Study GuideChapter 1 1
Chapter One
An Introduction to Accounting
Learning Objectives for the Chapter
After learning the material in this chapter you should be able to:
1.Explain the role of accounting in society.
2. Construct an accounting equation using elements of financial statements terminology.
3.Record business events in general ledger accounts organized under the accounting equation.
4.Classify business events as asset source, use, or exchange transactions.
5.Use the general ledger account information to prepare four financial statements.
6.Record business events using a horizontal financial statements model.
Brief Explanation of the Learning Objectives
1.Explain the role of accounting in society.
Many decisions made by individuals, businesses, not-for-profit entities, and governments are based on financial information. Accounting is the profession responsible for developing much of that financial information.
2.Construct an accounting equation using elements of financial statements terminology.
The most common way of stating the accounting equation is:
Assets =Liabilities+Equity
Assets:Things with future economic value to the business.
Liabilities:Claims against assets made by non-owners.
Equity:Equity refers to the owners' claims against assets. Generically, equity is often referred to as owners' equity, but in a corporation the term most commonly used is stockholders’ equity, and this is the term used throughout this course. Common stock is that portion of equity resulting from direct investment by the owners. Retained earnings is that portion of owners’ equity resulting from net income the business has earned but has not distributed to the owners.
The relationships that exist among the three variables in the accounting equation are like those of any other algebraic equation. If the amount on one side of the equation are increased or decreased, the amounts on the other side must increase or decrease by the same amount.
3.Record business events in general ledger accounts organized under an accounting equation.
This is done with the use of the self-study problems presented below. The articulation problems are especially intended to help you accomplish this objective, but remember, the articulation problems focus on broad account types such as assets. The general ledger accounts are more detailed, and include numerous different types of asset, liability, and stockholders’ equity accounts.
4.Classify business events as asset source, use, or exchange transactions.
Asset source: An event that causes total assets to increase. There will be a corresponding increase in liabilities and/or stockholders’ equity.
Asset use: An event that causes total assets to decrease. There will be a corresponding decrease in liabilities and/or stockholders’ equity.
Asset exchange: An event that causes one asset to increase and another asset to decrease by the same amount. It is possible that more than two assets will be involved in such an event, but the net effect on assets will be that total assets do not change.
5.Use the general ledger account information to prepare four financial statements.
The four financial statements are:
Balance Sheet:A listing of the assets, liabilities, and components of stockholders' equity of a business as of a particular date.
Income Statement:A comparison of the revenues earned and expenses incurred by a business for a particular period, usually one year.
Statement ofA detailed explanation of the stockholders’ equity section of the balance
Changes in sheet. This statement provides more explanation about why the balances
Stockholders’ Equity:changed for common stock and retained earningsduring a particular
period than is provided on the balance sheet.
Statement of A detailed explanation of how the business obtained and used cash during
Cash Flows: a particular period, usually a year. This statement is divided into three sections: operating activities, investing activities, and financing activities.
The two exercise-type self-study problems are intended to help you accomplish this objective more completely.
6.Record business events using a horizontal financial statements model.
This is accomplished with the use of the self-study problems presented below. The articulation problems are especially intended to help you accomplish this objective.
Self-Study Problems
Articulation Problems
For each situation below, indicate its effects on the accounting elements shown on the accompanying chart. Use the following letters to indicate your answer (you do not need to enter amounts):
Increase = I Decrease = D No effect = N
1.Alston Co. acquired cash from the owners to begin business operations.
Assets / Liabilities / Equity / Revenues / Expenses / Net Income / Cash2.BerryCo. borrowed cash from the Local Bank.
Assets / Liabilities / Equity / Revenues / Expenses / Net Income / Cash3.CheeksCo. provided services to its customers for cash.
Assets / Liabilities / Equity / Revenues / Expenses / Net Income / Cash4. Dreyfus Co. purchased land for cash.
Assets / Liabilities / Equity / Revenues / Expenses / Net Income / Cash5.Erin Co. incurred operating expenses and paid cash.
Assets / Liabilities / Equity / Revenues / Expenses / Net Income / Cash6.Fung Co. made a cash distribution to its owners
Assets / Liabilities / Equity / Revenues / Expenses / Net Income / CashMultiple-Choice Problems
The following information applies to Questions 1 - 5.
