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Chapter 01 - An Introduction to Accounting
1-1
General Comments for Chapter 1
An Introduction to Accounting
The primary objective of this chapter is to teach students how business events affect financial
statements. First, students learn the elements of financial statements: assets, liabilities, equity,
common stock, retained earnings, revenue, expenses, and distributions. Next, students learn how
the elements are interrelated, and finally, how those interrelationships are expressed in financial
statements.
There are two distinct ways to introduce financial accounting using this text. One alternative
(equation approach) is to show students how to record transaction data using the accounting
equation and then to develop financial statements from the data organized in equation form. The
second alternative (statements model approach) is first to introduce financial statements and then
show students how to record events in a financial statements model. The text material for
Chapter 1 uses the equation approach. Even so, many instructors using the text successfully
employ the second approach. Indeed, we provide detailed lesson plans for both approaches.
Detailed Outline of a Lesson Plan for Chapter 1
(Equation Approach)
I. Distribute copies of Demonstration Problem 1-1.
II. Define assets. Use the simplest definition possible, words that students can understand.
They will read the technical terminology in the text. For example:
Assets are things of value to a business. An asset’s value is its capacity to be used to
earn other assets (money). For example, a lawyer uses supplies (assets) to obtain mon-
ey (other assets) from clients.
Use the classroom to provide other specific examples. For example, the chairs, desks,
and building the students are using are assets of the university because they are used to
produce tuition dollars (other assets). Emphasize the point further by distinguishing
between personal assets and business assets. Tom (one of the authors of the textbook)
uses an old key chain his brother gave him over twenty years ago. While it has great
value to Tom, it would have little value to a business because it could not be sold or
otherwise used to produce other assets. If you saw this key chain you would truly
understand its limitations as a business asset. You may not have an old key chain, but
we’re sure you can think of something meaningful to you that has little usefulness as a
business asset. You might use a framed photograph of a family member. Select
examples that reflect your personality and interests. Students respond favorably to
personalized examples.
III. Introduce the accounting equation. You can make a smooth transition from defining
assets to introducing the accounting equation by noting that assets belong to some person
Chapter 01 - An Introduction to Accounting
1-2
or organization. The individual or institutional interests in the assets are called claims.
The accounting equation expresses the relationship between assets and claims as
follows:
Assets
=
Claims
IV. Use the demonstration problem to introduce new terms and to elaborate on the
interrelationships represented by the accounting equation. Individuals or institutions
acquire claims by providing assets to a business. There are three primary sources of
assets. The first three events of the demonstration problem illustrate the three sources.
Discuss each event separately. Define the appropriate terms, and explain how the event
affects the accounting equation.
A. Event No. 1: Use Event No. 1 to introduce and define common stock. Explain that
when a business acquires assets from owners, the assets of the business increase and
the business establishes a corresponding claims account called common stock.
Introduce the accounting equation and the term equity. Show students how to record
the event under the accounting equation. Record common stock under the term
equity. Leave room for retained earnings which will be illustrated in Event No. 3.
Note that equity represents ownership interest in the business. As you lead in to
Event No. 2, tell the students that creditors also have an interest in the assets of a
business.
B. Event No. 2: Use this event to introduce liabilities. Define liabilities as obligations
of a business. Note that Video Services Company (VSC) is obligated to return
$5,000 of assets to creditors. Therefore, the creditors have a $5,000 claim on assets.
Expand the accounting equation to include creditor interests.
C. Event No. 3: This event introduces the concept of revenue. Define revenue as an
increase in assets resulting from the operating activities of providing services or
goods to customers.
1
This definition defines revenue in terms of its relationship with
assets. It is extremely important that students understand how the elements of
financial statements articulate. You can achieve this goal by defining various
elements in terms of their relationship to other elements. Expand the accounting
equation to include retained earnings and record Event No. 3 under the equation.
