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Learning Objectives

1. Describe the nature of a business and 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.
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.
6. Describe and illustrate the use of the ratio of liabilities to owner’s
equity in evaluating a company’s financial condition.
 Learn
i ng O
bject
i ve
1
Desc
ribe t
he na
ro ture
le of e
accou of a busi
nting ness,
, an d th
ethic e
s in
busin
ess.

c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Nature of Business and Accounting

o A business is an organization in which basic

resources (inputs), such as materials and labor, are
assembled and processed to provide goods or
services (outputs) to customers.
Nature of Business and Accounting

o The objective of most businesses is to earn a profit.

o Profit is the difference between the amounts received
from customers for goods or services and the
amounts paid for the inputs used to provide the goods
or services.
Types of Businesses

Service Businesses Service

Delta Air Lines Transportation services
The Walt Disney Company Entertainment services

Merchandising Businesses Product

WalMart General merchandise
Amazon.com Internet books, music, videos

Manufacturing Businesses Product

Ford Motor Company Cars, trucks, vans
Dell Inc. Personal computers
The Role of Accounting in Business

o Accounting can be defined as an information system

that provides reports to users about the economic
activities and condition of a business.
The Role of Accounting in Business

o The process by which accounting provides

information to users is as follows:
 Identify users.
 Assess users’ information needs.
 Design the accounting information system to meet users’
needs.
 Record economic data about business activities and events.
 Prepare accounting reports for users.
 THE ROLE OF
ACCOUNTING IN
BUSINESS
Managerial Accounting

o The area of accounting that provides internal users

with information is called managerial accounting or
management accounting.
o Managerial accountants employed by a business are
employed in private accounting.
Financial Accounting

o The area of accounting that provides external users

with information is called financial accounting.
o The objective of financial accounting is to provide
relevant and timely information for the decision-
making needs of users outside of the business.
o General-purpose financial statements are one type of
financial accounting report that is distributed to
external users.
Role of Ethics in Accounting and Business

o The objective of accounting is to provide relevant,

timely information for user decision making.
o Accountants must behave in an ethical manner so that
the information they provide users will be
trustworthy and, thus, useful for decision making.
o Ethics are moral principles that guide the conduct of
individuals.
Role of Ethics in Accounting and Business
Role of Ethics in Accounting and Business

The answer to …  Failure of individual

character
“What went wrong for these  Firm culture of greed and
companies?” … ethical indifference

involves one or both of these

factors. (Exhibit 2)
Role of Ethics in Accounting and Business
Opportunities for Accountants

o Accountants and their staff who provide services on

a fee basis are said to be employed in public
accounting.
o Accountants employed by a business firm,
government, or a not-for-profit organization are said
to be employed in private accounting.
o Public accountants who have met a state’s education,
experience, and examination requirements may become
Certified Public Accountants (CPAs).
Opportunities for Accountants
 Learn
i ng O
bject
i v e
accou
nt i n
S umma
r i ze ng pri
ncipl the develo
es a n
2
d rela pment of
te the
m to
pract
i ce .

c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Generally Accepted Accounting Principles

o Financial accountants follow generally accepted

accounting principles (GAAP) in preparing reports.
o Within the U.S., the Financial Accounting Standards
Board (FASB) has the primary responsibility for
developing accounting principles.
Generally Accepted Accounting Principles

o 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 (stock) are
traded and sold to the public.
o Many countries outside the United States use
generally accepted accounting principles adopted by
the International Accounting Standards Board
(IASB).
Business Entity Concept

o Under the business entity concept, the activities of a

business are recorded separately from the activities
of its owners, creditors, or other businesses.
PROPRIETORSHIP

A proprietorship is owned  70% of business entities

by one individual. in the U.S. are
proprietorships.
 They are easy and cheap
to organize.
 Resources are limited to
those of the owner.
 Used by small
businesses.
PARTNERSHIP

A partnership is similar  10% of business

to a proprietorship organizations in the
U.S. (combined with
except that it is owned
limited liability
by two or more companies) are
individuals. partnerships.
 Combines the skills
and resources of more
than one person.
CORPORATION

