement of Owner’s
Equity and Balance
Sheet
 The owner’s
capital at the end
of the period is
reported on the
statement of
owner’s equity
and is also
reported on the
balance sheet as
owner’s capital.
Interrelationships Among Financial Statements
o In Exhibit 6, Chris Clark, Capital of $26,050 as of
November 30, 2013, on the statement of owner’s
equity also appears on the November 30, 2013,
balance sheet as Chris Clark, Capital.
INTERRELATIONSHIPS AMONG
FINANCIAL STATEMENTS
Balance Sheet and
Statement of Cash
Flows
 The cash
reported on the
balance sheet is
also reported as
the end-of-period
cash on the
statement of cash
flows.
Interrelationships Among Financial Statements
o In Exhibit 6, cash of $5,900 reported on the
balance sheet as of November 30, 2013, is also
reported on the November statement of cash
flows as the end-of-period cash.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
RATIO OF
LIABILITIES TO
OWNER’S EQUITY
Ratio of Liabilities
to Owner’s Equity
Ratio of Liabilities
to Owner’s Equity
=
Total Liabilities
Total Owner’s Equity (or Total
Stockholders’ Equity)
=
$400
$26,050
= 0.015
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.