Introduction to Accounting and Business

11e

Principles of Financial and Managerial Accounting

11e

Principles of Corporate Financial Accounting

Principles of Financial &

Chapter 1 Managerial Accounting
Using Excel for Success
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University

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Reeve Warren Duchac
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 Learning Objectives
1. Describe the nature of a business, 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 corporation
and explain how they interrelate.
6. Describe and illustrate the use of the ratio of
liabilities to stockholders’ equity in evaluating a
company’s financial condition.
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 Learning Objective 1

Describe the nature of

a business, the role of
accounting, and
ethics in business.

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 LO 1

Nature of Business and Accounting

➔ 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.

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 LO 1

Nature of Business and Accounting

➔ The objective of most businesses is to earn

a profit.
➔ 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.

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 LO 1

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 Personal computers

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 LO 1

The Role of Accounting in Business

➔ Accounting can be defined as an
information system that provides reports to
users about the economic activities and
condition of a business.

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 LO 1

The Role of Accounting in Business

➔ 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.
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 LO 1

The Role of Accounting in Business

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 LO 1

Managerial Accounting
➔ The area of accounting that provides
internal users with information is called
managerial accounting or management
accounting.
➔ Managerial accountants employed by a
business are employed in private
accounting.

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 LO 1

Financial Accounting
➔ The area of accounting that provides
external users with information is called
financial accounting.
➔ The objective of financial accounting is to
provide relevant and timely information for
the decision-making needs of users outside
of the business.
➔ General-purpose financial statements are
one type of financial accounting report that
is distributed to external users.
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 LO 1

Role of Ethics in Accounting and Business

➔ The objective of accounting is to provide

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

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 LO 1

Role of Ethics in Accounting and Business

(continued)
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 LO 1

Role of Ethics in Accounting and Business

(continued)
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 LO 1

Role of Ethics in Accounting and Business

(concluded)
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 LO 1

Role of Ethics in Accounting and Business

➔ The answer to “What ▪ Failure of

went wrong for these individual
companies?” involves character
one or both of these ▪ Firm culture of
factors. (Exhibit 2) greed and ethical
indifference

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 LO 1

Role of Ethics in Accounting and Business

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 LO 1

Opportunities for Accountants

➔ Accountants and their staffs who provide
services on a fee basis are said to be
employed in public accounting.
➔ Accountants employed by a business firm
or a not-for-profit organization are said to
be employed in private accounting.
➔ Public accountants who have met a state’s
education, experience, and examination
requirements may become Certified Public
Accountants (CPAs).
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 LO 1

Opportunities for Accountants

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 Learning Objective 2

Summarize the
development of
accounting principles
and relate them to
practice.

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 LO 2

Generally Accepted Accounting Principles

➔ Financial accountants follow generally
accepted accounting principles (GAAP) in
preparing reports.
➔ Within the U.S., the Financial Accounting
Standards Board (FASB) has the primary
responsibility for developing accounting
principles.

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 LO 2

Generally Accepted Accounting Principles

➔ 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.
➔ Many countries outside the United States
use generally accepted accounting
principles adopted by the International
Accounting Standards Board (IASB).
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 LO 2

Business Entity Concept

➔ Under the business entity concept, the
activities of a business are recorded
separately from the activities of its owners,
creditors, or other businesses.

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 LO 2

Proprietorship
➔A proprietorship is ▪ 70% of business entities
owned by one in the U.S. are
individual. proprietorships.
▪ They are easy and
cheap to organize.
▪ Resources are limited
to those of the owner.
▪ Used by small
businesses.

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 LO 2

Partnership
➔ A partnership is ▪ 10% of business
similar to a organizations in the
proprietorship U.S. (combined with
limited liability
except that it is
companies) are
owned by two or partnerships.
more individuals.
▪ Combines the skills and
resources of more than
one person.

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 LO 2

Corporation
➔ A corporation is ▪ Corporations generate
organized under 90% of business
state or federal revenues.
statutes as a ▪ 20% of the business
separate legal organizations in the U.S.
are corporations.
taxable entity.
▪ Ownership is divided
into shares, called
stock.

(continued)

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 LO 2

Corporation
➔ A corporation is ▪ Can obtain large
organized under amounts of resources
state or federal by issuing stocks.
statutes as a ▪ Used by large
separate legal businesses.
taxable entity.

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 LO 2

Limited Liability Company (LLC)

➔ A limited liability ▪ 10% of business
company (LLC) organizations in the
combines the U.S. (combined with
partnerships).
attributes of a
partnership and a ▪ Often used as an
alternative to a
corporation.
partnership.
▪ Has tax and legal
liability advantages for
owners.

