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Accounting 24e
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CHAPTER
1
© AP Photo/Paul Sakuma
Introduction to Accounting
and Business
Google™
W
hen two teams pair up for a game of football, there is
often a lot of noise. The band plays, the fans cheer, and
fireworks light up the scoreboard. Obviously, the fans are committed and care about the outcome of the game. Just like fans at
a football game, the owners of a business want their business to
“win” against their competitors in the marketplace. While having
your football team win can be a source of pride, winning in the
marketplace goes beyond pride and has many tangible benefits.
Companies that are winners are better able to serve customers,
provide good jobs for employees, and
make money for their owners.
One such successful company is
Google, one of the most visible companies on the Internet. Many of us cannot
visit the Web without using Google to
power a search. As one writer said, “Google is the closest thing
the Web has to an ultimate answer machine.” And yet, Google
is a free tool—no one asks for your credit card when you use
Google’s search tools.
Do you think Google has been a successful company? Does
it make money? How would you know? Accounting helps to
answer these questions. Google’s accounting information tells
us that Google is a successful company that makes a lot of
money, but not from you and me. Google makes its money
from advertisers.
This textbook introduces you to
accounting, the language of business.
Chapter 1 begins by discussing what a
business is, how it operates, and the role
that accounting plays.
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Learning Objectives
After studying this chapter, you should be able to:
Example Exercises
Page
Describe the nature of a business, the role of accounting, and ethics in business.
Nature of Business and Accounting
Types of Businesses
The Role of Accounting in Business
Role of Ethics in Accounting and Business
Opportunities for Accountants
Summarize the development of accounting principles and relate them to practice.
Generally Accepted Accounting Principles
Business Entity Concept
The Cost Concept
EE 1-1
8
State the accounting equation and define each element of the equation.
The Accounting Equation
EE 1-2
9
Describe and illustrate how business transactions can be recorded in terms
of the resulting change in the elements of the accounting equation.
Business Transactions and the Accounting Equation
EE 1-3
14
Describe the financial statements of a proprietorship and explain how they interrelate.
Financial Statements
Income Statement
EE 1-4
Statement of Owner’s Equity
EE 1-5
Balance Sheet
EE 1-6
Statement of Cash Flows
EE 1-7
Interrelationships Among Financial Statements
Describe and illustrate the use of the ratio of liabilities to owner’s equity
in evaluating a company’s financial condition.
Financial Analysis and Interpretation: Ratio of Liabilities to Owner’s Equity
22
EE 1-8
At a Glance
Describe the
nature of a
business, the role of
accounting, and ethics
in business.
15
16
18
19
1
Page 22
Nature of Business and Accounting
A business1 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. Businesses come in all sizes, from a local coffee house to Starbucks, which
sells over $10 billion of coffee and related products each year.
The objective of most businesses is to earn a profit. 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. This text focuses on businesses operating to earn a profit. However, many of the same concepts and principles also apply
to not-for-profit organizations such as hospitals, churches, and government agencies.
Types of Businesses
Three types of businesses operated for profit include service, merchandising, and
manufacturing businesses.
Each type of business and some examples are described below.
Service businesses provide services rather than products to customers.
Delta Air Lines (transportation services)
The Walt Disney Company (entertainment services)
Merchandising businesses sell products they purchase from other businesses
to customers.
Wal-Mart (general merchandise)
Amazon.com (Internet books, music, videos)
Manufacturing businesses change basic inputs into products that are sold to
customers.
Ford Motor Co. (cars, trucks, vans)
Dell Inc. (personal computers)
1 A complete glossary of terms appears at the end of the text.
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Chapter 1 Introduction to Accounting and Business
3
The Role of Accounting in Business
The role of accounting in business is to provide information for managers to use in
operating the business. In addition, accounting provides information to other users
in assessing the economic performance and condition of the business.
Thus, accounting can be defined as an information system that provides reports
to users about the economic activities and condition of a business. You may think
of accounting as the “language of business.” This is because accounting is the means
by which businesses’ financial information is communicated to users.
The process by which accounting provides information to users is as follows:
1.
2.
3.
4.
5.
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.
Note:
Accounting is an
information system
that provides reports
to users about the
economic activities and
condition of a business.
As illustrated in Exhibit 1, users of accounting information can be divided into
two groups: internal users and external users.
EXHIBIT 1
Internal
(managers &
employees)
1
Accounting as
an Information
System
External
(investors, creditors,
Identify customers, government)
Users
2
5
Assess
Users’
Information
Needs
Prepare
Accounting
Reports
3
4
Design
Accounting
System
Record
Economic
Data
Internal users of accounting information include managers and employees. These
users are directly involved in managing and operating the business. The area of accounting that provides internal users with information is called managerial accounting or management accounting.
The objective of managerial accounting is to provide relevant and timely information for managers’ and employees’ decision-making needs. Often times, such information is sensitive and is not distributed outside the business. Examples of sensitive
information might include information about customers, prices, and plans to expand
the business. Managerial accountants employed by a business are employed in private accounting.
External users of accounting information include investors, creditors, customers,
and the government. These users are not directly involved in managing and operating
the business. The area of accounting that provides external users with information
is called financial accounting.
The objective of financial accounting is to provide relevant and timely information
for the decision-making needs of users outside of the business. For example, financial
reports on the operations and condition of the business are useful for banks and
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4
Chapter 1 Introduction to Accounting and Business
other creditors in deciding whether to lend money to the business. General-purpose
financial statements are one type of financial accounting report that is distributed to
external users. The term general-purpose refers to the wide range of decision-making
needs that these reports are designed to serve. Later in this chapter, general-purpose
financial statements are described and illustrated.
Role of Ethics in Accounting and Business
The objective of accounting is to provide relevant, timely information for user decision
making. Accountants must behave in an ethical manner so that the information they
provide users will be trustworthy and, thus, useful for decision making. Managers
and employees must also behave in an ethical manner in managing and operating a
business. Otherwise, no one will be willing to invest in or loan money to the business.
Ethics are moral principles that guide the conduct of individuals. Unfortunately,
business managers and accountants sometimes behave in an unethical manner. A
number of managers of the companies listed in Exhibit 2 engaged in accounting or
EXHIBIT 2
Accounting and Business Frauds
Company
Nature of Accounting
or Business Fraud
Result
American International Group,
Inc. (AIG)
Used sham accounting transactions to inflate
performance.
CEO resigned. Executives criminally
convicted. AIG paid $126 million in fines.
Computer Associates
International, Inc.
Fraudulently inflated its financial results.
CEO and senior executives indicted.
Five executives pled guilty. $225 million
fine.
Enron
Fraudulently inflated its financial results.
Bankrupcty. Senior executives criminally
convicted. Over $60 billion in stock market
losses.
Fannie Mae
Improperly shifted financial performance
between periods.
CEO and CFO fired. Company made a
$9 billion correction to previously reported
earnings.
HealthSouth
Overstated performance by $4 billion in false
entries.
Senior executives criminally convicted.
Qwest Communications
International, Inc.
Improperly recognized $3 billion in false
receipts.
CEO and six other executives criminally
convicted of “massive financial fraud.”
$250 million SEC fine.
Satyam Computer Services
Significantly inflated assets and earnings.
Chairman and founder is in jail; investors lost
billions.
Terex
Recorded profit prematurely and inflated
profits.
Company paid $8 million to Securities and
Exchange Commission in settlement.
Tyco International, Ltd.
Failed to disclose secret loans to executives
that were subsequently forgiven.
CEO forced to resign and subjected to frozen
asset order and criminally convicted.
United Rental
Inflated profits to meet earnings forecasts
and analysts expectations.
Vice chairman and chief financial officer
indicted for conspiracy, securities fraud, and
insider trading.
Xerox Corporation
Recognized $3 billion in revenue prior to
when it should have been.
$10 million fine to SEC. Six executives forced
to pay $22 million.
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Chapter 1 Introduction to Accounting and Business
business fraud. These ethical violations led to fines, firings, and lawsuits. In some
cases, managers were criminally prosecuted, convicted, and sent to prison.
What went wrong for the managers and companies listed in Exhibit 2? The answer
normally involved one or both of the following two factors:
Failure of Individual Character. An ethical manager and accountant is honest and fair. However, managers and accountants often face pressures from
supervisors to meet company and investor expectations. In many of the cases
in Exhibit 2, managers and accountants justified small ethical violations to
avoid such pressures. However, these small violations became big violations
as the company’s financial problems became worse.
Culture of Greed and Ethical Indifference. By their behavior and attitude,
senior managers set the company culture. In most of the companies listed
in Exhibit 2, the senior managers created a culture of greed and indifference
to the truth.
As a result of the accounting and business frauds shown in Exhibit 2, Congress
passed new laws to monitor the behavior of accounting and business. For example,
the Sarbanes-Oxley Act of 2002 (SOX) was enacted. SOX established a new oversight
body for the accounting profession called the Public Company Accounting Oversight
Board (PCAOB). In addition, SOX established standards for independence, corporate
responsibility, and disclosure.
How does one behave ethically when faced with financial or other types of pressure? Guidelines for behaving ethically are shown in Exhibit 3.2
EXHIBIT 3
1.
2.
3.
4.
Identify an ethical decision by using your personal ethical standards of honesty and fairness.
Identify the consequences of the decision and its effect on others.
Consider your obligations and responsibilities to those that will be affected by your decision.
Make a decision that is ethical and fair to those affected by it.
Guidelines for
Ethical Conduct
Integrity, Objectivity, and Ethics in Business
BERNIE MADOFF
In June 2009, Bernard L. “Bernie” Madoff was sentenced to
150 years in prison for defrauding thousands of investors
in one of the biggest frauds in American history. Madoff’s
fraud started several decades earlier when he began a
“Ponzi scheme” in his investment management firm, Bernard L. Madoff Securities LLC.
In a Ponzi scheme, the investment manager uses
funds received from new investors to pay a return to
existing investors, rather than basing investment returns
on the fund’s actual performance. As long as the investment manager is able to attract new investors, he or she will
have new funds to pay existing investors and continue the
fraud. While most Ponzi schemes collapse quickly when the
investment manager runs out of new investors, Madoff’s
reputation, popularity, and personal contacts provided a
steady stream of investors which allowed the fraud to survive for decades.
Opportunities for Accountants
Numerous career opportunities are available for students majoring in accounting.
Currently, the demand for accountants exceeds the number of new graduates entering the job market. This is partly due to the increased regulation of business
caused by the accounting and business frauds shown in Exhibit 2. Also, more and
2 Many companies have ethical standards of conduct for managers and employees. In addition, the Institute of Management
Accountants and the American Institute of Certified Public Accountants have professional codes of conduct.
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6
Chapter 1 Introduction to Accounting and Business
more businesses have come to recognize the importance and value of accounting
information.
As indicated earlier, accountants employed by a business are employed in private accounting. Private accountants have a variety of possible career options within
a company. Some of these career options are shown in Exhibit 4 along with their
starting salaries. Accountants who provide audit services, called auditors, verify the
accuracy of financial records, accounts, and systems. As shown in Exhibit 4, several
private accounting careers have certification options.
Accountants and their staff who provide services on a fee basis are said to be
employed in public accounting. In public accounting, an accountant may practice
as an individual or as a member of a public accounting firm. Public accountants who
have met a state’s education, experience, and examination requirements may become
Certified Public Accountants (CPAs). CPAs generally perform general accounting,
EXHIBIT 4
Accounting Career Paths and Salaries
Accounting Career
Track
Private Accounting
Public Accounting
Description
Accountants employed by
companies, government,
and not-for-profit entities.
Accountants employed
individually or within a
public accounting firm in
tax or audit services.
Career Options
Annual Starting
Salaries1
Certification
Bookkeeper
$36,125
Payroll clerk
$34,875
General accountant
Budget analyst
Cost accountant
$42,000
$44,375
$43,750
Internal auditor
$48,250
Information technology
auditor
$56,500
Local firms
$45,063
Certified Public
Accountant (CPA)
National firms
$54,250
Certified Public
Accountant (CPA)
Certified Payroll
Professional (CPP)
Certified Management
Accountant (CMA)
Certified Internal
Auditor (CIA)
Certified Information
Systems Auditor (CISA)
Source: Robert Half 2010 Salary Guide (Finance and Accounting), Robert Half International, Inc.
1
Mean salaries of a reported range. Private accounting salaries are reported for large companies. Salaries may vary by region.
audit, or tax services. As can be seen in Exhibit 4, CPAs have slightly better starting
salaries than private accountants. Career statistics indicate, however, that these salary
differences tend to disappear over time.
Because all functions within a business use accounting information, experience
in private or public accounting provides a solid foundation for a career. Many positions in industry and in government agencies are held by individuals with accounting
backgrounds.
Summarize the
development of
accounting principles
and relate them to
practice.
Generally Accepted Accounting Principles
If a company’s management could record and report financial data as it saw fit, comparisons among companies would be difficult, if not impossible. Thus, financial accountants follow generally accepted accounting principles (GAAP) in preparing reports.
These reports allow investors and other users to compare one company to another.
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Chapter 1 Introduction to Accounting and Business
Accounting principles and concepts develop from research, accepted accounting
practices, and pronouncements of regulators. Within the United States, the Financial
Accounting Standards Board (FASB) has the primary responsibility for developing
accounting principles. The FASB publishes Statements of Financial Accounting Standards as well as Interpretations of these Standards. In addition, 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. The SEC normally accepts the accounting
principles set forth by the FASB. However, the SEC may issue Staff Accounting Bulletins on accounting matters that may not have been addressed by the FASB.
Many countries outside the United States use generally accepted accounting principles adopted by the International Accounting Standards Board (IASB). The IASB
issues International Financial Reporting Standards (IFRSs). Significant differences
currently exist between FASB and IASB accounting principles. However, the FASB
and IASB are working together to reduce and eliminate these differences into a single
set of accounting principles. Such a set of worldwide accounting principles would
help facilitate investment and business in an increasingly global economy.
In this chapter and text, accounting principles and concepts are emphasized. It
is by this emphasis on the “why” as well as the “how” that you will gain an understanding of accounting.
InternationalConnection
INTERNATIONAL FINANCIAL
REPORTING STANDARDS (IFRS)
IFRS are considered to be more “principles-based” than
U.S. GAAP, which is considered to be more “rules-based.”
For example, U.S. GAAP consists of approximately 17,000
pages, which includes numerous industry-specific account-
7
See Appendix D for
more information
ing rules. In contrast, IFRS allow more judgment in deciding how business transactions are recorded. Many believe
that the strong regulatory and litigation environment in
the United States is the cause for the more rules-based
GAAP approach. Regardless, IFRS and GAAP share more in
common than differences.*
*Diff erences between U.S. GAAP and IFRS are further discussed and illustrated in Appendix D.
Business Entity Concept
The business entity concept limits the economic data in an accounting system to
data related directly to the activities of the business. In other words, the business
is viewed as an entity separate from its owners, creditors, or other businesses. For
example, the accountant for a business with one owner would record the activities
of the business only and would not record the personal activities, property, or debts
of the owner.
