Chapter 1

Introduction to Accounting
and Business

By Tewodros E.
 Objectives
Objectives
1. After
Describe the nature studying
Afterof this
a business.
studying this
2. chapter,
chapter,
Describe the role you
you should
of accountingshould
in business.
be
be able
able to:
to:
3. Describe the profession of accounting.
4. Summarize the development of accounting
principles and relate them to practice.
5. State the accounting equation and define each
element of the equation.

By Tewodros E.
 Objectives
Objectives
6. Explain how business transactions can be
stated in terms of the resulting change in
the basic elements of the accounting
equation.
7. Describe the financial statements of a
proprietorship and explain how they
interrelate.

By Tewodros E.
 Types of Businesses
A. Based on Business Activities
 Types of business organizations: business organizations may be
divided in to three based on
• the type of activities they perform or are engaged in to generate
income,
1. Service: an enterprise that renders professional and technical
services.
• Example: Banks, Telecommunication and Transportation
Companies.
2. Merchandising: an enterprise that buys and resells finished goods to
customers.
• Example: Stationery Shops, Retail and Wholesale Stores,
Supermarkets, etc.
3. Manufacturing: an enterprise that buys and converts raw materials
into finished products for sale to other businesses (merchandising) or
direct to consumers.
• Example: Textile and Cement Factories, Wood and Metal-
 Types of Businesses
Manufacturing
Manufacturing Business
Business

Product
Product
General
General Motors
Motors Cars,
Cars, trucks,
trucks, vans
vans
Intel
Intel Computer
Computer chips
chips
Boeing
Boeing Jet
Jet aircraft
aircraft
Metehara
Metehara sugar
sugar Sugar
Sugar
Coca-Cola
Coca-Cola Beverages
Beverages
Sony
Sony Stereos
Stereos and
and television
television
By Tewodros E.
 Types of Businesses
Merchandising
Merchandising Business
Business

Product
Product
Wal-Mart
Wal-Mart General
General merchandise
merchandise
Al-Sam
Al-Sam Merchandise
Merchandise
Mega
Mega Books
Books Books
Books and
and stationery
stationery
Amazon.com
Amazon.com Internet
Internet books,
books, music,
music, video
video
retailer
retailer

By Tewodros E.
 Types of Businesses
Service
Service Business
Business

Product
Product
Bekelcha
Bekelcha Transport
Transport Transportation
Transportation
Wabe
Wabe Shebele
Shebele Hotels
Hotels Hospitality
Hospitality and
and lodging
lodging
Awash
Awash IB
IB Financial
Financial advice
advice
ETC
ETC Telecommunication
Telecommunication

By Tewodros E.
There
There are
are three
three types
types of
of
business
business organizations
organizations

 Proprietorship
 Partnership
 Corporation

By Tewodros E.
Forms of Business Organizations
B. Based on Ownership
1. Sole proprietorship:
 an enterprise owned by one person and usually operated and
managed by the same person.
 The sole proprietorship form of business is not a separate legal
entity from its owner.
2. Partnership:
 an enterprise owned by two/more persons called partners and
the partners are usually engaged in operations and
management of the organization.
3. Corporation:
 an enterprise owned usually by three/more persons called
shareholders or stockholders.
 The unique feature of a corporation is that it is a legal entity.

By Tewodros E.
A
A proprietorship
proprietorship Advantages
isis owned
owned by
by one
one • Ease in organizing
individual.
individual. • Low cost of
organizing
Disadvantage
Ato Kebede • Limited source of
financial resources
• Unlimited liability

By Tewodros E.
 Advantages
AA partnership
partnership isis • More financial
owned
owned by
by two
two or
or resources than a
more
more individuals.
individuals. proprietorship.
• Additional
Ato Kebede & W/ro
management skills.
Munira
Disadvantage
• Unlimited liability.

By Tewodros E.
 AA corporation
corporation isis
organized
organized under
under state
state Advantage
or
or federal
federal statutes
statutes as
as aa • The ability to obtain
separate
separate legal
legal entity.
entity. large amounts of
resources by issuing
stocks.
J & M, Inc. Disadvantage
• Double taxation.

