Chapter 1 –
Introduction to Accounting and Business
After studying this chapter, you should be able to:
1.
2.
3.
4.
5.
Describe the nature of a business and the role of
accounting in business.
Summarize the development of accounting
principles and relate them to practice.
State the accounting equation and define each
element of the equation.
Describe and illustrate how business transactions
can be recorded in terms of the resulting change in
the basic elements of the accounting equation.
Describe the financial statements of a proprietorship
1
Objective #1 - Describe the nature of a business and
the role of accounting in business.
1-1
Types of Businesses
Service Business
The Walt Disney Company
Atlas Air
Marriott International Hotels
Bank of America Corporation
XM Satellite Radio
Service
Entertainment
Transportation
Hospitality and
lodging
Financial services
Satellite radio
2
Types of Businesses
Merchandising Business
Wal-Mart
GameStop Corporation
Best Buy
Gap Inc.
Amazon.com
1-1
Product
General merchandise
Video games and accessories
Consumer electronics
Apparel
Internet books, music, video
3
Types of Businesses
Manufacturing Business
General Motors Corp.
Samsung
Dell Inc.
Nike
Pepsico
Sony Corporation
1-1
Product
Cars, trucks, vans
Cell phones
Personal computers
Athletic shoes and apparel
Beverages and Snacks
Stereos and televisions
4
Accounting can be defined as an information
system that provides reports to stakeholders about
the economic activities and condition of a business.
1-1
Who are stakeholders? – anyone or any entity that has an interest in
the economic performance and well-being of a business
Bankers and other creditors – need to ensure that the business has the
ability to repay loans, and on a timely basis
Suppliers – need to ensure their customer (the business) will be around to
purchase their supplies and then be able to pay for them
Customers – are interested in the business to determine if they will always
be around to provide a constant flow of goods and services
Government – need to ensure that the business pays the correct amount of
taxes
Employees and Management– need to ensure that the business is doing
well so that they will have a job
5
Different types of Accounting
1-1
Financial accounting is primarily concerned with the recording &
reporting of economic data and activities for a business to external parties.
Managerial accounting uses both financial accounting and
estimated data to aid management in running day-to-day
operations and in planning future operations.
Accountants employed by a business firm or a not-for-profit
organization are said to be employed in private accounting.
E.g. CFO, Controller, or Financial Analyst of Pepsico
Accountants and their staff who provide services to the
public (i.e. individuals and corporations) on a fee basis are
said to be employed in public accounting. E.g.
PricewaterhouseCoopers, Ernst & Young, KPMG, Deloitte
6
Objective #2 - Summarize the development of
accounting principles and relate them to practice. 1-2
GAAP – Generally Accepted Accounting Principles. These are the
rules that govern how businesses record and report financial transactions
FASB – Financial Accounting Standards Board. This body is
the major one responsible for preparing US GAAP.
IASB – International Accounting Standards Board. This body
is the one responsible for preparing International GAAP, which is also
known as ‘International Financial Reporting Standards (IFRS)’
The business entity concept limits the economic data in the accounting
system to data related directly to the activities of the business. – i.e.
nothing personal unless it has been given/assigned to the business
The cost concept is the basis for entering the exchange price, or cost
of an acquisition in the accounting records. – e.g. what was paid for it.
7
Common Forms of Business Entities
1-1
 Proprietorship
 Partnership
 Corporation
 Limited liability company
8
A proprietorship is owned by one individual and—




1-1
Comprises 70% of business organizations in the United States.
Requires low cost of organizing.
Is limited to financial resources of the owner.
Is used by small businesses.
A partnership is similar to a proprietorship except that it is
owned by two or more individuals and—
 Comprises 10% of business organizations in the United States.
 Combines the skills and resources of more than one person.
9
1-1
A corporation is organized under state or federal statues as a
separate legal taxable entity and—
 Generates 90% of the total dollars of business receipts received.
 Comprises 20% of the businesses.
 Includes ownership divided into shares of stock, sold to
shareholders (stockholders).
 Is able to obtain large amounts of resources by issuing stock.
 Is used by large businesses.
10
1-1
A limited liability company (LLC) combines attributes
of a partnership and a corporation in that it is organized
as a corporation. However, a limited liability
corporation can elect to be taxed as a partnership and—
 Is a popular alternative to a partnership.
 Has tax and liability advantages to the owners.
11
Objective #3 - State the accounting equation
and define each element of the equation.
1-3
The Accounting Equation
Assets = Liabilities + Owner’s Equity
The resources owned
The rights of the
by a business
owners
The rights of the
creditors, which
represent debts of the
business
12
Objective #4 - Describe and illustrate how business
transactions can be recorded in terms of the
1-4
resulting change in the basic elements of the
accounting equation.
A business transaction is an economic event or condition that directly
changes an entity’s financial condition or directly affects its results of
operations.
