Accounting 10
Module 1
Lesson 1-5
Accounting 10
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Lesson 1
Accounting 10
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Lesson 1
Lesson One--Establishing A Business
Read chapter 1, pages 1 to 22 in the textbook
Topics:
•
Establishing the Accounting Equation
•
Introducing the Balance Sheet
•
Remember These Important Points
•
Do You Understand?
•
Conclusion
•
Self Test
•
Answers for Self Test
•
Assignment 1
After studying Lesson 1, you should be able to
•
define accounting.
•
describe the difference between bookkeeping and accounting.
•
define financial accounting, cost accounting, and management accounting.
•
list the main differences of a sole proprietorship, partnership, and corporation.
•
make a list of what is required to begin a business.
•
distinguish between such accounting terms as debtor and creditor.
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Lesson 1
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define accounting terms.
•
explain the entity concept as it relates to accounting theory.
•
solve the one unknown element from an accounting equation when two elements are given.
•
classify various items commonly found in the accounting equation as being either assets,
liabilities, or owner's equity accounts.
•
calculate the amount of owner's equity after listing and totalling various asset and liability items.
•
construct an accounting equation that itemizes the three elements for a given service firm.
•
prepare in good form the opening balance sheet from previously constructed accounting
equations for given service firms.
•
prepare in good form the opening balance sheet of a service firm from given information and
without the aid of an accounting equation.
Introduction
Before you study the basics of establishing a business, look briefly at what is meant by financial
accounting, cost accounting, and management accounting.
What is accounting?
Accounting is the process of recording, classifying, reporting and interpreting the financial data of an
organization, and it is often referred to as the "language of business". Accounting enables business
people to talk to each other about financial activities that take place every day, the results of these
activities, the financial plans a company may have, and other pertinent topics.
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Lesson 1
What is the difference between bookkeeping and accounting?
Bookkeeping is the recording, posting, and proving of financial data. Accounting is the establishing and
maintaining of the entire accounting system, the interpreting of the results of the recorded data, and the
assisting in the management or decision-making aspects of the organization. Thus, bookkeeping must be
completed before accounting can take place.
What is meant by financial accounting, cost accounting, and management
accounting?
Financial accounting is concerned with the preparation of financial statements.
Cost accounting is concerned with the reporting of costs (assets and expenses) as accurately as possible.
Management accounting is concerned with decision making and the preparation of special reports to
be used in making those decisions. This course concentrates on financial accounting.
Different Forms of Business Ownership
Depending on its form of ownership, a business can be classified in one of the following ways:
• sole proprietorship
• partnership
• corporation
The first type is the sole proprietorship. This business has one owner or "proprietor." In many cases
the company name serves to inform the customer who the owner or owners are of the organization. For
example, "J. Barnby, Lawyer" is a sole or single proprietorship.
The second business type is the partnership. This business has two or more owners or proprietors. For
example, the accounting firm "Kelso, Hermes, and Petts, Accountants" has three partners.
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Lesson 1
Finally, there is the corporation or limited company. A corporation is owned by
a number of people called shareholders and it is operated under a government charter. Corporations
must, by law, indicate to the consumer that the business is a corporation by using the terms "Limited" or
"Incorporated" in their company names. Thus, the company Technolinks Incorporated is a corporation
owned by its shareholders. "Ltd." or "Inc." may be used in place of "Limited" or "Incorporated."
Different Types of Business Activities
Depending on whether a business sells a service or provides a product it can be called a
• service business
• merchandising business
• manufacturing business
A business that provides the customer with a service in exchange for payment is called a service
business. Some examples of service businesses are legal firms, dry cleaning operations, golf driving
ranges, management consultants, bowling alleys, taxi cabs, and so on.
A business that buys goods and resells them to their customers for a profit is called a merchandising
business.
Finally, manufacturing businesses are businesses that buy raw materials such as steel, textiles, lumber,
or paper and convert them into finished products such as filing cabinets, clothing, houses, or books.
Establishing the Accounting Equation
To start any type of profit-making business, a person needs resources such as land, building, furniture,
goods for sale, equipment, and so on.
Since these resources are scarce in the sense that they exist in limited quantities and since all require
effort to produce--through the combination of input, such as machinery and also labour and
management--these resources are called economic resources.
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Lesson 1
How does any business obtain economic resources in order to start business operations?
•
partly through borrowing from banks and suppliers of goods called creditors by business. Until
a debt that is owed by the business is paid, a creditor has a claim against the economic resources
of the business.
