Accounting 1

1 Copyright © 2012 Pearson Education
Chapter 1

Define accounting vocabulary
Define the users of financial information
Describe the accounting profession and the
organizations that govern it
Identify the different types of business
organizations
Delineate the distinguishing characteristics
and organization of a proprietorship
3
Copyright © 2012 Pearson Education
Apply accounting concepts and principles
Describe the accounting equation, and define
assets, liabilities, and equity
Use the accounting equation to analyze
transactions
Prepare financial statements
Use financial statements to evaluate business
performance
4
1
Define accounting vocabulary

Accounting is “the language of business.”
The information system that:

Measures business activity
Processes the data into reports
Communicates the results to decision makers
Presents information in monetary terms
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2
Define the users of
financial information

Individuals Businesses
Creditors Investors
Taxing Authorities
8
Financial Accounting Managerial Accounting
Provides information for Focuses on information for
external decision makers internal decision makers
Investors Managers
Creditors Business Owners
Taxing Authorities
Competition
Suppliers

S1-2: USERS OF FINANCIAL INFORMATION
Suppose you are the manager of Greg’s Tunes. The
company needs a bank loan in order to purchase music
equipment. In evaluating the loan request, the banker
asks about the assets and liabilities of the business. In
particular, the banker wants to know the amount of the
business’s stockholders’ equity.
Requirements:
1. Is the banker considered an internal or external user
of financial information?
The banker is an external user.
2. Which financial statement would provide the best
information to answer the banker’s questions?
The balance sheet would include assets,
liabilities and equity.
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3
Describe the accounting
profession and the organizations
that govern it

Lucrative career with many opportunities
Certified Public Accountants (CPAs)
Pass qualifying exam
Meet education and/or experience requirements
• Licensed professional accountants
Certified Public who serve the general public
Accountants, or CPAs
Certified Management
• Certified professionals who work for
Accountants, or CMAs
a single company.
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• Financial Accounting Standards Board
FASB • A privately funded organization, formulates
accounting standards.
• Securities and Exchange Commission

SEC • U.S. governmental agency that oversees U.S.
financial markets.
• American Institute of Certified Public Accountants
AICPA • Private organization of public accountants
• Generally Accepted Accounting Principles

GAAP • Main U.S. accounting rule book
• International Accounting Standards Board

IASB • Publishes the International Financial Reporting
Standards, the international accounting rule book
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Investors and creditors
want reliable financial
information
Conflict of Interest
Companies want to
attract investors
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SEC requires companies to have financial statements
examined by independent accountants
Auditors will provide an opinion on financial
statements, if possible
Recent accounting scandals hurt investor confidence
U.S. Government passed the Sarbanes-Oxley Act
(SOX)
Criminal offense to falsify financial statements
Also created the Public Companies Accounting
Oversight Board (PCAOB)
Watchdog of accounting profession
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AICPA IMA
Code of Standards of
Professional Ethical
Conduct Conduct
Sets standards
Guides CPAS for private
in their work accountants
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4
Identify the different types
of business organizations

Proprietorship Partnership
Corporation LLC and LLP
Not-for-profit
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Not-for-
Proprietorship Partners Corporation LLC, LLP
Profit
Partners:
Proprietor: Stockholders:
Owners Two or Members None
One Owner usually many
more
Limited by Limited by
Life of owner's owner’s
Indefinite Indefinite Indefinite
Organization choice or choice or
death death
Liability of Proprietor: Members Fiduciary

Partners are Stockholders
owners for Owner is are not liability
personally not personally
business personally personally of board
liable liable
debts liable liable members
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5
Delineate the distinguishing
characteristics and organization of
a proprietorship

Separate Legal Entity
• Distinct from owners
No Continuous Life/Transferability of
Ownership
• The life of business is limited by the owner’s choice or
the owner’s death
Unlimited Liability of Owner
• Owner has unlimited liability for the business’s debts
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Unification of Ownership and Management
• Owners manage the business
Business Taxation
• Not a separate taxable entity

