. 2
( 25)


and Footer command permits you to add titles and comments to spreadsheets that will appear
on printed output. The Zoom command allows spreadsheets to be resized as they appear on
the monitor to make them easier to see. This command does not affect printed output.
Insert. Use the Insert menu to insert Rows, Columns, and Cells. To enter a new row, select
the row below the row you wish to add and click on Insert/Row. To enter a new column,
CHAPTER F1: Accounting and Organizations
24 Accounting and Organizations

select the column to the left of the column you want to add and click on Insert/Column. To
enter a new cell, click on the cell where you want to add a new cell and click on Insert/Cell.
A dialog box will ask whether you want the existing cell moved to the right or down. When
you enter a new cell, all existing cells to the right or below the entered cell will be moved to
make room for the new cell.
Format. Use the Format menu to format Cells. Select the cells and click on Format/Cells.
A dialog box provides options. The Number tab provides various formatting options. The
Alignment tab provides options for how numbers or text will be aligned. The Wrap text
box can be checked (click on the box) to allow for more than one line of text to appear in a
particular cell.
Tools. Use the Tools menu to check your Spelling.
Data. Use the Data menu to Sort data. To sort, select all the columns in the spreadsheet
and click Data/Sort. A dialog box lets you select the column or columns you want to use to
sort the data.
Help. Use the Help menu to get additional directions about using Excel. Click on
Help/Contents and Index. Select a topic from the Contents tab or click on the Index
tab. Type the keyword for an item to get additional information and click on the Display

Several of the buttons under the menu are particularly useful. The identity of each but-
ton and its use are described below.
Save. Click to save your spreadsheet. Save your work often.
Copy. Copies the contents of a selected cell or group of cells.
Paste. Pastes the contents of a copied cell or group of cells into a selected cell or
Format Painter. Copies the format of a selected cell into another cell or group of
cells. Select the cell with the format to be copied and click the button. Then click on
the cell or click and drag over the cells where the format will be copied.
AutoSum. Select a cell to contain the sum of a neighboring set of cells (above or to
the left of the selected cell). For example, we want to sum the contents of cells E10
and E11 into cell E12. Select cell E12 and click on the AutoSum button. The Sum
formula appears in cell E12 as shown below. You can change the cells to be included
in the sum by clicking on the top cell to be included and dragging the cursor over the
cells to be added as part of the sum.

Once the sum formula is correct, click on the checkmark in the selection box at the top
of the spreadsheet:

Click on the green checkmark to accept the cell contents. Click on the red X to remove
the cell contents.

Format. Select a cell or group of cells and click on B for bold, I for italics,
and U for underline.
F26 SECTION F1: The Accounting Information System
Accounting and Organizations

Align. Select a cell or group of cells and click on a button to align the cell
contents to the left, center, or right of the cell.
Merge and Center. Select two or more neighboring cells in a row and click on the
button to merge the cells into a single cell and center the cell contents. For example,
the caption (The Book Wermz) in the following example was created by selecting
cells B1 and C1 and clicking on the Merge and Center button.

Number Formatting. Select a cell or group of cells and click on a button
to include a dollar sign in the cell(s), to convert from decimals to percent-
ages, or to add comma separators between thousands™ digits in numbers.
Decimal Places. Select a cell or group of cells and click on a button to in-
crease or decrease the number of decimal places showing in the cell(s).
Indent. Select a cell or group of cells and click on a button to indent the cell
contents or to remove the indentation.
Borders. Select a cell or group of cells and click on the down arrow. Select the type
of border you want for the cell(s) from the options provided. If the option you want
is already showing on the button, click on the button to select that option.


1. The accounting process provides information about business activities to help decision
makers allocate scarce resources.
a. Accounting measures profits created by a business as the dollar amount of
resources created from selling goods and services minus the dollar amount of
resources consumed in producing and making the goods and services available to
b. Accounting helps decision makers determine the risk and return they should antic-
ipate from a business investment or activity.
2. Organizations serve the needs of society by providing a means for people to work
together to accomplish their goals.
a. Businesses operate as merchandising, manufacturing, and service companies. Other
organizations, like governments and nonprofit organizations, are nonbusiness
b. All organizations benefit society by transforming resources from one form to an-
other form that is more valuable in meeting the needs of people.
3. Businesses sell their products and acquire resources in competitive markets.
a. Markets provide a way for people to express their perceptions of the value of
goods and services by the products they purchase and the prices they pay. Markets
allocate resources to those companies and activities that market participants be-
lieve best meet their needs.
b. Value created by a business is measured by the difference between the dollar
amount of resources created from selling goods and services and the dollar
amount of resources consumed in producing and making the goods and services
available to customers.
4. Owners invest in a business to receive a return on their investments from business prof-
its. Businesses that operate effectively and efficiently normally will earn higher profits.
a. Businesses that are not profitable will have difficulty attracting investors and will
be forced to change their behavior or to go out of business.
CHAPTER F1: Accounting and Organizations
26 Accounting and Organizations

b. Markets make financial and other scarce resources available to organizations that
can best transform them to maximize their value for society.

5. Businesses operate as corporations, proprietorships, and partnerships.
a. Corporations can obtain large amounts of capital by selling stock to many in-
b. Owners of corporations usually hire professional managers to run their businesses.
They depend on these managers to run the business for the benefit of owners and
to report reliable information about their business activities.

6. Accounting information is used in corporations and other organizations to create and
evaluate contracts and other agreements between a company and its stakeholders.
a. Accounting information helps investors and creditors assess the return and risk as-
sociated with their investments and loans.
b. Accounting information is useful for determining management compensation, de-
termining an organization™s resources, and evaluating results of its operating activ-
c. Accounting information helps managers evaluate employee performance and helps
employees evaluate the risk and return of their employment contracts.
d. Accounting information helps companies evaluate their suppliers and helps cus-
tomers evaluate the companies from which they make purchases.
e. Accounting information helps government agencies make taxation and regulatory

7. Because investors and other external stakeholders have limited access to business infor-
mation, information reported to external parties is regulated.
a. Companies must prepare financial accounting information in conformity with
generally accepted accounting standards.
b. This information is audited by an independent accountant to ensure that it fairly
represents a company™s business activities.
c. Reliable accounting information is essential for the proper operation of markets
that depend on the information to determine how to allocate resources.

8. Ethical behavior is important to ensure that businesses are managed properly and that
accounting information is reliable. Accounting rules and controls have been created to
help monitor and enforce ethical behavior.


accounting (F10) market (F7)
audit (F20) merchandising companies (F5)
business organization (F6) moral hazard (F14)
contracts (F16) mutual agency (F13)
corporation (F10) organization (F5)
creditor (F14) partnerships (F11)
effective business (F9) profit (F8)
efficient business (F9) proprietorships (F11)
financial accounting (F20) retail companies (F5)
generally accepted accounting principles return on investment (ROI) (F9)
(GAAP) (F20) risk (F5)
governmental and nonprofit organizations service companies (F6)
(F6) shareholders (F11)
information (F3) stakeholders (F5)
management accounting (F20) stock (F11)
managerial accounting (F20) stockholders (F11)
manufacturing companies (F6)
F28 SECTION F1: The Accounting Information System
Accounting and Organizations

SSP1-1 A.

