Chapter 1 - Ijaz

Accounting and the Business
Environment
Chapter 1
Copyright 2012 Pearson Education, Inc. Publishing as
1
Define accounting
ILLUSTRATION 1-1
THE ACCOUNTING PROCESS

Identificat
ion
Recording
Communicat
ion
Accou
nting
Repor
ts
200
0
Prepare
accounting
reports
SOFTBYTE
Select economic
events
(transactions)
Record,
classify,
and
summarize
Annual Report
Analyse and
interpret
Copyright 2012 Pearsonfor
Education,
Inc. Publishing as
users
Definition of Accounting:
Accounting is the language of business. Accounting is the information
system that measures business activity, processes the data into reports,
and communicates the results to decision makers.
Accounting is the language of

business.
The information system that:
Measures business activity
Processes the data into reports
Communicates the results to decision makers
Financial Accounting
o Provides information primarily to people outside the

company
o Provides information that would be helpful in attracting
capital
Equity and debt (useful in debt contracts)
Credit from suppliers
Customers
o Provides information helpful in monitoring and
evaluating management performance
Managerial Accounting
Provides information to people inside the company
Internal investment decisions
Performance evaluation
Tax Accounting
Provides information to the tax authorities
ILLUSTRATION 1-2
QUESTIONS ASKED BY INTERNAL USERS
What is the cost of manufacturing

each unit of product?
Is cash sufficient to pay bills?
Can we afford to give employees

pay raises this year?
Which product line is the most

profitable?
ILLUSTRATION 1-3
QUESTIONS ASKED BY EXTERNAL USERS
Is the company earning

satisfactory income?
How does the company compare

in size and profitability with its
competitors?
Will the company be able to pay its debts as they come due?
BOOKKEEPING DISTINGUISHED
FROM ACCOUNTING
Accounting
1. Includes bookkeeping
2. Also includes much more
Bookkeeping
1. Involves only the recording of economic
events
2. Is just one part of accounting
16
2
Define the users of
financial information
17
Decision Makers
Individuals
Businesses
Creditors
Investors
Taxing Authorities
18
Two Fields of Accounting

Financial Accounting
Managerial Accounting
Provides information for

external decision makers
Focuses on information for

internal decision makers
Investors
Creditors
Taxing Authorities
Managers
Business Owners
Employees
19
S1-2: USERS OF FINANCIAL INFORMATION
Suppose you are the manager of Gregs Tunes, Inc. The

company needs a bank loan in order to purchase music
equipment. In evaluating the loan request, the banker
asks about the assets and liabilities of the business. In
particular, the banker wants to know the amount of the
businesss stockholders equity.
Requirements:
1. Is the banker considered an internal or external user
of financial
information?
The banker
is an external user.
2. Which financial statement would provide the best
The balance
sheet the bankers questions?
information
to answer
20
3
Describe the accounting
profession and the organizations
that govern it
21
The Accounting Profession

Lucrative career with many opportunities
Certified Public Accountants (CPAs)
Pass qualifying exam
Meet education and/or experience requirements
22
Governing Organizations
23
Ethics in Accounting and Business
Conflict of Interest
24
Audit
SEC requires companies to have financial statements
examined by independent accountants
Auditors will provide an opinion on financial
statements, if possible
25
4
Identify the different types
of business organizations
26
BUSINESS ENTERPRISES
A business owned by one person is generally a

proprietorship (owners equity).
A business owned by two or more persons associated as
partners is a partnership (partners equity).
A business organized as a separate legal entity under
corporation law and having ownership divided into
transferable shares is called a corporation
(shareholders equity).
27
Comparison of Business Forms

Proprietorship
Partners
Corporation
Proprietor:
One Owner
Partners: Two or
more
Stockholders:
usually many
Life of
Organization
Limited by owner's
choice or death
Limited by
owners choice
or death
Indefinite
Liability of owners
for business debts
Proprietor: Owner
is personally liable
Partners are
personally liable
Stockholders not
personally liable
Owners
28
5
Delineate the distinguishing
characteristics and organization
of a corporation
29
Corporate Characteristics
30
(continued)
31
(continued)
32
Organization of a Corporation
Incorporators obtain charter from the state
Charter authorizes corporation to:
Issue stock
Conduct business in accordance with state law
Incorporators agreed to a set of bylaws