At the beginning of 2012Gander Co. had the following account balances:
Assets$10,000
Liabilities 6,000
Common stock 3,000
Retained Earnings 1,000
During 2012 the following cash events occurred:
a.Provided services to customers for $8,000.
b.Repaid $2,000 of debt.
c.Owners invested an additional $3,000 in the business.
d.Incurred operating expenses of $5,000.
e.Dividends amounted to $1,000.
1.Gander's net income for 2012 was:
a.$1,000
b.$2,000
c.$3,000
d.$4,000
2.Total assets at the end of 2012 are:
a.$ 3,000
b.$13,000
c.$15,000
d.$18,000
3.Total liabilities at the end of 2012 are:
a.$ 0
b.$4,000
c.$6,000
d.$8,000
4.Common stock at the end of 2012 is:
a.$3,000
b.$4,000
c.$5,000
d.$6,000
5.Retained earnings at the end of 2012 are:
a.$1,000
b.$2,000
c.$3,000
d.$4,000
6.The Harlow Company provided services to a customer for $1,000 cash. Which of the following statements related to this transaction are false?
a.Total assets would increase.
b.Total liabilities would not be affected.
c.Retained earnings would not be affected.
d.Cash flow from operating activities would increase.
7.The following amounts were drawn from the records of Irvine Co.: Total Assets = $1,100; Common stock = $300; Retained Earnings = $200. Based on this information, total liabilities must be equal to:
a.$300
b.$600
c.$800
d.$900
8.During 2011 the following events occurred at Jackson Co.: owners invested $10,000 of cash; revenue of $20,000 was earned; the company borrowed $4,000 from the bank; expenses of $13,000 were incurred; and $2,000 cash was distributed to the owners. What was Jackson's net income for 2011?
a.$ 1,000
b.$ 5,000
c.$ 7,000
d.$11,000
9.Kuhn Co. borrowed $8,000 cash. As a result of this event:
a.Assets increased.
b.Expenses increased.
c.Stockholders’ equity increased.
d.Revenue increased.
10.Lawson Co. purchased land for $2,000 cash. As a result of this event:
a.Cash flow from operating activities would decrease.
b.Cash flow from investing activities would increase.
c.Cash flow from financing activities would decrease.
d.Cash flow from investing activities would decrease.
11.Which of the following statements is true?
a.An increase in net income will always cause stockholders’ equity on the balance sheet to increase.
b.An increase in assets is always the result of revenues earned.
c.A decrease in liabilities will be reflected in the investing section of the statement of cash flows.
d.A distribution will decrease common stock on the balance sheet.
12.Which of the following would appear in the investing section of the statement of cash flows?
a.A stock-brokerage firm earns revenue by providing investment advice.
b.A business purchases land on which to build an office.
c.The owners of a company invest cash in the business.
d.A company repays money it had borrowed from the local bank.
13.Murro Co. borrowed $1,000 from the Town & Country Bank. Which of the following elements of financial statements would not be immediately affected by this event?
a.Assets
b.Liabilities
c.Revenues
d.Cash
14.Which of the following statements is true?
a.Net income is an account on the balance sheet.
b.Cash flow from operating activities appears on the income statement.
c.Beginning and ending cash balances appear on the statement of changes in stockholders’ equity.
d.Retained earnings is an account that appears on both the balance sheet and the statement of changes in stockholders’ equity.
15.Nevada Co. borrowed cash from the Corner Bank. Which of the following choices reflects how this event would affect the company’s financial statements?
Study GuideChapter 1 1
Assets / = / Liab. / + / Equity / Rev. / - / Exp. / = / Net Inc. / Cash Flowa. / I / I / N / N / N / N / I
b. / I / I / I / I / N / I / I
c. / I / I / N / N / I / D / I
d. / N / I / D / N / I / D / I
Study GuideChapter 1 1
16.Oregon Co. provided services to customers and received cash. Which of the following choices reflects how this event would affect the company’s financial statements?
Study GuideChapter 1 1
Assets / = / Liab. / + / Equity / Rev / - / Exp. / = / Net Inc. / Cash Flowa. / I / N / N / I / N / N / I
b. / I / N / I / I / N / I / I
c. / N / N / I / I / N / I / I
d. / N / N / N / I / N / I / I
Study GuideChapter 1 1
17.Parker Co. incurred operating expenses and paid cash. Which of the following choices reflects how this event would affect the company’s financial statements?
