CHAPTER 1

Introduction to Accounting and

Business
For Marketing/Management Stu-
dents
Organized by: Anteneh,Solomon,
Neway & Wondmagegn
1-1 1
 Introduction to Accounting
Chapter 1 and Business

Learning Objectives
After studying this chapter, you should be able to:

1. Explain what accounting is.

2. Identify the users and uses of accounting.
3. Understand why ethics is a fundamental business concept.
4. Explain accounting standards and the measurement principles.
5. Explain the monetary unit assumption and the economic entity assump-
tion.
6. State the accounting equation, and define its components.
7. Analyze the effects of business transactions on the accounting equation.

8. Understand the four financial statements and how they

1-2
are prepared.
 What is Accounting?

Accounting consists of three basic activities - it

 identifies,
 records, and
 communicates

the economic events of an organization to interested users.

 Identifying- to distinguish an event or a transaction that must be identified.

 Recording- this is the basic function of accounting. It is essentially concerned
with not only ensuring that all business transactions of financial character are in
Communicating- the accounting information after being meaningfully analyzed
and interpreted has to be communicated in a proper form and manner to the
proper person for decision maker.
1-3 LO 1 Explain what accounting is.
 What is Accounting?
Illustration 1-1

Three Activities The activities of the

accounting process

The accounting process includes

the bookkeeping function.

1-4 LO 1 Explain what accounting is.

 BOOKKEEPING DISTINGUISHED
FROM ACCOUNTING
Accounting
1. Includes bookkeeping
2. Also includes much more
Bookkeeping
1. Involves only the recording of eco-
nomic events
2. Is just one part of accounting

1-5
5
 Who Uses Accounting Data

External
Internal Users
Human Re- Taxing Au-
Users
sources thorities
Labor
Unions
Finance
Management Customers

Creditors
Marketing Regulatory
Agencies
Investors

1-6 LO 2 Identify the users and uses of accounting.

 Who Uses Accounting Data (internal)

Common Questions Asked User

1. Can we afford to give our
employees a pay raise? Human Resources
2. Should any product lines be
eliminated? Management
3. Is cash sufficient to pay divi-
dends to shareholders? Finance
4. What price for our product will
maximize net income? Marketing

1-7 LO 2 Identify the users and uses of accounting.

 Who Uses Accounting Data (External)

Common Questions Asked User

1. Did the company earn a
satisfactory income? Investors

2. Will the company be able to

pay its debts? Creditors

3. Will the company be able to

pay its debts? Creditors

Financial accounting answers these questions. It

provides economic and financial information for
investors, creditors, and other external users
1-8 LO 2 Identify the users and uses of accounting.
 Who Uses Accounting Data (External)…..

 Taxing authorities, such as the State Administration of Taxa-

tion in the People’s Republic of Ethiopia, want to know
whether the company complies with tax laws.
 Regulatory agencies or GOVERNMENT AGENCIES, such
as the Federal Trade Commission (USA), want to know
whether the company is operating within prescribed rules.
 Customers are interested in whether a company like General
Motors (USA) will continue to honor product warranties and
support its product lines.
 EMPLOYEES & LABOR UNION: are also interested in the
stability & profitability of the business organization that
hires them in negotiating labor contract.

1-9 LO 2 Identify the users and uses of accounting.

 Nature of Business and Accounting
A business is an organization in which basic re-
sources (inputs), such as materials and labor, are
assembled and processed to provide goods or ser-
vices (outputs) to customers.
The objective of most businesses is to earn a
profit.
Profit is the difference between the amounts re-
ceived from customers for goods or services and
the amounts paid for the in-puts used to provide
the goods or services. In this text, we focus on
businesses operating to earn a profit.
1-10
 Types of business organizations
 Service - an enterprise that renders professional and
technical services. E.g. banks, telecommunication
and transportation companies.
 Merchandising - an enterprise that buys and resells
finished goods to customers. E.g. Stationery shops,
retail and wholesale stores, supermarkets, etc.
 Manufacturing - an enterprise that buys and con-
verts raw materials into finished products for sale to
other businesses (merchandising) or direct to con-
sumers. E.g. textile and cement factories, wood- and
metal-work shops, etc.
1-11
 The Role of Accounting in Business

 What is the role of accounting in business?

