1
Introduction to
Accounting and Business
Principles of Financial Accounting, 11e
Reeve • Warren • Duchac
1
Introduction to Accounting and Business
After studying this chapter, you should be able to:
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1
Describe the nature of a business, the
role of accounting, and ethics in
business.
2
Summarize the development of
accounting principles and relate them to
practice.
3
State the accounting equation and define
each element of the equation.
2
Introduction to Accounting and Business (continued)
1-3
1-3
4
Describe and illustrate how business
transactions can be recorded in terms of the
resulting change in the elements of the
accounting equation.
5
Describe the financial statements of a
proprietorship and explain how they interrelate.
3
1
1
Describe the nature of a
business, the role of
accounting, and ethics in
business.
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4
1
Types of Businesses
Service Business
Delta Air Lines
The Walt Disney Company
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Service
Transportation
services
Entertainment
services
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1
Types of Businesses
Merchandising Business
Wal-Mart
Amazon.com
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Product
General merchandise
Internet books, music,
videos
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1
Types of Businesses
Manufacturing Business
Product
General Motors Corp.
Dell Inc.
Cars, trucks, vans
Personal computers
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1
The Role of Accounting in Business
Accounting can be defined as an
information system that provides
reports to users about the economic
activities and condition of a business.
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1
The process by which accounting provides
information to users is as follows:
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•
•
•
Identify users.
•
Record economic data about business
activities and events.
•
Prepare accounting reports for users.
Assess users’ informational needs.
Design the accounting information system
to meet users’ needs.
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1
Exhibit 1
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Users of Accounting Information
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1
Managerial Accounting
The area of accounting that provides
internal users with information is called
managerial accounting.
The objective of managerial
accounting is to provide relevant and
timely information for managers’ and
employees’ decision-making needs.
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1
Financial Accounting
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.
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1
Role of Ethics in
Accounting and Business
Ethics are moral principles
that guide the conduct of
individuals.
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1
Exhibit 3
Guideline for Ethical Conduct
1. Identify an ethical decision by using your personal ethical standards of
honesty and fairness.
2. Identify the consequences of the decision and its effect on others.
3. Consider your obligations and responsibilities to those that will be affected
by your decision.
4. Make a decision that is ethical and fair to those affected by it.
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2
Summarize the
development of accounting
principles and relate them
to practice.
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2
Generally Accepted
Accounting Principles
• Financial accountants follow generally
accepted accounting principles (GAAP) in
preparing reports.
• Within the United States, the Financial
Accounting Standards Board (FASB) has the
primary responsibility for developing
accounting principles.
(continued)
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2
• 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 are traded and sold to the public.
• Many countries outside the United States use
generally accepted accounting principles
adopted by the International Accounting
Standards Board (IASB).
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2
Business Entity Concept
Under the business entity
concept, the activities of a
business are recorded
separately from the activities
of its owners, creditors, or
other businesses.
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2
Business Entity Concept
A proprietorship is owned by one
individual.
• Easy and cheap to organize.
• Resources are limited to those of the
owner.
• Used by small businesses.
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2
Business Entity Concept
A partnership is similar to a
proprietorship except that it is owned
by two or more individuals.
• Combines the skills and resources of
more than one person.
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2
Business Entity Concept
A corporation is organized under state or federal
statutes as a separate legal taxable entity.
•
•
•
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Ownership is divided into shares called stock.
Can obtain large amounts of resources by issuing
stocks.
Used by large businesses.
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2
Cost Concept
Under the cost concept,
amounts are initially recorded
in the accounting records at
their cost or purchase price.
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2
Objectivity Concept
The objectivity concept requires
that the amounts recorded in the
accounting records be based on
objective evidence.
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2
Unit of Measure Concept
The unit of measure concept
requires that economic data
be recorded in dollars.
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2
Example Exercise 1-1
Cost Concept
On August 25, Gallatin Repair Service extended an
offer of $125,000 for land that had been priced for sale
at $150,000. On September 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 a national retail chain. At what value should
the land be recorded in Gallatin Repair Service’s
records?
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25
Example Exercise 1-1 (continued)
2
Follow My Example 1-1
$137,000. Under the cost concept, the land should be
recorded at the cost to Gallatin Repair Service.
For Practice: PE 1-1A, PE 1-1B
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3
State the accounting
equation and define each
element of the equation.
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3
The Accounting Equation
Assets = Liabilities + Owner’s Equity
The resources
owned by a
business
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3
The Accounting Equation
Assets = Liabilities + Owner’s Equity
The rights of the
creditors are the
debts of the
business.