• Income flows directly to the sole owner’s tax return, where he or she pays
self-employment and income tax
Government Regulation
• Minimal regulation is an advantages
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Incorporators obtain charter from the state
Charter authorizes corporation to:
Issue stock
Conduct business in accordance with state law
Incorporators agreed to a set of bylaws
Bylaws are the rule book that guides the
corporation.
Corporations begins to exist when stock is
issued
Stockholders vote on who will serve on Board of
Directors
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S1-4: TYPES OF BUSINESS ORGANIZATION
Chloe Michaels plans on opening Chloe Michaels’
Floral Designs. She is considering the various types
of business organizations and wishes to organize
her business with unlimited life and limited liability
features. Additionally, Chloe wants the option to
raise additional equity easily in the future. Which
type of business organization will meet Chloe’s
needs best?
A corporation has all the requirements of Chloe’s
request. A corporation has an unlimited life,
shareholders have limited liability and additional
stock can be sold to raise additional equity.
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6
Apply accounting concepts and
principles

Generally Accepted Accounting Principles
Guidelines that govern accounting
Based on a conceptual framework
Goals include:
Provide useful information for investment and lending
decisions
Must be relevant, reliable, and comparable
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Faithful
Entity
Representation
Concept
Principle
Cost Going- Stable

Concern Monetary Unit
Principle Concept Concept
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Entity Concept
• A business is separate from its owners
Faithful Representation Principle

• Accounting information is complete, neutral, and
free from material error
Cost Principle
• Assets are recorded at purchase price
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Going-Concern
• Assumption that business will remain in
operation for the foreseeable future
Stable Monetary Unit Concept
• In the U.S. amounts are recorded in dollars
• The dollar is considered a stable unit of
measure
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7
Describe the accounting equation,
and define assets, liabilities, and
equity

ASSETS LIABILITIES EQUITY
Economic Claims to Economic

Resources Resources
32
Economic resources
Benefit the business in the future
Examples:
Cash
Accounts receivable
Merchandise inventory
Furniture
Land
33
Liabilities Equity
Debts payable to outsiders Owner’s claims to the
Examples: assets of the business
Accounts payable In a proprietorship,
Bank loans owner’s equity
Mortgages

Assets Liabilities Equity
$5,000 $2,000 $3,000
Liabilities
Assets
Owner’s
Equity
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+ Revenues
+ Net income
(loss)
Capital
- Expenses
- Drawing
36
Amounts earned by delivering goods or services
to customers
Sales revenue
Service revenue
Interest revenue
Dividend revenue
37
Outflows of assets or increasing liabilities in the
course of delivering goods or services to
customers
Store or rent expense
Salary expense
Advertising expense
Utilities expense
Interest expense
Property tax expense
38
E1-16: CHARACTERISTICS OF A CORPORATION,
ACCOUNTING CONCEPTS, AND USING THE
ACCOUNTING EQUATION
Select financial information for three corporations follows:
Assets Liabilities Equity
New Rock Gas $?
$74,000 $24,000 $50,000
DJ Video Rentals $75,000 $?
$43,000 $32,000
Corner Grocery $100,000 $53,000 $?
$47,000
Requirements:
1. Compute the missing amount in the accounting equation
for each entity.
39
E1-16: CONTINUED
2. List the five main characteristics of a corporation.
Business Taxation
Government Regulation
Separate Entity with No Continuous Life
Unification of Ownership and Management
Unlimited Liability of Owner
3. Which accounting concept tells us that the previous

three companies will cease to exist if the owners die?
Going Concern Concept

40
8
Use the accounting equation to
analyze transactions
41
An event that affects the financial position of
the business
Can be measured reliably
Every transaction impacts at least two items
The accounting equation balances before and
after each transaction
42
Caren Smith opened a medical practice. During July, the first
month of operation, the business, titled Caren Smith, M.D.
experienced the following events:
1. Analyze the effects of these events on the accounting

equation of the medical practice of Caren Smith, M.D.
43
Caren Smith opened a medical practice. During July, the first
month of operation, the business, titled Caren Smith, M.D.
experienced the following events:
1. Analyze the effects of these events on the accounting
equation of the medical practice of Caren Smith, M.D.
Assets Liabilities Owner’s

