Chapter 1

Introduction to Accounting and Business

After studying this chapter, you should be able to:
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
1
Objective #1 - Describe the nature of a business and
the role of accounting in business.
Types of Businesses 1-1

Service
ServiceBusiness
Business Service
Service
The
TheWalt
Walt Disney
Disney Company
Company Entertainment
Entertainment
Atlas
AtlasAir
Air Transportation
Transportation
Marriott
Marriott International
International Hotels
HotelsHospitality
Hospitality and
and
lodging
lodging
Bank
Bank of
ofAmerica
America Corporation
Corporation Financial
Financial services
services
XM
XM Satellite
Satellite Radio
Radio Satellite
Satellite radio
radio

2
Types of Businesses 1-1

Merchandising
Merchandising Business
Business Product
Product
Wal-Mart
Wal-Mart General
General merchandise
merchandise
GameStop
GameStop Corporation
Corporation Video
Video games
games and
and accessories
accessories
Best
Best Buy
Buy Consumer
Consumer electronics
electronics
Gap
Gap Inc.
Inc. Apparel
Apparel
Amazon.com
Amazon.com Internet
Internet books,
books, music,
music, video
video

3
Types of Businesses 1-1

Manufacturing
Manufacturing Business
Business Product
Product
General
General Motors
Motors Corp.
Corp. Cars,
Cars, trucks,
trucks, vans
vans
Samsung
Samsung Cell
Cell phones
phones
Dell
Dell Inc.
Inc. Personal
Personal computers
computers
Nike
Nike Athletic
Athletic shoes
shoes and
and apparel
apparel
Pepsico
Pepsico Beverages
Beverages and and Snacks
Snacks
Sony
Sony Corporation
Corporation Stereos
Stereos and
and televisions
televisions

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 Accounting can be defined as an information 1-1
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
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, 6Deloitte
 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.

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 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 + Owners Equity

The resources owned The rights of the

by a business The rights of the owners
creditors, which
represent debts of the
business

12
 Objective #4 - Describe and illustrate how business
transactions can be recorded in terms of the
resulting change in the basic elements of the 1-4
accounting equation.
A business transaction is an economic event or condition that directly
changes an entitys 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 = Owners Equity

Cash Chris Clark, Capital
=
a. 25,000 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 = Owners Equity

Cash + Land Chris Clark, Capital
Bal. 25,000 = 25,000
b. 20,000 +20,000
Bal. 5,000 20,000 25,000

b. NetSolutions purchased land for $20,000.

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 1-4

Owners
Assets Liabilities + Equity
Accounts Chris Clark,
Cash + Supplies + Land Payable Capital
=
Bal. 5,000 20,000 25,000
c. +1,350 +1,350
Bal. 5,000 1,350 20,000 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
 1-4
Revenue and expenses

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
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 1-4
Assets Liabilities + Owners Equity

Accounts Chris Clark, Fees

Cash + Supplies + Land Payable + Capital + Earned

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

d. +7,500 +7,500
=
Bal. 12,500 1,350 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 owners 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 owners
equity will be shown in the following slide.

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 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.

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 1-4

Liabilities + Owners Equity

Accounts Chris Clark, Fees Wages Rent Utilities Misc.
Payable + Capital + Earned Expense Expense Expense
Expense
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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 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.
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 1-4

Liabilities + Owners Equity

Accounts Chris Clark, Fees Wages Rent Utilities Misc.
Payable + Capital + Earned Expense Expense Expense
Expense
1,350 25,000 7,500 2,125 800 450 275
950 f.
400 25,000 7,500 2,125 800 450 275

f. NetSolutions paid $950 to

creditors during the month.
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 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
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 1-4

Liabilities + Owners Equity

Accounts Chris Clark, Fees Wages Rent Supplies Util. Misc.
Payable + Capital + Earned Exp. Exp. Exp. Exp. Exp.
400 25,000 7,500 2,125 800 450 275
800 g.

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

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.
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 1-4

Liabilities + Owners Equity

Accounts Chris Clark, Chris Clark Fees Wages Rent Supplies Util. Misc.
Payable + Capital + Drawing Earned Exp. Exp. Exp. Exp. Exp.
400 25,000 7,500 2,125 800 800 450 275
2,000 h.
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.
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Summary

28
 1-4

Owners Equity

Increased by Decreased by

Owners Owners
investments withdrawals
Revenues Expenses

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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 Owners Equity
3. Balance Sheet
4. Statement of Cash Flow

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 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.
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 Income Statement
1-5

Net income is carried to the statement of owners32

equity
 1-5

A statement of owners equity is a

summary of the changes in the
owners equity that have occurred
during a specific period of time.

33
Statement of Owners 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
owners equity as of a
specific date.

35
 Balance Sheet
1-5

This amount is compared

to the net cash flow on the From the statement
statement of cash flows of owners
36 equity
 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

38
Cash on the balance sheet.
 1-5
Example Exercise 1-4, 1-5 & 1-6
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 $ 12,950
Accounts receivable 31,350 Office expense 63,000
Cash 53,050 Supplies 3,350
Fees earned 263,200 Wages expense 131,700
Land 80,000
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 owners equity
c. Prepare a balance sheet
39
 1-5
Example
ExampleExercise
Exercise1-4
1-4,&1-5
1-5& 1-6

CHICKADEE TRAVEL SERVICE

INCOME STATEMENT
For the Year Ended April 30, 2010
Fees earned $263,200
Expenses:
Wages expense $131,700
Office expense 63,000
Miscellaneous expense 12,950
Total expenses 207,650
Net income $ 55,550

40
 1-5
Example Exercise 1-4, 1-5 & 1-6

CHICKADEE TRAVEL SERVICE

STATEMENT OF OWNERS EQUITY
For the Year Ended April 30, 2010
Adam Cellini, capital, May 1, 2009 $ 80,000
Additional investment by owner during year $ 50,000
Net income for the year 55,550
$105,550
Less withdrawals 30,000
Increase in owners equity 75,550
Adam Cellini, capital, April 30, 2010 $155,550

41
 Balance Sheet 1-5

The account form of balance sheet lists the assets

on the left and the liabilities and owners equity on
the rightsimilar to design of an account.

The report form of balance sheet presents the

liabilities and owners equity sections below
the assets section.

42
 1-5
Example Exercise 1-4, 1-5 & 1-6

CHICKADEE TRAVEL SERVICE

BALANCE SHEET
April 30, 2010
Assets Liabilities
Cash $ 53,050 Accounts payable $12,200
Accounts receivable 31,350
Supplies 3,350 Owners Equity
Land 80,000 Adam Cellini, capital 155,550
Total assets $167,750 Total liab. & owners 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 1-5
section reports a summary of cash receipts and
cash payments from operations.

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 $251,000
Cash received from additional
investment of owner 50,000
Cash payments:
Cash paid for expenses 210,000
Cash paid for land 80,000
Cash 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.
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 $ 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 $ 50,000
Deduct cash withdrawals by owner 30,000
Net cash flows from financing activities 20,000
Net decrease in cash during year $(19,000)
Cash as of May 1, 2009 72,050
Cash as of April 30, 2010 $ 53,050

47
 5

Financial Analysis and

Interpretation
Ratio of Liabilities Total Liabilities
to Owners Equity =
Total Owners Equity
(or Total
Stockholders Equity)
For NetSolutions:
Ratio of Liabilities $400
to Owners Equity = = 0.015
$26,050

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