Accounting in Action: The Navigator

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Chapter
Accounting 1
in Action
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The Navigator is a learning
system designed to prompt you T H E N AV I G AT O R
to use the learning aids in the
chapter and set priorities as Understand Concepts for Review ❏
you study.
Read Feature Story ❏
Scan Study Objectives ❏
Read Preview ❏
Read text and answer Before You Go On
p. 8 ❏ p. 14 ❏ p. 20 ❏ p. 24 ❏
Work Demonstration Problem ❏
Review Summary of Study Objectives ❏
Answer Self-Study Questions ❏
Complete Assignments ❏
Concepts for Review highlight

CONCEPTS FOR REVIEW concepts from your earlier
reading that you need to un-
Before studying this chapter, you should know or, if necessary, review: derstand before starting the
new chapter.
■ How to use the study aids in this book.
(Student Owner’s Manual, pages vii–xiv)
■ How you learn best.
(Student Owner’s Manual, pages xvi–xviii)
■ The nature of the special student supplements that accompany this textbook.
(Student Owner’s Manual, page xv)
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■ THE
NAVIGATOR
1
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The Feature Story helps you picture how the chapter topic relates to the real world of accounting and
business. You will find references to the story throughout the chapter.
F E AT U R E S T O RY
Financial Reporting: A Matter of Trust In 2002 the financial press was full of
articles about financial scandals and accounting misdeeds. It started with Enron, but then
spread to Xerox, Qwest, Global Crossing, and WorldCom, among others. Many of the articles
expressed concern that as an increasing number of misdeeds came
to public attention, a mistrust of financial reporting in general was
developing. These articles made clear just how important accounting
and financial reporting are to the U.S. and world financial markets
and to society as a whole. Without financial reports, managers would
not be able to evaluate how well their company is doing or to make
decisions about the best way to make their company grow in the fu-
ture. Without financial reports, investors and lenders could not make
informed decisions about how to allocate their funds. There is no
doubt that a sound, well-functioning economy depends on accurate
and dependable financial reporting.
In order to make financial decisions as either an investor or a manager, you need to know
how to read financial reports. In this book you will learn about financial reporting and some
basic tools used to evaluate financial reports. In the first chapter we introduce you to the real
financial statements of a company whose products most of you probably are familiar with—
PepsiCo, Inc. We have chosen the financial statements of PepsiCo because they are a good ex-
ample from the real world. An appendix to this textbook contains the statements in their en-
tirety, and a copy of the PepsiCo, Inc. 2002 Annual Report accompanies this text.
PepsiCo manufactures Pepsi-Cola, the number two soft drink beverage in the world.
PepsiCo also manufactures the number one bottled water (Aquafina), the number one sports
drink (Gatorade), the number one ready-to-drink tea (Lipton), and the number one ready-to-
drink coffee (Frappuccino). In addition, PepsiCo is the largest manufacturer of snack foods in
the world. Its Frito-Lay chips dominate the U.S. market, with 59% of all snack chip sales and
the world market with over 32%. In all, PepsiCo ranks among the world’s largest packaged
good and beverage companies, with over $25 billion in sales, $23 billion in assets, and 140,000
employees. PepsiCo is not only large; it is also quite profitable, ranking
www.pepsico.com
twenty-eighth among all U.S. companies, with $3.3 billion in net income.
Chapter-opening vignettes end with the Internet addresses of the companies cited in the
story to help you connect with these real businesses and explore them further. ■✓
■ THE
NAVIGATOR
STUDY OBJECTIVES
After studying this chapter, you should be able to: Study Objectives give you a
framework for learning the
1. Explain what accounting is. specific concepts covered in
2. Identify the users and uses of accounting. the chapter.
3. Understand why ethics is a fundamental business concept.

4. Explain the meaning of generally accepted accounting principles and the cost principle.
5. Explain the meaning of the monetary unit assumption and the economic entity assumption.
6. State the basic accounting equation, and explain the meaning of assets, liabilities, and owner’s equity.
7. Analyze the effects of business transactions on the basic accounting equation. ✓ THE
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NAVIGATOR
8. Understand what the four financial statements are and how they are prepared.
P RPE V
R IE
EWV IOEF WC H A
O PFT E C
R H1 A P T E R 1 5
The opening story about PepsiCo, Inc. highlights the importance of having good financial in-
formation to make effective business decisions. Whatever one’s pursuits or occupation, the
need for financial information is inescapable. You cannot earn a living, spend money, buy on
credit, make an investment, or pay taxes without receiving, using, or dispensing financial in-
formation. Good decision making depends on good information.
The purpose of this chapter is to show you that accounting is the system used to provide
useful financial information. The content and organization of Chapter 1 are as follows.
ACCOUNTING IN ACTION
Why Study What Is The Building Blocks Using the

Financial Statements
Accounting? Accounting? of Accounting Building Blocks
• Who uses accounting • Ethics—a fundamental • Transaction analysis • Income statement

data business concept • Summary of • Owner’s equity
• Brief history of • Generally accepted transactions statement
accounting accounting principles • Balance sheet
• Bookkeeping and • Assumptions • Statement of cash
accounting • Basic accounting flows
• Accounting and you equation
■✓
■ THE
NAVIGATOR
The Preview describes and

outlines the major topics and
subtopics you will see in the
chapter.
Why Study Accounting?

As indicated in the Feature Story, accounting scandals and corporate misdeeds
made headlines on a weekly basis for over two years. WorldCom’s $3.8 billion re-
statement of inflated earnings contributed to losses to shareholders of $179.3 billion
and to job losses of 17,000. Enron’s variety of schemes that inflated income by $586
million, leading to financial restatements and bankruptcy, caused investor losses
of $66.4 billion and job losses of 6,100. Xerox Corp., using “accounting tricks” to
fool investors, restated five years of earnings to reclassify more than $6 billion in
revenue.
Numerous proposals to improve business practices and accounting oversights
have come from federal agencies and regulators, the investment community, and the
accounting profession. As a consequence, new laws have been passed to legislate
3
4 CHAPTER 1 Accounting in Action
business behavior as well as accounting and auditing practices. The Sarbanes-Oxley

Act, signed into law in July of 2002, increases the resources for the government to
combat fraud and to curb poor reporting practices, and it introduces sweeping
changes to the structure of the accounting and auditing professions.
One thing is very evident from these recent embarrassing, illegal, or unethical
business events: Accounting is important. Good accounting is essential to sound
business and investing decisions. Bad accounting cannot be tolerated. At the slight-
est hint of a company’s accounting improprieties, investors sell their stock and bat-
ter its stock price.
Recent events prove the worth of studying, understanding, and using the ac-
counting process and accounting information. This textbook is your introduction to
accounting as a valuable tool of business record keeping, communication, and analy-
sis. Make the most of this course—it will serve you for a lifetime in ways you can-
not now imagine.
What Is Accounting?
STUDY OBJECTIVE 1
Accounting is an information system that identifies, records, and communicates the
economic events of an organization to interested users. Let’s take a closer look at
Explain what these three activities.
accounting is.
1. Identifying economic events involves selecting the economic activities relevant
to a particular organization. The sale of snack chips by PepsiCo, the providing
Essential terms are printed in of services by Sprint, the payment of wages by Ford Motor Company, and the
blue when they first appear, collection of ticket and broadcast money and the payment of expenses by major
and are defined in the league sports teams are examples of economic events.
end-of-chapter glossary.
2. Once identified, economic events are recorded to provide a history of the or-
ganization’s financial activities. Recording consists of keeping a systematic,
chronological diary of events, measured in dollars and cents. In recording, eco-
nomic events are also classified and summarized.
3. The identifying and recording activities are of little use unless the information
is communicated to interested users. Financial information is communicated
through accounting reports, the most common of which are called financial
statements. To make the reported financial information meaningful, accountants
report the recorded data in a standardized way. Information resulting from sim-
References throughout the ilar transactions is accumulated and totaled. For example, all sales transactions
chapter tie the accounting con- of PepsiCo are accumulated over a certain period of time and reported as one
cepts you are learning to the amount in the company’s financial statements. Such data are said to be reported
story that opened the chapter.
in the aggregate. By presenting the recorded data in the aggregate, the ac-
counting process simplifies a multitude of transactions and makes a series of ac-
tivities understandable and meaningful.
A vital element in communicating economic events is the accountant’s ability
to analyze and interpret the reported information. Analysis involves the use of ra-
tios, percentages, graphs, and charts to highlight significant financial trends and re-
lationships. Interpretation involves explaining the uses, meaning, and limitations of
reported data. Appendix A of this textbook illustrates the financial statements and
accompanying notes and graphs from PepsiCo, Inc.; Appendix B illustrates the fi-
nancial statements of The Coca-Cola Company. We refer to these statements at var-
ious places throughout the text. At this point, they probably strike you as complex
and confusing. By the end of this course, you’ll be surprised at your ability to un-
derstand and interpret them.
The accounting process may be summarized as shown in Illustration 1-1.
What Is Accounting? 5
Illustration 1-1
Accounting process
Communication
SOFTBYTE
Identification Recording
SOFTBYTE
Prepare accounting reports

DISKS
Select economic events (transactions) Record, classify, and summarize
TE rt
BY epo
FT l R
SOnnua
A
Analyze and interpret for users
Accounting should consider the needs of the users of financial information.

Therefore, you should know who these users are and something about their needs
for information.
Who Uses Accounting Data

Because it communicates financial information, accounting is often called “the lan-
STUDY OBJECTIVE 2
guage of business.” The information that a user of financial information needs de-
pends upon the kinds of decisions the user makes. The differences in the decisions Identify the users and
divide the users of financial information into two broad groups: internal users and uses of accounting.
external users.
Internal Users
Internal users of accounting information are managers who plan, organize, and run
a business. These include marketing managers, production supervisors, finance di-
rectors, and company officers. In running a business, managers must answer many
important questions, as shown in Illustration 1-2 (page 6).
To answer these and other questions, users need detailed information on a
timely basis. For internal users, accounting provides internal reports. Examples are
financial comparisons of operating alternatives, projections of income from new
Helpful Hints help clarify
sales campaigns, and forecasts of cash needs for the next year. In addition, summa- concepts or items being
rized financial information is presented in the form of financial statements. discussed.
External Users HELPFUL HINT
There are several types of external users of accounting information. Investors (own- The IRS requires busi-
ers) use accounting information to make decisions to buy, hold, or sell stock. Credi- nesses to retain records
that can be audited. Also,
tors such as suppliers and bankers use accounting information to evaluate the risks
the Foreign Corrupt
of granting credit or lending money. Some questions that may be asked by investors Practices Act requires
and creditors about a company are shown in Illustration 1-3 (page 6). public companies to keep
The information needs and questions of other external users vary considerably. records.
Taxing authorities, such as the Internal Revenue Service, want to know whether the
Illustration 1-2
Questions asked by
internal users
Questions Asked by Internal Users
BOWLING
BALL
MACHINE
BILL
COLLECTOR
Is cash sufficient to pay bills? What is the cost of manufacturing each unit of product?
ST ON
ST RIK r
RIK E fai es
E Un ctic
Acme Pr
a
Products
Acme
Acme Acme
Mouse Traps
Products Bowling Balls
Can we afford to give employee pay raises this year? Which product line is the most profitable?
Illustration 1-3
Questions asked by
external users
Questions Asked by External Users
XYZ Tires
Yeah! ABC Tires
Is the company earning satisfactory income? How does the company compare in size
and profitability with competitors?
What do we do
if they catch us?
BILL
COLLECTOR
Will the company be able to pay its debts as they come due?
What Is Accounting? 7
company complies with the tax laws. Regulatory agencies, such as the Securities and
Exchange Commission and the Federal Trade Commission, want to know whether
the company is operating within prescribed rules. Customers are interested in whether
a company will continue to honor product warranties and support its product lines.
Labor unions want to know whether the owners can pay increased wages and bene-
Accounting in Action
fits. Economic planners use accounting information to forecast economic activity. examples illustrate important
and interesting accounting
situations in business.
ACCOUNTING IN ACTION International Insight
Concern over the quality and integrity of financial reporting is not limited to the
United States. Recently the Chinese Ministry of Finance reprimanded a large ac-
counting firm for preparing fraudulent financial reports for a number of its pub-
licly traded companies. Afterward, the state-run news agency noted that investors
and analysts actually felt that the punishment of the firm was not adequate. In
fact, a 2001 survey of investors in China found that less than 10% had full con-
fidence in companies’ annual reports. As a result of these concerns the Chinese
Institute of Certified Public Accountants vowed to strengthen its policing of its
members.
Brief History of Accounting

The origins of accounting are generally attributed to the work of Luca Pacioli, an
Italian Renaissance mathematician. Pacioli was a close friend and tutor to Leonardo
da Vinci and a contemporary of Christopher Columbus. In his 1494 text Summa de
Arithmetica, Geometria, Proportione et Proportionalite, Pacioli described a system
to ensure that financial information was recorded efficiently and accurately.
With the advent of the industrial age in the nineteenth century and, later, the
emergence of large corporations, a separation of the owners from the managers of
businesses took place. As a result, the need to report the financial status of the en-
terprise became more important, to ensure that managers acted in accord with own-
ers’ wishes. Also, transactions between businesses became more complex, making
necessary improved approaches for reporting financial information.
Our economy has now evolved into a post-industrial age—the information
age—in which many “products” are information services. The computer has been
the driver of the information age.
Distinguishing Between Bookkeeping and Accounting

