1. Principles of Financial Accounting, 11e
Introduction to
Accounting and Business
Principles of Financial Accounting, 11e
Reeve • Warren • Duchac

2. 1 2 3 Introduction to Accounting and Business
After studying this chapter, you should be able to: 1
Describe the nature of a business, the role of accounting, and ethics 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.
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3. Introduction to Accounting and Business (continued)4
Describe and illustrate how business transactions can be recorded in terms of the resulting change in the elements of the accounting equation. 5
Describe the financial statements of a proprietorship and explain how they interrelate.
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4. 1 1
Describe the nature of a business, the role of accounting, and ethics in business.
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5. 1
Types of Businesses
Service Business Service
Delta Air Lines Transportation services
The Walt Disney Company Entertainment services

6. 1
Types of Businesses
Merchandising Business Product
Wal-Mart General merchandise
Amazon.com Internet books, music, videos

7. 1
Types of Businesses
Manufacturing Business Product
General Motors Corp. Cars, trucks, vans
Dell Inc. Personal computers

8. The Role of Accounting in Business1
The Role of Accounting in Business
Accounting can be defined as an information system that provides reports to users about the economic activities and condition of a business.

9. 1
The process by which accounting provides information to users is as follows:
Identify users.
Assess users’ informational needs.
Design the accounting information system to meet users’ needs.
Record economic data about business activities and events.
Prepare accounting reports for users.

10. 1
Exhibit 1
Users of Accounting Information

11. Managerial Accounting1
Managerial Accounting
The area of accounting that provides internal users with information is called managerial accounting.
The objective of managerial accounting is to provide relevant and timely information for managers’ and employees’ decision-making needs.

12. 1
Financial Accounting
The area of accounting that provides external users with information is called financial accounting.
The objective of financial accounting is to provide relevant and timely information for the decision-making needs of users outside of the business.

13. Role of Ethics in Accounting and Business1
Role of Ethics in Accounting and Business
Ethics are moral principles that guide the conduct of individuals.

14. 1 Exhibit 3 Guideline for Ethical Conduct
Identify an ethical decision by using your personal ethical standards of honesty and fairness.
Identify the consequences of the decision and its effect on others.
Consider your obligations and responsibilities to those that will be affected by your decision.
Make a decision that is ethical and fair to those affected by it.

15. 2
Summarize the development of accounting principles and relate them to practice.
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16. Generally Accepted Accounting Principles2
Generally Accepted Accounting Principles
Financial accountants follow generally accepted accounting principles (GAAP) in preparing reports.
Within the United States, the Financial Accounting Standards Board (FASB) has the primary responsibility for developing accounting principles.
(continued)

17. 2
The Securities and Exchange Commission (SEC), an agency of the U.S. government, has authority over the accounting and financial disclosures for companies whose shares of ownership are traded and sold to the public.
Many countries outside the United States use generally accepted accounting principles adopted by the International Accounting Standards Board (IASB).

18. Business Entity Concept2
Business Entity Concept
Under the business entity concept, the activities of a business are recorded separately from the activities of its owners, creditors, or other businesses.

19. Business Entity Concept2
Business Entity Concept
A proprietorship is owned by one individual.
Easy and cheap to organize.
Resources are limited to those of the owner.
Used by small businesses.

20. Business Entity Concept2
Business Entity Concept
A partnership is similar to a proprietorship except that it is owned by two or more individuals.
Combines the skills and resources of more than one person.

21. Business Entity Concept2
Business Entity Concept
A corporation is organized under state or federal statutes as a separate legal taxable entity.
Ownership is divided into shares called stock.
Can obtain large amounts of resources by issuing stocks.
Used by large businesses.

22. 2
Cost Concept
Under the cost concept, amounts are initially recorded in the accounting records at their cost or purchase price.

23. 2
Objectivity Concept
The objectivity concept requires that the amounts recorded in the accounting records be based on objective evidence.

24. Unit of Measure Concept2
Unit of Measure Concept
The unit of measure concept requires that economic data be recorded in dollars.