Bach™s Music Store
Profit Earned
For December 2004

Resources created from selling goods and services:
Musical instruments $8,000
Sheet music 1,400
Repair of instruments 2,200
Total resources created $11,600
Resources consumed:
Cost of instruments sold 4,300
Cost of sheet music sold 870
Rent 650
Supplies used 250
Advertising 300
Utilities 200
Miscellaneous 180
Total resources consumed 6,750
Profit $ 4,850

B. The value created by a transformation of resources is the difference between the total
price of the goods and services sold and the total cost of the resources consumed in
producing these goods and services. This difference is profit for the seller.

Hammer Hardware is owned and managed by Harvey Hammer. As a small company, Ham-
mer Hardware does not need access to large amounts of capital. Harvey is probably more in-
terested in maintaining control of his company rather than having others invest in it. As a
proprietorship, Harvey has total control of the business. All company profits belong to him.
A primary disadvantage of the proprietorship is that Harvey is personally liable for all of the
company™s obligations. He is responsible for paying the company™s debts, even if they require
use of his personal resources.
Home Depot is a large corporation. To obtain the financial resources the company needs,
it sells stock to a large number of investors. These investors expect a return from their in-
vestments but have no interest in managing the company. Instead, they hire professional man-
agers to run the company for them. Corporations permit access to large amounts of capital.
Also, individual owners are not responsible for the corporation™s debt, thus reducing the risk
of ownership. A primary disadvantage of corporations is that owners have little access to in-
formation about the company. They depend on managers to run the business for the benefit
of owners and to provide reliable information about their business activities.

A. Exchanges and contracts between managers, owners, and creditors: Owners and cred-
itors exchange money with Floorshine for the right to receive cash in the future from
the company. Contracts exist among managers, owners, and creditors. Managers con-
tract with owners and creditors for money to acquire resources that will generate prof-
its for the company and to employ the resources effectively and efficiently. Managers
expect to be rewarded for their effectiveness and efficiency, and owners and creditors
expect a fair return on their investments. These contracting parties need information to
assess how well managers have performed and to determine how much cash from the
company™s operations should be distributed to each party. Managers, owners, and cred-
itors decide whether the terms of contracts are being met. Owners hire independent
auditors (CPAs) to examine the financial information provided by managers to owners
and creditors to ensure its reliability.
CHAPTER F1: Accounting and Organizations
28 Accounting and Organizations

B. Exchanges and contracts between suppliers and managers: Suppliers exchange goods
and services with the company for the right to receive cash. Contracts between suppli-
ers and managers require information to determine that the company receives the cor-
rect types and quantities of goods and services at the appropriate times. Also,
information is needed to demonstrate that the company has made timely payments for
these goods and services.

C. Exchanges and contracts between employees and managers: Employees exchange la-
bor services with the company for wages and benefits. Contracts between employees
and managers describe the payments, benefits, and rights employees have negotiated
with managers. Information is needed to demonstrate that labor services have been
provided and employees have been treated fairly. The demands of employees for future
wages and benefits depend, in part, on the profitability of the company. Employees and
managers need information about the performance of the company to negotiate future

D. Exchanges and contracts between customers and managers: Customers exchange cash
for goods and services provided by the company. Customers, such as retail stores, may
receive the goods and pay for them later, say within 30 or 60 days. Managers expect to
receive the payments when they are due. Contracts between customers and managers
call for the delivery of goods to customers and payment to the company. Customers
decide whether to continue to purchase the company™s goods. The quality and costs of
the goods and future prospects for obtaining the goods when needed are relevant pieces
of information. Information about the payment history of customers helps managers
decide whether to continue to extend credit to customers.

E. Exchanges and contracts between government agencies and managers: Government
agencies monitor companies to determine if they are engaged in fair trade and labor
practices. Managers provide information to demonstrate that the company is conform-
ing to government regulations. Governments provide services to companies in the form
of police and fire protection, utilities, sanitation, and streets and roads. Companies pay
taxes and fees for these services. Information is required to verify that appropriate
amounts of taxes and fees are being paid.

Thinking Beyond the Question
What do we need to know to start a business?

The chapter introduction asked you to consider what you would need to know
in order to start a company. This chapter identified several important consider-
ations. How would your answer to this question differ if you were starting a ser-
vice business or a nonprofit service organization as opposed to a retail business?

What is the purpose of accounting? How does accounting accomplish that purpose?
Obj. 1

How can accounting information help investors understand risk?
Obj. 1

How does the purpose of merchandising, manufacturing, and service companies differ? How
do they each create value?
Obj. 2
F30 SECTION F1: The Accounting Information System
Accounting and Organizations

List an example of each of the following types of organization. Describe how each type of or-
ganization differs from each of the others.
Obj. 2
a. Merchandising
b. Manufacturing
c. Service
d. Governmental
e. Nonprofit
Sandy Dune overheard some friends from your accounting class discussing the “transforma-
tion of resources.” She is curious about what this term means and how it applies to organi-
Obj. 3
zations and accounting. Explain to Sandy your understanding of the transformation of
resources and why it is an important concept in accounting.
Accounting is an information system that measures and reports the value created when a com-
pany transforms resources. Does an accounting system create value? If so, how? If not, why
Obj. 3
do companies have them?
Phillip invested $3,000 in a business at the beginning of the year. By the end of the year, the
value of this investment had risen to $4,100. Near year-end, the business sent Phillip a check
Obj. 4
for $2,000. Describe the difference between a return on investment and a return of investment.
What portion of the $2,000 is return on investment and what portion is return of investment?
How are effectiveness, efficiency, return on investment, and accounting interrelated? Be spe-
Obj. 4

What is a contract, and why are contracts important for business organizations?
Obj. 6

What is meant by risk, and why is it an important concept for decision makers to understand?
What is the relationship between risk and accounting?
Obj. 6

Your friend is puzzled that the topic of contracts has come up in your accounting class. Says
he, “Contracts are the business of lawyers, not accountants. Why are we studying contracts in
Obj. 6
an accounting class?” Educate your friend.
Your uncle tells you that risk is to be avoided when considering potential investments. In fact,
he believes the government should ban risky investments to protect the public. Do you agree
Obj. 6
with your uncle? Why or why not?
It is often said that there exists a risk-return tradeoff. That is, to obtain a higher return, one
must be willing to accept higher risk. If one wishes to incur little risk, one must be willing to
Obj. 6
accept a smaller return. What evidence of this do you observe in the world around you, ei-
ther in investments or other aspects of life?
Why do owners invest in businesses even though such an investment is more risky than in-
vesting in U.S. Savings Bonds? If you had $3,000 to invest, how would you decide whether to
Obj. 6
invest it in businesses or whether to invest it in U.S. Savings Bonds?
What is the interrelationship among the concepts of risk, moral hazard (when setting execu-
tive compensation), and generally accepted accounting principles?
Objs. 6, 7

