Chapter 2

Introduction to Accounting and Business

Accounting, 21st Edition
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Objectives
1. Describe the nature of a business. After studying this 2. Describe the chapter, role of accounting in business. you should 3. Describe the importance business ethics and be ableof to: 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.
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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 owners equity to analyze the ability of a business to withstand poor business conditions.

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Types of Businesses
Manufacturing Business
Product

General Motors Intel Boeing Nike Coca-Cola Sony

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Cars, trucks, vans Computer chips Jet aircraft Athletic shoes and apparel Beverages Stereos and television
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Types of Businesses
Merchandising Business
Product

Wal-Mart Toys R Us Circuit City Lands End Amazon.com

General merchandise Toys Consumer electronics Apparel Internet books, music, video retailer
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Types of Businesses
Service Business
Product

Disney Delta Air Lines Marriott Hotels Merrill Lynch Sprint

Entertainment Transportation Hospitality and lodging Financial advice Telecommunication

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There are three types of business organizations

Proprietorship Partnership Corporation

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A proprietorship is owned by one individual.

Advantages
Ease in organizing Low cost of organizing

Joes

Disadvantage Limited source of financial resources Unlimited liability

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A partnership is owned by two or more individuals.

Advantages More financial resources than a proprietorship. Additional management skills.

Disadvantage Unlimited liability.

Joe and Martys

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A corporation is organized under state or federal statutes as a separate legal entity.

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

J & M, Inc.

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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.

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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
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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
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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.
Inputs Business Processes Products or Services Customer Value

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Business Stakeholders
A business stakeholder is a person or entity having an interest in the economic performance of the business.

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The Process of Providing Information

Identify stakeholders.

STAKEHOLDERS External: Internal: Customers, Owners, creditors, managers, government employees

2
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Assess stakeholders informational needs.

The Process of Providing Information

Record economic data about business activities and events. Design the accounting information system to meet stakeholders needs.

Accounting Information System

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The Process of Providing Information

STAKEHOLDERS

Internal: Owners, managers, employees

External: Customers, creditors, government

Prepare accounting reports for stakeholders.

Accounting Information System

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Business Ethics
Sound Principles that form the foundation for ethical behavior
1. Avoid small ethical lapses. 2. Focus on your long-term reputation. 3. You may expect to suffer adverse personal consequences for holding to an ethical position.

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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.
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Generally Accepted Accounting Principles (GAAP)

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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.
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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.
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The Accounting Equation

Assets = Liabilities + Owners Equity
The resources owned by a business

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The Accounting Equation

Assets = Liabilities + Owners Equity
The rights of the creditors, which represent debts of the business

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The Accounting Equation

Assets = Liabilities + Owners Equity
The rights of the owners

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What is a business transaction?

A business transaction is an economic event or

condition that directly changes an entitys financial condition or directly affects its results of operations.
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On November 1, 2005, Chris Clark begins a business that will be known as NetSolutions.

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a. Chris Clark deposits $25,000 in a bank account in the name of NetSolutions.

Assets
a. Cash 25,000 = = Owners Equity Chris Clark, Capital 25,000 Investment by Chris Clark

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b. NetSolutions exchanged $20,000 for land.

Owners Equity Chris Clark, Capital 25,000 25,000

Assets
Cash + Land Bal. 25,000 b. 20,000 +20,000 Bal. 5,000 20,000

= =

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c. During the month, NetSolutions purchased supplies for $1,350 and agreed to pay the supplier in the near future (on account).
Assets =

Cash + Supplies + Land

Bal. 5,000 c. Bal. 5,000 20,000 + 1,350 1,350 20,000 =

Owners Liabilities + Equity Accounts Chris Clark, Payable Capital

25,000 + 1,350 1,350 25,000

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d. NetSolutions provided services to customers, earning fees of $7,500 and received the amount in cash.
Assets =

Cash + Supplies + Land Bal. 5,000 1,350 20,000 d. + 7,500 Bal. 12,500 1,350 20,000

Owners Liabilities + Equity Accounts Chris Clark, Payable Capital 1,350 25,000 + 7,500 Fees earned 1,350 32,500

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e. NetSolutions paid the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.
Assets =

Cash + Supplies + Land Bal. 12,500 1,350 20,000 e. 3,650

Bal.8,850

1,350

20,000
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Owners Liabilities + Equity Accounts Chris Clark, Payable Capital 1,350 32,500 2,125 Wages 800 Rent 450 Util. 275 Misc. 1,350 28,850

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f. NetSolutions paid $950 to creditors during the month.

