Chapter one

Introduction to Accounting and Business

ACCOUNTING: is the process of identifying, recording and communicating economic events
of an organization to the interested users. Let’s take a c loser look at these three activities. The
first one is identifying which means selecting economic events. The next activity is recording;
which contain recording, classifying and summarizing the transactions. And the last activity is
communicating; which reflects preparing report then analyzes and interprets to the users.
1.1. The nature of a business
A business is an organization in which basic resources re assembled and processed to provide
goods or services to customer. It is the activity of making one’s living or making money by
producing or buying and selling products (goods and services). It comes in all size that means
from local coffee to large corporation. The objective of most businesses is to maximize profits.
Profit is the difference between the amounts received from customers for goods or services
provided and the amounts paid for the inputs used to provide the goods or services.

Some businesses operate with an objective other than to maximize profits. The objective of such
nonprofit businesses is to provide some benefit to society. In other cases, governmental units
such as cities operate water works sewage treatment plants on a nonprofit basis. However the
focus of this course is businesses operating to earn a profit.

Types of businesses
There are three major types of business:
 Manufacturing businesses: a business in which change basic inputs into products that are
sold to individual customers. E.g. zebider beer, Coca-cola, Sony, Nike, General Motors
 Merchandising businesses: by which purchase products and also resell products to
customers. However, rather than making the products, they purchase them from other
businesses (such as manufacturers). It brings product and customer together E.g. Wal-Mart,
Amazon.com
 Service giving businesses: it provides services rather than products to customers. It is based
on the profession. E.g. Air Lines, Hospitals

Forms/types of Business Organizations

Proprietorship: it is owned by one individual and usually managed by the owner. The
popularity of this form is due to the ease and the low cost of organizing. The primary
disadvantage of proprietorships is that the financial resources available to the business are
limited to the individual owner’s resources and has unlimited liability. A proprietorship is a
separate entity for accounting purposes but it is not a separate legal entity from the owners. That
is, from the legal point of view, the owner and the business are treated as one and the same. The
owner will be held personally responsible for the debts and actions of the business.

Partnership: is owned by two or more individuals. It has more financial resources than a
proprietorship and has additional management skills. Its disadvantage is unlimited liability. The
partners share the profits and losses of the partnership according to an agreed –on formula. The
personal resources of each partner can be called on to pay the obligations of the partnership. That
is, each partner is personally responsible for the debts of the partnership. From an accounting
standpoint, however, a partnership is a business entity separate from the personal activities of the
partners.

Corporation: is organized under state or federal statutes as a separate legal taxable entity. The
ownership of a corporation is divided into shares of stock. A corporation issues the stock to
individuals or other businesses, who then become owners or stockholders of the corporation. Its
advantage is the ability to obtain large amounts of resources by issuing stocks. The stockholders
are free to sell all or part of their shares to other investors at any time. This ease of transfer of
ownership adds to the attractiveness of investing in a corporation.

Since a corporation is a separate legal entity, the stockholders are not personally liable for the
debts of the corporation. Their risk of loss is limited to the amount they paid (invested). Because
of this limited liability in a corporation shareholders are willing to invest in riskier, but
potentially more profitable, activities. Its disadvantage is 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. The two basic
strategies a business may use are a low-cost strategy or a differentiation strategy.
Low-cost strategy, a business designs and produces products or services of acceptable quality
at a cost lower than that of its competitors. A primary concern of a business using a low-cost
strategy is that a competitor may achieve even lower costs by replicating the low costs or
developing technological advances
Differentiation strategy, a business designs and produces products or services that possess
unique attributes or characteristics for which customers are willing to pay a premium price. For
the differentiation strategy to be successful, a product or service must be truly unique or
perceived as unique in quality, reliability, image, or design.
A business may attempt to implement a combination strategy that includes elements of both
the low-cost and differentiation strategies. That is, a business may attempt to develop a
differentiated product at competitive, low-cost prices.

