Chapter 1

Introduction to Accounting
and Business
Accounting, 21st Edition
Author: Warren Reeve Fess
Lecturer: Ahmed Mohamed Ali

PowerPoint Presentation by Douglas Cloud

Professor Emeritus of Accounting
Pepperdine University
The process of preparing interim and annual financial
statements is called financial accounting. Most businesses
have their annual financial accounts audited by an
independent CPA firm. Certain entities, such as publicly-
traded corporations, are required to undergo audits. As part
of their lending covenants, lenders frequently require the
annual results of an external audit. Therefore, the bulk of
businesses will perform annual audits for whatever reason.

Accounting is the process of measuring, processing, and

sharing financial and other information about businesses and
corporations.
Financial accounting is the process of recording,
summarizing and reporting the myriad(a countless) of
transactions resulting from business operations over a
period of time. These transactions are summarized in the
preparation of financial statements, including the balance
sheet, income statement and cash flow statement, that
record the company's operating performance over a
specified period.

Financial Accounting Definition – Financial accounting

helps to classify, analyze, summarize, and record financial
transactions of the company
financial accounting focuses on aggregating information
into financial statements for both internal and external use.
 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 is owned by one individual.

Advantages Disadvantage
• Ease in organizing • Limited source of
• Low cost of financial resources
organizing • Unlimited liability
 A partnership is owned by two or more
individuals.

Advantages
Disadvantage
• More financial
resources than a • Unlimited liability.
proprietorship.
• Additional
management skills.
A corporation is organized under state or federal
statutes as a separate legal entity.

Advantage Disadvantage
• The ability to obtain • Double taxation.
large amounts of
resources by issuing
stocks.
 Business Stakeholders

A business stakeholder is a person

or entity having an interest in the
economic performance of the
business.
 STAKEHOLDERS

Internal: External:
Owners, Customers,
managers, creditors,
employees government
 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.
 Definition of Accounting

•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.
 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)

Financial accountants follow Generally

Accepted Accounting Principles (GAAP) in
preparing reports.

These reports allow investors and other

stakeholders to compare one company to
another.
Account: The location where financial entries are recorded.
Different accounts exist for different financial transactions.
Account—a record of increases and decreases in a
specific asset, liability, equity, revenue, or expense
item.
An account is a detailed record of all the money that a
business or a person receives and spends. In double entry
bookkeeping, every debit or credit in the account is also
represented as a credit or debit somewhere else.

An account refers to a place to record transactions that

occur within the business.
Equity: The amount the business owner has
contributed to the business from their personal
funds (capital) and how much has been
withdrawn for personal use (drawings).
Equity is the fund that is required to create the
resources, whereas assets are those resources that
are required to run a business.

Equity is anything that is invested in the

company by its owner,
Equity accounts represent the financial ownership in a
company and are visible in the balance sheet
immediately after the liability accounts. There are
different kinds of equity accounts that are aggregated
to form shareholder’s equity.