Bylaws are the rule book that guides the
corporation.
Corporations begins to exist when stock is

issued
33
Stockholders vote on who will serve on Board of

Directors
Structure of a Corporation
34
S1-4: TYPES OF BUSINESS ORGANIZATION
Akbar plans on opening Akbar Computers. He is

considering various types of business organizations
and wishes to organize his business with unlimited
life and limited liability features. Additionally,
Akbar wants the option to raise additional equity
easily in the future. Which type of business
organization will meet Akbars needs best?
A corporation has all the requirements of Akbars
request. A corporation has an unlimited life,
shareholders have limited liability and additional
stock can be sold to raise additional equity.
35
6
Apply accounting concepts and
principles
36
IFRS
International Financial Reporting Standards
Guidelines that govern accounting
Goals include:
Provide useful information for investment and lending
decisions
Must be relevant, reliable, and comparable
37
Accounting Principles
38
39
(continued)
40
7
Describe the accounting equation,
and define assets, liabilities, and
equity
41
The Accounting Equation

ASSETS
Economic
Resources
42
LIABILITIES
EQUITY
Claims to Economic
Resources
Assets
Economic resources
Benefit the business in the future
Examples:
Cash
Accounts receivable
Merchandise inventory
Furniture
Land
43
Claims to Assets
Liabilities
Equity
Debts payable to outsiders

Examples:
Accounts payable
Bank loans
Mortgages
44
Owners claims to the

assets of the business
In a corporation,
stockholders equity
The Accounting Equation

Assets
Liabilities
Equity
$5,000
$2,000
$3,000
Liabilities
Assets
Equity
45
Equity of a Corporation
Assets
Liabilities
Stockholders
equity
Paid-in
capital
46
Retained
earnings
Equity of a Corporation
47
Net Income
Retained
earnings
+ Net income
(loss)
- Dividends
48
+ Revenues
- Expenses
Revenues
Amounts earned by delivering goods or services
to customers
Sales revenue
Service revenue
Interest revenue
Dividend revenue
49
Expenses
Outflows of assets or increasing liabilities in the
course of delivering goods or services to
customers
rent expense
Salary expense
Advertising expense
Utilities expense
Interest expense
Property tax expense
50
E1-16: CHARACTERISTICS OF A CORPORATION,