Many individuals mistakenly consider bookkeeping and accounting to be the same.
This confusion is understandable because the accounting process includes the book-
keeping function. However, accounting also includes much more. Bookkeeping
usually involves only the recording of economic events. It is therefore just one part
of the accounting process. In total, accounting involves the entire process of identi-
fying, recording, and communicating economic events.
Accounting may be further divided into financial accounting and managerial ac-
counting. Financial accounting is the field of accounting that provides economic and
financial information for investors, creditors, and other external users. Managerial
accounting provides economic and financial information for managers and other in-
ternal users. Financial accounting is covered in Chapters 1–19 of this text. Manage-
rial accounting is discussed in Chapters 20–27.
ACCOUNTING IN ACTION Business Insight
E-business involves much more than simply selling goods over the Internet. Ac-
cording to Lou Gerstner, IBM’s CEO, “e-business is all about cycle time, speed,
globalization, enhanced productivity, reaching new customers, and sharing knowl-
edge across institutions for competitive advantage.” Many accountants are in-
volved in designing and implementing computer systems, including systems for e-
business. In fact, in recent years e-business consulting has been one of the largest
areas of growth for large accounting firms.
Accounting and You

One question frequently asked by students of accounting is, “How will the study of
E-Business Insight examples
show how e-business technol-
accounting help me?” It should help you a great deal, because a working knowledge
ogy has expanded the services of accounting is desirable for virtually every field of endeavor. Some examples of
provided by accountants. how accounting is used in other careers include:
General management: Imagine running General Motors, a major hospital,
a school, a McDonald’s franchise, a bike shop. All general managers need
to understand accounting data in order to make wise business decisions.
Marketing: A marketing specialist develops strategies to help the sales force
be successful. But making a sale is meaningless unless it is a profitable sale.
Marketing people must be sensitive to costs and benefits, which accounting
helps them quantify and understand.
Finance: Do you want to be a banker, an investment analyst, a stock bro-
ker? These fields rely heavily on accounting. In all of them you will regu-
larly examine and analyze financial statements. In fact, it is difficult to get
a good job in a finance function without two or three courses in account-
ing.
Real estate: The most prevalent career in real estate is that of a broker, a
person who sells real estate. Because a third party—the bank—is almost al-
ways involved in financing a real estate transaction, brokers must under-
stand the numbers involved: Can the buyer afford to make the payments to
the bank? Does the cash flow from an industrial property justify the pur-
chase price? What are the tax benefits of the purchase?
Accounting is useful even for occupations you might think completely unre-
lated. If you become a doctor, a lawyer, a social worker, a teacher, an engineer, an
architect, or an entrepreneur—you name it—a working knowledge of accounting is
relevant. You will need to understand financial reports in any enterprise you are as-
sociated with.
Before You Go On questions

at the end of major text BEFORE YOU GO ON...
sections offer an opportunity
to stop and reexamine the key Review It
points you have studied. 1. What is accounting?
2. What is meant by analysis and interpretation?
3. Who uses accounting information? Identify specific internal and external
users of accounting information.
The Building Blocks of Accounting 9
4. To whom are the origins of accounting generally attributed?

5. What is the difference between bookkeeping and accounting?
6. How can you use your accounting knowledge? ■ ✓
■ THE
NAVIGATOR
The Building Blocks of Accounting

Every profession develops a body of theory consisting of principles, assumptions,
and standards. Accounting is no exception. Just as a doctor follows certain standards
in treating a patient’s illness, an accountant follows certain standards in reporting fi-
nancial information. For these standards to work, a fundamental business concept
is followed—ethical behavior.
Ethics—A Fundamental Business Concept

Wherever you make your career—whether in accounting, marketing, management, STUDY OBJECTIVE 3
finance, government, or elsewhere—your actions will affect other people and or-
ganizations. The standards of conduct by which one’s actions are judged as right or Understand why ethics is
wrong, honest or dishonest, fair or not fair, are ethics. Imagine trying to carry on a a fundamental business
concept.
business or invest money if you could not depend on the individuals you deal with
to be honest. If managers, customers, investors, co-workers, and creditors all consis-
tently lied, effective communication and economic activity would be impossible. In-
formation would have no credibility.
Fortunately most individuals in business are ethical. Their actions are both
legal and responsible, and they consider the organization’s interests in their deci-
sion making.
To sensitize you to ethical situations and to give you practice at solving ethical
dilemmas, we have included in the book three types of ethics materials: (1) marginal
notes that provide helpful hints for developing ethical sensitivity, (2) Ethics in Ac-
counting boxes that highlight ethics situations and issues, and (3) at the end of the
chapter, an ethics case simulating a business situation. In the process of analyzing
these ethics cases and your own ethical experiences, you should apply the three
steps outlined in Illustration 1-4. Illustration 1-4
Steps in analyzing
ethics cases
Solving an Ethical Dilemma

1. Recognize an ethical 2. Identify and analyze 3. Identify the alternatives,
situation and the ethical the principal elements and weigh the impact of
issues involved. in the situation. each alternative on various
Use your personal ethics to Identify the stakeholders— stakeholders.
identify ethical situations and persons or groups who may Select the most ethical
issues. Some businesses and be harmed or benefited. Ask alternative, considering all the
#1 #2 professional organizations the question: What are the consequences. Sometimes there
ALT ALT provide written codes of responsibilities and obligations will be one right answer. Other
ethics for guidance in some of the parties involved? situations involve more than
business situations. one right solution; these
situations require an evaluation
of each and a selection of the
best alternative.
Generally Accepted Accounting Principles

The accounting profession has developed standards that are generally accepted and
universally practiced. This common set of standards is called generally accepted ac-
counting principles (GAAP).These standards indicate how to report economic events.
Two organizations are primarily responsible for establishing generally accepted

STUDY OBJECTIVE 4
accounting principles.The first is the Financial Accounting Standards Board (FASB).
Explain the meaning of This private organization establishes broad reporting standards of general applica-
generally accepted bility as well as specific accounting rules. The second standards-setting group is the
accounting principles and Securities and Exchange Commission (SEC). The SEC is a governmental agency
the cost principle. that requires companies to file financial reports following generally accepted ac-
counting principles. In situations where no principles exist, the SEC often mandates
that certain guidelines be used. In general, the FASB and the SEC work hand in
hand to assure that timely and useful accounting principles are developed.
One important principle is the cost principle, which states that assets should be
recorded at their cost. Cost is the value exchanged at the time something is ac-
quired. If you buy a house today, the cost is the amount you pay for it, say $200,000.
If you sell the house in two years for $230,000, the sales price is its market value—
the value determined by the market for homes at that time. At the time of acquisi-
tion, cost and fair market value are the same. In subsequent periods, cost and fair
market value may vary, but the cost amount continues to be used in the accounting
records.
To see the importance of the cost principle, consider the following example. At
one time, Greyhound Corporation had 128 bus stations nationwide that cost ap-
proximately $200 million. The current market value of the stations is now close to
$1 billion. But, until the bus stations are actually sold, estimates of their market val-
ues are subjective—they are informed estimates. So, under the cost principle, the bus
stations are recorded and reported at $200 million, not $1 billion.
ALTERNATIVE As the Greyhound example indicates, cost has an important advantage over
TERMINOLOGY
other valuations: Cost is reliable. The values exchanged at the time something is ac-
The cost principle is often
quired generally can be objectively measured and can be verified. Critics argue that
referred to as the historical cost is often not relevant and that market values provide more useful information.
cost principle. Despite this shortcoming, cost continues to be used in the financial statements be-
cause of its reliability.
Assumptions
In developing generally accepted accounting principles, certain basic assumptions
STUDY OBJECTIVE 5
are made. These assumptions provide a foundation for the accounting process. Two
Explain the meaning of main assumptions are the monetary unit assumption and the economic entity as-
the monetary unit assump- sumption.
tion and the economic
entity assumption.
Monetary Unit Assumption
The monetary unit assumption requires that only transaction data that can be ex-
pressed in terms of money be included in the accounting records. This assumption
enables accounting to quantify (measure) economic events. The monetary unit as-
sumption is vital to applying the cost principle discussed earlier. This assumption
does prevent some relevant information from being included in the accounting
records. For example, the health of the owner, the quality of service, and the morale
of employees would not be included because they cannot be quantified in terms of
money.
An important part of the monetary unit assumption is the added assumption
that the unit of measure remains sufficiently constant over time. However, the as-
sumption of a stable monetary unit has been challenged because of the significant
decline in the purchasing power of the dollar. For example, what used to cost $1 in
1960 costs over $4 in 2004. In such situations, adding, subtracting, or comparing 1960
dollars with 2004 dollars is highly questionable. The profession has recognized this
problem and encourages companies to disclose the effects of changing prices.
Economic Entity Assumption

An economic entity can be any organization or unit in society. It may be a business
enterprise (such as General Electric Company), a governmental unit (the state of
Ohio), a municipality (Seattle), a school district (St. Louis District 48), or a church
(Southern Baptist). The economic entity assumption requires that the activities of
the entity be kept separate and distinct from the activities of its owner and all other
economic entities. To illustrate, Sally Rider, owner of Sally’s Boutique, should keep
her personal living costs separate from the expenses of the Boutique. PepsiCo,
Coca-Cola Company, and Cadbury-Schweppes are segregated into separate eco-
nomic entities for accounting purposes.
We will generally discuss the economic entity assumption in relation to a busi-
ness enterprise, which may be organized as a proprietorship, partnership, or corpo-
ration.
P R O P R I E T O R S H I P. A business owned by one person is generally a proprietor- HELPFUL HINT

ship. The owner is often the manager/operator of the business. Small service-type
businesses (plumbing companies, beauty salons, and auto repair shops), farms, and Approximately 70% of
small retail stores (antique shops, clothing stores, and used-book stores) are often U. S. companies are
sole proprietorships. Usually only a relatively small amount of money (capital) is proprietorships; however,
necessary to start in business as a proprietorship. The owner (proprietor) receives they account for only
6.5% of gross revenues.
any profits, suffers any losses, and is personally liable for all debts of the business.
Corporations, on the other
There is no legal distinction between the business as an economic unit and the
hand, are approximately
owner, but the accounting records of the business activities are kept separate from 19% of all companies, but
the personal records and activities of the owner. account for 90% of the
revenues. Obviously,
P A R T N E R S H I P. A business owned by two or more persons associated as part- proprietorships, though
ners is a partnership. In most respects a partnership is like a proprietorship except numerous, tend to
that more than one owner is involved. Typically a partnership agreement (written be small.
or oral) sets forth such terms as initial investment, duties of each partner, division
of net income (or net loss), and settlement to be made upon death or withdrawal
of a partner. Each partner generally has unlimited personal liability for the debts
of the partnership. Like a proprietorship, for accounting purposes the partnership
affairs must be kept separate from the personal activities of the partners. Partner-
ships are often used to organize retail and service-type businesses, including pro-
fessional practices (lawyers, doctors, architects, and certified public accountants).
C O R P O R A T I O N . A business organized as a separate legal entity under state cor-

poration law and having ownership divided into transferable shares of stock is a
corporation. The holders of the shares (stockholders) enjoy limited liability; that is,
they are not personally liable for the debts of the corporate entity. Stockholders may
transfer all or part of their shares to other investors at any time (i.e., sell their
shares). The ease with which ownership can change adds to the attractiveness of in-
vesting in a corporation. Because ownership can be transferred without dissolving
the corporation, the corporation enjoys an unlimited life.
Although the combined number of proprietorships and partnerships in the
United States is more than four times the number of corporations, the revenue pro-
duced by corporations is nine times greater. Most of the largest enterprises in the
United States—for example, ExxonMobil, General Motors, Wal-Mart, Citigroup,
and PepsiCo, Inc.—are corporations. STUDY OBJECTIVE 6
State the basic accounting