1.2. The role of accounting in business

Accounting provides information for managers to use in operating the business. In addition,
accounting provides information to other stakeholders to use in assessing the economic
performance and condition of the business. In a general sense, accounting can be defined as an
information system that provides reports to stakeholders about the economic activities and
condition of a business

You may think of accounting as the “language of business.” This is because accounting is the
means by which business information is communicated to the stakeholders. Stakeholders use
accounting reports as a primary source of information on which they base their decisions.
Stakeholders can be internal and external.
 Internal: These are persons that are directly involved in managing and operating an
organization. The area of accounting aimed at serving the decision-making needs of internal
users is called Management Accounting. E.g. Owners, managers and human resource
 External: they are parties, which are not directly involved in running the business enterprise.
The area of accounting aimed at serving external users is called Financial Accounting. E.g.
Customers, creditors, employees, governments and others
1.3. The profession of Accounting
Accountants engage in either private accounting or public accounting.

Private Accounting: Accountants employed by a business firm or a not-for-profit organization.

The scope of activities and duties of private accountants varies widely. Private accountants are
frequently called management accountants. If they are employed by a manufacturer, they may be
referred to as industrial or cost accountants.

Public accounting: Accountants and their staff who provide services on a fee basis. In public
accounting, an accountant may practice as an individual or as a member of a public accounting
firm. A major portion of public accounting practice is involved with Auditing. Public
accountants who have met a state’s education, experience, and examination requirements may
become Certified Public Accountants (CPAs).

Specialized Accounting Fields

Several specialized field in accounting have evolved as a result of ever increasing rapid
technological advances and accelerated economic growth. Among the most important accounting
fields are described briefly in the following paragraphs.

Financial Accounting: - Concerned with the recording of transactions for a business enterprise
or other economic unit and the periodic preparation of various reports from such records. The
report is a general-purpose one that can equal is important in meeting the users’ interest.
Financial Accounting reports are prepared based on international financial reporting standard
(IFRS).

Auditing: - as a specialized accounting field involving an independent review of the accounting

records during audit work, public accountants examine the records supporting the financial
reports of an enterprise and give an opinion regarding their fairness and reliability. Auditors'
responsibility (job) may take to forms.

i) Internal auditors: - those who are responsible about the operations of the business
(organization) to determine compliance with management policies and evaluating the
efficiency of operations.
ii) External auditors: - those examine the records supporting the financial statements of
a firm and give an opinion.
Cost Accounting: - particularly concerned with determination and control of the cost of
producing specific products. It is primarily concerned with the cost of manufacturing processes
and of manufactures products ultimately management uses these date in controlling current
operations and in planning for the future.
Managerial Accounting: - Uses both historical and estimated data in assisting management in
daily operations and planning future operations it deals with specific problems that confront
enterprise managers at various organizational levels. It is frequently concerned with identifying
alternative courses of action and then helping to select the best one.

Tax Accounting: - deals with the preparation of tax returns and the consideration of the tax
consequences of proposed business transactions or alternative courses of action. One specialized
in this field should be well informed about tax statues, administrative regulations and court
decisions on tax cases.

Accounting system: - is the specialized field concerned with the design and implementation of
procedures for the accountant must device appropriate “checks and balance” to safe guard
business properties and provide for information flow that will be efficient and helpful to
management.

Budgetary Accounting: - presents the plan of financial operation for a period and through
records and summaries, provided comparisons of actual operation in the predetermined plan. A
combination of planning and controlling future operations, it is sometimes considered to be a
part of managerial accounting.

International Accounting: - is concerned with the special problems associated with

international trade of multinational business organizations, Accountants specializing in this area
must be familiar with the influences that custom, law and taxation of various countries bring to
bear on international operations and accounting principles.

Not-for-profit Accounting: - specializes in recording, reporting, and planning the operations of

various governmental units and other not-for-profit organizations such as churches, charities, and
educational institutions.