25. 2 Example Exercise 1-1 Cost Concept
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?
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26. Example Exercise 1-1 (continued)2
Follow My Example 1-1
$137,000. Under the cost concept, the land should be recorded at the cost to Gallatin Repair Service.
For Practice: PE 1-1A, PE 1-1B
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27. 3
State the accounting equation and define each element of the equation.
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28. The Accounting Equation3
The Accounting Equation
Assets = Liabilities + Owner’s Equity
The resources owned by a business

29. The Accounting Equation3
The Accounting Equation
Assets = Liabilities + Owner’s Equity
The rights of the creditors are the debts of the business.

30. The Accounting Equation3
The Accounting Equation
Assets = Liabilities + Owner’s Equity
The rights of the owners

31. 3 Example Exercise 1-2 Accounting Equation
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, 2009, You’re A Star has assets of $800,000 and liabilities of $350,000. Using the accounting equation, determine the following amounts:
Owner’s equity, as of December 31, 2009.
b. Owner’s equity, as of December 31, 2010, assuming that assets increased by $130,000 and liabilities decreased by $25,000 during 2010.
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32. Example Exercise 1-2 (continued)3
a Assets = Liabilities + Owner’s Equity $800,000 = $350,000 + Owner’s Equity
Owner’s Equity = $450,000
Follow My Example 1-2
b. First, determine the change in Owner’s Equity during 2010 as follows:
Assets = Liabilities + Owner’s Equity $130,000 = –$25,000 + Owner’s Equity
Owner’s Equity = $155,000
Next, add the change in Owner’s Equity on December 31, 2009 to arrive at Owner’s Equity on December 31, 2010, as shown below:
$605,000 = $450,000 + $155,000
Example Exercise1-2 continued
For Practice: PE 1-2A, PE 1-2B
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33. 4
Describe and illustrate how business transactions can be recorded in terms of the resulting change in the elements of the accounting equation.
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34. 4
Business Transaction
A business transaction is an economic event or condition that directly changes an entity’s financial condition or its results of operations.

35. 4
Transaction A
On November 1, 2009, Chris Clark deposits $25,000 in a bank account in the name of NetSolutions.

36. 4 Assets Owner’s Equity = = 25,000 25,000 Investment by Chris Clark a.
Transaction A (continued)
Assets =
Owner’s Equity
CASH
25,000 a.
CHRIS CLARK, CAPITAL
25, Investment by Chris Clark =

37. 4
Transaction B
On November 5, 2009, NetSolutions paid $20,000 for the purchase of land as a future building site.

38. 4 Assets Owner’s Equity = = CASH + LAND 25,000 25,000 Bal.
Transaction B (continued)
Assets =
Owner’s Equity
CASH LAND
25,000
CHRIS CLARK, CAPITAL
25,000
Bal. =
b –20, ,000
Bal. 5,000 20, ,000

39. 4
Transaction C
On November 10, 2009, NetSolutions purchased supplies for $1,350 and agreed to pay the supplier in the near future.

40. 4 = Transaction C (continued) Assets Liabilities + Owner’s Equity
ACCOUNTS CHRIS CLARK,
PAYABLE CAPITAL
CASH + SUPPLIES + LAND
5, , ,000 =
Bal.
c , ,350
Bal. 5, , , , ,000

41. 4
Beginning with Transaction D the asset section will be shown first, then the liabilities and owner’s equity will be shown in the following slide.

42. 4
Transaction D
On November 18, 2009, NetSolutions received cash of $7,500 for providing services to customers. A business earns money by selling goods or services to its customers. This amount is called Revenue.

43. 4 Transaction D (continued) Assets CASH + SUPPLIES + LAND
5, , ,000
Bal.
d ,500
Bal , ,000

44. Liabilities + Owner’s Equity4
Transaction D (continued)
Liabilities Owner’s Equity
ACCOUNTS CHRIS CLARK, FEES
PAYABLE CAPITAL EARNED
1, ,000
Bal.
d ,500
Bal , , ,500

45. 4
Expenses
During the month, NetSolutions spent cash or used up other assets in earning revenue. Assets used in this process of earning revenue are called expenses.

46. 4
Transaction E
On November 30, 2009, NetSolutions paid the following expenses during the month: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.

47. 4 Transaction E (continued) Assets CASH + SUPPLIES + LAND
12, , ,000
Bal.
e –3,650
Bal , ,000

48. 4 Transaction E (continued) Liabilities + Owner’s Equity
ACCOUNTS CHRIS CLARK, FEES WAGES RENT UTIL. MISC.
PAYABLE + CAPITAL EARNED – EXP. – EXP. – EXP. – EXP.
1, , ,500
Bal.
e –2, – –450 –275
Bal , , , –2, – –450 –275

49. On November 30, 2009, NetSolutions paid creditors on account, $950.4
Transaction F
On November 30, 2009, NetSolutions paid creditors on account, $950.