equation, and explain the
Basic Accounting Equation meaning of assets, liabili-
Other essential building blocks of accounting are the categories into which eco- ties, and owner’s equity.
nomic events are classified. The two basic elements of a business are what it owns
This CD icon informs you of and what it owes. Assets are the resources owned by a business. For example, Pep-
additional resources available siCo’s competitor The Coca-Cola Company has total assets of approximately $24.5
on the CD that came with your
text.
billion. Liabilities and owner’s equity are the rights or claims against these re-
sources. Thus, a company such as Coca-Cola Company that has $24.5 billion of as-
sets also has $12.7 billion of claims against those assets. Claims of those to whom
money is owed (creditors) are called liabilities. Claims of owners are called owner’s
equity. For example, Coca-Cola Company has liabilities of $12.7 billion and owners’
Accounting Cycle Tutorial— equity of $11.8 billion. This relationship of assets, liabilities, and owner’s equity can
Analyzing Business Transactions be expressed as an equation as follows.
Illustration 1-5
The basic accounting Assets = Liabilities + Owner’s Equity
equation
This relationship is referred to as the basic accounting equation. Assets must equal
the sum of liabilities and owner’s equity. Because creditors’ claims must be paid be-
fore ownership claims if a business is liquidated, liabilities are shown before owner’s
equity in the basic accounting equation.
The accounting equation applies to all economic entities regardless of size, na-
ture of business, or form of business organization. It applies to a small proprietor-
ship such as a corner grocery store as well as to a giant corporation such as Kellogg
or General Mills. The equation provides the underlying framework for recording
and summarizing the economic events of a business enterprise.
Let’s look in more detail at the categories in the basic accounting equation.
Assets
As noted above, assets are resources owned by a business. They are used in carry-
ing out such activities as production, consumption, and exchange. The common char-
acteristic possessed by all assets is the capacity to provide future services or bene-
fits. In a business enterprise, that service potential or future economic benefit
eventually results in cash inflows (receipts) to the enterprise.
For example, the enterprise Campus Pizza owns a delivery truck that provides
economic benefits from its use in delivering pizzas. Other assets of Campus Pizza are
tables, chairs, jukebox, cash register, oven, mugs and silverware, and, of course, cash.
Liabilities
Liabilities are claims against assets. That is, liabilities are existing debts and obliga-
tions. For example, businesses of all sizes usually borrow money and purchase mer-
chandise on credit. Campus Pizza, for instance, purchases cheese, sausage, flour, and
beverages on credit from suppliers. These obligations are called accounts payable.
Campus Pizza also has a note payable to First National Bank for the money bor-
rowed to purchase the delivery truck. Campus Pizza may also have wages payable
to employees and sales and real estate taxes payable to the local government. All
of these persons or entities to whom Campus Pizza owes money are its creditors.
Most claims of creditors attach to the entity’s total assets rather than to the spe-
cific assets provided by the creditor. Creditors may legally force the liquidation of
TEACHING HELP a business that does not pay its debts. In that case, the law requires that creditor
Stress the description of claims be paid before ownership claims.
owner’s equity—the amount
of ownership claim on total
assets; the excess of total Owner’s Equity
assets over total liabilities;
the residual, often referred The ownership claim on total assets is known as owner’s equity. It is equal to total
to as net worth. assets minus total liabilities. Here is why: The assets of a business are supplied or
claimed by either creditors or owners. To find out what belongs to owners, we sub- HELPFUL HINT
tract the creditors’ claims (the liabilities) from assets. The remainder is the owner’s
claim on the assets—the owner’s equity. Since the claims of creditors must be paid In some places we use the
before ownership claims, owner’s equity is often referred to as residual equity. term owner’s equity and in
others we use owners’
I N C R E A S E S I N O W N E R ’ S E Q U I T Y. In a proprietorship, owner’s equity is in- equity. Owner’s refers to
creased by owner’s investments and revenues. one owner (the case with
a sole proprietorship), and
Investments by Owner. Investments by owner are the assets the owner puts into owners’ refers to multiple
the business. These investments increase owner’s equity. owners (the case with
partnerships or
Revenues. Revenues are the gross increase in owner’s equity resulting from corporations).
business activities entered into for the purpose of earning income. Generally, rev-
enues result from the sale of merchandise, the performance of services, the rental of
property, and the lending of money.
Revenues usually result in an increase in an asset. They may arise from differ-
ent sources and are identified by various names depending on the nature of the
business. Campus Pizza, for instance, has two categories of sales revenues—pizza
sales and beverage sales. Common sources of revenue are: sales, fees, services, com-
missions, interest, dividends, royalties, and rent.
D E C R E A S E S I N O W N E R ’ S E Q U I T Y. In a proprietorship, owner’s equity is

decreased by owner’s drawings and expenses.
Drawings. An owner may withdraw cash or other assets for personal use. These
withdrawals could be recorded as a direct decrease of owner’s equity. However, it
is generally considered preferable to use a separate classification called drawings to
determine the total withdrawals for each accounting period. Drawings decrease
owner’s equity.
Expenses. Expenses are the cost of assets consumed or services used in the
process of earning revenue. They are decreases in owner’s equity that result from
operating the business. Expenses represent actual or expected cash outflows (pay-
ments). Like revenues, expenses take many forms and are identified by various
names depending on the type of asset consumed or service used. For example, Cam-
pus Pizza recognizes the following expenses: cost of ingredients (meat, flour, cheese,
tomato paste, mushrooms, etc.); cost of beverages; wages expense; utility expense
(electric, gas, and water expense); telephone expense; delivery expense (gasoline, re-
pairs, licenses, etc.); supplies expense (napkins, detergents, aprons, etc.); rent ex-
pense; interest expense; and property tax expense.
In summary, owner’s equity is increased by an owner’s investments and by rev-
enues from business operations. In contrast, owner’s equity is decreased by an
owner’s withdrawals of assets and by expenses. These relationships are shown in Il-
lustration 1-6. Net income results when revenues exceed expenses. A net loss occurs
when expenses exceed revenues.
Illustration 1-6
Increases and decreases in
INCREASES DECREASES owner’s equity
Investments by owner Withdrawals by owner

Owner's
Equity
Revenues Expenses
BEFORE YOU GO ON...

Review It questions marked Review It
with this icon require that you
1. Why is ethics a fundamental business concept?
use PepsiCo’s Annual Report.
2. What are generally accepted accounting principles? Give an example.
3. Explain the monetary unit and the economic entity assumptions.
4. The accounting equation is: Assets = Liabilities + Owner’s Equity. Replac-
ing the words in that equation with dollar amounts, what is PepsiCo’s ac-
counting equation at December 28, 2002? (Hint: Owner’s equity is equiv-
alent to stockholders’ equity. The answer to this question is provided on
page 42.)
5. What are assets, liabilities, and owner’s equity?
Sometimes Review It ques-
tions stand alone; other times Do It
they are accompanied by prac- Classify the following items as investment by owner (I), owner’s drawings
tice exercises.
The Do It exercises, like the
(D), revenues (R), or expenses (E). Then indicate whether the following
one here, ask you to put newly items increase or decrease owner’s equity: (1) rent expense, (2) service rev-
acquired knowledge to work. enue, (3) drawings, and (4) salaries expense.
They outline the Action Plan
necessary to complete the exer- ACTION PLAN
cise and show a Solution. ■ Review the rules for changes in owner’s equity: Investments and revenues
increase owner’s equity. Expenses and drawings decrease owner’s equity.
■ Understand the sources of revenue: the sale of merchandise, performance
of services, rental of property, and lending of money.
■ Understand what causes expenses: the consumption of assets or services.
■ Recognize that drawings are withdrawals of cash or other assets from the
business for personal use.
SOLUTION
1. Rent expense is classified as an expense (E); it decreases owner’s equity.
2. Service revenue is classified as revenue (R); it increases owner’s equity.
3. Drawings is classified as owner’s drawings (D); it decreases owner’s equity.
4. Salaries expense is classified as an expense (E); it decreases owner’s equity.
Related exercise material: BE1-1, BE1-2, BE1-3, BE1-4, BE1-5, BE1-6, BE1-7,
BE1-9, E1-1, E1-2, E1-3, E1-4, E1-6, and E1-7. ■✓
■ THE
NAVIGATOR
Using the Building Blocks

Transactions (often referred to as business transactions) are the economic events of
STUDY OBJECTIVE 7
an enterprise that are recorded. Transactions may be identified as external or inter-
Analyze the effects of nal. External transactions involve economic events between the company and some
business transactions on outside enterprise. For example, Campus Pizza’s purchase of cooking equipment
the basic accounting from a supplier, payment of monthly rent to the landlord, and sale of pizzas to cus-
equation. tomers are external transactions. Internal transactions are economic events that
occur entirely within one company. The use of cooking and cleaning supplies illus-
trates internal transactions for Campus Pizza.
A company may carry on many activities that do not in themselves represent
business transactions. Hiring employees, answering the telephone, talking with cus-
Using the Building Blocks 15
tomers, and placing orders for merchandise are examples. Some of these activities,
however, may lead to business transactions: Employees will earn wages, and mer-
chandise will be delivered by suppliers. Each event must be analyzed to find out if
it has an effect on the components of the basic accounting equation. If it does, it will
be recorded in the accounting process. Illustration 1-7 demonstrates the transaction
identification process. Illustration 1-7
Transaction identification
process
Events
Ch
eck
US Mail
Purchase computer Discuss product design with Pay rent

potential customer
Criterion Is the financial position (assets, liabilities, and owner’s equity) of the company changed?
Yes No Yes
Don't
Record record Record
Record/
Don’t Record
The equality of the basic equation must be preserved. Therefore, each transac- TEACHING HELP
tion must have a dual effect on the equation. For example, if an asset is increased, Emphasize that each transac-
there must be a corresponding: tion has a dual effect on the
basic accounting equation.
1. Decrease in another asset, or
2. Increase in a specific liability, or
3. Increase in owner’s equity.
It follows that two or more items could be affected when an asset is increased. For
example, as one asset is increased $10,000, another asset could decrease $6,000 and
a specific liability could increase $4,000. Any change in a liability or ownership claim
is subject to similar analysis.
Transaction Analysis
The following examples are business transactions for a computer programming
business during its first month of operations. You will want to study these transac-
tions until you are sure you understand them. They are not difficult, but they are
important to your success in this course. The ability to analyze transactions in terms
of the basic accounting equation is essential for an understanding of accounting.
T R A N S A C T I O N ( 1 ) . I N V E S T M E N T B Y O W N E R . Ray Neal decides to

open a computer programming service which he names Softbyte. On September 1,
2005, he invests $15,000 cash in the business. This transaction results in an equal
increase in assets and owner’s equity. The asset Cash increases $15,000, as does the
owner’s equity, identified as R. Neal, Capital. The effect of this transaction on the
basic equation is:
Assets Liabilities Owner’s Equity

R. Neal,
Cash
Capital
(1) $15,000 $15,000 Investment
Observe that the equality of the basic equation has been maintained. Note also that
the source of the increase in owner’s equity (Investment) is indicated. Why does this
matter? Because investments by the owner do not represent revenues, and they are
excluded in determining net income. Therefore it is necessary to make clear that the
increase is an investment rather than revenue from operations.
T R A N S A C T I O N ( 2 ) . P U R C H A S E O F E Q U I P M E N T F O R C A S H . Softbyte
purchases computer equipment for $7,000 cash. This transaction results in an equal
increase and decrease in total assets, though the composition of assets changes: Cash
is decreased $7,000, and the asset Equipment is increased $7,000. The specific effect
of this transaction and the cumulative effect of the first two transactions are:

Cash Equipment R. Neal,
Capital
Old Bal. $15,000 $15,000
(2) 7,000 $7,000
New Bal. $ 8,000 $7,000 $15,000
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$15,000
Observe that total assets are still $15,000, and Neal’s equity also remains at $15,000,
the amount of his original investment.
T R A N S A C T I O N ( 3 ) . P U R C H A S E O F S U P P L I E S O N C R E D I T. Softbyte
purchases for $1,600 from Acme Supply Company computer paper and other sup-
plies expected to last several months. Acme agrees to allow Softbyte to pay this bill
next month, in October. This transaction is referred to as a purchase on account or
a credit purchase. Assets are increased because of the expected future benefits of
using the paper and supplies, and liabilities are increased by the amount due Acme
Company. The asset Supplies is increased $1,600, and the liability Accounts Payable
is increased by the same amount. The effect on the equation is:
Accounts R. Neal,
Cash Supplies Equipment
Payable Capital
Old Bal. $8,000 $7,000 $15,000
(3) $1,600 $1,600
New Bal. $8,000 $1,600 $7,000 $1,600 $15,000
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$16,600 $16,600
Total assets are now $16,600. This total is matched by a $1,600 creditor’s claim and
a $15,000 ownership claim.
T R A N S A C T I O N ( 4 ) . S E R V I C E S P R O V I D E D F O R C A S H . Softbyte re-
ceives $1,200 cash from customers for programming services it has provided. This
transaction represents Softbyte’s principal revenue-producing activity. Recall that
revenue increases owner’s equity. In this transaction, Cash is increased $1,200, and
R. Neal, Capital is increased $1,200. The new balances in the equation are:

Accounts R. Neal,
Payable Capital
Old Bal. $8,000 $1,600 $7,000 $1,600 $15,000
(4) $1,200 1,200 Service Revenue
New Bal. $9,200 $1,600 $7,000 $1,600 $16,200
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$17,800 $17,800
The two sides of the equation balance at $17,800. The source of the increase in
owner’s equity is indicated as Service Revenue. Service revenue is included in de-
termining Softbyte’s net income.
T R A N S A C T I O N ( 5 ) . P U R C H A S E O F A D V E R T I S I N G O N C R E D I T. Soft-
byte receives a bill for $250 from the Daily News for advertising but postpones pay-
ment of the bill until a later date. This transaction results in an increase in liabilities
and a decrease in owner’s equity. The specific items involved are Accounts Payable
and R. Neal, Capital. The effect on the equation is:

Accounts R. Neal,
Payable Capital
Old Bal. $9,200 $1,600 $7,000 $1,600 $16,200
(5) 250 250 Advertising Expense
New Bal. $9,200 $1,600 $7,000 $1,850 $15,950
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$17,800 $17,800
The two sides of the equation still balance at $17,800. Owner’s equity is decreased
when the expense is incurred, and the specific cause of the decrease (advertising ex-
pense) is noted. Expenses do not have to be paid in cash at the time they are in-
curred. When payment is made at a later date, the liability Accounts Payable will be
decreased and the asset Cash will be decreased [see Transaction (8)]. The cost of ad-
vertising is considered an expense, as opposed to an asset, because the benefits have
been used. This expense is included in determining net income.
T R A N S A C T I O N ( 6 ) . S E R V I C E S P R O V I D E D F O R C A S H A N D C R E D I T.
Softbyte provides $3,500 of programming services for customers. Cash of $1,500 is
received from customers, and the balance of $2,000 is billed on account. This trans-
action results in an equal increase in assets and owner’s equity. Three specific items
are affected: Cash is increased $1,500; Accounts Receivable is increased $2,000; and
R. Neal, Capital is increased $3,500. The new balances are as follows.