Social Accounting: - is a kind of specialization which emphasizes the measurement of social

costs and benefits.

1.4. Overview of International Financial reporting Standards (IFRS)

In order to ensure high-quality financial reporting, accountants present financial statements in
conformity with accounting standards that are issued by standard setting bodies. Presently,
there are two primary accounting standard-setting bodies—the International Accounting
Standards Board (IASB) and the Financial Accounting Standards Board (FASB). More than
130 countries follow standards referred to as International Financial Reporting Standards
(IFRS). IFRSs are determined by the IASB. The IASB is headquartered in London, with its 15
board members drawn from around the world. Most companies in the United States follow
standards issued by the FASB, referred to as generally accepted accounting principles
(GAAP). As markets become more global, it is often desirable to compare the results of
companies from different countries that report using different accounting standards. In order to
increase comparability, in recent years the two standard-setting bodies have made efforts to
reduce the differences between IFRS and U.S. GAAP. This process is referred to as
convergence. As a result of these convergence efforts, it is likely that someday there will be a
single set of high-quality accounting standards that are used by companies around the world.
The main international standard-setting organization is based in London, United Kingdom, and
is called International Accounting Standards Board (IASB). IFRS has the best potential to
provide a common platform on which companies can report and investors can compare
financial information. It is simpler and less stringent in its accounting and disclosure
requirements. It is more principles-based.
Qualities of Useful Information
Recently, the IASB and FASB completed the first phase of a joint project in which they
developed a conceptual framework to serve as the basis for future accounting standards. The
framework begins by stating that the primary objective of financial reporting is to provide
financial information that is useful to investors and creditors for making decisions about
providing capital. According to the IASB, useful information should possess two fundamental
qualities, relevance and faithful representation.

Relevance: Accounting information has relevance if it would make a difference in a business

decision. Information is considered relevant if it provides information that has predictive value,
that is, helps provide accurate expectations about the future, and has confirmatory value, that is,
confirms or corrects prior expectations. In addition, materiality is a company-specific aspect of
relevance. An item is material when its size makes it likely to influence the decision of an
investor or creditor.
Faithful Representation: It means that information accurately depicts what really happened. To
provide a faithful representation, information must be complete (nothing important has been
omitted), neutral (is not biased toward one position or another), and free from error. So sentence
should read: To provide faithful representation, information must be complete (nothing important
has been omitted), neutral (is not biased toward one position or another), and free from error.
Enhancing Qualities
In addition to the two fundamental qualities, the IASB and FASB also describe a number of
enhancing qualities of useful information. These include comparability, consistency,
verifiability, timeliness, and understandability. In accounting, comparability results when
different companies use the same accounting principles. Another characteristic that enhances
comparability is consistency. Consistency means that a company uses the same accounting
principles and methods from year to year. Information is verifiable if independent measures,
using the same methods, obtain similar results. For accounting information to have relevance, it
must be timely. That is, it must be available to decision-makers before it loses its capacity to
influence decisions. Information has the quality of understandability if it is presented in a clear
and

Principles in financial reporting

Measurement Principles
IFRS generally uses one of two measurement principles, the historical cost principle or the fair
value principle. Selection of which principle to follow generally relates to trade-offs between
relevance and faithful representation. Relevance means that financial information is capable of
making a difference in a decision. Faithful representation means that the numbers and
descriptions match what really existed or happened—they are factual.