Study GuideChapter 1 1
Assets / = / Liab. / + / Equity / Rev / - / Exp. / = / Net Inc. / Cash Flowa. / D / N / D / D / N / D / D
b. / N / D / D / N / I / D / D
c. / D / D / N / N / N / N / D
d. / D / N / D / N / I / D / D
Study GuideChapter 1 1
Multiple True-False Problems
1.Indicate if each of the following statements about the balance sheet is true or false.
a.The accounting equation may be expressed as: Assets - Liabilities = Equity.
b.One purpose of the balance sheet is to explain how a company obtained its cash.
c.A liability account or an equity account must decrease if the cash account decreases.
d. If a company owned land, its balance sheet would report the land at the amount at which it was purchased originally, not at its current market value.
e. If a company paid cash for advertising expense but forgot to record this transaction, the company’s balance sheet would not balance.
2.The following information relates to the Quinn Co. for its first year of operations. All transactions were in cash.
Acquired $20,000 from its owners.
Paid $4,000 for salaries.
Purchased land for $15,000
Earned $12,000 of revenue.
Made a $2,000 distribution to the owners.
Indicate if each of the following statements is true or false.
a.At the end of the year total assets were $11,000.
b.Net income for the year was $6,000.
c.Net cash flows from financing activities was $18,000.
d.The balance in Retained Earnings at the end of the year was $6,000.
e.The balance in the cash account at the end of the year was $11,000.
3.Indicate if each of the following statements about the statement of cash flows (SCF) is true or false.
a.When a business acquires cash from the owners, it is reported in the investing activities section of the SCF.
b.When a business buys land for cash, it is reported in the operating activities section of the SCF.
c.When a business makes a distribution to its owners, it is reported in the financing activities section of the SCF.
d.When a company repays a bank loan, it is reported in the financing activities section of the SCF.
e.When a company incurs cash expenses, it is reported in the operating activities section of the SCF.
4.Indicate if each of the following statements about the closing process is true or false.
a.The Common Stock account is closed at the end of each year.
b.Liability accounts are closed at the end of each year.
c. Revenue accounts are closed at the end of each year.
d. Expense accounts are closed at the end of each year.
e. Accounts that are closed always begin the following year with a $-0- balance.
Exercise-Type Problems
P-1.Rock Co. began its operations on January 1, 2011. During 2011 it had the following cash transactions.
a.The owners invested $10,000 in the business.
b.Provided services to customers for $6,000.
c.Borrowed $5,000 from the Local Bank.
d.Incurred $2,500 in expenses.
e.Made a $1,500 distribution to the owners.
Required:
1.Explain how each of these transactions would affect Rock's accounting equation using the form provided below. Use brackets, ( ), to indicate amounts being subtracted. The first transaction has been done as an example.
2.Prepare an income statement, statement of changes in stockholders’ equity, balance sheet, and statement of cash flows. Use the forms provided below.
Form for requirement 1
Stockholders’ Equity _
CommonRetained
EventAssets =Liabilities+ Stock +Earnings
a.10,00010,000
b.
c.
d.
e.
Totals
Forms for requirement 2
RockCompany
Income Statement
For the Year Ended December 31, 2011
Revenues$
Expenses
Net income$
RockCompany
Statement of Changes in Stockholders’ Equity
For the Year Ended December 31, 2011
Beginning Common stock$
Plus: Investments
Ending Common stock$
Beginning Retained Earnings$
Plus: Net Income
Less: Dividends
Ending Retained Earnings
Total Stockholders’ Equity$
Rock Company
Balance Sheet
As of December 31, 2011
Assets:
Cash$
Total Assets$
Liabilities:
Note payable$
Total Liabilities
Stockholders’ Equity:
Common stock$
Retained Earnings______
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity$
Rock Company
Statement of Cash Flows
For the Year Ended December 31, 2011
Cash Flows from Operating Activities:
Cash Receipts from Revenue$
Cash Payments for Expenses
Net Cash Flow from Operating Activities$
Cash Flow from Investing Activities:
Cash Flows from Financing Activities:
Cash Receipts from Owners' Investments
Cash Receipts from Borrowed Funds
Cash Payments for Dividends
Net Cash Flow from Financing Activities
Net Increase in Cash$
P-2Rock Co., which began operations in 2011 (see P-1 above), continued in business during 2012. Assume the account balances at January 1, 2012, were:
Assets$17,000Common stock$10,000
Liabilities 5,000Retained Earnings 2,000
Rock had the following cash transactions during 2012:
a.Purchased land for $8,000.
b.Provided service to customers for $10,000.
c.Owners invested $6,000 in the business.
d.Rock repaid the $5,000 borrowed from the Local Bank in 2011. (Assume no interest charges).
e.Incurred $4,500 in expenses.
f.Made a $2,000 distribution to the owners.
