Introduction to
Accounting and
Business
1
1
After studying this chapter, you should be able to:
1. Describe the nature of a business and the
role of ethics and accounting 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
After studying this chapter, you should be able to:
4. Describe and illustrate how business
transactions can be recorded in terms of the
resulting change in the basic elements of the
accounting equation.
5. Describe the financial statements of a
proprietorship and explain how they
interrelate.
3
1-1
Objective 1
Describe the nature of a
business and the role of ethics
and accounting in business.
4
1-1
Types of Businesses
Service Business
The Walt Disney Company
Delta Air Lines
Marriott International Hotels
Bank of America Corporation
XM Satellite Radio
Service
Entertainment
Transportation
Hospitality and
lodging
Financial services
Satellite radio
5
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
6
Types of Businesses
Manufacturing Business
General Motors Corp.
Samsung
Dell Inc.
Nike
The Coca-Cola Company
Sony Corporation
1-1
Product
Cars, trucks, vans
Cell phones
Personal computers
Athletic shoes and apparel
Beverages
Stereos and televisions
7
Common Forms of Business Organizations
1-1
 Proprietorship
 Partnership
 Corporation
 Limited liability company
8
1-1
A proprietorship is owned by one
individual and—
 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.
9
1-1
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.
10
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.
Continued
11
1-1
 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.
12
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.
13
1-1
A business stakeholder is a
person or entity having an
interest in the economic
performance and well-being
of a business.
14
1-1
Capital market stakeholders
provide the major financing for the
business in order for the business to
begin and continue its operations.
15
1-1
Product or service market
stakeholders include customers
who purchase the business’s
products or services as well as
the vendors who supply inputs to
the business.
16
1-1
Government stakeholders have an
interest in the economic
performance of a business. City,
county, state, and federal
governments collect taxes from
businesses within their jurisdiction.
17
1-1
Internal stakeholders include
individuals employed by the
business. Managers have an
incentive to maximize the
economic value of the business.
Employees have an interest
because their jobs depend on it.
18
1-1
The moral principles that guide
the conduct of individuals are
called ethics.
19
1-1
The answer to
1. Individual
“What went
character
wrong for these
2. Firm culture
companies?”
3. Laws and
(Exhibit 2)
enforcement
involves three
factors.
20
1-1
Accounting can be defined as an
information system that provides
reports to stakeholders about the
economic activities and
condition of a business.
21
1-1
The process by which accounting provides
information to business stakeholders is as follows:
 Identify stakeholders.
 Assess stakeholders’ information needs.
 Design the accounting information system to
meet stakeholders’ needs.
 Record economic data about business
activities and events.
 Prepare accounting reports for stakeholders.
22
1-1
23
23
1-1
Financial accounting is primarily concerned
with the recording and reporting of economic
data and activities for a business.
Managerial accounting uses both financial
accounting and estimated data to aid
management in running day-to-day
operations and in planning future operations.
24
1-1
Accountants employed by a business firm or
a not-for-profit organization are said to be
employed in private accounting.
Accountants and their staff who provide
services on a fee basis are said to be
employed in public accounting.
25
1-2
Objective 2
Summarize the development
of accounting principles and
relate them to practice.
26
1-2
The business entity concept
limits the economic data in
the accounting system to
data related directly to the
activities of the business.
27
1-2
The cost concept is the
basis for entering the
exchange price, or cost
of an acquisition in the
accounting records.
28
1-2
The objectivity concept
requires that the accounting
records and reports be based
upon objective evidence.
29
1-2
The unit of measure
concept requires that
economic data be
recorded in dollars.
30
1-2
Example Exercise 1-1
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?
Follow My Example 1-1
$137,000. Under the cost concept, the land should be recorded at
the cost to Gallatin Repair Service.
31
1-3
Objective 3
State the accounting
equation and define each
element of the equation.
32
The Accounting Equation
1-3
Assets = Liabilities + Owner’s Equity
The resources
owned by a
business
33
The Accounting Equation
1-3
Assets = Liabilities + Owner’s Equity
The rights of the
creditors, which
represent debts
of the business
34
1-3
The Accounting Equation
Assets = Liabilities + Owner’s Equity
The rights of the
owners
35
1-3
Example Exercise 1-2
John Joos is the owner and operator of You’re A Star, a motivational
consulting
business.