Equity
Medical Accounts Smith,
Date Cash Land
supplies payable capital
Jul 6 $ 55,000 $ 55,000
Bal $ 55,000 $ 0 $ 0 $ 0 $ 55,000
9 (46,000) 46,000
Bal $9,000 $ 0 $46,000 $ 0 $55,000
44
Assets Liabilities Owner’s
Equity
Medical Accounts Smith,
Date Cash Land
supplies payable capital
Jul 12 $1,800 $1,800
Bal $9,000 $1,800 $46,000 $1,800 $55,000
15
Bal $9,000 $1,800 $46,000 $1,800 $55,000
15-31 8,000 8,000
Bal $17,000 $1,800 $46,000 $1,800 $63,000

(1,600)
(1,600)
(900)
29 (900)
(100)
(100)
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Assets Liabilities Stockholders’ Equity
Medical Accounts Common Retained

Date Cash Land
supplies payable stock earnings
Bal $14,400 $1,800 $46,000 $1,800 $55,000 $5,400
30 (700) (700)
Bal $14,400 $1,100 $46,000 $1,100 $55,000 $5,400
31 (1,100) (1,100)
Bal $13,300 $1,100 $46,000 $ 0 $55,000 $5,400
46
9
Prepare financial statements

Income Balance
Statement Sheet
Statement of Statement of
Owner’s Equity Cash Flows
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The statement of cash flows reports the cash
coming in (positive amounts) and the cash going
out (negative amounts) during a period.
Business activities result in a net cash inflow or
a net cash outflow.
The statement of cash flows reports the net
increase or decrease in cash during the period
and the ending cash balance
54
Studio Photography works weddings and prom-type parties. The balance
of Ansel, capital was $16,000 at December 31, 2011. At December 31,
2012, the business’s accounting records show these balances:
Insurance expense $ 8,000 Accounts receivable $ 8,000

Cash 37,000 Note payable 12,000
Accounts payable 7,000 Ansel, capital, Dec 31, 2012 ?
Advertising expense 3,000 Salary expense 25,000
Service revenue 80,000 Equipment 50,000
Ansel, drawing 31,000 Owner’s investment, 2012 29,000
Prepare the following financial statements for Studio Photography, Inc.

for the year ended December 31, 2012:
a. Income statement
b. Statement of owner’s equity
c. Balance sheet
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Studio Photography
Income Statement
Year Ended December 31, 2012
Revenue:
Service revenue $ 80,000
Expenses:
Salary expense $ 25,000
Insurance expense 8,000
Advertising expense 3,000
Total expenses 36,000

Net income $ 44,000
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Studio Photography
Statement of Owner’s Equity
Year Ended December 31, 2012
Ansel, capital, December 31, 2011 $ 16,000
Owner investment 29,000
Net income 44,000
Subtotal $ 89,000
Less: Drawings (13,000)
Ansel, capital, December 31, 2012 $ 76,000
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Studio Photography, Inc.
Balance Sheet
December 31, 2012
Assets Liabilities
Cash $37,000 Accounts payable $ 7,000
Accounts receivable 8,000 Note payable 12,000
Equipment 50,000 Total liabilities 19,000
Owner’s Equity
Ansel, capital 76,000
Total liabilities and

Total assets $95,000 $95,000
owner’s equity
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10
Use financial statements to evaluate business
performance

