1 1 Introduction to Accounting and Business

2 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: 1. Describe the nature of a business and the role of ethics and accounting in business.

3 4. Describe and illustrate how business transactions can be recorded in terms of the resulting change in the basic elements of the accounting equation. After studying this chapter, you should be able to: 5. Describe the financial statements of a proprietorship and explain how they interrelate.

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

5 Service Business Service Service Business Service The Walt Disney CompanyEntertainment Delta Air LinesTransportation Marriott International HotelsHospitality and lodging Bank of America CorporationFinancial services XM Satellite RadioSatellite radio The Walt Disney CompanyEntertainment Delta Air LinesTransportation Marriott International HotelsHospitality and lodging Bank of America CorporationFinancial services XM Satellite RadioSatellite radio 1-1 Types of Businesses

6 Merchandising Business Product Wal-MartGeneral merchandise GameStop CorporationVideo games and accessories Best BuyConsumer electronics Gap Inc.Apparel Amazon.comInternet books, music, video Wal-MartGeneral merchandise GameStop CorporationVideo games and accessories Best BuyConsumer electronics Gap Inc.Apparel Amazon.comInternet books, music, video Types of Businesses 1-1

7 Manufacturing Business Product General Motors Corp.Cars, trucks, vans SamsungCell phones Dell Inc.Personal computers NikeAthletic shoes and apparel The Coca-Cola CompanyBeverages Sony CorporationStereos and televisions General Motors Corp.Cars, trucks, vans SamsungCell phones Dell Inc.Personal computers NikeAthletic shoes and apparel The Coca-Cola CompanyBeverages Sony CorporationStereos and televisions Types of Businesses 1-1

8 Proprietorship Partnership Corporation Limited liability company Common Forms of Business Organizations 1-1

9  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

10  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— 1-1

11  Generates 90% of the total dollars of business receipts received.  Comprises 20% of the businesses. A corporation is organized under state or federal statues as a separate legal taxable entity and— 1-1 Continued

12  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

13  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— 1-1

14 A business stakeholder is a person or entity having an interest in the economic performance and well-being of a business. 1-1

15 Capital market stakeholders provide the major financing for the business in order for the business to begin and continue its operations. 1-1

16 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

17 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

18 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

19 The moral principles that guide the conduct of individuals are called ethics. 1-1

20 1.Individual character 2.Firm culture 3.Laws and enforcement The answer to “What went wrong for these companies?” (Exhibit 2) involves three factors. 1-1

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

22 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. 1-1

23 1-1

24 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

25 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. 1-1

26 Summarize the development of accounting principles and relate them to practice. Objective 2 1-2

27 The limits the economic data in the accounting system to data related directly to the activities of the business. The business entity concept limits the economic data in the accounting system to data related directly to the activities of the business. 1-2

28 The cost concept is the basis for entering the exchange price, or cost of an acquisition in the accounting records. 1-2

29 The objectivity concept requires that the accounting records and reports be based upon objective evidence. 1-2

30 The unit of measure concept requires that economic data be recorded in dollars. 1-2

31 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

32 State the accounting equation and define each element of the equation. Objective 3 1-3

33 Assets = Liabilities + Owner’s Equity The resources owned by a business The Accounting Equation 1-3

34 The rights of the creditors, which represent debts of the business Assets = Liabilities + Owner’s Equity The Accounting Equation 1-3

35 The rights of the owners Assets = Liabilities + Owner’s Equity The Accounting Equation 1-3

36 The following accounts appear in the adjusted trial balance of Hindsight Consulting. Indicate whether each account would be reported in the (a) current asset; (b) property, plant, and equipment; (c) current liability, (d) long-term liability; or (e) owner’s equity section of the December 31, 2007, balance sheet of Hindsight Consulting. Example Exercise 1-2 John Joos is the owner and operator of You’re A Star, a motivational consulting business. At the end of its accounting period, December 31, 2007, You’re A Star has assets of $800,000 and liabilities of $350,000. Using the accounting equation, determine the following amounts: a.Owner’s equity, as of December 31, b.Owner’s equity, as of December 31, 2008, assuming that assets increased by $130,000 and liabilities decreased by $25,000 during Follow My Example 1-2 a. A = L + OE $800,000 = $350,000 + OE OE = $450,000 b. A = L + OE $130,000 = –$25,000 + OE OE = $155,000 OE on Dec. 31, 2008: $605,000 ($450,000 + $155,000)