A business entity may take the form of a proprietorship, partnership, corporation,
or limited liability company (LLC). Each of these forms and their major characteristics
are listed below.
Form of Business Entity
Proprietorship is owned by one individual.
Partnership is owned by two or more individuals.
Note:
Under the business
entity concept,
the activities of a
business are recorded
separately from
the activities of its
owners, creditors, or
other businesses.
Characteristics
• 70% of business entities in the United States.
• Easy and cheap to organize.
• Resources are limited to those of the owner.
• Used by small businesses.
• 10% of business organizations in the United States
(combined with limited liability companies).
• Combines the skills and resources of more than one
person.
(continued)
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8
Chapter 1 Introduction to Accounting and Business
Form of Business Entity
Corporation is organized under state or federal
statutes as a separate legal taxable entity.
Limited liability company (LLC) combines the attributes of a partnership and a corporation.
Characteristics
• Generates 90% of business revenues.
• 20% of the business organizations in the United States.
• Ownership is divided into shares called stock.
• Can obtain large amounts of resources by issuing stock.
• Used by large businesses.
• 10% of business organizations in the United States
(combined with partnerships).
• Often used as an alternative to a partnership.
• Has tax and legal liability advantages for owners.
The three types of businesses discussed earlier—service, merchandising, and manufacturing—may be organized as proprietorships, partnerships, corporations, or limited
liability companies. Because of the large amount of resources required to operate a
manufacturing business, most manufacturing businesses such as Ford Motor Company are
corporations. Most large retailers such as Wal-Mart and Home Depot are also corporations.
The Cost Concept
Under the cost concept, amounts are initially recorded in the accounting records at
their cost or purchase price. To illustrate, assume that Aaron Publishers purchased
the following building on February 20, 2010, for $150,000:
Price listed by seller on January 1, 2010
Aaron Publishers’ initial offer to buy on January 31, 2010
Purchase price on February 20, 2010
Estimated selling price on December 31, 2012
$160,000
140,000
150,000
220,000
Assessed value for property taxes, December 31, 2012
190,000
Under the cost concept, Aaron Publishers records the purchase of the building
on February 20, 2010, at the purchase price of $150,000. The other amounts listed
above have no effect on the accounting records.
The fact that the building has an estimated selling price of $220,000 on December 31, 2012, indicates that the building has increased in value. However, to use the
$220,000 in the accounting records would be to record an illusory or unrealized profit.
If Aaron Publishers sells the building on January 9, 2014, for $240,000, a profit of
$90,000 ($240,000 − $150,000) is then realized and recorded. The new owner would
record $240,000 as its cost of the building.
The cost concept also involves the objectivity and unit of measure concepts. The
objectivity concept requires that the amounts recorded in the accounting records
be based on objective evidence. In exchanges between a buyer and a seller, both
try to get the best price. Only the final agreed-upon amount is objective enough to
be recorded in the accounting records. If amounts in the accounting records were
constantly being revised upward or downward based on offers, appraisals, and opinions, accounting reports could become unstable and unreliable.
The unit of measure concept requires that economic data be recorded in dollars.
Money is a common unit of measurement for reporting financial data and reports.
EExample
xample Exercise 1-1
Cost Concept
On August 25,
25 Gallatin Repair Service extended an offer of $125,000 for land that had been priced for sale at $150,000.
On September
Septem
mbe 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
b 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.
Practice Exercises: PE 1-1A, PE 1-1B
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Chapter 1 Introduction to Accounting and Business
The Accounting Equation
The resources owned by a business are its assets. Examples of assets include cash,
land, buildings, and equipment. The rights or claims to the assets are divided into two
types: (1) the rights of creditors and (2) the rights of owners. The rights of creditors
are the debts of the business and are called liabilities. The rights of the owners are
called owner’s equity. The following equation shows the relationship among assets,
liabilities, and owner’s equity:
9
State the
accounting
equation and define
each element of the
equation.
Assets = Liabilities + Owner’s Equity
This equation is called the accounting equation. Liabilities usually are shown
before owner’s equity in the accounting equation because creditors have first rights
to the assets.
Given any two amounts, the accounting equation may be solved for the third unknown amount. To illustrate, if the assets owned by a business amount to $100,000
and the liabilities amount to $30,000, the owner’s equity is equal to $70,000, as
shown below.
Assets – Liabilities
= Owner’s Equity
$100,000 – $30,000
=
EExample
xample Exercise 1-2
$70,000
Accounting Equation
John Joos is
is the
t owner and operator of You’re A Star, a motivational consulting business. At the end of its accounting
31, 2011, You’re A Star has assets of $800,000 and liabilities of $350,000. Using the accounting
period, December
Decce
determine
the following amounts:
equation, d
det
’ equity, as of December 31, 2011.
a. O
Owner’s
b. Owner’s equity, as of December 31, 2012, assuming that assets increased by $130,000 and liabilities decreased by
$25,000 during 2012.
Follow My Example 1-2
a.
Assets = Liabilities + Owner’s Equity
$800,000 = $350,000 + Owner’s Equity
Owner’s Equity = $450,000
b. First, determine the change in Owner’s Equity during 2012 as follows:
Assets = Liabilities + Owner’s Equity
$130,000 = –$25,000 + Owner’s Equity
Owner’s Equity = $155,000
Next, add the change in Owner’s Equity on December 31, 2011, to arrive at Owner’s Equity on December 31, 2012, as
shown below.
Owner’s Equity on December 31, 2012 = $605,000 = $450,000 + $155,000
Practice Exercises: PE 1-2A, PE 1-2B
Business Transactions and the
Accounting Equation
Paying a monthly telephone bill of $168 affects a business’s financial condition
because it now has less cash on hand. Such an economic event or condition that
directly changes an entity’s financial condition or its results of operations is a business
transaction. For example, purchasing land for $50,000 is a business transaction. In
contrast, a change in a business’s credit rating does not directly affect cash or any
other asset, liability, or owner’s equity amount.
Describe and
illustrate how
business transactions
can be recorded in
terms of the resulting
change in the elements
of the accounting
equation.
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Chapter 1 Introduction to Accounting and Business
BusinessConnection
THE ACCOUNTING EQUATION
The accounting equation serves as the basic foundation for
the accounting systems of all companies. From the smallest business, such as the local convenience store, to the
largest business, such as Ford Motor Company, companies use the accounting equation. Some examples taken
from recent financial reports of well-known companies are
shown below.
Company
Assets* = Liabilities + Owner’s Equity
The Coca-Cola Company
Dell, Inc.
eBay, Inc.
Google
McDonald’s
Microsoft Corporation
Southwest Airlines Co.
Wal-Mart
$ 40,519
26,500
15,593
31,768
28,462
77,888
14,308
163,429
= $20,047
= 22,229
=
4,509
=
3,529
= 15,079
= 38,330
=
9,355
= 98,144
+
+
+
+
+
+
+
+
$20,472
4,271
11,084
28,239
13,383
39,558
4,953
65,285
*Amounts are shown in millions of dollars.
Note:
All business
transactions can
be stated in terms
of changes in the
elements of the
accounting equation.
Transaction A
All business transactions can be stated in terms of changes in the elements of the
accounting equation. How business transactions affect the accounting equation can be
illustrated by using some typical transactions. As a basis for illustration, a business
organized by Chris Clark is used.
Assume that on November 1, 2011, Chris Clark begins a business that will be
known as NetSolutions. The first phase of Chris’s business plan is to operate NetSolutions as a service business assisting individuals and small businesses in developing Web pages and installing computer software. Chris expects this initial phase of
the business to last one to two years. During this period, Chris plans on gathering
information on the software and hardware needs of customers. During the second
phase of the business plan, Chris plans to expand NetSolutions into a personalized
retailer of software and hardware for individuals and small businesses.
Each transaction during NetSolutions’ first month of operations is described in
the following paragraphs. The effect of each transaction on the accounting equation
is then shown.
Nov. 1, 2011 Chris Clark deposited $25,000 in a bank account in the name of
NetSolutions.
This transaction increases the asset cash (on the left side of the equation) by $25,000.
To balance the equation, the owner’s equity (on the right side of the equation) increases by the same amount. The equity of the owner is identified using the owner’s
name and “Capital,” such as “Chris Clark, Capital.”
The effect of this transaction on NetSolutions’ accounting equation is shown below.
Assets
=
Owner’s Equity
Cash
a. 25,000
=
Chris Clark, Capital
25,000
Since Chris Clark is the sole owner, NetSolutions is a proprietorship. Also, the
accounting equation shown above is only for the business, NetSolutions. Under the
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Chapter 1 Introduction to Accounting and Business
11
business entity concept, Chris Clark’s personal assets, such as a home or personal
bank account, and personal liabilities are excluded from the equation.
Nov. 5, 2011 NetSolutions paid $20,000 for the purchase of land as a future
building site.
Transaction B
The land is located in a business park with access to transportation facilities. Chris
Clark plans to rent office space and equipment during the first phase of the business plan. During the second phase, Chris plans to build an office and a warehouse
on the land.
The purchase of the land changes the makeup of the assets, but it does not change
the total assets. The items in the equation prior to this transaction and the effect of
the transaction are shown below. The new amounts are called balances.
Assets
Cash + Land
Bal. 25,000
+20,000
b. –20,000
Bal. 5,000
20,000
=
Owner’s Equity
=
Chris Clark, Capital
25,000
25,000
Nov. 10, 2011 NetSolutions purchased supplies for $1,350 and agreed to pay the
supplier in the near future.
Transaction C
You have probably used a credit card to buy clothing or other merchandise. In this
type of transaction, you received clothing for a promise to pay your credit card bill
in the future. That is, you received an asset and incurred a liability to pay a future
bill. Net-Solutions entered into a similar transaction by purchasing supplies for $1,350
and agreeing to pay the supplier in the near future. This type of transaction is called
a purchase on account and is often described as follows: Purchased supplies on account, $1,350.
The liability created by a purchase on account is called an account payable. Items
such as supplies that will be used in the business in the future are called prepaid
expenses, which are assets. Thus, the effect of this transaction is to increase assets
(Supplies) and liabilities (Accounts Payable) by $1,350, as follows:
Assets
Cash
Bal. 5,000
c.
Bal. 5,000
Nov. 18, 2011
+ Supplies +
+1,350
1,350
=
Land
20,000
20,000
=
Liabilities + Owner’s Equity
Accounts
Payable
+1,350
1,350
+ Chris Clark,
Capital
25,000
25,000
NetSolutions received cash of $7,500 for providing services to
customers.
Transaction D
You may have earned money by painting houses or mowing lawns. If so, you received
money for rendering services to a customer. Likewise, a business earns money by
selling goods or services to its customers. This amount is called revenue.
During its first month of operations, NetSolutions received cash of $7,500 for
providing services to customers. The receipt of cash increases NetSolutions’ assets
and also increases Chris Clark’s equity in the business. The revenues of $7,500 are
recorded in a Fees Earned column to the right of Chris Clark, Capital. The effect of
this transaction is to increase Cash and Fees Earned by $7,500, as shown at the top
of the next page.
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Chapter 1 Introduction to Accounting and Business
Assets
Cash + Supplies + Land
1,350
20,000
Bal. 5,000
d. +7,500
Bal. 12,500
1,350
20,000
=
=
Liabilities +
Owner’s Equity
Accounts
Chris Clark,
Fees
Payable + Capital
+ Earned
1,350
25,000
+7,500
1,350
25,000
7,500
Different terms are used for the various types of revenues. As illustrated above,
revenue from providing services is recorded as fees earned. Revenue from the
sale of merchandise is recorded as sales. Other examples of revenue include rent,
which is recorded as rent revenue, and interest, which is recorded as interest
revenue.
Instead of receiving cash at the time services are provided or goods are sold, a
business may accept payment at a later date. Such revenues are described as fees
earned on account or sales on account. For example, if NetSolutions had provided
services on account instead of for cash, transaction (d) would have been described
as follows: Fees earned on account, $7,500.
In such cases, the firm has an account receivable, which is a claim against the
customer. An account receivable is an asset, and the revenue is earned and recorded
as if cash had been received. When customers pay their accounts, Cash increases and
Accounts Receivable decreases.
Transaction E
Nov. 30, 2011 NetSolutions paid the following expenses during the month: wages,
$2,125; rent, $800; utilities, $450; and miscellaneous, $275.
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.
Expenses include supplies used and payments for employee wages, utilities, and
other services.
NetSolutions paid the following expenses during the month: wages, $2,125;
rent, $800; utilities, $450; and miscellaneous, $275. Miscellaneous expenses include small amounts paid for such items as postage, coffee, and newspapers.
The effect of expenses is the opposite of revenues in that expenses reduce assets
and owner’s equity. Like fees earned, the expenses are recorded in columns to
the right of Chris Clark, Capital. However, since expenses reduce owner’s equity,
the expenses are entered as negative amounts. The effect of this transaction is
shown below.
Assets
Cash + Supplies + Land
1,350
20,000
Bal. 12,500
e. –3,650
Bal. 8,850
1,350
20,000
=
=
Liabilities +
Owner’s Equity
Accounts Chris Clark,
Fees
Wages
Payable + Capital + Earned – Exp. –
1,350
25,000
7,500
–2,125
1,350
25,000
7,500
–2,125
Rent Utilities Misc.
Exp. – Exp. – Exp.
–800
–800
–450
–450
–275
–275
Businesses usually record each revenue and expense transaction as it occurs.
However, to simplify, NetSolutions’ revenues and expenses are summarized for the
month in transactions (d) and (e).
Transaction F
Nov. 30, 2011 NetSolutions paid creditors on account, $950.
When you pay your monthly credit card bill, you decrease the cash in your checking
account and decrease the amount you owe to the credit card company. Likewise,
when NetSolutions pays $950 to creditors during the month, it reduces assets and
liabilities, as shown at the top of the next page.
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Chapter 1 Introduction to Accounting and Business
Assets
=
Cash + Supplies + Land
1,350
20,000
Bal. 8,850
–950
f.
Bal. 7,900
1,350
20,000
=
Liabilities +
13
Owner’s Equity
Accounts Chris Clark,
Fees
Wages
Rent Utilities Misc.
Payable + Capital + Earned – Exp. – Exp. – Exp. – Exp.
1,350
25,000
7,500
–2,125 –800
–450
–275
−950
–2,125
–800
–450
–275
400
25,000
7,500
Paying an amount on account is different from paying an expense. The paying
of an expense reduces owner’s equity, as illustrated in transaction (e). Paying an
amount on account reduces the amount owed on a liability.
Nov. 30, 2011 Chris Clark determined that the cost of supplies on hand at the end
of the month was $550.
Transaction G
The cost of the supplies on hand (not yet used) at the end of the month is $550.
Thus, $800 ($1,350 – $550) of supplies must have been used during the month. This
decrease in supplies is recorded as an expense, as shown below.
Assets
Cash + Supplies + Land
1,350
20,000
Bal. 7,900
g.
–800
Bal. 7,900
550
20,000
Nov. 30, 2011
=
Liabilities +
=
Accounts Chris Clark,
Fees
Wages
Rent
Supplies Utilities Misc.