At the
end ofinits
accounting
December
The
following
accounts
appear
the
adjusted period,
trial balance
of 31,
2007, You’re
A Star has Indicate
assets of $800,000
and liabilities
$350,000.
Hindsight
Consulting.
whether each
account of
would
be
Using the
equation,
determine
the following
amounts:
reported
inaccounting
the (a) current
asset;
(b) property,
plant, and
a. Owner’s
as liability,
of December
31, 2007. liability; or (e)
equipment;
(c)equity,
current
(d) long-term
b. Owner’s
as of December
31, 2008,
assuming
that assets
owner’s
equityequity,
section
the December
31, 2007,
balance
sheet
increased
by $130,000 and liabilities decreased by $25,000
of Hindsight
Consulting.
during 2008.
Follow My Example 1-2
a.
A = L + OE
b.
$800,000 = $350,000 + OE
OE = $450,000
A = L + OE
$130,000 = –$25,000 + OE
OE = $155,000
OE on Dec. 31, 2008:
$605,000 ($450,000 + $155,000)
36
36
1-4
Objective 4
Describe and illustrate how
business transactions can be
recorded in terms of the resulting
change in the basic elements of the
accounting equation.
37
1-4
A business transaction is an
economic event or condition that
directly changes an entity’s
financial condition or directly
affects its results of operations.
38
1-4
On November 1, 2007, Chris
Clark begins a business that will
be known as NetSolutions.
39
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.
40
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 exchanged $20,000 for land.
41
1-4
Assets
=
Cash + Supplies + Land
Bal. 5,000
c.
Bal. 5,000
20,000
+1,350
1,350
20,000
Owner’s
Liabilities + Equity
Accounts
Chris Clark,
Payable
Capital
=
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).
42
1-4
Beginning with entry (d) the
asset section will be shown
first, then the liabilities and
owner’s equity will be shown in
the following slide.
43
1-4
Assets
Cash + Supplies + Land
Bal. 5,000
d. +7,500
Bal. 12,500
1,350
20,000
1,350
20,000
d. NetSolutions provided services to
customers, earning fees of $7,500 and
received the amount in cash.
44
1-4
Liabilities +
Owner’s Equity
Accounts
Chris Clark,
Fees
Payable +
Capital + Earned
Bal.
1,350
25,000
+7,500 d.
1,350
25,000
7,500 Bal.
d. NetSolutions provided services to
customers, earning fees of $7,500 and
received the amount in cash.
45
Expenses
1-4
The amounts used in earning revenue are
called expenses. 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 Slides 48, 50, 52, and 54. The
bottom row in these four slides provides
the balances after each transaction.
46
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.
47
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.
48
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.
49
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
f. NetSolutions paid $950 to
creditors during the month.
–450
–275
50
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 were used.
51
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 were used.
52
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.
53
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
h. At the end of the month, Chris
withdrew $2,000 in cash from the
business for personal use.
–275
54
1-4
Owner’s Equity
Increased by
Decreased by
Owner’s
investments
Owner’s
withdrawals
Revenues
Expenses
55
1-4
Example Exercise 1-3
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 owners for personal use, $1,000.
Continued
56
1-4
Example Exercise 1-3
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.
57
1-4
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; Owner’s Equity
(Joel Salvo, Drawing) increases by $1,000.
For Practice: PE 1-3A, PE 1-3B
58
1-5
Objective 5
Describe the financial
statements of a proprietorship
and explain how they
interrelate.
59
1-5
Accounting reports, called
financial statements,
provide summarized
information to the owner.
60
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.
61
Income Statement
1-5
Net income is carried
to the statement of 62
62
owner’s equity
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.
63
1-5
Statement of Owner’s Equity
From the income statement
To the balance sheet
64
64
1-5
A balance sheet is a list of
the assets, liabilities, and
owner’s equity as of a
specific date.
