CHAPTER 1

Introduction to Accounting and

Business (12 Hrs.)
only for Accounting Dept.
Students

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
assumption.
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
 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
economic events
2. Is just one part of accounting

1-5
5
 Who Uses Accounting Data

External
Internal Users
Human Taxing
Users
Resources Authorities
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
dividends 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

Taxation 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
resources (inputs), such as materials and labor, are
assembled and processed to provide goods or
services (outputs) to customers.
The objective of most businesses is to earn a
profit.
Profit is the difference between the amounts
received 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
converts raw materials into finished products for
sale to other businesses (merchandising) or direct to
consumers. 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
companies and are involved in a number of activities,
including cost and tax accounting, systems, and internal
auditing.
 Financial accounting - area of accounting aimed at
serving financial information needs of external users.
 Managerial accounting - field of accounting
concerned 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,
hospitals, labour unions, colleges/universities,
and charities. Government Careers with the tax
authorities, law enforcement agencies, and
corporate regulators.
 Forensic Accounting: Uses accounting,
auditing, and investigative skills to conduct
investigations 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
Services (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

liabilities should be reported at fair value (the price
received 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
denominator.
Eg. it is expressed only in terms of real money , the
customer pays for service, it is monetary unit
assertion.
Periodicity - company can divide its economic
activities into time periods.
Accrual
1-19
Basis of Accounting – transactions
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
one person. holders or investors
Often retail and
Often small service- service-type Separate legal entity
type businesses organized under state
businesses (Retail means corporation law
selling goods to the
Owner receives any customer ) Investors has Limited
profits, suffers any liability (liability in this
losses, and is Generally unlimited particular case is to pay back debt
personally liable for personal liability & other obligation like electric bill
etc)
all debts. Are more than 2 and Eg a company has different
have Partnership brand names or branches, like
agreement HP, Toshiba,Apple,toyota

1-21
 Sole Proprietorship

Advantages Disadvantages
Easiest to start Limited to life of
Least regulated owner
Single owner keeps Equity capital limited

all of the profits to owner’s personal

Taxed once as wealth
Unlimited liability
personal income
Difficult to sell
ownership interest

1-22 22
 Partnership

Advantages Disadvantages
Two or more owners Unlimited liability
More capital  General partnership
 Limited partnership
available
Relatively easy to Partnership

start dissolves when one

Income taxed once partner dies or
as personal income wishes to sell
Difficult to transfer
ownership

1-23 23
 Corporation

Advantages Disadvantages
Limited liability Separation of
Unlimited life ownership and
Separation of management (agency
problem)
ownership and
Double taxation
management
Transfer of (income taxed at the
corporate rate and
ownership is easy
then dividends taxed
Easier to raise
at personal rate,
capital while dividends paid
are not tax
deductible)
1-24 24
 Indicate whether each of the following statements presented below
is true or false.

1. The three steps in the accounting process are

identification, 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

liability as compared to partners in a partnership.
True

1-25
 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 True
Standards Board (IASB).

5. The cost principle dictates that companies record

assets 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.

1-26
 Forms of Business Ownership

Question
A business organized as a separate legal entity under law
having ownership divided into ordinary shares is a

a. proprietorship.

b. partnership.

c. corporation.

d. sole proprietorship.

1-27
LO 5 Explain the monetary unit assumption
and the economic entity assumption.
 Overview
Overviewof
ofInternational
InternationalFinancial
FinancialReporting
ReportingStandards
Standards(IFRS)
(IFRS)

 The main international standard-setting

organization is based in London, United Kingdom,
and is called the International Accounting
Standards Board (IASB). The IASB issues
International Financial Reporting Standards
(IFRS),
 IFRS is presently used or permitted in over 179
jurisdictions (similar to countries) and is rapidly
gaining acceptance in other countries as well.
 IFRS has the best potential to provide a common
platform on which companies can report and
investors can compare financial information

1-28
28
 Overview
Overviewof
offinancial
financialreporting
reportingrequirements
requirementsin
inEthiopia
Ethiopiaand
and
AABE
AABE
 The Accounting and Auditing Board of
Ethiopia (AABE) is the statutory/legal/
body established in terms of the
Financial Reporting Proclamation
847/2014, with the primary purpose of
protecting the public interest.
 To achieve this, AABE is responsible
for regulating the profession as well
as for issuing a national professional
accountancy qualification that is
recognized internationally.
1-29
29
 Overview
Overviewof
offinancial
financialreporting
reportingrequirements
requirementsin
inEthiopia
Ethiopiaand
andAABE….
AABE….

