Chapter 1

Elements of Accounting

Accounting is a subject that requires you to learn concepts in a specific order. That's because concept B builds upon what you learned about concept A. In fact, an accounting student can get very frustrated trying to learn a concept by jumping ahead and not understanding earlier concepts. This chapter provides some of the critical elements of accounting. You need these concepts before moving on to any other accounting topics.

The Problems You'll Work On

In this chapter, you see a variety of algebra problems:

• Working with transactions that change the accounting equation
• Defining assets, liabilities, equity, revenue, and expenses
• Understanding the differences between cash-basis and accrual-basis accounting
• Compiling the income statement using revenue and expense transactions
• Using the balance sheet and the income statement

What to Watch Out For

Don't let common mistakes trip you up. Some of the following suggestions may be helpful:

• Be careful when using the accounting equation. There are two versions of the formula. One is assets - liabilities = equity. The other is assets = liabilities + equity. Keep in mind which version you're using.
• The profit calculation using accrual accounting is unrelated to a firm's cash position. A firm can have a very profitable month and have a very low cash position.
• To understand the statement of cash flows, identify the investment and financing transactions first. After you identify those transactions, all the other cash flows are related to operations.
• Accounts receivable and accounts payable transactions are only posted when you use accrual accounting. If a company is using the cash basis, you don't use receivables or payables.

Types of Business Entities

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1. Business entities can legally be organized in a variety of ways. What is a common characteristic among all business entity types?

2. What business type is a single-owner business?

3. Entering into a business with another person is an example of what type of business entity?

4. Why is a sole partnership not one of the ways of legally organizing a business?

5. Which business type is most difficult to create initially but, once created, makes it easier to raise funds and provides liability protection for the owners?

The Accounting Equation and Why It Balances

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6. What is the proper format of the basic accounting equation?

7. What are assets?

8. What makes a vehicle purchased with a loan an example of an asset?

9. What are liabilities?

10. Why is money owed to a bank on a loan considered a liability?

11. What does it mean when a company purchases something on account?

12. Why is a loan from a bank not an asset?

13. Why is office equipment an example of an asset?

14. What is the name for resources owned by a company?

15. A business has assets of $135,000 and liabilities of $45,000. Calculate the amount of owners' equity.

16. A business has liabilities of $345,700 and owners' equity of $154,300. Calculate the amount of assets the company has.

17. At the end of an accounting period, a company's total assets equaled $1,450,000, and owners' equity was $654,000. How much were the company's liabilities?

18. At the end of an accounting period, a company's total assets equaled $576,000, and liabilities equaled $245,000. How much was the company's owners' equity?

19. At the end of an accounting period, a company's owners' equity equaled $2,376,000, and its liabilities equaled $142,000. How much were the company's assets?

20. What does it mean when a business has negative retained earnings?

21. What is the effect on the accounting equation if a company buys a truck with a cash down payment of $5,000 and borrows the remaining $25,000?

22. What is the effect on the accounting equation when a company pays cash for purchases of inventory?

23. What is the effect on the accounting equation when a company obtains a loan to purchase a delivery truck?

24. A company owes a supplier $37,000 for inventory purchased a week ago. What is the effect on the accounting equation if the company makes a $20,000 payment?

25. What is the effect on the accounting equation when owners contribute a delivery truck to a company?

26. What is the effect on the accounting equation when a company earns revenue by selling a product and collects the amount of the sale in cash?

27. What is the impact on the accounting equation when a company uses its cash to pay for office expenses such as rent and utilities?

28. What does it mean when a business is highly leveraged?

29. The owners of a start-up invest $1,000,000 into the business. After one year of operations, the business has assets of $850,000 and losses of $300,000. What are the total liabilities at the end of the first year?

30. The owners of a start-up invest $50,000 into the business. After one year of operations, the business has assets of $350,000 and liabilities of $200,000. How much profit or loss did the business generate during the first year?

Cash-basis Accounting versus Accrual-basis Accounting

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31. What is the main characteristic of cash-basis accounting?

32. What is the main characteristic of accrual-basis accounting?

33. What is the primary difference between cash-basis and accrual-basis accounting?

34. Cash-basis accounting is most frequently used by which group?

35. Accrual-basis accounting is most frequently used by which group?

36. Why is cash-basis accounting not used by large businesses?

37. When are transactions recorded under accrual-basis accounting?

38. Al LaMode Ice Cream Company produces high-quality ice cream that is distributed to shops in resort areas. On July 1, the company purchased the raw materials to make the ice cream. On July 15, the process was complete, and the product was stored in the freezer ready to ship to customers. On July 31, Ken and Mary's Ice Cream Shop ordered 200 pounds of ice cream. On August 1, Al LaMode delivered the ice cream to Ken and Mary's Ice Cream Shop. Ken and Mary paid Al LaMode on August 10. Ken and Mary sold all the ice cream between August 5 and August 12. If it uses accrual-basis accounting, when will Al LaMode record the revenue from the sale to Ken and Mary?

39. Al LaMode Ice Cream Company produces high quality ice cream that is distributed to shops in resort areas. On July 1, the company purchased the raw materials to make the ice cream. On July 15, the process was complete, and the product was stored in the freezer ready to ship to customers. On July 31, Ken and Mary's Ice Cream Shop ordered 200 pounds of ice cream. On August 1, Al LaMode delivered the ice cream to Ken and Mary's Ice Cream Shop. Ken and Mary paid Al LaMode on August 10. Ken and Mary sold all the ice cream between August 5 and August 12. If it uses cash-basis accounting, when will Al LaMode record the revenue from the sale to Ken and Mary?

40. Little Falls Bandages sells medical supplies to college football teams. The teams pay a flat fee of $10,000 on August 1 for as many bandages as they need during the football season, September through November. If they use cash-basis accounting, how much revenue does Little Falls record in September?

41. Furd Buggy Company uses electricity in its retail shop during the month of May. On June 15, the company receives the bill for the May electricity usage for $759. Furd pays the bill on July 1. If Furd Buggy Company uses accrual-basis accounting, on which month's income statement will the expense appear, and how much will it be?

42. Credit Cab Corporation buys fuel from a fuel bank, paying $1,000,000 on January 1 for 250,000 gallons of fuel. The company uses the last of the 250,000 gallons on July 1. The January income statement shows a fuel expense of $1,000,000. What basis of accounting does Credit Cab use?

43-49 Use the following information to answer the questions. The following is selected information regarding Ace, Inc. for the fiscal year 2015:

• Cash receipts from sales made in 2015: $750,000
• Cash payments for purchases of inventory in 2015: $325,000
• The company did not have a beginning inventory balance in 2015.
• Cash payments for other expenses: $375,000
• Year-end receivables balance from customers for sales made during the year 2015: $155,000
• Cost of products in ending inventory that have not been sold: $120,000
• Liability for unpaid expenses that were incurred in 2015: $450,000

43. Calculate the amount of cash-basis revenues for Ace, Inc. for 2015.

44. Calculate the amount of cash-basis expenses for Ace, Inc. for 2015.

45. Calculate the amount of cash-basis profit or loss for Ace, Inc. for 2015.

46. Calculate...