Historical Cost Principle The historical cost principle (or cost principle) dictates that companies
record assets at their cost. This is true not only at the time the asset is purchased, but also over
the time the asset is held. For example, if Gazprom (RUS) purchases land for $ 300,000, the
company initially reports it in its accounting records at $ 300,000. But what does Gazprom do if,
by the end of the next year, the fair value of the land has increased to $ 400,000? Under the
historical cost principle, it continues to report the land at $ 300,000.
Fair Value Principle The fair value principle states that assets and liabilities should be reported
at fair value (the price received to sell an asset or settle a liability). Fair value information may
be more useful than historical cost for certain types of assets and liabilities. For example, certain
investment securities are reported at fair value because market value information is usually
readily available for these types of assets. In determining which measurement principle to use,
companies weight the factual nature of cost figures versus the relevance of fair value. In general,
even though IFRS allows companies to revalue property, plant, and equipment and other long-
lived assets to fair value, most companies choose to use cost. Only in situations where assets are
actively traded, such as investment securities, do companies apply the fair value principle
extensively.

Revenue recognition principle the revenue recognition principle requires that companies
recognize revenue in the accounting period in which the performance obligation is satisfied. In a
service company, revenue is recognized at the time the service is performed. In a merchandising
company, the performance obligation is generally satisfied when the goods transfer from the
seller to the buyer. At this point, the sales transaction is complete and the sales price established.
Expense recognition principle the expense recognition principle (often referred to as the
matching principle) dictates that efforts (expenses) be matched with results (revenues). Thus,
expenses follow revenues.
Full disclosure principle the full disclosure principle requires that companies disclose all
circumstances and events that would make a difference to financial statement users. If an
important item cannot reasonably be reported directly in one of the four types of financial
statements, then it should be discussed in notes that accompany the statements.
Cost Constraint the cost constraint relates to the fact that providing information is costly. In
deciding whether companies should be required to provide a certain type of information,
accounting standard-setters weigh the cost that companies will incur to provide the information
against the benefit that financial statement users will gain from having the information available.
Assumptions
Monetary Unit Assumption: The monetary unit assumption requires that only those things that
can be expressed in money are included in the accounting records. This means that certain
important information needed by investors, creditors, and managers, such as customer
satisfaction, is not reported in the financial statements.
Economic Entity Assumption: The economic entity assumption states that the activities of the
entity must be kept separate and distinct from the activities of the owner. In order to assess a
company’s performance and financial position accurately, it is important that we not blur
company transactions with personal transactions (especially those of its managers) or
transactions of other companies.
Time Period (Periodicity) Assumption: Notice that the income statement, retained earnings
statement, and statement of cash flows all cover periods of one year, and the statement of
financial position is prepared at the end of each year. The time period assumption states that the
life of a business can be divided into artificial time periods and that useful reports covering those
periods can be prepared for the business.
Going Concern Assumption: The going concern assumption states that the business will remain
in operation for the foreseeable future. Of course, many businesses do fail, but in general, it is
reasonable to assume that the business will continue operating.
1.5. The accounting equation and elements of the equation
The resources owned by a business are its assets. Examples of assets include cash, land,
buildings, and equipment. The rights or claims to the properties are normally divided into two
principal types: (1) the rights of creditors and (2) the rights of owners. The rights of creditors
represent debts of the business and are called liabilities. The rights of the owners are called
owner’s equity. The relationship between the two may be stated in the form of an equation called
accounting equation, as follows:
Assets = Liabilities + Owner’s Equity

It is usual to place liabilities before owner’s equity in the accounting equation because creditors
have first rights to the assets.
Exercise 1.1: If a company’s assets increase by $20,000 and its liabilities decrease by $5,000,
how much did the owner’s equity increase or decrease?

The accounting equation applies to all economic entities regardless of size, nature of business, or
form of business organization. It applies to a small proprietorship such as a corner grocery store
as well as to a giant corporation such as ADIDAS. The equation provides the underlying
framework for recording and summarizing economic events.

