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Chapter 1 –

Introduction to Accounting and BusinessIntroduction to Accounting and Business

1. Describe the nature of a business and the role of 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.

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

After studying this chapter, you should be able to:

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ServiceService BusinessBusiness ServiceService ServiceService BusinessBusiness ServiceService

The Walt Disney Company EntertainmentAtlas Air TransportationMarriott International Hotels Hospitality and

lodgingBank of America Corporation Financial servicesXM Satellite Radio Satellite radio

The Walt Disney Company EntertainmentAtlas Air TransportationMarriott International Hotels Hospitality and

lodgingBank of America Corporation Financial servicesXM Satellite Radio Satellite radio

1-1Types of Businesses

Objective #1 - Describe the nature of a business and the role of accounting in business.

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Merchandising BusinessMerchandising Business ProductProductMerchandising BusinessMerchandising Business ProductProduct

Wal-Mart General merchandiseGameStop Corporation Video games and accessoriesBest Buy Consumer electronicsGap Inc. ApparelAmazon.com Internet books, music, video

Wal-Mart General merchandiseGameStop Corporation Video games and accessoriesBest Buy Consumer electronicsGap Inc. ApparelAmazon.com Internet books, music, video

Types of Businesses 1-1

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Manufacturing BusinessManufacturing Business ProductProductManufacturing BusinessManufacturing Business ProductProduct

General Motors Corp. Cars, trucks, vansSamsung Cell phonesDell Inc. Personal computersNike Athletic shoes and apparelPepsico Beverages and SnacksSony Corporation Stereos and televisions

General Motors Corp. Cars, trucks, vansSamsung Cell phonesDell Inc. Personal computersNike Athletic shoes and apparelPepsico Beverages and SnacksSony Corporation Stereos and televisions

Types of Businesses 1-1

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1-1Accounting can be defined as an information system that provides reports to stakeholders about the economic activities and condition of a business.

Who are stakeholders? – anyone or any entity that has an interest in the economic performance and well-being of a business

Suppliers – need to ensure their customer (the business) will be around to purchase their supplies and then be able to pay for them

Bankers and other creditors – need to ensure that the business has the ability to repay loans, and on a timely basis

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

Customers – are interested in the business to determine if they will always be around to provide a constant flow of goods and services

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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.

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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

Different types of Accounting

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The The business entity concept limits the economic data in the accounting limits the economic data in the accounting system to data related directly to the activities of the business. – system to data related directly to the activities of the business. – i.e.i.e.

nothing personal unless it has been given/assigned to the businessnothing personal unless it has been given/assigned to the business

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Objective #2 - Summarize the development of accounting principles and relate them to practice.

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.

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)’

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Proprietorship Partnership Corporation Limited liability company

Common Forms of Business Entities 1-1

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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 proprietorship is owned by one individual and— 1-1

Comprises 10% of business organizations in the United States. Combines the skills and resources of more than one person.

A partnership is similar to a proprietorship except that it is owned by two or more individuals and—

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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.

A corporation is organized under state or federal statues as a separate legal taxable entity and—

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Is a popular alternative to a partnership. Has tax and liability advantages to the owners.

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—

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Assets = Liabilities + Owner’s Equity

The resources owned by a business

The Accounting Equation

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Objective #3 - State the accounting equation and define each element of the equation.

The rights of the creditors, which

represent debts of the business

The rights of the owners

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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.

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.

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a. Chris Clark deposits $25,000 in a bank account in the name of NetSolutions.

Chris Clark, Capital25,000 Investment

by Chris Clark

Cash25,000 a.

=

Assets Owner’s Equity=

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b. NetSolutions purchased land for $20,000.

Chris Clark, Capital25,000

Cash + Land 25,000 Bal.

Assets Owner’s Equity=

=b. –20,000 +20,000Bal. 5,000 20,000 25,000

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Accounts Chris Clark, Cash + Supplies + Land Payable Capital

Assets

c. During the month, NetSolutions purchased supplies for $1,350 and agreed to pay the supplier in the near future (on account).

Owner’s Liabilities + Equity

5,000 20,000 25,000=

+1,350 +1,350c.Bal.

5,000 1,350 20,000 1,350 25,000Bal.

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Note – these supplies e.g. wires, cables etc, will be used up later in the business

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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.

Revenue and expenses1-4

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

Note:

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Cash + Supplies + Land

Assets

5,000 1,350 20,000

d. NetSolutions provided services to customers, earning fees of $7,500 and received the amount in cash.

Bal.

12,500 1,350 20,000

+7,500d.

Bal.

1-4 Liabilities + Owner’s Equity

Accounts Chris Clark, Fees Payable Capital + Earned

1,350 25,000 +7,500

+

25,000 7,5001,350

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

=

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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.

Note……….

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Cash + Supplies + Land

Assets

e. NetSolutions paid the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.

Bal. 12,500 1,350 20,000

Bal. 8,850 1,350 20,000 e. –3,650

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Accounts Chris Clark, Fees Wages Rent Utilities Misc. Payable + Capital + Earned Expense Expense Expense Expense

Liabilities + Owner’s Equity

1,350 25,000 7,500

–2,125 –800 –450 –275 e.

1,350 25,000 7,500 –2,125 –800 –450 –275

e. NetSolutions paid the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.

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f. NetSolutions paid $950 to creditors during the month.