50. 4 Transaction F (continued) Assets CASH + SUPPLIES + LAND
8, , ,000
Bal.
f –950
Bal , ,000

51. 4 Transaction F (continued) Liabilities + Owner’s Equity
ACCOUNTS CHRIS CLARK, FEES WAGES RENT UTIL. MISC.
PAYABLE + CAPITAL EARNED – EXP. – EXP. – EXP. – EXP.
1, , , –2, – – –275
Bal.
f –950
Bal , , –2, – – –275

52. 4
Transaction G
On November 30, 2009, Chris Clark determined that the cost of supplies on hand at the end of the period was $550.

53. 4 Transaction G (continued) Assets CASH + SUPPLIES + LAND
7, , ,000
Bal.
g –800
Bal , ,000

54. 4 Transaction G (continued) Liabilities + Owner’s Equity
ACCOUNTS CHRIS CLARK, FEES WAGES RENT SUP. UTIL. MISC.
PAYABLE + CAPITAL EARNED – EXP. – EXP. – EXP. – EXP. – EXP.
, , –2, – –450 –275
Bal.
g –800
Bal , , –2, – –800 –450 –275

55. 4
Transaction H
On November 30, 2009, Chris Clark withdrew $2,000 from NetSolutions for personal use.

56. 4 Transaction H (continued) Assets CASH + SUPPLIES + LAND
7, ,000
Bal.
h –2,000
Bal , ,000

57. 4 Transaction H (continued) Liabilities + Owner’s Equity
ACCTS CLARK, CLARK, FEES WAGES RENT SUP. UTIL. MISC.
PAY CAPITAL – DRAW. + EARNED – EXP. – EXP. – EXP. – EXP. – EXP.
, , –2, –800 –800 –450 –275
Bal.
h –2,000
Bal , –2, , –2, –800 –800 –450 –275

58. 4
Summary

59. 4
Exhibit 5
Effects of Transactions on Owner’s Equity

60. 4 Example Exercise 1-3 Transactions
Salvo Delivery Service is owned and operated by Joel Salvo. The following selected transactions were completed by Salvo Delivery Service during February:
Received cash from owner as additional investment, $35,000.
Paid creditors on account, $1,800.
Billed customers for delivery services on account, $11,250.
Received cash from customers on account, $6,740.
Paid cash to owner for personal use, $1,000.
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(Continued)

61. Example Exercise 1-3 (continued)4
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 $35,000.
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62. 4 Follow My Example 1-3 Follow My Example 1-3
Example Exercise 1-3 (continued) 4
Follow My Example 1-3
Follow My Example 1-3
Asset (Cash) decreases by $1,800; Liability (Accounts Payable) decreases by $1,800.
Asset (Accounts Receivable) increases by $11,250; Revenue (Delivery Service Fees) increases by $11,250.
Asset (Cash) increases by $6,740; Asset (Accounts Receivable) decreases by $6,740.
Asset (Cash) decreases by $1,000; Drawing (Joel Salvo, Drawing) increases by $1,000.
For Practice: PE 1-3A, PE 1-3B
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63. 5
Describe the financial statements of a proprietorship and explain how they interrelate.
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64. 5
Financial Statements
After transactions have been recorded and summarized, reports are prepared for users. The accounting reports providing this information are called financial statements.

65. 5
Income Statement
The income statement reports the revenues and expenses for a period of time, based on the matching concept.

66. 5
Matching Concept
The matching concept is applied by matching the expenses with the revenue generated during a period by those expenses.

67. 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.

68. Net income is carried to the statement of owner’s equity.5
Exhibit 6
Financial Statements for NetSolutions
Net income is carried to the statement of owner’s equity.

69. 5 Example Exercise 1-4 Income Statement
The assets and liabilities of Chick 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 ,000
Cash 53,050 Supplies 3,350
Fees earned 263,200 Wages expense 131,700
Land 80,000
Prepare an income statement for the current year ended April 30, 2010.
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70. For the Year Ended April 30, 2010
Example Exercise 1-4 (continued) 5
Follow My Example 1-3
Follow My Example 1-4
CHICK 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 ,650
Net income $ 55,550
For Practice: PE 1-4A, PE 1-4B
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71. Statement of Owner’s Equity5
Statement of Owner’s Equity
The statement of owner’s equity reports the changes in the owner’s equity for a period of time.