A corporation is  Generates 90% of business

revenues.
organized under state  20% of the business
or federal statutes as a organizations in the U.S.
separate legal taxable  Ownership is divided into
shares, called stock.
entity.
 Can obtain large amounts
of resources by issuing
stock.
 Used by large businesses.
LIMITED LIABILITY COMPANY
(LLC)
A limited liability  10% of business
company (LLC) organizations in the
combines the attributes U.S. (combined with
of a partnership and a partnerships).
corporation.  Often used as an
alternative to a
partnership.
 Has tax and legal
liability advantages
for owners.
Cost Concept

o Under the cost concept, amounts are initially

recorded in the accounting records at their cost or
purchase price.
Cost Concept

o Aaron Publishers purchased a building on February

20, 2012, for $150,000. Other amounts related to this
purchased are shown on the next slide.
Cost Concept

 Price listed by seller on Jan. 1, 2012 $160,000

 Aaron Publishers’ initial offer to buy on Jan. 31, 2012 140,000
 Purchase price on Feb. 20, 2012 150,000
 Estimated selling price on Dec. 31, 2014 220,000
 Assessed value for property taxes, Dec. 31, 2014 190,000

Under the cost concept, Aaron Publishers records the purchase

of the building on February 20, 2012, at the purchase price of
$150,000.
The other amounts listed above have no effect on the
accounting records.
Objectivity Concept

o The objectivity concept requires that the amounts

recorded in the accounting records be based on
objective evidence.
o Only the final agreed-upon amount is objective
enough to be recorded in the accounting records.
Unit of Measure Concept

o The unit of measure concept requires that economic

data be recorded in dollars.
 Learn
i ng O
State bj ectiv
the ac
coun
t i ng e
e 3
each quati
e l em on an
en t o d
f the define
equat
ion

c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
The Accounting Equation

o The resources owned by a business are its assets.

o The rights of creditors are the debts of the business
and are called liabilities.
o The rights of the owners are called owner’s equity.
o The equation Assets = Liabilities + Owner’s Equity
is called the accounting equation.
 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
creditors are the
debts of the
business
 THE
ACCOUNTING
EQUATION

Assets = Liabilities + Owner’s Equity

The rights of the

owners
 Learn
i ng O
bj e ct i v e
trans D
actio
e
ns
scribe
an
ting c
d i ll u
resul can be re strate ho
c
hang orded in
w bu
s
4
e in t terms iness
he ele of the
accou m ents o
nting f the
equat
io n

c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Business Transaction

o A business transaction is an economic event or

condition that directly changes an entity’s financial
condition or its results of operations.
TRANSACTION A

On November 1, 2013, Chris Clark deposited

$25,000 in a bank account in the name of
NetSolutions.
TRANSACTION B

On November 5, 2013, NetSolutions paid

$20,000 for the purchase of land as a future
building site.
TRANSACTION C

On November 10, 2013, NetSolutions

purchased supplies for $1,350 and agreed to
pay the supplier in the near future.
Transaction C

o The liability created by a purchase on account is

called an account payable.
o Items such as supplies that will be used in the
business in the future are called prepaid expenses,
which are assets.
TRANSACTION D

On November 18, 2013, 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.
Transaction D

o Revenue from providing services is recorded as fees

earned.
o Revenue from the sale of merchandise is recorded as
sales.
o Other examples of revenue include rent, which is
recorded as rent revenue, and interest, which is
recorded as interest revenue.
o An account receivable is a claim against a customer,
which is an asset.
TRANSACTION E

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.
TRANSACTION E

On November 30, 2013, NetSolutions paid the

following expenses: wages, $2,125; rent, $800;
utilities, $450; and miscellaneous, $275.
TRANSACTION F

On November 30, 2013, NetSolutions paid

creditors on account, $950.
TRANSACTION G

On November 30, 2013, Chris Clark

determined that the cost of supplies on
hand at the end of the period was $550.
TRANSACTION H

On November 30, 2013, Chris Clark

withdrew $2,000 from NetSolutions for
personal use.
SUMMARY
Types of Transactions Affecting Owner’s Equity
 Learn
i ng O
bject
Desc i v e
ribe t
propr
i
he f inanc
etors
hip a cial statem
nd ex
5
plain ents of a
how
interr they
el a t e.

