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Accounting
and the
Business
Environment
WHAT YOU PROBABLY ALREADY KNOW
You want to purchase a cell phone and service plan. It would be easy to visit the
closest store and buy the phone and company service plan the salesperson
recommends. But would that necessarily be the selection that best services your
needs with the least cost? Perhaps not. Before making this decision, it might make
sense to:
1. gather information from reliable sources;
2. identify the various options and relevant costs;
3. evaluate the cost/benefit relationship of the different plans; and
4. make the decision.
Financial decisions require thoughtful analysis utilizing accurate, reliable, and
relevant information. The choice may be finding the best investment for your
savings, deciding to purchase or lease a car, or choosing the optimal cell phone
service plan. The process that is undertaken to manage our personal financial lives
is the same as that employed by managers and owners of businesses. This chapter
will explain the importance of accounting to the many users of financial
information and how such data are accumulated and reported.
Learning Objectives/Success Keys
Define accounting vocabulary.
Accounting is an information system that measures business activities, processes that
information into reports, and communicates the results to decision makers. It is often
referred to as the language of business. It’s important as you begin your study of
accounting to understand the basic accounting vocabulary. Make sure you review the
first three sections in Chapter 1 of the textbook carefully, as well as the list of interchangeable terms commonly used in accounting. Review Exhibit 1-3 (p. 4) in the main
text to observe the flow of information between accounting and related organizations
and users. Compare the three forms of business organization in Exhibit 1-4 (p. 7).
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Define the users of financial information.
Financial accounting information is used by individuals, businesses, investors, creditors,
and taxing authorities. These users are known as decision makers. In other words, these
people are reading the financial accounting information because they are hoping that it
will assist them in coming to a decision about the accounting entity to which the statements relate.
Describe the accounting profession and the organizations that govern it.
All businesses need accountants. Accountants must deal with everything in a company in
order to record all of its activities and therefore accountants often have the broadest view
of what’s going on in that company.
The Financial Accounting Standards Board (FASB) formulates accounting standards in
the United States, while Certified public accountants, or CPAs, are licensed professional
accountants who serve the general public.
Indentify the different types of business organizations.
Businesses can be organized as proprietorships, partnerships, or corporations. To allow
for more liability protection, the Limited-Liability Partnership (LLP) and Limited-Liability
Company (LLC) business organizations can also be used. Review Exhibit 1-4 (p. 7) in the
text to see the differences among these types of organizations.
Delineate the distinguishing characteristics and organization of a proprietorship.
Sole proprietorships are businesses owned by a single person, who is usually also the
main managed of the business. Proprietorships are distinct from their owners, and have
separate accounting.
Apply accounting concepts and principles.
The basic accounting concepts and principles include the entity concept, the reliability
(objectivity) principle, the cost principle, the going-concern principle, and the stablemonetary-unit concept. Make sure you understand these concepts and principles and
how they are applied in the business world.
Define and use the accounting equation.
It is critical to understand each of the basic components of the accounting equation:
Assets = Liabilities + Owner’s Equity
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Review carefully “The Accounting Equation” section of the main text to understand
these important components. Owner’s equity can be confusing. Pay special attention
to Exhibit 1-6 (p. 11), which summarizes the four types of transactions that affect
owner’s equity.
Depict accounting for business transactions.
A business transaction is an event that can be measured and affects any of the components of the accounting equation: assets, liabilities, or owner’s equity. Use the accounting
equation to record the effects of each business transaction. Make sure that the amount
of the increase or decrease on the left side of the equation (assets) is the same as that
on the right side (liabilities and owner’s equity.) This is a simple but crucial concept to
understand. Review the analysis of transactions in Exhibit 1-7 (p. 13).
Explain and prepare the financial statements.
Business transactions are analyzed, recorded, classified, and reported in the financial
statements. Financial statements are commonly prepared on a monthly, quarterly, or
annual basis and include the income statement, statement of owner’s equity, balance
sheet, and statement of cash flows. Refer to Exhibit 1-8 (p. 19) for examples of the four
financial statements.
Use financial statements to evaluate business performance.
Financial statements communicate important information necessary for users to make
business decisions. Together the financial statements provide useful information to evaluate business performance.