Accounts Accounts R. Neal,
Receivable Payable Capital
Old Bal. $9,200 $1,600 $7,000 $1,850 $15,950
(6) 1,500 $2,000 3,500 Service Revenue
New Bal. $10,700 $2,000 $1,600 $7,000 $1,850 $19,450
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$21,300 $21,300
Why increase owner’s equity $3,500 when only $1,500 has been collected? Be-
cause the inflow of assets resulting from the earning of revenues does not have to
be in the form of cash. Remember that owner’s equity is increased when revenues
are earned; in Softbyte’s case revenues are earned when the service is provided.
When collections on account are received later, Cash will be increased and Ac-
counts Receivable will be decreased [see Transaction (9)].
T R A N S A C T I O N ( 7 ) . P A Y M E N T O F E X P E N S E S . Expenses paid in cash for

September are store rent $600, salaries of employees $900, and utilities $200. These
payments result in an equal decrease in assets and owner’s equity. Cash is decreased
$1,700, and R. Neal, Capital is decreased by the same amount. The effect of these
payments on the equation is:

Old Bal. $10,700 $2,000 $1,600 $7,000 $1,850 $19,450
(7) 1,700 600 Rent Expense
900 Salaries Expense
200 Utilities Expense
New Bal. $9,000 $2,000 $1,600 $7,000 $1,850 $17,750
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$19,600 $19,600
The two sides of the equation now balance at $19,600. Three lines are required in
the analysis to indicate the different types of expenses that have been incurred.
T R A N S A C T I O N ( 8 ) . P A Y M E N T O F A C C O U N T S P A Y A B L E . Softbyte pays
its $250 Daily News advertising bill in cash. Remember that the bill was previously
recorded [in Transaction (5)] as an increase in Accounts Payable and a decrease in
owner’s equity. This payment “on account” decreases the asset Cash by $250 and
also decreases the liability Accounts Payable by $250. The effect of this transaction
on the equation is:

Old Bal. $9,000 $2,000 $1,600 $7,000 $1,850 $17,750
(8) 250 250
New Bal. $8,750 $2,000 $1,600 $7,000 $1,600 $17,750
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$19,350 $19,350
Observe that the payment of a liability related to an expense that has previously
been recorded does not affect owner’s equity. The expense was recorded in Trans-
action (5) and should not be recorded again.
T R A N S A C T I O N ( 9 ) . R E C E I P T O F C A S H O N A C C O U N T . The sum of
$600 in cash is received from customers who have previously been billed for serv-
ices [in Transaction (6)]. This transaction does not change total assets, but it changes
the composition of those assets. Cash is increased $600 and Accounts Receivable is
decreased $600. The new balances are:
Cash Accounts Supplies Equipment Accounts R. Neal,

Old Bal. $8,750 $2,000 $1,600 $7,000 $1,600 $17,750
(9) 600 600
New Bal. $9,350 $1,400 $1,600 $7,000 $1,600 $17,750
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$19,350 $19,350
Note that a collection on account for services previously billed and recorded does
not affect owner’s equity. Revenue was already recorded in Transaction (6) and
should not be recorded again.
T R A N S A C T I O N ( 1 0 ) . W I T H D R A W A L O F C A S H B Y O W N E R . Ray Neal
withdraws $1,300 in cash from the business for his personal use. This transaction re-
sults in an equal decrease in assets and owner’s equity. Both Cash and R. Neal, Cap-
ital are decreased $1,300, as shown below.

Old Bal. $9,350 $1,400 $1,600 $7,000 $1,600 $17,750
(10) 1,300 1,300 Drawings
New Bal. $8,050 $1,400 $1,600 $7,000 $1,600 $16,450
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$18,050  $18,050
Observe that the effect of a cash withdrawal by the owner is the opposite of the ef-
fect of an investment by the owner. Owner’s drawings are not expenses. Like owner’s
investment, they are excluded in determining net income.
Summary of Transactions
The September transactions of Softbyte are summarized in Illustration 1-8 (page
20). The transaction number, the specific effects of the transaction, and the balances
after each transaction are indicated. The illustration demonstrates some significant
facts listed below.
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 causes of each change in the owner’s claim on assets must be indicated in
the owner’s equity column.
Illustration 1-8
Tabular summary of Softbyte
transactions

Transaction Receivable Payable Capital
(1) $15,000 $15,000 Investment
(2) 7,000 $7,000
8,000 7,000 15,000
(3) $1,600 $1,600
8,000 1,600 7,000 1,600 15,000
(4) 1,200 1,200 Service Revenue
9,200 1,600 7,000 1,600 16,200
(5) +250 –250 Advertising Expense
9,200 1,600 7,000 1,850 15,950
(6) 1,500 $2,000 3,500 Service Revenue
10,700 2,000 1,600 7,000 1,850 19,450
(7) 1,700 600 Rent Expense
900 Salaries Expense
200 Utilities Expense
9,000 2,000 1,600 7,000 1,850 17,750
(8) 250 –250
8,750 2,000 1,600 7,000 1,600 17,750
(9) 600 600
9,350 1,400 1,600 7,000 1,600 17,750
(10) 1,300 1,300 Drawings
$8,050 $1,400 $1,600 $7,000 $1,600 $16,450
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$18,050 $18,050
There! You made it through transaction analysis. If you feel a bit shaky on any
of the transactions, it might be a good idea at this point to get up, take a short break,
and come back again for a 10- to 15-minute review of the transactions, to make sure
you understand them before you go on to the next section.
BEFORE YOU GO ON...

Review It
1. What is an example of an external transaction? What is an example of an
internal transaction?
2. If an asset increases, what are the three possible effects on the basic ac-
counting equation?
Do It
A tabular analysis of the transactions made by Roberta Mendez & Co., a cer-
tified public accounting firm, for the month of August is shown on page 21.
Each increase and decrease in owner’s equity is explained.
Financial Statements 21

Cash Office Accounts R. Mendez,
Equipment Payable Capital
1. $25,000 25,000 Investment
2. 7,000 7,000
3. 8,000 8,000 Service Revenue
4. 850 850 Rent Expense
Describe each transaction that occurred for the month.
ACTION PLAN
■ Analyze the tabular analysis to determine the nature and effect of each
transaction.
■ Keep the accounting equation always in balance.
■ Remember that a change in an asset will require a change in another
asset, a liability, or in owner’s equity.
SOLUTION
1. The owner invested $25,000 of cash in the business.
2. The company purchased $7,000 of office equipment on credit.
3. The company received $8,000 of cash in exchange for services performed.
4. The company paid $850 for this month’s rent.
Related exercise material: BE1-4, BE1-5, BE1-6, BE1-7, E1-2, E1-3, E1-4,
■ ✓
■ THE
E1-6, and E1-7. NAVIGATOR
Financial Statements
After transactions are identified, recorded, and summarized, four financial state- STUDY OBJECTIVE 8
ments are prepared from the summarized accounting data:
Understand what the four
1. An income statement presents the revenues and expenses and resulting net in- financial statements are
come or net loss for a specific period of time. and how they are
2. An owner’s equity statement summarizes the changes in owner’s equity for a prepared.
specific period of time.
3. A balance sheet reports the assets, liabilities, and owner’s equity at a specific
date.
4. A statement of cash flows summarizes information about the cash inflows (re-
ceipts) and outflows (payments) for a specific period of time.
Each statement provides management, owners, and other interested parties with rel- HELPFUL HINT
evant financial data.
The financial statements of Softbyte are shown in Illustration 1-9 (page 22). The The income statement,
statements are interrelated: (1) Net income of $2,750 shown on the income state- owner’s equity statement,
ment is added to the beginning balance of owner’s capital in the owner’s equity and statement of cash
statement. (2) Owner’s capital of $16,450 at the end of the reporting period shown flows are all for a period
of time, whereas the
in the owner’s equity statement is reported on the balance sheet. (3) Cash of $8,050
balance sheet is for a
on the balance sheet is reported on the statement of cash flows.
point in time.
Also, every set of financial statements is accompanied by explanatory notes and
supporting schedules that are an integral part of the statements. Examples of these
notes and schedules are illustrated in later chapters of this textbook.
Illustration 1-9
Financial statements and SOFTBYTE
their interrelationships Income Statement
For the Month Ended September 30, 2005
Revenues
HELPFUL HINT
Service revenue $ 4,700
The heading of each state- Expenses
ment identifies the com- Salaries expense $900
pany, the type of state- Rent expense 600
ment, and the specific Advertising expense 250
date or time period cov- Utilities expense 200
ered by the statement. Total expenses 1,950
Net income $ 2,750
1
SOFTBYTE
Owner’s Equity Statement
R. Neal, Capital September 1 $ −0−

HELPFUL HINT Add: Investments $15,000
Note that final sums are
Net income 2,750 17,750
double-underlined, and 17,750
negative amounts are Less: Drawings 1,300
presented in parentheses. R. Neal, Capital, September 30 $16,450
SOFTBYTE
Balance Sheet
September 30, 2005
Assets
Cash $ 8,050
Accounts receivable 1,400
Supplies 1,600 2
Equipment 7,000
Total assets $18,050
Liabilities and Owner’s Equity

Liabilities
Accounts payable $ 1,600
Owner’s equity
R. Neal, Capital 16,450
Total liabilities and owner’s equity $18,050
3
SOFTBYTE
HELPFUL HINT Statement of Cash Flows
Net income is computed
first and is needed to de- Cash flows from operating activities
termine the ending bal- Cash receipts from revenues $ 3,300)
ance in owner’s equity. Cash payments for expenses (1,950)
The ending balance in
Net cash provided by operating activities 1,350)
owner’s equity is needed
Cash flows from investing activities
in preparing the balance
Purchase of equipment (7,000)
sheet. The cash shown on
Cash flows from financing activities
the balance sheet is
Investments by owner $15,000)
needed in preparing the
Drawings by owner (1,300) 13,700)
statement of cash flows.
Net increase in cash 8,050)
Cash at the beginning of the period 0)
Cash at the end of the period $ 8,050)
22
Financial Statements 23
Be sure to carefully examine the format and content of each statement. The es-
sential features of each are briefly described in the following sections.
Income Statement
Softbyte’s income statement reports the revenues and expenses for a specific period of
ALTERNATIVE
time (in this “case, “For the Month Ended September 30, 2005”). Its income statement
TERMINOLOGY
is prepared from the data appearing in the owner’s equity column of Illustration 1-8.
On the income statement, revenues are listed first, followed by expenses. Finally The income statement is
net income (or net loss) is determined. Although practice varies, we have chosen in sometimes referred to as
our illustrations and homework solutions to list expenses in order of magnitude. Al- the statement of opera-
ternative formats for the income statement will be considered in later chapters. tions, earnings statement,
Note that investment and withdrawal transactions between the owner and the or profit and loss
business are not included in the measurement of net income. For example, the with- statement.
drawal by Ray Neal of cash from Softbyte was not regarded as a business expense,
as explained earlier.

Softbyte’s owner’s equity statement reports the changes in owner’s equity for a spe-
cific period of time. The time period is the same as that covered by the income state-
ment. Data for the preparation of the owner’s equity statement are obtained from
the owner’s equity column of the tabular summary (Illustration 1-8) and from the
income statement. The beginning owner’s equity amount is shown on the first line
of the statement. Then, the owner’s investments, net income, and the owner’s draw-
ings are identified. The information in this statement indicates the reasons why
owner’s equity has increased or decreased during the period.
What if Softbyte reported a net loss in its first month? Let’s assume that dur-
ing the month of September 2005, Softbyte lost $10,000. The presentation in the
owner’s equity statement of a net loss appears in Illustration 1-10.
Illustration 1-10
SOFTBYTE Presentation of net loss
R. Neal, Capital, September 1 $ −0−

Add: Investments 15,000
15,000
Less: Drawings $ 1,300
Net loss 10,000 11,300
R. Neal, Capital, September 30 $ 3,700
Any additional investments are reported as investments in the owner’s equity

statement.
Balance Sheet
Softbyte’s balance sheet reports the assets, liabilities, and owner’s equity at a spe-
cific date (in this case, September 30, 2005). The balance sheet is prepared from the
column headings and the month-end data shown in the last line of the tabular sum-
mary (Illustration 1-8).
Observe that the assets are listed at the top, followed by liabilities and owner’s
equity. Total assets must equal total liabilities and owner’s equity. In the Softbyte
balance sheet, only one liability, accounts payable, is reported. In most cases, there
will be more than one liability. When two or more liabilities are involved, a cus-
tomary way of listing is as follows.
Illustration 1-11
Presentation of liabilities Liabilities
Notes payable $10,000

Account payable 63,000
Salaries payable 18,000
Total liabilities $91,000
The balance sheet is like a snapshot of the company’s financial condition at a spe-
cific moment in time (usually the month-end or year-end).
ACCOUNTING IN ACTION Business Insight
Why do companies choose the particular year-ends that they do? Not every com-
pany uses December 31 as the accounting year-end. Many companies choose to
end their accounting year when inventory or operations are at a low. This is ad-
vantageous because compiling accounting information requires much time and ef-
fort by managers, so they would rather do it when they aren’t as busy operating
the business. Also, inventory is easier and less costly to count when it is low. Some
companies whose year-ends differ from December 31 are Delta Air Lines, June 30;
Walt Disney Productions, September 30; Kmart Corp., January 31; and Dunkin’
Donuts Inc., October 31.
Statement of Cash Flows

HELPFUL HINT Softbyte’s statement of cash flows provides information on the cash receipts and
payments for a specific period of time. The statement of cash flows reports (1) the
Investing activities pertain cash effects of a company’s operations during a period, (2) its investing transactions,
to investments made by (3) its financing transactions, (4) the net increase or decrease in cash during the pe-
the company, not invest- riod, and (5) the cash amount at the end of the period.
ments made by the owner. Reporting the sources, uses, and net increase or decrease in cash is useful be-
cause investors, creditors, and others want to know what is happening to a com-
pany’s most liquid resource. The statement of cash flows, therefore, provides an-
swers to the following simple but important questions.
1. Where did the cash come from during the period?
2. What was the cash used for during the period?
3. What was the change in the cash balance during the period?
Softbyte’s statement of cash flows is provided in Illustration 1-9.
As shown in the statement, cash increased $8,050 during the period. Net cash flow
provided from operating activities increased cash $1,350. Cash flow from investing
transactions decreased cash $7,000. And cash flow from financing transactions in-
creased cash $13,700. At this time, you need not be concerned with how these amounts
are determined. Chapter 18 will examine the statement of cash flows in detail.
BEFORE YOU GO ON...

