Chapter 1

Introduction to Accounting
and Business
Accounting, 21st Edition
Warren Reeve Fess

© Copyright 2004 South-Western, a division of

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Professor Emeritus of Accounting
Pepperdine University
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 Objectives
1. Describe the nature
Afterofstudying
a business.
this
2. Describe the role of accounting
chapter, in business.
you should be
3. Describe the importanceableofto:
business ethics and the
basic principles of proper ethical conduct.
4. Describe the profession of accounting.
5. Summarize the development of accounting principles
and relate them to practice.
6. State the accounting equation and define each
element of the equation.
 Objectives
7. Explain how business transactions can be stated in
terms of the resulting change in the basic elements
of the accounting equation.
8. Describe the financial statements of a
proprietorship and explain how they interrelate.
9. Use the ratio of liabilities to owner’s equity to
analyze the ability of a business to withstand poor
business conditions.
 Types of Businesses
Manufacturing Business

Product
General Motors Cars, trucks, vans
Intel Computer chips
Boeing Jet aircraft
Nike Athletic shoes and apparel
Coca-Cola Beverages
Sony Stereos and television
 Types of Businesses
Merchandising Business

Product
Wal-Mart General merchandise
Toys “R” Us Toys
Circuit City Consumer electronics
Lands’ End Apparel
Amazon.com Internet books, music, video
retailer
 Types of Businesses
Service Business

Product
Disney Entertainment
Delta Air Lines Transportation
Marriott Hotels Hospitality and lodging
Merrill Lynch Financial advice
Sprint Telecommunication
There are three types of
business organizations

 Proprietorship
 Partnership
 Corporation
A proprietorship is Advantages
owned by one • Ease in organizing
individual. • Low cost of
organizing
Disadvantage
Joe’s • Limited source of
financial resources
• Unlimited liability
 Advantages
A partnership is • More financial
owned by two or resources than a
more individuals. proprietorship.
• Additional
management skills.
Joe and Marty’s Disadvantage
• Unlimited liability.
 A corporation is
organized under state or Advantage
federal statutes as a • The ability to obtain
separate legal entity. large amounts of
resources by issuing
stocks.
J & M, Inc. Disadvantage
• Double taxation.
 Business Strategies

A business strategy is an integrated

set of plans and actions designed to
enable the business to gain an
advantage over its competitors, and in
doing so, to maximize its profits.
 Business Strategies

Under a low-cost strategy, a business

designs and produces products or
services of acceptable quality at a cost
lower than that of its competitors.
Wal-Mart
Southwest Airlines
 Business Strategies

Under a differential strategy, a business

designs and produces products or services that
possess unique attributes or characteristics
which customers are willing to pay a premium
price.
Maytag
Tommy Hilfiger
 Value Chain of a Business

A value chain is the way a

business adds value for its
customers by processing inputs
into product or service.
Business Products or Customer
Inputs
Processes Services Value
 Business Stakeholders

A business stakeholder is a person or entity

having an interest in the economic
performance of the business.
 The Process of Providing
Information
STAKEHOLDERS
Internal: External:
Identify stake- Owners, Customers,
1 holders. managers, creditors,
government
employees

Assess
stakeholders’
2 informational
needs.
 The Process of Providing
Information

Design the
Record accounting
economic Accounting
information
4 data about
business
Information
System
3 system to meet
stakeholders’
activities and needs.
events.
 The Process of Providing
Information
STAKEHOLDERS
Internal: External:
Owners, Customers,
managers, creditors,
employees government

Prepare accounting
5 reports for
stakeholders.
Accounting
Information
System
 Business Ethics

1. Avoid small ethical lapses.

Sound
2. Focus on your long-term
Principles that reputation.
form the
3. You may expect to suffer
foundation for adverse personal
ethical behavior consequences for holding to
an ethical position.
 Profession of Accounting

Accountants employed by a business firm or a

not-for-profit organization are said to be engaged
in private accounting.

Accountants and their staff who provide services

on a fee basis are said to be employed in public
accounting.
 Generally Accepted
Accounting Principles
(GAAP)
 The business entity concept
limits the economic data in the
accounting system to data
related directly to the activities
of the business.
The cost concept is the
basis for entering the
exchange price, or cost of
an acquisition in the
accounting records.
 The objectivity concept
requires that the accounting
records and reports be based
upon objective evidence.
The unit-of-measure
concept requires that
economic data be
recorded in dollars.
 The Accounting Equation

Assets = Liabilities + Owner’s Equity

The resources
owned by a
business
 The Accounting Equation

Assets = Liabilities + Owner’s Equity

The rights of the

creditors, which
represent debts of
the business
 The Accounting Equation

Assets = Liabilities + Owner’s Equity

The rights of the

owners
 What is a business
transaction?

A business transaction is an economic event or condition

that directly changes an entity’s financial condition or
directly affects its results of operations.
 On November 1,
2005, Chris Clark
begins a business
that will be known
as NetSolutions.
a. Chris Clark deposits $25,000 in a bank
account in the name of NetSolutions.

Assets = Owner’s Equity

Cash Chris Clark, Capital
=
a. 25,000 25,000 Investment by
Chris Clark
 b. NetSolutions exchanged $20,000 for land.

