1
chapter
1
Introduction to
Accounting and Business
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OPENING COMMENTS
For many students, Chapter 1 of Accounting is their first taste of the business or accounting disciplines.
The teaching challenge is to get students to understand and accept the importance of learning business and
accounting concepts. This will make the course more than just another requirement that students must
complete to graduate. Because this chapter will set the tone for the entire course and their business
careers, avoid the temptation to rush through the material.
Chapter 1 begins with a discussion of the nature of a business and the different types of businesses
(service, merchandising, and manufacturing) and types of business organizations (proprietorship,
partnership, corporation, and limited liability corporations). Next, the chapter describes different types of
business stakeholders, introduces business ethics, and discusses three factors of individual character, firm
culture, and laws and enforcement that affect ethics as well as the accounting/business frauds of the
After studying the chapter, your students should be able to:
1. Describe the nature of a business, the role of accounting, and ethics in business.
2. Summarize the development of accounting principles and relate them to practice.
4. Describe and illustrate how business transactions can be recorded in terms of the resulting change in
the elements of the accounting equation.
6. Describe and illustrate the use of the ratio of liabilities to owner’s equity in evaluating a company’s
financial condition.
STUDENT FAQS
• Why do I have to take this course since my major is not “Accounting”?
• Why is “Accounting” so important?
• Why is the accounting equation set the way it is? Why could it not be “Owner’s Equity – Assets =
Liabilities” or “Liabilities – Assets = Owner’s Equity”?
• Why are Net Income and Cash not the same?
• Why do people call revenue by so many names?
• Why do the financial statements have to go in a certain order?
• Why is Cash the first asset listed?
• What is the difference between revenues and assets?
• What is the difference between expenses and liabilities?
• Why does the balance sheet report the accounts at a point in time while the income statement and
statement of owner’s equity report the activity for a period of time? Shouldn’t they all report for a
period of time?
• Why use a ratio to judge a company’s ability to pay its obligations rather than dollar amounts?
Chapter 1 Introduction to Accounting and Business 3
OBJECTIVE 1
Describe the nature of a business, the role of accounting, and ethics in business.
KEY TERMS
Accounting Merchandising Businesses
Business Private Accounting
Certified Public Accountant (CPA) Profit
Ethics Public Accounting
SUGGESTED APPROACH
The first class of your semester/quarter often sets the tone for the rest of the term. Many instructors
believe it is easier to spark classroom discussion if you can get each student to speak on the first day of
class and to write something about themselves. Objective 1 provides a good opportunity to encourage
early class participation. Your students will be familiar with most of the terms introduced in this learning
objective. Use the first writing exercise and classroom discussion suggestions to get students talking
about business and accounting.
The text defines accounting as “an information system that provides reports to users about the economic
activities and condition of a business.” Accounting is also known as the “language of business.” The
goal of Objective 1 is also to make this definition meaningful and to make students aware of the uses of
accounting data.
To spark discussion, you may want to ask students what they think of when they hear the term
“accounting.” You could also ask what accounting information they or their families need in managing
4 Chapter 1 Introduction to Accounting and Business
It may be important to point out the reason these ethical codes are necessary. Accountants are privy to a
variety of private and often sensitive information about businesses. Without these ethical codes, the
accountant can be in a position to impact the businesses future in a significant way, either positively or
negatively. This trusted relationship between business and accountant requires that the accountant live by
these codes of conduct.
The Institute of Management Accountants and the American Institute of Certified Public Accountants
codes of ethics are excellent items to review and are shown in Transparency Masters (TM) 1-1 and 1-2
respectively. It is important to illustrate how these codes can be used to help accountants make difficult
decisions. Four cases, which should stimulate a class discussion on ethics, are described in the Class
Discussion section below.
You may want to refer to your college or university “Student Code of Conduct” as an example of ethical
codes for students. You may want to hand out to each student your school’s “Student Code of Conduct”
and discuss it or have whoever is in charge of your “Student Code of Conduct” policy, such as Dean of
Students, discuss issues relating to classroom learning, testing, and cheating. To spark discussion, ask
your students to develop a “Student Code of Conduct” for your course. Controversial issues you could ask
them to consider are whether or not their code of conduct should include a policy on attending classes,
tardiness, cell phone ring/usage, what is considered cheating (electronically as well as manually), or the
proper use of the solutions to test questions, exercises, and problems transferred electronically. Most
colleges are constantly working on updating student code rules relating to technology.
This learning objective also provides the opportunity to stress that accountants do more than just prepare
tax forms!
You may want to describe the differences between public and private accounting and then discuss the
specialized fields in accounting. Specialized fields are shown in TMs 1-7 through 1-9.
WRITING EXERCISE—The Definition of Business
Everyone has heard the term “business.” Ask your students to write short sentences/phrases that describe
a business they have recently used. After giving them a couple of minutes, ask your students to share their
ideas as you make a list of their key phrases. Next, ask your students to use these ideas to write a
Chapter 1 Introduction to Accounting and Business 5
definition of “business.” You may want to compare their definitions to the one provided in the text, which
defines a business as “an organization in which basic resources (inputs), such as materials and labor, are
assembled and processed to provide goods or services (outputs) to customers.”