Review It
1. What are the income statement, statement of owner’s equity, balance sheet,
and statement of cash flows?
2. How are the financial statements interrelated? ✓ THE
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Demonstration Problem 25
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Joan Robinson opens her own law office on July 1, 2005. During the first month of
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operations, the following transactions occurred.
1. Invested $10,000 in cash in the law practice.
2. Paid $800 for July rent on office space. Demonstration Problems are
3. Purchased office equipment on account $3,000. a final review of the chapter.
4. Provided legal services to clients for cash $1,500. The Action Plan gives tips
about how to approach the
5. Borrowed $700 cash from a bank on a note payable. problem, and the Solution
6. Performed legal services for client on account $2,000. demonstrates both the form
7. Paid monthly expenses: salaries $500, utilities $300, and telephone $100. and content of complete
answers.
Instructions
(a) Prepare a tabular summary of the transactions.
(b) Prepare the income statement, owner’s equity statement, and balance sheet at
July 31 for Joan Robinson, Attorney at Law.
S O L U T I O N T O D E M O N S T R AT I O N P R O B L E M ACTION PLAN
(a) Assets Liabilities Owner’s Equity ■ Remember that assets
Joan must equal liabilities and
Trans- Accounts Notes Accounts owner’s equity after each
Cash Equipment Robinson,
action Receivable Payable Payable transaction.
Capital
■ Investments and revenues
(1) $10,000 $10,000 Investment
increase owner’s equity.
(2) 800 800 Rent Expense
■ Expenses decrease
9,200 = 9,200
owner’s equity.
(3) $3,000 $3,000
■ The income statement
9,200 3,000 3,000 9,200
shows revenues and ex-
(4) 1,500 1,500 Service Revenue penses for a period of
10,700 3,000 3,000 10,700 time.
(5) 700 $700 ■ The owner’s equity state-
11,400 3,000 700 3,000 10,700 ment shows the changes
(6) $2,000 2,000 Service Revenue in owner’s equity for a pe-
11,400 2,000 3,000 700 3,000 12,700 riod of time.
(7) 900 500 Salaries Expense ■ The balance sheet reports
300 Utilities Expense assets, liabilities, and
100 Telephone Expense owner’s equity at a
$10,500 $2,000 $3,000 $700 $3,000 $11,800 specific date.
(b) JOAN ROBINSON

Attorney at Law
Income Statement
For the Month Ended July 31, 2005
Revenues
Service revenue $3,500
Expenses
Rent expense $800
Salaries expense 500
Utilities expense 300
Telephone expense 100
Total expenses 1,700
Net income $1,800
JOAN ROBINSON
Attorney at Law
Owner‘s Equity Statement
This would be a good time to
return to the Student Owner’s
For the Month Ended July 31, 2005
Manual at the beginning of Joan Robinson, Capital, July 1 $ –0–
the book (or look at it for the
Add: Investments $10,000
first time if you skipped it be-
fore) to read about the various
Net income 1,800 11,800
types of assignment materials Joan Robinson, Capital, July 31 $11,800
that appear at the end of each
chapter. Knowing the purpose
of the different assignments JOAN ROBINSON
will help you appreciate what Attorney at Law
each contributes to your
Balance Sheet
accounting skills and
competencies. July 31, 2005
Assets
Cash $10,500
Accounts receivable 2,000
Equipment 3,000
Liabilities and Owner’s Equity
Liabilities
Notes payable $ 700
Accounts payable 3,000
Total liabilities 3,700
Owner‘s equity
Joan Robinson, Capital 11,800
Total liabilities and owner‘s equity $15,500
■ ✓
■ THE
NAVIGATOR
SUMMARY OF STUDY OBJECTIVES
1. Explain what accounting is. Accounting is an information esty of the individuals you deal with, effective communi-
system that identifies, records, and communicates the eco- cation and economic activity would be impossible, and in-
nomic events of an organization to interested users. formation would have no credibility.
2. Identify the users and uses of accounting. The major users 4. Explain the meaning of generally accepted accounting
and uses of accounting are: (a) Management uses ac- principles and the cost principle. Generally accepted ac-
counting information in planning, controlling, and evaluat- counting principles are a common set of standards used by
ing business operations. (b) Investors (owners) decide accountants. The cost principle states that assets should be
whether to buy, hold, or sell their financial interests on the recorded at their cost.
basis of accounting data. (c) Creditors (suppliers and 5. Explain the meaning of the monetary unit assumption and
bankers) evaluate the risks of granting credit or lending the economic entity assumption. The monetary unit as-
money on the basis of accounting information. Other sumption requires that only transaction data capable of
groups that use accounting information are taxing author- being expressed in terms of money be included in the
ities, regulatory agencies, customers, labor unions, and eco- accounting records. The economic entity assumption re-
nomic planners. quires that the activities of each economic entity be kept
3. Understand why ethics is a fundamental business concept. separate from the activities of its owner and other eco-
Ethics are the standards of conduct by which actions are nomic entities.
judged as right or wrong. If you cannot depend on the hon-
Glossary 27
6. State the basic accounting equation, and explain the mean- sponding (1) decrease in another asset, or (2) increase in
ing of assets, liabilities, and owner’s equity. The basic ac- a specific liability, or (3) increase in owner’s equity.
counting equation is: 8. Understand what the four financial statements are and
Assets Liabilities Owner’s Equity how they are prepared. An income statement presents the
Assets are resources owned by a business. Liabilities are revenues and expenses of a company for a specified period
creditorship claims on total assets. Owner’s equity is the of time. An owner’s equity statement summarizes the
ownership claim on total assets. changes in owner’s equity that have occurred for a specific
period of time. A balance sheet reports the assets, liabilities,
7. Analyze the effects of business transactions on the basic and owner’s equity of a business at a specific date. A state-
accounting equation. Each business transaction must have ment of cash flows summarizes information
a dual effect on the accounting equation. For example, if about the cash inflows (receipts) and outflows ■✓ THE
■
NAVIGATOR
an individual asset is increased, there must be a corre- (payments) for a specific period of time.
Web icons next to end-of-chapter materials indicate that you

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GLOSSARY
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Accounting The information system that identifies, records, Income statement A financial statement that presents the
and communicates the economic events of an organization revenues and expenses and resulting net income or net
to interested users. (p. 4). loss of a company for a specific period of time. (p. 21).
Assets Resources owned by a business. (p. 12). Investments by owner The assets put into the business by the
Balance sheet A financial statement that reports the assets, owner. (p. 13).
liabilities, and owner’s equity at a specific date. (p. 21). Liabilities Creditorship claims on total assets. (p. 12).
Basic accounting equation Assets Liabilities Owner’s Managerial accounting The field of accounting that provides
Equity. (p. 12). economic and financial information for managers and
Bookkeeping A part of accounting that involves only the other internal users. (p. 7).
recording of economic events. (p. 7). Monetary unit assumption An assumption stating that only
Corporation A business organized as a separate legal entity transaction data that can be expressed in terms of money
under state corporation law, having ownership divided into be included in the accounting records. (p. 10).
transferable shares of stock. (p. 11). Net income The amount by which revenues exceed expenses.
Cost principle An accounting principle that states that assets (p. 13).
should be recorded at their cost. (p. 10). Net loss The amount by which expenses exceed revenues.
Drawings Withdrawal of cash or other assets from an unin- (p. 13).
corporated business for the personal use of the owner(s). Owner’s equity The ownership claim on total assets. (p. 12).
(p. 13). Owner’s equity statement A financial statement that summa-
Economic entity assumption An assumption that requires rizes the changes in owner’s equity for a specific period of
that the activities of the entity be kept separate and dis- time. (p. 21).
tinct from the activities of its owner and all other eco- Partnership An association of two or more persons to carry
nomic entities. (p. 11). on as co-owners of a business for profit. (p. 11).
Ethics The standards of conduct by which one’s actions are Proprietorship A business owned by one person. (p. 11).
judged as right or wrong, honest or dishonest, fair or not
Revenues The gross increase in owner’s equity resulting from
fair. (p. 9).
business activities entered into for the purpose of earning
Expenses The cost of assets consumed or services used in the income. (p. 13).
process of earning revenue. (p. 13).
Securities and Exchange Commission (SEC) A governmen-
Financial accounting The field of accounting that provides tal agency that requires companies to file financial reports
economic and financial information for investors, credi- in accordance with generally accepted accounting princi-
tors, and other external users. (p. 7). ples. (p. 10).
Financial Accounting Standards Board (FASB) A private or- Statement of cash flows A financial statement that summa-
ganization that establishes generally accepted accounting rizes information about the cash inflows (receipts) and
principles. (p. 10). cash outflows (payments) for a specific period of time.
Generally accepted accounting principles (GAAP) Common (p. 21).
standards that indicate how to report economic events. Transactions The economic events of an enterprise that are
(p. 9). recorded by accountants. (p. 14).
A PPENDIX T HE A CCOUNTING P ROFESSION
The Accounting Profession

What would you do if you join the accounting profession? You probably would
work in one of three major fields—public accounting, private accounting, or not-
Careers in Accounting for-profit accounting.
Public Accounting
STUDY OBJECTIVE 9 In public accounting, you would offer expert service to the general public in much
the same way that a doctor serves patients and a lawyer serves clients. A major por-
Identify the three major
fields of the accounting tion of public accounting involves auditing. In this area, a certified public account-
profession and potential ant (CPA) examines the financial statements of companies and expresses an opin-
accounting careers. ion as to the fairness of presentation. When the presentation is fair, users consider
the statements to be reliable. For example, PepsiCo investors would demand au-
dited financial statements before extending it financing.
Taxation is another major area of public accounting. The work performed by tax
specialists includes tax advice and planning, preparing tax returns, and representing
clients before governmental agencies such as the Internal Revenue Service.
A third area in public accounting is management consulting. It ranges from the
installing of basic accounting systems to helping companies determine whether they
should use the space shuttle for high-tech research and development projects.
Private Accounting
Instead of working in public accounting, you might choose to be an employee of a
business enterprise. In private (or managerial) accounting, you would be involved
in one of the following activities.
1. General accounting—recording daily transactions and preparing financial state-
ments and related information.
2. Cost accounting—determining the cost of producing specific products.
3. Budgeting—assisting management in quantifying goals concerning revenues,
costs of goods sold, and operating expenses.
4. Accounting information systems—designing both manual and computerized
data processing systems.
5. Tax accounting—preparing tax returns and doing tax planning for the company.
6. Internal auditing—reviewing the company’s operations to see if they comply
with management policies and evaluating the efficiency of operations.
You can see that within a specific company, private accountants perform as wide a
variety of duties as the public accountant.
Illustration 1A-1 (page 29) presents the general career paths in public and pri-
vate accounting.
Not-for-Profit Accounting
Like businesses that exist to make a profit, not-for-profit organizations also need
sound financial reporting and control. Donors to such organizations as the United
Way, the Ford Foundation, and the Red Cross want information about how well the
organization has met its financial objectives and whether continued support is jus-
tified. Hospitals, colleges, and universities must make decisions about allocating
funds.
Glossary for Appendix 29
Illustration 1A-1
Career paths in public and
ACCOUNTING CAREER LADDER private accounting
Private Public
Accounting Accounting
VP Finance and Partner
10+ years
Chief Financial
Officer (CFO)
Corporate 6–8 years Manager

Controller
Senior 2–4+ years Senior

Accountant
Entry level Junior

Junior
Accountant
Another area of not-for-profit accounting is government accounting. Local,

state, and federal governmental units provide financial information to legislators,
citizens, employees, and creditors. At the federal level, the largest employers of ac-
countants are the Internal Revenue Service, the General Accounting Office, the
Federal Bureau of Investigation, and the Securities and Exchange Commission.
SUMMARY OF STUDY OBJECTIVE FOR APPENDIX
9. Identify the three major fields of the accounting profes- gerial accounting, one may pursue a career in cost ac-
sion and potential accounting careers. The accounting pro- counting, budgeting, general accounting, accounting infor-
fession is comprised of three major fields: public account- mation systems, tax accounting, or internal auditing. In
ing, private accounting, and not-for-profit accounting. In not-for-profit accounting one may pursue a career at hos-
public accounting one may pursue a career in auditing, pitals, universities, and foundations, or in local, state, and
taxation, or management consulting. In private or mana- federal governmental units.
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GLOSSARY FOR APPENDIX

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Auditing The examination of financial statements by a certi- counting, budgeting, and accounting information systems.
fied public accountant in order to express an opinion as to (p. 28).
the fairness of presentation. (p. 28). Public accounting An area of accounting in which the ac-
Management consulting An area of public accounting in- countant offers expert service to the general public.
volving financial planning and control and the develop- (p. 28).
ment of accounting and computer systems. (p. 28). Taxation An area of public accounting involving tax advice,
Private (or managerial) accounting An area of accounting tax planning, and preparation of tax returns. (p. 28).
within a company that involves such activities as cost ac-
30 CHAPTER 1 Accounting in Action andt

