CHAPTER 1
Accounting and Organizations
THINKING BEYOND THE QUESTION
What do we need to know to start a business?
Service businesses and most nonprofit organizations provide services ra-
QUESTIONS
Q1-1 The purpose of accounting is to help people make decisions about eco-
nomic activities. This is accomplished by providing information to deci-
Q1-2 Accounting provides information about results that owners and other de-
cision makers should expect will occur. By understanding past activities,
Q1-3 The purpose of merchandising companies is to sell goods, that are pro-
duced by others, to customers. Customers might include either individu-
als or other businesses. The purpose of merchandising firms is only to
Q1-4 a. Merchandising organizations sell goods to customers for a profit.
The goods are obtained from other organizations. Examples include
most retail stores: grocery, hardware, department, etc.
b. Manufacturing organizations sell goods they produce to customers
for a profit. Examples include many major corporations that manu-
Q1-5 Transformation involves converting resources from one form to another.
Q1-6 An accounting system should create value. If it does not create value, it is
a waste of resources. Value is created when resources in existing form
are transformed to another more valuable form. An accounting system
Q1-7 A return on investment is a return of profits over and above the amount
Q1-8 First, the underlying interest of investors is the return on investment.
They seek to invest in businesses that have the ability to earn and dis-
Q1-9 A contract is an agreement among parties wishing to exchange re-
sources. It is the vehicle by which the expectations and responsibilities of
each party are established. Subsequently, it is the vehicle to which all
Q1–10 Risk is the uncertainty about whether a particular outcome will occur. It
could be said that risk is the chance that a desired outcome will not oc-
Q1–11 The major purpose of business is to transform resources. Accordingly,
resources of different types are exchanged among a business and its
suppliers, investors, creditors, and employees. Contracts establish the
Q1–12 It is not possible to avoid risk. It is present in any investment. Risk is not
necessarily bad because greater returns are possible when greater risk is
taken. Some investment opportunities are safer than others (e.g., an in-
Q1–13 The risk-return tradeoff is readily observable regarding investments that
students are aware of. For example, they may know that the return on an
FDIC-insured savings account is less than that available from money–
Q1–14 Owners invest in (risky) businesses rather than U.S. Savings Bonds be-
cause they seek a greater return on investment than is available from
Q1–15 Risk is uncertainty. Moral hazard arises when setting executive compen-
sation because owners must rely on accounting information that is con-
trolled by management to make those decisions. Management may be
Q1–16 First, an audit is a detailed examination of the firm’s financial reports.
Second, the audit is conducted by highly trained personnel supervised by
Q1–17 Actually, there are probably many cases where the classmate’s point is
well taken. In most cases, GAAP is designed to reveal and report im-
EXERCISES
E1-1 Definitions of all terms are listed in the glossary.
E1-2 DATE: (today’s date)
TO: Edwina Polinder
FROM: (student’s name)
SUBJECT: Inquiry about accounting
The purpose of accounting is to help people make decisions about eco-
E1-3 If Wilma and other stockholders are concerned about the future opera-
tions of Essex International, they may sell their stock or may be unwilling
to buy additional shares at current prices. Creditors may be unwilling to
provide additional loans or may charge higher interest rates for loans
E1-5 Resources created from selling sundials $1,050
Resources consumed:
E1-6 Resources created from sale of lamps (40,000 × $70) $2,800,000
Resources consumed:
E1-7 Amount of profit earned at each step:
a. Sales price of cotton $ 5.50
Cost to produce cotton 5.00
Profit from producing cotton $ 0.50
E1-8 Sales price per glove $475.00
Costs of producing each glove:
Leather ($80 ÷ 2) $40.00
E1-9 Antonio’s Restaurant
Profit Earned
For June
Resources created from sales to customers $20,500
E1–10 The Quick Stop
Profit Earned
For March
Resources created from sales to customers $4,400
E1–11 Pam Lucas’s Paper Route
Profit Earned
For May
Resources created from papers delivered $450
E1–12 Return on investment:
January ($4,020 − $4,000) $ 20.00
E1–13 Ending value of Smith’s investment $ 19,500
Beginning value of Smith’s investment 17,000
Return on Smith’s investment $ 2,500
E1–14 J-Mart was more effective and efficient than Buy-Lo in providing goods to
consumers. The two companies sold the same products, so J-Mart was
apparently more effective in selecting a location that created greater de-
E1–15 Rogers was more effective since it was able to sell more of its product.
Consumer preference might reflect a preferred taste or better marketing.
E1–16 Beta appears to be more efficient and effective. It is selling more of its
product and earning a higher profit on the units sold than is Alpha (Al-
E1–17 a. corporations
b. corporations or partnerships
c. corporations
E1–18 Yashiko should be concerned about the reliability of the information.
Even if she has no reason to doubt Hendrick’s honesty, she should want
verification of the information. Also, she might be concerned about how
reports before approving a loan.
E1–19 Several factors might be considered in evaluating the products. Market—
The laser printer is an established product with an established market.
The projector is a new product without an established market. Therefore,
it is a riskier product. Competition—The printer will be sold in a highly
E1–20 The bonus arrangement provides an incentive for managers to report a
higher return than they actually have earned. Net income could be in-
creased by overreporting revenues or underreporting expenses. Total as-
sets could be decreased by omitting some assets. Therefore, the board of
E1–21 If Andy confronts Meredith or informs the auditors of Meredith’s actions,
he will likely lose his job. Andy is in a tough situation. He simply did as he
was told by the owner of the company. Andy should have concerns about
PROBLEMS
P1-1 A. Betsy could borrow money from a bank or other financial institution.
She could go into partnership with other individuals who are inter-
ested in investing in the business. She might form a corporation and
P1-2 Organization Type
Merchandising companies
JCPenney
Amazon.com
Sears
Manufacturing companies
Dow Chemical Company
P1-3 A. Linda Greene’s Car Dealership
Profit Earned
For July
Resources created from sales to customers $230,000
Resources consumed:
Cars $189,000
Rent 2,550
Utilities 800
Insurance 825