The Nature of Accounting
Chapter 1
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Learning Objectives
1.
Define accounting and related terms.
2.
Explain who uses accounting
information.
3.
Identify four forms of business
organizations and three types of
business operations.
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Learning Objectives
4.
Define and describe the elements of
accounting.
5.
State the accounting equation.
6.
Define business transaction.
7.
Record business transactions in
equation form.
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Learning Objectives
8.
Identify four types of transactions that
affect owner’s equity.
9.
Prepare three basic financial
statements.
10. Define ethics and explain the
importance of ethical behavior in
modern business.
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Learning Objective 1
Define accounting and related terms
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Accounting is the process of recording, summarizing,
analyzing, and interpreting financial activities to permit
individuals and organizations to make informed
judgments and decisions.
Accounting combines recording, summarizing,
analyzing, and interpreting into a single process and
applies this process to financial activities.
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Learning Objective 2
Explain who uses accounting information
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Individuals
Owners
Managers
Investors
Banks and other lending institutions
Governments
Tax authorities
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Users
Use of Accounting Information
Individuals
Individuals, such as Janice Graham and Ray Clermont, must
understand accounting to function personally within our society,
which is very dependent on financial activities. They—and
you—keep checkbooks and other bank records, receive
paychecks, pay taxes, use charge cards, borrow money, and
purchase a variety of products and services.
Owners
Business owners, such as Drew Beedy and Lynn Bennett, must
understand accounting to achieve success in their
organizations. Very often, the owners do not actually run the
business. In such cases, the owners rely on accounting
information to determine how well their businesses are being
managed.
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Users
Use of Accounting Information
Managers
Managers use accounting data extensively in deciding on
alternatives, such as what to sell, how to price, and when to
expand the product line.
Investors
Investors use accounting data for insights on the financial
condition of potential investments when deciding whether to
invest in a business.
Banks and
other lending
institutions
Lenders, such as banks, use accounting data in deciding
whether to approve a loan.
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Users
Use of Accounting Information
Governments
Governmental units (federal, state, and local) also record,
summarize, analyze, and interpret financial events to operate
with limited resources.
Tax authorities
Tax authorities use accounting data reported to the government
in deciding whether a business is complying with tax rules and
regulations. Since our country has an extensive taxing system,
this is a major use of accounting data.
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Learning Objective 3
Identify four forms of business
organizations and three types of
business operations
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Sole Proprietorship
A business owned
by one person
Partnership
A business co-owned
by two or more persons
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Corporation
A business that is owned by investors called
stockholders
Limited Liability Company (LLC)
A business that combines features of a corporation
and those of proprietorships and partnerships
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Service Business
Performs services for customers to earn a profit
Merchandising Business
Purchases goods produced by others and then
sells these goods to customers
Manufacturing Business
Produces a product to sell to its customers
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Learning Objective 4
Define and describe the elements of
accounting
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Assets
An item with money value that is owned by a
business
Liability
A debt owed by a business
Owner’s Equity
The excess of assets over liabilities
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Quick Check
Another name for owner’s equity is
a. note payable.
b. accounts receivable.
c. capital.
d. accounts payable.
e. notes receivable.
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Learning Objective 5
State the accounting equation
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Assets = Liabilities + Owner’s Equity
For example, on December 31, 20X2, Jeanette Deese
has business assets of $30,000, business liabilities of
$10,000, and owner’s equity of $20,000.
Her accounting equation is:
Assets (A)
$30,000
= Liabilities (L) + Owner’s Equity (OE)
=
$10,000
+
$20,000
or
$30,000
=
$30,000
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Example
1. If assets are $30,000 and liabilities are $15,000,
owner’s equity must be ____?
2. If owner’s equity is $9,000 and assets are $25,000,
liabilities must be ____?
3. If liabilities are $5,500 and owner’s equity is $8,000,
assets must be ____?
Answer :
1. $15,000
2. $16,000
3. $13,500
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Review Quiz 1-1
Find the missing element in each of the following.
A
=
L
(a)
$40,000
$25,000
(b)
$90,000
$?
$38,000
(c)
$70,000
(d)
$75,000
$?
$22,000
$0
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OE
$15,000
$?
$52,000
$48,000
$75,000
$?
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Learning Objective 6
Define business transaction
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Any activity that changes the value of a firm’s
assets, liabilities, or owner’s equity is called a
transaction.
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Purchase of equipment on credit
Cash payment to a creditor
Receipt of cash for services rendered to a customer
Purchase of supplies for cash
Payment of rent for the month
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Payment of utility bill
Receipt of a bill to be paid later
Payment to employees for the payroll
Owner investment of cash in the business
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Total assets must always equal liabilities plus
owner’s equity.
To maintain this balance, transactions are recorded
as having a dual effect on the basic accounting
elements.
Every business transaction has at least two effects
on the accounting equation.