Payable + Capital + Earned – Exp. – Exp. – Exp. – Exp. – Exp.
400
25,000
7,500
–2,125
–800
–450
–275
–800
–2,125
–800
–800
–450
–275
400
25,000
7,500
Owner’s Equity
Transaction H
Chris Clark withdrew $2,000 from NetSolutions for personal use.
At the end of the month, Chris Clark withdrew $2,000 in cash from the business for
personal use. This transaction is the opposite of an investment in the business by
the owner. Withdrawals by the owner should not be confused with expenses. Withdrawals do not represent assets or services used in the process of earning revenues.
Instead, withdrawals are a distribution of capital to the owner. Owner withdrawals are
identified by the owner’s name and Drawing. For example, Chris Clark’s withdrawal
is identified as Chris Clark, Drawing. Like expenses, withdrawals are recorded in a
column to the right of Chris Clark, Capital. The effect of the $2,000 withdrawal is
as follows:
Assets
Cash + Supp. + Land
550
20,000
Bal. 7,900
h. –2,000
Bal. 5,900
550
20,000
=
=
Liabilities +
Owner’s Equity
Accounts Chris Clark, Chris Clark,
Fees
Payable + Capital – Drawing + Earned –
400
25,000
7,500
–2,000
400
25,000
–2,000
7,500
Wages
Exp.
–2,125
–
–2,125
Rent
Supplies Utilities Misc.
Exp. – Exp. – Exp. – Exp.
–800
–800
–450
–275
–800
–800
Summary The transactions of NetSolutions are summarized at the top of the next
page. Each transaction is identified by letter, and the balance of each accounting
equation element is shown after every transaction.
You should note the following:
1. The effect of every transaction is an increase or a decrease in one or more of the accounting equation elements.
2. The two sides of the accounting equation are always equal.
3. The owner’s equity is increased by amounts invested by the owner and is decreased
by withdrawals by the owner. In addition, the owner’s equity is increased by revenues
and is decreased by expenses.
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–450
–275
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14
Chapter 1 Introduction to Accounting and Business
Assets
= Liabilities +
Owner’s Equity
Accounts Chris Clark, Chris Clark,
Fees
Wages Rent Supplies Utilities Misc.
Cash + Supp. + Land = Payable + Capital – Drawing + Earned – Exp. – Exp. – Exp. – Exp. – Exp.
a. +25,000
+25,000
b. –20,000
+20,000
Bal.
5,000
20,000
25,000
c.
+1,350
+1,350
Bal.
5,000 +1,350
20,000
+1,350
25,000
d.
+7,500
+7,500
Bal. 12,500
1,350
20,000
1,350
25,000
7,500
e.
–3,650
–2,125 –800
–450
–275
Bal.
8,850
1,350
20,000
1,350
25,000
7,500 –2,125 –800
–450
–275
f.
–950
–950
Bal.
7,900
1,350
20,000
400
25,000
7,500 –2,125 –800
–450
–275
g.
–800
–800
Bal.
7,900
550
20,000
400
25,000
7,500 –2,125 –800 –800
–450
–275
h.
–2,000
–2,000
Bal.
5,900
550
20,000
400
25,000
–2,000
7,500 –2,125 –800 –800
–450
–275
The four types of transactions affecting owner’s equity are illustrated in Exhibit 5.
EXHIBIT 5
Types of
Transactions
Affecting
Owner’s Equity
Owner’s Equity
Types of
Transacons
Owner’s
Investments
Owner’s
Withdrawals
Revenues
Expenses
Net Income (Net Loss)
Example Exercise
Example
Exercise 1-3
1-3
-3
T an
Tr
Transactions
a sa
act
cti
tio
ions
Salvo Delivery Service is owned and operated by Joel Salvo. The following selected transactions were completed by
Salvo Delivery Service during February:
1.
2.
3.
4.
5.
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 owner for personal use, $1,000.
Indicate the effect of each transaction on the accounting equation elements (Assets, Liabilities, Owner’s Equity, Drawing,
Revenue, and Expense). 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.
Follow My Example 1-3
(2) Asset (Cash) decreases by $1,800; Liability (Accounts Payable) decreases by $1,800.
(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; Drawing (Joel Salvo, Drawing) increases by $1,000.
Practice Exercises: PE 1-3A, PE 1-3B
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Chapter 1 Introduction to Accounting and Business
Financial Statements
Describe the
financial
statements of a
proprietorship
and explain
how they
interrelate.
After transactions have been recorded and summarized, reports are prepared for users.
The accounting reports providing this information are called financial statements. The
primary financial statements of a proprietorship are the income statement, the statement
of owner’s equity, the balance sheet, and the statement of cash flows. The order that the
financial statements are prepared and the nature of each statement is described as follows.
Order
Prepared
Financial Statement
Description of Statement
1.
Income statement
2.
Statement of owner’s
equity
3.
Balance sheet
4.
Statement of cash flows
A summary of the revenue and expenses for a specific
period of time, such as a month or a year.
A summary of the changes in the owner’s equity that
have occurred during a specific period of time, such as a
month or a year.
A list of the assets, liabilities, and owner’s equity as of
a specific date, usually at the close of the last day of a
month or a year.
A summary of the cash receipts and cash payments for a
specific period of time, such as a month or a year.
15
The four financial statements and their interrelationships are illustrated in Exhibit 6,
on page 17. The data for the statements are taken from the summary of transactions
of NetSolutions on page 14.
All financial statements are identified by the name of the business, the title of the
statement, and the date or period of time. The data presented in the income statement,
the statement of owner’s equity, and the statement of cash flows are for a period of
time. The data presented in the balance sheet are for a specific date.
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
incurred during a period with the revenue that those expenses generated. The excess
of the revenue over the expenses is called net income, net profit, or earnings. If
the expenses exceed the revenue, the excess is a net loss.
The revenue and expenses for NetSolutions were shown in the equation as
separate increases and decreases. Net income for a period increases the owner’s
equity (capital) for the period. A net loss decreases the owner’s equity (capital) for
the period.
The revenue, expenses, and the net income of $3,050 for NetSolutions are reported
in the income statement in Exhibit 6, on page 17. The order in which the expenses
are listed in the income statement varies among businesses. Most businesses list
expenses in order of size, beginning with the larger items. Miscellaneous expense is
usually shown as the last item, regardless of the amount.
Example Exercise
Exercise 1-4
1-4
1Example
Note:
When revenues exceed
expenses, it is referred
to as net income,
net profits, or earnings.
When expenses exceed
revenues, it is referred
to as net loss.
Inco
In
ome
e Statement
Sta
ate
teme
ent
nt
Income
The revenu
revenues
ues and expenses of Chickadee Travel Service for the year ended April 30, 2012, are listed below.
Fees earned
$263,200
Miscellaneous expense
12,950
Office expense
63,000
Wages expense
131,700
Prepare an income statement for the current year ended April 30, 2012.
(Continued)
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16
Chapter 1 Introduction to Accounting and Business
Follow My Example 1-4
Chickadee Travel Service
Income Statement
For the Year Ended April 30, 2012
Fees earned ...........................................................
$263,200
Expenses:
Wages expense ............................................... $131,700
Office expense .................................................
63,000
12,950
Miscellaneous expense ................................
Total expenses ............................................
207,650
$ 55,550
Net income ............................................................
Practice Exercises: PE 1-4A, PE 1-4B
Statement of Owner’s Equity
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 because the net income
or net loss for the period must be reported in this statement. Similarly, it is prepared before the balance sheet, since the amount of owner’s equity at the end of
the period must be reported on the balance sheet. Because of this, the statement
of owner’s equity is often viewed as the connecting link between the income statement and balance sheet.
Three types of transactions affected owner’s equity of NetSolutions during November:
1. the original investment of $25,000,
2. the revenue and expenses that resulted in net income of $3,050 for the month, and
3. a withdrawal of $2,000 by the owner.
The preceding information is summarized in the statement of owner’s equity in Exhibit 6.
Example
Example Exercise
Exercise 1-5
1-5
1-
Statement
Stat
atem
e en
e t of Owner’s
Own
w er
er’ss Equity
Equ
q itty
Using the income
inc
statement for Chickadee Travel Service shown in Example Exercise 1-4, prepare a statement of
owner’s equity
equi for the year ended April 30, 2012. Adam Cellini, the owner, invested an additional $50,000 in the
business and
an withdrew cash of $30,000 for personal use during the year. The capital of the owner, Adam Cellini, was
$80,000
$80
000 on May
M 1, 2011, the beginning of the current year.
Follow My Example 1-5
Chickadee Travel Service
Statement of Owner’s Equity
For the Year Ended April 30, 2012
Adam Cellini, capital, May 1, 2011 .......................................................................
Additional investment by owner during year .................................................
Net income for the year ...........................................................................................
Less withdrawals .........................................................................................................
Increase in owner’s equity.......................................................................................
Adam Cellini, capital, April 30, 2012 ....................................................................
$ 80,000
$ 50,000
55,550
$105,550
30,000
75,550
$155,550
Practice Exercises: PE 1-5A, PE 1-5B
Balance Sheet
The balance sheet in Exhibit 6 reports the amounts of NetSolutions’ assets, liabilities,
and owner’s equity as of November 30, 2011. The asset and liability amounts are taken
from the last line of the summary of transactions on page 14. Chris Clark, Capital
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Chapter 1 Introduction to Accounting and Business
EXHIBIT 6
NetSolutions
Financial
Statements for
NetSolutions
Income Statement
For the Month Ended November 30, 2011
Fees earned . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expenses:
Wages expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rent expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Utilities expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Miscellaneous expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 7,500
$2,125
800
800
450
275
4,450
$3,050
NetSolutions
Statement of Owner’s Equity
For the Month Ended November 30 2011
Chris Clark, capital, November 1, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment on November 1, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income for November . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less withdrawals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in owner’s equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Chris Clark, capital, November 30, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
0
$ 25,000
3,050
$ 28,050
2,000
26,050
$ 26,050
NetSolutions
Balance Sheet
November 30, 2011
Assets
Cash . . . . . . . . . . . . . . . . .
Supplies . . . . . . . . . . . . . .
Land . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . .
$ 5,900
550
20,000
$ 26,450
Liabilities
Accounts payable . . . . . . . . . . . . . . . . . . . . .
Owner’s Equity
Chris Clark, capital. . . . . . . . . . . . . . . . . . . . .
Total liabilities and owner’s equity . . . . . .
$
400
26,050
$ 26,450
NetSolutions
Statement of Cash Flows
For the Month Ended November 30, 2011
Cash flows from operating activities:
Cash received from customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deduct cash payments for expenses and payments
to creditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash flow from operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from investing activities:
Cash payments for purchase of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from financing activities:
Cash received as owner’s investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deduct cash withdrawal by owner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash flow from financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash flow and November 30, 2011, cash balance. . . . . . . . . . . . . . . . .
17
$ 7,500
4,600
$ 2,900
(20,000)
$ 25,000
2,000
23,000
$ 5,900
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18
Chapter 1 Introduction to Accounting and Business
Bank loan officers use
a business’s financial
statements in deciding
whether to grant a loan
to the business. Once
the loan is granted,
the borrower may be
required to maintain a
certain level of assets
in excess of liabilities.
The business’s financial
statements are used to
monitor this level.
as of November 30, 2011, is taken from the statement of owner’s equity. The form
of balance sheet shown in Exhibit 6 is called the account form. This is because it
resembles the basic format of the accounting equation, with assets on the left side
and the liabilities and owner’s equity sections on the right side.3
The assets section of the balance sheet presents assets in the order that they
will be converted into cash or used in operations. Cash is presented first, followed
by receivables, supplies, prepaid insurance, and other assets. The assets of a more
permanent nature are shown next, such as land, buildings, and equipment.
In the liabilities section of the balance sheet in Exhibit 6, accounts payable is the
only liability. When there are two or more liabilities, each should be listed and the
total amount of liabilities presented as follows:
Liabilities
Accounts payable
Wages payable
Total liabilities
Example
Example Exercise
Exercise 1-6
1-5
1-5
$12,900
2,570
$15,470
Balance Sheet
Using the following
ffol
data for Chickadee Travel Service as well as the statement of owner’s equity shown in Example
Exercise 1-5,
1-5
5, prepare a balance sheet as of April 30, 2012.
Accounts receivable
Accounts payable
Cash
Land
Supplies
$31,350
12,200
53,050
80,000
3,350
Follow My Example 1-6
Chickadee Travel Service
Balance Sheet
April 30, 2012
Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts receivable . . . . . . . . . . . . . . . . . .
Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 53,050
31,350
3,350
80,000
$167,750
Liabilities
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 12,200
Owner’s Equity
Adam Cellini, capital . . . . . . . . . . . . . . . . . . . . . . . .
Total liabilities and owner’s equity . . . . . . . . . .
155,550
$167,750
Practice Exercises: PE 1-6A, PE 1-6B
Statement of Cash Flows
The statement of cash flows consists of the following three sections, as shown in
Exhibit 6:
1. operating activities,
2. investing activities, and
3. financing activities.
Each of these sections is briefly described below.
Cash Flows from Operating Activities
This section reports a summary of cash
receipts and cash payments from operations. The net cash flow from operating activities
normally differs from the amount of net income for the period. In Exhibit 6, NetSolutions
3 An alternative form of balance sheet, called the report form, is illustrated in Chapter 6. It presents the liabilities and owner’s equity
sections below the assets section.
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Chapter 1 Introduction to Accounting and Business
19
reported net cash flows from operating activities of $2,900 and net income of $3,050. This
difference occurs because revenues and expenses may not be recorded at the same time
that cash is received from customers or paid to creditors.
Cash Flows from Investing Activities This section reports the cash transactions for
the acquisition and sale of relatively permanent assets. Exhibit 6 reports that NetSolutions
paid $20,000 for the purchase of land during November.
Cash Flows from Financing Activities This section reports the cash transactions
related to cash investments by the owner, borrowings, and withdrawals by the owner.
Exhibit 6 shows that Chris Clark invested $25,000 in the business and withdrew $2,000
during November.
Preparing the statement of cash flows requires that each of the November cash
transactions for NetSolutions be classified as an operating, investing, or financing
activity. Using the summary of transactions shown on page 14, the November cash
transactions for NetSolutions are classified as follows:
Transaction
Amount
Cash Flow Activity
a.
b.
d.
e.
f.
h.
$25,000
–20,000
7,500
–3,650
–950
–2,000
Financing (Investment by Chris Clark)
Investing (Purchase of land)
Operating (Fees earned)
Operating (Payment of expenses)
Operating (Payment of account payable)
Financing (Withdrawal by Chris Clark)
Transactions (c) and (g) are not listed above since they did not involve a cash
receipt or payment. In addition, the payment of accounts payable in transaction (f) is
classified as an operating activity since the account payable arose from the purchase of
supplies, which are used in operations. Using the preceding classifications of November cash transactions, the statement of cash flows is prepared as shown in Exhibit 6.4
The ending cash balance shown on the statement of cash flows is also reported
on the balance sheet as of the end of the period. To illustrate, the ending cash of
$5,900 reported on the November statement of cash flows in Exhibit 6 is also reported
as the amount of cash on hand in the November 30, 2011, balance sheet.
