Chapter 1
Introducing 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,
4. Business owners and managers use accounting information to help answer
5. Service businesses include: Standard and Poor’s, Dun & Bradstreet, Merrill Lynch,
6. The internal role of accounting is to serve the organization’s internal operating
7. Accounting professionals offer many services including auditing, management
8. Marketing managers are likely interested in information such as sales volume,
Financial & Managerial Accounting, 5th Edition
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9. Accounting is described as a service activity because it serves decision makers by
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
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
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
*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
18. Equity is increased by investments from the stockholder(s) and by net income
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.
21. Net income (also called income, profit or earnings) equals revenues minus expenses
22. The four basic financial statements are: income statement, statement of retained
23. An income statement reports a company’s revenues and expenses along with the
24. Rent expense, utilities expense, administrative expenses, advertising and promotion
25. The statement of retained earnings explains the changes in retained earnings from
26. The balance sheet describes a company’s financial position (types and amounts of
27. The statement of cash flows reports on the cash inflows and outflows from a
28. Return on assets, also called return on investment, is a profitability measure that is
29A. Return refers to income, and risk is the uncertainty about the return we expect to
30B. Organizations carry out three major activities: financing, investing, and operating.
Financing provides the means used to pay for resources. Investing refers to the
Financial & Managerial Accounting, 5th Edition
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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’s 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
QUICK STUDIES
Quick Study 1-1
(a) and (b)
GAAP: Generally Accepted Accounting Principles
SEC delegates part of this responsibility to the FASB.
FASB: Financial Accounting Standards Board
Importance: FASB is an independent group of full-time members who are
responsible for setting accounting rules.
IASB: International Accounting Standards Board.
Importance: A global set of accounting standards issued by the IASB.
Many countries require or permit companies to comply with
IFRS in preparing their financial statements. The FASB is
undergoing a process with the IASB to converge GAAP and
IFRS and to create a single set of accounting standards for
global use.
Quick Study 1-2
a.
E
E
b.
E
E
c.
E
I
d.
E
E
e.
I
E
f.
E
I
Financial & Managerial Accounting, 5th Edition
6
Quick Study 1-3
Internal controls serve several purposes:
• They involve monitoring an organization’s activities to promote
cameras, security guards, and many others.
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
these individuals.
Quick Study 1-6
Quick Study 1-7
Assets = Liabilities + Equity
Quick Study 1-8
Assets = Liabilities + Equity
Financial & Managerial Accounting, 5th Edition
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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’s 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 retained earnings (E), or
Statement of cash flows (CF).]
*The more advanced student might know that this item would also appear on the CF, which is an acceptable
answer.
Quick Study 1-12
Quick Study 1-13 (10 minutes)
a. International Financial Reporting Standards (IFRS)
Financial & Managerial Accounting, 5th Edition
10
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)
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
c. Accounting professionals who prepare tax returns can face situations
d. Auditing professionals with competing audit clients are likely to learn
Financial & Managerial Accounting, 5th Edition
12
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.
4.
2.
5.
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
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(?)
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
Assets
=
Liabilities
+
Equity
$190,000 – $60,000
=
$70,000
+
?
$130,000
=
$70,000
+
?
Financial & Managerial Accounting, 5th Edition
14
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 dividends (or some other asset) paid to the stockholder(s) of the
business; OR, the business incurs an expense paid in cash.
f. Business incurs an expense that is not yet paid (for example, when
employees earn wages that are not yet paid).
Exercise 1-11 (30 minutes)
Assets
=
Liabilities
+
Equity
Cash
+
Accounts
Receivable
+
Equip-
ment
=
Accounts
Payable
+
Common
Stock
–
Dividends
+
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 in exchange for common stock.