Let’s look in more detail at the categories in the basic accounting equation.
Assets

As noted above, assets are resources a business owns. The business uses its assets in carrying out
such activities as production and sales. The common characteristic possessed by all assets is the
capacity to provide future services or benefits. In a business, that service potential or future
economic benefit eventually results in cash inflows (receipts). For example, consider Campus
Pizza, a local restaurant. It owns a delivery truck that provides economic benefits from delivering
pizzas. Other assets of Campus Pizza are tables, chairs, jukebox, cash register, oven, tableware,
and, of course, cash.
To qualify as assets, there are three characteristics to be fulfilled
 Have future economic benefits (be capable of producing profits).
 Be under managements control (can be freely deployed or disposed of)
 Result from past transaction (the transaction or event giving rise to the entity’s right to, or
control of, the benefit has already occurred)

Liabilities
Liabilities: are claims against assets—that is, existing debts and obligations. Businesses of all
sizes usually borrow money and purchase merchandise on credit. Creditors may legally force the
liquidation of a business that does not pay its debts. In that case, the law requires that creditor

claims be paid before ownership claims. To qualify as liabilities, obligations must:

 Require transfer of assets having future economic benefit.

 Specify to whom the asset must be transferred (the terms, parties, and conditions under

which asset transfers will take place must be specified).

 Result from past transactions.

Equity

The ownership claim on total assets is equity. It is equal to total assets minus total liabilities.
Here is why: The assets of a business are claimed by either creditors or shareholders. To find out
what belongs to shareholders, we subtract creditors’ claims (the liabilities) from the assets. The
remainder is the shareholders’ claim on the assets—equity. It is often referred to as residual
equity—that is, the equity “left over” after creditors’ claims are satisfied. It generally consists of
(1) share capital – ordinary and (2) retained earnings.
Share Capital – Ordinary: A corporation may obtain funds by selling ordinary shares to
investors. Share capital - ordinary is the term used to describe the amounts paid in by
shareholders for the ordinary shares they purchase.
Retained earnings: it is determined by three items: revenues, expenses, and dividends.
 Revenues: They are the gross increases in equity resulting from business activities entered
into for the purpose of earning income. Generally, revenues result from selling merchandise,
performing services, renting property, and lending money. Revenues usually result in an
increase in an asset.
 Expenses: They are the cost of assets consumed or services used in the process of earning
revenue. They are decreases in equity that result from operating the business. Like revenues,
expenses take many forms and are called various names depending on the type of asset
consumed or service used.

 Dividend: The distribution of cash or other assets to shareholders is called a dividend.

Dividends reduce retained earnings. However, dividends are not an expense. A
corporation first determines its revenues and expenses and then computes net income or
net loss. If it has net income, and decides it has no better use for that income, a
corporation may decide to distribute a dividend to its owners (the shareholders).

1.6. Business transactions and financial statements

Business transactions are economic events that should be recorded because they affect the
financial position of the business enterprise. These businesses transactions are the raw materials
of accounting reports. A transaction can be an exchange (such as the purchase or sale of
property, payment or collection of a loan etc.) between two or more parties.

For a given transaction to qualify to be recorded it has: to be related to the business enterprise, to
be measurable in terms of money and to be completed / happened/ action. Transactions may be
external or internal. External transactions involve economic events between the company and
some outside enterprise. Internal transactions are economic events that occur entirely within
one company.

Transaction Analysis
All business transactions can be stated in terms of changes in the elements of the accounting
equation.

Illustration 1.1
TRANSACTION1. INVESTMENT BY SHAREHOLDERS Ray and Barbara Neal decide to
open a computer programming company that they incorporate as Softbyte Inc. On September 1,
2014, they invest €15,000 cash in the business in exchange for €15,000 of ordinary shares. The
ordinary shares indicate the ownership interest that the Neals have in Softbyte Inc. This
transaction results in an equal increase in both assets and equity

The asset Cash increases €15,000, and equity identified as Share Capital— ordinary increases
€15,000.

Assets = liability + Owner’s Equity

Cash = Share holder Capital
1. 15,000 15,000 issued share

TRANSACTION2. PURCHASE OF EQUIPMENT FOR CASH Softbyte Inc. purchases

computer equipment for €7,000 cash. This transaction results in an equal increase and decrease
in total assets, though the composition of assets changes.