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Demo Doc 1
Basic Transactions
Learning Objectives 1–10
Rick Baldwin opened Rick’s Delivery Service on August 1, 2011. He is the sole proprietor of the business. During the month of August, Rick had the following transactions:
a. Rick invested $6,000 of his personal funds in the business.
b. The business paid $650 cash for supplies.
c. The business purchased bicycles, paying $1,000 in cash and putting
$2,000 on account.
d. The business paid $700 on the accounts to the bicycle store.
e. The business performed delivery services for customers totaling $1,200.
These customers paid in cash.
f. The business performed delivery services for customers on account, totaling $2,400.
g. The business collected $550 on account.
h. The business paid rent (for the month of August) of $850.
i. The business paid employees $1,800 for the month of August.
j. Rick purchased groceries for his own use, paying $100 cash from his personal bank account.
k. The business received a telephone bill for $175. As of August 31, 2011, it
had not been paid.
l. Rick withdrew $900 cash from the business for personal use.
Requirements
1. What type of business organization is Rick’s Delivery Service? Describe
this type of organization. Does this business need accountants?
2. Analyze the preceding transactions in terms of their effects on the
accounting equation of Rick’s Delivery Service.
3. Prepare the income statement, statement of owner’s equity, and
balance sheet of the business as of August 31, 2011.
4. Was the delivery service profitable for the month of August? Given this
level of profit or loss, do you think the withdrawal of $900 was
appropriate?
5. Who will likely be the primary user of the financial statements for Rick’s
Delivery Service?
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Demo Doc 1 Solutions
Describe the
accounting profession
and the organizations
that govern it
Requirement 1
What type of business organization is Rick’s Delivery Service? Describe of
this type of organization. Does this business need accountants?
Part 1
Identify the different
types of business
organizations
Delineate the
distinguishing
characteristics and
organization of a
proprietorship
Part 3
Part 4
Part 5
Part 6
Part 7
Demo Doc
Complete
Rick’s Delivery Service is a sole proprietorship. The accounting records of a sole
proprietorship do not include the proprietor’s (owner’s) personal records. However,
from a legal perspective, the business is the proprietor.
All businesses need accountants, including Rick’s Delivery Service.
Requirement 2
Analyze the preceding transactions in terms of their effects on the
accounting equation of Rick’s Delivery Service.
Part 1
Use accounting
vocabulary
Part 2
Part 2
Part 3
Part 4
Part 5
Part 6
Part 7
Demo Doc
Complete
The accounting equation is:
Assets = Liabilities + Owner’s Equity
Apply accounting
concepts and
principles
It is critical to understand each of these basic components:
Define and use the
accounting equation
Assets are economic resources that should benefit the business in the future.
Common examples of these would be cash, inventory, equipment, and furniture.
Depict accounting for
business transactions
Liabilities are debts or obligations to outsiders. The most common liability is an
account payable, an amount owed to a supplier for goods or services. A note
payable is a written promise of future payment and usually requires the payment of interest in addition to the repayment of the debt, unlike accounts
payable.
Owner’s equity represents the owner’s interest in the business. It is the amount
remaining after subtracting liabilities from assets.
Transaction analysis is a critical first step in understanding how individual transactions are treated in accounting.
a. Rick invested $6,000 of his personal funds in the business.
Rick is using his own money, but he is giving it to the business. This means that
the business is involved and it is a recordable transaction.
From the business’s perspective, this increases Cash (an asset) by $6,000 and
increases Rick Baldwin, Capital (owner’s equity) by $6,000.
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b. The business paid $650 cash for supplies.
The supplies are an asset that increased by $650. Because they were paid for
with cash, the Cash account (an asset) is decreased by $650.
c. The business purchased bicycles, paying $1,000 in cash and putting
$2,000 on account.
The Bicycles account (an asset) is increasing. But by how much? What is the
cost of the bicycles? If $1,000 is paid in cash and $2,000 is bought on account, the
total cost is $1,000 + $2,000 = $3,000. Why? This is the total amount that the business will (eventually) end up paying in order to acquire the bicycles. This is consistent with the cost principle.
So the Bicycles account (an asset) is increased by $3,000, whereas the Cash
account (an asset) is decreased by $1,000.
The $2,000 on account relates to accounts payable (because it will have to be
paid later). Because we now have more money that has to be paid later, it is an
increase in Accounts Payable (a liability) of $2,000.
The end result is that Bicycles (an asset) is increased by $3,000, Cash (an asset)
is decreased by $1,000, and Accounts Payable (a liability) is increased by $2,000.
d. The business paid $700 on the payable to the bicycle store.
