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
1. Describe the nature of a business.
After studying this
2. Describe the chapter,
role of accounting
you shouldin business.
3. Describe the importance
be ableofto:
business ethics and
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
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 owner’s equity to
analyze the ability of a business to withstand
poor business conditions.
 Types of Businesses
Manufacturing Business

Product
General Motors Cars, trucks, vans
Intel Computer chips
Boeing Jet aircraft
Nike Athletic shoes and apparel
Coca-Cola Beverages
Sony Stereos and television
 Types of Businesses
Merchandising Business

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

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

 Proprietorship
 Partnership
 Corporation
A proprietorship Advantages
is owned by one • Ease in organizing
individual. • Low cost of
organizing
Disadvantage
Joe’s • Limited source of
financial resources
• Unlimited liability
 Advantages
A partnership is • More financial
owned by two or resources than a
more individuals. proprietorship.
• Additional
management skills.
Joe and Marty’s Disadvantage
• Unlimited liability.
 A corporation is
organized under state Advantage
or federal statutes as a • The ability to obtain
separate legal entity. large amounts of
resources by issuing
stocks.
J & M, Inc. Disadvantage
• 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.
 Business Strategies

Under a low-cost strategy, a business

designs and produces products or
services of acceptable quality at a cost
lower than that of its competitors.
Wal-Mart
Southwest Airlines
 Business Strategies

Under a differential strategy, a business

designs and produces products or services
that possess unique attributes or
characteristics which customers are willing
to pay a premium price.
Maytag
Tommy Hilfiger
 Value Chain of a Business

A value chain is the way a

business adds value for its
customers by processing inputs
into product or service.
Business Products or Customer
Inputs
Processes Services Value
 Business Stakeholders

A business stakeholder is a person or

entity having an interest in the
economic performance of the business.
 The Process of
Providing Information
STAKEHOLDERS
Internal: External:
Identify
Owners, Customers,
1 stake-
holders.
managers, creditors,
government
employees

Assess
stakeholders’
2 informational
needs.
 The Process of
Providing Information

Design the
Record accounting
economic Accounting
information
4 data about
business
Information
System
3 system to meet
stakeholders’
activities needs.
and events.
 The Process of
Providing Information
STAKEHOLDERS
Internal: External:
Owners, Customers,
managers, creditors,
employees government
Prepare
accounting
5 reports for
stakeholders.
Accounting
Information
System
 Business Ethics

1. Avoid small ethical lapses.

Sound
2. Focus on your long-term
Principles that reputation.
form the
3. You may expect to suffer
foundation for adverse personal
ethical consequences for holding
behavior to an ethical position.
 Profession of Accounting

Accountants employed by a business firm or

a not-for-profit organization are said to be
engaged in private accounting.

Accountants and their staff who provide

services on a fee basis are said to be
employed in public accounting.
Generally Accepted
Accounting
Principles (GAAP)
The business entity concept
limits the economic data in
the accounting system to
data related directly to the
activities of the business.
The cost concept is the
basis for entering the
exchange price, or cost
of an acquisition in the
accounting records.
 The objectivity concept
requires that the accounting
records and reports be based
upon objective evidence.
The unit-of-measure
concept requires that
economic data be
recorded in dollars.
 The Accounting Equation

Assets = Liabilities + Owner’s Equity

The resources
owned by a
business
 The Accounting Equation

Assets = Liabilities + Owner’s Equity

The rights of the

creditors, which
represent debts
of the business
 The Accounting Equation

Assets = Liabilities + Owner’s Equity

The rights of the

owners
 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.
On November 1,
2005, Chris
Clark begins a
business that will
be known as
NetSolutions.
a. Chris Clark deposits $25,000 in a bank
account in the name of NetSolutions.

Assets = Owner’s Equity

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

Assets = Owner’s 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 the month, NetSolutions purchased
supplies for $1,350 and agreed to pay the
supplier in the near future (on account).
Owner’s
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 provided services to
customers, earning fees of $7,500 and
received the amount in cash.
Owner’s
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 paid the following
expenses: wages, $2,125; rent, $800;
utilities, $450; and miscellaneous, $275.
Owner’s
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. NetSolutions paid $950 to
creditors during the 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
 g. At the end of the month, the cost
of supplies on hand is $550, so
$800 of supplies were 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
 h. At the end of the month, Chris
withdrew $2,000 in cash from the
business for personal use.
Owner’s
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 of Transactions on Owner’s Equity

Owner’s Equity

Decreased by Increased by

Owner’s Owner’s
withdrawals investments
Expenses Revenues

Net
income
Accounting reports, called
financial statements,
provide summarized
information to the owner.
 Financial 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.
 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 4 450 00
To the statement
Net income $3 050 00
of owner’s equity
 NetSolutions
Statement of Owner’s 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 3 050 00
statement
$28 050 00
Less withdrawals 2 000 00
Increase in owner’s equity 26 050 00
To
Chris Clark, capital, November 30, 2005
the $26 050 00
balance sheet
 NetSolutions
Balance Sheet From the
November 30, 2005 statement of
Assets Liabilities owner’s equity
Cash $ 5 900 00 Accounts Payable $ 400 00
Supplies 550 00 Owner’s Equity
Land 20 000 00 Chris Clark, cap. 26 050 00
Total liabilities and
Total assets $26 450 00 owner’s equity $26 450 00

This balance sheet presented

using the account form
 When the balance sheet displays
the liabilities and owner’s equity
below the assets, the report form is
being 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 owner’s 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 Nov.
match 30, 2005
Cash on thecash bal. sheet
balance $ 5 900 00
 Statement of Cash 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.
 Tools for Financial
Analysis and Interpretation
The ratio of liabilities to owner’s equity
allows owners like Chris Clark to analyze
the firm’s ability to withstand poor
business conditions.

Ratio of liabilities Total Liabilities

=
to owner’s equity Total owner’s equity (or total
stockholders’ equity)
 Tools for Financial
Analysis and Interpretation
Ratio of
$400
liabilities to =
owner’s equity $26,050

Ratio of
liabilities to = 0.015
owner’s equity
Chapter 1

The End