Chapter 1

ACCOUNTING IN BUSINESS

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Winston Kwok, Ph.D., CA

Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved.

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What is Accounting?

Accounting is an information and measurement

system that identifies, records, and communicates
relevant, reliable, and comparable information
about an organization’s business activities.
 1-4

Accounting consists of Three Basic

Activities
Illustration :The activities of the
accounting process

The accounting process includes

the bookkeeping function.
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Assumptions

Review Question
Which of the following is not a step in the accounting
process?
a. Identification.
b. Recording.
c. Economic entity.
d. Communication
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C2 USERS OF ACCOUNTING
INFORMATION

External Users Internal Users

• Lenders • Consumer Groups • Managers • Sales Staff

• Shareholders • External Auditors • Officers/Directors • Budget Officers
• Customers • Internal Auditors • Controllers
• Governments
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Questions that internal users ask

INTERNAL
USERS

Illustration 1-2
Questions that internal
users ask
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Questions that external users ask

EXTERNAL
USERS
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C2 FINANCIAL & MANAGERIAL

ACCOUNTING

External Users Internal Users

Financial accounting Managerial accounting

provides external users provides information needs
with financial statements. for internal decision-makers.
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C3

ETHICS - A KEY CONCEPT

Ethics

Beliefs that Accepted standards

distinguish right of good and bad
from wrong behavior
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C3

ETHICS - A KEY CONCEPT

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C4 GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES
Financial accounting practice is governed by concepts
and rules known as generally accepted accounting
principles (GAAP).

Relevant Information Affects the decision of its users.

Reliable Information Is trusted by users.

Comparable Is helpful in contrasting

Information organizations.
 1 - 13

Accounting Standards

International Accounting Standards

Board (IASB) http://www.iasb.org/

International Financial
Reporting Standards

Financial Accounting Standards Board

(FASB) http://www.fasb.org/

Generally Accepted Accounting Principles (GAAP)

 1 - 14

C4

INTERNATIONAL STANDARDS

The International Accounting Standards Board (IASB), an

independent group (consisting of 16 individuals from many
countries), issues International Financial Reporting Standards
(IFRS) that identify preferred accounting practices.

IASB
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C4 GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES
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C4 PRINCIPLES AND ASSUMPTIONS

OF ACCOUNTING

Revenue Recognition Principle

1. Recognize revenue when it is earned. Cost Principle
2. Proceeds need not be in cash. Accounting information is based on
3. Measure revenue by cash received actual cost. Actual cost is
plus cash value of items received. considered objective.

Expense Recognition or Full Disclosure Principle

Matching Principle A company is required to report the
A company must record its expenses details behind financial statements that
incurred to generate the revenue reported. would impact users’ decisions.
 1 - 17

Revenue Recognition Principle

1. Recognize revenue when it is earned.
2. Proceeds need not be in cash.
3. Measure revenue by cash received plus cash value of items received.

 Example: Credit sales

 Illustration: Assume that Jordan Company sells
merchandise on account to Polo Company for
$1,000
 1 - 18

COST PRINCIPLE

 Accounting information is based on actual

cost. Actual cost is considered objective.
 Example: Equipment.
 PURCHASE OF EQUIPMENT FOR CASH
Softbyte SA purchases computer equipment for
€7,000 cash.
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EXPENSE RECOGNITION OR
MATCHING PRINCIPLE
 A companymust record its expenses incurred to
generate the revenue reported.
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FULL DISCLOSURE PRINCIPLE

A company is required to report the

details behind financial statements
that would impact users’ decisions.
Most of the details are reported in the
notes to the financial statements
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C4

ACCOUNTING ASSUMPTIONS

Now Future
Going-Concern Assumption Monetary Unit Assumption
Express transactions and events in
Reflects assumption that the business
monetary, or money, units.
will continue operating instead of being
closed or sold.