Think of Accounts Payable (a liability) as a list of companies to which the
business owes money. In other words, it is a list of companies to which the business will pay money at some future time. In this particular problem, the business
owes money to the company from which it purchased bicycles on account (see
transaction c). When the business pays the money in full, it can cross this company
off the list of companies to which it owes money. Right now, the business is paying only part of the money owed to the bicycle store. This decreases Accounts
Payable (a liability) by $700 and decreases Cash (an asset) by $700.
e. The business performed delivery services for customers totaling $1,200.
These customers paid in cash.
When the business performs services, it means that it is doing work for customers. Doing work for customers is the way that the business makes money. By
performing services, the business is earning revenues.
This means that Service Revenues is increased (which increases owner’s equity)
by $1,200. Because the business receives the cash the customers paid, Cash is also
increased (an asset) by $1,200.
f. The business performed delivery services for customers on account, totaling $2,400.
Again, the delivery service is performing services for customers, which means
that it is earning revenues. This results in an increase in Service Revenues (owner’s
equity) of $2,400.
However, this time the customers charged the services on account. This is money
that the business will receive in the future (when the customers eventually pay) so it is
called accounts receivable. Accounts Receivable (an asset) is increased by $2,400.
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g. The business collected $550 on account.
Think of Accounts Receivable (an asset) as a list of customers from whom the
business will collect money. In other words, it is a list of customers from whom the
business will receive money at some future time. In this particular situation, these
customers received services but did not pay at that time (see transaction f). Later,
when the business collects (receives) the cash in full from any particular customer, it
can cross that customer off the list. This is a decrease to Accounts Receivable (an
asset) of $550.
Because the cash is received, Cash (an asset) is increased by $550.
h. The business paid rent (for the month of August) of $850.
The rent has already been used. By the end of August, the service has been
operating and using the space for the entire month. This means that the benefit of
the rent has already been received or used up. This means that this is a rent expense.
[Note that if the rent was paid for September, it would not yet be used up and would
still be a future benefit (an asset) and not an expense. This issue will be discussed in
Chapter 3.]
So Rent Expense is increased by $850, which is a decrease to owner’s equity.
The question states that the rent was paid. This means it was paid in cash.
Therefore, Cash (an asset) is decreased by $850.
i. The business paid employees $1,800 for the month of August.
Again, the transaction states that the business paid the employees, meaning
that it paid in cash. Therefore, Cash (an asset) is decreased by $1,800.
The work the employees have given to the business has already been used. By
the end of August, the delivery service has had the employees working and delivering for customers for the entire month. This means that the benefit of the work has
already been received, so it is a salary expense. Salary Expense is increased by
$1,800, which is a decrease to owner’s equity.
j. Rick purchased groceries for his own use, paying $100 cash from his personal bank account.
These groceries were purchased with Rick’s personal money for Rick’s personal
use. Therefore, this purchase does not relate to the business and is not a recordable
transaction for the delivery service.
k. The business received a telephone bill for $175. As of August 31, 2011, it
had not been paid.
Utilities (such as water, gas, electricity, phone, and Internet service) are generally not billed until after they have been used. If these utilities have already been
used, then they are utilities expenses. So, Utility Expense is increased by $175,
which is a decrease to owner’s equity.
Because the bill has not yet been paid as of August 31, it is an account payable.
This increases Accounts Payable (a liability) by $175.
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l. Rick withdrew $900 cash from the business for personal use.
Although Rick is taking the money, the cash is coming from the business, so
this is a recordable transaction for the business. There is a decrease of $900 to Cash
(an asset). Because Rick is the owner, this results in an increase of $900 to Owner
Withdrawals, which is a decrease to owner’s equity.
Requirement 3
Prepare the income statement, statement of owners equity, and balance
sheet of the business as of August 31, 2011.
Part 1
Part 2
Part 3
Part 4
LIABILITIES
ASSETS
a.
Accounts
receivable
–650
c.
–1,000
d.
–700
Supplies
+
Bicycles
OWNER’S
EQUITY
Owner investment
+1,200
Service revenue
–2,400
Service revenue
+$2,000
+$3,000
–700
=
–550
–850
–850
i.
–1,800
–1,800
Rent expense
Salary expense
Not a transaction of the business.
+175
k.
l.
TYPE OF
OWNER’S EQUITY
TRANSACTION
+6,000
h.
j.
Demo Doc
Complete
Rick
Baldwin,
Capital
Accounts
payable
+2,400
+550
Part 7
+$650
+1,200
f.
g.