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3
The Accounting Equation
Assets = Liabilities + Owner’s Equity
The rights of the
owners
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3
Example Exercise 1-2
Accounting Equation
John Joos is the owner and operator of You’re A Star, a
motivational consulting business. At the end of its
accounting period, December 31, 2009, You’re A Star has
assets of $800,000 and liabilities of $350,000. Using the
accounting equation, determine the following amounts:
a. Owner’s equity, as of December 31, 2009.
b. Owner’s equity, as of December 31, 2010,
assuming that assets increased by $130,000 and
liabilities decreased by $25,000 during 2010.
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Example Exercise 1-2 (continued)
3
Follow My Example 1-2
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 2010 as
follows:
Assets = Liabilities + Owner’s Equity
$130,000 = –$25,000 + Owner’s Equity
Owner’s Equity = $155,000
a.
Next, add the change in Owner’s Equity on December 31, 2009
to arrive at Owner’s Equity on December 31, 2010, as shown
below:
$605,000 = $450,000 + $155,000
Example
Exercise1-2 continued
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For Practice: PE 1-2A, PE 1-2B
32
4
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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4
Business Transaction
A business transaction is an
economic event or condition that
directly changes an entity’s
financial condition or its results
of operations.
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4
Transaction A
On November 1, 2009, Chris Clark
deposits $25,000 in a bank account
in the name of NetSolutions.
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4
Transaction A (continued)
Assets
CASH
a.
25,000
=
=
Owner’s Equity
CHRIS CLARK, CAPITAL
25,000
Investment by Chris Clark
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4
Transaction B
On November 5, 2009, NetSolutions
paid $20,000 for the purchase of land
as a future building site.
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4
Transaction B (continued)
Assets
CASH
Bal. 25,000
b. –20,000
Bal.
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1-38
5,000
+
=
Owner’s Equity
CHRIS CLARK, CAPITAL
LAND
=
25,000
+20,000
20,000
25,000
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4
Transaction C
On November 10, 2009,
NetSolutions purchased supplies
for $1,350 and agreed to pay the
supplier in the near future.
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4
Transaction C (continued)
= Liabilities + Owner’s Equity
Assets
CASH + SUPPLIES + LAND
Bal. 5,000
20,000
c.
+1,350
Bal. 5,000
1-40
1-40
1,350
20,000
=
ACCOUNTS CHRIS CLARK,
PAYABLE +
CAPITAL
25,000
+1,350
1,350
25,000
40
4
Beginning with Transaction D
the asset section will be shown
first, then the liabilities and
owner’s equity will be shown in
the following slide.
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4
Transaction D
On November 18, 2009, NetSolutions
received cash of $7,500 for providing
services to customers. A business
earns money by selling goods or
services to its customers. This amount
is called Revenue.
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4
Transaction D (continued)
Assets
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1-43
Bal.
d.
CASH
5,000
+7,500
Bal.
12,500
+
SUPPLIES +
1,350
1.350
LAND
20,000
20,000
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4
Transaction D (continued)
Liabilities +
Bal.
d.
Bal.
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1-44
ACCOUNTS
PAYABLE
1,350
+
Owner’s Equity
CHRIS CLARK,
FEES
CAPITAL + EARNED
25,000
+7,500
1,350
25,000
7,500
44
4
Expenses
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.
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4
Transaction E
On November 30, 2009, NetSolutions
paid the following expenses during
the month: wages, $2,125; rent, $800;
utilities, $450; and miscellaneous,
$275.
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4
Transaction E (continued)
Assets
Bal.
e.
Bal.
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1-47
CASH +
12,500
–3,650
8,850
SUPPLIES +
1,350
1.350
LAND
20,000
20,000
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4
Transaction E (continued)
Liabilities +
Bal.
Owner’s Equity
ACCOUNTS CHRIS CLARK,
FEES
WAGES RENT UTIL. MISC.
PAYABLE + CAPITAL
+ EARNED – EXP. – EXP. – EXP. – EXP.
1,350
25,000
7,500
e.
Bal.
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1,350
25,000
7,500
–2,125
–800
–450 –275
–2,125
–800
–450 –275
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4
Transaction F
On November 30, 2009,
NetSolutions paid creditors on
account, $950.
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4
Transaction F (continued)
Assets
1-50
1-50
Bal.
f.
CASH
8,850
–950
Bal.
7,900
+
SUPPLIES +
1,350
1.350
LAND
20,000
20,000
50
4
Transaction F (continued)
Liabilities
+
Owner’s Equity
ACCOUNTS CHRIS CLARK,
FEES
WAGES RENT UTIL. MISC.
PAYABLE + CAPITAL
+ EARNED – EXP. – EXP. – EXP. – EXP.
Bal.
f.
1,350
–950
25,000
7,500
–2,125
–800
–450
–275
Bal.
