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 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
Objective 11
Describe the nature of a
business and the role of ethics
and accounting in business.
4

Types of Businesses

1-1

Service
ServiceBusiness
Business
The
TheWalt
Walt Disney
Disney Company
Company
Delta
DeltaAir
Air Lines
Lines
Marriott
Marriott International
International Hotels
Hotels

Service
Service
Entertainment
Entertainment
Transportation
Transportation
Hospitality
Hospitality and
and
lodging
lodging
Bank
Bank of
ofAmerica
America Corporation
Corporation Financial
Financial services
services
XM
Satellite
XM Satellite
Satellite Radio
Radio
Satellite radio
radio
5

Types of Businesses

Merchandising
Merchandising Business
Business
Wal-Mart
Wal-Mart
GameStop
GameStop Corporation
Corporation
Best
Best Buy
Buy
Gap
Gap Inc.
Inc.
Amazon.com
Amazon.com

1-1

Product
Product
General
General merchandise
merchandise
Video
Video games
games and
and accessories
accessories
Consumer
Consumer electronics
electronics
Apparel
Apparel
Internet
Internet books,
books, music,
music, video
video

Types of Businesses

Manufacturing
Manufacturing Business
Business
General
General Motors
Motors Corp.
Corp.
Samsung
Samsung
Dell
Dell Inc.
Inc.
Nike
Nike
The
The Coca-Cola
Coca-Cola Company
Company
Sony
Sony Corporation
Corporation

1-1

Product
Product
Cars,
Cars, trucks,
trucks, vans
vans
Cell
Cell phones
phones
Personal
Personal computers
computers
Athletic
Athletic shoes
shoes and
and apparel
apparel
Beverages
Beverages
Stereos
Stereos and
and televisions
televisions
7

Common Forms of Business Organizations

1-1

Proprietorship
Partnership
Corporation
Limited liability company

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 businesss
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

2323

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
Objective 22
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 sellers
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 Services records?

Follow My Example 1-1

$137,000. Under the cost concept, the land should be recorded at
the cost to Gallatin Repair Service.

3131

1-3

Objective
Objective 33
State the accounting
equation and define each
element of the equation.
32

The Accounting Equation

1-3

Assets = Liabilities + Owners Equity

The resources
owned by a
business

33

The Accounting Equation

1-3

Assets = Liabilities + Owners Equity

The rights of the
creditors, which
represent debts
of the business
34

1-3

The Accounting Equation

Assets = Liabilities + Owners Equity

The rights of the
owners

35

1-3
Example Exercise 1-2
John Joos is the owner and operator of Youre A Star, a motivational
consulting
business.
At the
end of
December
The
following
accounts
appear
inits
theaccounting
adjusted period,
trial balance
of 31,
2007, Youre
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. Owners
as liability,
of December
31, 2007. liability; or (e)
equipment;
(c)equity,
current
(d) long-term
b. Owners
as of December
31, 2008,
assuming
that assets
owners
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)

3636

1-4

Objective
Objective 44
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 entitys
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

=
=

Owners 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.

4040

1-4

Assets
Cash + Land
Bal. 25,000
b. 20,000
+20,000
Bal. 5,000
20,000

=
=

Owners Equity
Chris Clark, Capital
25,000
25,000

b. NetSolutions exchanged $20,000 for land.

4141

1-4
Assets

Cash + Supplies + Land

Bal. 5,000
c.
Bal. 5,000

20,000
+1,350
1,350

20,000

Owners
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). 4242

1-4

Beginning with entry (d) the

asset section will be shown
first, then the liabilities and
owners equity will be shown
in the following slide.

43

1-4
Assets
Cash + Supplies + Land
5,000
1,350
20,000

Bal.
d. +7,500
12,500
Bal.

1,350

20,000

d. NetSolutions provided services to

customers, earning fees of $7,500 and
received the amount in cash.

4444

1-4
Liabilities +
Owners 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.
4545

Expenses

1-4

The amounts used in earning revenue are

called expenses. 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 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.
4747

1-4
Liabilities +
Owners Equity
Accounts
Chris Clark,
Fees
Wages
Rent
Utilities
Payable + Capital + Earned Expense Expense Expense
Expense
1,350
25,000
7,500
1,350

25,000

7,500

2,125

800

450

2,125

800

450

Misc.

275

e. NetSolutions paid the following expenses:

wages, $2,125; rent, $800; utilities, $450; and
miscellaneous, $275.

e.

275

4848

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.

4949

1-4

Liabilities +
Owners Equity
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

5050

1-4
Assets
Cash + Supplies + Land
Bal. 7,900
1,350
20,000
g.
Bal. 7,900

800
550

20,000

g. At the end of the month, the cost

of supplies on hand is $550, so
$800 of supplies were used.

5151

1-4

Liabilities +

Owners Equity

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.

5252

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.

5353

1-4

Liabilities +

Owners Equity

Accounts Chris Clark, Chris Clark Fees Wages

Payable + Capital + Drawing Earned Exp.
400

25,000

7,500 2,125

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

5454

1-4

Owners Equity
Increased by

Decreased by

Owners
investments

Owners
withdrawals

Revenues

Expenses
5555

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

5656

1-4
Example Exercise 1-3
Indicate the effect of each transaction on the accounting
equation elements (Assets, Liabilities, Owners 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; Owners Equity
(Joel Salvo, Capital) increases by $35,000.
5757

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; Owners Equity
(Joel Salvo, Drawing) increases by $1,000.
For Practice: PE 1-3A, PE 1-3B

5858

1-5

Objective
Objective 55
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
owners 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.

63

1-5

Statement of Owners Equity

From the income statement

To the balance sheet

6464

1-5

A balance sheet is a list of

the assets, liabilities, and
owners 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 owners equity
6666

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.

7171

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
7272

Statement of Owners Equity

1-5

The statement of owners

equity reports the changes in
the owners 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
owners 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.

7474

1-5
Follow My Example 1-5
CHICKADEE TRAVEL SERVICE
STATEMENT OF OWNERS 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 owners 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

7575

Balance Sheet

1-5

The balance sheet reports

the amounts of a firms
assets, liabilities, and
owners 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 owners
equity on the rightsimilar to
design of an account.
77

1-5

The report form of balance

sheet presents the liabilities
and owners 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
Owners Equity
80,000 Adam Cellini, capital
155,550
$167,750 Total liab. & owners eq. $167,750

For Practice: PE 1-6A, PE 1-6B

7979

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.

8484

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

$ 41,000
(80,000)

20,000
$(19,000)
72,050
$ 53,050

85
For Practice: PE 1-7A, PE 1-7B

85

Interrelationships Among Financial Statements

1-5

The income statement and the statement

of owners equity are interrelated.
Net income or net loss
appears on both statements.

86

1-5

The statement of owners equity and

the balance sheet are interrelated.
The owners capital at the end of the
period on the statement of owners
equity also appears on the balance
sheet as owners 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