On November 1, 2007, Chris
Clark begins a business that will
be known as NetSolutions. This
business provides web design services,
and computer repair services etc.
13
1-4
Assets
a.
Cash
25,000
=
=
Owner’s Equity
Chris Clark, Capital
25,000 Investment
by Chris
Clark
a. Chris Clark deposits $25,000 in a bank
account in the name of NetSolutions.
14
1-4
Assets
Cash + Land
Bal. 25,000
b. –20,000
+20,000
Bal. 5,000
20,000
=
=
Owner’s Equity
Chris Clark, Capital
25,000
25,000
b. NetSolutions purchased land for $20,000.
15
1-4
Owner’s
Liabilities + Equity
Accounts
Chris Clark,
Payable
Capital
Assets
Cash + Supplies + Land
Bal. 5,000
c.
Bal. 5,000
20,000
+1,350
1,350
20,000
=
25,000
+1,350
1,350
25,000
c. During the month, NetSolutions purchased
supplies for $1,350 and agreed to pay the
supplier in the near future (on account).
Note – these supplies e.g. wires, cables etc, will be used up
later in the business
16
Revenue and expenses
1-4
A company earns revenues by
•selling products - Sales
•providing services - Fees Earned
•renting out premises - Rent Revenue
•lending money - Interest Revenue
The amounts used in earning revenue are called expenses.
Note:
Expenses that have paid for (or incurred) but not yet been used
up are referred to as prepaid expenses e.g. supplies.
When these prepaid expenses have been used up, they will
then become regular expenses e.g. supplies expenses
17
1-4
Liabilities +
Assets
Accounts
Payable
Cash + Supplies + Land
Bal.
d.
5,000
+7,500
1,350
Bal.
12,500
1,350
20,000
1,350
Owner’s Equity
Chris Clark,
Fees
+ Capital + Earned
25,000
+7,500
=
20,000
1,350
25,000
7,500
d. NetSolutions provided services to
customers, earning fees of $7,500 and
received the amount in cash.
Note – If the customers did not pay immediately, but opted to pay
on account ( i.e. at a later date), then the asset that would have
been increased would have been accounts receivable
18
1-4
Note……….
1. Adding expenses to the owner’s equity section
results in a space problem. To adjust for
these added headings, the word “Bal.” has
been omitted from some slides. The bottom
row still provides the balances after each
transaction.
2. Beginning with entry (e) the asset section will
be shown first, then the liabilities and owner’s
equity will be shown in the following slide.
19
1-4
Assets
Cash + Supplies + Land
Bal. 12,500
1,350
20,000
e. –3,650
Bal. 8,850
1,350
20,000
e. NetSolutions paid the following
expenses: wages, $2,125; rent, $800;
utilities, $450; and miscellaneous, $275.
20
1-4
Owner’s Equity
Liabilities +
Accounts Chris Clark,
Fees
Wages Rent Utilities
Misc.
Payable + Capital + Earned Expense Expense Expense Expense
1,350
25,000
7,500
1,350
25,000
7,500
–2,125
–800
–450
–275 e.
–2,125
–800
–450
–275
e. NetSolutions paid the following expenses:
wages, $2,125; rent, $800; utilities, $450; and
miscellaneous, $275.
21
1-4
Assets
Cash + Supplies + Land
Bal. 8,850
1,350
20,000
f. –950
Bal. 7,900
1,350
20,000
f. NetSolutions paid $950 to
creditors during the month.
22
1-4
Owner’s Equity
Liabilities +
Accounts Chris Clark,
Fees
Wages Rent Utilities
Misc.
Payable + Capital + Earned Expense Expense Expense Expense
–800
–450
–275
1,350
25,000
7,500 –2,125
f.
–950
400
25,000
7,500
–2,125
–800
–450
–275
f. NetSolutions paid $950 to
creditors during the month.
23
1-4
Assets
Cash + Supplies + Land
Bal. 7,900
1,350
20,000
g.
–800
Bal. 7,900
550
20,000
g. At the end of the month, the cost
of supplies on hand is $550, so
$800 of supplies must have been
used up
24
1-4
Owner’s Equity
Liabilities +
Accounts Chris Clark, Fees
Wages
Payable + Capital + Earned
Exp.
400
25,000
7,500 –2,125
400
25,000
7,500
–2,125
Rent Supplies Util. Misc.
Exp. Exp. Exp. Exp.
–800
–450 –275
g.
–800
–800
–800
–450 –275
g. At the end of the month, the cost
of supplies on hand is $550, so
$800 of supplies must have been
used up
25
1-4
Assets
Cash + Supplies + Land
Bal. 7,900
550
20,000
h. –2,000
Bal. 5,900
550
20,000
h. At the end of the month, Chris
withdrew $2,000 in cash from the
business for personal use.