How does an audit increase the credibility of financial statements?
Obj. 7

An accounting classmate notes that adherence to GAAP is not required for managerial ac-
counting reports. She observes, “If it™s so important for financial accounting, it seems rea-
Obj. 7
sonable that it would also be useful for managerial reporting.” Explain to her why it™s more
important that financial accounting reports adhere to GAAP than it is for managerial ac-
counting reports to do so. In what ways is managerial accounting different from financial ac-
CHAPTER F1: Accounting and Organizations
30 Accounting and Organizations

If your instructor is using Personal Trainer in this course, you may complete online the assign-
EXERCISES ments identified by .
E1-1 Write a short definition for each of the terms listed in the Terms and Concepts Defined in This
Chapter section.
Assume you have a friend, Edwina Polinder, who has no knowledge of accounting. Draft a
short memo to Edwina that will help her understand the purpose of accounting.
Obj. 1
DATE: (today™s date)
TO: Edwina Polinder
FROM: (your name)
SUBJECT: Inquiry about accounting
(your response)
Wilma Borrelli is a stockholder of Essex International, a major supplier of building materials.
Wilma received information that Essex sustained a large loss during the most recent quarter
Objs. 1, 6
and is expecting bigger losses during the coming quarter. How might this information affect
those who contract with Essex?
Match the type of organization with the characteristics and examples provided below:
Obj. 2
Type of organization:
1. Merchandising (or retail) companies
2. Manufacturing companies
3. Service companies
4. Governmental and nonprofit organizations
Characteristics and examples:
a. Provide goods or services without the intent of making a profit. Examples include the
IRS and the United Way.
b. Produce goods that are sold to consumers or to merchandising companies. Examples
include Ford Motor Company and PepsiCo.
c. Sell to consumers goods that are produced by other companies. Examples include Wal-
Mart and Sears.
d. Sell services rather than goods. Examples include H&R Block and Delta Air Lines.
Leonardo has started a small business making sundials. The following transactions occurred for
the business during a recent period. How much profit did the company earn for this period?
Obj. 3

Sales to customers $970
Rent for the period 450
Supplies used during the period 225
Wages for the period 180

Soft Light Company produces specialty lamps and sells them to retail stores. During the latest
year, the company sold 40,000 lamps at an average price of $70 per lamp. The production and
Obj. 3
distribution costs per lamp were $25, on average. Other costs for the year were $1,200,000 for
management salaries and facilities. Total investment in the company is $3,000,000. How much
profit did Soft Light earn for the year? Describe the steps you went through to get your answer.
Fashion Threads Company uses the following four steps to make a particular pair of cotton slacks:
Obj. 3
a. Cotton is planted, grown, harvested, and shipped to a textile manufacturer. The cost to
produce the cotton associated with the slacks is $5. This amount of cotton is sold to
the manufacturer for $5.50.
b. Raw cotton is processed into cotton fabric. The cost of producing the fabric for the
slacks, including the cost of the raw cotton, is $13.25. This fabric is sold to a garment
manufacturer for $17.
c. Cotton fabric is cut and sewn to produce a pair of slacks. The cost of making the
slacks, including the cost of the fabric, is $25. The slacks are sold to a retailer for $30.
d. The cost to the retailer of making the slacks available for sale, including the cost of the
slacks, is $34. The retailer sells the slacks for $56.

F32 SECTION F1: The Accounting Information System
Accounting and Organizations

Use Exhibits 5 and 6 to help you answer the following questions. How much profit is earned
at each step in the production and selling process? How much total profit is earned by those
involved in making and selling the slacks? Why are customers willing to pay the amounts in-
volved in this process?
Alexander makes professional baseball gloves by hand. He buys leather for $80 a yard. Padding
costs $6 a pound; thread and other materials cost $16 for a month™s supply. He pays $500 a
Obj. 3
month rent for a small shop, and utilities average $150 a month. Shipping costs are about
$4.50 per glove. In an average month, Alexander produces and sells 8 gloves. Each glove re-
quires a half yard of leather and a half pound of padding. What is the average cost of a glove
made by Alexander? How much profit does Alexander earn on each glove if he sells them for
$475 each? How much profit does Alexander earn each month, on average? Exhibits 5 and 6
will help you answer these questions.
E1-9 Mario™s Restaurant specializes in Italian food. During February, Mario™s recorded the follow-
ing sales to customers and costs of doing business:
Obj. 3

Sales to customers $19,500
Cost of food products used 5,750
Cost of rented building and equipment 4,376
Cost of employee labor services used 3,750
Maintenance and utilities used 2,000

Prepare a schedule that shows the amount of profit (or loss) earned by Mario™s Restaurant
during February. (Hint: See Exhibit 6.)
The Quick Stop is a fast-food restaurant. During March, Quick Stop recorded the following
Obj. 3
sales to customers and costs of doing business:

Sales to customers $4,400
Cost of food products used 2,100
Cost of rented building and equipment 1,250
Cost of employee labor services used 1,000
Maintenance and utilities used 600

Prepare a schedule that shows the amount of profit (or loss) earned by Quick Stop during
March. (Hint: See Exhibit 6.)
Pam Lucas is a high school student who delivers papers to earn spending money. During May,
she received $450 from customers in payment for their subscriptions for the month. She paid
Obj. 3
$300 for the papers she delivered. In addition, she paid $45 to her parents for use of their car
to deliver the papers, and she paid $30 for gas. Prepare a statement to compute the amount
of profit Pam earned from her paper route in May. (Hint: See Exhibit 6.)
On January 1, 2004, Alicia invested $4,000 in a savings account. At the end of January, the ac-
count balance had increased to $4,020. The balance at the end of February was $4,040.10. The
Obj. 4
balance at the end of March was $4,060.30. The increases occurred because of interest earned
on the account. What was Alicia™s return on investment, in dollars and cents, for each of the
three months? What was the total return for the three months taken together?
Davy Crockett invested $15,000 in Mike Fink Rafting Company. At the end of the year, Crock-
ett™s investment was worth $17,250 because of earnings during the year. Fink paid Crockett
Obj. 4
$3,000 at the end of the year. What was Crockett™s return on investment (in dollars) for the
year? What was his return of investment (in dollars) for the year? Did Mike Fink Rafting main-
tain its capital as a result of these events? Explain.
Flick and Flack are two companies that sell identical products. They are located in different parts
of the same city. During September, Flick sold $24,000 of goods, while Flack sold $18,000. Flick™s
Obj. 4
profit was $8,000, and Flack™s profit was $2,000. Compare the efficiency and effectiveness of the
two companies.
E1-15 Rogers and Hornsby are two companies that compete in the same market with the same prod-
uct, a brand of steak sauce. The companies are the same size and sell to the same grocery re-
Obj. 4
tailers. Both products are sold by the retailers at the same price. During 2004, Rogers sold
500,000 bottles of its sauce at a profit of 10 cents per bottle. Hornsby sold 425,000 bottles at
CHAPTER F1: Accounting and Organizations
32 Accounting and Organizations

a profit of 15 cents a bottle. Which company was more effective? Which was more efficient?
Which company was more profitable?
You have a choice of investing in either of two companies, Lewis or Clark. Both companies
make the same products and compete in the same markets. Over the last five years, the oper-
Obj. 4
ating results for the two companies have been:

Lewis Clark
Sales to customers $4,500,000 $5,625,000
Profit $412,500 $675,000
Return on investment per dollar invested 4.5% 7.5%

Which company is more efficient? Which is more effective? In which company would you
invest? State the reasons for your answers.
Identify each of the following as describing corporations, proprietorships, and/or partnerships.
Some items have more than one answer.
Obj. 5

a. Distinct legal entity separate from its owners.
b. More than one owner.
c. Ownership by stockholders.
d. Controlled by a board of directors.
e. Legal identity changes when a company is sold.
f. Limited liability.
g. Mutual agency.
h. Access to large amounts of capital.
i. Direct taxation of profits.
j. Moral hazard usually not a major problem.
Yashiko Takawsa is a loan officer at a major bank. Hendrick Swindler recently applied for a
small business loan for his dry cleaning company, Take ˜Em to the Cleaners. As part of the
Obj. 6
application, Swindler was asked to provide financial information about his company. The fi-
nancial reports revealed that the company had been fabulously profitable. What concerns
might Yashiko have about the information provided by Swindler? What actions might she take
to relieve these concerns?
Wendy Hu is considering two new products for her office products manufacturing business.
One is a laser printer. Wendy has had numerous calls for the product, which will compete
Obj. 6
with existing well-known brands. The other product is a new computer projection system that
permits a presenter to display color computer images without the need of a regular computer
or projection system. The product would have little competition. Wendy believes the market
will be receptive to this product. What are some of the risks that Wendy must consider in de-
ciding whether to produce the two products?
To encourage its managers to earn a profit for its stockholders, Primrose Mining Company
pays a bonus to top managers if the company earns at least a 15% return on investment each
Obj. 7
year. Management prepares financial reports from which the return on investment is calcu-
lated. Should the board and the stockholders be concerned about the reliability of the finan-
cial reports? Discuss. What can they do to make sure the reports faithfully represent the
company™s economic activities?
Andy attends college on a full-time basis and works part-time for Meredith™s Garden Center.
The owner, Jim Meredith, asked Andy to work late into the night to move merchandise from
Obj. 8
one warehouse to an empty warehouse located across town. Andy thought his assignment was
unusual but was happy to get the extra hours of work.
The next day, Andy overheard the company™s auditors discussing their visit to the ware-
house where he had moved the merchandise. Apparently, Mr. Meredith was attempting to
fool the auditors. They had counted the merchandise on the previous day. On the following
day, they had counted the same merchandise a second time but at a different warehouse.
Meredith was attempting to acquire a bank loan and wanted to impress the loan officer with
a strong financial report. Andy knew Meredith would mislead the auditors and banker but
did not know what to do.
What may happen to Andy if he informs the auditors of his activities from the night be-
fore? Who may be harmed by Meredith™s actions?
F34 SECTION F1: The Accounting Information System
Accounting and Organizations

If your instructor is using Personal Trainer in this course, you may complete online the assign-
PROBLEMS ments identified by .

Obtaining Funding
Obj. 1 Betsy wants to start a business making flags. She has calculated that she will need $62,500
to start the business. The money will be used to rent a building, purchase equipment, hire
workers, and begin production and sales. Betsy has $12,500 in savings she can invest in the

A. What alternatives might Betsy have for obtaining the additional $50,000 she needs for
her business?
B. What information about her business will lenders or investors want to have?

Types of Organizations
Obj. 2 Provided below are four types of organizations and a list of organizations with which you are
probably familiar. Associate each organization with a type of organization.
Types of organizations
Merchandising companies
Manufacturing companies
Service companies
Governmental or nonprofit organizations
United Parcel Service (UPS) Internal Revenue Service (IRS)
Amazon.com March of Dimes
Dow Chemical Company JCPenney
United States Postal Service (USPS) DaimlerChrysler
PepsiCo Sears
Federal Express (FedEx) Verizon Communications

Determining Profit and Return on Investment
Obj. 3 Harry Honda owns a small car dealership. He rents the property he uses, buys cars from a
manufacturer, and resells them to customers. During July, Harry sold 14 cars that cost him a
total of $189,000. The total amount he received from the sale of these cars was $224,000. Other
costs incurred by Harry for the month included rent, $2,550; utilities, $800; insurance, $825;
maintenance of property and cars, $500; advertising, $1,000; and property taxes and business
license, $200.

A. Prepare a profit report that calculates the amount of profit earned during July.
B. What can Harry do with the profit he earned?
C. Assuming he invested $1,200,000 in the dealership, what was the return on his invest-
ment for July expressed as a percentage of his investment?

Developing Profit and Return on Investment
Objs. 3, 4 Through hard work and careful saving, Hans and his family have $152,000 to start a small spe-
cialty foods business. The family estimates sales to customers will be about $4,500 per month
during the first year. On the average, expected costs per month are budgeted as follows:

Wages for occasional labor $ 700 Utilities $100
Rent on land and buildings 1,200 Advertising 300
Supplies 75 Delivery costs 225

A. What is the projected monthly profit?
B. What is the expected annual return on investment?
CHAPTER F1: Accounting and Organizations
34 Accounting and Organizations

P1-5 The Relationship between Profit and Value Created
Obj. 3
Marty and Judi own and operate Tender Sender Company, a store providing private mail
boxes, contract shipping services on commission, and a wide variety of gift and novelty items.
The following transactions occurred during the month of February.
1. Sold $6,000 of gift items for which the company had paid $3,100.
2. Advertising, both newspaper and radio, was $1,500.
3. Rent for the month received from mail box customers totaled $1,640.
4. The cost of monthly rent for the store location was $2,200.
5. The cost of utilities for the month was $475.
6. Commissions earned from shipping services for the month totaled $1,588.
7. Sold $3,200 of novelty items that had cost the company $1,450.
8. The cost of supplies used during the month was $384.
9. Other miscellaneous costs for the month of February totaled $250.

A. Prepare a schedule that shows the amount of profit earned by the company during the
month of February.
B. Has the company created value? Explain your answer.