37 Describe and illustrate how business transactions can be recorded in terms of the resulting change in the basic elements of the accounting equation. Objective 4 1-4

38 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

39 On November 1, 2007, Chris Clark begins a business that will be known as NetSolutions. 1-4

40 a. Chris Clark deposits $25,000 in a bank account in the name of NetSolutions. Chris Clark, Capital 25,000Investment by Chris Clark Cash 25,000 a. = Assets Owner’s Equity =

41 b. NetSolutions exchanged $20,000 for land. Chris Clark, Capital 25,000 Cash + Land 25,000 Bal. Assets Owner’s Equity = = b. –20,000+20,000 Bal. 5,00020,00025,

42 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 = 5,00020,00025,000 =+1,350c. Bal. 5,0001,35020,0001,35025,000 Bal

43 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

44 Cash + Supplies + Land Assets 5,0001,35020,000 d. NetSolutions provided services to customers, earning fees of $7,500 and received the amount in cash. Bal. 12,5001,35020,000 +7,500 d.d. Bal

45 d. NetSolutions provided services to customers, earning fees of $7,500 and received the amount in cash Liabilities + Owner’s Equity Accounts Chris Clark, Fees Payable Capital + Earned 1,350 25,000 Bal. +7,500 d. + 25,000 7,500 Bal. 1,350

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. Expenses

47 Cash + Supplies + Land Assets e. NetSolutions paid the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275. Bal.12,5001,35020,000 Bal.8,8501,35020,000 e.–3,

48 Accounts Chris Clark, Fees Wages Rent Utilities Misc. Payable + Capital + Earned Expense Expense Expense Expense Liabilities + Owner’s Equity 1,35025,0007,500 –2,125–800–450 –275 e. 1,35025,0007,500–2,125–800–450– e. NetSolutions paid the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $

49 f. NetSolutions paid $950 to creditors during the month. Cash + Supplies + Land Assets Bal.8,8501,35020,000 Bal.7,9001,35020,000 f.–

50 Accounts Chris Clark, Fees Wages Rent Utilities Misc. Payable + Capital + Earned Expense Expense Expense Expense Liabilities + Owner’s Equity 1,35025,0007,500 –2,125–800–450 – ,0007,500–2,125–800–450–275 f. NetSolutions paid $950 to creditors during the month. f. –

51 g. At the end of the month, the cost of supplies on hand is $550, so $800 of supplies were used. Cash + Supplies + Land Assets Bal.7,9001,35020,000 Bal.7, ,000 g.–

52 Accounts Chris Clark, Fees Wages Rent Supplies Util. Misc. Payable + Capital + Earned Exp. Exp. Exp. Exp. Exp. Liabilities + Owner’s Equity 40025,0007,500 –2,125–800–450 –275 g. At the end of the month, the cost of supplies on hand is $550, so $800 of supplies were used. g. – ,0007,500–2,125–800–800–450–

53 Cash + Supplies + Land Assets Bal.7, ,000 Bal.5, ,000 h.–2,000 h. At the end of the month, Chris withdrew $2,000 in cash from the business for personal use

54 Accounts Chris Clark, Chris Clark Fees Wages Rent Supplies Util. Misc. Payable + Capital + Drawing Earned Exp. Exp. Exp. Exp. Exp. Liabilities + Owner’s Equity 40025,0007,500 –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 ,000–2,0007,500–2,125–800–800–450–

55 Owner’s withdrawals Expenses Decreased by Owner’s Equity Increased by Owner’s investments Revenues

56 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: 56 1.Received cash from owner as additional investment, $35, Paid creditors on account, $1, Billed customers for delivery services on account, $11, Received cash from customers on account, $6, Paid cash to owners for personal use, $1, Continued

