Chapter 1
Accounting in Business
QUESTIONS
1. The purpose of accounting is to provide decision makers with relevant and reliable
2. Technology reduces the time, effort, and cost of recordkeeping. There is still a
demand for people who can design accounting systems, supervise their operation,
3. External users and their uses of accounting information include: (a) lenders, to
measure the risk and return of loans; (b) shareholders, to assess whether to buy,
sell, or hold their shares; (c) directors, to oversee their interests in the organization;
4. Business owners and managers use accounting information to help answer
questions such as: What resources does an organization own? What debts are
5. Service businesses include: Standard and Poor’s, Dun & Bradstreet, Merrill Lynch,
Southwest Airlines, CitiCorp, Humana, Charles Schwab, and Prudential. Businesses
6. The internal role of accounting is to serve the organization’s internal operating
7. Accounting professionals offer many services including auditing, management
advice, tax planning, business valuation, and money management.
8. Marketing managers are likely interested in information such as sales volume,
9. Accounting is described as a service activity because it serves decision makers by
providing information to help them make better business decisions.
10. Some accounting-related professions include consultant, financial analyst,
11. Ethics rules require that auditors avoid auditing clients in which they have a direct
12. In addition to preparing tax returns, tax accountants help companies and individuals
plan future transactions to minimize the amount of tax to be paid. They are also
13. The objectivity concept means that financial statement information is supported by
14. This treatment is justified by both the cost principle and the going-concern
assumption.
15. The revenue recognition principle provides guidance for managers and auditors so
they know when to recognize revenue. If revenue is recognized too early, the
16. Business organizations can be organized in one of three basic forms: sole
proprietorship, partnership, or corporation. These forms have implications for legal
liability, taxation, continuity, number of owners, and legal status as follows:
Proprietorship Partnership Corporation
Business entity yes yes yes
Legal entity no no yes
*Proprietorships and partnerships that are set up as LLCs provide limited liability.
17. (a) Assets are resources owned or controlled by a company that are expected to
yield future benefits. (b) Liabilities are creditors’ claims on assets that reflect
18. Equity is increased by investments from the owner and by net income (which is the
excess of revenues over expenses). It is decreased by withdrawals by the owner
19. Accounting principles consist of (a) general and (b) specific principles. General
principles are the basic assumptions, concepts, and guidelines for preparing
20. Revenue (or sales) is the amount received from selling products and services.
24. Rent expense, utilities expense, administrative expenses, advertising and promotion
expenses, maintenance expense, and salaries and wages expenses are some
examples of business expenses.
28. Return on assets, also called return on investment, is a profitability measure that is
useful in evaluating management, analyzing and forecasting profits, and planning
29A. Return refers to income, and risk is the uncertainty about the return we expect to
make. The lower the risk of an investment, the lower the expected return. For
30B. Organizations carry out three major activities: financing, investing, and operating.
Financing provides the means used to pay for resources. Investing refers to the
31B. An organization’s financing activities (liabilities and equity) pay for investing
activities (assets). An organization cannot have more or less assets than its
32. The dollar amounts in Polaris’ financial statements are rounded to the nearest
33. At March 31, 2011, Arctic Cat had ($ in thousands) assets of $272,906, liabilities of
34. Confirmation of KTM’s accounting equation follows (numbers in EUR thousands):
Assets
=
Liabilities
+
Equity
485,775
=
266,000
+
219,775
35. The independent auditor for Polaris, is Ernst & Young, LLP. The auditor expressly
states that “our responsibility is to express an opinion on these consolidated
QUICK STUDIES
Quick Study 1-1
(a) and (b)
GAAP: Generally Accepted Accounting Principles
Importance: GAAP are the rules that specify acceptable accounting
practices.
SEC: Securities and Exchange Commission
Importance: The SEC is charged by Congress to set reporting rules for
organizations that sell ownership shares to the public. The
SEC delegates part of this responsibility to the FASB.