How Businesses Create Value
Objs. 1, 3 You are considering opening a shop in a nearby mall that will sell specialty T-shirts. T-shirts, con-
taining designs and words selected by customers, will be produced for customers on order. You
will need to borrow $25,000 to begin operations. A local bank has agreed to consider a loan and
has asked for a summary plan to demonstrate the performance you expect from your company
and your ability to repay the loan. You will pay $5.50 for T-shirts and will sell them for $8. The
cost of paint and supplies will be $0.50 per shirt. An examination of similar stores at other malls
indicates that you should be able to sell an average of 1,000 shirts per month. Rent for your store
will be $300 per month. Utilities will be $150 per month, on average. Wages will be $800 per month.

A. Calculate the expected profit of your company for the first year of operation.
B. Explain how a bank loan officer may use your profit projections to help make the lend-
ing decision.

Measuring Value Created
Obj. 3 T. Edison owns her own business and had the following activity during September. She earned
$2,600 from royalties on inventions. She consumed resources as follows: $525 for rent, $300
for clerical salaries, $124 for legal services, $100 for office supplies, $90 for utilities, $70 for
fuel, and $200 for insurance.

A. Prepare a report in good form, following the example of Exhibit 6, to describe Edison™s
financial activities for September.
B. How might this information be useful for Edison?
C. Identify some decisions Edison might make using this information.

The Results of the Transformation Process
Obj. 3 Betsy started Betsy™s Flag Co. on September 1. During September, Betsy consumed the fol-
lowing resources:
Rent $ 625 Utilities 250
Supplies 3,000 Repairs 1,500
Fabric 8,750 Wages 2,500
Business license 500

Betsy created resources by selling flags for $22,000 during the month of September.

Required Determine the profit earned by Betsy during September.
F36 SECTION F1: The Accounting Information System
Accounting and Organizations

P1-9 Using Accounting Information for Decisions
Objs. 1, 4
The chief financial officer (CFO) of Flash Bulb and Seed Company has prepared the follow-
ing projections for the month of August.

Expected sales $480,000
Projected monthly resources consumed:
Rent $ 85,000
Utilities 2,900
Wages 274,000
Advertising 115,000
Repairs 12,000
Supplies 2,500
Total cost of resources consumed 491,400
Projected loss $ (11,400)

Although Flash Bulb and Seed Company predicts a loss for August, the CFO is confident that
sales will increase in the future.

A. Why is it important that the CFO prepare a document like this?
B. If the company came to your bank requesting a loan, how would you respond? From
the data given, does the firm appear that it is likely to be able to repay a loan? Why?

Return on Investment and Return of Investment
Obj. 4 John invested $250,000 into a business that earned a profit of $2,250 during the past month
as shown below. John believes the business will earn an annual profit equal to twelve times
the monthly profit. Assume John wants to take $20,000 from the business each year for his
personal use.

Resources created from sales $17,000
Resources consumed:
Materials $7,500
Insurance 1,500
Rent 2,000
Utilities 950
Wages 2,800
Total cost of resources consumed 14,750
Profit earned $ 2,250

A. Determine the company™s return on investment.
B. Determine John™s return of investment.

Choosing a Form of Business Organization
Obj. 5 Below are three independent situations.
A. Larry, Ulysses, and Irene are three college student friends planning to set up a summer
business at a nearby resort to sell T-shirts, souvenirs, and novelties to tourists. While
they have no assets (to speak of) of their own, Larry™s uncle has agreed to finance them
with upfront capital to acquire merchandise and so on. They plan to operate for only
one summer, as all expect to graduate soon and take permanent jobs in a nearby state.
B. Molly and Vicky are twin sisters who have decided to start a computer software con-
sulting firm. Molly is the “techie,” and a bit unreliable. Vicky is a highly successful
manager gifted with organizational and business skills. Between the two, they believe
they can attract and serve a profitable clientele. In fact, they envision rapid expansion
of their practice and diversification into a variety of related business activities. Between
them, they have only enough liquid capital to start a small operation.
CHAPTER F1: Accounting and Organizations
36 Accounting and Organizations

C. Reginald and Ruth Ann are ne™er-do-well offspring of a deceased industrialist who left
them each $400 million”most of which they still have. Ever the optimists, they think
there is money to be made in the steel business. A friend they met at the country club
has persuaded them to provide $10 million to set up a business that would manufac-
ture and distribute a line of lightweight steel kites. Operations would be located in a
nearby state.

Required For each of the three independent situations, recommend the form of business
organization that you believe would be most appropriate. Explain your reasoning in each case,
both in favor of your selection and any reasons against your choice.

Business Ownership Structures
Obj. 5 Mary Jackson is graduating with a degree in business administration. She has scheduled in-
terviews with a variety of companies. Mary found the following diagram in the packet of in-
formation provided by one of the companies:


Chairman of the Board &
Board of Directors

President“Chief Operating Officer (COO)

Vice President of Vice President of
Vice President of
Manufacturing Finance

A. Is Mary interviewing with a proprietorship, partnership, or corporation?
B. What are the advantages of this form of organization?
C. In this form of organization, management ultimately is responsible to whom?

Contracts, Risk, and Uses of Accounting Information
Obj. 6 Sonny Beam established Solar Supply Corporation earlier in the current year. To obtain re-
sources, he contributed $5,000 of his savings to the company, had the company borrow $8,000
from his mother, sold shares of company stock to friends totaling $10,000, and obtained a
$25,000 bank loan. The company is obligated to buy out all investors and repay the two loans
within 12 months of the business becoming profitable. Sonny located space in a nearby busi-
ness park and leased it for monthly rent of $1,000 plus 1% of his company™s sales. Several
competing manufacturers tried to attract him as a distributor of their products. He signed an
exclusive agreement with one that offered its products at 52% off their normal sales prices
F38 SECTION F1: The Accounting Information System
Accounting and Organizations

with 30-day free credit. Sonny hired a sales manager at a salary of $3,000 per month and
promised her a profit-sharing plan payable each December 31. Sonny™s credit policy is that
commercial customers receive 60-day free credit and that retail customers must pay by cash
or credit card. All goods carry the manufacturer™s warranty and Sonny™s secondary warranty
of “satisfaction guaranteed or your money back.” Because the company is a corporation, it
will pay corporate income tax to the city, state, and federal governments. In addition, the state
will levy a merchandise tax each July 1.

A. Identify the primary exchanges and contracts between the company and those that in-
teract with it.
B. Which of the parties have taken on risk? For each such party, describe that risk.
C. Which contracts will require the parties to rely on accounting information to verify
performance according to the contract? Be specific.

Using Information About Risk to Make Decisions
Objs. 4, 6 Nancy and Mauro are reviewing the information given below for different reasons. Nancy is
a bank loan officer who has received a 2-year, $50,000 loan application from both firms. Mauro
is an independently wealthy investor who is considering investing $50,000 in a company. The
information below is just one part of a complete data set about the companies that both per-
sons are reviewing. The data reveal the profit history of the two firms over the last seven years.
The companies are very similar except for the way in which their profits vary over the years.
(All dollar amounts are in thousands.)