Assets = liability + Owner’s Equity

Cash + equipment = Capital
1.15,000 15,000
2.-7,000 + €7,000 --------
= 8000 + 7000 15000

TRANSACTION3. PURCHASE OF SUPPLIES ON CREDIT Softbyte Inc. purchases for

€1,600 from Acme Supply Company computer paper and other supplies expected to last
several months. Acme agrees to allow Softbyte to pay this bill in October. This transaction is
a purchase on account (a credit purchase). Assets increase because of the expected future
benefits of using the paper and supplies, and liabilities increase by the amount due Acme
Company.

Assets = liability + Owner’s Equity

Cash + supplies + equipment account payable Capital
1.15,000 15,000
2.-7,000 + €7,000 --------
= 8000 + 7000 15000
3. ------- 1,600 -------- 1600 -----------
8000 €1,600 7000 1600 15000
TRANSACTION4. SERVICES PROVIDED FOR CASH Softbyte Inc. receives €1,200 cash
from customers for programming services it has provided. This transaction represents Softbyte’s
principal revenue-producing activity. Recall that revenue increases equity

Assets = liability + Owner’s Equity

Cash + supplies + equipment account payable Capital + retained earning
Rev - exp - div
1.15,000 15,000
2.-7,000 + €7,000 --------
= 8000 + 7000 15000
3. ------- 1,600 -------- 1600 -----------
=8000 €1,600 7000 1600 15000
4.+1200 ------ ------- -------------- --------- +1200
=9200 1600 7000 1600 15000 1200

TRANSACTION5. PURCHASE OF ADVERTISING ON CREDIT Softbyte receives a bill for

€250 from the Daily News for advertising but postpones payment until a later date. This
transaction results in an increase in liabilities and a decrease in equity.

Assets = liability + Owner’s Equity

Cash + supplies + equipment account payable Capital + retained earning
Rev - exp - div
1.15,000 15,000
2.-7,000 + €7,000 --------
= 8000 + 7000 15000
3. ------- 1,600 -------- 1600 -----------
=8000 €1,600 7000 1600 15000
4.+1200 ------ ------- -------------- --------- +1200 ----- ----
=9200 1600 7000 1600 15000 1200
5.------- ---- ----- 250 -------- -------- -250 ------
=9200 1600 7000 1850 15000 1200 -250

TRANSACTION6. SERVICES PROVIDED FOR CASH AND CREDIT Softbyte Inc. provides
€3,500 of programming services for customers. The company receives cash of €1,500 from
customers, and it bills the balance of €2,000 on account. This transaction results in an equal
increase in assets and equity.

Assets = liability + Owner’s Equity

Cash + A/R + supplies + equipment account payable Capital + retained earning
Rev - exp - div
1.15,000 15,000
2.-7,000 + €7,000 --------
= 8000 + 7000 15000
3. ------- 1,600 -------- 1600 -----------
=8000 €1,600 7000 1600 15000
4.+1200 ------ ------- -------------- --------- +1200 ----- ----
=9200 1600 7000 1600 15000 1200
5.------- ---- ----- 250 -------- -------- -250 ------
=9200 1600 7000 1850 15000 1200 -250
6.+1500 +2000 ----- ------- ------- ----- 3500 --- ------
=10700 2000 1600 7000 1850 15000 4700 -250

TRANSACTION7. PAYMENT OF EXPENSES Softbyte pays the following expenses in cash

for September: store rent €600, salaries and wages of employees €900, and utilities €200. These
payments result in an equal decrease in assets and expenses.

