Chapter 1

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

Copyright 2004 South-Western, a division

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Professor Emeritus of Accounting
Pepperdine University
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 Objectives
Objectives
1. Describe the nature After
of a business.
After studying
studying this
this
2. Describe the role of chapter,
accountingyouin should
business.
chapter, you should
3. Describe the importancebe of business
be able to: ethics and
able to:
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
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 owners equity to
analyze the ability of a business to withstand
poor business conditions.
 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
Nike
Nike Athletic
Athletic shoes
shoes and
and apparel
apparel
Coca-Cola
Coca-Cola Beverages
Beverages
Sony
Sony Stereos
Stereos and
and television
television
 Types of Businesses
Merchandising
Merchandising Business
Business

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

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

Proprietorship
Partnership
Corporation
A
Aproprietorship
proprietorship Advantages
isis owned
owned by
by one
one Ease in organizing
individual.
individual. Low cost of
organizing
Disadvantage
Joes Limited source of
financial resources
Unlimited liability
 Advantages
AApartnership
partnership isis More financial
owned
owned by
by two
two or
or resources than a
more
more individuals.
individuals. proprietorship.
Additional
management skills.
Joe and Martys Disadvantage
Unlimited liability.
 AAcorporation
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.
 Business
Business Stakeholders
Stakeholders

A business stakeholder is a person or

entity having an interest in the
economic performance of the business.
 Business
Business Ethics
Ethics
1. Avoid small ethical lapses.
Sound
Sound 2. Focus on your long-term
Principles
Principles that
that reputation.
form
form the
the 3. You may expect to suffer
foundation
foundation for
for adverse personal
ethical
ethical consequences for holding
behavior
behavior to an ethical position.
 Profession
Profession of
of Accounting
Accounting

Accountants
Accountants employed
employed by by aa business
business firm
firm or
or
aa not-for-profit
not-for-profit organization
organization are
are said
said to
to be
be
engaged
engaged inin private
private accounting.
accounting.

Accountants
Accountants and
and their
their staff
staff who
who provide
provide
services
services on
on aa fee
fee basis
basis are
are said
said to
to be
be
employed
employed inin public
public accounting.
accounting.
Generally
Generally Accepted
Accepted
Accounting
Accounting
Principles
Principles (GAAP)
(GAAP)
The
The business
business entity
entity concept
concept
limits
limits the
the economic
economic datadata inin
the
the accounting
accounting system
system to to
data
data related
related directly
directly toto the
the
activities
activities of
of the
the business.
business.
The
The cost
cost concept
concept isis the
the
basis
basis for
for entering
entering thethe
exchange
exchange price,
price, oror cost
cost
of
of anan acquisition
acquisition in in the
the
accounting
accounting records.
records.
 The
The objectivity
objectivity concept
concept
requires
requires that
that the
the accounting
accounting
records
records and
and reports
reports be
be based
based
upon
upon objective
objective evidence.
evidence.
The
The unit-of-measure
unit-of-measure
concept
concept requires
requires that
that
economic
economic data
data be
be
recorded
recorded inin dollars.
dollars.
 The
The Accounting
Accounting Equation
Equation

Assets = Liabilities + Owners Equity

The
The resources
resources
owned
owned by
byaa
business
business
 The
The Accounting
Accounting Equation
Equation

Assets = Liabilities + Owners Equity

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

Assets = Liabilities + Owners Equity

The
The rights
rights of
of the
the
owners
owners
 What is a business
transaction?

A business transaction is an economic event or

condition that directly changes an entitys 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
a. Chris Clark
Clark deposits
deposits $25,000
$25,000 in
in aa bank
bank
account in
account in the
the name
name ofof NetSolutions.
NetSolutions.