CLASS DISCUSSION—Types of Businesses
Have the class provide the names of businesses they have used in the past week. Include places they have
shopped, eating establishments, products they use every day, and services they have used. When listing
products, name the manufacturer; for iPod, for example, the manufacturer would be Apple. List these on
the board or overhead.
Show a list of the three types of businesses (these are shown in TM 1-20):
Service Businesses
CLASS DISCUSSION—Ethics in Accounting
Read one or more of the following cases to the class and discuss whether or not the accountant acted
ethically. You can stimulate discussion by playing “devil’s advocate”—arguing an opposing view to
whatever opinion is first offered. (You may want to use TMs 1-3 through 1-6 in presenting these cases.)
1. Lauren Smith is the controller for Sports Central, a chain of sporting goods stores. She has been
asked to recommend a site for a new store. Lauren has an uncle who owns a shopping plaza in the
area of town where the new store is to be located, so she decides to contact her uncle about leasing
space in his plaza. Lauren also contacted several other shopping plazas and malls, but her uncle’s
store turned out to be the most economical place to lease. Therefore, Lauren recommended locating
the new store in her uncle’s shopping plaza. In making her recommendation to management, she did
not disclose that her uncle owns the shopping plaza.
DISCUSSION NOTES: Lauren has a conflict of interest in recommending her uncle’s shopping
plaza as a site for the new store. After reviewing the data, management at Sports Central may agree
2. John Jones is the chief accountant for the Southwest district office of Security Life Insurance
Company. While preparing the fourth-quarter sales report, John overheard the company president say
that he would close Security’s Phoenix office if it did not meet its fourth-quarter sales quota. John’s
best friend from college works at the Phoenix office.
6 Chapter 1 Introduction to Accounting and Business
Anxious to find out whether the office was in jeopardy, John immediately finished the Phoenix
office’s report, only to find that it showed sales 25 percent below the quota. Later that afternoon, the
company president called John for Phoenix’s sales results. John told the president that he had not
finished preparing the sales report for the Phoenix office. John wanted time to compile data that
might convince the president to continue operations in Phoenix, despite lagging sales.
DISCUSSION NOTES: Management accountants must communicate all information, both good
3. Tech-Smart Computer Company recently discovered a defect in the hard disks installed in its model
R24 computer. The hard disk head in these units retracts too violently whenever the computers are
turned off. As a result, the hard disks are destroyed after the computer is turned on and off
approximately 500 times. Tech-Smart has sold 4,000 model R24 computers nationwide.
The marketing department at Tech-Smart contacted most of the 4,000 owners of the model R24
computer and discovered that 20 percent (or 800) use their computers in businesses that operate 24
hours per day. These customers never turn their computers off; therefore, the defect should not
damage their hard disk units.
Judy Govan, Tech-Smart’s controller, has been asked to determine the cost to correct the hard disk
problem and recommend a course of action. After studying the marketing department’s report, Judy
decides to recommend that Tech-Smart replace the hard drives only in the 3,200 units used by
customers who actually turn their computers off.
DISCUSSION NOTES: In the real world, accountants must be good stewards of company funds.
For example, although it may be socially responsible to donate a portion of the company’s profits to a
4. Tom Brown, the controller for MicroTech Software Company, is responsible for preparing the
company’s financial statements. He learns that sales for the first quarter of the year have dropped so
dramatically that the company is in danger of bankruptcy. As a result, he applies for an accounting
position with another software company that competes with MicroTech. During his job interview,
Tom is asked why he wants to leave MicroTech. He replies truthfully, “The company sales are down
another 10 percent this quarter. I fear they will go out of business.” At that time, MicroTech had not
released its sales results to the public.
DISCUSSION NOTES: Tom may not disclose any confidential information. He is expressly
forbidden from providing nonpublic sales information to anyone. Accountants are privy to a variety
Chapter 1 Introduction to Accounting and Business 7
LECTURE AID—Accounting as an Information System
The goal of accounting can be illustrated using the following equation:
Goal of Accounting = Record + Report + Interpret Economic Data for use by decision makers
Ask your students to name those who would be interested in the economic results of a business. List their
responses on the board. When complete, the list should contain many of the following:
1. Owner
3. Bankers
4. Governmental Agencies (e.g., IRS)
5. Managers
7. Customers
8. Competitors
After compiling this list, you may want to ask students to state what economic data each of those listed
previously would be interested in seeing and why. Examples follow:
Interested In
Reason
1. Owner . . . . . . . . . . . . . .
Sales
Is advertising effective?
Profit
Can I take home more money each week?
Cash
Can I afford to buy more equipment?
2. Investors/Stockholders. .
Profit
Is my investment making money?
Dividends
What dividends are being paid?
3. Bankers . . . . . . . . . . . . .
Debts
Can this business repay a loan?
4. IRS . . . . . . . . . . . . . . . .
Profit
What taxes does this business owe?