Business Entity Assumption Time Period Assumption

A business is accounted for Presumes that the life of a company can
separately from other business be divided into time periods, such as
entities, including its owner. months and years.
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C4

FORMS OF BUSINESS ENTITIES

Sole
Sole Partnership
Partnership Corporation
Corporation
Proprietorship
Proprietorship
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Forms of Business Ownership

Sole Proprietorship Partnership Corporation

 Owned by one  Owned by two or  Ownership divided

person more persons into shares (Owners
 Owner is often  Often retail and of a corporation or
manager/operator service-type company are called
businesses shareholders (or
 Owner receives stockholders).
any profits, suffers  Generally
 Separate legal entity
any losses, and is unlimited
personally liable personal liability organized under
for all debts corporation law
 Partnership
 Limited liability
agreement
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> DO IT!

Indicate whether each of the following statements presented

below is true or false.

1. Convergence refers to efforts to reduce

True
differences between IFRS and U.S. GAAP.

2. A business owner’s personal expenses must be

separated from expenses of the business to True
comply with accounting’s economic entity
assumption.
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The Basic Accounting Equation

Basic Accounting Equation

 Provides the underlying framework for
recording and summarizing economic
events.
 Assets must equal the sum of liabilities
and equity.

Assets
Assets = Liabilities
Liabilities + Equity
Equity
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Basic Accounting Equation

Assets
Assets = Liabilities
Liabilities + Equity
Equity

Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Inventory, Equipment, etc.
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Basic Accounting Equation

Assets
Assets = Liabilities
Liabilities + Equity
Equity

Liabilities
 Claims against assets (debts and obligations).
 Creditors (party to whom money is owed).
 Accounts Payable, Notes Payable, Salaries and Wages
Payable, etc.
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Basic Accounting Equation

Assets
Assets = Liabilities
Liabilities + Equity
Equity

Equity
 Ownership claim on total assets.
 Referred to as residual equity.
 Share Capital—Ordinary and Retained Earnings.
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Equity Illustration
Increases and
decreases in equity

Investments by shareholders represent the total amount paid

in by shareholders for the ordinary shares they purchase.
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Stockholders’ Equity Illustration

Increases and
decreases in equity

Revenues result from business activities entered into for the

purpose of earning income.
Common sources of revenue are: sales, fees, services,
commissions, interest, dividends, royalties, and rent.
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Stockholders’ Equity Illustration

Increases and
decreases in equity

Expenses are the cost of assets consumed or services used in

the process of earning revenue.
Common expenses are: salaries expense, rent expense, utilities
expense, property tax expense, etc.
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Stockholders’ Equity Illustration

Increases and
decreases in equity

Dividends are the distribution of cash or other assets to

shareholders.
Dividends reduce retained earnings. However, dividends are not
expenses.
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> DO IT!

Classify the following items as issuance of stock, dividends,

revenues, or expenses. Then indicate whether each item
increases or decreases stockholders’ equity.

Classification Effect on Equity

1. Rent Expense Expense Decrease

2. Service Revenue Revenue Increase

3. Dividends Dividends Decrease

4. Salaries and Wages
Expense Expense Decrease
 1 - 34

The Basic Accounting Equation

Transactions are a business’s economic

events recorded by accountants.
 May be external or internal.
 Not all activities represent transactions.
 Each transaction has a dual effect on the accounting
equation.
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Transaction Analysis

Illustration: Are the following events recorded in the accounting

records?
Discuss product
Purchase
Event design with Pay rent
computer
potential customer

Criterion Is the financial position (assets, liabilities, or

stockholder’s equity) of the company changed?

Record/
Don’t Record
Illustration :Transaction-
identification process
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Transaction Analysis

Illustration: Expanded
accounting equation
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Transaction Analysis
TRANSACTION 1. INVESTMENT BY STOCKHOLDERS Ray and
Barbara Neal decide to start a smartphone app development company that
they incorporate as Softbyte SA. On September 1, 2017, they invest
€15,000 cash in the business in exchange for €15,000 of ordinary
shares. The ordinary shares indicates the ownership interest that the
Neals have in Softbyte SA. This transaction results in an equal increase in
both assets and equity.
Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies +Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
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TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH Softbyte

SA purchases computer equipment for €7,000 cash.

