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c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objectives

• LO1: Describe the nature of a business and the

role of accounting and ethics in business.
• LO2: Summarize the development of accounting
principles and relate them to practice.
• LO3: State the accounting equation and define
each element of the equation.
• LO4: Describe and illustrate how business
transactions can be recorded in terms of the
resulting change in the elements of the accounting
equation.

©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Nature of Business and Accounting

• A business is an organization in which

basic resources (inputs), such as materials
and labor, are assembled and processed to
provide goods or services (outputs) to
customers.
• The objective of most businesses is to earn
a profit.
• Profit is the difference between the
amounts received from customers for
goods or services and the amounts paid
for the inputs used to provide the goods or
services.
©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Types of Businesses

Service Businesses provide services rather than products to customers.

Company Service
Delta Air Lines Transportation services
The Walt Disney Company Entertainment services

Merchandising Businesses sell products they purchase from other

businesses to customers.
Company Product
Walmart General merchandise
Amazon.com Internet books, music, videos

Manufacturing Businesses change basic inputs into products that are sold
to customers.
Company Product
Ford Motor Co. Cars, trucks, vans
Dell Inc. Personal computers
©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Role of Accounting in Business

• Accounting can be defined as an

information system that provides reports
to users about the economic activities and
condition of a business.
• The process by which accounting provides
information to users is as follows:
o Identify users.
o Assess users’ information needs.
o Design the accounting information system to
meet users’ needs.
o Record economic data about business activities
and events.
o Prepare accounting reports for users.
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Managerial Accounting

• The area of accounting that provides

internal users with information is called
managerial accounting, or
management accounting.
• Managerial accountants employed by a
business are employed in private
accounting.

©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Financial Accounting

• The area of accounting that provides

external users with information is called
financial accounting.
• The objective of financial accounting is to
provide relevant and timely information for
the decision-making needs of users
outside of the business.
• General-purpose financial statements
are one type of financial accounting report
that is distributed to external users.

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The Accounting Equation
(slide 1 of 2)

• The resources owned by a business are its

assets.
• The rights of creditors are the debts of the
business and are called liabilities.
• The rights of the owners are called
owner’s equity.
• The equation Assets = Liabilities +
Owner’s Equity is called the accounting
equation.

©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Accounting Equation
(slide 2 of 2)

The rights of
creditors are the
debts of the
business

Assets = Liabilities + Owner’s Equity

The resources The rights of the

owned by a owners
business

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Example Exercise Accounting Equation
(slide 1 of 2)

John Joos is the owner and operator of You’re A Star, a

motivational consulting business. At the end of its accounting
period, December 31, 2018, You’re A Star has assets of $800,000
and liabilities of $350,000. Using the accounting equation,
determine the following amounts:
a. Owner’s equity as of December 31, 2018.
OE2018 = A2018 - L2018 = 800,000 – 350,000 = 450,000
b. Owner’s equity as of December 31, 2019, assuming that assets
increased by $130,000 and liabilities decreased by $25,000
during 2019.
A2019 = 800,000 + 130,000 = 930,000
L2019 = 350,000 – 25,000 = 325,000
OE2019 = 930,000 – 325,000 = 605,000
©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Example Exercise Accounting Equation
(slide 2 of 2)

©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Business Transactions and
the Accounting Equation

• A business transaction is an economic

event or condition that directly changes an
entity’s financial condition or its results of
operations.

©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Owner’s Equity
Illustration 1-6

Increases in Owner’s Equity

 Investments by owner are the assets the owner puts into the
business.
 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.
Owner’s Equity
Illustration 1-6

Decreases in Owner’s Equity

 Drawings An owner may withdraw cash or other assets for
personal use.
 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, tax expense, etc.
• A business earns money by selling goods or
services to its customers. This amount is
called revenue.
• Revenue from providing services is recorded
as fees earned.
• Revenue from the sale of merchandise is
recorded as sales.
• Other examples of revenue include rent,
which is recorded as rent revenue, and
interest, which is recorded as interest
revenue.
• Receivables are all money claims against other entities,
including people, business firms, and other organizations.
• The Supplies account is an asset because the supplies
purchased have not been used yet. Items such as
supplies that will be used in the business in the future are
called prepaid expenses, which are assets.
• A prepaid expense is an asset until it has been used up
in the business operations.
• The liability created by a purchase on account is called
an account payable. Accounts payable are promises by
a business to pay for a good or service later. Typical
goods purchased on credit include merchandise,
equipment, supplies, etc.
• Unearned revenue is a liability created by receiving
revenue in advance.
Transaction Analysis
Transaction (1): Ray Neal decides to open a computer programming
service which he names Softbyte. On September 1, 2014, Ray Neal
invests $15,000 cash in the business.

LO 7
Transaction Analysis
Transaction (2): Purchase of Equipment for Cash. Softbyte purchases
computer equipment for $7,000 cash.

LO 7
Transaction Analysis
Transaction (3): Softbyte purchases for $1,600 from Acme Supply
Company computer paper and other supplies expected to last several
months. The purchase is made on account.

LO 7
Transaction Analysis
Transaction (4): Softbyte receives $1,200 cash from customers for
programming services it has provided.

LO 7
Transaction Analysis
Transaction (5): Softbyte receives a bill for $250 from the Daily News
for advertising but postpones payment until a later date.

LO 7
Transaction Analysis
Transaction (6): Softbyte 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.

LO 7
Transaction Analysis
Transaction (7): Softbyte pays the following expenses in cash for
September: store rent $600, salaries of employees $900, and utilities
$200.

LO 7
Transaction Analysis
Transaction (8): Softbyte pays its $250 Daily News bill in cash.

LO 7
Transaction Analysis
Transaction (9): Softbyte receives $600 in cash from customers who
had been billed for services [in Transaction (6)].

LO 7
Transaction Analysis
Transaction (10): Ray Neal withdraws $1,300 in cash from the
business for his personal use. Illustration 1-8
Tabular summary of
Softbyte transactions

LO 7
Transaction Analysis
Transaction (10): Ray Neal withdraws $1,300 in cash from the
business for his personal use. Illustration 1-8
Tabular summary of
Softbyte transactions

LO 7
Example Exercise Transactions
(slide 1 of 2)

Salvo Delivery Service is owned and operated by Joel Salvo. The following
selected transactions were completed by Salvo Delivery Service during
February:
1. Received cash from owner as additional investment, $35,000.
2. Paid creditors on account, $1,800.
3. Billed customers for delivery services on account, $11,250.
4. Received cash from customers on account, $6,740.
5. Paid cash to owner for personal use, $1,000.
Indicate the effect of each transaction on the accounting equation elements
(Assets, Liabilities, Owner’s Capital, Drawing, Revenue, and Expense). Also
indicate the specific item within the accounting equation element that is
affected. To illustrate, the answer to (1) follows:

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Example Exercise Transactions
(slide 2 of 2)

©2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.