Chapter 1
Accounting and the Business Environment
Review Questions
1. What is accounting?
2. Briefly describe the two major fields of accounting.
3. Describe the various types of individuals who use accounting information and how they use
that information to make important decisions.
Individuals use accounting information to help them manage their money, evaluate a new
4. What are two certifications available for accountants? Briefly explain each certification.
Certified Public Accountants (CPAs) are licensed professional accountants who serve the
5. What is the role of the Financial Accounting Standards Board (FASB)?
The FASB oversees the creation and governance of accounting standards. They work with
6. Explain the purpose of Generally Accepted Accounting Principles (GAAP), including the
organization currently responsible for the creation and governance of these standards.
The guidelines for accounting information are called GAAP. It is the main U.S. accounting
7. Describe the similarities and differences among the four different types of business entities
discussed in the chapter.
A sole proprietorship has a single owner, terminates upon the owner’s death or choice, the
8. A business purchases an acre of land for $5,000. The current market value is $5,550, and the
land was assessed for property tax purposes at $5,250. What value should the land be
recorded at, and which accounting principle supports your answer?
The land should be recorded at $5,000. The cost principle states that assets should be
9. What does the going concern assumption mean for a business?
10. Which concept states that accounting information should be complete, neutral, and free from
material error?
11. Financial statements in the United States are reported in U.S. dollars. What assumption
supports this statement?
12. Explain the role of the International Accounting Standards Board (IASB) in relation to
International Financial Reporting Standards (IFRS).
The IASB is the organization that develops and creates IFRS which are a set of global
13. What is the accounting equation? Briefly explain each of the three parts.
Assets = Liabilities + Equity. Assets are economic resources that are expected to benefit the
represents the net worth of the corporation.
14. How does retained earnings increase? What are the two ways that retained earnings
decreases?
15. How is net income calculated? Define revenues and expenses.
16. What are the steps used when analyzing a business transaction?
17. List the four financial statements. Briefly describe each statement.
Income Statement – Shows the difference between an entity’s revenues and expenses and
reports the net income or net loss for a specific period.
18. What is the calculation for ROA? Explain what ROA measures.
company uses its assets.
Short Exercises
S1-1 Identifying users of accounting information
Learning Objective 1
For each user of accounting information, identify if the user would use financial accounting or
managerial accounting
a. investor e. controller
b. banker f. stockholder
c. IRS g. human resources director
d. manager of the business h. creditor
S1-2 Determining organizations that govern accounting
Learning Objective 2
Suppose you are starting a business, Wholly Shirts, to imprint logos on T-shirts. In organizing the
business and setting up its accounting records, you take your information to a CPA to prepare
financial statements for the bank. Name the organization that governs the majority of the
guidelines that the CPA will use to prepare financial statements for Wholly Shirts. What are those
guidelines called?
S1-3 Identifying types of business organizations
Learning Objective 2
Chloe Michaels plans on opening Chloe Michaels Floral Designs. She is considering the various
types of business organizations and wishes to organize her business with unlimited life and wants
owners of the business to not be held personally liable for the business’s debts. Additionally,
Chloe wants the business to be a separate taxable entity. Which type of business organization will
meet Chloe’s needs best?
S1-4 Identifying types of business organizations
Learning Objective 2
You would like to start a cellular telephone equipment service business. You are considering
organizing the business as a sole proprietorship. Identify the advantages and disadvantages of
owning a sole proprietorship.
SOLUTION
S1-5 Applying accounting assumptions and principles
Learning Objective 2
Michael McNamee is the proprietor of a property management company, Apartment Exchange,
near the campus of Pensacola State College. The business has cash of $8,000 and furniture that
cost $9,000 and has a market value of $13,000. The business debts include accounts payable of
$6,000. Michael’s personal home is valued at $400,000, and his personal bank account has a
balance of $1,200. Consider the accounting principles and assumptions discussed in the chapter,
and identify the principle or assumption that best matches the situation:
a. Michael’s personal assets are not recorded on the Apartment Exchange’s balance sheet.
b. The Apartment Exchange records furniture at its cost of $9,000, not its market value of
$13,000.
c. The Apartment Exchange reports its financial statements in U.S. dollars.
d. Michael expects the Apartment Exchange to remain in operation for the foreseeable
future.