400
25,000
7,500
–2,125
–800
–450
–275
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4
Transaction G
On November 30, 2009, Chris Clark
determined that the cost of supplies
on hand at the end of the period was
$550.
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4
Transaction G (continued)
Assets
Bal.
g.
Bal.
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1-53
CASH +
7,900
7,900
SUPPLIES
1,350
–800
550
+
LAND
20,000
20,000
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4
Transaction G (continued)
Liabilities +
Owner’s Equity
ACCOUNTS CHRIS CLARK, FEES
WAGES RENT SUP. UTIL. MISC.
PAYABLE + CAPITAL
+ EARNED – EXP. – EXP. – EXP. – EXP. – EXP.
Bal.
g.
400
Bal.
400
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25,000
7,500
–2,125
–800
–450 –275
–800
25,000
7,500
–2,125
–800
–800 –450 –275
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4
Transaction H
On November 30, 2009, Chris Clark
withdrew $2,000 from NetSolutions
for personal use.
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4
Transaction H (continued)
Assets
Bal.
h.
Bal.
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CASH +
7,900
–2,000
5,900
SUPPLIES
550
550
+
LAND
20,000
20,000
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4
Transaction H (continued)
Liabilities +
Owner’s Equity
ACCTS.
CLARK, CLARK,
FEES
WAGES RENT SUP. UTIL. MISC.
PAY. + CAPITAL – DRAW. + EARNED – EXP. – EXP. – EXP. – EXP. – EXP.
Bal. 400
h.
25,000
Bal.400
25,000
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7,500
–2,125
–800 –800 –450 –275
–2,125
–800 –800 –450 –275
–2,000
–2,000
7,500
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4
Summary
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4
Exhibit 5
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Effects of Transactions on Owner’s Equity
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4
Example Exercise 1-3
Transactions
Salvo Delivery Service is owned and operated by Joel
Salvo. The following selected transactions were
completed by Salvo Delivery Service during February:
1. Received cash from owner as additional
investment, $35,000.
2. Paid creditors on account, $1,800.
3. Billed customers for delivery services on account,
$11,250.
4. Received cash from customers on account, $6,740.
5. Paid cash to owner for personal use, $1,000.
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(Continued)
60
Example Exercise 1-3 (continued)
4
Indicate the effect of each transaction on the
accounting equation elements (Assets, Liabilities,
Owner’s Equity, Drawing, Revenue, and Expense) by
listing the numbers identifying the transactions, (1)
through (5). 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.
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Example Exercise 1-3 (continued)
4
Follow
My Example 1-3
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.
For Practice: PE 1-3A, PE 1-3B
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5
Describe the financial
statements of a
proprietorship and
explain how they
interrelate.
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5
Financial Statements
After transactions have been
recorded and summarized, reports
are prepared for users. The
accounting reports providing this
information are called financial
statements.
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5
Income Statement
The income statement reports
the revenues and expenses for
a period of time, based on the
matching concept.
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5
Matching Concept
The matching concept is
applied by matching the
expenses with the revenue
generated during a period
by those expenses.
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5
The excess of revenue over the
expenses is called net income
or net profit. If the expenses
exceed the revenue, the excess
is a net loss.
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5
Exhibit 6
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Financial Statements for NetSolutions
Net income is carried
to the statement of
owner’s equity.
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5
Example Exercise 1-4
Income Statement
The assets and liabilities of Chick Travel Service at April 30,
2010, the end of the current year, and its revenue and
expenses for the year are listed below. The capital of the
owner, Adam Cellini, was $80,000 at May 1, 2009, the
beginning of the current year.
Accounts payable
$ 12,200
Accounts receivable
31,350
Cash
53,050
Fees earned
263,200
Land
80,000
Miscellaneous expense $ 12,950
Office expense
63,000
Supplies
3,350
Wages expense
131,700
Prepare an income statement for the current year ended
April 30, 2010.
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Example Exercise 1-4 (continued)
5
Follow
My Example 1-3
Follow My Example 1-4
CHICK TRAVEL SERVICE
INCOME STATEMENT
For the Year Ended April 30, 2010
Fees earned
Expenses:
Wages expense
Office expense
Miscellaneous expense
Total expenses
Net income
$263,200
$131,700
63,000
12,950
207,650
$ 55,550
For Practice: PE 1-4A, PE 1-4B
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5
Statement of Owner’s Equity
The statement of owner’s equity
reports the changes in the
owner’s equity for a period of
time.