Since November is NetSolutions’ first period of operations, the net cash flow for
November and the November 30, 2011, cash balance are the same amount, $5,900,
as shown in Exhibit 6. In later periods, NetSolutions will report in its statement of
cash flows a beginning cash balance, an increase or a decrease in cash for the period,
and an ending cash balance. For example, assume that for December NetSolutions
has a decrease in cash of $3,835. The last three lines of NetSolutions’ statement of
cash flows for December would be as follows:
Decrease in cash
Cash as of December 1, 2011
Cash as of December 31, 2011
Example Exercise
Exercise 1-7
1--7
1
Example
$3,835
5,900
$2,065
Sttat
atem
emen
ent off Cash
Cas
ash Flows
Flows
Fl
ow
ws
Statement
A summaryy o
of cash flows for Chickadee Travel Service for the year ended April 30, 2012, is shown below.
Cash receipts:
Cash received from customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash received from additional investment of owner . . . . . . . . . . . . . . . . . . . . . . . .
$251,000
50,000
Cash payments:
Cash paid for expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash paid for land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash paid to owner for personal use . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
210,000
80,000
30,000
The cash balance as of May 1, 2011, was $72,050. Prepare a statement of cash flows for Chickadee Travel Service for the
year ended April 30, 2012.
(Continued)
4 This method of preparing the statement of cash flows is called the “direct method.” This method and the indirect method are
discussed further in Chapter 16.
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20
Chapter 1 Introduction to Accounting and Business
Follow My Example 1-7
Chickadee Travel Service
Statement of Cash Flows
For the Year Ended April 30, 2012
Cash flows from operating activities:
Cash received from customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deduct cash payments for expenses . . . . . . . . . . . . . . . . . . . . . . . .
Net cash flows from operating activities . . . . . . . . . . . . . . . . . . . . .
Cash flows from investing activities:
Cash payments for purchase of land . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from financing activities:
Cash received from owner as investment. . . . . . . . . . . . . . . . . . . .
Deduct cash withdrawals by owner . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash flows from financing activities . . . . . . . . . . . . . . . . . . . . .
Net decrease in cash during year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash as of May 1, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash as of April 30, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$251,000
210,000
$ 41,000
(80,000)
$ 50,000
30,000
20,000
$(19,000)
72,050
$ 53,050
Practice Exercises: PE 1-7A, PE 1-7B
Interrelationships Among Financial Statements
Financial statements are prepared in the order of the income statement, statement
of owner’s equity, balance sheet, and statement of cash flows. This order is important because the financial statements are interrelated. These interrelationships
for NetSolutions are shown in Exhibit 6 and are described below.5
Financial Statements
Interrelationship
NetSolutions Example (Exhibit 6)
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 as either
an addition (net income) to or deduction
(net loss) from the beginning owner’s
equity and any additional investments
by the owner during the period.
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.
Statement of Owner’s
Equity and Balance
Sheet
Owner’s capital at the end of the
period reported on the statement of
owner’s equity is also reported on the
balance sheet as owner’s capital.
Chris Clark, Capital of $26,050 as of
November 30, 2011, on the statement
of owner’s equity also appears on the
November 30, 2011, balance sheet as
Chris Clark, Capital.
Balance Sheet and
Statement of Cash
Flows
The cash reported on the balance
sheet is also reported as the end-ofperiod cash on the statement of
cash flows.
Cash of $5,900 reported on the
balance sheet as of November 30, 2011,
is also reported on the November
statement of cash flows as the end-ofperiod cash.
The preceding interrelationships are important in analyzing financial statements
and the impact of transactions on a business. In addition, these interrelationships
serve as a check on whether the financial statements are prepared correctly. For
example, if the ending cash on the statement of cash flows doesn’t agree with the
balance sheet cash, then an error has occurred.
5 Depending on the method of preparing the cash flows from operating activities section of the statement of cash flows, net income
(or net loss) may also appear on the statement of cash flows. This interrelationship or method of preparing the statement of cash
flows, called the “indirect method,” is described and illustrated in Chapter 16.
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Chapter 1 Introduction to Accounting and Business
Financial Analysis and Interpretation:
Ratio of Liabilities to Owner’s Equity
F•A•I
The basic financial statements illustrated in this chapter are useful to bankers, creditors, owners, and others in analyzing and interpreting the financial performance and
condition of a company. Throughout this text, various tools and techniques that are
often used to analyze and interpret a company’s financial performance and condition
are described and illustrated. The first such tool that is discussed is useful in analyzing the ability of a company to pay its creditors.
The relationship between liabilities and owner’s equity, expressed as a ratio of
liabilities to owner’s equity, is computed as follows:
Describe and
illustrate the
use of the ratio of
liabilities to owner’s
equity in evaluating
a company’s financial
condition.
Total Liabilities
Ratio of Liabilities
=
to Owner’s Equity
Total Owner’s Equity (or Total
Stockholders’ Equity)
NetSolutions’ ratio of liabilities to owner’s equity at the end of November is 0.015,
as computed below.
$400
Ratio of Liabilities
=
= 0.015
to Owner’s Equity
$26,050
Corporations refer to total owner’s equity as total stockholders’ equity. Thus, total
stockholders’ equity is substituted for total owner’s equity when computing this ratio.
To illustrate, balance sheet data (in millions) for Google Inc. and McDonald’s
Corporation are shown below.
Dec. 31,
2009
Dec. 31,
2008
Google Inc.
Total liabilities
Total stockholders’ equity
$ 3,529
28,239
$ 2,646
22,690
McDonald’s Corporation
Total liabilities
Total stockholders’ equity
$15,079
13,383
$14,112
15,280
The ratio of liabilities to stockholders’ equity as of December 31, 2009 and 2008
for Google and McDonald’s is computed below.
Google Inc.
Total liabilities
Total stockholders’ equity
Ratio of liabilities to stockholders’ equity
McDonald’s Corporation
Total liabilities
Total stockholders’ equity
Ratio of liabilities to stockholders’ equity
21
Dec. 31,
2009
Dec. 31,
2008
$ 3,529
28,239
0.12
($3,529/$28,239)
$ 2,646
22,690
0.12
($2,646/$22,690)
$15,079
13,383
1.13
($15,079/$13,383)
$14,112
15,280
0.92
($14,112/$15,280)
The rights of creditors to a business’s assets come before the rights of the owners
or stockholders. Thus, the lower the ratio of liabilities to owner’s equity, the better
able the company is to withstand poor business conditions and pay its obligations
to creditors.
Google is unusual in that it has a very low amount of liabilities; thus, its ratio of
liabilities to stockholders’ equity of 0.12 is small. In contrast, McDonald’s has more
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22
Chapter 1 Introduction to Accounting and Business
liabilities; its ratio of liabilities to stockholders’ equity is 1.13 and 0.92 on December
31, 2009 and 2008, respectively. Since McDonald’s ratio of liabilities to stockholders’
equity increased slightly from 2008 to 2009, its creditors are slightly more at risk on
December 31, 2009, as compared to December 31, 2008. Also, McDonald’s creditors
are more at risk than are Google’s creditors. The creditors of both companies are,
however, well protected against the risk of nonpayment.
Example Exercise
Exercise 1-8
1-7
1-7
Example
Rati
Ra
tio
io of
o Liabilities
Lia
iabi
bili
liti
iti
ties
ies
es to
to Owner’s
Owne
Ow
er’
r s Equity
Equi
uity
y
Ratio
The following
followiing data were taken from Hawthorne Company’s balance sheet:
Dec. 31,
2012
$120,000
80,000
Total liabilities
Total owner’s equity
Dec. 31,
2011
$105,000
75,000
a. Compute the ratio of liabilities to owner’s equity.
b. Has the creditors’ risk increased or decreased from December 31, 2011, to December 31, 2012?
Follow My Example 1-8
a.
Total liabilities
Total owner’s equity
Ratio of liabilities to owner’s equity
Dec. 31,
2012
$120,000
80,000
1.50
($120,000/$80,000)
Dec. 31,
2011
$105,000
75,000
1.40
($105,000/$75,000)
b. Increased
Practice Exercises: PE 1-8A, PE 1-8B
At a Glance
1
Describe the nature of a business, the role of accounting, and ethics in business.
A business provides goods or services (outputs) to customers with the objective of earning a
profit. Three types of businesses include service, merchandising, and manufacturing businesses.
Accounting is an information system that provides reports to users about the economic activities and
condition of a business.
Ethics are moral principles that guide the conduct of individuals. Good ethical conduct depends on
individual character and firm culture.
Accountants are engaged in private accounting or public accounting.
Key Points
Learning Outcomes
Example
Exercises
Practice
Exercises
• Distinguish among service, merchandising, and manufacturing businesses.
• Describe the role of accounting in business and explain why accounting is called the “language of business.”
• Define ethics and list the two factors affecting ethical conduct.
• Describe what private and public accounting means.
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Chapter 1 Introduction to Accounting and Business
23
Summarize the development of accounting principles and relate them to practice.
Generally accepted accounting principles (GAAP) are used in preparing financial statements.
Accounting principles and concepts develop from research, practice, and pronouncements of authoritative
bodies.
The business entity concept views the business as an entity separate from its owners, creditors, or other
businesses. Businesses may be organized as proprietorships, partnerships, corporations, and limited liability
companies. The cost concept requires that purchases of a business be recorded in terms of actual cost. The
objectivity concept requires that the accounting records and reports be based on objective evidence. The
unit of measure concept requires that economic data be recorded in dollars.
Key Points
Learning Outcomes
Example
Exercises
Practice
Exercises
EE1-1
PE1-1A, 1-1B
• Explain what is meant by generally accepted accounting principles.
• Describe how generally accepted accounting principles are developed.
• Describe and give an example of what is meant by the business
entity concept.
• Describe the characteristics of a proprietorship, partnership,
corporation, and limited liability company.
• Describe and give an example of what is meant by the cost concept.
• Describe and give an example of what is meant by the
objectivity concept.
• Describe and give an example of what is meant by the unit of
measure concept.
State the accounting equation and define each element of the equation.
The resources owned by a business and the rights or claims to these resources may be stated in
the form of an equation, as follows:
Key Points
Assets = Liabilities + Owner’s Equity
Learning Outcomes
Example
Exercises
Practice
Exercises
EE1-2
PE1-2A, 1-2B
• State the accounting equation.
• Define assets, liabilities, and owner’s equity.
• Given two elements of the accounting equation, solve for the third
element.
Describe and illustrate how business transactions can be recorded in terms of the resulting
change in the elements of the accounting equation.
All business transactions can be stated in terms of the change in one or more of the three elements of the accounting equation.
Key Points
Learning Outcomes
Example
Exercises
Practice
Exercises
EE1-3
PE1-3A, 1-3B
• Define a business transaction.
• Using the accounting equation as a framework, record transactions.
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24
Chapter 1 Introduction to Accounting and Business
Describe the financial statements of a proprietorship and explain how they interrelate.
The primary financial statements of a proprietorship are the income statement, the statement of
owner’s equity, the balance sheet, and the statement of cash flows. The income statement reports a period’s
net income or net loss, which is also reported on the statement of owner’s equity. The ending owner’s capital reported on the statement of owner’s equity is also reported on the balance sheet. The ending cash balance is reported on the balance sheet and the statement of cash flows.
Key Points
Example
Exercises
Practice
Exercises
• Prepare an income statement.
EE1-4
PE1-4A, 1-4B
• Prepare a statement of owner’s equity.
EE1-5
PE1-5A, 1-5B
• Prepare a balance sheet.
EE1-6
PE1-6A, 1-6B
• Prepare a statement of cash flows.
EE1-7
PE1-7A, 1-7B
Learning Outcomes
• List and describe the financial statements of a proprietorship.
• Explain how the financial statements of a proprietorship are interrelated.
Describe and illustrate the use of the ratio of liabilities to owner’s equity in evaluating a
company’s financial condition.
A ratio useful in analyzing the ability of a business to pay its creditors is the ratio of liabilities
to owner’s (stockholders’) equity. The lower the ratio of liabilities to owner’s equity, the better able the
company is to withstand poor business conditions and pay its obligations to creditors.
Key Points
Learning Outcomes
Example
Exercises
Practice
Exercises
EE1-8
PE1-8A, 1-8B
• Describe the usefulness of the ratio of liabilities to owner’s
(stockholders’) equity.
• Compute the ratio of liabilities to owner’s (stockholders’) equity.
Key Terms
account form (18)
account payable (11)
account receivable (12)
accounting (3)
accounting equation (9)
assets (9)
balance sheet (15)
business (2)
business entity concept (7)
business transaction (9)
Certified Public Accountant
(CPA) (6)
corporation (8)
cost concept (8)
earnings (15)
ethics (4)
expenses (12)
fees earned (12)
financial accounting (3)
Financial Accounting Standards
Board (FASB) (7)
financial statements (15)
general-purpose financial
statements (4)
generally accepted accounting
principles (GAAP) (6)
income statement (15)
interest revenue (12)
International Accounting
Standards Board (IASB) (7)
liabilities (9)
limited liability company
(LLC) (8)
management (or managerial)
accounting (3)
manufacturing business (2)
matching concept (15)
merchandising business (2)
net income (or net profit) (15)
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Chapter 1 Introduction to Accounting and Business
net loss (15)
objectivity concept (8)
owner’s equity (9)
partnership (7)
prepaid expenses (11)
private accounting (3)
profit (2)
25
Securities and Exchange
Commission (SEC) (7)
service business (2)
statement of cash flows (15)
statement of owner’s
equity (15)
unit of measure concept (8)
proprietorship (7)
public accounting (6)
ratio of liabilities to owner’s
(stockholders’) equity (21)
rent revenue (12)
revenue (11)
sales (12)
Illustrative Problem
Cecil Jameson, Attorney-at-Law, is a proprietorship owned and operated by Cecil Jameson.
On July 1, 2011, Cecil Jameson, Attorney-at-Law, has the following assets and liabilities:
cash, $1,000; accounts receivable, $3,200; supplies, $850; land, $10,000; accounts payable,
$1,530. Office space and office equipment are currently being rented, pending the construction of an office complex on land purchased last year. Business transactions during
July are summarized as follows:
a. Received cash from clients for services, $3,928.
b. Paid creditors on account, $1,055.
c. Received cash from Cecil Jameson as an additional investment, $3,700.
d. Paid office rent for the month, $1,200.
e. Charged clients for legal services on account, $2,025.
f. Purchased supplies on account, $245.
g. Received cash from clients on account, $3,000.
h. Received invoice for paralegal services from Legal Aid Inc. for July (to be paid on
August 10), $1,635.
i. Paid the following: wages expense, $850; answering service expense, $250; utilities
expense, $325; and miscellaneous expense, $75.
j. Determined that the cost of supplies on hand was $980; therefore, the cost of supplies used during the month was $115.
k. Jameson withdrew $1,000 in cash from the business for personal use.