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SELF-STUDY QUESTIONS Self-Study/Self-Test
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Answers are at the end of the chapter. c. expenses exceed revenues.

d. revenues exceed expenses.
(SO 1) 1. Which of the following is not a step in the accounting
process? 6. Performing services on account will have the following (SO 7)
a. identification. c. recording. effects on the components of the basic accounting equa-
b. verification. d. communication. tion:
a. increase assets and decrease owner’s equity.
(SO 2) 2. Which of the following statements about users of ac-
b. increase assets and increase owner’s equity.
counting information is incorrect?
c. increase assets and increase liabilities.
a. Management is an internal user.
d. increase liabilities and increase owner’s equity.
b. Taxing authorities are external users.
c. Present creditors are external users. 7. As of December 31, 2005, Stoneland Company has assets (SO 7)
d. Regulatory authorities are internal users. of $3,500 and owner’s equity of $2,000. What are the lia-
bilities for Stoneland Company as of December 31, 2005?
(SO 4) 3. The cost principle states that:
a. $1,500. b. $1,000. c. $2,500. d. $2,000.
a. assets should be initially recorded at cost and adjusted
when the market value changes. 8. On the last day of the period, Jim Otto Company buys a (SO 8)
b. activities of an entity are to be kept separate and dis- $900 machine on credit. This transaction will affect the:
tinct from its owner. a. income statement only.
c. assets should be recorded at their cost. b. balance sheet only.
d. only transaction data capable of being expressed in c. income statement and owner’s equity statement only.
terms of money be included in the accounting records. d. income statement, owner’s equity statement, and bal-
ance sheet.
(SO 5) 4. Which of the following statements about basic assump-
tions is incorrect? 9. The financial statement that reports assets, liabilities, and (SO 8)
a. Basic assumptions are the same as accounting princi- owner’s equity is the:
ples. a. income statement.
b. The economic entity assumption states that there b. owner’s equity statement.
should be a particular unit of accountability. c. balance sheet.
c. The monetary unit assumption enables accounting to d. statement of cash flow.
measure economic events. *10. Services provided by a public accountant include: (SO 9)
d. An important part of the monetary unit assumption a. auditing, taxation, and management consulting.
is the stable monetary unit assumption. b. auditing, budgeting, and management consulting.
(SO 6) 5. Net income will result during a time period when: c. auditing, budgeting, and cost accounting.
a. assets exceed liabilities. d. internal auditing, budgeting, and ■✓ THE
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NAVIGATOR
b. assets exceed revenues. management consulting.
QUESTIONS
C 1. “Accounting is ingrained in our society and it is vital to 7. What is the monetary unit assumption? What impact does C
our economic system.” Do you agree? Explain. inflation have on the monetary unit assumption?
C 2. Identify and describe the steps in the accounting process. 8. What is the economic entity assumption? K
C 3. (a) Who are internal users of accounting data?(b) How 9. What are the three basic forms of business organizations K
does accounting provide relevant data to these users? for profit-oriented enterprises?
C 4. What uses of financial accounting information are made 10. Teresa Alvarez is the owner of a successful printing shop. C
by (a) investors and (b) creditors? Recently her business has been increasing, and Teresa has
C 5. “Bookkeeping and accounting are the same.” Do you been thinking about changing the organization of her
agree? Explain. business from a proprietorship to a corporation. Discuss
some of the advantages Teresa would enjoy if she were to
C 6. Jackie Remmers Travel Agency purchased land for
incorporate her business.
$85,000 cash on December 10, 2005. At December 31,
2005, the land’s value has increased to $93,000. What 11. What is the basic accounting equation? K
amount should be reported for land on Jackie Remmers’ 12. (a) Define the terms assets, liabilities, and owner’s equity. K
balance sheet at December 31, 2005? Explain. (b) What items affect owner’s equity?
Brief Exercises 31
C 13. Which of the following items are liabilities of Design Jew- (d) Accounts receivable.
elry Stores? (e) Frank B. Robinson, Capital.
(a) Cash. (f) Equipment. (f) Wages payable.
(b) Accounts payable. (g) Salaries payable. 18. In February 2005, Erica Shin invested an additional C
(c) Drawings. (h) Service revenue. $10,000 in her business, Shin’s Pharmacy, which is organ-
(d) Accounts receivable. (i) Rent expense. ized as a proprietorship. Shin’s accountant, Lance Jones,
(e) Supplies. recorded this receipt as an increase in cash and revenues.
C 14. Can a business enter into a transaction in which only the Is this treatment appropriate? Why or why not?
left side of the basic accounting equation is affected? If 19. “A company’s net income appears directly on the income C
so, give an example. statement and the owner’s equity statement, and it is in-
C 15. Are the following events recorded in the accounting cluded indirectly in the company’s balance sheet.” Do
records? Explain your answer in each case. you agree? Explain.
(a) The owner of the company dies. 20. Jardine Enterprises had a capital balance of $158,000 at AP
(b) Supplies are purchased on account. the beginning of the period. At the end of the accounting
(c) An employee is fired. period, the capital balance was $198,000.
(d) The owner of the business withdraws cash from the (a) Assuming no additional investment or withdrawals
business for personal use. during the period, what is the net income for the pe-
C 16. Indicate how the following business transactions affect riod?
the basic accounting equation. (b) Assuming an additional investment of $13,000 but
(a) Paid cash for janitorial services. no withdrawals during the period, what is the net in-
(b) Purchased equipment for cash. come for the period?
(c) Invested cash in the business. 21. Summarized operations for H. J. Oslo Co. for the month AP
(d) Paid accounts payable in full. of July are as follows.
C 17. Listed below are some items found in the financial state- Revenues earned: for cash $30,000; on account $70,000.
ments of Frank B. Robinson Co. Indicate in which finan-
Expenses incurred: for cash $26,000; on account $40,000.
cial statement(s) the following items would appear.
(a) Service revenue. Indicate for H. J. Oslo Co. (a) the total revenues, (b) the
(b) Equipment. total expenses, and (c) net income for the month of July.
(c) Advertising expense.
BRIEF EXERCISES
BE1-1 Presented below is the basic accounting equation. Determine the missing amounts. Use basic accounting equation.
Assets Liabilities Owner’s Equity (SO 6), AP
(a) $90,000 $50,000 ?

(b) ? $45,000 $70,000
(c) $94,000 ? $65,000
BE1-2 Given the accounting equation, answer each of the following questions. Use basic accounting equation.
(a) The liabilities of Shumway Company are $100,000 and the owner’s equity is $232,000. What (SO 6), AP
is the amount of Shumway Company’s total assets?
(b) The total assets of Company are $190,000 and its owner’s equity is $80,000. What is the
amount of its total liabilities?
(c) The total assets of Norris Co. are $600,000 and its liabilities are equal to one half of its total
assets. What is the amount of Norris Co.’s owner’s equity?
BE1-3 At the beginning of the year, Gonzales Company had total assets of $870,000 and total Use basic accounting equation.
liabilities of $500,000. Answer the following questions. (SO 6), AP
(a) If total assets increased $150,000 during the year and total liabilities decreased $80,000,
what is the amount of owner’s equity at the end of the year?
(b) During the year, total liabilities increased $100,000 and owner’s equity decreased $70,000.
What is the amount of total assets at the end of the year?
(c) If total assets decreased $80,000 and owner’s equity increased $120,000 during the year,
Determine effect of transac-
what is the amount of total liabilities at the end of the year?
tions on basic accounting
BE1-4 Presented below are three business transactions. On a sheet of paper, list the letters (a), equation.
(b), (c) with columns for assets, liabilities, and owner’s equity. For each column, indicate whether (SO 7), C
the transactions increased (+), decreased (−), or had no effect (NE) on assets, liabilities, and
owner’s equity.
(a) Purchased supplies on account.
(b) Received cash for providing a service.
(c) Paid expenses in cash.
Determine effect of transac- BE1-5 Follow the same format as BE1-4 above. Determine the effect on assets, liabilities, and
tions on basic accounting owner’s equity of the following three transactions.
equation.
(a) Invested cash in the business.
(SO 7), C (b) Withdrawal of cash by owner.
(c) Received cash from a customer who had previously been billed for services provided.
Determine effect of transac- BE1-6 Classify each of the following items as owner’s drawing (D), revenue (R), or expense
tions on owner’s equity. (E).
(SO 7), C _______(a) Advertising expense _______(e) Carland, Drawing
_______(b) Commission revenue _______(f) Rent revenue
_______(c) Insurance expense _______(g) Utilities expense
_______(d) Salaries expense
Determine effect of transac- BE1-7 Presented below are three transactions. Mark each transaction as affecting owner’s in-
tions on basic owner’s equity. vestment (I), owner’s drawings (D), revenue (R), expense (E), or not affecting owner’s equity
(SO 7), C (NOE).
_______(a) Received cash for services performed
_______(b) Paid cash to purchase equipment
_______(c) Paid employee salaries.
Prepare a balance sheet. BE1-8 In alphabetical order below are balance sheet items for Gomez Company at December
(SO 8), AP 31, 2005. Kim Gomez is the owner of Gomez Company. Prepare a balance sheet, following the
format of Illustration 1-9.
Accounts payable $85,000
Accounts receivable $72,500
Cash $44,000
Kim Gomez, Capital $31,500
Identify assets, liabilities, and BE1-9 Indicate whether each of the following items is an asset (A), liability (L), or part of
owner’s equity. owner’s equity (OE).
(SO 6), C _______(a) Accounts receivable _______(d) Office supplies
_______(b) Salaries payable _______(e) Owner’s investment
_______(c) Equipment _______(f) Notes payable
Determine where items appear BE1-10 Indicate whether the following items would appear on the income statement (IS), bal-
on financial statements. ance sheet (BS), or owner’s equity statement (OE).
(SO 8), C _______(a) Notes payable _______(d) Cash
_______(b) Advertising expense _______(e) Service revenue
_______(c) Morgan M. Sondgeroth, Capital
EXERCISES
Classify accounts as assets, lia- E1-1 Robinson Cleaners has the following balance sheet items.
bilities, and owner’s equity.
Accounts payable Accounts receivable
(SO 6), C Cash Notes Payable
Cleaning equipment Salaries payable
Cleaning supplies Karin Robinson, Capital
Instructions
Classify each item as an asset, liability, or owner’s equity.
Analyze the effect of transac- E1-2 Selected transactions for Green Acres Lawn Care Company are listed below.
tions.
1. Made cash investment to start business.
(SO 6, 7), C 2. Paid monthly rent.
Exercises 33
3. Purchased equipment on account.

4. Billed customers for services performed.
5. Withdrew cash for owner’s personal use.
6. Received cash from customers billed in (4).
7. Incurred advertising expense on account.
8. Purchased additional equipment for cash.
9. Received cash from customers when service was performed.
Instructions
List the numbers of the above transactions and describe the effect of each transaction on as-
sets, liabilities, and owner’s equity. For example, the first answer is: (1) Increase in assets and in-
crease in owner’s equity.
E1-3 Rollins Computer Timeshare Company entered into the following transactions during Analyze the effect of transac-
May 2005. tions on assets, liabilities, and
owner’s equity.
1. Purchased computer terminals for $21,500 from Digital Equipment on account.
2. Paid $4,000 cash for May rent on storage space. (SO 6, 7), C
3. Received $15,000 cash from customers for contracts billed in April.
4. Provided computer services to Fisher Construction Company for $3,000 cash.
5. Paid Northern States Power Co. $11,000 cash for energy usage in May.
6. Rollins invested an additional $32,000 in the business.
7. Paid Digital Equipment for the terminals purchased in (1) above.
8. Incurred advertising expense for May of $1,200 on account.
Instructions
Indicate with the appropriate letter whether each of the transactions above results in:
(a) an increase in assets and a decrease in assets.
(b) an increase in assets and an increase in owner’s equity.
(c) an increase in assets and an increase in liabilities.
(d) a decrease in assets and a decrease in owner’s equity.
(e) a decrease in assets and a decrease in liabilities.
(f) an increase in liabilities and a decrease in owner’s equity.
(g) an increase in owner’s equity and a decrease in liabilities.
E1-4 An analysis of the transactions made by J. L. Kang & Co., a certified public accounting Analyze transactions and com-
firm, for the month of August is shown below. Each increase and decrease in owner’s equity is pute net income.
explained. (SO 7), AP
Accounts Office Accounts Owner’s Equity