ACCOUNTING CONCEPTS, AND USING THE
ACCOUNTING EQUATION
Select financial information for three corporations follows:
Assets
Liabilities
Equity
New Rock Gas
$74,000
$?
$24,000
$50,000
DJ Video Rentals
$75,000
$32,000
Corner Grocery
$100,000
$43,000
$?
$53,000
$47,000
$?
Requirements:
1. Compute the missing amount in the accounting equation
for each entity.
51
E1-16: CONTINUED
2. List the seven main characteristics of a
corporation.
Continuous Life and transferability
Corporate taxation
Government regulation
Limited Liability of Stockholders
No Mutual Agency
Separate Legal Entity
Separation of ownership and managers
3. Which accounting concept tells us that the previous
three corporations will continue to exist in the future?
Going Concern Concept
52
8
Use the accounting equation to
analyze transactions
53
Transaction
An event that affects the financial position of
the business
Can be measured reliably
Every transaction impacts at least two items
The accounting equation balances before
and after each transaction
54
TRANSACTION ANALYSIS
Marc Doucet decides to open a computer
programming service.
BANK
Softb
yte
TRANSACTION 1
On September 1, he invests $15,000
cash in the business, which he names
Softbyte.
Trans. #
(1)
Assets
Cash
15,000
Supplies
= Liabilities +
Owner's Equity
Accounts
M. Doucet,
Equipment
Payable
Capital
=
15,000 Investment
There
Thereisisan
anincrease
increasein
inthe
theasset
assetCash,
Cash,$15,000,
$15,000,and
and
an
anequal
equalincrease
increasein
inthe
theowners
ownersequity,
equity,M.
M.Doucet,
Doucet,
Capital,
Capital,$15,000.
$15,000.
TRANSACTION 2
Softbyte purchases computer equipment for $7,000 cash.
Trans. #
(2)
Balance
Assets
Cash
Supplies
15,000
(7,000)
8,000 +
= Liabilities +
Owner's Equity
Accounts
M. Doucet,
Equipment
Payable
Capital
15,000 Investment
7,000
7,000 =
15,000
Cash
Cashisisdecreased
decreased$7,000,
$7,000,and
andthe
theasset
asset
Equipment
Equipmentisisincreased
increased$7,000.
$7,000.
TRANSACTION 3
Softbyte purchases computer paper and supplies expected to last
several months from Chuah Supply Company for $1,600 on
account.
Trans. #
Balance
(3)
Balance
Assets
== Liabilities
Owner's
Liabilities ++
Owner's Equity
Accounts
M.
Accounts
M. Doucet,
Cash
Supplies
Equipment
Payable
Capital
Equipment
Payable
8,000
7,000
15,000
8,000
7,000
15,000
1,600
1,600
8,000 +
1,600 +
7,000 =
1,600 +
15,000
The
Theasset
assetSupplies
Suppliesisisincreased
increased$1,600,
$1,600,and
andthe
theliability
liability
Accounts
AccountsPayable
Payableisisincreased
increasedby
bythe
thesame
sameamount.
amount.
TRANSACTION 4
Softbyte receives $1,200 cash from
customers for programming services it
has provided.
Trans. #
Balance
(4)
Balance
Assets
= Liabilities +
Owner's Equity
Accounts
M. Doucet,
Cash
Payable
Capital
Supplies
Equipment
1,600
7,000
1,600
8,000
15,000
1,200
1,200 Service Revenue
9,200 +
1,600 +
7,000 =
1,600 +
16,200
Cash
Cashisisincreased
increased$1,200,
$1,200,and
and
M.
M.Doucet,
Doucet,Capital
Capitalisisincreased
increased$1,200.
$1,200.
TRANSACTION 5
Softbyte receives a bill for $250 for advertising its business
but pays the bill on a later date.
Trans. #
Balance
(5)
Balance
Assets
= Liabilities +
Owner's
Owner's Equity
Accounts
M. Doucet,
Cash
Supplies
Equipment
Payable
Capital
9,200 +
1,600
7,000
1,600
16,200
1,600 +
7,000 =
1,600 +
16,200
250
(250) Advertising Expense
9,200
1,600
7,000
1,850
15,950
Accounts
AccountsPayable
Payable isisincreased