Instructions
1. Determine the amount of owner’s equity (Cecil Jameson’s capital) as of July 1, 2011.
2. State the assets, liabilities, and owner’s equity as of July 1 in equation form similar
to that shown in this chapter. In tabular form below the equation, indicate the increases and decreases resulting from each transaction and the new balances after
each transaction.
3. Prepare an income statement for July, a statement of owner’s equity for July, and a
balance sheet as of July 31, 2011.
4. (Optional). Prepare a statement of cash flows for July.
Solution
1.
Assets − Liabilities
($1,000 + $3,200 + $850 + $10,000) − $1,530
$15,050 − $1,530
$13,520
=
=
=
=
Owner’s
Owner’s
Owner’s
Owner’s
Equity
Equity
Equity
Equity
(Cecil
(Cecil
(Cecil
(Cecil
Jameson, capital)
Jameson, capital)
Jameson, capital)
Jameson, capital)
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Chapter 1 Introduction to Accounting and Business
2.
Assets
Bal.
a.
Bal.
b.
Bal.
c.
Bal.
d.
Bal.
e.
Bal.
f.
Bal.
g.
Bal.
h.
Bal.
i.
Bal.
j.
Bal.
k.
Bal.
= Liabilities +
Owner’s Equity
Cecil
Cecil
Fees
Paralegal
Jameson, Jameson,
Accts.
Accts
Cash + Rec. + Supp. + Land = Pay. + Capital − Drawing + Earned − Exp. −
1,000
3,200
850
10,000
1,530
13,520
+3,928
3,928
850
10,000
1,530
13,520
3,928
4,928
3,200
−1,055
−1,055
850
10,000
475
13,520
3,928
3,873
3,200
+3,700
+3,700
850
10,000
475
17,220
3,928
7,573
3,200
−1,200
850
10,000
475
17,220
3,928
6,373
3,200
+ 2,025
+ 2,025
5,225
850
10,000
475
17,220
5,953
6,373
+245
+245
5,225
1,095
10,000
720
17,220
5,953
6,373
+3,000
−3,000
1,095
10,000
720
17,220
5,953
9,373
2,225
+1,635
–1,635
2,225
1,095
10,000
2,355
17,220
5,953
–1,635
9,373
−1,500
1,095
10,000
2,355
17,220
5,953
−1,635
7,873
2,225
−115
2,225
980
10,000
2,355
17,220
5,953
–1,635
7,873
–1,000
–1,000
6,873
2,225
980
10,000
2,355
17,220
–1,000
5,953
–1,635
Rent Wages Utilities
Exp. − Exp. − Exp. −
Answering
Service
Supp Misc.
Exp.
− Exp. − Exp.
−1,200
−1,200
−1,200
−1,200
–1,200
–1,200
–850
−1,200 −850
–325
−325
–250
−250
−75
−75
–1,200 –850
–325
–250
−115
–115
–75
–1,200 –850
–325
–250
–115
–75
3.
Cecil Jameson, Attorney-at-Law
Income Statement
For the Month Ended July 31, 2011
Fees earned. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expenses:
Paralegal expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rent expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Wages expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Utilities expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Answering service expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Miscellaneous expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$5,953
$1,635
1,200
850
325
250
115
75
4,450
$1,503
Cecil Jameson, Attorney-at-Law
Statement of Owner’s Equity
For the Month Ended July 31, 2011
Cecil Jameson, capital, July 1, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additional investment by owner. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income for the month . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in owner’s equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cecil Jameson, capital, July 31, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$13,520
$3,700
1,503
$5,203
1,000
4,203
$17,723
(continued)
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Chapter 1 Introduction to Accounting and Business
27
Cecil Jameson, Attorney-at-Law
Balance Sheet
July 31, 2011
Assets
Liabilities
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts receivable . . . . . . . . . . . . . . .
Supplies . . . . . . . . . . . . . . . . . . . . . . . . . .
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . .
$ 6,873
2,225
980
10,000
$20,078
Accounts payable . . . . . . . . . . . . . . . .
Owner’s Equity
Cecil Jameson, capital . . . . . . . . . . . .
Total liabilities and owner’s
equity . . . . . . . . . . . . . . . . . . . . . . . .
$ 2,355
17,723
$20,078
4. Optional.
Cecil Jameson, Attorney-at-Law
Statement of Cash Flows
For the Month Ended July 31, 2011
Cash flows from operating activities:
Cash received from customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deduct cash payments for operating expenses . . . . . . . . . . . . . . . . . . . . . .
Net cash flows from operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from financing activities:
Cash received from owner as investment. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deduct cash withdrawals by owner. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash flows from financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net increase in cash during year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash as of July 1, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash as of July 31, 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$6,928*
3,755**
$3,173
—
$3,700
1,000
2,700
$5,873
1,000
$6,873
*$6,928 = $3,928 + $3,000
**$3,755 = $1,055 + $1,200 + $1,500
Discussion Questions
1. Name some users of accounting information.
2. What is the role of accounting in business?
3. Why are most large companies like Microsoft,
PepsiCo, Caterpillar, and AutoZone organized as
corporations?
4. Murray Stoltz is the owner of Ontime Delivery
Service. Recently, Murray paid interest of $3,200
on a personal loan of $60,000 that he used to begin the business. Should Ontime Delivery Service
record the interest payment? Explain.
5. On October 3, A2Z Repair Service extended an offer of $75,000 for land that had been priced for sale
at $90,000. On November 23, A2Z Repair Service
accepted the seller’s counteroffer of $82,000. Describe how A2Z Repair Service should record the
land.
6. a. Land with an assessed value of $400,000 for
property tax purposes is acquired by a business for $525,000. Ten years later, the plot of
land has an assessed value of $700,000 and the
business receives an offer of $1,000,000 for it.
Should the monetary amount assigned to the
land in the business records now be increased?
b. Assuming that the land acquired in (a) was
sold for $1,000,000, how would the various elements of the accounting equation be affected?
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Chapter 1 Introduction to Accounting and Business
7. Describe the difference between an account receivable and an account payable.
8. A business had revenues of $430,000 and operating
expenses of $615,000. Did the business (a) incur
a net loss or (b) realize net income?
10. What particular item of financial or operating data
appears on both the income statement and the
statement of owner’s equity? What item appears
on both the balance sheet and the statement of
owner’s equity? What item appears on both the
balance sheet and the statement of cash flows?
9. A business had revenues of $825,000 and operating
expenses of $708,000. Did the business (a) incur
a net loss or (b) realize net income?
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Chapter 1 Introduction to Accounting and Business
29
Practice Exercises
Learning
Objectives
Example
Exercises
OBJ. 2
EE 1-1 p. 8
PE 1-1A Cost concept
On June 10, Easy Repair Service extended an offer of $95,000 for land that had been priced
for sale at $118,500. On August 2, Easy Repair Service accepted the seller’s counteroffer
of $105,000. On August 27, the land was assessed at a value of $80,000 for property tax
purposes. On April 1, Easy Repair Service was offered $125,000 for the land by a national
retail chain. At what value should the land be recorded in Easy Repair Service’s records?
OBJ. 2
EE 1-1 p. 8
PE 1-1B Cost concept
On February 7, AAA Repair Service extended an offer of $50,000 for land that had been
priced for sale at $65,000. On February 21, AAA Repair Service accepted the seller’s
counteroffer of $57,500. On April 30, the land was assessed at a value of $40,000 for
property tax purposes. On August 30, AAA Repair Service was offered $90,000 for the
land by a national retail chain. At what value should the land be recorded in AAA Repair
Service’s records?
OBJ. 3
EE 1-2 p. 9
PE 1-2A Accounting equation
Shannon Cook is the owner and operator of Galaxy LLC, a motivational consulting business. At the end of its accounting period, December 31, 2011, Galaxy has assets of
$800,000 and liabilities of $450,000. Using the accounting equation, determine the following amounts:
a. Owner’s equity, as of December 31, 2011.
b. Owner’s equity, as of December 31, 2012, assuming that assets increased by $175,000
and liabilities decreased by $60,000 during 2012.
OBJ. 3
EE 1-2 p. 9
PE 1-2B Accounting equation
Jan Petri is the owner and operator of You’re the One, a motivational consulting business. At the end of its accounting period, December 31, 2011, You’re the One has assets
of $575,000 and liabilities of $125,000. Using the accounting equation, determine the
following amounts:
a. Owner’s equity, as of December 31, 2011.
b. Owner’s equity, as of December 31, 2012, assuming that assets increased by $85,000
and liabilities increased by $30,000 during 2012.
OBJ. 4
EE 1-3 p. 14
PE 1-3A Transactions
Queens Delivery Service is owned and operated by Lisa Dewar. The following selected
transactions were completed by Queens Delivery Service during June:
1. Received cash from owner as additional investment, $18,000.
2. Paid creditors on account, $1,800.
3. Billed customers for delivery services on account, $12,500.
4. Received cash from customers on account, $6,900.
5. Paid cash to owner for personal use, $4,000.
Indicate the effect of each transaction on the accounting equation elements (Assets, Liabilities, Owner’s Equity, Drawing, Revenue, and Expense). 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 $18,000; Owner’s Equity (Lisa Dewar, Capital) increases by
$18,000.
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Chapter 1 Introduction to Accounting and Business
Learning
Objectives
Example
Exercises
OBJ. 4
EE 1-3 p. 14
PE 1-3B Transactions
Motorcross Delivery Service is owned and operated by Jim Smith. The following selected
transactions were completed by Motorcross Delivery Service during February:
1. Received cash from owner as additional investment, $30,000.
2. Paid advertising expense, $1,200.
3. Purchased supplies on account, $450.
4. Billed customers for delivery services on account, $7,500.
5. Received cash from customers on account, $4,900.
Indicate the effect of each transaction on the accounting equation elements (Assets, Liabilities, Owner’s Equity, Drawing, Revenue, and Expense). 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 $30,000; Owner’s Equity (Jim Smith, Capital) increases by
$30,000.
OBJ. 5
EE 1-4 p. 16
PE 1-4A Income statement
The revenues and expenses of Dynasty Travel Service for the year ended June 30, 2012,
are listed below.
Fees earned
Office expense
Miscellaneous expense
Wages expense
$950,000
222,000
16,000
478,000
Prepare an income statement for the current year ended June 30, 2012.
OBJ. 5
EE 1-4 p. 16
PE 1-4B Income statement
The revenues and expenses of Escape Travel Service for the year ended November 30,
2012, are listed below.
Fees earned
Office expense
Miscellaneous expense
Wages expense
$942,500
391,625
15,875
562,500
Prepare an income statement for the current year ended November 30, 2012.
OBJ. 5
EE 1-5 p. 16
PE 1-5A Statement of owner’s equity
Using the income statement for Dynasty Travel Service shown in Practice Exercise 1-4A,
prepare a statement of owner’s equity for the current year ended June 30, 2012. Nancy
Coleman, the owner, invested an additional $60,000 in the business during the year and
withdrew cash of $36,000 for personal use. Nancy Coleman, capital as of July 1, 2011,
was $250,000.
OBJ. 5
EE 1-5 p. 16
PE 1-5B Statement of owner’s equity
Using the income statement for Escape Travel Service shown in Practice Exercise 1-4B,
prepare a statement of owner’s equity for the current year ended November 30, 2012.
Brett Daniels, the owner, invested an additional $45,000 in the business during the year
and withdrew cash of $25,000 for personal use. Brett Daniels, capital as of December 1,
2011, was $475,000.
OBJ. 5
EE 1-6 p. 18
PE 1-6A Balance sheet
Using the following data for Dynasty Travel Service as well as the statement of owner’s
equity shown in Practice Exercise 1-5A, prepare a balance sheet as of June 30, 2012.
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Chapter 1 Introduction to Accounting and Business
Learning
Objectives
Example
Exercises
Accounts receivable
Accounts payable
Cash
Land
Supplies
OBJ. 5
EE 1-6 p. 18
$ 64,000
24,000
156,000
300,000
12,000
PE 1-6B Balance sheet
Using the following data for Escape Travel Service as well as the statement of owner’s
equity shown in Practice Exercise 1-5B, prepare a balance sheet as of November 30, 2012.
Accounts receivable
Accounts payable
Cash
Land
Supplies
OBJ. 5
31
EE 1-7 p. 20
$ 94,375
52,500
56,750
362,500
6,375
PE 1-7A Statement of cash flows
A summary of cash flows for Dynasty Travel Service for the year ended June 30, 2012,
is shown below.
Cash receipts:
Cash received from customers
Cash received from additional investment of
owner
Cash payments:
Cash paid for operating expenses
Cash paid for land
Cash paid to owner for personal use
$920,000
60,000
710,000
208,000
36,000
The cash balance as of July 1, 2011, was $130,000.
Prepare a statement of cash flows for Dynasty Travel Service for the year ended June
30, 2012.
OBJ. 5
EE 1-7 p. 20
PE 1-7B Statement of cash flows
A summary of cash flows for Escape Travel Service for the year ended November 30,
2012, is shown below.
Cash receipts:
Cash received from customers
Cash received from additional investment of owner
Cash payments:
Cash paid for operating expenses
Cash paid for land
Cash paid to owner for personal use
$875,000
45,000
912,500
67,500
25,000
The cash balance as of December 1, 2011, was $141,750.
Prepare a statement of cash flows for Escape Travel Service for the year ended November 30, 2012.
OBJ. 6
EE 1-8 p. 22
F•A•I
PE 1-8A Ratio of liabilities to owner’s equity
The following data were taken from White Company’s balance sheet:
Total liabilities
Total owner’s equity
Dec. 31, 2012
Dec. 31, 2011
$375,000
300,000
$287,500
250,000
a. Compute the ratio of liabilities to owner’s equity.
b. Has the creditor’s risk increased or decreased from December 31, 2011 to December
31, 2012?
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Chapter 1 Introduction to Accounting and Business
Learning
Objectives
Example
Exercises
OBJ. 6
EE 1-8 p. 22
F•A•I
PE 1-8B Ratio of liabilities to owner’s equity
The following data were taken from Stone Company’s balance sheet:
Total liabilities
Total owner’s equity
Dec. 31, 2012
Dec. 31, 2011
$340,000
500,000
$300,000
400,000
a. Compute the ratio of liabilities to owner’s equity.
b. Has the creditor’s risk increased or decreased from December 31, 2011 to December
31, 2012?
Exercises
OBJ. 1
EX 1-1 Types of businesses
The following is a list of well-known companies.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
H&R Block
eBay Inc.
Wal-Mart Stores, Inc.
Ford Motor Company
Citigroup
Boeing
SunTrust
Alcoa Inc.
Procter & Gamble
FedEx
Gap Inc.
Hilton Hospitality, Inc.
CVS
Caterpillar
The Dow Chemical Company
a. Indicate whether each of these companies is primarily a service, merchandise, or
manufacturing business. If you are unfamiliar with the company, use the Internet to
locate the company’s home page or use the finance Web site of Yahoo (http://finance.
yahoo.com).
b. For which of the preceding companies is the accounting equation relevant?