Cash
Receivable Supplies Equipment Payable J. L. Kang, Capital
1. $15,000 $15,000 Investment
2. 2,000 $5,000 $3,000
3. 750 $750
4. 2,600 $3,700 6,300 Service Revenue
5. 1,500 1,500
6. 2,000 2,000 Drawings
7. 650 −650 Rent Expense
8. 450 450
9. 3,900 3,900 Salaries Expense
10. 500 −500 Utilities Expense
Instructions
(a) Describe each transaction that occurred for the month.
(b) Determine how much owner’s equity increased for the month. (b) Increase in O.E. $14,250
(c) Compute the amount of net income for the month. (c) Net income $1,250
E1–5 An analysis of transactions for J. L. Kang & Co. was presented in E1–4. Prepare an income statement
and owner‘s equity statement.
Instructions
(SO 8), AP
Prepare an income statement and an owner‘s equity statement for August and a balance sheet
at August 31, 2005.
Determine net income (or E1–6 The Kimm Company had the following assets and liabilities on the dates indicated.
loss).
December 31 Total Assets Total Liabilities
(SO 7), AP
2005 $380,000 $250,000
2006 $460,000 $310,000
2007 $590,000 $400,000
Kimm began business on January 1, 2005, with an investment of $100,000.
Instructions
From an analysis of the change in owner’s equity during the year, compute the net income (or
loss) for:
(a) 2005, assuming Kimm’s drawings were $15,000 for the year.
(a) Net income $45,000 (b) 2006, assuming Kimm made an additional investment of $50,000 and had no drawings in
(b) Net loss $30,000 2006.
(c) Net income $55,000
(c) 2007, assuming Kimm made an additional investment of $15,000 and had drawings of
$30,000 in 2007.
Analyze financial statements E1–7 Two items are omitted from each of the following summaries of balance sheet and in-
items. come statement data for two proprietorships for the year 2005, Craig Stevens and Holly En-
(SO 6,7), AP terprises.
Craig Holly
Stevens Enterprises
Beginning of year:
Total assets $ 97,000 $129,000
Total liabilities 85,000 (c)
Total owner’s equity (a) 75,000
End of year:
Total assets 160,000 180,000
Total liabilities 120,000 50,000
Total owner’s equity 40,000 130,000
Changes during year in owner’s equity:
Additional investment (b) 25,000
(a) $12,000
Drawings 24,000 (d)
(b) $12,000
(c) $54,000 Total revenues 215,000 100,000
(d) $15,000 Total expenses 175,000 55,000
Instructions
Determine the missing amounts.
Prepare income statement and E1–8 The following information relates to Karin Weigel Co. for the year 2005.
owner’s equity statement.
Karin Weigel, Capital, January 1, 2005 $ 48,000 Advertising expense $ 1,800
(SO 8), AP
Karin Weigel, Drawing during 2005 5,000 Rent expense 10,400
Service revenue 62,500 Utilities expense 3,100
Salaries expense 28,000
Instructions
Net income $19,200 After analyzing the data, prepare an income statement and an owner’s equity statement for the
Capital, Dec. 31 $62,200 year ending December 31, 2005
Correct an incorrectly pre- E1–9 Lynn Close is the bookkeeper for Sanculi Company. Lynn has been trying to get the bal-
pared balance sheet. ance sheet of Sanculi Company to balance. Sanculi’s balance sheet is as follows.
(SO 8), AN
S A N C U L I C O M PA N Y
Balance Sheet
December 31, 2005
Assets Liabilities
Cash $16,500 Accounts payable $20,000
Supplies 8,000 Accounts receivable (8,500)
Equipment 46,000 Sanculi, Capital 67,500
Sanculi, Drawing 8,500 Total liabilities and
Total assets $79,000 Total assets $79,000 owner’s equity $79,000
Problems: Set A 35
Instructions
Prepare a correct balance sheet.
E1–10 Jan Way is the sole owner of Bear Park, a public camping ground near the Lake Mead Compute net income and
National Recreation Area. Jan has compiled the following financial information as of Decem- prepare a balance sheet.
ber 31, 2005. (SO 8), AP
Revenues during 2005—camping fees $140,000 Market value of equipment $140,000

Revenues during 2005—general store 47,000 Notes payable 60,000
Accounts payable 11,000 Expenses during 2005 150,000
Cash on hand 20,000 Supplies on hand 2,500
Original cost of equipment 105,500
Instructions
(a) Determine Jan Way’s net income from Bear Park for 2005. Net income $37,000
(b) Prepare a balance sheet for Bear Park as of December 31, 2005. Total assets $128,000
E1–11 Presented below is financial information related to the 2005 operations of Debra-Joan Prepare an income statement.
Cruise Company. (SO 8), AP
Maintenance expense $ 97,000

Property tax expense (on dock facilities) 10,000
Salaries expense 142,000
Advertising expense 3,500
Ticket revenue 335,000
Instructions
Prepare the 2005 income statement for Debra-Joan Cruise Company. Net income $82,500
E1–12 Presented below is information related to the sole proprietorship of Douglas William, Pepare an owner’s equity
attorney. statement.
Legal service revenue—2005 $340,000 (SO 8), AP
Total expenses—2005 211,000
Assets, January 1, 2005 85,000
Liabilities, January 1, 2005 62,000
Assets, December 31, 2005 168,000
Liabilities, December 31, 2005 80,000
Drawings—2005 ?
Instructions
Prepare the 2005 owner’s equity statement for Douglas William’s legal practice. Capital, Dec 31 $88,000
PROBLEMS: SET A
P1-1A On April 1, Holly Palmer established Matrix Travel Agency. The following transactions Analyze transactions and
were completed during the month. compute net income.
(SO 6, 7), AP
1. Invested $10,000 cash to start the agency.
2. Paid $400 cash for April office rent.
3. Purchased office equipment for $2,500 cash.
4. Incurred $300 of advertising costs in the Chicago Tribune, on account.
5. Paid $600 cash for office supplies.
6. Earned $7,500 for services rendered: $1,000 cash is received from customers, and the bal-
ance of $6,500 is billed to customers on account.
7. Withdrew $200 cash for personal use.
8. Paid Chicago Tribune amount due in transaction (4). The check figures you see
9. Paid employees’ salaries $2,200. next to Problems are also
10. Received $5,000 in cash from customers who have previously been billed in transaction (6). shown in the students’ text.
Instructions
(a) Prepare a tabular analysis of the transactions using the following column headings: Cash, (a) Ending capital $14,400
Accounts Receivable, Supplies, Office Equipment, Accounts Payable, and Holly Palmer,
Capital.
(b) Net income $4,600 (b) From an analysis of the column Holly Palmer, Capital, compute the net income or net loss
for April.
Analyze transactions and P1-2A Mandy Arnold opened a law office, Mandy Arnold, Attorney at Law, on July 1, 2005.
prepare income statement, On July 31, the balance sheet showed Cash $4,000, Accounts Receivable $1,500, Supplies $500,
owner’s equity statement, and Office Equipment $5,000, Accounts Payable $4,200, and Mandy Arnold, Capital $6,800. During
balance sheet. August the following transactions occurred.
(SO 6, 7, 8), AP
1. Collected $1,400 of accounts receivable.
2. Paid $2,700 cash on accounts payable.
3. Earned revenue of $7,500 of which $3,000 is collected in cash and the balance is due in Sep-
tember.
4. Purchased additional office equipment for $1,000, paying $400 in cash and the balance on
account.
5. Paid salaries $3,000, rent for August $900, and advertising expenses $350.
6. Withdrew $550 in cash for personal use.
7. Received $2,000 from Standard Federal Bank—money borrowed on a note payable.
8. Incurred utility expenses for month on account $250.
Instructions
(a) Ending capital $9,250 (a) Prepare a tabular analysis of the August transactions beginning with July 31 balances. The
column headings should be as follows: Cash Accounts Receivable Supplies Office
Equipment Notes Payable Accounts Payable Mandy Arnold, Capital.
(b) Net income $3,000 (b) Prepare an income statement for August, an owner’s equity statement for August, and a
Total assets $13,600 balance sheet at August 31.
Prepare income statement, P1-3A On June 1, Jennifer Garner started Divine Cosmetics Co., a company that provides in-
owner’s equity statement, and dividual skin care treatment, by investing $26,200 cash in the business. Following are the assets
balance sheet. and liabilities of the company at June 30 and the revenues and expenses for the month of June.
(SO 8), AP
Cash $10,000 Notes Payable $13,000
Accounts Receivable 4,000 Accounts Payable 1,200
Service Revenue 5,500 Supplies Expense 1,600
Cosmetic Supplies 2,000 Gas and Oil Expense 800
Advertising Expense 500 Utilities Expense 300
Equipment 25,000
Jennifer made no additional investment in June, but withdrew $1,700 in cash for personal use
during the month.
Instructions
(a) Net income $2,300 (a) Prepare an income statement and owner’s equity statement for the month of June and a
Owner’s equity $26,800 balance sheet at June 30, 2005.
Total assets $41,000 (b) Prepare an income statement and owner’s equity statement for June assuming the follow-
(b) Net income $3,000 ing data are not included above: (1) $800 of revenue was earned and billed but not col-
Owner’s equity $27,500 lected at June 30, and (2) $100 of gas and oil expense was incurred but not paid.
Analyze transactions and P1-4A Laura Stiner started her own consulting firm, Stiner Consulting, on May 1, 2005. The
prepare financial statements. following transactions occurred during the month of May.
(SO 7, 8), A
May 1 Stiner invested $8,000 cash in the business.
2 Paid $800 for office rent for the month.
3 Purchased $500 of supplies on account.
5 Paid $50 to advertise in the County News.
9 Received $3,000 cash for services provided.
12 Withdrew $700 cash for personal use.
15 Performed $3,300 of services on account.
17 Paid $3,000 for employee salaries.
20 Paid for the supplies purchased on account on May 3.
23 Received a cash payment of $2,000 for services provided on account on May 15.
26 Borrowed $5,000 from the bank on a note payable.
29 Purchased office equipment for $2,400 on account.
30 Paid $150 for utilities.
Problems: Set B 37
Instructions
(a) Show the effects of the previous transactions on the accounting equation using the follow- (a) Ending capital $9,600
ing format.
Owner’s
Assets Liabilities Equity
Accounts Office Notes Accounts L. Stiner
Date Cash Supplies
Receivable Equipment Payable Payable Capital
Include explanations for any changes in the L. Stiner, Capital account in your analysis.
(b) Prepare an income statement for the month of May. (b) Net income $2,300
(c) Prepare a balance sheet at May 31, 2005. (c) Cash $12,800
P1-5A Financial statement information about four different companies is as follows. Determine financial statement
amounts and prepare owner’s
Winger Selara Delta Hindi
equity statement.
Company Company Company Company (SO 7, 8), AP
January 1, 2005
Assets $ 75,000 $90,000 (g) $150,000
Liabilities 50,000 (d) 75,000 (j)
Owner’s equity (a) 50,000 54,000 100,000
December 31, 2005
Assets (b) 117,000 180,000 (k)
Liabilities 55,000 62,000 (h) 80,000
Owner’s equity 40,000 (e) 100,000 140,000
Owner’s equity changes in year
Additional investment (c) 8,000 10,000 15,000
Drawings 10,000 (f) 12,000 10,000
Total revenues 350,000 400,000 (i) 500,000
Total expenses 335,000 385,000 360,000 (l)
Instructions
(a) Determine the missing amounts. (Hint: For example, to solve for (a), Assets − Liabilities =
Owner’s equity = $25,000.)
(b) Prepare the owner’s equity statement for Winger Company.
(c) Write a memorandum explaining the sequence for preparing financial state-
ments and the interrelationship of the owner’s equity statement to the income statement
and balance sheet.
PROBLEMS: SET B
P1-1B McInnes’s Repair Shop was started on May 1 by Jane McInnes. A summary of May Analyze transactions and
transactions is presented below. compute net income.
(SO 6, 7), AP
1. Invested $10,000 cash to start the repair shop.
2. Purchased equipment for $5,000 cash.
3. Paid $400 cash for May office rent.
4. Paid $500 cash for supplies.
5. Incurred $250 of advertising costs in the Beacon News on account.
6. Received $3,100 in cash from customers for repair service.
7. Withdrew $1,000 cash for personal use.
8. Paid part-time employee salaries $1,000.
9. Paid utility bills $140.
10. Provided repair service on account to customers $850.
11. Collected cash of $120 for services billed in transaction (10).
Instructions
(a) Prepare a tabular analysis of the transactions, using the following column headings: Cash, (a) Ending capital $11,160
Accounts Receivable, Supplies, Equipment, Accounts Payable, and Jane McInnes, Capital.
Revenue is called Service Revenue.
(b) Net income $2,160 (b) From an analysis of the column Jane McInnes, Capital, compute the net income or net loss
for May.
Analyze transactions and P1-2B Patricia Perez opened a veterinary business in Nashville, Tennessee, on August 1. On
prepare income statement, August 31, the balance sheet showed Cash $9,000, Accounts Receivable $1,700, Supplies $600,
owner’s equity statement, and Office Equipment $6,000, Accounts Payable $3,600, and P. Perez, Capital $13,700. During Sep-
balance sheet. tember the following transactions occurred.
(SO 6, 7, 8), AP
1. Paid $2,900 cash on accounts payable.
2. Collected $1,300 of accounts receivable.
3. Purchased additional office equipment for $2,100, paying $800 in cash and the balance on
account.
4. Earned revenue of $6,300, of which $2,500 is paid in cash and the balance is due in Octo-
ber.
5. Withdrew $600 cash for personal use.
6. Paid salaries $1,700, rent for September $900, and advertising expense $300.
7. Incurred utilities expense for month on account $170.
8. Received $10,000 from Capital Bank–money borrowed on a note payable.
Instructions
(a) Ending capital $16,330 (a) Prepare a tabular analysis of the September transactions beginning with August 31 bal-
ances. The column headings should be as follows: Cash Accounts Receivable Sup-
plies Office Equipment Notes Payable Accounts Payable P. Perez, Capital.
(b) Net income $3,230 (b) Prepare an income statement for September, an owner’s equity statement for September,
Total assets $28,500 and a balance sheet at September 30.
Prepare income statement, P1-3B On May 1, Jacob Bablad started Skyward Flying School, a company that provides fly-
owner’s equity statement, and ing lessons, by investing $45,000 cash in the business. Following are the assets and liabilities of
balance sheet. the company on May 31, 2005, and the revenues and expenses for the month of May.
(SO 8), AP
Cash $ 4,500 Notes Payable $30,000
Accounts Receivable 7,200 Rent Expense 1,200
Equipment 64,000 Repair Expense 400
Lesson Revenue 6,600 Fuel Expense 2,500
Advertising Expense 500 Insurance Expense 400
Accounts Payable 800
Jacob Bablad made no additional investment in May, but he withdrew $1,700 in cash for per-
sonal use.
Instructions
(a) Net income $1,600 (a) Prepare an income statement and owner’s equity statement for the month of May and a
Owner’s equity $44,900 balance sheet at May 31.
Total assets $75,700 (b) Prepare an income statement and owner’s equity statement for May assuming the follow-
(b) Net income $1,000 ing data are not included above: (1) $900 of revenue was earned and billed but not col-
Owner’s equity $44,300 lected at May 31, and (2) $1,500 of fuel expense was incurred but not paid.
Analyze transactions and P1-4B Pat Donahue started his own delivery service, Donahue Deliveries, on June 1, 2005. The
prepare financial statements. following transactions occurred during the month of June.
(SO 7, 8), A
June 1 Pat invested $10,000 cash in the business.
2 Purchased a used van for deliveries for $10,000. Pat paid $2,000 cash and signed a
note payable for the remaining balance.
3 Paid $500 for office rent for the month.
5 Performed $2,400 of services on account.
9 Withdrew $200 cash for personal use.
12 Purchased supplies for $150 on account.
15 Received a cash payment of $750 for services provided on June 5.
17 Purchased gasoline for $100 on account.
20 Received a cash payment of $1,500 for services provided.
23 Made a cash payment of $500 on the note payable.
26 Paid $250 for utilities.
29 Paid for the gasoline purchased on account on June 17.
30 Paid $1,000 for employee salaries.
Broadening Your Perspective 39
Instructions
(a) Show the effects of the previous transactions on the accounting equation using the follow- (a) Ending capital $11,850
ing format.
Owner’s
Assets Liabilities Equity
Accounts Delivery Notes Accounts P. Donahue
Date Cash Supplies
Receivable Van Payable Payable Capital
Include explanations for any changes in the P. Donahue, Capital account in your analysis.
(b) Prepare an income statement for the month of June. (b) Net income $2,050
(c) Prepare a balance sheet at June 30, 2005. (c) Cash $7,700
P1–5B Financial statement information about four different companies is as follows. Determine financial statement
amounts and prepare owner’s
Karma Molly McCain Bodie equity statement.
Company Company Company Company (SO 7, 8), AP
January 1, 2005
Assets $ 89,000 $110,000 (g) $170,000
Liabilities 50,000 (d) 75,000 (f)
Owner’s equity (a) 60,000 40,000 90,000
December 31, 2005
Assets (b) 147,000 200,000 (k)
Liabilities 55,000 75,000 (h) 80,000
Owner’s equity 60,000 (e) 130,000 160,000
Owner’s equity changes in year
Additional investment (c) 15,000 10,000 15,000
Drawings 25,000 (f) 14,000 20,000
Total revenues 350,000 420,000 (i) 520,000
Total expenses 320,000 385,000 342,000 (l)
Instructions
(a) Determine the missing amounts.
(b) Prepare the owner’s equity statement for Molly Company.
(c) Write a memorandum explaining the sequence for preparing financial state-
ments and the interrelationship of the owner’s equity statement to the income statement
and balance sheet.
BROADENING YOUR PERSPECTIVE