c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Financial Statements

o After transactions have been recorded and

summarized, reports are prepared for users. The
accounting reports providing this information are
called financial statements.
 FINANCIAL
STATEMENTS
Income Statement

o The income statement reports the revenues and expenses

for a period of time, based on the matching concept.
o The matching concept is applied by “matching” the
expenses incurred during a period with the revenue that
those expenses generated.
o The excess of the revenue over the expenses is called net
income, net profit, or earnings. If expenses exceed
revenue, the excess is a net loss.
Statement of Owner’s Equity

o The statement of owner’s equity reports the changes

in the owner’s equity for a period of time.
o It is prepared after the income statement because the
net income or net loss for the period must be
reported in this statement.
Financial Statements – Income Statement

Net income is carried to

the statement of
owner’s equity.
Financial Statements – Statement of Owner’s Equity

From the income statement

To the balance sheet

(continued)
Balance Sheet

o A balance sheet is a list of the assets, liabilities, and

owner’s equity as of a specific date.
Account Form

o The account form of a balance sheet lists the assets

on the left and the liabilities and owner’s equity on
the right. It resembles the basic format of the
accounting equation.
Financial Statements – Balance Sheet

This amount is
compared to the From the statement
net cash flow on of owner’s equity
the statement of
cash flows.
(continued)
Statement of Cash Flows

o A statement of cash flows is a summary of the cash

receipts and cash payments for a specific period of
time.
 It consists of three sections:
(1) operating activities
(2) investing activities
(3) financing activities
Financial Statements – Statement of Cash Flows

This amount should match

Cash on the balance sheet
(concluded)
Cash Flows from Operating Activities
o The cash flows from operating activities section
reports a summary of cash receipts and cash
payments from operations.
Cash Flows from Investing Activities

o The cash flows from investing activities section

reports the cash transactions for the acquisition and
sale of relatively permanent assets.
Cash Flows from Financing Activities

o The cash flows from financing activities section

reports the cash transactions related to cash
investments by the owner, borrowings, and
withdrawals by the owner.
INTERRELATIONSHIPS
AMONG FINANCIAL
STATEMENTS
Income Statement and  Net income or net loss
Statement of Owner’s reported on the
Equity income statement is
also reported on the
statement of owner’s
equity and any
additional investments
by the owner during
the year.
Interrelationships Among Financial Statements

o In Exhibit 6, NetSolutions’ net income of $3,050 for

November is added to Chris Clark’s investment of
$25,000 in the statement of owner’s equity.
INTERRELATIONSHIPS
AMONG FINANCIAL
STATEMENTS
Statement of Owner’s  The owner’s capital
Equity and Balance at the end of the
Sheet period is reported on
the statement of
owner’s equity and
is also reported on
the balance sheet as
owner’s capital.
Interrelationships Among Financial Statements

o In Exhibit 6, Chris Clark, Capital of $26,050 as of

November 30, 2013, on the statement of owner’s
equity also appears on the November 30, 2013,
balance sheet as Chris Clark, Capital.
INTERRELATIONSHIPS
AMONG FINANCIAL
STATEMENTS
Balance Sheet and  The cash reported
Statement of Cash on the balance sheet
Flows is also reported as
the end-of-period
cash on the
statement of cash
flows.
Interrelationships Among Financial Statements

o In Exhibit 6, cash of $5,900 reported on the balance

sheet as of November 30, 2013, is also reported on
the November statement of cash flows as the end-of-
period cash.
 Learn
i ng O
bject
Desc i v e
ratio ribe and
of lia illust
ating
r
evalu bilities to rate the us
owne e of t
6
a com r ’s eq he
pany u
’s fin ity in
an
condi cial
tion.

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 RATIO OF
LIABILITIES TO
OWNER’S
EQUITY
Ratio of Liabilities Total Liabilities
=
to Owner’s Equity Total Owner’s Equity (or Total
Stockholders’ Equity)

Ratio of Liabilities $400

= = 0.015
to Owner’s Equity $26,050
 n t i n g
c c o u
n to A s s
uc t i o u s i n e
nt r od n d B
I a d
hee E nd
T
c. 2014 Cengage Learning.   All Rights Reserved.  May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.