OBJ. 1
EX 1-2 Professional ethics
A fertilizer manufacturing company wants to relocate to Jones County. A report from
a fired researcher at the company indicates the company’s product is releasing toxic
by-products. The company suppressed that report. A later report commissioned by the
company shows there is no problem with the fertilizer.
Should the company’s chief executive officer reveal the content of the unfavorable report in discussions with Jones County representatives? Discuss.
OBJ. 2
EX 1-3 Business entity concept
Rocky Mountain Sports sells hunting and fishing equipment and provides guided hunting and fishing trips. Rocky Mountain Sports is owned and operated by Mike Weber, a
well-known sports enthusiast and hunter. Mike’s wife, Susan, owns and operates Madison
Boutique, a women’s clothing store. Mike and Susan have established a trust fund to
finance their children’s college education. The trust fund is maintained by National Bank
in the name of the children, Kerri and Kyle.
a. For each of the following transactions, identify which of the entities listed should
record the transaction in its records.
Entities
R
B
M
X
Rocky Mountain Sports
National Bank Trust Fund
Madison Boutique
None of the above
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Chapter 1 Introduction to Accounting and Business
33
1. Susan authorized the trust fund to purchase mutual fund shares.
2. Susan purchased two dozen spring dresses from a Chicago designer for a special
spring sale.
3. Mike paid a breeder’s fee for an English springer spaniel to be used as a hunting
guide dog.
4. Susan deposited a $3,000 personal check in the trust fund at National Bank.
5. Mike paid a local doctor for his annual physical, which was required by the workmen’s compensation insurance policy carried by Rocky Mountain Sports.
6. Mike received a cash advance from customers for a guided hunting trip.
7. Susan paid her dues to the YWCA.
8. Susan donated several dresses from inventory for a local charity auction for the
benefit of a women’s abuse shelter.
9. Mike paid for dinner and a movie to celebrate their fifteenth wedding anniversary.
10. Mike paid for an advertisement in a hunters’ magazine.
b. What is a business transaction?
OBJ. 3
Starbucks,
$3,046
EX 1-4 Accounting equation
The total assets and total liabilities of Peat’s Coffee & Tea Inc. and Starbucks Corporation are
shown below.
Peat’s Coffee & Tea (in millions)
Starbucks (in millions)
$176
32
$5,577
2,531
Assets
Liabilities
Determine the owners’ equity of each company.
OBJ. 3
Dollar Tree,
$1,253
EX 1-5 Accounting equation
The total assets and total liabilities of Dollar Tree Inc. and Target Corporation are shown below.
Dollar Tree (in millions) Target Corporation (in millions)
Assets
Liabilities
$2,036
783
$44,106
30,394
Determine the owners’ equity of each company.
OBJ. 3
a. 600,000
EX 1-6 Accounting equation
Determine the missing amount for each of the following:
Assets
a.
b.
c.
OBJ. 3, 4
b. $530,000
×
$275,000
615,000
= Liabilities + Owner’s Equity
= $150,000
=
×
= 190,000
+
+
+
$450,000
50,000
×
EX 1-7 Accounting equation
Todd Olson is the owner and operator of Alpha, a motivational consulting business. At
the end of its accounting period, December 31, 2011, Alpha has assets of $800,000 and
liabilities of $350,000. Using the accounting equation and considering each case independently, determine the following amounts:
a. Todd Olson, capital, as of December 31, 2011.
b. Todd Olson, capital, as of December 31, 2012, assuming that assets increased by
$150,000 and liabilities increased by $70,000 during 2012.
c. Todd Olson, capital, as of December 31, 2012, assuming that assets decreased by
$60,000 and liabilities increased by $20,000 during 2012.
d. Todd Olson, capital, as of December 31, 2012, assuming that assets increased by
$100,000 and liabilities decreased by $40,000 during 2012.
e. Net income (or net loss) during 2012, assuming that as of December 31, 2012,
assets were $975,000, liabilities were $400,000, and there were no additional investments or withdrawals.
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Chapter 1 Introduction to Accounting and Business
OBJ. 3
EX 1-8 Asset, liability, owner’s equity items
Indicate whether each of the following is identified with (1) an asset, (2) a liability, or
(3) owner’s equity:
a. cash
b. wages expense
c. accounts payable
d. fees earned
e. supplies
f. land
OBJ. 4
EX 1-9 Effect of transactions on accounting equation
Describe how the following business transactions affect the three elements of the accounting equation.
a. Invested cash in business.
b. Purchased supplies for cash.
c. Purchased supplies on account.
d. Received cash for services performed.
e. Paid for utilities used in the business.
OBJ. 4
EX 1-10 Effect of transactions on accounting equation
a. A vacant lot acquired for $100,000 is sold for $350,000 in cash. What is the effect of the
sale on the total amount of the seller’s (1) assets, (2) liabilities, and (3) owner’s equity?
b. Assume that the seller owes $75,000 on a loan for the land. After receiving the $350,000
cash in (a), the seller pays the $75,000 owed. What is the effect of the payment on
the total amount of the seller’s (1) assets, (2) liabilities, and (3) owner’s equity?
c. Is it true that a transaction always affects at least two elements (Assets, Liabilities, or
Owner’s Equity) of the accounting equation? Explain.
a. (1) increase
$250,000
OBJ. 4
EX 1-11 Effect of transactions on owner’s equity
Indicate whether each of the following types of transactions will either (a) increase owner’s
equity or (b) decrease owner’s equity:
1. owner’s investments
2. revenues
3. expenses
4. owner’s withdrawals
OBJ. 4
EX 1-12 Transactions
The following selected transactions were completed by Speedy Delivery Service during
October:
1. Received cash from owner as additional investment, $30,000.
2. Purchased supplies for cash, $1,500.
3. Paid rent for October, $4,000.
4. Paid advertising expense, $2,500.
5. Received cash for providing delivery services, $18,750.
6. Billed customers for delivery services on account, $41,500.
7. Paid creditors on account, $6,000.
8. Received cash from customers on account, $26,200.
9. Determined that the cost of supplies on hand was $250; therefore, $1,250 of supplies
had been used during the month.
10. Paid cash to owner for personal use, $2,000.
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Chapter 1 Introduction to Accounting and Business
Indicate the effect of each transaction on the accounting equation by listing the numbers identifying the transactions, (1) through (10), in a column, and inserting at the right
of each number the appropriate letter from the following list:
a. Increase in an asset, decrease in another asset.
b. Increase in an asset, increase in a liability.
c. Increase in an asset, increase in owner’s equity.
d. Decrease in an asset, decrease in a liability.
e. Decrease in an asset, decrease in owner’s equity.
OBJ. 4
d. $13,200
EX 1-13 Nature of transactions
Jeremy Zabel operates his own catering service. Summary financial data for February are
presented in equation form as follows. Each line designated by a number indicates the
effect of a transaction on the equation. Each increase and decrease in owner’s equity,
except transaction (5), affects net income.
Assests
Bal.
1.
2.
3.
4.
5.
6.
7.
Bal.
a.
b.
c.
d.
e.
OBJ. 5
Cash
+ Supplies +
Land
25,000
+29,000
–20,000
–14,000
2,000
75,000
12,000
90,000
29,000
+20,000
−14,000
+1,000
+1,000
– 2,000
– 7,000
11,000
= Liabilities +
Owner’s Equity
Accounts Jeremy Zabel, Jeremy ZaFees
= Payable +
Capital
− bel, Drawing + Earned − Expenses
–2,000
–7,000
–1800
1,200
95,000
6,000
90,000
–2,000
29,000
–1,800
–15,800
Describe each transaction.
What is the amount of net decrease in cash during the month?
What is the amount of net increase in owner’s equity during the month?
What is the amount of the net income for the month?
How much of the net income for the month was retained in the business?
EX 1-14 Net income and owner’s withdrawals
The income statement of a proprietorship for the month of December indicates a net
income of $120,000. During the same period, the owner withdrew $130,000 in cash from
the business for personal use.
Would it be correct to say that the business incurred a net loss of $10,000 during the month? Discuss.
OBJ. 5
Leo: Net income,
$60,000
EX 1-15 Net income and owner’s equity for four businesses
Four different proprietorships, Aries, Gemini, Leo, and Pisces, show the same balance sheet
data at the beginning and end of a year. These data, exclusive of the amount of owner’s
equity, are summarized as follows:
Beginning of the year
End of the year
Total Assets
Total Liabilities
$400,000
750,000
$100,000
300,000
On the basis of the above data and the following additional information for the year,
determine the net income (or loss) of each company for the year. (Hint: First determine
the amount of increase or decrease in owner’s equity during the year.)
Aries:
The owner had made no additional investments in the business and had made
no withdrawals from the business.
Gemini: The owner had made no additional investments in the business but had withdrawn $40,000.
Leo:
Pisces:
The owner had made an additional investment of $90,000 but had made no
withdrawals.
The owner had made an additional investment of $90,000 and had withdrawn $40,000.
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Chapter 1 Introduction to Accounting and Business
OBJ. 5
EX 1-16 Balance sheet items
From the following list of selected items taken from the records of Hoosier Appliance
Service as of a specific date, identify those that would appear on the balance sheet:
1. Accounts Receivable
2. Cash
3. Fees Earned
4. Land
5. Patsy Adkins, Capital
6. Supplies
7. Supplies Expense
8. Utilities Expense
9. Wages Expense
10. Wages Payable
OBJ. 5
EX 1-17 Income statement items
Based on the data presented in Exercise 1-16, identify those items that would appear on
the income statement.
OBJ. 5
EX 1-18 Statement of owner’s equity
Penny Beall, capital, Financial information related to Lost Trail Company, a proprietorship, for the month ended
June 30, 2012: $482,000 June 30, 2012, is as follows:
Net income for June
$125,000
Penny Beall’s withdrawals during June
18,000
Penny Beall’s capital, June 1, 2012
375,000
a. Prepare a statement of owner’s equity for the month ended June 30, 2012.
b. Why is the statement of owner’s equity prepared before the June 30, 2012, balance
sheet?
OBJ. 5
Net income:
$449,000
EX 1-19 Income statement
Universal Services was organized on October 1, 2012. A summary of the revenue and
expense transactions for October follows:
Fees earned
Wages expense
Rent expense
Supplies expense
Miscellaneous expense
$800,000
270,000
60,000
9,000
12,000
Prepare an income statement for the month ended October 31.
OBJ. 5
(a) $45,000
EX 1-20 Missing amounts from balance sheet and income statement data
One item is omitted in each of the following summaries of balance sheet and income
statement data for the following four different proprietorships:
Beginning of the year:
Assets
Liabilities
End of the year:
Assets
Liabilities
During the year:
Additional investment in the business
Withdrawals from the business
Revenue
Expenses
Aquarius
Libra
Scorpio
Taurus
$300,000
120,000
$500,000
260,000
$100,000
76,000
(d)
$120,000
420,000
110,000
700,000
220,000
90,000
80,000
248,000
136,000
(a)
25,000
190,000
80,000
100,000
32,000
(b)
128,000
10,000
(c)
115,000
122,500
40,000
60,000
112,000
128,000
Determine the missing amounts, identifying them by letter. (Hint: First determine the
amount of increase or decrease in owner’s equity during the year.)
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OBJ. 5
b. $40,000
Chapter 1 Introduction to Accounting and Business
37
EX 1-21 Balance sheets, net income
Financial information related to the proprietorship of Lady Interiors for July and August
2012 is as follows:
Accounts payable
Accounts receivable
Garth Jacobs, capital
Cash
Supplies
July 31, 2012
August 31, 2012
$ 90,000
200,000
?
80,000
20,000
$100,000
240,000
?
95,000
15,000
a. Prepare balance sheets for Lady Interiors as of July 31 and August 31, 2012.
b. Determine the amount of net income for August, assuming that the owner made no
additional investments or withdrawals during the month.
c. Determine the amount of net income for August, assuming that the owner made no
additional investments but withdrew $35,000 during the month.
OBJ. 5
EX 1-22 Financial statements
Each of the following items is shown in the financial statements of ExxonMobil Corporation.
1. Accounts payable
2. Cash equivalents
3. Crude oil inventory
4. Equipment
5. Exploration expenses
6. Income taxes payable
7. Investments
8. Long-term debt
9. Marketable securities
10. Notes and loans payable
11. Notes receivable
12. Operating expenses
13. Prepaid taxes
14. Sales
15. Selling expenses
a. Identify the financial statement (balance sheet or income statement) in which each
item would appear.
b. Can an item appear on more than one financial statement?
c. Is the accounting equation relevant for ExxonMobil Corporation?
OBJ. 5
EX 1-23 Statement of cash flows
Indicate whether each of the following activities would be reported on the statement of
cash flows as (a) an operating activity, (b) an investing activity, or (c) a financing activity:
1. Cash received from fees earned.
2. Cash paid for expenses.
3. Cash paid for land.
4. Cash received as an additional investment by owner.
OBJ. 5
EX 1-24 Statement of cash flows
A summary of cash flows for Absolute Consulting Group for the year ended July 31,
2012, is shown below.
Cash receipts:
Cash received from customers
Cash received from additional investment of owner
Cash payments:
Cash paid for operating expenses
Cash paid for land
Cash paid to owner for personal use
$187,500
40,000
127,350
30,000
5,000
The cash balance as of August 1, 2011, was $27,100.
Prepare a statement of cash flows for Absolute Consulting Group for the year ended
July 31, 2012.
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Chapter 1 Introduction to Accounting and Business
OBJ. 5
Correct amount
of total assets is
$88,200.
EX 1-25 Financial statements
Empire Realty, organized May 1, 2012, is owned and operated by Bertram Mitchell. How
many errors can you find in the following statements for Empire Realty, prepared after
its first month of operations?
Empire Realty
Income Statement
May 31, 2012
Sales commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expenses:
Office salaries expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rent expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Automobile expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Miscellaneous expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$233,550
$145,800
49,500
11,250
3,600
1,350
211,500
$ 67,050
Bertram Mitchell
Statement of Owner’s Equity
May 31, 2011
Bertram Mitchell, capital, May 1, 2012. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less withdrawals during May . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additional investment during May. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income for May . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Bertram Mitchell, capital, May 31, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 46,800
9,000
$ 37,800
11,250
$ 49,050
67,050
$ 116,100
Balance Sheet
For the Month Ended May 31, 2012
Assets
OBJ. 6
Liabilities
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts payable . . . . . . . . . . . . . . . . .
$14,850
17,100
Total assets . . . . . . . . . . . . . . . . . . . . . . .
$31,950
Accounts receivable . . . . . . . . . . . . . . . . . . . . .
Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Owner’s Equity
Bertram Mitchell, capital . . . . . . . . . . . . . . . . .
Total liabilities and owner’s equity . . . . . . . .
$ 64,350
9,000
116,100
$189,450
EX 1-26 Ratio of liabilities to stockholders’ equity
The Home Depot, Inc., is the world’s largest home improvement retailer and one of the
largest retailers in the United States based on net sales volume. The Home Depot operates over 2,000 Home Depot® stores that sell a wide assortment of building materials and
home improvement and lawn and garden products.