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5
Exhibit 6
Financial Statements for NetSolutions (continued)
From the income statement
To the balance sheet
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5
Example Exercise 1-5
Statement of Owner’s Equity
Using the data for Chick Travel Service shown in
Example Exercise 1-4, prepare a statement of
owner’s equity for the current year ended April 30,
2010. Adam Cellini invested an additional $50,000
in the business during the year and withdrew cash
of $30,000 for personal use.
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Example Exercise 1-5 continued
5
Follow My Example 1-5
CHICK TRAVEL SERVICE
STATEMENT OF OWNER’S EQUITY
For the Year Ended April 30, 2010
Adam Cellini, capital, May 1, 2009
$ 80,000
Additional investment by owner during year
$ 50,000
Net income for the year
55,550
$105,550
Less withdrawals
30,000
Increase in owner’s equity
75,550
Adam Cellini, capital, April 30, 2010
$155,550
For Practice: PE 1-5A, PE 1-5B
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5
Balance Sheet
A balance sheet is a list of
the assets, liabilities, and
owner’s equity as of a
specific date.
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5
Account Form
The account form of a balance
sheet lists the assets on the left and
the liabilities and owner’s equity on
the right—similar to the design of
an account.
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5
Exhibit 6
Financial Statements for NetSolutions (continued)
This amount is compared
to the net cash flow on the
statement of cash flows.
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From the statement
of owner’s equity
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5
Example Exercise 1-6
Balance Sheet
Using the data for Chick Travel Service shown in
Example Exercises 1-4 and 1-5, prepare the balance
sheet as of April 30, 2010.
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Example Exercise 1-6 (continued)
5
Follow
My Example 1-3
Follow My Example 1-6
Assets
Cash
Accounts receivable
Supplies
Land
Total assets
CHICK TRAVEL SERVICE
BALANCE SHEET
April 30, 2010
Liabilities
$ 53,050 Accounts payable
$ 12,200
31,350
3,350
Owner’s Equity
80,000 Adam Cellini, capital
155,550
$167,750 Total liab. & owner’s eq. $167,750
For Practice: PE 1-6A, PE 1-6B
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5
Statement of Cash Flows
A statement of cash flows is a
summary of the cash receipts and
payments for a specific period of time.
It consists of three sections: (1)
operating activities, (2) investing
activities, and (3) financing activities.
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5
Exhibit 6
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Financial Statements for NetSolutions (continued)
This amount should match
Cash on the balance sheet.
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5
Operating Activities
The cash flows from operating
activities section reports a
summary of cash receipts and
cash payments from operations.
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5
Investing Activities
The cash flows from investing
activities section reports the cash
transactions for the acquisition and sale
of relatively permanent assets.
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5
Financing Activities
The cash flows from financing
activities section reports the cash
transactions related to cash
investments by the owner,
borrowings, and withdrawals by the
owner.
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5
Example Exercise 1-7
Statement of Cash Flows
A summary of cash flows for Chick Travel Service for the
year ended April 30, 2010, is shown below.
Cash receipts:
Cash received from customers
Cash received from additional
investment of owner
Cash payments:
Cash paid for expenses
Cash paid for land
Cash paid to owner for personal use
$251,000
50,000
210,000
80,000
30,000
The cash balance as of May 1, 2009, was $72,050.
Prepare a statement of cash flows for Chick Travel Service for
1-88 the year ended April 30, 2010.
85
Example Exercise 1-7 (continued)
5
Follow
My Example 1-3
Follow My Example 1-7
Cash flows from operating activities:
Cash received from customers
$251,000
Deduct cash payments for expenses
210,000
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 $ 50,000
Deduct cash withdrawals by owner
30,000
Net cash flows from financing activities
Net decrease in cash during year
Cash as of May 1, 2009
Cash as of April 30, 2010
$ 41,000
(80,000)
20,000
$(19,000)
72,050
$ 53,050
For Practice: PE 1-7A, PE 1-7B
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5
Interrelationships Among
Financial Statements
• The income statement and the statement of
owner’s equity are interrelated.
Net income or net
loss appears on both
statements.
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5
Interrelationships Among
Financial Statements
• The statement of owner’s equity and the
balance sheet are interrelated.
The owner’s capital at the end of
the period on the statement of
owner’s equity also appears on the
balance sheet as owner’s capital.
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Interrelationships Among
Financial Statements
• The balance sheet and the statement of
cash flows are interrelated.
The cash reported on the
balance sheet is also reported
as the end-of-period cash on the
statement of cash flows.
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5
Financial Analysis and
Interpretation
Ratio of Liabilities
to Owner’s Equity
Total Liabilities
=
For NetSolutions:
Ratio of Liabilities
to Owner’s Equity
1-90
1-90
=
Total Owner’s Equity
(or Total
Stockholders’ Equity)
$400
$26,050
= 0.015
90