Income Statement of
Balance Sheet
Statement Owner’s Equity
Demonstrates
Shows economic
Demonstrates changes in resources
profitability capital as well as
balance debts the
company
owes
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Accounting is the language of business. Financial
statements report a company’s activities in monetary
terms.
Different users—including individuals, business
owners, managers, investors, creditors, and tax
authorities—review a company’s financial statements
for different reasons. Each user’s goal will determine
which pieces of the financial statements he or she will
find most useful.
61
Most U.S. businesses follow generally accepted
accounting principles (GAAP). If the company is
publicly traded, then it must also follow SEC
guidelines. If the company operates internationally,
then international financial reporting standards
(IFRS) will apply. The goal is that, eventually, all
public U.S. companies will report using IFRS rules.
There are five main forms of business organizations:
proprietorships, partnerships, corporations,
LLPs/LLCs, and not-for-profits. Each is unique in its
formation, ownership, life, and liability exposure.
62
Proprietorships are formed when one person creates a
business. One person owns the proprietorship.
Although the proprietorship is a separate entity, it has
no continuous life, and the owner has unlimited
liability for the business’s debts. Proprietorships have
a more difficult time raising capital, but have the
advantage of reduced regulation and less taxes than
the corporate form of business.
The accounting concepts are the underlying
assumptions used when recording financial
information for a business. Think of the concepts like
rules of a game. You have to play by the rules.
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The accounting equation must always equal. That is,
Assets (what you own) must equal Liabilities (what
you owe) + Equity (net worth).
The accounting equation is Assets = Liabilities +
Equity. Every business transaction affects various
parts of the equation, but after each transaction is
recorded, the equation must ALWAYS balance
(equal).
Financial statements are prepared from the ending
balances of each account. Each financial statement
shows a different view of the company’s overall
results
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Financial statements are prepared from the
transaction analyses (summary of events) reported
in each account (Exhibit 1-6) in the order shown in
Exhibit 1-7. No one financial statement shows
everything about a company. It is the financial
statements AND the relationships the statements
show that give users the overall picture for a
specific company.
65
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1 Copyright © 2012 Pearson Education

2 Copyright © 2012 Pearson Education

5 Copyright © 2012 Pearson Education

The information system that:

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9 Copyright © 2012 Pearson Education

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• Securities and Exchange Commission

• Generally Accepted Accounting Principles

• International Accounting Standards Board

17 Copyright © 2012 Pearson Education

Corporation LLC and LLP

Liability of Proprietor: Members Fiduciary

20 Copyright © 2012 Pearson Education

• Distinct from owners

Unlimited Liability of Owner

• Owner has unlimited liability for the business’s debts

• Owners manage the business

• Not a separate taxable entity

• Minimal regulation is an advantages

26 Copyright © 2012 Pearson Education

Cost Going- Stable

Faithful Representation Principle

31 Copyright © 2012 Pearson Education

Economic Claims to Economic

34 Copyright © 2012 Pearson Education

$5,000 $2,000 $3,000

3. Which accounting concept tells us that the previous

Going Concern Concept

1. Analyze the effects of these events on the accounting

Assets Liabilities Owner’s

Bal $9,000 $1,800 $46,000 $1,800 $55,000

15-31 8,000 8,000

Bal $17,000 $1,800 $46,000 $1,800 $63,000

Medical Accounts Common Retained

Bal $14,400 $1,800 $46,000 $1,800 $55,000 $5,400

Bal $14,400 $1,100 $46,000 $1,100 $55,000 $5,400

Bal $13,300 $1,100 $46,000 $ 0 $55,000 $5,400

47 Copyright © 2012 Pearson Education

Insurance expense $ 8,000 Accounts receivable $ 8,000

Prepare the following financial statements for Studio Photography, Inc.

Total expenses 36,000

Ansel, capital 76,000

Total liabilities and

59 Copyright © 2012 Pearson Education

All rights reserved. No part of this publication may be reproduced, stored

67 Copyright © 2012 Pearson Education

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