2004 2003 2002 2001 2000 1999 1998 Total
Hill Country Enterprises 337 315 303 268 207 225 201 1,856
Low Land Associates 730 (55) (10) 598 (131) 619 498 2,249

A. Explain the concept of risk and its usual relationship to return on investment.
B. If you were Nancy, would you be more likely to make the loan to Hill Country or to
Low Land? Why?
C. If you were Mauro, would you be more likely to invest in Hill Country or Low Land?
D. Suppose the financial information of Low Land Associates (but not that of Hill Coun-
try Enterprises) has been audited and verified as being in conformance with generally
accepted accounting principles. Would that change your responses to parts (b) and (c)

Using Financial Information to Assess Risk
Obj. 6 Assume you are the credit manager for a manufacturing company that sells its products to
retail businesses. One of your company™s sales representatives has been working hard to
establish business relationships with two different retailers. Both businesses are interested
in marketing your products. Summary earnings information is presented below for each

Profits (losses)
2001 2002 2003 2004
Company A 80,000 20,000 (10,000) 70,000
Company B 30,000 32,000 40,000 43,000

A. Based on the summary financial information, which company is a better credit risk?
B. When a new relationship is established between two businesses, would the customer be
interested in information about the supplier™s financial condition? Why or why not?
CHAPTER F1: Accounting and Organizations
38 Accounting and Organizations

P1-16 Accounting Information and Management Compensation
Objs. 6, 8
Taylor Grey is the sales manager of an electronics manufacturing company. His annual bonus
is based on profits earned by the company. On December 30, Taylor is inquiring about the
status of a very large order that he would like to include in the year-end profit figures. Un-
fortunately, a production machine has broken down. Taylor has been advised the order will
not be completed and shipped by the end of the year. The profit figures including and ex-
cluding the order appear below.

Profit Including the Order Profit Excluding the Order
$2,300,000 $1,500,000

Taylor™s bonus is 3% of profits.

A. Using the financial information provided, calculate Taylor™s bonus under both scenarios.
B. Why do companies use accounting information to evaluate managerial performance?
C. Is there an economic incentive for Taylor to misrepresent the annual sales?

The Value of an Audit
Obj. 7 Assume you have inherited a sum of money from a distant relative and are looking for good
investment opportunities. You are considering investing in one of two companies, Wonder-
works or Hoffstetter™s. Both companies are retailing organizations that have earned profits
during the month of January as follows:

Wonderworks Hoffstetter™s
Resources created $50,000 $60,000
Resources consumed:
Cost of merchandise sold $30,000 $35,000
Wages 5,000 4,000
Rent 2,000 2,500
Supplies 1,500 1,700
Utilities 700 500
Total cost of resources consumed 39,200 43,700
Profit earned $10,800 $16,300

You learn that a CPA examined the financial information provided by Wonderworks and
confirmed the information was prepared according to GAAP.
“I don™t see any reason to pay a CPA to examine my company™s books,” Patty Hoffstet-
ter tells you. They add to the cost of conducting business. Hoffstetter™s brother-in-law pre-
pared the company™s financial information. He has no formal training in accounting but
followed the instructions provided in the accounting software package that he purchased from
an office supply company.

A. Do you agree that the audit adds no value? Why or why not?
B. GAAP help ensure that users can compare the financial information of two different
companies. The two sets of financial information appear identical in format. Are they

The Importance of Accounting Regulations
Obj. 7 In its 2001 annual report, Qwest Communications International Inc. (“Qwest”) stated that
because of an SEC investigation, it couldn™t guarantee that it would not have to restate its
earnings (to make them consistent with GAAP). A restatement could wipe out more than $500
million of earnings, bringing Qwest close to violating agreements with its creditors. The biggest
problem with a restatement is that Qwest faces lawsuits alleging that company executives made
misleading statements to prop up the stock price.
Learn more about the
SEC. (Continued)
Source: www.msnbc.com
F40 SECTION F1: The Accounting Information System
Accounting and Organizations

A. What is the SEC? What is its mission?
B. If a company™s management believes they have reported earnings in a meaningful way,
why can the SEC force them to restate earnings?
C. If management issued misleading financial information, do the shareholders have a rea-
son to be upset with the company? Explain.

Ethics and Moral Hazard
Obj. 8 You are the manager of a retail electronics store. Recently, you purchased 200 What-A-Sound
portable CD players from a wholesaler in a going-out-of-business sale. These units cost you
$80 each, about half of the normal cost of other brands that you sell for $260. You expected
to sell these units at the regular price and earn an above-normal profit. After your purchase,
you discovered that the units were poorly constructed and would probably last about a third
as long as other major brands.
Customers often ask you for a recommendation when considering the purchase of a
portable CD player. If you tell them the truth about the What-A-Sound model, you may have
difficulty selling these units, even if you offer a steep discount.

A. What will you tell a customer who asks about these units?
B. What are the short-run and long-run implications for your company™s profits if (a) you
conceal the quality of the units and sell them at their regular price or (b) reveal the
quality problem? If you were to choose alternative b, what options might you consider
in an effort to minimize the effect of these units on your profits?

Ethics and Moral Hazard
Obj. 8 You manage an auto service store. One of your major services is brake replacement. You pur-
chase replacement parts at an average cost of $30 per set. Each set contains parts for four
wheels and will repair one car. You charge an average of $100 per car for replacing worn
brakes, including an average labor cost of $40. Your current volume for brake replacements
is about 700 jobs per month. A new vendor has contacted you with an offer to sell you re-
placement parts at an average cost of $22.50 per set. After checking on the quality of these
parts, you find that their average life is about two-thirds that of the parts you are currently

A. What are the short-run profit implications of using the $22.50 brakes instead of the
$30 brakes?
B. What are the long-run profit implications?
C. What ethical issues should be considered in choosing which brakes to use?

Excel in Action
Millie and Milo Wermz are the owners and managers of a small bookstore, The Book Wermz,
near a college campus. The store specializes in rare and out-of-print books. During Septem-
ber 2004, the company sold $40,000 of books. The books cost the company $28,000. The cost
of other resources used during September included:

Wages $4,200
SPREADSHEET Supplies 2,000
Rent 1,500
Utilities 300

Required Use a spreadsheet to prepare a report describing profit earned by The Book Wermz
for September. The spreadsheet should contain the following heading:

The Book Wermz
Profit Earned
For September 2004
CHAPTER F1: Accounting and Organizations
40 Accounting and Organizations

The merge and center button can be used to center the heading in the first three
rows of the spreadsheet. Select the cells that will contain the heading, and then click the merge
button to combine these cells.
The report should list each resource created or consumed during September and should
include a formula to automatically calculate the profit earned as the difference between re-
sources created and resources consumed. Use the appropriate format buttons to format the
numbers to include commas. Show resources consumed as negative amounts. The first and
last numbers in the column should include dollar signs.
The completed worksheet should look like the following example:

Use formula to
calculate total

It is important to save your work on a regular basis. Save your work before you make
any major changes so that mistakes will not require you to redo a lot of work.