 The simplest answer is that accounting pro-
vides information for managers( internal user)
to use in operating the business.
 In addition, accounting provides information to
other users ( external user) in assessing the
economic performance and condition of the
business.

1-12
 PROFESSION OF ACCOUNTING
 Public accountants offer their expertise to the general
public through the services they perform. Taxation is
another major area of public accounting.
 Private accountants are employees of individual com-
panies and are involved in a number of activities, includ-
ing cost and tax accounting, systems, and internal audit-
ing.
 Financial accounting - area of accounting aimed at
serving financial information needs of external users.
 Managerial accounting - field of accounting con-
cerned with serving information needs of internal
users - managers.
 Cost accounting - a managerial accounting activity
designed to help managers in identifying, measuring
and controlling operating costs.
1-13
13
 PROFESSION OF ACCOUNTING Cont’d..
 Not-for-profit accounting includes reporting and
control for government units, foundations, hos-
pitals, labour unions, colleges/universities, and
charities. Government Careers with the tax au-
thorities, law enforcement agencies, and corpo-
rate regulators.
 Forensic Accounting: Uses accounting, audit-
ing, and investigative skills to conduct investi-
gations into theft and fraud.

1-14
14
 The Building Blocks of Accounting

Ethics In Financial Reporting

Standards of conduct by which one’s actions are

judged as right or wrong, honest or dishonest,
fair or not fair, are ethics.
 Recent financial scandals include: Enron
(USA), Parmalat (ITA), Satyam Computer Ser-
vices (IND), AIG (USA), and others.
 Effective financial reporting depends on
1-15 sound ethical behavior.
 Ethics in Financial Reporting

Question
Ethics are the standards of conduct by which one's actions are
judged as:
a. right or wrong.
b. honest or dishonest.
c. fair or not fair.
d. all of these options.

1-16 LO 3 Understand why ethics is a fundamental business concept.

 The Building Blocks of Accounting

Accounting Standards

International Accounting Standards Board (IASB)

http://www.iasb.org/

International Financial Reporting Standards (IFRS)

Financial Accounting Standards Board (FASB)

http://www.fasb.org/

Generally Accepted Accounting Principles (GAAP)

1-17 LO 4 Explain accounting standards and the measurement principles.

 The Building Blocks of Accounting
Measurement Principles
Cost Principle or historical cost principle, dictates
that companies record assets at their cost.
.Eg. If you buy computer by 5000birr TODAY you must
recorded 5000 birr at cost etc..

Fair Value Principle – states that assets and liabili-

ties should be reported at fair value (the price re-
ceived to sell an asset or settle a liability).
Eg. if you sell your computer after 2 years for Birr 5,200.00,
the sale price is its market value/fair value/.
1-18
 Basic Assumptions
Economic Entity – company keeps its activity
separate from its owners and other business
unit. Eg one restaurant, Hotel
Going Concern - company to last long enough
to fulfill objectives and commitments.
Monetary Unit - money is the common denom-
inator.
Eg. it is expressed only in terms of real money , the cus-
tomer pays for service, it is monetary unit assertion.
Periodicity - company can divide its economic
activities into time periods.
Accrual Basis of Accounting – transactions
1-19
are recorded in the periods in which the
 Fundamentals of Accounting Assumptions

Assumptions
Monetary Unit – include in the accounting records only
transaction data that can be expressed in money terms. Eg.it
is expressed only in terms of real money , the customer
pays for service it is monetary unit assertion.

Economic Entity – requires that activities of the entity be

kept separate and distinct from the activities of its owner and
all other economic entities.
 Proprietorship.
Forms of Business
 Partnership. Ownership
 Corporation.