The Home Depot reported the following balance sheet data (in millions):
Total assets
Total stockholders’ equity
Feb. 1, 2009
Feb. 3, 2008
$41,164
17,777
$44,324
17,714
a. Determine the total liabilities as of February 1, 2009, and February 3, 2008.
b. Determine the ratio of liabilities to stockholders’ equity for 2009 and 2008. Round to
two decimal places.
c. What conclusions regarding the margin of protection to the creditors can you draw
from (b)?
OBJ. 6
EX 1-27 Ratio of liabilities to stockholders’ equity
Lowe’s, a major competitor of The Home Depot in the home improvement business, operates over 1,600 stores. For the years ending January 30, 2009, and February 1, 2008,
Lowe’s reported the following balance sheet data (in millions):
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Chapter 1 Introduction to Accounting and Business
Total assets
Total liabilities
Jan. 30, 2009
Feb. 1, 2008
$32,686
14,631
$30,869
14,771
39
a. Determine the total stockholders’ equity as of January 30, 2009, and February 1, 2008.
b. Determine the ratio of liabilities to stockholders’ equity for 2009 and 2008. Round to
two decimal places.
c. What conclusions regarding the margin of protection to the creditors can you draw
from (b)?
d. Using the balance sheet data for The Home Depot in Exercise 1-26, how does the ratio
of liabilities to stockholders’ equity of Lowe’s compare to that of The Home Depot?
Problems Series A
OBJ. 4
Cash bal. at end of
September: $37,700
PR 1-1A Transactions
On September 1 of the current year, Maria Edsall established a business to manage rental
property. She completed the following transactions during September:
a. Opened a business bank account with a deposit of $40,000 from personal funds.
b. Purchased supplies (pens, file folders, and copy paper) on account, $2,200.
c. Received cash from fees earned for managing rental property, $6,000.
d. Paid rent on office and equipment for the month, $2,700.
e. Paid creditors on account, $1,000.
f. Billed customers for fees earned for managing rental property, $5,000.
g. Paid automobile expenses (including rental charges) for month, $600, and miscellaneous expenses, $300.
h. Paid office salaries, $1,900.
i. Determined that the cost of supplies on hand was $1,300; therefore, the cost of supplies used was $900.
j. Withdrew cash for personal use, $1,800.
Instructions
1. Indicate the effect of each transaction and the balances after each transaction, using
the following tabular headings:
Assets
= Liabilities +
Owner’s Equity
Accounts
Accounts
Maria Edsall,
Maria Edsall,
Fees
Rent
Salaries
Supplies
Auto
Misc.
Cash + Receivable + Supplies = Payable +
Capital
–
Drawing + Earned – Expense – Expense – Expense – Expense – Expense
2.
Briefly explain why the owner’s investment and revenues increased owner’s
equity, while withdrawals and expenses decreased owner’s equity.
3. Determine the net income for September.
4. How much did September’s transactions increase or decrease Maria Edsall’s capital?
OBJ. 5
1. Net income:
$40,000
PR 1-2A Financial statements
Following are the amounts of the assets and liabilities of New World Travel Agency at
December 31, 2012, the end of the current year, and its revenue and expenses for the
year. The capital of Kris Taber, owner, was $120,000 on January 1, 2012, the beginning
of the current year. During the current year, Kris withdrew $10,000.
Accounts payable
Accounts receivable
Cash
Fees earned
Miscellaneous expense
$ 25,000
60,000
110,000
200,000
4,000
Rent expense
Supplies
Supplies expense
Utilities expense
Wages expense
$45,000
5,000
3,000
18,000
90,000
Instructions
1. Prepare an income statement for the current year ended December 31, 2012.
2. Prepare a statement of owner’s equity for the current year ended December 31, 2012.
(Continued )
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Chapter 1 Introduction to Accounting and Business
3. Prepare a balance sheet as of December 31, 2012.
4. What item appears on both the statement of owner’s equity and the balance sheet?
OBJ. 5
1. Net income:
$26,400
PR 1-3A Financial statements
Heidi Fritz established Freedom Financial Services on March 1, 2012. Freedom Financial
Services offers financial planning advice to its clients. The effect of each transaction and
the balances after each transaction for March are shown below.
Assets
a.
b.
Bal.
c.
Bal.
d.
Bal.
e.
Bal.
f.
Bal.
g.
Bal.
h.
Bal.
i.
Bal.
j.
Bal.
= Liabilities +
Heidi
Heidi
Accounts
Accounts
Fritz,
Fritz,
Fees
Cash + Receivable + Supplies = Payable + Capital − Drawing + Earned −
+45,000
+45,000
+6,540
+6,540
45,000
6,540
6,540
45,000
–1,800
−1,800
43,200
6,540
4,740
45,000
+84,000
+84,000
127,200
6,540
4,740
45,000
84,000
–22,500
104,700
6,540
4,740
45,000
84,000
−17,100
87,600
6,540
4,740
45,000
84,000
−48,000
39,600
6,540
4,740
45,000
84,000
–4,500
39,600
2,040
4,740
45,000
84,000
+34,500
+34,500
39,600
34,500
2,040
4,740
45,000
118,500
–15,000
–15,000
24,600
34,500
2,040
4,740
45,000 –15,000
118,500
Owner’s Equity
Salaries
Rent
Auto
Supplies
Misco.
Expense − Expense − Expense − Expense − Expense
–22,500
–22,500
–48,000
–48,000
–22,500
–13,500
–13,500
–22,500
–13,500
–3,600
–3,600
–3,600
–48,000
–22,500
–13,500
–4,500
–4,500
–48,000
–22,500
–13,500
–4,500
–3,600
–48,000
–22,500
–13,500
–4,500
–3,600
–3,600
Instructions
1.
2.
3.
4.
OBJ. 4, 5
2. Net income:
$12,150
Prepare an income statement for the month ended March 31, 2012.
Prepare a statement of owner’s equity for the month ended March 31, 2012.
Prepare a balance sheet as of March 31, 2012.
(Optional). Prepare a statement of cash flows for the month ending March 31, 2012.
PR 1-4A Transactions; financial statements
On January 1, 2012, Carlton Myers established Vista Realty. Carlton completed the following transactions during the month of January:
a. Opened a business bank account with a deposit of $25,000 from personal funds.
b. Purchased supplies (pens, file folders, paper, etc.) on account, $2,500.
c. Paid creditor on account, $1,600.
d. Earned sales commissions, receiving cash, $25,500.
e. Paid rent on office and equipment for the month, $5,000.
f. Withdrew cash for personal use, $8,000.
g. Paid automobile expenses (including rental charge) for month, $2,500, and miscellaneous expenses, $1,200.
h. Paid office salaries, $3,000.
i. Determined that the cost of supplies on hand was $850; therefore, the cost of supplies
used was $1,650.
Instructions
1. Indicate the effect of each transaction and the balances after each transaction, using
the following tabular headings:
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Chapter 1 Introduction to Accounting and Business
Assets
= Liabilities +
Owner’s Equity
Carlton
Carlton
Office
Accounts
Myers
Myers,
Sales
Rent
Salaries
Auto
Supplies
Misc.
Cash + Supplies = Payable + Capital – Drawing + Commissions – Expense – Expense – Expense – Expense – Expense
2. Prepare an income statement for January, a statement of owner’s equity for January,
and a balance sheet as of January 31.
OBJ. 4, 5
3. Net income:
$14,900
PR 1-5A Transactions; financial statements
Kean Dry Cleaners is owned and operated by Wally Lowman. A building and equipment
are currently being rented, pending expansion to new facilities. The actual work of dry
cleaning is done by another company at wholesale rates. The assets and the liabilities
of the business on March 1, 2012, are as follows: Cash, $15,000; Accounts Receivable,
$31,000; Supplies, $3,000; Land, $36,000; Accounts Payable, $13,000. Business transactions
during March are summarized as follows:
a. Wally Lowman invested additional cash in the business with a deposit of $28,000 in
the business bank account.
b. Paid $14,000 for the purchase of land as a future building site.
c. Received cash from cash customers for dry cleaning revenue, $17,000.
d. Paid rent for the month, $5,000.
e. Purchased supplies on account, $2,500.
f. Paid creditors on account, $12,800.
g. Charged customers for dry cleaning revenue on account, $34,000.
h. Received monthly invoice for dry cleaning expense for March (to be paid on April
10), $13,500.
i. Paid the following: wages expense, $7,500; truck expense, $2,500; utilities expense,
$1,300; miscellaneous expense, $2,700.
j. Received cash from customers on account, $28,000.
k. Determined that the cost of supplies on hand was $1,900; therefore, the cost of supplies used during the month was $3,600.
l. Withdrew $8,000 cash for personal use.
Instructions
1. Determine the amount of Wally Lowman’s capital as of March 1 of the current year.
2. State the assets, liabilities, and owner’s equity as of March 1 in equation form similar to
that shown in this chapter. In tabular form below the equation, indicate increases and
decreases resulting from each transaction and the new balances after each transaction.
3. Prepare an income statement for March, a statement of owner’s equity for March, and
a balance sheet as of March 31.
4. (Optional). Prepare a statement of cash flows for March.
OBJ. 5
k. $300,000
PR 1-6A Missing amounts from financial statements
The financial statements at the end of Alpine Realty’s first month of operations are as
follows:
Alpine Realty
Income Statement
For the Month Ended June 30, 2012
Fees earned. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expenses:
Wages expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rent expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Utilities expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Miscellaneous expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
(a)
$120,000
40,000
(b)
8,000
10,000
190,000
$110,000
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Chapter 1 Introduction to Accounting and Business
Alpine Realty
Statement of Owner’s Equity
For the Month Ended June 30, 2012
Aaron Gilbert, capital, June 1, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment on June 1, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income for June . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in owner’s equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Aaron Gilbert, capital, June 30, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
(c)
$
(f )
(g)
$150,000
(d)
$
(e)
50,000
Alpine Realty
Balance Sheet
June 30, 2012
Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . .
Supplies . . . . . . . . . . . . . . . . . . . . . . . .
Land . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . .
Liabilities
$ 185,000 Accounts payable . . . . . . . . . . . . . . .
Owner’s Equity
5,000
60,000 Aaron Gilbert, capital . . . . . . . . . . . .
$
(h) Total liabilities and owner’s equity
$40,000
$
(i)
(j)
$
(l)
Alpine Realty
Statement of Cash Flows
For the Month Ended June 30, 2012
Cash flows from operating activities:
Cash received from customers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deduct cash payments for expenses and payments to creditors. . . . .
Net cash flow from operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from investing activities:
Cash payments for acquisition of land . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from financing activities:
Cash received as owner’s investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deduct cash withdrawal by owner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash flow from financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash flow and June 30, 2012, cash balance . . . . . . . . . . . . . . . . . . . . . .
$
(k)
155,000
(m)
$
(n)
(o)
$
(p)
(q)
Instructions
By analyzing the interrelationships among the four financial statements, determine the
proper amounts for (a) through (q).
Problems Series B
OBJ. 4
Cash bal. at end of
January: $73,500
PR 1-1B Transactions
Cody Macedo established an insurance agency on January 1 of the current year and completed the following transactions during January:
a. Opened a business bank account with a deposit of $75,000 from personal funds.
b. Purchased supplies on account, $3,000.
c. Paid creditors on account, $1,000.
d. Received cash from fees earned on insurance commissions, $11,800.
e. Paid rent on office and equipment for the month, $4,000.
f. Paid automobile expenses for month, $600, and miscellaneous expenses, $200.
g. Paid office salaries, $2,500.
h. Determined that the cost of supplies on hand was $1,900; therefore, the cost of supplies used was $1,100.
i. Billed insurance companies for sales commissions earned, $12,500.
j. Withdrew cash for personal use, $5,000.
Instructions
1. Indicate the effect of each transaction and the balances after each transaction, using
the following tabular headings:
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Chapter 1 Introduction to Accounting and Business
Assets
= Liabilities +
43
Owner’s Equity
Cody
Cody
Accounts
Accounts
Macedo,
Macedo,
Fees
Rent
Salaries
Supplies
Auto
Misc.
Cash + Receivable + Supplies = Payable + Capital – Drawing + Earned – Expense – Expense – Expense – Expense – Expense
2.
Briefly explain why the owner’s investment and revenues increased owner’s
equity, while withdrawals and expenses decreased owner’s equity.
3. Determine the net income for January.
4. How much did January’s transactions increase or decrease Cody Macedo’s capital?
OBJ. 5
1. Net income:
$80,000
PR 1-2B Financial statements
The amounts of the assets and liabilities of St. Simon Travel Service at June 30, 2012, the
end of the current year, and its revenue and expenses for the year are listed below. The
capital of Gwen Perez, owner, was $150,000 at July 1, 2011, the beginning of the current
year, and the owner withdrew $30,000 during the current year.
Accounts payable
Accounts receivable
Cash
Fees earned
Miscellaneous expense
Rent expense
$ 25,000
90,000
123,000
500,000
11,000
75,000
Supplies
Supplies expense
Taxes expense
Utilities expense
Wages expense
$ 12,000
10,000
8,000
36,000
280,000
Instructions
1.
2.
3.
4.
OBJ. 5
1. Net income:
$91,900
a.
b.
Bal.
c.
Bal.
d.
Bal.
e.
Bal.
f.
Bal.
g.
Bal.
h.
Bal.
i.
Bal.
j.
Bal.
Prepare an income statement for the current year ended June 30, 2012.
Prepare a statement of owner’s equity for the current year ended June 30, 2012.
Prepare a balance sheet as of June 30, 2012.
What item appears on both the income statement and statement of owner’s equity?
PR 1-3B Financial statements
Rory Kalur established Computers 4 Less on February 1, 2012. The effect of each transaction and the balances after each transaction for February are shown below.
Assets
= Liabilities +
Owner’s Equity
Accounts
Accounts
Rory Kalur,
Rory Kalur,
Fees
Salaries
Rent
Auto
Supplies
Misc.
Cash
+ Receivable + Supplies = Payable +
Capital
− Drawing + Earned − Expense − Expense − Expense − Expense − Expense
+120,000
+120,000
+10,400
+10,400
120,000
10,400
10,400
120,000
+118,000
+118,000
238,000
10,400
10,400
120,000
118,000
–32,000
–32,000
206,000
10,400
10,400
120,000
118,000
–32,000
–5,000
–5,000
201,000
10,400
5,400
120,000
118,000
–32,000
+83,000
+83,000
5,400
120,000
201,000
–32,000
201,000
83,000
10,400
–23,000
–15,500
–7,500
178,000
83,000
10,400
5,400
120,000
201,000
–32,000 –15,500
–7,500
–48,000
–48,000
130,000
83,000
10,400
5,400
120,000
201,000
–48,000
–32,000 –15,500
–7,500
–6,100
–6,100
130,000
83,000
4,300
5,400
120,000
201,000
–48,000
–32,000 –15,500
–6,100
–7,500
–30,000
–30,000
100,000
83,000
4,300
5,400
120,000
–30,000
201,000
–48,000
–32,000 –15,500
–6,100
–7,500
Instructions
1.
2.