Multiple-Choice Overview of the Chapter
1. The basic purpose of accounting is to:
a. minimize the amount of taxes a company has to pay.
b. permit an organization to keep track of its economic activities.
c. report the largest amount of earnings to stockholders.
d. reduce the amount of risk experienced by investors.

2. A primary purpose of all organizations in our society is to:
a. make a profit.
b. minimize the payment of taxes.
c. provide employment for the largest number of workers possible.
d. create value by transforming resources from one form to another.

3. Value is created when organizations:
a. raise capital by borrowing funds from banks, individuals, or other businesses.
b. pay cash to suppliers, employees, owners, and government.
c. sell products or services at prices that exceed the value of resources consumed.
d. invest in machinery.

4. Which of the following are features of the corporate form of business organization?
Mutual Agency Limited Liability
a. Yes Yes
b. Yes No
c. No Yes
d. No No
5. Tammy Faye invested $2,000 in a partnership. One year later, the partnership was sold,
and cash from the sale was distributed to the partners. On that date, Tammy received a
check for her share of the company in the amount of $2,250. What was Tammy™s re-
turn on investment?
F42 SECTION F1: The Accounting Information System
Accounting and Organizations

a. $0
b. $250
c. $2,000
d. $2,250

6. Sternberg Enterprises developed a new type of roller skate that is very popular because
of its high quality and reasonable price. Sternberg is losing money on the product,
however, because several key production personnel recently resigned and replacements
are not as skilled. Which of the following terms properly describe the firm?
Effective Efficient
a. Yes Yes
b. Yes No
c. No Yes
d. No No

7. The transformation of resources refers to:
a. the assessment of employee performance.
b. converting resources from one form to a more valuable form.
c. procedures designed to reduce a company™s risk.
d. training methods by which unskilled workers become efficient and effective.

8. An investor is evaluating the potential investments described below. Past financial re-
sults of these two companies are judged to be indicative of future returns and risk.

Abercrombie Fitch
Year Profits Profits
A $16 $6
B 18 48
C 20 3

From the information provided, which investment appears to have the higher return
and which the higher risk?
Highest Return Highest Risk
a. Abercrombie Abercrombie
b. Abercrombie Fitch
c. Fitch Abercrombie
d. Fitch Fitch

9. SEC stands for:
a. Securities Excellence Commission
b. Securities and Exchange Commission
c. Standard Executive Compensation
d. Salaried Executive™s Council

10. Ethical behavior is particularly important for accounting because:
a. companies cannot detect unethical behavior.
b. if the reports are wrong, accountants may have to go to jail.
c. the SEC cannot carefully audit each company™s financial statements.
d. the reliability of accounting information depends on the honesty of those who pre-
pare, report, and audit this information.

Understanding the Transformation Process
Obj. 2 Environmental Housing Company designs and builds log homes. It purchases logs and other
building materials from other companies. The logs are cut to the dimensions called for in a
design and shipped to the customer™s building site with other materials for assembly. Envi-
ronmental Housing employs construction and assembly workers, maintenance personnel, and
CHAPTER F1: Accounting and Organizations
42 Accounting and Organizations

marketing and service personnel, in addition to its management and office staff. The com-
pany is in charge of the construction process until the home is completed and ready for oc-

Required Identify the resources, transformation activities, and goods of Environmental
Housing™s transformation process. Construct a diagram similar to Exhibit 4 that shows the
flow of resources through the transformation process.
F2 2
How do we know how well our business is doing?

A fter developing an understanding of the purpose of a business and the consid-
erations involved in starting a business, Maria and Stan officially began Mom™s
Cookie Company in January of 2004. Their first task was to obtain financial resources
for the business. Then, they acquired equipment and other resources for the business,
and they began to produce and sell their products. In addition, they needed an ac-
counting system to record their business activities and to report how the business was

If you were starting a business, what kinds of information would you want to know about your business?
How would you keep track of where the company obtained financial resources, how those resources were
used, and the amounts of other resources the company has available for use? How would you know how
much of your product you were selling and how much it was costing you to acquire and sell the product?
For answers to these questions Maria and Stan are meeting with their accountant, Ellen.

Once you start your business, you will need an accounting system for recording business activities and for
providing reports to help you understand how your business is performing.
Is this something we can do ourselves?
Yes, for now, since your business will not be very complicated. You can set up a basic accounting system
and keep track of your activities. The system will help you understand your business and events that affect
how well you are doing.
How do we get started?
We will start with a simple set of accounts and look at how these accounts are related. As your company
acquires and uses resources, we will record each event. At the end of the month, we will summarize these
activities and prepare financial statements.
What will the statements tell us?
The statements will report the resources available to your company, how you financed those resources,
and how the resources were used.
Will we know whether our company is making money?
Yes, we can prepare a statement that will tell you how much profit the company earns each month. By the
time we are finished, you™ll have a pretty good idea of whether the company is performing as well as you
hope it will.
CHAPTER F2: Business Activities”The Source of Accounting Information
44 Business Activities - The Source of Accounting Information


Once you have completed this chapter, you 3 Identify investing activities and explain
should be able to: why they are important to a business.
1 Identify financing activities and explain 4 Identify operating activities and explain
why they are important to a business. how they create profits for a company.
2 Demonstrate how accounting measures 5 Describe how financial reports summarize
and records business activities. business activities and provide information
for business decisions.

A business is an organization that exists for the purpose of making a profit for its
owners. A business creates a profit if it can sell goods and services to customers at prices
that are greater than the total costs incurred to provide those goods and services. To be
Identify financing
activities and explain why successful, a business must be effective in meeting the needs of customers by provid-
they are important to a ing goods and services demanded by customers at prices they are willing to pay. Also,
business. a business must be efficient in controlling costs so that the prices charged to customers
exceed the costs to the company of acquiring and selling its products. If a company is
successful, it creates value for its owners as well as for other stakeholders. Profit is a
measure of the value created by a business for its owners.
Maria and Stan started Mom™s Cookie Company in January of 2004. The goods they
sell are prepared from their mother™s recipes. It is important to keep in mind that a busi-
ness is a separate entity from its owners. The resources and activities of the business
should be kept separate from those of the owners or managers of a business. Through-
out this book we will discuss accounting issues related to Mom™s Cookie Company. We
will be accounting for the company, not for the owners or other stakeholders.
To start their business, Maria and Stan invested $10,000 from their savings. This
money enabled the company to acquire resources it would need to operate. A contri-
bution by owners to a business, along with any profits that are kept in the business,
is known as owners™ equity. The contribution provides resources to the company and
represents a claim by the owners. Owners have a claim to profits earned by a business
and to the resources owned by the business.
Because they needed more money to get started, Maria and Stan borrowed $8,000
from a local bank to help finance the business. Borrowing is another source of money
for a company and represents a claim by the lender of the money. As noted in Chap-
ter F1, those who lend money to a business are referred to as creditors of the business.
Creditors have a claim for repayment of amounts the company borrows and for inter-
est on amounts borrowed. The amount a company borrows is the principal of a loan.
Interest is the cost of borrowing and is paid to cred-
itors in addition to the repayment of principal.
Contributions by owners and loans from credi-
Keep in mind that the business is an accounting entity separate
tors are examples of business activities, as illustrated
from its owners. From an accounting perspective, the bank lends
in Exhibit 1. Business activities are events that oc-
the $8,000 to the business, Mom™s Cookie Company, not to Maria
cur when a business acquires, uses, or sells re-
and Stan.
sources or claims to those resources. Exhibit 1
illustrates business activities as the exchange of re-
sources and claims between creditors and owners and the company.
Contributions by owners and loans from creditors are examples of financing activ-
ities. Financing activities occur when owners or creditors provide resources to a com-
pany or when a company transfers resources to owners or creditors, as in the repayment
of a loan principal. Financing activities provide financial resources for businesses. How
F46 SECTION F1: The Accounting Information System
Business Activities - The Source of Accounting Information