increased$250,
$250,and
andM.
M.
Doucet,
Doucet,Capital
Capitalisisdecreased
decreased$250.
$250.
TRANSACTION 6
Softbyte provides programming services of
$3,500 for customers and receives cash of
$1,500, with the balance payable on
account.
Trans.
##
Assets
== Liabilities
Liabilities ++
Owner's
Owner's Equity
Balance
Balance
(6)
Balance
Cash
9,200
9,200
1,500
10,700
Account
Account
Accounts
Accounts
Receivable
Receivable Supplies
Supplies Equipment
Equipment
Payable
Payable
++
00 ++ 1,600
1,600 ++
7,000
7,000 ==
1,850
1,850
2,000
2,000
1,600
7,000
1,850
M.
M. Doucet,
Doucet,
Capital
Capital
15,950
15,950
3,500 Service Revenue
19,450
Cash
Cashisisincreased
increased$1,500;
$1,500;Accounts
AccountsReceivable
Receivableisis
increased
increased$2,000;
$2,000;and
andM.
M.Doucet,
Doucet,Capital
Capitalisis
increased
increased$3,500.
$3,500.
TRANSACTION 8
Softbyte pays its advertising bill of $250 in cash.
Trans. #
Balance
Balance
(8)
Balance
Cash
Cash
9,000
9,000
(250)
8,750 +
AccountAssets
Account
Receivable
Supplies
Receivable
Supplies
2,000
1,600
2,000
1,600
2,000 +
1,600 +
Equipment
Equipment
7,000
7,000
7,000
= Liabilities
Owner's Equity
Accounts + M. Doucet,
Accounts
M.Capital
Doucet,
Payable
Payable
Capital
1,850
17,750
1,850
17,750
(250)
=
1,600 +
17,750
Cash
Cashisisdecreased
decreased$250
$250and
andAccounts
Accounts
Payable
Payableisisdecreased
decreasedthe
thesame
sameamount.
amount.
TRANSACTION 9
The sum of $600 in cash is received from customers who
have previously been billed for services in Transaction 6.
Trans. #
Balance
(9)
Balance
Assets
= Liabilities +
Owner's Equity
Account
Accounts
M. Doucet,
Cash
Receivable
Supplies
Payable
Capital
Equipment
8,750 +
2,000 +
1,600 +
7,000 =
1,600 +
17,750
600
(600)
9,350 +
1,400 +
1,600 +
7,000 =
1,600 +
17,750
Cash
Cashisisincreased
increased$600
$600and
andAccounts
Accounts
Receivable
Receivableisisdecreased
decreasedby
bythe
thesame
sameamount.
amount.
TRANSACTION 10
Marc Doucet withdraws $1,300 in cash from
the business for his personal use.
Trans. #
Balance
(10)
Balance
Assets
Cash
9,350
(1,300)
8,050
= Liabilities
Owner's
Liabilities ++
Owner's Equity
Account
Accounts
M.
Accounts
M. Doucet,
Doucet,
Receivable Supplies
Equipment
Payable
Capital
Equipment
Payable
Capital
1,400
1,600
7,000
1,600
17,750
1,600
7,000
1,600
17,750
(1,300) Doucet, Drawings
+
1,400 +
1,600 +
7,000 =
1,600 +
16,450
Cash
Cashisisdecreased
decreased$1,300
$1,300and
andM.
M.Doucet,
Doucet,
Capital
Capitalisisdecreased
decreasedby
bythe
thesame
sameamount.
amount.
FINANCIAL STATEMENTS
After transactions are identified, recorded, and
summarized, four financial statements are prepared
from the summarized accounting data:
1. An income statement presents the revenues
and expenses and resulting net income or net
loss of a company for a specific period of
time.
2. A statement of owners equity summarizes the
changes in owners equity for a specific period
of time.
FINANCIAL STATEMENTS
In addition to the income statement and
statement of owners equity, two
additional statements are prepared:
3. A balance sheet reports the assets,
liabilities, and
owners equity of a
business enterprise at a
specific date.
4. A cash flow statement summarizes
information
concerning the cash
inflows (receipts) and
outflows (payments) for a specific period
Income Statement
67
Statement of Retained
Earnings
68
Balance Sheet
69
Statement of Cash Flows
70
P1-36A: PREPARING FINANCIAL STATEMENTS