SOLUTION
S1-6 Using the accounting equation
Learning Objective 3
Thompson Handyman Services has total assets for the year of $18,400 and total liabilities of
$9,050.
Requirements
1. Use the accounting equation to solve for equity.
2. If next year assets increased by $4,300 and equity decreased by $3,850, what would be the
amount of total liabilities for Thompson Handyman Services?
SOLUTION
Requirement 1
S1-7 Using the accounting equation
Learning Objective 3
Roland’s Overhead Doors reports the following financial information:
Assets $ 45,800
Liabilities 17,220
Common Stock 27,460
Dividends 6,500
Revenues 8,850
Expenses ?
Requirements
1. Use the accounting equation to solve for the missing information.
2. Did Roland’s Overhead Doors report net income or net loss?
SOLUTION
c. Common Stock
d. Accounts Receivable
e. Rent Expense
f. Service Revenue
g. Office Supplies
h. Dividends
i. Land
j. Salaries Expense
Identify each account as Asset, Liability, or Equity.
SOLUTION
S1-9 Using the accounting equation to analyze transactions
Learning Objective 4
Tiny Town Kennel earns service revenue by caring for the pets of customers. Tiny Town Kennel
is organized as a corporation. During the past month, Tiny Town Kennel has the following
transactions:
a. Received $520 cash for service revenue earned.
b. Paid $325 cash for salaries expense.
c. Received a $1,000 contribution in exchange for common stock.
d. Earned $640 for service revenue, but the customer has not paid Tiny Town Kennel yet.
e. Received utility bill of $85, which will be paid next month.
f. Cash dividends of $100 were paid to stockholders.
Indicate the effects of the business transactions on the accounting equation for Tiny Town
Kennel. Transaction (a) is answered as a guide.
a. Increase asset (Cash); Increase equity (Service Revenue)
SOLUTION
S1-10 Using the accounting equation to analyze transactions
Learning Objective 4
Elaine’s Inflatables earns service revenue by providing party planning services and inflatable
playscapes. Elaine’s Inflatables is organized as a corporation. During the past month, Elaine’s
Inflatables had the following transactions:
a. Received contributions of $10,000 in exchange for common stock.
b. Purchased equipment for $5,000 on account.
c. Paid $400 for office supplies.
d. Earned and received $2,500 cash for service revenue.
e. Paid $400 for wages to employees.
f. Cash dividends of $1,000 were paid to stockholders.
g. Earned $1,000 for services provided. Customer has not yet paid.
h. Paid $1,000 for rent.
i. Received a bill for $250 for the monthly utilities. The bill has not yet been paid.
Indicate the effects of the business transactions on the accounting equation for Elaine’s
Inflatables. Transaction (a) is answered as a guide.
a. Increase asset (Cash); Increase equity (Common Stock)
SOLUTION
S1-11 Identifying accounts on the financial statements
Learning Objective 5
Consider the following accounts:
a. Accounts Payable
b. Cash
c. Common Stock
d. Accounts Receivable
e. Rent Expense
f. Service Revenue
g. Office Supplies
h. Dividends
i. Land
j. Salaries Expense
Identify the financial statement (or statements) that each account would appear on. Use I for
Income Statement, RE for Statement of Retained Earnings, B for Balance Sheet, and C for
Statement of Cash Flows.
SOLUTION
Use the following information to answer Short Exercises S1-12 through S1-14.
Centerpiece Arrangements has just completed operations for the year ended December 31, 2018.
This is the third year of operations for the company. The following data have been assembled for
the business:
Insurance Expense $ 4,500 Salaries Expense $ 46,000
Service Revenue 70,000 Accounts Payable 17,600
Utilities Expense 1,400 Office Supplies 1,700
Rent Expense 16,000 Dividends 4,800
Common Stock 9,000 Accounts
Receivable
8,000
Cash 7,200 Equipment 12,100
Retained Earnings, January 1,
2018
5,100