5. Managers . . . . . . . . . . . .
Expenses
Am I keeping expenses within my budget?
Sales
Will I be eligible for a bonus this year?
6. Employees . . . . . . . . . . .
Profit
Can my company afford raises?
Is my job secure?
7. Customers . . . . . . . . . . .
Amount spent
on warranty
How dependable is this product?
How responsive is the service department?
You may want to emphasize that different accounting data are needed by different people and
organizations. For example, a banker evaluating an application for a short-term loan and a public utility
commission considering a rate increase would not consider the same types of accounting information.
8 Chapter 1 Introduction to Accounting and Business
GROUP LEARNING ACTIVITY — Accounting as an Information System
The ethics cases provided on TM 1-3 through 1-6 can be assigned to groups to discuss and present a brief
explanation to the class as to their opinions and recommendations.
INTERNET ACTIVITY
Ask your students to research some nontraditional accounting careers. Two government organizations
who hire accountants to help with investigations of fraud and criminal activities are the FBI and the IRS.
Web sites for these organizations are:
OBJECTIVE 2
Summarize the development of accounting principles and relate them to practice.
KEY TERMS
Business Entity Concept Limited Liability Company (LLC)
Corporation Objectivity Concept
SUGGESTED APPROACH
This objective introduces students to the Financial Accounting Standards Board (the FASB) and
Generally Accepted Accounting Principles (GAAP). It is important to stress that the FASB sets the
standards that govern the rules of financial accounting. These rules are defined in the GAAP. The
International Accounting Standards Board (IASB) is the international equivalent of the FASB.
Additionally this objective introduces the business entity concept, the cost concept, the objectivity
concept, and the unit of measure concept–––four principles that govern how accounting data are
accumulated. Remind students that accounting data would be inconsistent from company to company if
standardized procedures were not followed.
Chapter 1 Introduction to Accounting and Business 9
The following example may help in illustrating the business entity concept: If an individual owned a dry
cleaner, a video store, and a gas station, how would the owner know the profitability of each? Answer: by
keeping separate accounting records.
WRITING EXERCISES — Business Entity and Cost Concept
Ask students to write an answer to the following questions. These exercises are shown in TM 1-10.
1. Sally Vertrees purchased a personal computer for use at home. Sally owns a dental practice. She
occasionally uses the computer for a task related to her dental practice; however, the computer is used
primarily by Sally’s children. Can the computer be recorded as an asset in the accounting records of
Sally’s dental office? Why or why not?
2. Jason Thompson purchased an office building 10 years ago for $780,000. The building was just
appraised at $1.25 million. What value should be used for the building in Jason’s accounting records?
Support your answer.
Possible explanation: This is a clear example of the cost concept. Assets are recorded at cost and
CLASS DISCUSSION—Types of Business Organizations
Ask for students to name examples of each type of business. Next, list the four types of business
organizations (these are shown in TM 1-21):
Proprietorship
Partnership
Corporation
Limited Liability Corporation
10 Chapter 1 Introduction to Accounting and Business
Again, ask students to name examples of businesses in each category. Explain that in the early chapters of
the text, they will be learning about accounting concepts related to service businesses organized as
proprietorships.
You may also want to emphasize the following key facts about business organizations:
2. About 10 percent of businesses are organized as partnerships and/or limited liability companies.
OBJECTIVE 3
State the accounting equation and define each element of the equation.
KEY TERMS
Accounting Equation Liabilities
Assets Owner’s Equity
SUGGESTED APPROACH
This objective asks the student to state the accounting equation: Assets = Liabilities + Owner’s Equity.
TM 1-11, which presents an alternative way to describe this accounting equation, is an effective lecture
aid.
This objective also asks the student to define each element of the equation. Most students easily grasp the
meaning of the terms “assets” (resources owned by a business) and “liabilities” (debts). “Owner’s equity,”
however, is not a simple concept.
Chapter 1 Introduction to Accounting and Business 11
OBJECTIVE 4
Describe and illustrate how business transactions can be recorded in terms of the resulting
changes in the basic elements of the accounting equation.
KEY TERMS
Account Payable Interest Revenue
Account Receivable Prepaid Expenses
Business Transaction Rent Revenue
Expenses Revenue
Fees Earned Sales
SUGGESTED APPROACH
This objective illustrates recording business transactions within the framework of the accounting
equation. The text defines a business transaction as “an economic event or condition that directly changes
the entity’s financial condition or its results of operations.” Problem 1-1A or Problem 1-1B, as well as
TM 1–12, describe some of the economic events that are recorded as business transactions. This list can
assist your students in determining which events/conditions to record. For practice, ask students to list
transactions that they recently entered into with a business entity, such as purchasing gas for the car,
getting their hair cut, or purchasing their textbook from the bookstore.
Owner’s
Accounts Accounts Name,
Cash Receivable Supplies Payable Capital + Others (see problem)
You will probably need to emphasize the following points as you demonstrate transactions:
1. The accounting equation must always stay in balance. Transactions may require additions to both
3. Revenues are recognized when services are rendered, not when the cash is received.