26
1-4
Liabilities +
Owner’s Equity
Accounts Chris Clark, Chris Clark Fees Wages
Payable + Capital + Drawing Earned Exp.
400
7,500 –2,125
25,000
Rent Supplies Util. Misc.
Exp. Exp. Exp. Exp.
–800
–800
–450
–275
h.
–2,000
400
25,000
–2,000
7,500 –2,125
–800
–800
–450
–275
h. At the end of the month, Chris
withdrew $2,000 in cash from the
business for personal use.
27
Summary
28
1-4
Owner’s Equity
Increased by
Decreased by
Owner’s
investments
Owner’s
withdrawals
Revenues
Expenses
29
Objective #5 - Describe the financial statements of
a proprietorship and explain how they interrelate.
1-5
Accounting reports, called financial statements,
provide summarized information to the owner.
The 4 common financial statements are prepared in
the following order:
1. Income Statement
2. Statement of Owner’s Equity
3. Balance Sheet
4. Statement of Cash Flow
30
1-5
The income statement is a summary of
the revenue and expenses for a specific
period of time, such as a month or a year.
The income statement is based on the matching concept.
This concept is applied by matching expenses with the
revenues they generated, only during the period that those
revenues were generated.
Note - The excess of revenue over the expenses is
called net income or net profit. If the expenses
exceed the revenue, the difference is a net loss.
31
Income Statement
Net income is carried to the statement of owner’s equity
1-5
32
1-5
A statement of owner’s equity is a
summary of the changes in the
owner’s equity that have occurred
during a specific period of time.
33
Statement of Owner’s Equity
1-5
From the income statement
To the balance sheet
34
1-5
A balance sheet is a list of
the assets, liabilities, and
owner’s equity as of a
specific date.
35
Balance Sheet
This amount is compared
to the net cash flow on the
statement of cash flows
1-5
From the statement
of owner’s equity
36
1-5
A statement of cash flows is a
summary of the cash receipts
and payments for a specific
period of time.
Note - It basically shows how the company spent its
money, and the sources from which it received money.
37
Statement of Cash Flows
1-5
This amount should match
Cash on the balance sheet.
38
Example Exercise 1-4, 1-5 & 1-6
1-5
The assets and liabilities of Chickadee 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
Accounts receivable
Cash
Fees earned
Land
$ 12,200
31,350
53,050
263,200
80,000
Miscellaneous expense $ 12,950
Office expense
63,000
Supplies
3,350
Wages expense
131,700
Adam Cellini invested an additional $50,000 in the business during the year and
withdrew cash of $30,000 for personal use.
For the current year ended April 30, 2010.
a. Prepare an income statement
b. Prepare a statement of owner’s equity
c. Prepare a balance sheet
39
1-5
Example
1-5& 1-6
Example Exercise
Exercise 1-4
1-4,&1-5
CHICKADEE 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
40
1-5
Example Exercise 1-4, 1-5 & 1-6
CHICKADEE TRAVEL SERVICE
STATEMENT OF OWNER’S EQUITY
For the Year Ended April 30, 2010
Adam Cellini, capital, May 1, 2009
Additional investment by owner during year
Net income for the year
Less withdrawals
Increase in owner’s equity
Adam Cellini, capital, April 30, 2010
$ 80,000
$ 50,000
55,550
$105,550
30,000
75,550
$155,550
41
Balance Sheet
1-5
The account form of balance sheet lists the assets
on the left and the liabilities and owner’s equity on
the right—similar to design of an account.
The report form of balance sheet presents the
liabilities and owner’s equity sections below
the assets section.
42
1-5
Example Exercise 1-4, 1-5 & 1-6
Assets
Cash
Accounts receivable
Supplies
Land
Total assets
CHICKADEE 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
43
Statement of Cash Flows
1-5
The statement of cash flows
consists of three sections:
(1) Operating activities
(2) Investing activities
(3) Financing activities
44
The cash flows from operating activities
section reports a summary of cash receipts and
cash payments from operations.
1-5
The cash flows from investing activities section
reports the cash transactions for the acquisition and
sale of relatively permanent assets.
The cash flows from financing activities section
reports the cash transactions related to cash
investments by the owner, borrowings, and cash
withdrawals by the owner.
45
1-5
Example Exercise 1-7
A summary of cash flows for Chickadee 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 Chickadee Travel
Service for the year ended April 30, 2010.
46
1-5
Follow My Example 1-7
CHICKADEE TRAVEL SERVICE
STATEMENT OF CASH FLOWS
For the Year Ended April 30, 2010
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
47
5
Financial Analysis and
Interpretation
Ratio of Liabilities
to Owner’s Equity
Total Liabilities
=
For NetSolutions:
Ratio of Liabilities
to Owner’s Equity
=
Total Owner’s Equity
(or Total
Stockholders’ Equity)
$400
$26,050
= 0.015
48
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