Cash + Supplies + Land

Assets

Bal. 8,850 1,350 20,000

Bal. 7,900 1,350 20,000 f. –950

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Accounts Chris Clark, Fees Wages Rent Utilities Misc. Payable + Capital + Earned Expense Expense Expense Expense

Liabilities + Owner’s Equity

1,350 25,000 7,500 –2,125 –800 –450 –275

400 25,000 7,500 –2,125 –800 –450 –275

f. NetSolutions paid $950 to creditors during the month.

f.–950

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g. At the end of the month, the cost of supplies on hand is $550, so $800 of supplies must have been used up

Cash + Supplies + Land

Assets

Bal. 7,900 1,350 20,000

Bal. 7,900 550 20,000 g. –800

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Accounts Chris Clark, Fees Wages Rent Supplies Util. Misc. Payable + Capital + Earned Exp. Exp. Exp. Exp. Exp.

Liabilities + Owner’s Equity

400 25,000 7,500 –2,125 –800 –450 –275 g. –800

400 25,000 7,500 –2,125 –800 –800 –450 –275

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g. At the end of the month, the cost of supplies on hand is $550, so $800 of supplies must have been used up

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Cash + Supplies + Land

Assets

Bal. 7,900 550 20,000

Bal. 5,900 550 20,000 h. –2,000

h. At the end of the month, Chris withdrew $2,000 in cash from the business for personal use.

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Accounts Chris Clark, Chris Clark Fees Wages Rent Supplies Util. Misc. Payable + Capital + Drawing Earned Exp. Exp. Exp. Exp. Exp.

Liabilities + Owner’s Equity

400 25,000 7,500 –2,125 –800 –800 –450 –275 h. –2,000

h. At the end of the month, Chris withdrew $2,000 in cash from the business for personal use.

400 25,000 –2,000 7,500 –2,125 –800 –800 –450 –275

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Summary

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Owner’s withdrawals

Expenses

Decreased byDecreased by

Owner’s Equity

Increased byIncreased by

Owner’s investments

Revenues

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Objective #5 - Describe the financial statements of a proprietorship and explain how they interrelate.

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

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The income statement is a summary of the revenue and expenses for a specific

period of time, such as a month or a year.

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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.

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.

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Net income is carried to the statement of owner’s equity

Income Statement

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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.

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1-5From the income statement

To the balance sheet

Statement of Owner’s Equity

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A balance sheet is a list of the assets, liabilities, and

owner’s equity as of a specific date.

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This amount is compared to the net cash flow on the statement of cash flows

From the statement of owner’s equity

Balance Sheet

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A statement of cash flows is a summary of the cash receipts and payments for a specific

period of time.

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Note - It basically shows how the company spent its money, and the sources from which it received money.

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This amount should match Cash on the balance sheet.

Statement of Cash Flows

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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 $ 12,200 Miscellaneous expense $ 12,950Accounts receivable 31,350 Office expense 63,000Cash 53,050 Supplies 3,350Fees earned 263,200 Wages expense 131,700Land 80,000

a. Prepare an income statement

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b. Prepare a statement of owner’s equity

For the current year ended April 30, 2010.

Adam Cellini invested an additional $50,000 in the business during the year and withdrew cash of $30,000 for personal use.

c. Prepare a balance sheet

Example Exercise 1-4, 1-5 & 1-6

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CHICKADEE TRAVEL SERVICEINCOME STATEMENT

For the Year Ended April 30, 2010

Fees earned $263,200Expenses:

Wages expense $131,700Office expense 63,000Miscellaneous expense 12,950 Total expenses 207,650

Net income $ 55,550

1-5Example Exercise 1-4 & 1-5Example Exercise 1-4, 1-5 & 1-6

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CHICKADEE TRAVEL SERVICESTATEMENT OF OWNER’S EQUITY

For the Year Ended April 30, 2010

Adam Cellini, capital, May 1, 2009 $ 80,000Additional investment by owner during year $ 50,000Net income for the year 55,550

$105,550Less withdrawals 30,000Increase in owner’s equity 75,550Adam Cellini, capital, April 30, 2010 $155,550

1-5Example Exercise 1-4, 1-5 & 1-6

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1-5Balance Sheet

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.

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CHICKADEE TRAVEL SERVICEBALANCE SHEET

April 30, 2010 Assets Liabilities

Cash $ 53,050 Accounts payable $12,200Accounts receivable 31,350Supplies 3,350 Owner’s EquityLand 80,000 Adam Cellini, capital 155,550Total assets $167,750 Total liab. & owner’s eq. $167,750

Example Exercise 1-4, 1-5 & 1-6

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The statement of cash flows consists of three sections:

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(1) Operating activities

(2) Investing activities

(3) Financing activities

Statement of Cash Flows

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The cash flows from operating activities section reports a summary of cash receipts and cash payments from operations.

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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.

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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 $251,000Cash received from additional investment of owner 50,000

Cash payments:Cash paid for expenses 210,000Cash paid for land 80,000Cash paid to owner for personal use 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.

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Follow My Example 1-7

CHICKADEE TRAVEL SERVICESTATEMENT OF CASH FLOWSFor the Year Ended April 30, 2010

Cash flows from operating activities:Cash received from customers $251,000Deduct cash payments for expenses 210,000Net cash flows from operating activities $ 41,000

Cash flows from investing activities:Cash payments for purchase of land (80,000)

Cash flows from financing activities:Cash received from owner as investment $ 50,000Deduct cash withdrawals by owner 30,000Net cash flows from financing activities 20,000

Net decrease in cash during year $(19,000)Cash as of May 1, 2009 72,050Cash as of April 30, 2010 $ 53,050

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Financial Analysis and Interpretation

Ratio of Liabilities to Owner’s Equity =

Total Liabilities

Total Owner’s Equity (or Total

Stockholders’ Equity)For NetSolutions:

Ratio of Liabilities to Owner’s Equity =

$400

$26,050 = 0.015

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