3.
4.
Prepare an income statement for the month ended February 29, 2012.
Prepare a statement of owner’s equity for the month ended February 29, 2012.
Prepare a balance sheet as of February 29, 2012.
(Optional). Prepare a statement of cash flows for the month ending February 29, 2012.
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Chapter 1 Introduction to Accounting and Business
PR 1-4B Transactions; financial statements
On June 1, 2012, Lindsey Brown established Equity Realty. Lindsey completed the following transactions during the month of June:
a. Opened a business bank account with a deposit of $15,000 from personal funds.
b. Paid rent on office and equipment for the month, $4,000.
c. Paid automobile expenses (including rental charge) for month, $1,200, and miscellaneous expenses, $800.
d. Purchased supplies (pens, file folders, and copy paper) on account, $1,000.
e. Earned sales commissions, receiving cash, $18,500.
f. Paid creditor on account, $600.
g. Paid office salaries, $2,500.
h. Withdrew cash for personal use, $5,000.
i. Determined that the cost of supplies on hand was $300; therefore, the cost of supplies
used was $700.
OBJ. 4, 5
2. Net income:
$9,300
Instructions
1. Indicate the effect of each transaction and the balances after each transaction, using
the following tabular headings:
Assets
Cash + Supplies
= Liabilities +
Owner’s Equity
Lindsey
Lindsey
Office
Accounts
Brown,
Brown,
Sales
Rent
Salaries
Auto
Supplies
Misc.
= Payable + Capital – Drawing + Commissions – Expense – Expense – Expense – Expense – Expense
2. Prepare an income statement for June, a statement of owner’s equity for June, and a
balance sheet as of June 30.
OBJ. 4, 5
3. Net income:
$3,700
PR 1-5B Transactions; financial statements
Anny’s Dry Cleaners is owned and operated by Anny Brum. A building and equipment
are currently being rented, pending expansion to new facilities. The actual work of dry
cleaning is done by another company at wholesale rates. The assets and the liabilities of
the business on June 1, 2012, are as follows: Cash, $25,000; Accounts Receivable, $30,000;
Supplies, $5,000; Land, $50,000; Accounts Payable, $18,000. Business transactions during
June are summarized as follows:
a. Anny Brum invested additional cash in the business with a deposit of $15,000 in the
business bank account.
b. Purchased land for use as a parking lot, paying cash of $20,000.
c. Paid rent for the month, $3,000.
d. Charged customers for dry cleaning revenue on account, $22,000.
e. Paid creditors on account, $13,000.
f. Purchased supplies on account, $1,000.
g. Received cash from cash customers for dry cleaning revenue, $28,000.
h. Received cash from customers on account, $27,000.
i. Received monthly invoice for dry cleaning expense for June (to be paid on July 10),
$21,500.
j. Paid the following: wages expense, $14,000; truck expense, $2,100; utilities expense,
$1,800; miscellaneous expense, $1,300.
k. Determined that the cost of supplies on hand was $3,400; therefore, the cost of supplies used during the month was $2,600.
l. Withdrew $1,000 for personal use.
Instructions
1. Determine the amount of Anny Brum’s capital as of June 1.
2. State the assets, liabilities, and owner’s equity as of June 1 in equation form similar to
that shown in this chapter. In tabular form below the equation, indicate increases and
decreases resulting from each transaction and the new balances after each transaction.
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Chapter 1 Introduction to Accounting and Business
3. Prepare an income statement for June, a statement of owner’s equity for June, and a
balance sheet as of June 30.
4. (Optional) Prepare a statement of cash flows for June.
OBJ. 5
i. $130,000
PR 1-6B Missing amounts from financial statements
The financial statements at the end of Cyber Realty’s first month of operations are shown
below.
Cyber Realty
Income Statement
For the Month Ended October 31, 2012
Fees earned. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expenses:
Wages expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rent expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Utilities expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Miscellaneous expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$250,000
$
(a)
30,000
11,000
9,000
3,000
$
180,000
(b)
$
(c)
$
(h)
(i)
Cyber Realty
Statement of Owner’s Equity
For the Month Ended October 31, 2012
Kendra Garcia, capital, October 1, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment on October 1, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income for October. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
$
Less withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in owner’s equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Kendra Garcia, capital, October 31, 2012 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(d)
(e)
(f )
(g)
Cyber Realty
Balance Sheet
October 31, 2012
Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . .
$77,000
8,000
(j)
$
(k)
Liabilities
Accounts payable . . . . . . . . . . . . . . . . . . . . . .
Owner’s Equity
Kendra Garcia, capital . . . . . . . . . . . . . . . . . .
Total liabilities and owner’s equity . . . . . . .
$ 30,000
$
(l)
(m)
$
(0)
Cyber Realty
Statement of Cash Flows
For the Month Ended October 31, 2012
Cash flows from operating activities:
Cash received from customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deduct cash payments for expenses and payments to creditors . . . . . . . . . .
Net cash flow from operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from investing activities:
Cash payments for acquisition of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash flows from financing activities:
Cash received as owner’s investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deduct cash withdrawal by owner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash flow from financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash flow and October 31, 2012, cash balance . . . . . . . . . . . . . . . . . . . . . . . .
$
(n)
158,000
(75,000)
$100,000
40,000
$
(p)
(q)
Instructions
By analyzing the interrelationships among the four financial statements, determine the
proper amounts for (a) through (q).
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Chapter 1 Introduction to Accounting and Business
Continuing Problem
2. Net income:
$1,980
Pat Sharpe enjoys listening to all types of music and owns countless CDs. Over the years,
Pat has gained a local reputation for knowledge of music from classical to rap and the
ability to put together sets of recordings that appeal to all ages.
During the last several months, Pat served as a guest disc jockey on a local radio station. In addition, Pat has entertained at several friends’ parties as the host deejay.
On June 1, 2012, Pat established a proprietorship known as PS Music. Using an extensive
collection of music MP3 files, Pat will serve as a disc jockey on a fee basis for weddings,
college parties, and other events. During June, Pat entered into the following transactions:
June 1. Deposited $5,000 in a checking account in the name of PS Music.
2. Received $3,600 from a local radio station for serving as the guest disc jockey for
June.
2. Agreed to share office space with a local real estate agency, Downtown Realty. PS
Music will pay one-fourth of the rent. In addition, PS Music agreed to pay a portion of the salary of the receptionist and to pay one-fourth of the utilities. Paid
$750 for the rent of the office.
4. Purchased supplies from City Office Supply Co. for $350. Agreed to pay $100
within 10 days and the remainder by July 5, 2012.
6. Paid $450 to a local radio station to advertise the services of PS Music twice daily
for two weeks.
8. Paid $700 to a local electronics store for renting digital recording equipment.
12. Paid $350 (music expense) to Cool Music for the use of its current music demos
to make various music sets.
13. Paid City Office Supply Co. $100 on account.
16. Received $500 from a dentist for providing two music sets for the dentist to play
for her patients.
22. Served as disc jockey for a wedding party. The father of the bride agreed to pay
$1,250 the 1st of July.
25. Received $400 for serving as the disc jockey for a cancer charity ball hosted by
the local hospital.
29. Paid $240 (music expense) to Galaxy Music for the use of its library of music
demos.
30. Received $900 for serving as PS disc jockey for a local club’s monthly dance.
30. Paid Downtown Realty $400 for PS Music’s share of the receptionist’s salary for
June.
30. Paid Downtown Realty $300 for PS Music’s share of the utilities for June.
30. Determined that the cost of supplies on hand is $170. Therefore, the cost of supplies used during the month was $180.
30. Paid for miscellaneous expenses, $300.
30. Paid $1,000 royalties (music expense) to National Music Clearing for use of various artists’ music during the month.
30. Withdrew $500 of cash from PS Music for personal use.
Instructions
1. Indicate the effect of each transaction and the balances after each transaction, using
the following tabular headings:
Assets
= Liabilities +
Owner’s Equity
Pat
Pat
Office
Equipment
Accts.
Accounts Sharpe,
Sharpe,
Fees
Music
Rent
Rent
Advertising Wages Utilities Supplies
Misc.
Cash + Rec. + Supplies = Payable + Capital – Drawing + Earned – Exp. – Exp. –
Exp.
–
Exp.
– Exp. – Exp. – Exp. – Exp.
2. Prepare an income statement for PS Music for the month ended June 30, 2012.
3. Prepare a statement of owner’s equity for PS Music for the month ended June 30,
2012.
4. Prepare a balance sheet for PS Music as of June 30, 2012.
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Chapter 1 Introduction to Accounting and Business
47
Cases & Projects
CP 1-1 Ethics and professional conduct in business
Group Project
Vince Hunt, president of Sabre Enterprises, applied for a $200,000 loan from First National Bank. The bank requested financial statements from Sabre Enterprises as a basis
for granting the loan. Vince has told his accountant to provide the bank with a balance
sheet. Vince has decided to omit the other financial statements because there was a net
loss during the past year.
In groups of three or four, discuss the following questions:
1. Is Vince behaving in a professional manner by omitting some of the financial statements?
2. a. What types of information about their businesses would owners be willing to provide bankers? What types of information would owners not be willing to provide?
b. What types of information about a business would bankers want before extending
a loan?
c. What common interests are shared by bankers and business owners?
CP 1-2 Net income
On July 1, 2011, Dr. Heather Dewitt established Life Medical, a medical practice organized
as a proprietorship. The following conversation occurred the following January between
Dr. Dewitt and a former medical school classmate, Dr. Naomi Kennedy, at an American
Medical Association convention in Boston.
Dr. Kennedy: Heather, good to see you again. Why didn’t you call when you were in Chicago? We could have had
dinner together.
Dr. Dewitt: Actually, I never made it to Chicago this year. My husband and kids went up to our Vail condo twice, but I
got stuck in Fort Lauderdale. I opened a new consulting practice this July and haven’t had any time for myself since.
Dr. Kennedy: I heard about it . . . Life . . . something . . . right?
Dr. Dewitt: Yes, Life Medical. My husband chose the name.
Dr. Kennedy: I’ve thought about doing something like that. Are you making any money? I mean, is it worth your
time?
Dr. Dewitt: You wouldn’t believe it. I started by opening a bank account with $40,000, and my December bank statement has a balance of $90,000. Not bad for six months—all pure profit.
Dr. Kennedy: Maybe I’ll try it in Chicago! Let’s have breakfast together tomorrow and you can fill me in on the details.
Comment on Dr. Dewitt’s statement that the difference between the opening
bank balance ($40,000) and the December statement balance ($90,000) is pure profit.
CP 1-3 Transactions and financial statements
Jan Martinelli, a junior in college, has been seeking ways to earn extra spending money.
As an active sports enthusiast, Jan plays tennis regularly at the Naples Tennis Club, where
her family has a membership. The president of the club recently approached Jan with
the proposal that she manage the club’s tennis courts. Jan’s primary duty would be to
supervise the operation of the club’s four indoor and 10 outdoor courts, including court
reservations.
In return for her services, the club would pay Jan $300 per week, plus Jan could keep
whatever she earned from lessons and the fees from the use of the ball machine. The club
and Jan agreed to a one-month trial, after which both would consider an arrangement for
the remaining two years of Jan’s college career. On this basis, Jan organized Topspin. During April 2012, Jan managed the tennis courts and entered into the following transactions:
a. Opened a business account by depositing $1,000.
b. Paid $300 for tennis supplies (practice tennis balls, etc.).
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Chapter 1 Introduction to Accounting and Business
c. Paid $200 for the rental of video equipment to be used in offering lessons during
April.
d. Arranged for the rental of two ball machines during April for $250. Paid $100 in advance, with the remaining $150 due May 1.
e. Received $1,600 for lessons given during April.
f. Received $500 in fees from the use of the ball machines during April.
g. Paid $800 for salaries of part-time employees who answered the telephone and took
reservations while Jan was giving lessons.
h. Paid $225 for miscellaneous expenses.
i. Received $1,200 from the club for managing the tennis courts during April.
j. Determined that the cost of supplies on hand at the end of the month totaled $180;
therefore, the cost of supplies used was $120.
k. Withdrew $250 for personal use on April 30.
As a friend and accounting student, you have been asked by Jan to aid her in assessing the venture.
1. Indicate the effect of each transaction and the balances after each transaction, using
the following tabular headings:
Assets
= Liabilities +
Owner’s Equity
Jan
Accounts
Martinelli,
Cash + Supplies = Payable +
Capital
Jan
Martinelli,
Service
Salary
Rent
Supplies
Misc.
– Drawing + Revenue – Expense – Expense – Expense – Expense
2.
3.
4.
5.
Prepare an income statement for April.
Prepare a statement of owner’s equity for April.
Prepare a balance sheet as of April 30.
a. Assume that Jan Martinelli could earn $9 per hour working 30 hours a week as a
waitress. Evaluate which of the two alternatives, working as a waitress or operating
Topspin, would provide Jan with the most income per month.
Discuss any other factors that you believe Jan should consider before discussb.
ing a long-term arrangement with the Naples Tennis Club.
Internet Project
CP 1-4 Certification requirements for accountants
By satisfying certain specific requirements, accountants may become certified as public
accountants (CPAs), management accountants (CMAs), or internal auditors (CIAs). Find
the certification requirements for one of these accounting groups by accessing the appropriate Internet site listed below.
Site
Description
http://www.ais-cpa.com This site lists the address and/or Internet link for each state’s board of accountancy. Find your state’s requirements.
http://www.imanet.org This site lists the requirements for becoming a CMA.
http://www.theiia.org
This site lists the requirements for becoming a CIA.
CP 1-5
Cash flows
Amazon.com, an Internet retailer, was incorporated and began operation in the mid-90s. On
the statement of cash flows, would you expect Amazon.com’s net cash flows from operating, investing, and financing activities to be positive or negative for its first three years
of operations? Use the following format for your answers, and briefly explain your logic.
First Year
Net cash flows from operating activities
Net cash flows from investing activities
Net cash flows from financing activities
Second Year
Third Year
negative
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
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Chapter 1 Introduction to Accounting and Business
49
CP 1-6 Financial analysis of Enron Corporation
The now defunct Enron Corporation, once headquartered in Houston, Texas, provided
products and services for natural gas, electricity, and communications to wholesale and
retail customers. Enron’s operations were conducted through a variety of subsidiaries
and affiliates that involved transporting gas through pipelines, transmitting electricity,
and managing energy commodities. The following data was taken from Enron’s financial
statements:
In millions
Total revenues
Total costs and expenses
Operating income
Net income
$100,789
98,836
1,953
979
Total assets
Total liabilities
Total owners’ equity
65,503
54,033
11,470
Net cash flows from operating activities
Net cash flows from investing activities
Net cash flows from financing activities
Net increase in cash
4,779
(4,264)
571
1,086
The market price of Enron’s stock was approximately $83 per share when the prior financial statement data was taken. Before it went bankrupt, Enron’s stock sold for $0.22
per share.
Review the preceding financial statement data and search the Internet for articles
on Enron Corporation. Briefly explain why Enron’s stock dropped so dramatically.
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
Copyright 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.