Chapter One

Introduction to
Accounting and
Business
LEARNING OBJECTIVES
After studying this chapter, you should be
able to:
1 Explain what accounting is.
2 Identify the users and uses of accounting.
3 Explain accounting standards and measurement
principles.
4 Explain the monetary unit assumption and the
economic entity assumption.
5 Explain the career opportunities in accounting.
6 State the accounting equation, and define its
components.
7 Analyze effects of business transactions on the
 1. What is Accounting?
1.
Accounting consists of three basic activities—
it
 identifies,
 records, and
 communicates

the economic events of an organization to

interested users.
 Cont’d
o As a starting point to the accounting process, a company
identifies the economic events relevant to its
business. Examples of economic events are the sale of
goods, the providing of telephone services …
o Once a company identifies economic events, it records
those events in order to provide a history of its
financial activities.
o Recording consists of keeping a systematic,
chronological diary of events, measured in
monetary units.
o In recording, the company also classifies and
summarizes economic events.
o Finally, the company communicates the collected
Three Activities
Illustration 1-1
The activities of the accounting
process

The accounting process includes

the bookkeeping function.
Who Uses Accounting Data?
o There are two broad groups of users of financial
information: internal users and external users.
1) INTERNAL USERS
o Internal users of accounting information are
managers who plan, organize, and run the business.
These include marketing managers, production
supervisors, finance directors, and company
officers.
o Managerial Accounting provides internal reports to
help users make decisions about their companies.
o Examples are financial comparisons of operating
alternatives, projections of income from new sales
 Cont’d

INTERNA
L USERS

Illustration 1-2
Questions that
internal users ask
 Cont’d
2) EXTERNAL USERS
o External users are individuals and organizations
outside a company who want financial information about
the company.
o The two most common types of external users are
investors and creditors.
o Investors (owners) use accounting information to
make decisions to buy, hold, or sell ownership shares of
a company.
o Creditors (such as suppliers & bankers) use
accounting information to evaluate the risks of granting
credit or lending money.
o Financial Accounting provides economic and financial
 Cont’d

EXTERN
AL
USERS

Illustration 1-3
Questions that external
users ask
 > DO
IT!
Indicate whether the following statements are
true or false.
1. The three steps in the accounting process are
identification, recording, and communication.
2. Bookkeeping encompasses all steps in the
accounting process.
3. Accountants prepare, but do not interpret, financial
reports.
4. The two most common types of external users are
investors and company officers.
 Accounting Standards,
1. Measurement Principles &
2. Assumptions
Accounting Standards
o In order to ensure high-quality financial reporting,
accountants present FS’s in conformity with
accounting standards that are issued by standard
setting bodies.
o Presently, there are two primary accounting
standard-setting bodies—the IASB and FASB.
o More than 140 countries follow standards referred to
IFRS.
o IFRS’s are determined by the IASB. The IASB is
headquartered in London, with its 15 board members
 Cont’d
o Most companies in the US follow standards issued by
the FASB, referred to as GAAP.
o As markets become more global, it is often desirable
to compare the results of companies from different
countries that report using different accounting
standards.
o In order to increase comparability, in recent years the
two standard-setting bodies have made efforts to
reduce the differences between IFRS and U.S. GAAP.
o This process is referred to as convergence.
o As a result of these convergence efforts, it is likely
that someday there will be a single set of high-quality
 Cont’d

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)

Measurement Principles
o IFRS generally uses one of two measurement
principles, the historical cost principle or the fair
value principle.
o The selection of which principle to follow generally
relates to trade-offs between relevance & faithful
representation.
o Relevance means that financial information is
capable of making a difference in a decision.
o Faithful representation means that the numbers
and descriptions match what really existed or
happened—they are factual.
 Cont’d
1) HISTORICAL COST PRINCIPLE (or Cost
Principle)
o It dictates that companies record assets at
their cost.

o This is true not only at the time the asset is

purchased, but also over the time the asset is
held.