Financial Reporting and Analysis
■ FINANCIAL REPORTING PROBLEM: PepsiCo
BYP1-1 The actual financial statements of PepsiCo, as presented in the company’s 2002 An- AN
nual Report, are contained in Appendix A (at the back of the textbook).
Instructions
Refer to PepsiCo’s financial statements and answer the following questions.
(a) What were PepsiCo’s total assets at December 28, 2002? At December 29, 2001?
(b) How much cash (and cash equivalents) did have on December 28, 2002?
(c) What amount of accounts payable did PepsiCo report on December 28, 2002? On Decem-
ber 29, 2001?
(d) What were PepsiCo net sales in 2000? In 2001? In 2002?
(e) What is the amount of the change in PepsiCo’s net income from 2001 to 2002?
■ COMPARATIVE ANALYSIS PROBLEM: PepsiCo vs. Coca-Cola

AN, E BYP1-2 PepsiCo’s financial statements are presented in Appendix A. Coca-Cola’s financial
statements are presented in Appendix B.
Instructions
(a) Based on the information contained in these financial statements, determine the following
for each company.
(1) Total assets at December 28, 2002, for PepsiCo, and for Coca-Cola at December 31,
2002.
(2) Accounts (notes) receivable, net at December 28, 2002, for PepsiCo and at December
31, 2002, for Coca-Cola.
(3) Net sales for year ended in 2002.
(4) Net income for year ended in 2002.
(b) What conclusions concerning the two companies can be drawn from these data?
■ INTERPRETING FINANCIAL STATEMENTS: A Global Focus

S BYP1-3 Today companies must compete in a global economy. Nestlé, a Swiss company, is the
largest food company in the world. If you were interested in broadening your investment port-
folio, you might consider investing in Nestlé. However, investing in international companies can
pose some additional challenges. Consider the following excerpts from the notes to Nestlé’s fi-
nancial statements.
NESTLÉ
Notes to the Financial Statements (partial)
(a) The Group accounts comply with International Accounting Standards (IAS) issued
by the International Accounting Standards Committee (IASC) and with the Stan-
dards Interpretations issued by the Standards Interpretation Committee of the
IASC (SIC).
(b) The accounts have been prepared under the historical cost convention and on an
accrual basis. All significant consolidated companies have a 31st December ac-
counting year end. All disclosures required by the 4th and 7th European Union
company law directives are provided.
(c) On consolidation, assets and liabilities of Group companies denominated in foreign
currencies are translated into Swiss francs at year-end rates. Income and expense
items are translated into Swiss francs at the annual average rates of exchange or,
where known or determinable, at the rate on the date of the transaction for signifi-
cant items.
Instructions
Discuss the implications of each of these items in terms of the effect it might have (positive or
negative) on your ability to compare Nestlé to a U.S. food company such as Tootsie Roll or Her-
shey Foods. (Hint: In preparing your answer review the discussion of principles and assump-
tions in financial reporting on pages 10 and 11.)
andt
w
eyg ■ EXPLORING THE WEB
o l l ege/
C, AN BYP1-4 This exercise will familiarize you with skill requirements, job descriptions, and salaries
www
/c
for accounting careers.

.
wi
le y . com
Address: www.careers-in-accounting.com, or go to www.wiley.com/college/weygandt

Broadening Your Perspective 41
Instructions
Go to the site shown above. Answer the following questions.
(a) What are the three broad areas of accounting (from “Skills and Talents Required”)?
(b) List eight skills required in accounting.
(c) How do the three accounting areas differ in terms of these eight required skills?
(d) Explain one of the key job functions in accounting.
(e) Based on the Smart Money survey, what is the salary range for a junior staff accountant
with Deloitte & Touche?
Critical Thinking
■ GROUP DECISION CASE
BYP1-5 Lucy and Nick Lars, local golf stars, opened the Chip-Shot Driving Range on March E
1, 2005, by investing $20,000 of their cash savings in the business. A caddy shack was constructed
for cash at a cost of $6,000, and $800 was spent on golf balls and golf clubs. The Lars leased five
acres of land at a cost of $1,000 per month and paid the first month’s rent. During the first
month, advertising costs totaled $750, of which $150 was unpaid at March 31, and $400 was paid
to members of the high-school golf team for retrieving golf balls. All revenues from customers
were deposited in the company’s bank account. On March 15, Lucy and Nick withdrew a total
of $800 in cash for personal living expenses. A $100 utility bill was received on March 31 but
was not paid. On March 31, the balance in the company’s bank account was $15,100.
Lucy and Nick thought they had a pretty good first month of operations. But, their estimates
of profitability ranged from a loss of $4,900 to net income of $1,650.
Instructions
With the class divided into groups, answer the following.
(a) How could the Lars have concluded that the business operated at a loss of $4,900? Was this
a valid basis on which to determine net income?
(b) How could the Lars have concluded that the business operated at a net income of $1,650?
(Hint: Prepare a balance sheet at March 31.) Was this a valid basis on which to determine
net income?
(c) Without preparing an income statement, determine the actual net income for March.
(d) What was the revenue earned in March?
■ COMMUNICATION ACTIVITY
BYP1-6 Erin Danielle, the bookkeeper for New York Company, has been trying to get the bal- E
ance sheet to balance. The company’s balance sheet is as follows.
N E W Y O R K C O M PA N Y
Balance Sheet
For the Month Ended December 31, 2005
Assets Liabilities
Equipment $22,500) Cole William, Capital $23,000
Cash 9,000) Accounts receivable (6,000)
Supplies 2,000) Cole William, Drawing (2,000)
Accounts payable (8,000) Notes payable 10,500
$25,500) $25,500
Instructions
Explain to Erin Danielle in a memo why the original balance sheet is incorrect, and what should
be done to correct it.
■ ETHICS CASE
E BYP1-7 After numerous campus interviews, Jeff Hunter, a senior at Great Northern College,
received two office interview invitations from the Baltimore offices of two large firms. Both
firms offered to cover his out-of-pocket expenses (travel, hotel, and meals). He scheduled the
interviews for both firms on the same day, one in the morning and one in the afternoon. At the
conclusion of each interview, he submitted to both firms his total out-of-pocket expenses for
the trip to Baltimore: mileage $98 (280 miles at $0.35), hotel $130, meals $36, parking and tolls
$18, for a total of $282. He believes this approach is appropriate. If he had made two trips, his
cost would have been two times $282. He is also certain that neither firm knew he had visited
the other on that same trip. Within ten days Jeff received two checks in the mail, each in the
amount of $282.
Instructions
(a) Who are the stakeholders (affected parties) in this situation?
(b) What are the ethical issues in this case?
(c) What would you do in this situation?
Answers to Self-Study Questions

1. b 2. d 3. c 4. a 5. d 6. b 7. a 8. b 9. c 10. a
Answer to PepsiCo Review It Question 4, p. 14

PepsiCo’s accounting equation is:
Assets Liabilities Owners’ (Stockholders’) Equity
$23,474,000,000 $14,183,000,000 $9,291,000,000
(Owners’ equity includes preferred stock.)
• • • • • ✓ REMEMBER to go back to the Navigator box on the chapter-opening page and check off your completed work.
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Concepts for Review highlight

3. Understand why ethics is a fundamental business concept.

Why Study What Is The Building Blocks Using the

• Who uses accounting • Ethics—a fundamental • Transaction analysis • Income statement

The Preview describes and

Why Study Accounting?

4 CHAPTER 1 Accounting in Action

business behavior as well as accounting and auditing practices. The Sarbanes-Oxley

Prepare accounting reports

Select economic events (transactions) Record, classify, and summarize

Analyze and interpret for users

Accounting should consider the needs of the users of financial information.

Who Uses Accounting Data

External Users HELPFUL HINT

6 CHAPTER 1 Accounting in Action

Questions Asked by Internal Users

Questions Asked by External Users

ACCOUNTING IN ACTION International Insight

Brief History of Accounting

Distinguishing Between Bookkeeping and Accounting

8 CHAPTER 1 Accounting in Action

ACCOUNTING IN ACTION Business Insight

Accounting and You

Before You Go On questions

The Building Blocks of Accounting 9

4. To whom are the origins of accounting generally attributed?

The Building Blocks of Accounting

Ethics—A Fundamental Business Concept

Solving an Ethical Dilemma

Generally Accepted Accounting Principles

10 CHAPTER 1 Accounting in Action

Two organizations are primarily responsible for establishing generally accepted

The Building Blocks of Accounting 11

Economic Entity Assumption

P R O P R I E T O R S H I P. A business owned by one person is generally a proprietor- HELPFUL HINT

C O R P O R A T I O N . A business organized as a separate legal entity under state cor-

State the basic accounting

12 CHAPTER 1 Accounting in Action

The Building Blocks of Accounting 13

D E C R E A S E S I N O W N E R ’ S E Q U I T Y. In a proprietorship, owner’s equity is

Investments by owner Withdrawals by owner

14 CHAPTER 1 Accounting in Action

BEFORE YOU GO ON...

Using the Building Blocks

Using the Building Blocks 15

Purchase computer Discuss product design with Pay rent

T R A N S A C T I O N ( 1 ) . I N V E S T M E N T B Y O W N E R . Ray Neal decides to

16 CHAPTER 1 Accounting in Action

Assets Liabilities Owner’s Equity

Assets Liabilities Owner’s Equity

Assets Liabilities Owner’s Equity

Using the Building Blocks 17

Assets Liabilities Owner’s Equity

Assets Liabilities Owner’s Equity

18 CHAPTER 1 Accounting in Action

Assets Liabilities Owner’s Equity

T R A N S A C T I O N ( 7 ) . P A Y M E N T O F E X P E N S E S . Expenses paid in cash for

Assets Liabilities Owner’s Equity

Assets Liabilities Owner’s Equity

Using the Building Blocks 19

Assets Liabilities Owner’s Equity

Cash Accounts Supplies Equipment Accounts R. Neal,

Assets Liabilities Owner’s Equity

20 CHAPTER 1 Accounting in Action

Assets Liabilities Owner’s Equity

BEFORE YOU GO ON...

Assets Liabilities Owner’s Equity

Describe each transaction that occurred for the month.

R. Neal, Capital September 1 $ −0−

Liabilities and Owner’s Equity

Owner’s Equity Statement

R. Neal, Capital, September 1 $ −0−

Any additional investments are reported as investments in the owner’s equity

24 CHAPTER 1 Accounting in Action