The Nature of Accounting
Chapter 1
© Paradigm Publishing, Inc.
1
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.
© Paradigm Publishing, Inc.
2
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.
© Paradigm Publishing, Inc.
3
Learning Objectives
8.
Identify four types of transactions that
affect owner’s equity.
9.
Define ethics and explain the
importance of ethical behavior in
modern business.
© Paradigm Publishing, Inc.
4
Learning Objective 1
Define accounting and related terms
© Paradigm Publishing, Inc.
5
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.
© Paradigm Publishing, Inc.
6
Learning Objective 2
Explain who uses accounting information
© Paradigm Publishing, Inc.
7
Individuals
Owners
Managers
Investors
Banks and other lending institutions
Governments
Tax authorities
© Paradigm Publishing, Inc.
8
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.
© Paradigm Publishing, Inc.
9
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.
© Paradigm Publishing, Inc.
10
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.
© Paradigm Publishing, Inc.
11
Learning Objective 3
Identify four forms of business
organizations and three types of
business operations
© Paradigm Publishing, Inc.
12
Sole Proprietorship
A business owned
by one person
Partnership
A business co-owned
by two or more persons
© Paradigm Publishing, Inc.
13
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
© Paradigm Publishing, Inc.
14
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
© Paradigm Publishing, Inc.
15
Learning Objective 4
Define and describe the elements of
accounting
© Paradigm Publishing, Inc.
16
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
© Paradigm Publishing, Inc.
17
Quick Check
Another name for owner’s equity is
a. note payable.
b. accounts receivable.
c. capital.
d. accounts payable.
e. notes receivable.
© Paradigm Publishing, Inc.
18
Learning Objective 5
State the accounting equation
© Paradigm Publishing, Inc.
19
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
© Paradigm Publishing, Inc.
20
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
© Paradigm Publishing, Inc.
21
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
© Paradigm Publishing, Inc.
+
OE
$15,000
$?
$52,000
$48,000
$75,000
$?
22
Learning Objective 6
Define business transaction
© Paradigm Publishing, Inc.
23
Any activity that changes the value of a firm’s
assets, liabilities, or owner’s equity is called a
transaction.
© Paradigm Publishing, Inc.
24
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
© Paradigm Publishing, Inc.
25
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
© Paradigm Publishing, Inc.
26
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.
© Paradigm Publishing, Inc.
27
Learning Objective 7
Record business transactions in
equation form
© Paradigm Publishing, Inc.
28
Example
Susan Gilbert invests $30,000 to start Susan’s Gifts and
Candies.
How will this transaction affect the accounting equation?
© Paradigm Publishing, Inc.
29
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
=
© Paradigm Publishing, Inc.
30
Example
Susan Gilbert purchases equipment costing $1,200 on
account.
How will this transaction affect the accounting equation?
© Paradigm Publishing, Inc.
31
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
© Paradigm Publishing, Inc.
32
Example
Susan Gilbert generates $500 of cash sales.
How will this transaction affect the accounting equation?
© Paradigm Publishing, Inc.
33
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
=
© Paradigm Publishing, Inc.
34
Learning Objective 8
Identify four types of transactions
that affect owner’s equity
© Paradigm Publishing, Inc.
35
Owner investments increase owner’s equity.
Revenue increases owner’s equity.
Expenses decrease owner’s equity.
Owner withdrawals decrease owner’s equity.
© Paradigm Publishing, Inc.
36
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.
© Paradigm Publishing, Inc.
37
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.
© Paradigm Publishing, Inc.
38
Review Quiz 1-2
© Paradigm Publishing, Inc.
39
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.
© Paradigm Publishing, Inc.
40
Learning Objective 9
Define ethics and explain the importance
of ethical behavior in modern business
© Paradigm Publishing, Inc.
41
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
© Paradigm Publishing, Inc.
42
Focus on Ethics
Do you agree with the U.S. government bailout
of Fannie Mae and Freddie Mac?
© Paradigm Publishing, Inc.
43
Joining the Pieces
The Expanded Accounting Equation
© Paradigm Publishing, Inc.
44