+
+
+$6,000
b.
e.
+
Part 6
Here’s how the transactions from Requirement 1 look in the accounting equation:
Define and use the
accounting equation
Cash
Part 5
–900
$1,850
$650
$1,850
$7,350
Explain and prepare
the financial
statements
$3,000
–175
Utilities expense
–900
Owner withdrawal
$5,875
$1,475
$7,350
Remember that financial statements communicate important information necessary for users to make business decisions. An overview of the financial statements
is as follows:
• Income Statement—Lists the revenues and expenses to determine net income or
net loss for a period. Net income results if revenues exceed expenses; the reverse
results in a net loss.
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• Statement of Owner’s Equity—Shows the changes in owner’s equity during the
period. Investments from owners and net income increase equity; owner withdrawals and net losses decrease equity.
• Balance Sheet—Lists the assets, liabilities, and owner’s equity at a point in time,
usually at the end of a month.
• Statement of Cash Flows—Report of cash receipts (inflows) and cash payments
(outflows) for a period of time. (The statement of cash flow is covered in
Chapter 17.)
The income statement is the first statement that should be prepared because the
other financial statements rely on the net income number calculated on the income
statement.
The income statement lists all revenues and expenses. It uses the following formula to calculate net income:
Revenues – Expenses = Net income
So, to create an income statement, we only need to list the revenue accounts
and then subtract the list of expense accounts to calculate net income.
We can read these amounts from the accounting equation work sheet.
There are two transactions impacting service revenue: e and f. Transaction e
increases service revenue by $1,200 and transaction f increases service revenue by
$2,400. This means that total service revenue for the month was:
$1,200 + $2,400 = $3,600
Rent expense of $850, salary expense of $1,800, and utilities expense of $175
were recorded in transactions h, i, and k (respectively).
RICK’S DELIVERY SERVICE
Income Statement
Month Ended August 31, 2011
Revenue:
Service revenue
Expenses:
Rent expense
Salary expense
Utilities expense
Total expenses
Net income
$3,600*
$ 850
1,800
175
2,825
$ 775
*(= $1,200 + $2,400)
Part 1
Part 2
Part 3
Part 4
Part 5
Part 6
Part 7
Demo Doc
Complete
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Net income is used on the statement of owner’s equity to calculate the new balance in the Capital account. This calculation uses the following formula:
Beginning capital amount
+ Owner investments
+ Net income
– Owner withdrawals
= Ending capital amount
Again, we just have to recreate this formula on the statement:
RICK’S DELIVERY SERVICE
Statement of Owner’s Equity
Month Ended August 31, 2011
Rick Baldwin, capital, August 1, 2011
Add: Investment by owner
Net income for month
$
0
6,000
775
6,775
(900)
$5,875
Less: Withdrawals by owner
Rick Baldwin, capital, August 31, 2011
Part 1
Part 2
Part 3
Part 4
Part 5
Part 6
Part 7
Demo Doc
Complete
The ending capital amount is used on the balance sheet. The balance sheet is
just a listing of all assets, liabilities, and equity, with the accounting equation verified at the bottom:
RICK’S DELIVERY SERVICE
Balance Sheet
August 31, 2011
Assets
Cash
Accounts receivable
Supplies
Bicycles
Total assets
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Chapter 1 | Demo Doc 1 Solutions
Liabilities
$1,850
1,850
650
3,000
$7,350
Accounts payable
$1,475
Equity
Rick Baldwin, capital
Total liabilities and equity
5,875
$7,350
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Requirement 4
Was the delivery service profitable for the month of August? Given this
level of profit or loss, do you think the withdrawal of $900 was
appropriate?
Part 1
Use the financial
statements to evaluate
business performance
Part 2
Part 3
Part 4
Part 5
Part 6
Part 7
Demo Doc
Complete
Evaluating business performance is critical to making sound business decisions. For
example, reviewing the income statement shows the results of operations, how
much the business generated in net income, or if it incurred a net loss. The statement
of owner’s equity indicates what caused the change in owner’s equity for the period.
The balance sheet is a statement of financial condition or financial position, which
includes the ending owner’s equity. The statement of cash flows would identify the
cash receipts and cash payments from operating, investing, and financing activities.
From the income statement prepared in Requirement 2, we can see that the delivery service earned $775 of profit during the month of August. The level of withdrawals ($900) seems high given that it is more than the amount of profit earned during the month.