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 LO 2

Cost Concept
➔ Under the cost concept, amounts are
initially recorded in the accounting records
at their cost or purchase price.

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 LO 2

Cost Concept
Aaron Publishers purchased a building on
February 20, 2010, for $150,000. Other amounts
related to this purchased are shown on the
next slide.

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 LO 2

Cost Concept
▪ Price listed by seller on January 1,
2010 $160,000
▪ Aaron Publishers’ initial offer to buy
on January 31, 2010 140,000
▪ Purchase price on February 20, 2010 150,000
▪ Estimated selling price on December
31, 2012 220,000
▪ Assessed value for property taxes,
December 31, 2012 190,000

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 LO 2

Objectivity Concept
➔ The objectivity concept requires that the
amounts recorded in the accounting
records be based on objective evidence.
➔ Only the final agreed-upon amount is
objective enough to be recorded in the
accounting records.

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 LO 2

Unit of Measure Concept

➔ The unit of measure concept requires that
economic data be recorded in dollars.

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 EE 1-1

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 Learning Objective 3

State the accounting

equation and define
each element of the
equation.

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 LO 3

The Accounting Equation

➔ The resources owned by a business are its
assets.
➔ The rights of creditors are the debts of the
business and are called liabilities.
➔ The rights of the owners are called owner’s
equity.
➔ The equation Assets = Liabilities + Owner’s
Equity is called the accounting equation.

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 LO 3

The Accounting Equation

Assets = Liabilities + Owner’s Equity

The resources
owned by a
business

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 LO 3

The Accounting Equation

Assets = Liabilities + Owner’s Equity

The rights of
creditors are the
debts of the
business

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 LO 3

The Accounting Equation

Assets = Liabilities + Owner’s Equity

The rights of the

owners

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 EE 1-2

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 Learning Objective 4

Describe and illustrate how

business transactions can be
recorded in terms of the
resulting change in the
elements of the accounting
equation.

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 LO 4

Business Transaction
➔ A business transaction is an economic
event or condition that directly changes an
entity’s financial condition or its results of
operations.

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 LO 4

Transaction A
On November 1, 2011, Chris Clark deposited
$25,000 in a bank account in the name of
NetSolutions in return for shares of stock in the
corporation.

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 Transaction A
➔ Stock issued to owners (stockholders), such
as Chris Clark, is referred to as capital
stock. The owner’s equity in a corporation is
called stockholders’ equity.

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 LO 4

Transaction B
On November 5, 2011, NetSolutions paid
$20,000 for the purchase of land as a future
building site.

The new amounts are called balances.

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 LO 4

Transaction C
On November 10, 2011, NetSolutions purchased
supplies for $1,350 and agreed to pay the supplier
in the near future.

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 LO 4

Transaction C
➔ The liability created by a purchase on
account is called an account payable.
➔ Items such as supplies that will be used in
the business in the future are called prepaid
expenses, which are assets.

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 LO 4

Transaction D
On November 18, 2011, 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.

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 LO 4

Transaction D
➔ Revenue from providing services is
recorded as fees earned.
➔ Revenue from the sale of merchandise is
record as sales.
➔ Other examples of revenue include rent,
which is recorded as rent revenue, and
interest, which is recorded as interest
revenue.
➔ An account receivable is a claim against a
customer, which is an asset.
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 LO 4

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.

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 LO 4

Transaction E
On November 30, 2011, NetSolutions paid the
following expenses: wages, $2,125; rent, $800;
utilities, $450; and miscellaneous, $275.

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 LO 4

Transaction F
On November 30, 2011, NetSolutions paid
creditors on account, $950.

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 LO 4

Transaction G
On November 30, 2011, Chris Clark determined
that the cost of supplies on hand at the end of
the period was $550; therefore, the amount of
supplies used amounted to $800 ($1,350 –
$550 = $800).

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 LO 4

Transaction H
On November 30, 2011, NetSolutions paid $2,000
to stockholders as dividends.

Dividends are distributions

of earnings to stockholders.

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 LO 4

Summary

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 LO 4

You Should Note the Following:

➔ The effect of every transactions is an
increase or a decrease in one or more of
the accounting equation elements.
➔ The two sides of the accounting equations
are always equal.
➔ The stockholders’ equity (owner’s equity) is
increased by amounts invested by
stockholders (capital stock).