Assets = Owners Equity

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

Assets = Owners 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
c. During the
the month,
month, NetSolutions
NetSolutions purchased
purchased
supplies for
supplies for $1,350
$1,350 and
and agreed
agreed toto pay
pay the
the
supplier in
supplier in the
the near
near future
future ((on
on account
account).).
Owners
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
d. NetSolutions provided
provided services
services to
to
customers, earning
customers, earning fees
fees of
of $7,500
$7,500 and
and
received the
received the amount
amount inin cash.
cash.
Owners
Assets = Liabilities + Equity
Accounts Chris Clark,
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
 e. NetSolutions
e. NetSolutions paid
paid the
the following
following
expenses: wages,
expenses: wages, $2,125;
$2,125; rent,
rent, $800;
$800;
utilities, $450;
utilities, $450; and
and miscellaneous,
miscellaneous, $275.
$275.
Owners
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.f. NetSolutions
NetSolutions paid
paid $950
$950 to
to
creditors during
creditors during the
the month.
month.

Owners
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
g. At the
the end
end of
of the
the month,
month, thethe cost
cost
of supplies
of supplies onon hand
hand isis $550,
$550, so
so
$800 of
$800 of supplies
supplies were
were used.
used.
Owners
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
 h. At
h. At the
the end
end of
of the
the month,
month, Chris
Chris
withdrew $2,000
withdrew $2,000 inin cash
cash from
from the
the
business for
business for personal
personal use.
use.
Owners
Assets = Liabilities + Equity
Accounts Chris Clark,
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
Effects
Effects of
of Transactions
Transactions on
on Owners
Owners Equity
Equity
Owners Equity

Decreased by Increased by

Owners Owners
withdrawals investments
Expenses Revenues

Net
income
Accounting
Accounting reports,
reports, called
called
financial
financial statements,
statements,
provide
provide summarized
summarized
information
information toto the
the owner.
owner.
 Financial
Financial Statements
Statements
Income statementA summary of the revenue and
expenses for a specific period of time.
Statement of owners equityA summary of the
changes in the owners equity that have occurred during
a specific period of time.
Balance sheetA list of the assets, liabilities, and
owners equity as of a specific date.
Statement of cash flowsA 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
Tothe
the statement
statement
Net income $3 050 00
of
of owners
ownersequity
equity
 NetSolutions
Statement of Owners 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 income
From the 3 050 00
statement
statement $28 050 00
Less withdrawals 2 000 00
Increase in owners equity 26 050 00
To
Tothe
Chris Clark, capital, November 30, 2005 the $26 050 00
balance
balance sheet
sheet
 NetSolutions
Balance Sheet From
Fromthe
the
November 30, 2005 statement
statement of
of
Assets Liabilities owners
ownersequity
equity
Cash $ 5 900 00 Accounts Payable $ 400 00
Supplies 550 00 Owners Equity
Land 20 000 00 Chris Clark, cap. 26 050 00
Total liabilities and
Total assets $26 450 00 owners equity $26 450 00

This balance sheet presented

using the account form
When
When thethe balance
balance sheet
sheet displays
displays
the
the liabilities
liabilities and
and owners
owners equity
equity
below
below thethe assets,
assets, the
the report
report form
form
isis being
being used.
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 owners investment $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, 2005
Cash
Cash on thecash
onthe bal. sheet
balance
balance sheet $ 5 900 00
 Statement
Statement of
of Cash
Cash Flows
Flows
Cash Flows from Operating ActivitiesThis section
reports a summary of cash receipts and cash payments
from operations.
Cash Flows from Investing ActivitiesThis section
reports the cash transactions for the acquisition and sale
of relatively permanent assets.
Cash Flows from Financing ActivitiesThis section
reports the cash transactions related to cash
investments by the owner, borrowings, and cash
withdrawals by the owner.
 Tools
Tools for
for Financial
Financial
Analysis
Analysis and
and Interpretation
Interpretation
The
The ratio
ratio of
of liabilities
liabilities to
to owners
owners equity
equity
allows
allows owners
owners likelike Chris
Chris Clark
Clark to
to analyze
analyze
the
the firms
firms ability
ability to
to withstand
withstand poor
poor
business
business conditions.
conditions.
Ratio of liabilities Total Liabilities
=
to owners equity Total owners equity (or total
stockholders equity)
 Tools
Tools for
for Financial
Financial
Analysis
Analysis and
and Interpretation
Interpretation
Ratio of
$400
liabilities to =
owners equity $26,050

Ratio of
liabilities to = 0.015
owners equity
Chapter 1

The
The End
End