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Learning Objective 7
Record business transactions in
equation form
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Example
Susan Gilbert invests $30,000 to start Susan’s Gifts and
Candies.
How will this transaction affect the accounting equation?
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Example Answer
Susan Gilbert invests $30,000 to start Susan’s Gifts and
Candies.
How will this transaction affect the accounting equation?
Assets
Cash
+$30,000
= Liabilities +
Owner’s Equity
Acc.
Payable
Susan
Gilbert,
Capital Revenue Expenses
Equip. Supplies
+$30,000
=
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Example
Susan Gilbert purchases equipment costing $1,200 on
account.
How will this transaction affect the accounting equation?
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Example Answer
Susan Gilbert purchases equipment costing $1,200 on
account.
How will this transaction affect the accounting equation?
Assets
Cash
= Liabilities +
Owner’s Equity
Acc.
Payable
Susan
Gilbert,
Capital Revenue Expenses
Equip. Supplies
+$1,200
=
+$1,200
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Example
Susan Gilbert generates $500 of cash sales.
How will this transaction affect the accounting equation?
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Example Answer
Susan Gilbert generates $500 of cash sales.
How will this transaction affect the accounting equation?
Assets
Cash
+$500
= Liabilities +
Owner’s Equity
Acc.
Payable
Susan
Gilbert,
Capital Revenue Expenses
Equip. Supplies
+$500
=
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Learning Objective 8
Identify four types of transactions
that affect owner’s equity
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Owner investments increase owner’s equity.
Revenue increases owner’s equity.
Expenses decrease owner’s equity.
Owner withdrawals decrease owner’s equity.
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Review Quiz 1-2
Record the following transactions for Susan Wright in
an expanded accounting equation with these headings:
Cash + Accounts Receivable + Supplies = Accounts
Payable + Susan Wright, Capital + Revenue – Expenses.
Include a Description column. After recording the last
transaction, prove that the equation is in balance.
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Review Quiz 1-2
(a) Susan invested $10,000 cash in the business.
(b) Invested supplies valued at $2,000 in the business.
(c) Paid rent for the month, $600.
(d) Performed services and received cash, $800.
(e) Purchased supplies on credit, $200.
(f) Performed services on credit, $625.
(g) Withdrew cash for personal use, $500.
(h) Received $250 cash as partial payment for services
performed on account.
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Review Quiz 1-2
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Quick Check
A business owner generates $2,000 of revenue on
account. This transaction
a. increases assets and decreases liabilities.
b. increases assets and increases owner’s equity.
c. increases liabilities and increases owner’s equity.
d. decreases assets and increases liabilities.
e. decreases assets and increases owner’s equity.
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Learning Objective 9
Prepare three basic financial statements
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Summaries of financial activities
Used to communicate important accounting
information to users
The three basic types:
 Income Statement
 Statement of Owner’s Equity
 Balance Sheet
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Income Statement
A summary of a business’s revenue and expenses
for a specific period of time, such as a month or year
Statement of Owner’s Equity
A summary of the changes that have occurred in
owner’s equity during a specific period of time
Balance Sheet
A listing of a firm’s assets, liabilities, and owner’s
equity at a specific point in time
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Quick Check
Salaries expense would appear on a firm’s
a. statement of owner’s equity.
b. balance sheet.
c. income statement.
d. balance sheet and statement of owner’s equity.
e. balance sheet and income statement.
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Income Statement
 Prepared first
 To determine a firm’s net income
Net Income
 Is shown on the statement of owner’s equity
 Part of determining ending owner’s equity
Ending Owner’s Equity
 Shown on the balance sheet
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Quick Check
Which financial statement is prepared first?
a. Statement of owner’s equity
b. Income statement
c. Balance sheet
d. Balance sheet or statement of owner’s equity,
depending on management’s preference
e. Balance sheet or income statement, depending on
management’s preference
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Quick Check
Net income would appear
a. only on a statement of owner’s equity.
b. on a firm’s balance sheet.
c. only on a firm’s income statement.
d. on both a firm’s balance sheet and statement of
owner’s equity.
e. on both a firm’s income statement and statement of
owner’s equity.
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Review Quiz 1-3
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Review Quiz 1-3
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Review Quiz 1-3
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Learning Objective 10
Define ethics and explain the importance
of ethical behavior in modern business
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Sarbanes-Oxley Act of 2002
A law, passed by Congress, requiring companies to
certify the accuracy of their financial information
Ethics
Principles of moral conduct that guide the behavior
of individuals and businesses
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Focus on Ethics
Do you agree with the U.S. government bailout
of Fannie Mae and Freddie Mac?
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Joining the Pieces
The Expanded Accounting Equation
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Joining the Pieces
Guide for Financial Statement Preparation
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Joining the Pieces
Guide for Financial Statement Preparation
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Joining the Pieces
Guide for Financial Statement Preparation
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