•
partly through the investment of the owner or owners. To establish a business enterprise, the
owner(s) must have invested some of their personal money and possibly some of their personal
furniture, equipment, and so on. Since the owner(s) have made this investment to establish the
business, it is important to remember they have claims against these economic resources.
Introducing Accounting Theory
Concepts are basic ideas that act as a foundation for all accounting theory. These provide the theoretical
foundation for Generally Accepted Accounting Principles, usually referred to as GAAPs.
The first GAAP to study is the entity concept. Accounting theory supports the idea that each business is
an economic unit, separate and distinct from its owner(s) and any other business.
These new ideas may be stated by using an equation(s).
1.
ECONOMIC
RESOURCES
$50 000
=
=
CLAIMS AGAINST
ECONOMIC RESOURCES
$50 000
The total economic resources of any business enterprise must be equal to the total claims against these
economic resources.
2.
ECONOMIC =
RESOURCES
CLAIMS OF +
CREDITORS
$50 000
=
Accounting 10
CLAIM OF
OWNER
$20 000
+
7
$30 000
Lesson 1
This equation explains the relationship between economic resources and how they were acquired. The
claims against the total economic resources are made up of claims of creditors (resulting from borrowing
by the business) and the claims of the owner(s) of the business (resulting from investment). The two
sides must balance.
Analyzing and Applying the Accounting Equation
The third equation is in the language of accounting.
A
=
L
+
Assets
=
Liabilities
+
$50 000 =
$20 000
+
OE
Owner's Equity
$30 000
Assets are the economic resources of the business required to establish any business.
They represent what a business owns.
Liabilities are the claims of the creditors against the assets. They represent the debts of the business.
Owner's Equity is the claim of the owner against the assets; it is also the value of the owner's
investment in the business.
Liabilities are listed before the owner's equity on the right side of the equation. The claims of the
creditors come before those of the owner(s). For example, if the business were to be declared bankrupt
(incapable of paying its debts), then in any sale of the assets the creditors' claims on the total assets
would have to be satisfied before the claims of the owner(s).
Study the section of "applying the accounting equation" on pages 9 and 10 in the textbook. Note the
examination of each element (assets, liabilities, and owner's equity).
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Lesson 1
Introducing the Balance Sheet
Accountants show the financial position of an individual or a business by means of a formal statement
called a balance sheet. The balance sheet reports assets, liabilities, and owner's equity at a certain
date.
The basic structure of a balance sheet is based upon the equation previously discussed. Note the
example on page 13 and the explanation on page 14 of the text. The preparation of the balance sheet is
explained in more detail on pages 15 to 18. These instructions should be followed in detail when
preparing any balance sheet.
There are two types of forms used for Balance Sheets. One is the Account form and another is called the
Report Form. Account form example is found on page 15 and the Report form example is on page 175
of your text.
Remember These Important Points
•
the three lines of the heading answer who, what, when.
•
assets are listed in order of liquidity.
•
liabilities are listed in the order in which debts are due.
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owner's equity is the claim of the owner against the assets of the business.
•
when the balance sheet is finished, use the ruler for all rulings.
Total Assets must = Total Liabilities + Total Owner's Equity.
Please note: The definitions throughout the course in "Do You Understand" do not have to be
memorized word for word. However, you should be able to explain them in your own words.
Do You Understand?
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Lesson 1
Accounting - is the process of recording, classifying, reporting and interpreting the financial data of an
organization.
Service Business - is a business that provides the customer with a service in exchange for payment.
Merchandising Business - a business that buys goods and resells them to a customer for a profit.
Manufacturing Business - are ones that buy raw materials and convert them into a
finished product.
Sole Proprietorship - a business owned by one person.
Partnership - a business owned by two or more persons.
Corporation - a business owned by one or more persons, and is operated under a government charter.
Economic Resources - scarce items which require effort to produce and for which a price must be paid.
Creditor - a person or business to whom money or goods are owed; one to whom a debt is owed.
Credit - the ability to buy or borrow upon a promise to pay at a later date.
Debt - a sum of money owed by one person (the debtor) to another (the creditor), payable either on
demand or at some fixed or determinable future time.
Debtor - a person or business who owes money or goods.
Owner Investment - results in the claim of the owner against economic resources.
GAAPs - broad rules or guidelines for preparing financial statements.
Entity Concept - one aspect of accounting theory that views the business as being
separate, distinct and apart from its owners.
Assets - the economic resources of a business.
Liabilities - the claims of the creditors against the assets of a business.
Owner's Equity - the claim of the owner against the assets of a business.