Requirement 5
Who will likely be the primary user of the financial statements for Rick’s
Delivery Service?
Part 1
Define the users of
financial information
Part 2
Part 3
Part 4
Part 5
Part 6
Part 7
Demo Doc
Complete
As the sole owner and manager, Rick Baldwin will likely be the primary user of the
financial statements for Rick’s Delivery Service.
Part 1
Part 2
Part 3
Part 4
Part 5
Part 6
Part 7
Demo Doc
Complete
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Quick Practice Questions
True/False
1. Financial accounting produces financial information and reports to be
used by managers inside a business.
2. An audit is a financial examination performed by independent
accountants.
3. The top financial position in private accounting is the rank of partner.
4. Professional accounting organizations and most companies have standards of ethical behavior.
5. A proprietorship’s owners are called shareholders.
6. An advantage of the partnership form of business is that the life of the
entity is indefinite.
7. The life of a sole proprietorship is limited to the owner’s choice or death.
8. The entity concept separates business transactions from personal
transactions.
9. A business has a net loss when total revenues are greater than total
expenses.
10. The statement of owner’s equity reports the cash coming in and
going out.
Multiple Choice
1. What is the private organization that is primarily responsible for formulating
accounting standards?
a. The Internal Revenue Service
b. The Securities and Exchange Commission
c. The American Institute of Certified Public Accountants
d. The Financial Accounting Standards Board
2. What is the watchdog agency created by the Sarbanes-Oxley Act?
a. The American Institute of Certified Public Accountants
b. The Public Companies Accounting Oversight Board
c. The Internal Revenue Service
d. The Financial Accounting Standards Board
3. Financial accounting provides financial statements and financial information
that are intended to be used by whom?
a. Management of the company
b. Potential investors
c. Employees of the company
d. The board of directors
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4. What is the purpose of financial accounting information?
a. Help managers plan and control business operations
b. Comply with the IRS rules
c. Help investors, creditors, and others make decisions
d. Provide information to employees
5. What characteristic is necessary for information to be useful?
a. Relevance
b. Reliability
c. Comparability
d. All of the above
6. Sue Mason owns a bagel shop as a sole proprietorship. Sue includes her
personal home, car, and boat on the books of her business. Which of the
following is violated?
a. Entity concept
b. Going-concern concept
c. Cost principle
d. Reliability principle
7. Which of the following is the accounting equation?
a.
Assets – Liabilities = Owner’s Equity
b.
Assets + Liabilities = Owner’s Equity
c.
Assets = Liabilities + Owner’s Equity
d.
Assets + Liabilities = Net income
8. If the assets of a business are $410,000 and the liabilities total $200,000,
how much is the owner’s equity?
a. $150,000
b. $160,000
c. $210,000
d. $610,000
9. Which financial statement contains a listing of assets, liabilities, and owner’s
equity?
a. Balance sheet
b. Statement of owner’s equity
c. Income statement
d. Statement of cash flows
10. What is the claim of a business owner to the assets of the business called?
a. Liabilities
b. Owner’s equity
c. Revenue
d. Withdrawals
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Quick Exercises
1-1.
Fill in the statements that follow with the correct type of business organization.
a. A
is a separate legal entity approved by the state.
b. A
is an entity with one owner where the business and not the
owner is liable for the company’s debts.
c. A
is an entity with two or more owners who are personally
liable for the company’s debts.
1-2.
Match the following terms with the best description.
Terms
a.
b.
c.
d.
e.
Entity concept
Reliability principle
Cost principle
Going-concern concept
Stable-monetary-unit concept
Description
An organization or part of an organization is separate from other
organizations and individuals.
An item should be recorded at the actual amount paid.
An entity is expected to remain in business in the future.
Assumption that the dollar’s purchasing power is constant.
Accounting data should be neutral, unbiased information that can be
confirmed by others.
1-3.
Determine the missing amounts:
a. Assets = $50,000; Liabilities = $30,000; Owner’s Equity =
b. Liabilities = $35,000; Owner’s Equity = $75,000; Assets =
c. Assets = $105,000; Owner’s Equity = $50,000; Liabilities =
1-4.
a.
Write a brief explanation for the following transactions:
ASSETS
LIABILITIES
Cash + Accounts receivable + Supplies
Accounts payable
20,000
1,000
–2,500
5,200
3,000
–3,000
a.
b.
c.
d.
e.
14
OWNER’S EQUITY
Capital
=
1,000
–2,500
d.
e.