Quick Study 1-2
a.
E
g.
b.
E
h.
c.
E
i.
d.
E
j.
e.
I
k.
f.
E
l.
Quick Study 1-3
Internal controls serve several purposes:
• They involve monitoring an organization’s activities to promote
efficiency and to prevent wrongful use of its resources.
Quick Study 1-4
Accounting professionals practice in at least four main areas. These four
areas, along with a listing of some work opportunities in each, are:
1. Financial accounting
• Preparation
2. Managerial accounting
• Cost accounting
3. Tax accounting
• Preparation
4. Accounting-related
• Lending
Quick Study 1-5
The choice of an accounting method when more than one alternative
method is acceptable often has ethical implications. This is because
accounting information can have major impacts on individuals’ (and firms’)
well-being.
Quick Study 1-6
Quick Study 1-7
Assets = Liabilities + Equity
Quick Study 1-8
Assets = Liabilities + Equity
$75,000 (a) $35,000 $40,000
Quick Study 1-9
(a) Examples of business transactions that are measurable include:
• Selling products and services.
(b) Examples of business events that are measurable include:
• Decreases in the value of securities (assets).
Quick Study 1-10
a. For December 31, 2011, the account and its dollar amount (in
thousands) for Polaris are:
(1)
Assets
=
$1,228,024
(2)
Liabilities
=
$ 727,968
(3)
Equity
=
$ 500,056
b. Using Polaris’ amounts from (a) we verify that (in millions):
Assets
=
Liabilities
+
Equity
$1,228,024
=
$ 727,968
+
$ 500,056
Quick Study 1-11
[Code: Income statement (I), Balance sheet (B), Statement of owner’s equity (E), or
Statement of cash flows (CF).]
Quick Study 1-12
Return on assets = = = 8.2%
Quick Study 1-13 (10 minutes)
a. International Financial Reporting Standards (IFRS)
$3,338
$40,501
Net income
Average total assets
EXERCISES
Exercise 1-1 (10 minutes)
1.
A
5.
C
2.
B
6.
C
3.
A
7.
B
4.
A
8.
B
Exercise 1-2 (10 minutes)
C 1. Analyzing and interpreting reports
Exercise 1-3 (20 minutes)
Part A.
1.
I
5.
I
2.
I
6.
E
3.
E
7.
I
4.
E
8.
I
Part B.
1.
I
5.
I
2.
E
6.
E
3.
I
7.
I
4.
E
Exercise 1-4 (20 minutes)
a. Situations involving ethical decision making in coursework include
performing independent work on examinations and individually
b. Managers face several situations demanding ethical decision making
in their dealings with employees. Examples include fairness in
c. Accounting professionals who prepare tax returns can face situations
where clients wish to claim deductions they cannot substantiate. Also,
d. Auditing professionals with competing audit clients are likely to learn
Exercise 1-5 (10 minutes)
Code
Description
Principle/Assumption
E
1.
Usually created by a pronouncement from an
authoritative body.
Specific accounting
principle
G
2.
Financial statements reflect the assumption that
the business continues operating.
Going-concern
assumption
A
3.
Derived from long-used and generally accepted
accounting practices.
General accounting
principle
C
4.
Every business is accounted for separately from
its owner or owners.
Business entity
assumption
D
5.
Revenue is recorded only when the earnings
process is complete.
Revenue recognition
principle
B
6.
Information is based on actual costs incurred in
transactions.
Cost principle
F
7.
A company records the expenses incurred to
generate the revenues reported.
Matching (expense
recognition) principle
H.
8.
A company reports details behind financial
statements that would impact users’ decisions.
Full disclosure
principle
Exercise 1-6 (10 minutes)
1.
C
4.
A
2.
F
5.
G
3.
D
Exercise 1-7 (10 minutes)
a.
Corporation
e.
Sole proprietorship
b.