72. From the income statement5
Exhibit 6
Financial Statements for NetSolutions (continued)
From the income statement
To the balance sheet

73. 5 Example Exercise 1-5 Statement of Owner’s Equity
Using the data for Chick 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.
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74. STATEMENT OF OWNER’S EQUITY For the Year Ended April 30, 2010
Example Exercise 1-5 continued 5
Follow My Example 1-5
CHICK TRAVEL SERVICE
STATEMENT OF OWNER’S EQUITY
For the Year Ended April 30, 2010
Adam Cellini, capital, May 1, $ 80, Additional investment by owner during year $ 50,000
Net income for the year 55,550
$105,550
Less withdrawals ,000
Increase in owner’s equity ,550
Adam Cellini, capital, April 30, $155,550
For Practice: PE 1-5A, PE 1-5B
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75. 5
Balance Sheet
A balance sheet is a list of the assets, liabilities, and owner’s equity as of a specific date.

76. 5
Account Form
The account form of a balance sheet lists the assets on the left and the liabilities and owner’s equity on the right—similar to the design of an account.

77. 5 Exhibit 6 Financial Statements for NetSolutions (continued)
This amount is compared to the net cash flow on the statement of cash flows.
From the statement of owner’s equity

78. 5 Example Exercise 1-6 Balance Sheet
Using the data for Chick Travel Service shown in Example Exercises 1-4 and 1-5, prepare the balance sheet as of April 30, 2010.
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79. 5 Follow My Example 1-3 Follow My Example 1-6 Assets Liabilities
Example Exercise 1-6 (continued) 5
Follow My Example 1-3
Follow My Example 1-6
CHICK TRAVEL SERVICE
BALANCE SHEET
April 30, 2010
Assets Liabilities
Cash $ 53,050 Accounts payable $ 12,200
Accounts receivable 31,350
Supplies 3, Owner’s Equity
Land 80,000 Adam Cellini, capital ,550
Total assets $167,750 Total liab. & owner’s eq. $167,750
For Practice: PE 1-6A, PE 1-6B
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80. Statement of Cash Flows5
Statement of Cash Flows
A statement of cash flows is a summary of the cash receipts and payments for a specific period of time. It consists of three sections: (1) operating activities, (2) investing activities, and (3) financing activities.

81. 5 Exhibit 6 Financial Statements for NetSolutions (continued)
This amount should match Cash on the balance sheet.

82. 5
Operating Activities
The cash flows from operating activities section reports a summary of cash receipts and cash payments from operations.

83. 5
Investing Activities
The cash flows from investing activities section reports the cash transactions for the acquisition and sale of relatively permanent assets.

84. 5
Financing Activities
The cash flows from financing activities section reports the cash transactions related to cash investments by the owner, borrowings, and withdrawals by the owner.

85. 5 Example Exercise 1-7 Statement of Cash Flows
A summary of cash flows for Chick 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 Chick Travel Service for the year ended April 30, 2010.
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86. 5 Follow My Example 1-3 Follow My Example 1-7
Example Exercise 1-7 (continued) 5
Follow My Example 1-3
Follow My Example 1-7
Cash flows from operating activities:
Cash received from customers $251,000
Deduct cash payments for expenses ,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 ,000
Net cash flows from financing activities ,000
Net decrease in cash during year $(19,000)
Cash as of May 1, ,050
Cash as of April 30, $ 53,050
For Practice: PE 1-7A, PE 1-7B
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87. Interrelationships Among Financial Statements5
Interrelationships Among Financial Statements
The income statement and the statement of owner’s equity are interrelated.
Net income or net loss appears on both statements.

88. Interrelationships Among Financial Statements5
Interrelationships Among Financial Statements
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.

89. Interrelationships Among Financial Statements5
Interrelationships Among Financial Statements
The balance sheet and the statement of cash flows are interrelated.
The cash reported on the balance sheet is also reported as the end-of-period cash on the statement of cash flows.

90. Financial Analysis and Interpretation5
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 =