+
20,000
b.
c.
?
?
?
Chapter 1 | Quick Practice Questions
5,200
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1-5.
On which of the following three financial statements would you expect to
find the items (a)–(f)?
Income Statement (IS)
Balance Sheet (BS)
Statement of Cash Flows (CF)
a.
Accounts Payable
b.
Service Revenue
c.
Collections from Customer
d.
Utilities Expense
e.
Office Supplies
f.
Payments to Suppliers
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Do It Yourself! Question 1
Jennifer Hill opened a Laundromat business on October 1, 2011. She is the sole proprietor of the business.
Requirement
Use accounting
vocabulary
Apply accounting
concepts and
principles
1. For each transaction of the business during the month of October,
analyze the transaction in terms of its effect on the accounting equation of
Jennifer’s Laundromat.
a. Jennifer invested $10,000 of her personal funds in the business.
Define and use the
accounting equation
Depict accounting for
business transactions
b. The Laundromat purchased washing machines, paying $4,000 in cash and
putting another $5,000 on account.
c. Jennifer purchased a washing machine for use in her home costing $2,100
on her personal account.
d. The business paid $500 cash for supplies.
e. The Laundromat performed cleaning services for customers totaling
$2,500. These customers paid in cash.
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f. The Laundromat also performed cleaning services for customers on
account totaling $3,700.
g. The Laundromat paid rent (for the month of October) of $1,000.
h. The business paid employees $1,500 for the month of October.
i. The Laundromat received a utility bill for $750. As of October 31, 2011, it
had not been paid.
j. Jennifer withdrew $2,000 cash from the business for personal use.
k. The Laundromat collected $2,250 on account.
l. The amount of $2,400 was paid on the account to the washing machine
store.
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2. Prepare the income statement, statement of owner’s equity, and balance
sheet of the business as of October 31, 2011.
Explained the financial
statements
ASSETS
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Chapter 1 | Do It Yourself! Question 1
LIABILITIES
EQUITY
TYPE OF
OWNER’S EQUITY
TRANSACTION
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Do It Yourself! Question 1 | Chapter 1
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Quick Practice Solutions
True/False
20
F
1. Financial accounting produces financial information and reports to be
used by managers inside a business.
False—Financial accounting produces information for people outside the
company. (p. 3)
T
2. An audit is a financial examination performed by independent accountants. (p. 5)
F
3. The top financial position in private accounting is the rank of partner.
False—The top financial position in private accounting is the chief
financial officer. (p. 4)
T
4. Professional accounting organizations and most companies have standards of ethical behavior. (p. 5)
F
5. A proprietorship’s owners are called shareholders.
False—A corporation’s owners are called shareholders. A proprietorship’s owners are called proprietors. (p. 6)
F
6. An advantage of the partnership form of business is that the life of the
entity is indefinite.
False—The life of a partnership is limited by the owners’ choices or
death. (p. 7)
F
7. The owner of a sole proprietorship is not personally liable for the debts
of the business.
False—The owner of a sole proprietorship is personally liable for the
debts of the business. (p. 7)
T
8. The entity concept separates business transactions from personal transactions. (p. 10)
F
9. A business has a net loss when total revenues are greater than total
expenses.
False—A business has net income when total revenues are greater than
total expenses. (p. 12)
F
10. The statement of owner’s equity reports the cash coming in and going out.
False—The statement of owner’s equity shows the changes in owner’s
equity during a time period. The statement of cash flows reports cash
coming in and going out. (p. 20)
Chapter 1 | Quick Practice Solutions
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Multiple Choice
1. What is the private organization that is primarily responsible for formulating
accounting standards? (p. 4)
a. The Internal Revenue Service
b. The Securities and Exchange Commission
c. The American Institute of Certified Public Accountants
d. The Financial Accounting Standards Board
2. What is the watchdog agency created by the Sarbanes-Oxley Act? (p. 5)
a. The American Institute of Certified Public Accountants
b. The Public Companies Accounting Oversight Board
c. The Internal Revenue Service
d. The Financial Accounting Standards Board
3. Financial accounting provides financial statements and financial information
that are intended to be used by whom? (p. 3)
a. Management of the company
b. Potential investors
c. Employees of the company
d. The board of directors
4. What is the purpose of financial accounting information? (p. 3)
a. To help managers plan and control business operations
b. To comply with the IRS rules
c. To help investors, creditors, and others make decisions
d. To provide information to employees
5. What characteristic is necessary for information to be useful? (p. 5)
a. Relevance
b. Reliability
c. Comparability
d. All of the above
6. Sue Mason owns a bagel shop as a sole proprietorship. Sue includes her
personal home, car, and boat on the books of her business. Which of the
following is violated? (p. 10)
a. Entity concept
b. Going-concern concept
c. Cost principle
d. Reliability principle
7. Which is the accounting equation? (p. 11)
a.