57 Example Exercise 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,

58 Follow My Example (2)Asset (Cash) decreases by $1,800; Liability (Accounts Payable) decreases by $1,800. For Practice: PE 1-3A, PE 1-3B (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,

59 Describe the financial statements of a proprietorship and explain how they interrelate. Objective 5 1-5

60 Accounting reports, called financial statements, provide summarized information to the owner. 1-5

61 The income statement is a summary of the revenue and expenses for a specific period of time, such as a month or a year. 1-5

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

63 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

From the income statement To the balance sheet Statement of Owner’s Equity

65 A balance sheet is a list of the assets, liabilities, and owner’s equity as of a specific date. 1-5

This amount is compared to the net cash flow on the statement of cash flows From the statement of owner’s equity Balance Sheet

67 A statement of cash flows is a summary of the cash receipts and payments for a specific period of time. 1-5

68 This amount should match Cash on the balance sheet. Statement of Cash Flows 1-5

69 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 Income Statement

70 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

71 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 $80,000 at May 1, 2007, the beginning of the current year. 71 Accounts payable$ 12,200Miscellaneous expense$ 12,950 Accounts receivable31,350Office expense63,000 Cash53,050Supplies3,350 Fees earned 263,200Wages expense131,700 Land80,000 Prepare an income statement for the current year ended April 30,

72 Follow My Example CHICKADEE TRAVEL SERVICE INCOME STATEMENT For the Year Ended April 30, 2008 Fees earned$263,200 Expenses: Wages expense$131,700 Office expense63,000 Miscellaneous expense 12,950 Total expenses 207,650 Net income$ 55,550 For practice: PE 1-4A, PE 1-4B 1-5

73 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 Statement of Owner’s Equity

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

75 Follow My Example 1-5 CHICKADEE TRAVEL SERVICE STATEMENT OF OWNER’S EQUITY For the Year Ended April 30, Adam Cellini, capital, May 1, 2007$ 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 owner’s equity 75,550 Adam Cellini, capital, April 30, 2008$155,550 For Practice: PE 1-5A, PE 1-5B 1-5

76 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 Balance Sheet

77 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

78 The report form of balance sheet presents the liabilities and owner’s equity sections below the assets section. 1-5

79 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, For Practice: PE 1-6A, PE 1-6B Follow My Example CHICKADEE TRAVEL SERVICE BALANCE SHEET April 30, 2008 Assets Liabilities Cash$ 53,050Accounts payable$12,200 Accounts receivable31,350 Supplies3,350 Owner’s Equity Land 80,000Adam Cellini, capital 155,550 Total assets$167,750Total liab. & owner’s eq.$167,750

80 The statement of cash flows consists of three sections: 1-5 (1)Operating activities (2)Investing activities (3)Financing activities Statement of Cash Flows

81 The cash flows from operating activities section reports a summary of cash receipts and cash payments from operations. 1-5

82 The cash flows from investing activities section reports the cash transactions for the acquisition and sale of relatively permanent assets. 1-5

83 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

84 Example Exercise 1-7 A summary of cash flows for Chickadee Travel Service for the year ended April 30, 2008, is shown below. 84 Cash receipts: Cash received from customers$251,000 Cash received from additional investment of owner50,000 Cash payments: Cash paid for expenses210,000 Cash paid for land80,000 Cash paid to owner for personal use30,000 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

85 Follow My Example 1-7 For Practice: PE 1-7A, PE 1-7B CHICKADEE TRAVEL SERVICE STATEMENT OF CASH FLOWS For the Year Ended April 30, 2008 Cash flows from operating activities: Cash received from customers$251,000 Deduct cash payments for expenses 210,000 Net cash flows from operating activities$ 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, ,050 Cash as of April 30, 2008 $ 53,

86  The income statement and the statement of owner’s equity are interrelated. Net income or net loss appears on both statements. 1-5 Interrelationships Among Financial Statements

87  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

88  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. 1-5