1-20
 Forms of Business Ownership

Proprietorship Partnership Corporation

Generally owned by Owned by two or Ownership divided into

more persons. shares holders, stock hold-
one person. ers or investors
Often retail and ser-
Often small service- Separate legal entity orga-
vice-type businesses nized under state corpora-
type businesses (Retail means selling goods tion law
Owner receives any to the customer )
Investors has Limited liabil-
profits, suffers any Generally unlimited ity (liability in this particular case
losses, and is person- personal liability is to pay back debt & other obliga-
ally liable for all tion like electric bill etc)
Are more than 2 and
debts. Eg a company has different
have Partnership brand names or branches, like
agreement HP, Toshiba,Apple,toyota

1-21
 Indicate whether each of the following statements presented below
is true or false.

1. The three steps in the accounting process are identi-

fication, recording, and communication. True

2. The two most common types of external users are

investors and company officers. False
3. Shareholders in a corporation enjoy limited legal lia-
bility as compared to partners in a partnership. True

1-22
 Indicate whether each of the following statements presented below
is true or false.

4. The primary accounting standard-setting body outside

the United States is the International Accounting Stan- True
dards Board (IASB).

5. The cost principle dictates that companies record as-

sets at their cost. In later periods, however, the fair False
value of the asset must be used if fair value is higher
than its cost.

1-23
 Forms of Business Ownership

Question
A business organized as a separate legal entity under law hav-
ing ownership divided into ordinary shares is a
a. proprietorship.
b. partnership.
c. corporation.
d. sole proprietorship.

1-24
LO 5 Explain the monetary unit assumption
and the economic entity assumption.
 The Basic Accounting Equation

Assets = Liabilities + Equity

Provides the underlying framework for recording and

summarizing economic events. Applies to all economic
entities regardless of size.

1-25 LO 6 State the accounting equation, and define its components.

 The Basic Accounting Equation

Assets = Liabilities + Equity

Assets: is something is values… Table, chair…asset is

divided in to two business asset(it makes money) &
Personal Asset(we don’t use it makes money )
Resources a business owns means you have control
owned.. Resources mean is something of value witch we
can use generate business or generate revenue or some-
thing uses to make money, eg.watch,close, land ,building,
chair, table..
Provide future services or benefits.

Cash, supplies, Equipment (Eg. are table, black -board etc ,)

1-26 LO 6 State the accounting equation, and define its components.
 The Basic Accounting Equation

Assets = Liabilities + Equity

Provides the underlying framework for recording and

summarizing economic events.

Liabilities
Claims against assets (debts and obligations).
Creditors - party to whom money is owed .eg. of
creditors are employees, suppliers, electric bill at the end of
the month

Accounts payable, Notes payable, etc. Account

payable is Some one sells you something on credit and you prom-
1-27 ise to pay later or at the end of the month
 CON’T…

Assets = Liabilities + Owners Equity

Owner’s Equity
Ownership claim on total assets.( take all the business
risk)

Referred to as residual equity. Residual

means any thing which is left after every
one counts satisfy means: owners equity
means all Asset-all liability means all
creditors pay all things get owners eq-
uity .
1-28 Owners Equity Account has affected WIRE(withdraws,28Invest,
 Con’t….

Illustration 1-7

Investment mean owners takes money from his pocket and put in to
the business means equity goes up….
Revenue means Money receive from a customer for goods or service
or product
Revenues result from business activities entered into for the purpose of
earning income.
Common sources of revenue are: sales, fees, services, commissions, interest,
dividends, royalties, and rent.
1-29
Expense is most commonly employees, salary, electicity, chock,
29
 The Basic Accounting Equation
Illustration 1-7

Expenses are the cost of assets consumed or services used in the

process of earning revenue.
Common expenses are salaries expense, rent expense, interest ex-
pense, property tax expense, etc.