Types of Equity Account

There are six types of equity accounts attributed to
corporations which are discussed in more detail
below. Sole proprietors and partnerships have
different equity accounts because of different legal
requirements.
Sole Proprietorship and Partnerships
A sole proprietorship is a business owned by a single owner
and a partnership is owned by two or more individuals. The
following are the most common equity accounts that are
associated with these two business entities.
• Owner’s capital. The owner’s capital which is known as
members’ capital for partnerships is the equity account
consisting of capital that has been contributed or invested
by a single owner or two or more members.
The essence of this account is much the same as retained
earnings for corporations. The ending owner’s capital is
equal to the beginning balance reduced by any
withdrawals, increased by any new investment, and
increased or decreased by net profit or loss for the period
Sole Proprietorship and Partnerships
A sole proprietorship is a business owned by a single owner
and a partnership is owned by two or more individuals. The
following are the most common equity accounts that are
associated with these two business entities.
• Owner’s capital. The owner’s capital which is known as
members’ capital for partnerships is the equity account
consisting of capital that has been contributed or invested
by a single owner or two or more members.
• Owner’s distribution. This is a contra-equity account that
records all the income distributions made to the owners. In
other words, this account tells us the amount of money that
has been taken out of the business.
Corporations
Common Stock (Capital contributed by shareholders or issued capital)
This is an equity account where the amount contributed
initially by shareholders is recorded. The right to vote and
the residual claim on the company’s assets depends upon the
share entitled in this equity account.
The value of this equity account is usually recorded at par
value of share times the number of shares outstanding. The
number of shares outstanding must also be disclosed in the
balance sheet and it is equal to issued shares subtracted by
treasury shares.
For example, 10 million shares with $1 of par value would
result in $10 million of common share capital on the balance
Preferred Stock
This account has the par value of the preferred stock. These
shares have precedence over the common shares –
precedence that pertains to the receipt of dividends and
receipt of assets in case the company declared bankrupt.
The preferred stocks have the characteristics of both debt
security and common stock. Preferred stockholders do not
have voting rights, but they are usually guaranteed by
cumulative dividend, which means the dividend can be
accrued until paid off.
For example, preferred stock with a fixed $10 dividend per
year. The company has not paid the dividends for the past
three years. For the current year, the preferred stockholder
will be entitled to receive a total of $40.
Additional Paid-In Capital
This equity account also known as contributed surplus is the
excess amount that investors have paid in addition to the par
value of the stocks (equity or preferred), it is seen as the
gain which a company has earned when it issues the stocks
initially.
Additional paid-in capital can be reduced when a company
repurchases its shares. This account can also increase or
decrease in value when the gain and loss occur due to the
sale of shares.
For example, a company issues 100,000 $5 par value shares
for $10 per share. A total of $500,000 will be recorded in a
common stock account and the excess amount of $500,000
(100,000 shares x ($10-$5)) will go in the additional paid-
Retained Earnings
Retained earnings are the part of the company’s net
earnings which is retained after paying dividends to
shareholders. The motive of retaining such earnings is to
use those proceeds to pay off debt, launch a new product or
business, or acquire other beneficial companies.
For example, a company has retained earnings of $100,000.
For the current year, the company has earned a profit of
$10,000 (net profit) and decided to pay $2000 in dividends.
So the ending retained earnings for the year will be equal to
$108,000 ($100,000 + ($10,000 – $2000)).
Other Comprehensive Income
This account includes all the changes in equity of a
business for a year except those resulting from investments
by the shareholders or distributions to them. In other
words, other comprehensive income excludes the profit that
has not been realized yet.
A classic example of this equity account is the portfolio of
bonds that the company has invested in. Profit & loss due
marked to the market value of this portfolio can be
determined in other comprehensive income. Once the
bonds have matured or sold the realized gain/loss is moved
into net income.
Treasury Stock
This is one of the equity accounts that have a debit balance.
A contra account that represents the amount a company has
paid to repurchase its common stock. These stocks are kept
as treasury stocks instead of canceling them, a company can
sell (reissue) them.
Some of the motives behind repurchasing its shares are
when management thinks that shares are undervalued or
when employees of the company want to exercise stock
options. The acquisition of treasury stocks reduces the
number of shares outstanding.
Equity is the source of funds required to create the
resources.
A decrease in owner's equity resulting from the
operation of a business. Assets taken out of a
business for the owner's personal use. The accounts
affected when receiving cash from the owner as an
investment. ... The accounts affected when paying
cash for an expense.
Equity is the owner's share of the assets of a
business (assets can be owned by the owner or
owed to external parties - debts).

Capital – An amount of finance provided,

generally by the owners or shareholders, to enable
a business to acquire assets and sustain its
operations.
Owner's equity represents the owner's
investment in the business minus the owner's
draws or withdrawals from the business plus the
net income (or minus the net loss) since the
business began. Mathematically, the amount of
owner's equity is the amount of assets minus the
amount of liabilities.
Assets—are resources owned or controlled by a company
and that have expected future benefits.
The economic value represents the maximum amount a
customer is willing to pay for something.
Both market value and economic value are widely used in
business for various purposes. Each valuation employs
different criteria in their calculations. Market value is the
price of something, such as an asset that's determined by
the supply and demand of the asset in the marketplace. The
economic value represents the maximum amount a
customer is willing to pay for something.
economic value is a measure of the benefit provided by a
good or service to an organization or individuals.
Assets are the resources required to run a business.
An asset is a resource with economic value that an
individual, corporation or country owns or controls with the
expectation that it will provide future benefit. Assets are
reported on a company's balance sheet, and they are bought
or created to increase the value of a firm or benefit the firm's
operations.
Economic value is the value that person places on an
economic good based on the benefit that they derive from
the good. It is often estimated based on the person's
willingness to pay for the good, typically measured in units
of currency.
the asset is anything that is owned by the company to
provide the economic benefits in the future.
Liabilities refers to a term in accounting that is used to
describe financial obligations and debts that a person,
organization, or business owes to external parties. Liabilities
encompass various financial responsibilities, including loans,
outstanding payments and contractual commitments.
Liabilities are crucial in assessing an entity’s financial health,
as they represent claims against its assets.
The three primary types of liabilities are current, long-term,
and contingent. Current liabilities, such as accounts payable,
are short-term obligations due within a year. Long-term
liabilities, like mortgages, extend beyond a year. Contingent
liabilities are potential obligations dependent on specific
future events.
Type Description Examples
Contingent Potential liabilities dependent on future events . legal claims
of conditions . warranty
obligations