Assets = liability + Owner’s Equity

Cash + A/R + supplies + equipment account payable Capital + retained earning
Rev - exp - div
1.15,000 15,000
2.-7,000 + €7,000 --------
= 8000 + 7000 15000
3. ------- 1,600 -------- 1600 -----------
=8000 €1,600 7000 1600 15000
4.+1200 ------ ------- -------------- --------- +1200 ----- ----
=9200 1600 7000 1600 15000 1200
5.------- ---- ----- 250 -------- -------- -250 ------
=9200 1600 7000 1850 15000 1200 -250
6.+1500 +2000 ----- ------- ------- ----- 3500 --- ------
=10700 2000 1600 7000 1850 15000 4700 -250
7 -1700 ------ ------ ------ ------- ---------- -------- -600 -----
-900
-200
=9000 2000 1600 7000 1850 15000 4700 -1950

TRANSACTION8. PAYMENT OF ACCOUNTS PAYABLE Softbyte pays its €250 Daily

News bill in cash. The company previously (in Transaction 5) recorded the bill as an increase in
Accounts Payable and a decrease in equity.
 Assets = liability + Owner’s Equity
Cash + A/R + supplies + equipment account payable Capital + retained earning
Rev - exp - div
1.15,000 15,000
2.-7,000 + €7,000 --------
= 8000 + 7000 15000
3. ------- 1,600 -------- 1600 -----------
=8000 €1,600 7000 1600 15000
4.+1200 ------ ------- -------------- --------- +1200 ----- ----
=9200 1600 7000 1600 15000 1200
5.------- ---- ----- 250 -------- -------- -250 ------
=9200 1600 7000 1850 15000 1200 -250
6.+1500 +2000 ----- ------- ------- ----- 3500 --- ------
=10700 2000 1600 7000 1850 15000 4700 -250
7 -1700 ------ ------ ------ ------- ---------- -------- -600 -----
-900
-200
=9000 2000 1600 7000 1850 15000 4700 -1950
8.-250 ------- ------- -------- -250 -------- --------- -------
=8750 2000 1600 7000 1600 1500 4700 -1950

TRANSACTION9. RECEIPT OF CASH ON ACCOUNT Softbyte receives €600 in cash from

customers who had been billed for services (in Transaction 6). This transaction does not change
total assets, but it changes the composition of those assets.

Assets = liability + Owner’s Equity

Cash + A/R + supplies + equipment account payable Capital + retained earning
Rev - exp - div
1.15,000 15,000
2.-7,000 + €7,000 --------
= 8000 + 7000 15000
3. ------- 1,600 -------- 1600 -----------
=8000 €1,600 7000 1600 15000
4.+1200 ------ ------- -------------- --------- +1200 ----- ----
=9200 1600 7000 1600 15000 1200
5.------- ---- ----- 250 -------- -------- -250 ------
=9200 1600 7000 1850 15000 1200 250
6.+1500 +2000 ----- ------- ------- ----- 3500 --- ------
=10700 2000 1600 7000 1850 15000 4700 250
7 -1700 ------ ------ ------ ------- ---------- -------- -600 -----
-900
-200
=9000 2000 1600 7000 1850 15000 4700 1950
8.-250 ------- ------- -------- -250 -------- --------- -------
=8750 2000 1600 7000 1600 1500 4700 1950
9.+600 -600 ----- ------- ------ ------- ------- --------
=9350 1400 1600 7000 1600 1500 4700 1950

TRANSACTION10. DIVIDENDS The Corporation pays a dividend of €1,300 in cash to Ray

and Barbara Neal, the shareholders of Softbyte Inc. This transaction results in an equal decrease
in assets and equity.