Studio Photography, Inc., works weddings and prom-type parties. The
balance of retained earnings was $16,000 at December 31, 2011. At
December 31, 2012, the businesss accounting records show these
balances:
Insurance expense
$ 8,000 Accounts receivable
$ 8,000
Cash
37,000 Note payable
12,000
Accounts payable
7,000 Retained earnings
Advertising expense
3,000 Salary expense
47,000
25,000
Service revenue
80,000 Equipment
50,000
Dividends
31,000 Common stock
29,000
Prepare the following financial statements for Studio Photography, Inc.

for the year ended December 31, 2012:
a. Income statement
b. Statement of retained earnings
c. Balance sheet
71
P1-36A: CONTINUED
Studio Photography, Inc.
Income Statement
Year Ended December 31, 2012
Revenue:
Service revenue
Expenses:
Salary expense
Insurance expense
Advertising expense
72
Total expenses
Net income
$ 80,000
$ 25,000
8,000
3,000
36,000
$ 44,000
P1-36A: CONTINUED

Statement of Retained Earnings
Year Ended December 31, 2012
73
Retained earnings, December 31, 2011

Add: Net income
$ 16,000
44,000
Subtotal
Less: Dividends
Retained earnings, December 31, 2011
$ 60,000
(13,000)
$ 47,000
P1-36A: CONTINUED
Balance Sheet
December 31, 2012
Assets
Cash
Accounts receivable
Equipment
Liabilities
$37,000
8,000
50,000
Accounts payable
$ 7,000
Note payable
12,000
Total liabilities
19,000
Stockholders Equity
Common stock
Retained earnings
Total assets
74
$95,000
Total stockholders
equity
Total liabilities and
stockholders equity
$29,000
47,000
76,000
$95,000
1
0
Use financial statements to evaluate business
performance
75
Decision Guidelines
76
Chapter 1 Summary
Accounting is the language of business. Financial
statements report a companys activities in monetary
terms.
Different usersincluding individuals, business
owners, managers, investors, creditors, and tax
authoritiesreview a companys financial statements
for different reasons. Each users goal will determine
which pieces of the financial statements he or she
will find most useful.
77
Chapter 1 Summary
Most U.S. businesses follow generally accepted
accounting principles (GAAP). If the company is
publicly traded, then it must also follow SEC
guidelines. If the company operates internationally,
then international financial reporting standards
(IFRS) will apply. The goal is that, eventually, all
public U.S. companies will report using IFRS rules.
There are three main forms of business organizations:
proprietorships, partnerships, corporations,. Each is
unique in its formation, ownership, life, and liability
exposure.
78
Chapter 1 Summary
Corporations are formed with a specific state by
issuance of a charter. The stockholders own the
corporation, but they have no liability for the
corporations actions.
Corporations usually raise capital more easily than
other forms of business, but have the disadvantage of
additional regulation and additional taxes.
The accounting concepts are the underlying
assumptions used when recording financial
information for a business. Think of the concepts like
rules of a game. You have to play by the rules.
79
Chapter 1 Summary
The accounting equation must always equal. That is,
Assets (what you own) must equal Liabilities (what
you owe) + Equity (net worth). In a corporation,
equity is composed of paid-in capital (by outsiders)
and retained earnings (earnings kept for use by the
company).
The accounting equation is Assets = Liabilities +
Equity. Every business transaction affects various
parts of the equation, but after each transaction is
recorded, the equation must ALWAYS balance
(equal).
80
Chapter 1 Summary
Financial statements are prepared from the ending
balances of each account. Each financial statement
shows a different view of the companys overall
results.
Financial statements are prepared from the
transaction analyses (summary of events) reported
in each account (Exhibit 1-6) in the order shown in
Exhibit 1-7. No one financial statement shows
everything about a company. It is the financial
statements AND the relationships the statements
show that give users the overall picture for a
specific company.
81
82

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Accounting and the Business

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

THE ACCOUNTING PROCESS

Copyright 2012 Pearson Education, Inc. Publishing as

Accounting is the language of

Copyright 2012 Pearson Education, Inc. Publishing as

o Provides information primarily to people outside the

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

QUESTIONS ASKED BY INTERNAL USERS

What is the cost of manufacturing

Is cash sufficient to pay bills?

Can we afford to give employees

Which product line is the most

Copyright 2012 Pearson Education, Inc. Publishing as

QUESTIONS ASKED BY EXTERNAL USERS

Is the company earning

How does the company compare

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Two Fields of Accounting

Provides information for

Focuses on information for

Copyright 2012 Pearson Education, Inc. Publishing as

S1-2: USERS OF FINANCIAL INFORMATION

Suppose you are the manager of Gregs Tunes, Inc. The

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

The Accounting Profession

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Ethics in Accounting and Business

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

A business owned by one person is generally a

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Comparison of Business Forms

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Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Incorporators agreed to a set of bylaws

Corporations begins to exist when stock is

Stockholders vote on who will serve on Board of

Copyright 2012 Pearson Education, Inc. Publishing as

S1-4: TYPES OF BUSINESS ORGANIZATION

Akbar plans on opening Akbar Computers. He is

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as

Copyright 2012 Pearson Education, Inc. Publishing as