Assets = Liabilities + Equity

Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies +Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
 1 - 39

TRANSACTION 3. PURCHASE OF SUPPLIES ON CREDIT Softbyte SA

purchases for €1,600 headsets and other accessories expected to last
several months. The supplier allows Softbyte to pay this bill in October.
Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies +Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
 1 - 40

TRANSACTION 4. SERVICES PERFORMED FOR CASH Softbyte SA

receives €1,200 cash from customers for app development services it has
performed.
Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies +Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
 1 - 41

TRANSACTION 5. PURCHASE OF ADVERTISING ON CREDIT Softbyte

SA receives a bill for €250 from the Programming News for advertising on
its website but postpones payment until a later date.
Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies +Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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TRANSACTION 6. SERVICES PROVIDED FOR CASH AND CREDIT.

Softbyte provides €3,500 of services. The company receives cash of
€1,500 from customers, and it bills the balance of €2,000 on account.
Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies +Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
 1 - 43

TRANSACTION 7. PAYMENT OF EXPENSES Softbyte SA pays the

following expenses in cash for September: office rent €600, salaries and
wages of employees €900, and utilities €200.
Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies +Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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TRANSACTION 8. PAYMENT OF ACCOUNTS PAYABLE Softbyte SA

pays its €250 Programming News bill in cash. The company previously (in
Transaction 5) recorded the bill as an increase in Accounts Payable.
Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies +Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
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TRANSACTION 9. RECEIPT OF CASH ON ACCOUNT Softbyte SA

receives €600 in cash from customers who had been billed for services
(in Transaction 6).
Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies +Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
$8,050 + $1,400 + $1,600 + $7,000 = $1,600 + $15,000 + $4,700 - $1,950 - $1,300
 1 - 46

TRANSACTION 10. DIVIDENDS The corporation pays a dividend of

€1,300 in cash to Ray and Barbara Neal, the shareholders of Softbyte SA.
Assets = Liabilities + Equity
Trans- Accounts Accounts Share Retained Earnings
Cash + + Supplies +Equipment = + +
action Receivable Payable Capital Rev. – Exp. – Div.

1. +15,000 +15,000
2. -7,000 +7,000
3. +1,600 +1,600
4. +1,200 +1,200
5. +250 -250
6. +1,500 +2,000 +3,500
7. -1,700 -600
-900
-200
8. -250 -250
9. +600 -600
10. -1,300 -1,300
€8,050 + €1,400 + €1,600 + €7,000 = €1,600 + €15,000 + €4,700 - €1,950 - €1,300

€18,050 €18,050
 1 - 47

Summary of Transactions

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 - 48

> DO IT!

Transactions made by Virmari & Co. SA, a public accounting firm, for
the month of August are shown below. Prepare a tabular analysis
which shows the effects of these transactions on the expanded
accounting equation, similar to that shown in Illustration 1-10.

1. The company issued ordinary shares for €25,000 cash.

2. The company purchased €7,000 of office equipment on credit.

3. The company received €8,000 cash in exchange for services

performed.

4. The company paid €850 for this month’s rent.

5. The company paid a dividend of €1,000 in cash to shareholders.

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> DO IT!

1. The company issued ordinary shares for €25,000 cash.

Assets = Liabilities + Equity

Trans- Accounts Share Retained Earnings
Cash + Equipment = + +
action Payable Capital Rev. – Exp. – Div.
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
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> DO IT!

2. The company purchased €7,000 of office equipment on credit.

Assets = Liabilities + Equity

Trans- Accounts Share Retained Earnings
Cash + Equipment = + +
action Payable Capital Rev. – Exp. – Div.
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
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> DO IT!

3. The company received €8,000 cash in exchange for services

performed.
Assets = Liabilities + Equity
Trans- Accounts Share Retained Earnings
Cash + Equipment = + +
action Payable Capital Rev. – Exp. – Div.
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
 1 - 52

> DO IT!

4. The company paid €850 for this month’s rent.

Assets = Liabilities + Equity

Trans- Accounts Share Retained Earnings
Cash + Equipment = + +
action Payable Capital Rev. – Exp. – Div.
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

$31,150 + $7,000 = $7,000 + $25,000 + $8,000 - $850 - $1,000

$18,050 $18,050
 1 - 53

> DO IT!