65
1-5
Balance Sheet
This amount is compared
to the net cash flow on the
statement of cash flows
From the statement
of owner’s equity
66
1-5
A statement of cash flows
is a summary of the cash
receipts and payments for
a specific period of time.
67
Statement of Cash Flows
This amount should match
Cash on the balance sheet.
1-5
68 68
Income Statement
1-5
The income statement reports the
revenues and expenses for a period of
time based on the matching concept.
This concept is applied by matching the
expenses with the revenue generated
during a period by those expenses.
69
1-5
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.
70
1-5
Example Exercise 1-4
The assets and liabilities of Chickadee Travel Service at April 30,
2008, 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, 2007, 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
Prepare an income statement for the current year ended April
30, 2008.
71
1-5
Follow My Example 1-4
CHICKADEE TRAVEL SERVICE
INCOME STATEMENT
For the Year Ended April 30, 2008
Fees earned
Expenses:
Wages expense
Office expense
Miscellaneous expense
Total expenses
Net income
For practice: PE 1-4A, PE 1-4B
$263,200
$131,700
63,000
12,950
207,650
$ 55,550
72
Statement of Owner’s Equity
1-5
The statement of owner’s
equity reports the changes in
the owner’s equity for a period
of time. It is prepared after the
income statement.
73
1-5
Example Exercise 1-5
Using the data for Chickadee Travel Service shown
in Example Exercise 1-4, prepare a statement of
owner’s equity for the current year ended April 30,
2008. Adam Cellini invested an additional $50,000
in the business during the year and withdrew cash
of $30,000 for personal use.
74
1-5
Follow My Example 1-5
CHICKADEE TRAVEL SERVICE
STATEMENT OF OWNER’S EQUITY
For the Year Ended April 30, 2008
Adam Cellini, capital, May 1, 2007
Additional investment by owner during year
Net income for the year
Less withdrawals
Increase in owner’s equity
Adam Cellini, capital, April 30, 2008
For Practice: PE 1-5A, PE 1-5B
$ 80,000
$ 50,000
55,550
$105,550
30,000
75,550
$155,550
75
Balance Sheet
1-5
The balance sheet reports
the amounts of a firm’s
assets, liabilities, and
owner’s equity at the end
of a specific period.
76
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.
77
1-5
The report form of balance
sheet presents the liabilities
and owner’s equity sections
below the assets section.
78
1-5
Example Exercise 1-6
Using the data for Chickadee Travel Service shown in Example
Exercise 1-4 and 1-5, prepare the balance sheet as of April 30, 2008.
Follow My Example 1-6
CHICKADEE TRAVEL SERVICE
BALANCE SHEET
Assets
Cash
Accounts receivable
Supplies
Land
Total assets
April 30, 2008
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
79
Statement of Cash Flows
1-5
The statement of cash flows
consists of three sections:
(1) Operating activities
(2) Investing activities
(3) Financing activities
80
1-5
The cash flows from
operating activities section
reports a summary of cash
receipts and cash payments
from operations.
81
1-5
The cash flows from investing
activities section reports the cash
transactions for the acquisition and sale
of relatively permanent assets.
82
1-5
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.
83
1-5
Example Exercise 1-7
A summary of cash flows for Chickadee Travel Service for the
year ended April 30, 2008, 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, 2007, was $72,050.
Prepare a statement of cash flows for Chickadee
Travel Service for the year ended April 30. 2008.
84
84
1-5
Follow My Example 1-7
CHICKADEE TRAVEL SERVICE
STATEMENT OF CASH FLOWS
For the Year Ended April 30, 2008
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, 2007
Cash as of April 30, 2008
For Practice: PE 1-7A, PE 1-7B
$ 41,000
(80,000)
20,000
$(19,000)
72,050
$ 53,050
85
85
Interrelationships Among Financial Statements

1-5
The income statement and the statement
of owner’s equity are interrelated.
Net income or net loss
appears on both statements.
86
1-5

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.
87
1-5

The balance sheet and the statement
of cash flows are interrelated.
The cash on the balance sheet also
appears as the end-of-period cash on
the statement of cash flows.
88