Assets = liability + Owner’s Equity

Cash + A/R + supplies + equipment account payable Capital + retained earning
Rev - exp - div
1.15,000 15,000
2.-7,000 + €7,000 --------
= 8000 + 7000 15000
3. ------- 1,600 -------- 1600 -----------
=8000 €1,600 7000 1600 15000
4.+1200 ------ ------- -------------- --------- +1200 ----- ----
=9200 1600 7000 1600 15000 1200
5.------- ---- ----- 250 -------- -------- -250 ------
=9200 1600 7000 1850 15000 1200 250
6.+1500 +2000 ----- ------- ------- ----- 3500 --- ------
=10700 2000 1600 7000 1850 15000 4700 250
7 -1700 ------ ------ ------ ------- ---------- -------- -600 -----
-900
-200
=9000 2000 1600 7000 1850 15000 4700 1950
8.-250 ------- ------- -------- -250 -------- --------- -------
=8750 2000 1600 7000 1600 1500 4700 1950
9.+600 -600 ----- ------- ------ ------- ------- -------
=9350 1400 1600 7000 1600 1500 4700 1950
10.-1300 ------ ------- ------- -------- ----- ------ ----- -1300
=8050 1400 1600 7000 1600 1500 4700 1950 1300

Summary of Transactions

Illustration 1-1 summarizes the September transactions of Softbyte Inc. to show their cumulative
effect on the basic accounting equation. It also indicates the transaction number and the specific
effects of each transaction. Finally, Illustration 1-1 demonstrates a number of significant facts:

1. Each transaction must be analyzed in terms of its effect on: (a) The three components of the
basic accounting equation. (b) Specific types (kinds) of items within each component.

2. The two sides of the equation must always be equal.

3. The Share Capital—Ordinary and Retained Earnings columns indicate the causes of each
change in the shareholders’ claim on assets.

1.6.1. Financial statements

After transactions have been recorded and summarized, reports are prepared for users. The
accounting reports that provide this information are called financial statements. The principal
financial statements of a proprietorship are the income statement, the statement of owner’s
equity, the balance sheet, and the statement of cash flows. The order in which the statements are
normally prepared and the nature of the data presented in each statement are as follows:
1. An income statement presents the revenues and expenses and resulting net income or net
loss for a specific period of time.
2. A retained earnings statement (Statements of Owner’s Equity) summarizes the changes
in retained earnings for a specific period of time.
3. A statement of financial position (sometimes referred to as a balance sheet) reports the
assets, liabilities, and equity of a company at a specific date.
4. A statement of cash flows summarizes information about the cash inflows (receipts) and
outflows (payments) for a specific period of time.
 Cash Flows from Operating Activities: 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.

All financial statements should be identified by the name of the business, the title of the
statement, and the date or period of time.

SOFTBYTE SA
Income Statement
For the Month Ended September 30, 2017
Service revenue $4700.00
Salary and wage expenses: €900.00
Rent expense €600.00
advertising expense €250.00
utility expense €200.00
Total operating expenses €1,950.00
Net income €2,750.00
 SOFTBYTE SA
Retained Earnings Statement
For the Month Ended September 30, 2017
Retained earnings, September 1 €0
Add: Net income €2750.00
€2750.00
Less withdrawals/dividend €1300.00
Retained earnings, September 30 €1,450.00

SOFTBYTE SA
Statement of Financial Position
September 30, 2017
Assets Owner's Equity
Equipment €7000.00 Retained earnings €1,450.00
Supplies €1600.00 Share capital—ordinary €15000.00
Accounts receivable €1400.00 Liabilities
Cash €8,050.00 Accounts payable €1600.00
Total liabilities and owner's equity €18,050.00
Total assets €18,050.00

SOFTBYTE SA
Statement of Cash Flows
For the Month Ended September 30, 2017
Cash flows from operating activities:
Cash receipts from revenues €3,300.00
Cash payments for expenses € (1950.00 )
Net cash provided by operating activities € 1,350.00
Cash flows from investing activities:
Purchase of equipment € (7,000.00)
Cash flows from financing activities:
Sale of ordinary shares €15,000.00
Payment of cash dividends € (1,300.00)
Net cash flow from financing activities €13,700.00
Net increase in cash €8050.00
Cash at the beginning of the period €0
Cash at the end of the period €8050.00