Emphasize that the first three events represent the three sources of assets. Identify
these events as asset source transactions and explain the basic nature of asset source
transactions. Emphasize that thousands of different events can be classified into one of
these three types of transactions. For example, businesses may increase their assets by
providing consulting services, cleaning services, music lessons, investment advice, legal
services, medical assistance, mechanical work, painting, and so on. Although these
services represent distinctly different events, they can all be classified as asset source
transactions. Emphasize that it is easier to understand the three types of transactions
than to memorize the infinite number of specific transactions in which businesses engage.
1
Revenues can also result from activities that decrease liabilities. Revenue recognition within this context requires
an understanding of deferrals. Deferrals are introduced in Chapter 2. Within the context of cash basis accounting,
which is the underlying assumption for Chapter 1, revenue can be defined simply as an increase in assets from
providing services and expenses as decreases in assets from revenue-producing activities. These definitions will be
expanded as accrual accounting topics are gradually introduced.
Chapter 01 - An Introduction to Accounting
1-3
The next two events represent asset use transactions.
D. Event No. 4: This event introduces the concept of expenses. Define expenses as
decreases in assets that occur in the process of attempting to earn revenue.
E. Event No. 5: This event introduces dividends. Clearly distinguish dividends from
expenses. While both are asset use transactions, dividends represent a transfer of
wealth rather than a sacrifice made to obtain revenue.
V. Have students record the events for the second accounting cycle in an accounting
equation. Explain that the 2014 ending balances become the 2015 beginning balances.
Illustrate the 2015 accounting equation with beginning balances before the students
attempt to record the 2015 events. Circulate through the room while your students
attempt to record the 2015 events. Help those who are having trouble getting started.
Event No. 2 represents debt repayment. While some students will immediately recognize
this event as the reverse of a borrowing event, many will view it as an independent
transaction that is totally foreign to them. If you notice that many students are having
trouble with the event, interrupt the students to provide a brief explanation to the class as
a whole.
Invariably, you will find that some students work faster than others. Instruct the
faster students to record the 2016 events while you continue to help those who are having
trouble with 2015. Stop the class after the majority of students have recorded the 2015
transactions. Assign the 2016 events as homework for those students who are unable to
finish them in class.
VI. Time considerations. Introducing the accounting equation, including student
participation with 2015 data, requires approximately one hour.
VII. Homework assignment. Problem 1-32 is similar to the demonstration problem. At this
point, students should be able to complete part a of the requirements for this problem.
Parts b-e require preparing and analyzing financial statements, which is discussed in the
next section.
VIII. Introduce financial statements. Return to the 2014 data for Demonstration Problem 1-1
and show students how the information recorded in the accounting equation is
summarized in financial statements. Emphasize that financial statements are designed to
provide information useful in decision-making. This is a good time to say a few words
about the different types of accounting information. Explain how outsiders (e.g.,
investors and creditors) need different kinds of information than insiders (e.g., managers).
For example, a person deciding whether to invest in Target versus Wal-Mart is interested
in knowing which company generated more earnings. In contrast, a Wal-Mart vice-
president needs information about specific stores and specific items in each store.
Different branches of accounting have been established to satisfy the information needs
of different users. Emphasize that financial accounting focuses on the information needs
of investors and creditors. Make the discussion light and breezy. Students quickly get
bored with this kind of general discussion.
Present the statements in this order: (1) income statement, (2) statement of changes
in stockholders’ equity, (3) balance sheet, and (4) statement of cash flows. As you
explain, point out the importance of this sequence. You need the amount of net income
Chapter 01 - An Introduction to Accounting
Education.
1-4
to prepare the statement of changes in stockholders’ equity. You need the amount of
stockholders’ equity to prepare the balance sheet. Comments relevant to each statement
follow:
A. Income Statement. Emphasize how the elements of the income statement are related
to the elements of the balance sheet. Reiterate that revenue increases assets from
providing services and expenses decrease assets in efforts to earn revenue. Teach
students more than the formula for computing net income (Revenue - Expenses = Net
Income). Help them understand that net income represents the change in wealth
resulting from business operations during the accounting period. If you want your
students to understand interrelationships, you must emphasize those relationships in
your classroom discussions and your examinations.