Assets – Liabilities = Owner’s Equity
b.
Assets + Liabilities = Owner’s Equity
c.
Assets = Liabilities + Owner’s Equity
d.
Assets + Liabilities = Net income
Quick Practice Solutions | Chapter 1
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8. If the assets of a business are $410,000 and the liabilities total $200,000,
how much is the owner’s equity? (p. 11)
a. $150,000
b. $160,000
c. $210,000
d. $610,000
9. Which financial statement contains a listing of assets, liabilities, and owner’s
equity? (p. 20)
a. Balance sheet
b. Statement of owner’s equity
c. Income statement
d. Statement of cash flows
10. What is the claim of a business owner to the assets of the business called? (p. 12)
a. Liabilities
b. Owner’s equity
c. Revenue
d. Withdrawals
Quick Exercises
1-1.
Fill in the statements that follow with the correct type of business organization. (p. 7)
a. A corporation is a separate legal entity approved by the state.
b. A limited-liability corporation is an entity with one owner where the
business and not the owner is liable for the company’s debts.
c. A partnership is an entity with two or more owners who are personally
liable for the company’s debts.
1-2.
Match the following terms with the best description. (p. 10)
Terms
a.
b.
c.
d.
e.
Entity concept
Reliability principle
Cost principle
Going-concern concept
Stable-monetary-unit concept
Description
a
c
d
e
b
22
Chapter 1 | Quick Practice Solutions
An organization or part of an organization is separate from other
organizations and individuals.
An item should be recorded at the actual amount paid.
An entity is expected to remain in business in the future.
Assumption that the dollar’s purchasing power is constant.
Accounting data should be neutral, unbiased information that can be
confirmed by others.
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1-3.
Determine the missing amounts: (p. 11)
a.
Assets = $50,000; Liabilities = $30,000; Owner’s Equity =
$20,000
($50,000 – $30,000)
b. Liabilities = $35,000; Owner’s Equity = $75,000; Assets =
$110,000
c.
Assets = $105,000; Owner’s Equity = $50,000; Liabilities =
$55,000
1-4.
a.
ASSETS
LIABILITIES
Cash + Accounts receivable + Supplies
Accounts payable
20,000
=
OWNER’S EQUITY
Capital
1,000
–2,500
–2,500
5,200
3,000
+
20,000
1,000
d.
e.
($105,000 – $50,000)
Write a brief explanation for the following transactions: (p. 14)
b.
c.
($35,000 + $75,000)
5,200
–3,000
a. The owner invested $20,000 cash in the business.
b. Purchased $1,000 of supplies on account.
c. Paid $2,500 for an expense or the owner withdrew $2,500 for personal use.
d. Performed services for customer on account, $5,200.
e. Received $3,000 cash from customers on account.
1-5.
On which of the following three financial statements would you expect to
find the items (a)–(f)? (p. 20)
Income Statement (IS)
Balance Sheet (BS)
Statement of Cash Flows (CF)
a. BS Accounts Payable
b. IS Service Revenue
c. CF Collections from Customer
d. IS Utilities Expense
e. BS Office Supplies
f. CF Payments to Suppliers
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Do It Yourself! Question 1 Solutions
Requirement
1. For each transaction of the business during the month of October,
analyze and describe the transaction in terms of its effect on the accounting
equation of Jennifer’s Laundromat.
a. Jennifer invested $10,000 of her personal funds in the business.
Cash (an asset) is increased by $10,000 and Jennifer Hill, Capital (owner’s
equity) is increased by $10,000.
b. The Laundromat purchased washing machines, paying $4,000 in cash and
putting another $5,000 on account.
Washing Machines (an asset) is increased by $9,000, whereas Cash (an asset) is
decreased by $4,000. Accounts Payable (a liability) is increased by $5,000.
c. Jennifer purchased a washing machine for use in her home costing $2,100
on her personal account.
This does not relate to the business and is not a recordable transaction for the
Laundromat.
d. The business paid $500 cash for supplies.