2) FAIR VALUE PRINCIPLE

o It states that assets and liabilities should be
reported at fair value (the price received to
 Cont’d
o Fair value information may be more useful than HC
for certain types of assets and liabilities.

o For example, certain investment securities are

reported at FV because market value information
is usually readily available for these types of
assets.

o In determining which measurement principle to

use, companies weigh the factual nature of cost
figures versus the relevance of fair value.

o In general, even though IFRS allows companies to

revalue PPE and other long-lived assets to FV, most
companies choose to use cost. Only in situations
where assets are actively traded, such as investment
Assumptions
o Assumptions provide a foundation for the accounting
process.
o Two main assumptions are the monetary unit
assumption and the economic entity
assumption.

1) MONETARY UNIT ASSUMPTION

o The monetary unit assumption requires that
companies include in the accounting records only
transaction data that can be expressed in money terms.
o This assumption enables accounting to quantify
(measure) economic events.
o The monetary unit assumption is vital to applying the
 Cont’d
o This assumption prevents the inclusion of some
relevant information in the accounting records.
o For example, the health of a company’s owner, the
quality of service, and the morale of employees are
not included.
o The reason: Companies cannot quantify this
information in money terms.
 Cont’d
2) ECONOMIC ENTITY ASSUMPTION
o It requires that activities of the entity be kept
separate and distinct from the activities of its
owner and all other economic entities.
 Proprietorship
 Partnership
Forms of
Business
 Corporation Ownership
 Cont’d
Proprietors Partnershi Corporatio
hip p n
 Owned by one  Owned by two  Ownership
person or more divided into
 Owner is often persons shares
manager/oper  Often retail  Separate legal
ator and service- entity
 Owner receives type organized
any profits, businesses under
suffers any  Generally corporation
losses, and is unlimited law
personally personal  Limited
liable for all liability liability
 Cont’d
Question #1
The historical cost principle states that:
a. Assets should be initially recorded at cost and
adjusted when the fair value changes.
b. Activities of an entity are to be kept separate
and distinct from its owner.
c. Assets should be recorded at their cost.
d. Only transaction data capable of being
expressed in terms of money be included in the
accounting records.
 > DO
IT!
Indicate whether each of the following
statements presented below is true or false.

1. Convergence refers to efforts to reduce differences

between IFRS and U.S. GAAP.

2. The primary accounting standard-setting body

headquartered in London is the International
Accounting Standards Board (IASB).

3. The historical cost principle dictates that companies

record assets at their cost. In later periods, however,
the fair value of the asset must be used if fair value
is higher than its cost.
 > DO
IT!
Indicate whether each of the following
statements presented below is true or false.

4. Relevance means that financial information

matches what really happened; the information is
factual.

5. A business owner’s personal expenses must be

separated from expenses of the business to comply
with accounting’s economic entity assumption.
 Accounting Career
1. Opportunities
3.Public Accounting
Provied service to public
Careers in auditing, taxation, and Private Accounting
management consulting serving the Careers in industry
general public. working in cost accounting,
budgeting, accounting
Governmental Accounting
Careers with the tax authorities, information systems, and
law enforcement agencies, and taxation.
corporate regulators.

Forensic Accounting
Uses accounting, auditing, and investigative skills to
conduct investigations into theft and fraud.
 The Basic Accounting
1. Equation
4.
Basic Accounting Equation
 Provides the underlying framework for
recording and summarizing economic events.
 Assets must equal the sum of liabilities and
equity.

Asset Liabilit Equi

= +
s ies ty
 Cont’d
Asset Liabilit Equi
= +
s ies ty
Assets
 Resources a business owns.
 Provide future services or benefits.
 Cash, Inventory, Equipment, etc.
 Cont’d
Asset Liabilit Equi
= +
s ies ty
Liabilities
 Claims against assets (debts and
obligations).
 Creditors (party to whom money is owed).
 Accounts Payable, Notes Payable, Salaries
and Wages Payable, etc.
 Cont’d
Asset Liabilit Equi
= +
s ies ty
Equity
 Ownership claim on total assets.
 Referred to as residual equity.
 Share Capital—Ordinary and Retained
Earnings.
 Cont’d
Illustration 1-7: Increases and Decreases in Equity

Investments by shareholders represent the

total amount paid in by shareholders for the
ordinary shares they purchase.
 Cont’d
Illustration 1-7: 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.
 Cont’d
Illustration 1-7: 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,
 Cont’d
Illustration 1-7: 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.
 > 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