B. Statement of Changes in Stockholders’ Equity. This statement provides the
opportunity to emphasize the difference between expenses and dividends. Expenses
affect the measurement of net income, after which a decision is made regarding how
much of the income to distribute versus how much to retain in the business.
Emphasize that net income is a periodic measurement, while retained earnings is a
cumulative amount.
C. Balance Sheet. Explain that the balance sheet is a summary of the accounting
equation. The statement lists assets and the corresponding claims on those assets. In
this chapter, too few assets are illustrated to introduce the idea of presenting assets in
accordance with liquidity. This subject is introduced later in the text. Explain that
the statement represents a company’s financial condition at a specific point in time.
D. Statement of Cash Flows. Introduce the categories of the statement of cash flows in
a sequence consistent with forming a business. First, a business must obtain
financing. Once a business has cash, it invests the cash. Finally, the business uses
and generates cash through its operations. Use the direct method. Prepare the
statement by analyzing the cash account. Students should learn to identify cash
transactions as operating, investing, or financing. Even so, many students find this
task to be a real challenge. While mastery requires a significant level of
reinforcement, be assured that your students will grasp this topic after working
through several of the multicycle problems. Because the first chapter covers only
cash transactions, the amount of cash flow from operating activities will equal the
amount of net income. Therefore, we do not contrast these two amounts until Chapter
2. Instead, we emphasize that the statement of cash flows is more inclusive than the
income statement. We point out that it reports investing and financing activities as
well as operating activities.
IX. Have students prepare financial statements for the 2015 transactions. Again, spend
your time walking around the room, observing, assisting, and encouraging. If you
discover a general misunderstanding, stop the class and clarify the matter. Encourage
your students with positive feedback as well as correction. If they are doing well, tell
them so. A few words of encouragement go further than a flurry of criticism.
X. Introduce the horizontal financial statements model to show your students how to
record the effects (increase, decrease, no effect) of transactions on the statements. The
effects of the 2014 transactions from Demonstration Problem 1 are recorded below as an
example.
Chapter 01 - An Introduction to Accounting
Education.
1-5
Event
Balance Sheet
Income Statement
Statement of
No.
Assets
=
Liab.
+
Equity
Rev.
−
Exp.
=
Net Inc.
Cash Flow
1
+
NA
+
NA
NA
NA
+ FA
2
+
+
NA
NA
NA
NA
+ FA
3
+
NA
+
+
NA
+
+ OA
4
−
NA
−
NA
+
−
− OA
5
−
NA
−
NA
NA
NA
− FA
XI. Filling in the gaps. You will find additional terms and concepts covered in the text but
not in the teaching notes. While we do not expect our students to read the text prior to
coming to class, we do expect them to read it after we have introduced the material. In
other words, we expect our students to read behind us. They are responsible for filling in
the gaps. There is simply not enough time to cover every single point in class. Class is a
place to get started. Try to cover the more important and conceptually complex points
there. Hold your students responsible for a reasonable level of homework.
XII. Enrichment. There is a section of materials at the end of each chapter (after exercises
and problems) entitled “Analyze, Think, Communicate.” These materials include real-
world cases, ethics cases, group exercises, internet assignments, communication exercises
and Excel problems. Use some of these materials to facilitate skill development among
your students. You will not have time to include all these materials. In Chapter 1, we
urge you to consider including ATC Case 1-1. It is important for students to see some
real-world statements early in the course. Students seem to be motivated by the fact that
what they are learning has real-world relevance. The Target Corporation’s annual report,
which is included in an Appendix in the back of the textbook, offers excellent
opportunities to introduce real-world reporting practices.
Detailed Outline of a Lesson Plan for Chapter 1
(Statements Model Approach)
I. Use the problem-based learning case, “Ask Me Anything,” to introduce financial
statements to students. (We describe problem-based learning in the introduction to this
manual.)
Instructions: The case appears below. You can cut and paste the case into a separate
Word Document or into PowerPoint. Display and/or distribute copies of the case to the
class before providing any explanation of accounting. Ask students to read the case and
individually develop answers.