By Tewodros E.
What is Accounting?
Accounting is a process of identifying, recording,
classifying, summarizing and interpreting the economic
activity of a business to make informed decisions.
The processes are defined below:
 Recording- transactions being recorded in the
books of the business
 Classifying- sorting and categorizing into
meaningful and orderly types or manners
 Summarizing- the accounting data are
summarized
 Interpreting- financial data are analyzed and
used to assist decision making
By Tewodros E.
Profession of Accounting

By Tewodros E.
By Tewodros E.
The Difference Between Book Keeping and Accounting
Accounting is a process of recording, classifying, summarizing and the
interpretation of the financial statements.
The processes are defined below:
 Recording- transactions being recorded in the books of the business
 Classifying- sorting and categorizing into meaningful and orderly types or
manners
 Summarizing- the accounting data are summarized
 Interpreting- financial data are analyzed and used to assist decision making
Bookkeeping is a part of Accounting.
It is merely a mechanical aspect of recording, classifying and summarizing
transaction.
Therefore, keeping the books of accounts is always the theme in
bookkeeping.
The finer aspect of interpreting all these data into information for
management to act upon is excluded.

By Tewodros E.
By Tewodros E.
By Tewodros E.
By Tewodros E.
Generally
Generally Accepted
Accepted
Accounting
Accounting
Principles
Principles (GAAP)
(GAAP)

By Tewodros E.
 Generally Accepted Accounting Principles (GAAP)
GAAP are
• the generally guidelines of the accountant
• throughout the practices of accounting and reporting
for the financial affairs of an economic entity
including governmental, non-governmental,
business and non-business organizations.
 GAAP include
• general concepts,
• assumptions,
• principles as well as
• specific accounting and reporting procedures, policies
and methods such as inventory valuation, revenue
recognition, depreciation
By Tewodroscomputation,
E. etc.
• Business Entity Concept:
• According to this assumption, each economic entity
– should be separated from and
– independent of its owner/s and other economic entities
under the same or different owner/s.
• Historical Cost Principle
• This principle states that goods and services
purchased or sold
– should be recorded in the accounting records and
– then reported on the financial statements at the initial
amount of cash or cash equivalent rather than on an
estimated/appraised/assessed or market value.

By Tewodros E.
 Objectivity Principle –
According to this principle, an economic entity’s financial
affairs to be recorded in its accounting records and reported
on its financial statements

 must be supported by objectively

determinable evidences
 known as source documents.
Monetary
Monetary Unit
Unit
The unit-of-measure
The unit-of-measure concept
concept requires
requires
that
that economic
economic data
data be
be recorded
recorded in
in
Birr/dollars.
Birr/dollars.
By Tewodros E.
 The
The Accounting
Accounting Equation
Equation

Assets = Liabilities + Owner’s Equity

The
The resources
resources
owned
owned by
by aa
business
business

By Tewodros E.
 The
The Accounting
Accounting Equation
Equation

Assets = Liabilities + Owner’s Equity

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

By Tewodros E.
 The
The Accounting
Accounting Equation
Equation

Assets = Liabilities + Owner’s Equity

The
The rights
rights of
of the
the
owners
owners

By Tewodros E.
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.
For example
1.Purchase of goods or services
2.Sales of goods and services
3.Paying salary for employees
4.Settlement of debt etc
By Tewodros E.
On November 1, 2005, Ato Megabi begins
a business that will be known as
NetSolutions.

By Tewodros E.
a) Ato
a) Ato Megabi
Megabi deposits
deposits birr
birr 25,000
25,000 in
in aa bank
bank
account in
account in the
the name
name of
of Net
Net Solutions.
Solutions.

Assets = Owner’s Equity

Cash Ato Megabi, Capital
= 25,000 Investment
a. 25,000
by Ato
Megabi

By Tewodros E.
b. NetSolutions
b. NetSolutions acquired
acquired Birr
Birr 20,000
20,000 for
for
land.
land.

Assets = Owner’s Equity

Cash + Land Ato Megabi, Capital
Bal. 25,000 = 25,000
b. –20,000 +20,000
Bal. 5,000 20,000 25,000

By Tewodros E.
 c. During
c. During the
the month,
month, NetSolutions
NetSolutions purchased
purchased
supplies for
supplies for Br.1,350
Br.1,350 and
and agreed
agreed to
to pay
pay the
the
supplier in
supplier in the
the near
near future
future ((on
on account
account).).
Owner’s
Assets = Liabilities + Equity
Accounts Ato Megabi,
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

By Tewodros E.
 d. NetSolutions
d. NetSolutions provided
provided services
services to
to
customers, earning
customers, earning fees
fees of
of Br.7,500
Br.7,500
and received
and received the
the amount
amount in
in cash.
cash.
Owner’s
Assets = Liabilities + Equity
Accounts Ato Megabi,
Cash + Supplies + Land Payable Capital
Bal. 5,000 1,350 20,000 = 1,350 25,000
d. + 7,500 + 7,500 Fees
earned
Bal. 12,500 1,350 20,000 1,350 32,500