2. Service Revenue

3. Dividends

4. Salaries and Wages Expense

 Using the Accounting
1. Equation
5.
Transactions are a business’s economic
events recorded by accountants.
 May be external or internal.
 Taipai Pizza’s purchase of cooking
equipment from a supplier,
 The use of cooking and cleaning supplies
 Not all activities represent transactions.
 Each transaction has a dual effect on the
accounting equation.
 Cont’d
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 1-8
Transaction-identification
process
 Cont’d
Illustration 1-9
Expanded Accounting Equation
 Cont’d
TRANSACTION 1. INVESTMENT BY STOCKHOLDERS Ray and Barbara
Neal decide to start a computer programming company that they
incorporate as Softbyte Inc. On September 1, 2014, 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
TRANSACTION 2. PURCHASE OF EQUIPMENT FOR CASH Softbyte
Inc. 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
TRANSACTION 3. PURCHASE OF SUPPLIES ON CREDIT Softbyte Inc.
purchases for €1,600 computer paper & other supplies 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
TRANSACTION 4. SERVICES PERFORMED FOR CASH Softbyte Inc.
receives €1,200 cash from customers for programming services it has
provided.
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
TRANSACTION 5. PURCHASE OF ADVERTISING ON CREDIT Softbyte
receives a bill for €250 from the Daily News for advertising 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
TRANSACTION 6. SERVICES PROVIDED FOR CASH AND CREDIT.
Softbyte Inc provides €3,500 of programming services for customers. 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
TRANSACTION 7. PAYMENT OF EXPENSES Softbyte pays the
following expenses in cash for September: Store 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
TRANSACTION 8. PAYMENT OF ACCOUNTS PAYABLE Softbyte pays its
€250 Daily News bill in cash. The company previously (in Transaction 5)
recorded the bill as an increase in Accounts Payable and a decrease in
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
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
TRANSACTION 9. RECEIPT OF CASH ON ACCOUNT Softbyte
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
TRANSACTION 10. DIVIDENDS The corporation pays a dividend of €1,300
in cash to Ray and Barbara Neal, the shareholders of Softbyte Inc.

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
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.
Illustration 1.10: Tabular Summery of Softbyte
Inc. Transactions
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
 > DO IT!
Transactions made by Virmari & Co., 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.
 > DO IT!

Solution:
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. Financial Statements
6.
 Companies prepare four financial statements from the
summarized accounting data:
 An IS presents the revenues and expenses and resulting
Net Income or Net Loss for a specific period of time.
 A RE’s statement summarizes the changes in retained
earnings for a specific period of time.
 A SoFP (sometimes referred to as a balance sheet)
reports the assets, liabilities, and equity of a company at a
specific date.
 A SCF summarizes information about the cash inflows
and cash outflows for a specific period of time.
 These statements provide relevant financial data for
 Illustration 1-10
Financial statements and
their interrelationships

Illustration 1-11: Financial Statements and their

SoFP & IS
are
needed
to
prepare
SCF.
Illustration
1-11: FS’s and
their
Interrelationsh
ips
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.
 Cont’d
Question #2
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.
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.
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 with 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).
 Cont’d
Question #3
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.
Statement of Cash Flows
 Information on the cash receipts and payments
for a specific period of time.
 Answers the following:
► Where did cash come from?
► What was cash used for?
► What was the change in the
cash balance? HELPFUL HINT
Investing activities pertain
to investments made by the
company, not investments
made by the owners.
 > DO IT!
Presented below is selected information related to Flanagan
Company at December 31, 2014. 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

Required:
(a) Determine the total assets of Flanagan at December 31, 2014.
(b) Determine the net income that Flanagan reported for December 2014.
(c) Determine the equity of Flanagan at December 31, 2014.
Information related to Flanagan Company at December 31, 2014.
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, 2014.

Equipment £10,000
Cash 8,000
Accounts Receivable 9,000
Total assets £27,000
Information related to Flanagan Company at December 31,
2014.
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 2014.
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
Information related to Flanagan Company at December 31,
2014.
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, 2014.
Total assets [as computed in (a)] £27,000
Less: Liabilities
Notes payable £16,500
Accounts payable 2,000 18,500
Equity £ 8,500
The End of Chapter
1
Thank You!!!