Introduction to Accounting and Business 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.
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.
1 -1 Objective 1 Describe the nature of a business and the role of ethics and accounting in business.
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
Types of Businesses 1 -1 Merchandising Business Product Wal-Mart General merchandise Game. Stop Corporation Video games and accessories Best Buy Consumer electronics Gap Inc. Apparel Amazon. com Internet books, music, video
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
Common Forms of Business Organizations ü Proprietorship ü Partnership ü Corporation ü Limited liability company 1 -1
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.
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.
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
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.
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.
1 -1 A business stakeholder is a person or entity having an interest in the economic performance and well-being of a business.
1 -1 Capital market stakeholders provide the major financing for the business in order for the business to begin and continue its operations.
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.
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.
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.
1 -1 The moral principles that guide the conduct of individuals are called ethics.
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.
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.
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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.
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.
1 -2 Objective 2 Summarize the development of accounting principles and relate them to practice.
1 -2 The business entity concept limits the economic data in the accounting system to data related directly to the activities of the business.
1 -2 The cost concept is the basis for entering the exchange price, or cost of an acquisition in the accounting records.
1 -2 The objectivity concept requires that the accounting records and reports be based upon objective evidence.
1 -2 The unit of measure concept requires that economic data be recorded in dollars.
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.
The Accounting Equation Assets = Liabilities + Owner’s Equity The resources owned by a business 1 -3
The Accounting Equation Assets = Liabilities + Owner’s Equity The rights of the creditors, which represent debts of the business 1 -3
1 -3 The Accounting Equation Assets = Liabilities + Owner’s Equity The rights of the owners
1 -3 Example Exercise 1 -2 John Joos is the owner and operator of You’re A Star, a motivational consulting business. At appear in the adjusted trial balance of The following accountsthe end of its accounting period, December 31, 2007, You’re A Star has assets of $800, 000 and account of $350, 000. Hindsight Consulting. Indicate whether each liabilities would be Using the (a) current asset; (b) property, plant, amounts: reported inaccounting equation, determine the followingand a. Owner’s current of December 31, 2007. equipment; (c)equity, asliability, (d) long-term liability; or (e) b. b. Owner’s equity, the December 31, 2007, balance sheet owner’s equity section ofas of December 31, 2008, assuming that assets 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
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.
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.
1 -4 On November 1, 2007, Chris Clark begins a business that will be known as Net. Solutions.
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 Net. Solutions. 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 b. Net. Solutions exchanged $20, 000 for land. 41
1 -4 Assets = Cash + Supplies + Land Bal. 5, 000 c. Bal. 5, 000 20, 000 +1, 350 20, 000 Owner’s Liabilities + Equity Accounts Chris Clark, Payable Capital = 25, 000 +1, 350 25, 000 c. During the month, Net. Solutions 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.
1 -4 Assets Cash + Supplies + Land Bal. 5, 000 d. +7, 500 Bal. 12, 500 1, 350 20, 000 d. Net. Solutions 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. Net. Solutions provided services to customers, earning fees of $7, 500 and received the amount in cash. 45
Expenses 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. 1 -4
1 -4 Assets Cash + Supplies + Land Bal. 12, 500 1, 350 20, 000 e. – 3, 650 Bal. 8, 850 1, 350 20, 000 e. Net. Solutions paid the following expenses: wages, $2, 125; rent, $800; utilities, $450; and miscellaneous, $275. 47
1 -4 Liabilities + Owner’s Equity Accounts Chris Clark, Fees Wages Rent Utilities Misc. Payable + Capital + Earned Expense 1, 350 25, 000 7, 500 – 2, 125 1, 350 25, 000 7, 500 – 800 – 450 – 2, 125 – 800 – 275 – 450 e. Net. Solutions paid the following expenses: wages, $2, 125; rent, $800; utilities, $450; and miscellaneous, $275. e. – 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. Net. Solutions paid $950 to creditors during the month. 49
1 -4 Liabilities + Owner’s Equity Accounts Chris Clark, Fees Wages Rent Utilities Misc. Payable + Capital + Earned Expense – 800 – 450 – 275 1, 350 25, 000 7, 500 – 2, 125 f. – 950 400 25, 000 7, 500 – 2, 125 – 800 f. Net. Solutions 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 Liabilities + Owner’s Equity Accounts Chris Clark, Fees Wages Payable + Capital + Earned Exp. 400 25, 000 7, 500 – 2, 125 Rent Supplies Util. Misc. Exp. – 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 25, 000 7, 500 – 2, 125 Rent Supplies Util. Exp. – 800 Misc. Exp. – 800 – 450 – 275 h. – 2, 000 400 25, 000 – 2, 000 7, 500 – 2, 125 – 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 -3 A, PE 1 -3 B 58
1 -5 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.
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 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.
1 -5 Statement of Owner’s Equity From the income statement To the balance sheet 64
1 -5 A balance sheet is a list of the assets, liabilities, and owner’s equity as of a specific date.
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 66
1 -5 A statement of cash flows is a summary of the cash receipts and payments for a specific period of time.
Statement of Cash Flows This amount should match Cash on the balance sheet. 1 -5 68
Income Statement 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. 1 -5
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.
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 -4 A, PE 1 -4 B $263, 200 $131, 700 63, 000 12, 950 207, 650 $ 55, 550 72
Statement of Owner’s Equity 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. 1 -5
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 -5 A, PE 1 -5 B $ 80, 000 $ 50, 000 55, 550 $105, 550 30, 000 75, 550 $155, 550 75
Balance Sheet The balance sheet reports the amounts of a firm’s assets, liabilities, and owner’s equity at the end of a specific period. 1 -5
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.
1 -5 The report form of balance sheet presents the liabilities and owner’s equity sections below the assets section.
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 -6 A, PE 1 -6 B 79
Statement of Cash Flows The statement of cash flows consists of three sections: (1) Operating activities (2) Investing activities (3) Financing activities 1 -5
1 -5 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.
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.
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
Follow My Example 1 -7 1 -5 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 -7 A, PE 1 -7 B $ 41, 000 (80, 000) 20, 000 $(19, 000) 72, 050 $ 53, 050 85
Interrelationships Among Financial Statements q 1 -5 The income statement and the statement of owner’s equity are interrelated. Net income or net loss appears on both statements.
1 -5 q 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.
1 -5 q 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.
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