AABE’s responsibilities include:

 setting accounting and auditing
standards and code of conduct to
regulate the behavior of professionals;
 register and certify professionals and
firms to provide such services;
review and monitor the work of
professionals and firms rendering
accountancy and/or audit services and
reporting entities;
1-30
30
 Overview
Overviewof
offinancial
financialreporting
reportingrequirements
requirementsin
inEthiopia
Ethiopiaand
andAABE…..
AABE…..

AABE’s responsibilities include:……

 providing professional qualification training,
supporting education and continuous professional
development programs;
enforcing the financial reporting law and taking
disciplinary measures on those who do not comply
with the provisions of the law and the regulation
set by the Government and directives,
other relevant policies and guidelines issued by
the Board.
1-31
31
 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.

1-32 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
something 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 ,)

1-33 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
1-34 promise 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
equity .
1-35 Owners Equity Account has affected WIRE(withdraws,35Invest,
 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.
1-36
36
 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
expense, property tax expense, etc.

1-37 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
1-38 decrease
 Classify the following items as issuance of shares, dividends,
revenues, or expenses. Then indicate whether each item
increases 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

1-39
 BUSINESS TRANSACTION and financial statements
Transactions are a business’s economic events recorded by
accountants 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
equation. 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…..
1-40
40
 Using the Accounting Equation

Transactions are a business’s economic

events recorded by accountants.

 May be external or internal.

 Not all activities represent

transactions.

 Each transaction has a dual effect on

1-41
the accounting equation.
 Using the Accounting Equation

Illustration: Are the following events recorded in the accounting

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

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

of the company changed?

Record/
Don’t Record

1-42 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

1-43 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

financial statement
44 2022.
b)1-44Prepare financial statements for the business for the month of June
 CONT’D…..SUMMARY OF
TRANSACTION

1-45
 Financial Statements

Companies prepare four financial statements :

Income Balance Statement of

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

1-46
46
 CONT’D….
After transactions are identified, recorded, and
summarized, 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 financial position
1-47
47
 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?
1-48
48
 CONT’D….
STATEMENT OF CASH FLOWS

Components of CFS has 3 Components

Operating Investing Financing
Activities Activities Activities
Transactions that Making and Transactions
enter into the collecting loans involving liability
determination of and acquiring and and equity items
net income disposing of from financial
investments and institution
property, plant,
and equipment

1-49 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

1-50
50
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

1-51
51
 All cash flow statements three groups
Statement of cash flow
ABC ‘s Repair Shop
or all business operation divided in to
three
Statement of Cash Flow 1)Operation activities: Eg. restaurant,
For the month of ending June 30, 2018
university(smu) etc,,,,
2)Investment Activities: Eg building , car
Cash from operation Activities etc, purchase a long term asset ,
cash receipt revenue 5,220.00 3)Financing Activities : eg. You take
Cash paid for expense (2,400.00) money from the bank,

cash provided by operation 2,820.00 Revenue – Account receivable

Cash flow from investors activities = (5,850-630= 5,220.00

purchased equipment's (5,000.00)

Salary expense + rent expense
Cash flow from financing activities
=2000+400
Investment by owners 10,000.00 =2,400.00
Drawing by owners (1,000.00)
Cash provide by financing 9,000.00 This amount must be equal to cash on
balance sheet
Net increase in cash 6,820.00
= (Investment + cash provided by
cash balance at the beginning June 1
operation ) – (Purchase equipment +
-
withdrawal )
cash balance June -30 6,820.00 =(10,000 + 2,820) – (5,000+1,000)
=12,820-6,000
1-52
52
=6,820.00
 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.

1-53 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
1-54 Accounts Payable 2,000LO 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
Equipment £10,000 7,000
RentCash
Expense 8,000 11,000
Accounts Receivable 9,000 Notes Payable
Total assets £27,000 16,500
Accounts Payable 2,000
Dividends
5,000

1-55 (a) Determine the total assets of Flanagan at December 31, 2017.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
Revenues Salaries and Wages Expense
Service revenue 7,000
£36,000
Rent Expense 11,000
Expenses
Notes Payable
Rent expense £11,000
16,500
Salaries
Accounts Payable and wages expense 7,000 2,000
Utilities expense 4,000 Dividends
Total expenses 5,000
22,000
1-56 (b) Determine the net income reported for December 2017.LO 8
Net income £14,000
 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
Total assets [as computed in (a)] £27,000
7,000
RentLess: Liabilities
Expense 11,000
Notes payable £16,500Notes Payable
Accounts payable 2,000 16,500
18,500
Accounts
EquityPayable 2,000
£ 8,500
Dividends
5,000

1-57 (c) Determine the equity of Flanagan at December 31, 2017.LO 8

 Another Perspective

GAAP Self-Test Questions

Which of the following is not a reason why a single set of high-
quality 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.

1-58
 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.

1-59
 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.

1-60