Current Liabilities due within one year or the normal Accounts payable
operating cycle of the business, whichever is short-term loans
longer.
Non -current Long-term liabilities not due within the . long-term loans
current accounting period . bonds payable

Common Widely encountered liabilities applicable to . mortgage loans

many individuals or business . vehicle loans

Statutes Liabilities imposed by law or regulatory . taxes payable

authorities . GST liabilities
The accounting equation states that a company’s total assets
are equal to the sum of its liabilities and its shareholders’
equity.
This straightforward relationship between assets, liabilities,
and equity is considered to be the foundation of the double-
entry accounting system. The accounting equation ensures
that the balance sheet remains balanced. That is, each entry
made on the debit side has a corresponding entry (or
coverage) on the credit side.

The accounting equation is also called the basic accounting

equation or the balance sheet equation.
liabilities include loans, accounts payable, mortgages,
deferred revenues, bonds, warranties, and accrued expenses.

Accounts Payable is Oral or implied promises to pay later,

which usually happens from purchases of merchandise on
account.

Notes Payable is A formal promise, usually indicated by the

signing of a promissory note, to pay a future amount.
Unearned Revenue is when the cash has been received but
the product or service has not been delivered.
 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.
Events—are happenings that affect an
entity’s accounting equation AND can be
reliably measured.
A business transaction is an economic event between two
or more parties that involves the exchange of goods,
services, or money. To document and manage business
transactions effectively, keep accurate records, use
invoicing software, and ensure all agreements are clearly
detailed to avoid disputes.
Types of business transactions
Business transactions are recorded according to their type
and category. There are four main types:
Sales transactions
Purchase transactions
Payment transactions
Receipt transactions
Transaction is a business events having a
monetary impact on the financial statements
of a business.

Transaction is an event which can be measure

in terms of money and that alters the financial
position of accounting entity.
Examples of transactions are as follows :
1. sales on cash to a customer.
2. sales on credit to a customer.
3. receive cash in payment of an invoice owed by a
customer.
4. purchase fix assets from a supplier.
5. borrow funds from a lender
6. Issue a dividend to investors
 Business Transactions and the
Accounting Equation

On November 1, 2005, Hassan Mohamed

begins a business that will be known as
Talasan
a. Hassan deposits $25,000 in a bank
account in the name of Talasan.

Assets = Owner’s Equity

Cash Hassan M, Capital
= 25,000 Investment
a. 25,000
by Hassan
 b. Talasan exchanged $20,000 for land.

Assets = Owner’s Equity

Cash + Land Hassan M, Capital
Bal. 25,000 = 25,000
b. –20,000 +20,000
Bal. 5,000 20,000 25,000
 c. During the month, Talasan purchased
supplies for $1,350 and agreed to pay the
supplier in the near future (on account).
Owner’s
Assets = Liabilities + Equity
Accounts Hassan M,
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. Talasan provided services to
customers, earning fees of $7,500 and
received the amount in cash.
Owner’s
Assets = Liabilities + Equity
Accounts Hassan M,
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. Talasan paid the following expenses:
wages, $2,125; rent, $800; utilities,
$450; and miscellaneous, $275.
Owner’s
Assets = Liabilities + Equity
Accounts Hassan M,
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. Talasan paid $950 to creditors
during the month.

Owner’s
Assets = Liabilities + Equity
Accounts Hassan M,
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 Hassan M,
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, Hassan
withdrew $2,000 in cash from the
business for personal use.
Owner’s
Assets = Liabilities + Equity
Accounts Hassan M,
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.
 Talasan
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
Net income $3 050 00
 Talasan
Statement of Owner’s Equity
For the Month Ended November 30, 2005
Hassan M, capital, November 1, 2005 $ 0
Investment on November 1 $25 000 00
Net income for November 3 050 00
$28 050 00
Less withdrawals 2 000 00
Increase in owner’s equity 26 050 00
Hassan M, capital, November 30, 2005 $26 050 00
 Talasan
Balance Sheet
November 30, 2005
Assets Liabilities
Cash $ 5 900 00 Accounts Payable $ 400 00
Supplies 550 00 Owner’s Equity
Land 20 000 00 Hassan M, 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.
Chapter 1

The End