Assets = Owner’s Equity

Cash + Land Chris Clark, Capital
Bal. 25,000 = 25,000
b. –20,000 +20,000
Bal. 5,000 20,000 25,000
 c. During the month, NetSolutions purchased
supplies for $1,350 and agreed to pay the
supplier in the near future (on account).
Owner’s
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
 d. NetSolutions provided services to
customers, earning fees of $7,500 and
received the amount in cash.
Owner’s
Assets = Liabilities + Equity
Accounts Chris Clark,
Cash + Supplies + Land Payable Capital
Bal. 5,000 1,350 20,000 = 1,350 25,000
Fees
d. + 7,500 + 7,500 earned
Bal. 12,500 1,350 20,000 1,350 32,500
 e. NetSolutions paid the following expenses:
wages, $2,125; rent, $800; utilities, $450;
and miscellaneous, $275.
Owner’s
Assets = Liabilities + Equity
Accounts Chris Clark,
Cash + Supplies + Land Payable Capital
Bal. 12,500 1,350 20,000 1,350 32,500
e. – 3,650 –2,125 Wages
=
– 800 Rent
– 450 Util.
– 275 Misc.

Bal.8,850 1,350 20,000 1,350 28,850

 f. NetSolutions paid $950 to creditors
during the month.

Owner’s
Assets = Liabilities + Equity
Accounts Chris Clark,
Cash + Supplies + Land Payable Capital
Bal. 8,850 1,350 20,000 = 1,350 28,850
f. – 950 – 950
Bal. 7,900 1,350 20,000 400 28,850
 g. At the end of the month, the cost of
supplies on hand is $550, so $800 of
supplies were used.
Owner’s
Assets = Liabilities + Equity
Accounts Chris Clark,
Cash + Supplies + Land Payable Capital
Bal. 7,900 1,350 20,000 = 400 28,850
Supplies
g. – 800 – 800 expense
Bal. 7,900 550 20,000 400 28,050
 h. At the end of the month, Chris
withdrew $2,000 in cash from the
business for personal use.
Owner’s
Assets = Liabilities + Equity
Accounts Chris Clark,
Cash + Supplies + Land Payable Capital
Bal. 7,900 550 20,000 = 400 28,050
With-
h. –2,000 –2,000 drawal
Bal. 5,900 550 20,000 400 26,050
Effects of Transactions on Owner’s Equity

Owner’s Equity

Decreased by Increased by

Owner’s Owner’s
withdrawals investments
Expenses Revenues

Net
income
 Accounting reports, called
financial statements, provide
summarized information to
the owner.
 Financial Statements
• Income statement—A summary of the revenue and
expenses for a specific period of time.
• Statement of owner’s equity—A summary of the
changes in the owner’s equity that have occurred
during a specific period of time.
• Balance sheet—A list of the assets, liabilities, and
owner’s equity as of a specific date.
• Statement of cash flows—A summary of the cash
receipts and disbursements for a specific period of
time.
 NetSolutions
Income Statement
For the Month Ended November 30, 2005
Fees earned $7 500 00
Operating expenses:
Wages expense $2 125 00
Rent expense 800 00
Supplies expense 800 00
Utilities expense 450 00
Miscellaneous expense 275 00
Total operating expenses 1 135 00
To the statement of
Net income $3 050 00
owner’s equity
 NetSolutions
Statement of Owner’s Equity
For the Month Ended November 30, 2005
Chris Clark, capital, November 1, 2005 $ 0
Investment on November 1 $25 000 00
From the income
Net income for November 3 050 00
statement
$28 050 00
Less withdrawals 2 000 00
Increase in owner’s equity 26 050 00
To
Chris Clark, capital, November 30, 2005
the balance $26 050 00
sheet
 NetSolutions
Balance Sheet From the
November 30, 2005 statement of
Assets Liabilities owner’s equity
Cash $ 5 900 00 Accounts Payable $ 400 00
Supplies 550 00 Owner’s Equity
Land 20 000 00 Chris Clark, cap. 26 050 00
Total liabilities and
Total assets $26 450 00 owner’s equity $26 450 00

This balance sheet presented

using the account form
When the balance sheet displays the
liabilities and owner’s equity below
the assets, the report form is being
used.
 NetSolutions
Statement of Cash Flows
For the Month Ended November 30, 2005
Cash flows from operating activities:
Cash received from customers $ 7 500 00
Deduct cash payments for expenses
and payments to creditors 4 600 00
Net cash flow from operating activities 2 900 00
Cash flows from investing activities:
Cash payment for acquisition of land (20 000 00 )
Cash flows from financing activities:
Cash received as owner’s investment $25 000 00
Deduct cash withdrawal by owner 2 000 00
Net cash flow from financing activities 23 000 00
Net cash flow andmatch
Should Nov. 30,
Cash2005 cashbalance
on the bal. sheet $ 5 900 00
 Statement of Cash Flows
Cash Flows from Operating Activities—This section
reports a summary of cash receipts and cash payments from
operations.
Cash Flows from Investing Activities—This section reports
the cash transactions for the acquisition and sale of relatively
permanent assets.
Cash Flows from Financing Activities—This section
reports the cash transactions related to cash investments by
the owner, borrowings, and cash withdrawals by the owner.
 Tools for Financial Analysis
and Interpretation

The ratio of liabilities to owner’s equity allows

owners like Chris Clark to analyze the firm’s
ability to withstand poor business conditions.

Ratio of liabilities Total Liabilities

=
to owner’s equity Total owner’s equity (or total
stockholders’ equity)
Tools for Financial Analysis
and Interpretation
Ratio of
$400
liabilities to =
owner’s equity $26,050

Ratio of
liabilities to = 0.015
owner’s equity
Chapter 1

The End