Chapter 1 Problem-Based Learning Case: Accounting Questions
Ask Me Anything
Chapter 01 - An Introduction to Accounting
1-6
Assume that you are considering going in business with Linda
Wilson. Assume that I am Linda’s accountant and that you
can ask me three questions. Write down the three questions
that you would ask.
II. Create a collaborative experience where students share their questions. After
allowing students time to develop their individual responses, put them into groups to
reach consensus on their questions. For example, have students pair off with one another,
share their questions, and reach consensus on three questions that represent the combined
interest of the two people. Combine pairs of students into groups of four people and have
each group of four choose the three questions that they would ask the accountant. Allow
groups time to develop answers. Also have each group select a spokesperson.
III. Briefly introduce the basic financial statements. Explain that accountants
communicate financial information to the public through a set of reports called financial
statements. At this point introduce three of these statements: 1) the balance sheet, 2) the
income statement, and 3) the statement of cash flows. Use a business cycle approach to
introduce the statement of cash flows. Specifically, starting a business requires some
cash (financing activities); the cash is used to buy operating assets (investing activities);
and finally, the business runs on a day to day basis (operating activities).
IV. Use student input to demonstrate the usefulness of financial statement information.
Ask the group spokespersons to share the questions their group would like to have the
accountant answer. Identify information that would appear in financial statements. For
example, “How much money does Linda make?” would appear as revenue on the income
statement. Draw a skeleton of an income statement on the board and show the students
where revenue appears on that statement. You could use this question to expand the
discussion into other areas. Ask, for example, “Is the amount of Linda’s salary equal to
Chapter 01 - An Introduction to Accounting
1-7
the amount of her take-home pay?” This question creates an opportunity to demonstrate
the difference between the income statement and the statement of cash flows. A question
like “Does she pay her bills on time?” affords the opportunity to explain that some
information is not provided directly in the statements but is available through financial
statement analysis. Some questions provide the opportunity to demonstrate the
limitations of financial statement data. For example, answers to questions like “Is Linda
an honest person?” cannot be found in the financial statements. However, this question
invites you to point out the importance of ethical conduct by accountants.
We hope these examples demonstrate the need for the instructor to be flexible and
creative in handling the student input. Expect a variety of questions. Also, be prepared
to raise questions if the students do not ask about some of the things you want to discuss.
Problem-based learning is designed to provide an opportunity for student discovery, not
discovery on the part of the professor. The instructor should be prepared to address
predetermined learning objectives. In this case, one objective is to introduce financial
statements in a way that engages students. The exercise is designed to stimulate student
interest and critical thinking. The primary learning objective, however, is for students to
leave class able to name three financial statements and to describe the specific elements
that appear in each statement. The instructor should guide the discussion toward the
accomplishment of these objectives.
V. Distribute copies of Demonstration Problem 1-1. After establishing an understanding
of financial statements, you can use this problem to show students how to record business
events directly into a set of financial statements (part b of Demonstration Problem 1-1).
VI. Create a financial statements model for Demonstration Problem 1-1 (part a). Either
draw on the board or use an e-transparency to display a financial statements model for the
students. Explain to the students that the statements model is a learning tool that doesn’t
include many details (titles, dates, headings, etc.) that normally appear in formal financial
statements. In lecture mode, analyze and record the transactions. Each transaction
introduces a new financial statement element. Provide a clear explanation of each
element, including the interrelationships between elements and their statements effects.
For example, describe revenue as an economic benefit a company obtains by providing
customers with goods and services. Revenue causes an increase in equity and a
corresponding increase in assets. At this early point, you can limit the explanation of
revenue to an increase in equity with a corresponding increase in assets. How does
revenue differ from issuing stock which also results in an increase in assets? Obviously,
revenue results from work performed by the company, while a successful stock issue
results from convincing stockholders that the company can produce revenue. Point out
the revenue appears on the income statement while a stock issue does not. Similarly,
describe each element and show the students how the business events affect the financial
statements.