Bank Loan Payable - the claim of a bank against the assets of a borrowing business.
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Lesson 1
Accounts Payable - amounts owing to creditors (other than banks) for the purchase of goods or services
on credit.
Mortgage Payable - a long term debt wherein the collateral consists of the property bought.
Balance Sheet - a financial statement reporting assets, liabilities, and owner's equity at a certain date.
Capital - the owner's claim against the assets through personal investment.
Balance Sheet Equation - the accounting equation represented in the balance sheet.
Liquidity Order - the order of assets according to how easily the assets may be
cash.
converted to
Order for Listing Liabilities - the order of retiring debts; this order is based on the due date.
Conclusion
You should now be able to:
•
•
•
•
write accounting records neatly and legibly in the accepted accounting format.
determine the financial position of an individual or a business.
explain the accounting equation.
prepare a simple balance sheet.
Please note: Always do your self test before you attempt the assignment throughout
the course.
Self Test
(Answers to these questions are always found before the lesson assignment.)
1.
Problem 1-2, page 11, text
2.
MC 1-2, page 12, text
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Lesson 1
3.
Problem 1-4 (a)--page 19, text
4.
MC 1-6 page 21, text
Throughout the course, MC problems are to be done on a lined sheet of paper. In a few cases, however,
paper is supplied.
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Lesson 1
P 1-4a
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Lesson 1
Answers for Self Test
P 1-2
Assets
Office
Cash Equipment
$700 + $4 000
=
Liabilities
Furniture
+ $1 900
$6 600
=
=
+
Owner’s Equity
+
Jeanne
Fung
$3 000
$3 000
Jeanne Fung Accounting Office
Balance Sheet
as at March 10, 20__
.......
Cash........................................
Office Equipment ...................
Office Furniture......................
................
Liabilities
$
700
4 000
1 900
..........
................
Total Assets ............................
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Bank Loan
Accounts
Payable
Payable
$3 300 + $300
$3 600
P 1-4
Assets
+
Bank Loan Payable ........................................
Accounts Payable:
Sherlock Office Suppliers, Ltd. ...................
Total Liabilities ..............................................
$ 3 300
300
$3 600
Owner's Equity
$6 600
Jeanne Fung, Capital
Total Liabilities and Owner's Equity .............
14
3 000
$6 600
Lesson 1
MC 1-2
Entity Concept
Igor must recognize a distinct difference between his personal assets and the assets of his new business.
The entity concept states that each business is an economic unit separate and distinct from its owner or
owners and any other business unit. Only if Igor applies this concept will he and any other person or
business be able to distinguish between his personal and his business assets and liabilities.
MC 1-6a
Format concerns as they relate to a formal balance sheet include:
•
•
•
•
•
•
•
•
•
the three-line centred heading
i)
the order of the heading - name of the company, name of the statement, date
ii)
the correct form of the date
the headings within the body
i)
Assets, Liabilities, Owner's Equity
the listing of the assets in the order of liquidity
the listing of the liabilities in the order in which payment falls due
the listing of multiple accounts receivable and accounts payable accounts
i)
accounts indented with amounts listed separately and sub-totalled
ii)
accounts in alphabetic order
the placement of dollar signs
i)
at the beginning of each new money column
ii)
usually at all sub-totals unless it clutters the statement
iii)
at all final totals
underlining of amounts
i)
single underlining below each column of numbers to be sub-totalled; i.e., list of accounts
receivable or accounts payable, total of all assets or liabilities
ii)
double underlining below all final totals
legibility of handwritten amounts
clear and understandable corrections
MC 1-6b
Format is particularly important because it encourages neatness and legibility. Furthermore, it permits
easy comparison of several years of statements within a single company or period performances and
financial positions among companies within the same industry.
•
Heading - each line must provide the same information in the same order
Body Headings - the headings reflect the same order and position as the accounting equation
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Lesson 1
•
•
•
•
•
•
Order of Liquidity (Assets) - provides the reader with an easy method of comparing one statement
to another and the statements of related businesses
Order of Indebtedness (Liabilities) - provides the reader with an easy method of comparing one
statement to another and the statements of related businesses
Sub-listing alphabetically and sub-totalling of accounts receivable and accounts payable - the
alphabetic listing sorts and classifies these accounts so that they will be easily dealt with, and the
sub-total produces a single total that promotes easier reading of the statement
dollar signs make the statement more readable and understandable
underlining indicates sub-totalling functions and totals for the reader
legibility and proper, neat corrections are essential because people other than the person who
prepares the statement must be able to read, understand, and interpret the statements
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Lesson 1