1-30 LO 6 State the accounting equation, and define its components.

 The Basic Accounting Equation

Dividends are the distribution of cash or other assets

to shareholders.
 Reduce retained earnings
 It is Not an expense. but, the equity is de-
1-31
crease
 Classify the following items as issuance of shares, dividends,
revenues, or expenses. Then indicate whether each item in-
creases or decreases equity.

Classification Effect on Equity

1. Rent expense Expense Decrease

2. Service revenue Revenue Increase

3. Dividends Equity Decrease

4. Salaries expense Expense Decrease

1-32
 BUSINESS TRANSACTION and financial statements
Transactions are a business’s economic events recorded by ac-
countants with chronological order.
 May be external or internal.
 External Transaction Example:-you deliver to customer and you take
money from the customer
 Internal transaction Examples:-at the end of the month comes we pays
the salary to the employees
 Not all activities represent transactions.
 Each transaction has a dual effect on the accounting equa-
tion. Means reduce one asset & increase another asset eg: If
you buy new laptop your asset in cash decreased and laptop
account is increased or cash is converted to laptop…..
1-33
33
 Using the Accounting Equation

Transactions are a business’s economic

events recorded by accountants.
 May be external or internal.
 Not all activities represent transac-
tions.
 Each transaction has a dual effect on
the accounting equation.
1-34
 Using the Accounting Equation

Illustration: Are the following events recorded in the accounting

records?
Illustration 1-8
Discuss
Purchase product de-
Event Pay rent.
computer. sign with
customer.

Criterion Is the financial position (assets, liabilities, or equity)

of the company changed?

Record/
Don’t Record

1-35 LO 7 Analyze the effects of business transactions on the accounting equation.

 Using the Accounting Equation

Expanded Accounting Equation

Illustration 1-9
Expanded accounting equation

1-36 LO 7 Analyze the effects of business transactions on the accounting equation.

 TRANSACTION ANALYSIS
ABC Repair Shop was started on June 1, 2022 by Dokimas.

a) Analyze the above transactions in terms of their effect on the elements of fi-
nancial statement
b) 37
1-37 Prepare financial statements for the business for the month of June 2022.
 CONT’D…..SUMMARY OF TRANSACTION

1-38
 Financial Statements

Companies prepare four financial statements :

Income Balance Statement of

Retained
Statement Sheet Cash Flows
Earnings
Statement
1st step 3rd step 4th Step

1-39
39
 CONT’D….
After transactions are identified, recorded, and sum-
marized, four financial statements are prepared from
the summarized accounting data:
1. An income statement presents the revenues
and expenses and resulting net income or net loss of
a company for a specific period of time.(Net income
revenue exceeds revenue).eg one week, month or 3 or
5 months
2.A balance sheet reports the assets, liabilities, and
owner’s equity of a business enterprise at a
specific date. It is listed Asset at the top followed by
liabilities & owners equity and it is American style ,
Total Asset must be equals to owner’s equity. specific
date means it report at the end of the month or week
or the year and it is also called statement of 40
1-40 financial
 CONT’D….
In addition to the income statement and statement of owner’s
equity, two additional statements are prepared:
3. A statement of Retained Earnings Statement indicates reasons
why owner’s equity has increased or decreased specific period
of time.
4. A cash flow statement summarizes information concerning
the cash inflows (receipts) and outflows (payments) for a specific
period of time.
Primary Purpose: To provide relevant information about the cash
receipts and cash payments of an enterprise during a period.
Statement provides answers to the following questions:
1. Where did the cash come from?
2. What was the cash used for?
3. What was the change in the cash balance?
1-41
41
 CONT’D….
STATEMENT OF CASH FLOWS

Components of CFS has 3 Components

Operating Ac- Investing Activ- Financing Ac-
tivities ities tivities
Transactions that Making and col- Transactions in-
enter into the de- lecting loans and volving liability
termination of net acquiring and dis- and equity items
income posing of invest- from financial in-
ments and prop- stitution
erty, plant, and
equipment