VII. Actively involve the students in learning. After explaining the 2014 accounting
transactions, show how this year’s ending balances become next year’s beginning balances.
Record the ending balances in a statements model that applies to the 2015 accounting cycle.
Observe that the balance sheet accounts are carried forward from year to year while the
income statement accounts are closed, resulting in zero beginning balances for all revenue
and expense accounts. This is an excellent time to mention the closing process without
getting into procedural detail. After students record the beginning balances in the statements
Chapter 01 - An Introduction to Accounting
1-8
model, require them to record the transactions for the 2015 accounting cycle in the model.
Walk around the room and provide assistance as needed. If you notice that a particular
transaction is confusing a lot of students, stop the class and provide a brief explanation to the
class as a whole. Instruct the faster students to move on to the 2016 accounting cycle. Have
those students who do not finish the third cycle in class complete part a of the problem as a
homework assignment.
VIII. Introduce the accounting equation. You can now define assets by noting that they belong
to some person or organization. The individual or institutional interests in those assets are
called claims. Explain that the accounting equation can be represented, Assets = Claims, and
that it is the logic underlying the balance sheet.
IX. Assign homework. Problem 1-34 will give students practice in recording transactions in
horizontal financial statements models and is an excellent review of Demonstration Problem
1-1.
X. Filling in the gaps. You will find additional terms and concepts covered in the text but not
in the teaching notes. While we do not expect our students to read the text prior to coming to
class, we do expect them to read it after we have introduced the material. In other words, we
expect our students to read behind us. They are responsible for filling in the gaps. There is
simply not enough time to cover every single point in class. Class is a place to get started.
Try to cover the more important and conceptually complex points there. Hold your students
responsible for a reasonable level of homework.
XI. Enrichment. There is a section of materials at the end of each chapter (after exercises and
problems) entitled “Analyze, Think, Communicate.” These materials include real-world
cases, ethics cases, group exercises, internet assignments, communication exercises and
Excel problems. Use some of these materials to facilitate skill development among your
students. You will not have time to include all these materials. In Chapter 1, we urge you to
consider including ATC Case 1-1. It is important for students to see some real-world
statements early in the course. Students seem to be motivated by the fact that what they are
learning has real-world relevance. The Target Corporation’s annual report, which is included
in an Appendix in the back of the textbook, offers excellent opportunities to introduce real-
world reporting practices.
Demonstration Problem for Chapter 1
Chapter 01 - An Introduction to Accounting
1-9
Demonstration Problem 1-1: The Accounting Cycle
The events below apply to the Video Services Company (VSC). Assume that all transactions
involve receiving or paying cash.
Transactions for the year 2014:
1. The company was started when it acquired $9,000 cash by issuing common stock.
2. The company borrowed $5,000 from creditors.
3. The company provided services to customers and received $4,000.
4. The company paid expenses of $2,900.
5. The company paid $500 in dividends to its stockholders.
Transactions for the year 2015:
1. The company issued additional common stock for $4,500.
2. The company paid $2,000 to reduce its liabilities to creditors.
3. The company provided services to customers and received $6,700.
4. The company paid expenses of $4,300.
5. The company paid $700 in dividends to its stockholders.
Transactions for the year 2016:
1. The company issued additional common stock for $2,500.
2. The company borrowed $1,000 from creditors.
3. The company provided services to customers and received $7,400.
4. The company paid expenses of $7,900.
5. The company paid $300 in dividends to its stockholders.
6. The company paid $9,000 to purchase land.
Required: For each year,
a. Record the events under an accounting equation.
b. Prepare an income statement, statement of changes in stockholders’ equity, balance sheet and
statement of cash flows.
SOLUTIONS TO
DEMONSTRATION PROBLEM
Chapter 01 - An Introduction to Accounting
1-10
The solutions for the equation approach are shown first, followed by
the solutions for the statements model approach.
We HIGHLY recommend that you try to display the solutions to the
class using the e-transparency option described in the introduction to