Assets =

Cash + Supplies + Land Bal. 8,850 1,350 20,000 f. 950 Bal. 7,900 1,350 20,000

Owners Liabilities + Equity Accounts Chris Clark, Payable Capital 1,350 28,850 950 400 28,850

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g. At the end of the month, the cost of supplies on hand is $550, so $800 of supplies were used.
Assets =

Cash + Supplies + Land Bal. 7,900 1,350 20,000 g. 800 Bal. 7,900 550 20,000

Owners Liabilities + Equity Accounts Chris Clark, Payable Capital 400 28,850 800 Supplies expense 400 28,050

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h. At the end of the month, Chris withdrew $2,000 in cash from the business for personal use.
Assets =

Cash + Supplies + Land Bal. 7,900 550 20,000 h. 2,000 Bal. 5,900 550 20,000

Owners Liabilities + Equity Accounts Chris Clark, Payable Capital 400 28,050 2,000 Withdrawal 400 26,050

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Effects of Transactions on Owners Equity

Owners Equity Decreased by Increased by

Owners withdrawals Expenses

Owners investments Revenues

Net income
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Accounting reports, called financial statements, provide summarized information to the owner.

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Financial Statements
Income statementA summary of the revenue and expenses for a specific period of time. Statement of owners equityA summary of the changes in the owners equity that have occurred during a specific period of time. Balance sheetA list of the assets, liabilities, and owners equity as of a specific date. Statement of cash flowsA summary of the cash receipts and disbursements for a specific period of time.
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NetSolutions Income Statement For the Month Ended November 30, 2005 Fees earned Operating expenses: Wages expense Rent expense Supplies expense $2 125 00 800 00 $7 500 00

Utilities expense Miscellaneous expense Total operating expenses

Net income

800 00 450 00
275 00

1 135 00
$3 050 00

To the statement of owners equity

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NetSolutions Statement of Owners Equity For the Month Ended November 30, 2005 Chris Clark, capital, November 1, 2005 Investment on November 1 From the income Net income for November $25 000 00 3 050 00 $28 050 00 2 000 00 26 050 00 $26 050 00 $ 0

statement

Less withdrawals Increase in owners equity To the Chris Clark, capital, November 30, 2005

balance sheet

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NetSolutions Balance Sheet November 30, 2005 Assets

From the statement of Liabilities owners equity

Cash Supplies Land

Total assets

$ 5 900 00 Accounts Payable $ 400 00 550 00 Owners Equity 20 000 00 Chris Clark, cap. 26 050 00 Total liabilities and $26 450 00 owners equity $26 450 00

This balance sheet presented using the account form

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When the balance sheet displays the liabilities and owners equity below the assets, the report form is being used.

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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 owners investment $25 000 00 Deduct cash withdrawal by owner 2 000 00 Net cash flow from financing activities 23 000 00 Net cash flow and Nov. 30, 2005 cash bal. sheet $ 5 900 00 Should match Cash on the balance
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Statement of Cash Flows

Cash Flows from Operating ActivitiesThis section reports a summary of cash receipts and cash payments from operations. Cash Flows from Investing ActivitiesThis section reports the cash transactions for the acquisition and sale of relatively permanent assets. Cash Flows from Financing ActivitiesThis section reports the cash transactions related to cash investments by the owner, borrowings, and cash withdrawals by the owner.
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Tools for Financial Analysis and Interpretation

The ratio of liabilities to owners equity allows owners like Chris Clark to analyze the firms ability to withstand poor business conditions.
Total Liabilities Ratio of liabilities = to owners equity Total owners equity (or total stockholders equity)
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Tools for Financial Analysis and Interpretation

Ratio of $400 liabilities to = $26,050 owners equity Ratio of liabilities to = 0.015 owners equity

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Chapter 2

The End

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