Supplies (an asset) is increased by $500 and Cash (an asset) is decreased by $500.
e. The Laundromat performed cleaning services for customers totaling
$2,500. These customers paid in cash.
Service Revenues (owner’s equity) is increased by $2,500. Cash (an asset) is
increased by $2,500.
f. The Laundromat also performed cleaning services for customers on
account totaling $3,700.
Service Revenues (owner’s equity) is increased by $3,700. Accounts Receivable
(an asset) is increased by $3,700.
g. The Laundromat paid rent (for the month of October) of $1,000.
Rent Expense is increased by $1,000, which is a decrease to owner’s equity.
Cash (an asset) is decreased by $1,000.
h. The business paid employees $1,500 for the month of October.
Salary Expense is increased by $1,500, which is a decrease to owner’s equity.
Cash (an asset) is decreased by $1,500.
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i. The Laundromat received a utility bill for $750. As of October 31, 2011, it
had not been paid.
Utility Expense is increased by $750, which is a decrease to owner’s equity.
Accounts Payable (a liability) is increased by $750.
j. Jennifer withdrew $2,000 cash from the business for personal use.
This is a recordable transaction for the business. Cash (an asset) is decreased by
$2,000. This results in an increase of $2,000 to Owner Withdrawals, which is
a decrease to owner’s equity.
k. The Laundromat collected $2,250 of accounts receivable.
Accounts Receivable (an asset) is decreased by $2,250. Because the cash is
received, Cash is increased (an asset) by $2,250.
l. The amount of $2,400 was paid on the accounts payable to the washing
machine store.
Accounts Payable (a liability) is decreased by $2,400 and Cash (an asset) is
decreased by $2,400.
2. Prepare the income statement, balance sheet, and statement of owner’s
equity of the business as of October 31, 2011.
LIABILITIES
ASSETS
Cash
+
Accounts
receivable
+
Supplies
+
Washing
Machines
b.
+$10,000
+$9,000
–4,000
TYPE OF
OWNER’S EQUITY
TRANSACTION
Jennifer
Hill,
Capital
Accounts
payable
+$10,000
a.
+
OWNER’S
EQUITY
Owner investment
+$5,000
Not a transaction of the business.
c.
–$500
d.
+2,500
+$500
=
+$3,700
e.
+2,500
Service revenue
+3,700
Service revenue
f.
–1,000
–1,000
Rent expense
g.
–1,500
–1,500
Salary expense
–750
+750
h.
i.
–2,000
j.
+2,250
–2,000
–2,250
Owner withdrawal
k.
–2,400
l.
Utilities expense
$3,350
–2,400
$1,450
$14,300
$500
$9,000
$10,950
$3,350
$14,300
Do It Yourself! Question 1 Solutions | Chapter 1
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JENNIFER’S LAUNDROMAT
Income Statement
Month Ended October 31, 2011
Revenue:
Service revenue
Expenses:
Salary expense
Rent expense
Utilities expense
Total xpenses
e
Net income
$6,200*
$1,500
1,000
750
3,250
$2,950
*(= $2,500 + $3,700)
JENNIFER’S LAUNDROMAT
Statement of Owner’s Equity
Month Ended October 31, 2011
Jennifer Hill, capital, October 1, 2011
Add: Investment by owner
Net income for month
$
0
10,000
2,950
12,950
(2,000)
$10,950
Less: Withdrawals by owner
Jennifer Hill, capital, October 31, 2011
JENNIFER’S LAUNDROMAT
Balance Sheet
October 31, 2011
Assets
Cash
Accounts receivable
Supplies
Washing machines
Total assets
26
Chapter 1 | Do It Yourself! Question 1 Solutions
Liabilities
$3,350
1,450
500
9,000
$14,300
Accounts payable
$3,350
Equity
Jennifer Hill, capital
Total liabilities and equity
10,950
$14,300
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The Power of Practice
For more practice using the skills learned in this chapter, visit MyAccountingLab.
There you will find algorithmically generated questions that are based on these
Demo Docs and your main textbook’s Review and Assess Your Progress sections.
Go to MyAccountingLab and follow these steps:
1. Direct your URL to www.myaccountinglab.com.
2. Log in using your name and password.
3. Click the MyAccountingLab link.
4. Click Study Plan in the left navigation bar.
5. From the table of contents, select Chapter 1, Accounting and the Business
Environment.
6. Click a link to work tutorial exercises.
The Power of Practice | Chapter 1
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