Exhibit 1
Business Activities:
Financing from Owners
and Creditors


Mom™s Cookie

Ownership and
Creditor Contracts

businesses use those resources is a topic discussed later in this chapter when we exam-
ine investing and operating activities. First, we look at how we account for financing and
other business activities.

Accounting provides a basis for describing business activities. Accounting measures,
records, reports, and analyzes business activities using accounts. An account is a record
Demonstrate how of increases and decreases in the dollar amount associated with a specific resource or
accounting measures and activity. Accounting transactions are descriptions of business activities (or events)
records business activities. that are measured in dollar values and recorded in accounts. In general, the amount
recorded for an event is the cash value of resources transferred or used in a business
Financial accounting records transactions by using the accounting equation. The
accounting equation shows the fundamental relationship between resources and claims
to those resources:


Assets are the resources controlled by a business. Liabilities are the claims of cred-
itors to a company™s resources. Liabilities are the resources a company would have to
transfer to creditors to satisfy those claims. As noted earlier, owners™ equity is the claim
of owners to a company™s resources. Accounts are
LEARNING NOTE specific types of assets, liabilities, or owners™ equity.
Exhibit 2 illustrates financing activities of Mom™s
“Account” is the root of “accounting.” The root of “account” is
Cookie Company. The company received $10,000 from
“count.” Thus, we can observe that accounting is a process of
Maria and Stan. Then, it borrowed $8,000 from a bank.
quantifying (“counting”) business activities and recording them
Consequently, the company has assets (cash) valued at
in specific information categories as a means of understanding
$18,000. Creditors have a claim of $8,000, and owners
these activities.
have a claim of $10,000 on the company™s assets.

Exhibit 2
Owners™ Equity
The Effect of Financing Liabilities
Activities on the $8,000
Accounting Equation
CHAPTER F2: Business Activities”The Source of Accounting Information
46 Business Activities - The Source of Accounting Information

Exhibit 3 provides an accounting representation of financing activities. On Janu-
ary 2, 2004, Mom™s Cookie Company received $10,000 from the company™s owners. On
January 3, 2004, the company received $8,000 from the bank. These events are recorded
as increases (or decreases, if needed) in specific accounts.

Exhibit 3 OWNERS™
Date Accounts
Representation of
Beginning Amounts 0 0 0
Financing Activities
Jan. 2 Cash 10,000
Contributed Capital 10,000
Jan. 3 Cash 8,000
Notes Payable 8,000
Ending Amounts 18,000 8,000 10,000

Accounts associated with these transactions include Cash, Contributed Capital,
and Notes Payable. Cash refers to financial resources in the form of coins and cur-
rency, bank deposits, and short-term investments that can be converted easily into
currency and that can be used to pay for resources and obligations of a company.
Contributed Capital is an owners™ equity account and identifies amounts con-
tributed to a company by its owners. Notes Payable is a liability account used to
identify amounts a company owes to creditors with whom a formal agreement, or
note, has been signed.
As Exhibit 3 illustrates, accounting measures business activities in terms of dollar
values, and records these activities in accounts. Thus, accounting provides a systematic
way for a business to keep track of its activities. A review of a company™s transactions
reveals the events that occurred, when they occurred, the amounts involved, and the
resources and claims that were exchanged. Good business decisions depend on accu-
rate and timely information about business activities. Decision makers need to know
what the business did and how the business was affected by those activities. Account-
ing is a primary source of this information. It is important that accounting provide a
complete record of a company™s business activities. Only then do decision makers have
a full and fair description of those activities.

Case In Point
Consequences of Unreported Liabilities
One of the primary criticisms of Enron Corporation™s accounting was that it failed to
report large amounts of debt (liabilities) that the company was responsible for repay-
ing. The company™s owners and other stakeholders were not easily able to identify or
http://ingram. measure the amount of debt owed by the corporation. Consequently, their investments
swlearning.com in Enron were riskier than they thought. When some of Enron™s business operations
proved to be less profitable than anticipated, the corporation had difficulty meeting its
Visit the Enron site for
obligations. If owners and other stakeholders had known the true amount of the com-
the latest news.
pany™s debt, they may have been less willing to purchase the company™s stock or lend
money to the company, and some owners and creditors may have avoided losses they
incurred when the company™s actual financial condition became known.

Before a company can sell goods and services to customers, it must acquire resources
needed to operate the business. The particular resources a business needs depends on
what the business is. Maria and Stan do not have sufficient resources to produce their
cookies. Instead, they have contracted with a local bakery to make the cookies from
F48 SECTION F1: The Accounting Information System
Business Activities - The Source of Accounting Information

their mother™s recipes. The bakery will order containers and package the cookies with
the Mom™s Cookie Company label. Maria and Stan have arranged to sell the cookies to
Identify investing local grocery stores.
activities and explain why The primary resources Mom™s Cookie Company needs are office equipment and de-
they are important to a livery equipment. Maria and Stan will use the office equipment to maintain information
business. about the business and to make contacts with the bakery and grocery stores. Delivery
equipment will be used to pick up cookies from the bakery and to deliver them to stores.
Resources such as office equipment and delivery equipment are long-term resources be-
cause they can be used for more than one year. These resources enable a company to ac-
quire and sell its products but are not products themselves. Activities involving the
acquisition or disposal of long-term resources used by a business are investing activ-
ities. Exhibit 4 illustrates investing activities for Mom™s Cookie Company. Long-term re-
sources (such as office and delivery equipment) are acquired from suppliers. Money, or
a promise of future payment, is transferred to suppliers of these resources.

Exhibit 4
Business Activities:
Investing in Long-Term

Office Distribution
Equipment Equipment

Mom™s Cookie


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