(continued)
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 LO 4

You Should Note the Following:

➔ The stockholders’ equity (owner’s equity) is
increased by revenue and decreased by
expenses.
➔ The stockholders’ equity (owner’s equity) is
decreased by dividends paid to
stockholders.
➔ Retained earnings is the stockholders’
equity created from business operations
through revenue and expense transactions.

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 LO 4
Types of Transactions Affecting Stockholders’ Equity

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 EE 1-3

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 Learning Objective 5

Describe the financial

statements of a corporation
and explain how they
interrelate.

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 LO 5

Financial Statements
➔ After transactions have been recorded and
summarized, reports are prepared for users.
The accounting reports providing this
information are called financial statements.

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 LO 5

Financial Statements

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 LO 5

Income Statement
➔ The income statement reports the revenues
and expenses for a period of time, based
on the matching concept.
➔ The matching concept is applied by
“matching” the expenses incurred during a
period with the revenue that those
expenses generated.
➔ 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.
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 EE 1-4

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 LO 5

Retained Earnings Statement

➔ The retained earnings statement reports the
changes in the retained earnings for a
period of time.
➔ It is prepared after the income statement
because the net income or net loss for the
period must be reported in this statement.

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 LO 5

Retained Earnings Statement

To illustrate, assume that NetSolutions earned net

income of $4,155 and paid dividends of $2,000 during
December. The following statement would be
prepared.

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 EE 1-5

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 LO 5

Income Statement

Net income is carried to

the retained earnings
statement

(continued)
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 LO 5

Retained Earnings Statement

From the income statement

To the balance sheet

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 LO 5

Balance Sheet
➔ A balance sheet is a list of the assets,
liabilities, and stockholders’ equity as of a
specific date.

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 LO 5

Account Form
➔ The account form of a balance sheet lists
the assets on the left and the liabilities and
stockholders’ equity on the right. It
resembles the basic format of the
accounting equation.

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 LO 5

Balance Sheet

This amount is
compared to the net From the retained
cash flow on the earnings statement
statement of cash flows.

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 LO 5

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 LO 5

Statement of Cash Flows

➔ 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

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 LO 5

Statement of Cash Flows

This amount should match

Cash on the balance sheet.

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 LO 5

Cash Flows from Operating Activities

➔ The cash flows from operating activities
section reports a summary of cash receipts
and cash payments from operations.

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 LO 5

Cash Flows from Investing Activities

➔ The cash flows from investing activities
section reports the cash transactions for the
acquisition and sale of relatively permanent
assets.

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 LO 5

Cash Flows from Financing Activities

➔ The cash flows from financing activities
section reports the cash transactions
related to cash investments by the owner,
borrowings, and withdrawals by the owner.

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 EE 1-7

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 EE 1-7

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 LO 5
Interrelationships Among Financial Statements

➔ Income Statement and ▪ Net income or net loss

Retained Earnings reported on the
Statement income statement is
also reported on the
retained earnings
statement as either an
addition (net income)
to or deduction (net
loss) from the
beginning retained
earnings.

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 LO 5

Interrelationships Among Financial Statements

In Exhibit 6, NetSolutions’ net income of

$3,050 for November is added to the
beginning retained earnings on November 1,
2011, in the retained earnings statement.

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 LO 5

Interrelationships Among Financial Statements

➔ Retained Earnings ▪ Retained earnings at

Statement and and the end of the period
Balance Sheet reported on the
retained earnings
statement is also
reported on the
balance sheet as
retained earnings.

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 LO 5

Interrelationships Among Financial Statements

In Exhibit 6, NetSolutions’ retained

earnings of $1,050 as of November 30,
2011, on the retained earnings statement
also appears on the November 30, 20l1,
balance sheet as retained earnings.

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 LO 5

Interrelationships Among Financial Statements

➔ Balance Sheet and ▪ The cash reported on

Statement of Cash the balance sheet is
Flows also reported as the
end-of-period cash
on the statement of
cash flows.

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 LO 5

Interrelationships Among Financial Statements

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

balance sheet as of November 30, 2011, is
also reported on the November statement
of cash flows as the end-of-period cash.

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 Learning Objective 6

Describe and illustrate

the use of the ratio of
liabilities to stockholders’
equity in evaluating a
company’s financial
condition.

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 LO 6

Ratio of Liabilities to Stockholders’ Equity

Ratio of Liabilities Total Liabilities

to Stockholders’ =
Total Stockholders’ Equity
Equity

Ratio of Liabilities $400

= = 0.015
to Stockholders’ $26,050
Equity

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 EE 1-8

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 Introduction to Accounting and Business

The End
Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University

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