Required:
1.Explain how each of these transactions would affect Rock's accounting equation using the form provided on the following page. Use brackets, ( ), to indicate amounts being subtracted. The first transaction has been done as an example.
2.Prepare an income statement, statement of changes in stockholders’ equity, balance sheet, and statement of cash flows. Prepare these statements using your own paper, but use the format shown in P-1 or in the textbook as your guide.
Form for requirement 1
Stockholders’ Equity
CommonRetained
Event Assets =Liabilities+ Stock +Earnings
Beg. Bal.17,000 5,000 10,000 2,000
a. 8,000 land
(8,000)
b.
c.
d.
e.
f.
Totals
Solutions to Self-Study Problems
Articulation Problems
1. Alston Co. acquired cash from the owners to begin business operations.
Assets Liabilities Equity Revenues Expenses Net Income Cash
I / N / I / N / N / N / ICash, an asset increased, and common stock, a part of stockholders’ equity, increased.
2.Berry Co. borrowed cash from the Local Bank.
Assets Liabilities Equity Revenues Expenses Net Income Cash
I / I / N / N / N / N / ICash, an asset increased. Because the borrowed money will have to be repaid to the bank, liabilities also increased. This cash was not earned. Therefore, it is not revenue.
3.CheeksCo. provided services to its customers for cash.
Assets Liabilities Equity Revenues Expenses Net Income Cash
I / N /I
/ I / N / I / ICash, an asset increased. The company earned revenues, which caused net income to increase. An increase in net income causes retained earnings, a part of stockholders’ equity, to increase.
4. Dreyfus Co. purchased land for cash.
Assets Liabilities Equity Revenues Expenses Net Income Cash
N / N / N / N / N / N / DOne asset, cash, decreased while another asset, land, increased by the same amount. Therefore, there was no change in total assets. This expenditure was not an expense because the company received land, an asset that the company can sell if it wishes.
5.ErinCo. incurred operating expenses and paid cash.
Assets Liabilities Equity Revenues Expenses Net Income Cash
D /N
/D
/ N / I / D / DCash, an asset, decreased. Because the cash was spent in the hopes of producing revenue, this is an expense. The increase in expense caused net income to decrease, which caused retained earnings, a part of stockholders’ equity, to decrease.
6.Fung Co. made a cash distribution to its owners.
Assets Liabilities Equity Revenues Expenses Net Income Cash
D / N / D / N / N / N / DCash, an asset, decreased while retained earnings, a part of stockholders’ equity, decreased. This payment of cash was not an expense because the money was not spent in the expectation that it would produce revenues.
Multiple-Choice Problems
1.c.Revenue$ 8,000
less: Expenses 5,000
Net Income$ 3,000
2.b.Beginning balance$10,000
Transaction a 8,000
Transaction b (2,000)
Transaction c 3,000
Transaction d (5,000)
Transaction e (1,000)
Ending balance$13,000
3.b.Beginning balance$ 6,000
Transaction b (2,000)
Ending balance$ 4,000
4.d.Beginning balance$ 3,000
Transaction c 3,000
Ending balance$ 6,000
5.c.Beginning balance$ 1,000
Transaction a 8,000
Transaction d (5,000)
Transaction e (1,000)
Ending balance$ 3,000
6.c.Revenues increase, causing net income to increase, causing retained earnings to increase.
7.b.Assets$ 1,100
less: Common stock 300
Retained Earnings 200
equals: Liabilities$ 600
8.c.Revenue$20,000
less: Expenses 13,000
Net Income$ 7,000
9.a.Cash is an asset. (Liabilities also increased.)
10.d.Purchasing land is an investing activity. The purchase of land caused cash to decrease.
11.a.
12.b.
13.c.
14.d.
15.a.See articulation problem No. 2 for an explanation of the correct answer.
16.b.See articulation problem No. 3 for an explanation of the correct answer.
17.d.See articulation problem No. 5 for an explanation of the correct answer.
Multiple True-False Problems
1.a.True, Assets - Liabilities = Equity is the algebraic equivalent of Assets = Liabilities + Equity.
b.False, the statement of cash flows explains how a company got its cash. The balance sheet does show how much cash a company has at year-end, but it does not provide much information as to how the cash was obtained.
c.False, cash could decrease and another asset account, such as land, could increase and the balance sheet would still balance.
d. True, this is referred to as the historical cost principle, and is explained more formally in Chapter 2.