Sole proprietorship
f.
Sole proprietorship
c.
Corporation
g.
Corporation
d.
Partnership
Exercise 1-8 (20 minutes)
a. Using the accounting equation:
Assets
=
Liabilities
+
Equity
$123,000
=
$47,000
+
?
b. Using the accounting equation at the beginning of the year:
Assets
=
Liabilities
+
Equity
$300,000
=
?
+
$100,000
Thus, beginning liabilities = $200,000
Using the accounting equation at the end of the year:
Assets
=
Liabilities
+
Equity
$300,000 + $80,000
=
$200,000+ $50,000
+
?
$380,000
=
$250,000
+
?
Alternative approach to solving part (b):
Assets($80,000) = Liabilities($50,000) + Equity(?)
where “” refers to “change in.”
Thus: Ending Equity = $100,000 + $30,000 = $130,000
c. Using the accounting equation at the end of the year:
Assets
=
Liabilities
+
Equity
$190,000
=
$70,000 – $5,000
+
?
$190,000
=
$65,000
+
$125,000
Using the accounting equation at the beginning of the year:
Assets
=
Liabilities
+
Equity
$190,000 – $60,000
=
$70,000
+
?
$130,000
=
$70,000
+
?
Exercise 1-9 (10 minutes)
Assets
=
Liabilities
+
Equity
(a) $ 65,000
=
$ 20,000
+
$45,000
$100,000
=
$ 34,000
+
(b) $66,000
$154,000
=
(c) $114,000
+
$40,000
Exercise 1-10 (15 minutes)
Examples of transactions that fit each case include:
a. Cash withdrawals (or some other asset) paid to the owner of the
business; OR, the business incurs an expense paid in cash.
employees earn wages that are not yet paid).
g. Owner invests cash (or some other asset) in the business; OR, the
business earns revenue and accepts cash (or another asset).
Exercise 1-11 (30 minutes)
Assets
=
Liabilities
+
Equity
Cash
+
Accounts
Receivable
+
Equip-
ment
=
Accounts
Payable
+
Holden,
Capital
–
Holden,
With-
drawals
+
Revenues
–
Expenses
a.
+$60,000
+
$15,000
=
+
$75,000
b.
– 1,500
______
______
–
$1,500
Bal.
58,500
+
+
15,000
=
+
75,000
–
1,500
c.
_______
+
10,000
+$10,000
______
_____
Bal.
58,500
+
+
25,000
=
10,000
+
75,000
–
1,500
d.
+ 2,500
______
_______
______
+
$2,500
_____
Bal.
61,000
+
+
25,000
=
10,000
+
75,000
+
2,500
–
1,500
e.
_______
+
$8,000
______
_______
______
+
8,000
_____
Bal.
61,000
+
8,000
+
25,000
=
10,000
+
75,000
+
10,500
–
1,500
f.
– 6,000
______
+
6,000
_______
______
_____
_____
Bal.
55,000
+
8,000
+
31,000
=
10,000
+
75,000
+
10,500
–
1,500
g.
– 3,000
______
______
_______
______
_____
–
3,000
Bal.
52,000
+
8,000
+
31,000
=
10,000
+
75,000
+
10,500
–
4,500
h.
+ 5,000
–
5,000
______
_______
______
_____
_____
Bal.
57,000
+
3,000
+
31,000
=
10,000
+
75,000
+
10,500
–
4,500
i.
– 10,000
______
______
– 10,000
______
_____
_____
Bal.
47,000
+
3,000
+
31,000
=
0
+
75,000
+
10,500
–
4,500
j.
– 1,000
______
______
_______
______
–
$1,000
_____
_____
Bal.
$46,000
+
$3,000
+
$31,000
=
$ 0
+
$75,000
–
$1,000
+
$10,500
–
$4,500
Exercise 1-12 (20 minutes)
a. Started the business with the owner investing $40,000 cash in the
business.