5. The company paid a dividend of €1,000 in cash to shareholders.

Assets = Liabilities + Equity

Trans- Accounts Share Retained Earnings
Cash + Equipment = + +
action Payable Capital Rev. – Exp. – Div.
1. +25,000 +25,000

2. +7,000 +7,000

3. +8,000 +8,000

4. -850 -850

5. -1,000 -1,000

€31,150 + €7,000 = €7,000 + €25,000 + €8,000 - €850 - €1,000

€38,150 €38,150
 1 - 54

The Basic Accounting Equation

Corporations prepare five financial
statements :

Retained Statement of
Income Earnings Financial
Statement Statement Position

Statement of Comprehensive
Cash Flows Income Statement
 1 - 55

Income Statement

 Reports the profitability of the company’s operations

over a specific period of time.
 Lists revenues first, followed by expenses.
 Shows net income (or net loss).
 Does not include investment and dividend
transactions between the shareholders and the
business.
 1 - 56

Financial Statements

Review Question
Net income will result during a time period when:
a. assets exceed liabilities.
b. assets exceed revenues.
c. expenses exceed revenues.
d. revenues exceed expenses.
 1 - 57

Retained Earnings Statement

 Reports the changes in retained earnings for a

specific period of time.
 The time period is the same as that covered by the
income statement.
 Information provided indicates the reasons why
retained earnings increased or decreased during the
period.
 1 - 58

Statement of Financial Position

 Reports the assets, liabilities, and equity at a specific

date.
 Lists assets at the top, followed by liabilities and
equity.
 Total assets must equal total liabilities and equity.
 Is a snapshot of the company’s financial condition at
a specific moment in time (usually the month-end or
year-end).
 1 - 59

Financial Statements

Review Question
The financial statement that reports assets, liabilities, and
equity is the:
a. income statement.
b. retained earnings statement.
c. statement of financial position.
d. statement of cash flows.
 1 - 60

Statement of Cash Flows

 Information on the cash receipts and payments for a

specific period of time.
 Answers the following:
HELPFUL HINT
► Where did cash come from? Investing activities
pertain to investments
made by the company,
► What was cash used for?
not investments made
by the owners.
► What was the change in the
cash balance?
 1 - 61

Illustration 1-10
Financial statements and
their interrelationships

Illustration : Financial statements and their

interrelationships
1 - 62
 1 - 63

Balance sheet and

income statement
are needed to
prepare statement of
cash flows.

Illustration :
Financial statements
and their
interrelationships
 1 - 64

Comprehensive Income Statement

 Other comprehensive income items are not part of

net income.
 Reported either by
► Combining with income statement, or
Illustration :
► Separate statement. Comprehensive
income
statement
 1 - 65

> DO IT!

Presented below is selected information related to Flanagan Group plc

at December 31, 2017. Flanagan reports financial information monthly.
Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(a) Determine the total assets of Flanagan at December 31, 2017.
(b) Determine the net income that Flanagan reported for December
2017.
(c) Determine the equity of Flanagan at December 31, 2017.
 1 - 66

Information related to Flanagan Group plc at December 31, 2017.

Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(a) Determine the total assets of Flanagan at December 31, 2017.

Equipment £10,000
Cash 8,000
Accounts Receivable 9,000
Total assets £27,000
 1 - 67

Information related to Flanagan Group plc at December 31, 2017.

Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(b) Determine the net income reported for December 2017.
Revenues
Service revenue £36,000
Expenses
Rent expense £11,000
Salaries and wages expense 7,000
Utilities expense 4,000
Total expenses 22,000
Net income £14,000
 1 - 68

Information related to Flanagan Group plc at December 31, 2017.

Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(c) Determine the equity of Flanagan at December 31, 2017.

Total assets [as computed in (a)] £27,000

Less: Liabilities
Notes payable £16,500
Accounts payable 2,000 18,500
Equity £ 8,500
 1 - 69

END OF CHAPTER 1