1-42 LO 5
 CONT’D….
Retained Earnings Statement
Income Statement

ABC ‘s Repair Shop

ABC ‘s Repair Shop
Income statement
Retained Earnings Statement
For the month of ending June 30, 2018 For the month of ending June 30, 2018
Revenue ABC’s Capital on June 1, -( o capital)
Service e revenue Add investment 10,000.00
5,850.00
Net Income 3,200.00
Expense
13,200.00
Salary expense 2,000.00
Less drawing (dividend) 1000.00
Rent expense 400.00
ABC’s capital on June 31 12,200.00
Advertisement expense 250.00

Total expense 2,650.00

Net Income 3,200.00

NB: Investment & Net income increased & drawing decreased

1-43
43
NB: Owners Equity : Add capital + Investment +profit and minus
drawing
Balance Sheet
It come from Retained
ABC ‘s Repair Shop
Earnings Statement
Balance Sheet
For the month of ending June 30, 2018
Asset
cash 6,820.00
account receivable 630.00
equipment's 5,000.00 This two
total Asset 12,450.00 amount should
Liability must be equal
Account payable 250.00
Owner’s equity
ABC’a Capital 12,200.00
total liability& Equity 12,450.00

1-44
44
 Financial Statements

Question
Net income will result during a time period when:
a. assets exceed liabilities.
b. assets exceed revenues.
c. expenses exceed revenues.
d. revenues exceed expenses.

1-45 LO 8 Understand the four financial statements and how they are prepared.
 > DO IT!

Presented below is selected information related to Flanagan Group plc

at December 31, 2017. Flanagan reports financial information monthly.
Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(a) Determine the total assets of Flanagan at December 31, 2017.
(b) Determine the net income that Flanagan reported for Decem-
ber 2017.
(c) Determine the equity of Flanagan at December 31, 2017.

1-46 LO 8
 Information related to Flanagan Group plc at December 31, 2017.
Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(a) Determine the total assets of Flanagan at December 31,
2017.
Equipment £10,000
Cash 8,000
Accounts Receivable 9,000
Total assets £27,000

1-47 LO 8
 Information related to Flanagan Group plc at December 31, 2017.
Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(b) Determine the net income reported for December 2017.
Revenues
Service revenue £36,000
Expenses
Rent expense £11,000
Salaries and wages expense 7,000
Utilities expense 4,000
Total expenses 22,000
Net income £14,000
1-48 LO 8
 Information related to Flanagan Group plc at December 31, 2017.
Equipment £10,000 Utilities Expense £ 4,000
Cash 8,000 Accounts Receivable 9,000
Service Revenue 36,000 Salaries and Wages Expense 7,000
Rent Expense 11,000 Notes Payable 16,500
Accounts Payable 2,000 Dividends 5,000
(c) Determine the equity of Flanagan at December 31, 2017.

Total assets [as computed in (a)] £27,000

Less: Liabilities
Notes payable £16,500
Accounts payable 2,000 18,500
Equity £ 8,500

1-49 LO 8
 Another Perspective

GAAP Self-Test Questions

Which of the following is not a reason why a single set of high-qual-
ity international accounting standards would be beneficial?

a) Mergers and acquisition activity.

b) Financial markets.

c) Multinational corporations.

d) GAAP is widely considered to be a superior reporting system.

1-50
 Another Perspective

GAAP Self-Test Questions

The Sarbanes-Oxley Act determines:

a) international tax regulations.

b) internal control standards as enforced by the IASB.

c) internal control standards of U.S. publicly traded companies.

d) U.S. tax regulations.

1-51
 Another Perspective

GAAP Self-Test Questions

IFRS is considered to be more:

a) principles-based and less rules-based than GAAP.

b) rules-based and less principles-based than GAAP.

c) detailed than GAAP.

d) None of the above.

1-52