By Tewodros E.
 e. NetSolutions
e. NetSolutions paid
paid the
the following
following
expenses: wages,
expenses: wages, Br.2,125;
Br.2,125; rent,
rent, Br.800;
Br.800;
utilities, Br.450;
utilities, Br.450; and
and miscellaneous,
miscellaneous,
Br.275.
Br.275. Owner’s
Assets = Liabilities + Equity
Accounts Ato Megabi,
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
By Tewodros E.
 f.f. NetSolutions
NetSolutions Br.950
Br.950 to
to creditors
creditors
during the
during the month.
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

By Tewodros E.
 g. At
g. At the
the end
end of
of the
the month,
month, the the cost
cost
of supplies
of supplies on
on hand
hand isis Br.
Br. 550,
550, so
so
Br. 800
Br. 800 of
of supplies
supplies were
were used.
used.
Owner’s
Assets = Liabilities + Equity
Accounts Chris Clark,
Cash + Supplies + Land Payable Capital
Bal. 7,900 1,350 20,000 = 400 28,850
g. – 800 – 800 Supplies
expense
Bal. 7,900 550 20,000 400 28,050

By Tewodros E.
 h. At
h. At the
the end
end of
of the
the month,
month, Megabi
Megabi
withdrew Br.2,000
withdrew Br.2,000 in
in cash
cash from
from
the business
the business for
for personal
personal use.
use.
Owner’s
Assets = Liabilities + Equity
Accounts Ato Megabi,
Cash + Supplies + Land Payable Capital
Bal. 7,900 550 20,000 = 400 28,050
h. –2,000 –2,000 With-
drawal
Bal. 5,900 550 20,000 400 26,050

By Tewodros E.
Effects
Effects of
of Transactions
Transactions on
on Owner’s
Owner’s Equity
Equity
Owner’s Equity

Decreased by Increased by

Owner’s Owner’s
withdrawals investments
Expenses Revenues

Net
income
By Tewodros E.
Accounting
Accounting reports,
reports, called
called
financial
financial statements,
statements,
provide
provide summarized
summarized
information
information toto the
the owner.
owner.

By Tewodros E.
 Financial
Financial Statements
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.

By Tewodros E.
 NetSolutions
Income Statement
For the Month Ended November 30, 2005
Fees earned Br.7 500
Operating expenses: 00
Wages expense Br.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
To the
the statement
statement
Net income 3 050 00
of
of owner’s
owner’s equity
equity

By Tewodros E.
 NetSolutions
Statement of Owner’s Equity
For the Month Ended November 30, 2005
Ato Megabi, capital, November 1, 2005 Br. 0
Investment on November 1 Br.25 000 00
From the income
Net income for November income
From the 3 050 00
statement
statement Br.28 050 00
Less withdrawals 2 000 00
Increase in owner’s equity 26 050 00
To
To the
Ato Megabi, capital, November 30, 2005 the Br.26 050 00
balance
balance sheet
sheet

By Tewodros E.
 NetSolutions
Balance Sheet
November 30, 2005
Assets Liabilities From
From the
the
Cash Br. 5 900 00 Accounts Payablestatement
Br. 400of
statement of00
Supplies 550 00 owner’s
owner’s equity
Owner’s Equity equity
Land 20 000 00 Ato Megabi, cap. 26 050 00
Total liabilities and
Total assets Br. 26 450 00 owner’s equity Br. 26 450 00

This balance sheet presented

using the account form
By Tewodros E.
When
When thethe balance
balance sheet
sheet displays
displays
the
the liabilities
liabilities and
and owner’s
owner’s equity
equity
below
below thethe assets,
assets, the
the report
report form
form
isis being
being used.
used.

By Tewodros E.
 NetSolutions
Statement of Cash Flows
For the Month Ended November 30, 2005
Cash flows from operating activities:
Cash received from customers Br. 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 Br.25 000 00
Deduct cash withdrawal by owner 2 000 00
Net cash flow from financing activities 23 000 00
Net cashShould
flow and
Should Nov.
match
match 30, on
Cash
Cash 2005thecash
onthe bal. sheet
balance
balance sheet Br. 5 900 00
By Tewodros E.
 Statement
Statement of
of Cash
Cash Flows
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.
By Tewodros E.
 The
End!
By Tewodros E.