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What are the three basic forms of business organizations?

The three basic forms of business organizations are (1) Sole proprietorship, (2) Partnership, and
(3) Corporation.

What are the advantages to a business of being formed as a corporation?

What are the disadvantages?
Advantages of a corporation are limited liability (stockholders not being personally liable for
corporate debts), easy transferability of ownership, and easier to raise funds. Disadvantages of
a corporation are increased taxation and government regulations.

What are the advantages to a business of being formed as a partnership or

sole proprietorship? What are the disadvantages?
Proprietorships and partnerships receive favorable tax treatment compared to corporations and
are easier to form than corporations. They are also owner controlled. Disadvantages of
proprietorships and partnerships are unlimited liability (proprietors/partners are personally liable
for all debts) and difficulty in obtaining financing compared to corporations.

Who are the internal users of accounting data? How does accounting provide
relevant data to the internal users?
Internal users are managers who plan, organize, and run a business. To assist management,
accounting provides timely internal reports. Examples include financial comparisons of operating
alternatives, projections of income from new sales campaigns, forecasts of cash needs for the
next year, and financial statements.

Who are the external users of accounting data? Give examples.

External users are those outside the business who have either a present or potential direct
financial interest (investors and creditors) or an indirect financial interest (taxing authorities,
regulatory agencies, labor unions, customers, and economic planners).

What are the three main types of business activity? Give examples of each
The three types of business activity are financing activities, investing activities, and operating
activities. Financing activities include borrowing money and selling shares of stock. Investing
activities include the purchase and sale of property, plant, and equipment. Operating activities
include selling goods, performing services, and purchasing inventory.

What is the basic accounting equation?

The basic accounting equation is Assets = Liabilities + Stockholders/Owners Equity.

Define the terms assets, liabilities, and Owners equity.

Assets are resources owned by a business. Liabilities are amounts owed to creditors. Put more
simply, liabilities are existing debts and obligations. Owners equity is the ownership claim on net

Which of these items are liabilities of ABC Cleaning Service?

(a) Cash.
(b) Dividends.
(c) Accounts payable.
(d) Accounts receivable.
(e) Supplies.
(f) Service revenue.
(g ) Equipment.
(h) Rent expense.
(i) Salaries and wages payable.
The liabilities are (c) Accounts payable and (i) Salaries and wages payable.




Owners Investment to Form the Business

July 1: Joan Miller invests $40,000 in cash to form Miller Design Studio.

Economic Event That Is Not a Business Transaction

July 2: Orders office supplies, $5,200.

Prepayment of Expenses in Cash

July 3: Rents an office; pays two months rent in advance, $3,200.

Purchase of an Asset on Credit

July 5: Receives office supplies ordered on July 2 and an invoice for $5,200.

Purchase of an Asset Partly in Cash and Partly on Credit

July 6: Purchases office equipment, $16,320; pays $13,320 in cash and agrees to pay
the rest next month.

Payment of a Liability
July 9: Makes a partial payment of the amount owed for the office supplies received on
July 5, $2,600.

Revenue in Cash
July 10: Performs a service for an investment advisor by designing a series of brochures
and collects a fee in cash, $2,800.

Revenue on Credit
July 15: Performs a service for a department store by designing a TV commercial; bills
for the fee now but will collect the fee later, $9,600.

Revenue Collected in Advance

July 19: Accepts an advance fee as a deposit on a series of brochures to be designed,

Collection on Account
July 22: Receives cash from customer previously billed on July 15, $5,000.

Expense Paid in Cash

July 26: Pays employees four weeks wages, $4,800.

Expense to Be Paid Later

July 30: Receives, but does not pay, the utility bill that is due next month, $680.

July 31: Withdraws $2,800 in cash.

Transaction Analysis Problem and Solution:

Joan Robinson opens her own law office on July 1, 2012. During the first month of operations,
the following transactions occurred.
1. Joan invested $11,000 in cash in the law practice.
2. Paid $800 for July rent on office space.
3. Purchased office equipment on account $3,000.
4. Provided legal services to clients for cash $1,500.
5. Borrowed $700 cash from a bank on a note payable.
6. Performed legal services for client on account $2,000.
7. Paid monthly expenses: salaries and wages $500, utilities $300, and supplies $100.
8. Joan withdraws $1,000 cash for personal use.
(a) Prepare a tabular summary of the transactions.

The following situations involve accounting principles and assumptions.
1. Rex Company owns buildings that are worth substantially more than they
originally cost. In an effort to provide more relevant information, Rex reports
the buildings at fair value in its accounting reports.
2. Levi Company includes in its accounting records only transaction data that
can be expressed in terms of money.
3. Josh Borke, owner of Joshs Photography, records his personal living costs
as expenses of the business.
For each of the three situations, say if the accounting method used is correct
or incorrect. If correct, identify which principle or assumption supports the
method used. If incorrect, identify which principle or assumption has been

Thornton Computer Timeshare Company entered into the following
transactions during May 2012.
1. Purchased computer terminals for $20,000 from Digital Equipment on
2. Paid $4,000 cash for May rent on storage space.
3. Received $17,000 cash from customers for contracts billed in April.
4. Provided computer services to Fisher Construction Company for $3,000
5. Paid Northern States Power Co. $11,000 cash for energy usage in May.
6. Thornton invested an additional $29,000 in the business.
7. Paid Digital Equipment for the terminals purchased in (1) above.
8. Incurred advertising expense for May of $1,200 on account.
Indicate with the appropriate letter whether each of the transactions above
results in:
(a) An increase in assets and a decrease in assets.
(b) An increase in assets and an increase in owners equity.
(c) An increase in assets and an increase in liabilities.

(d) A decrease in assets and a decrease in owners equity.

(e) A decrease in assets and a decrease in liabilities.
(f) An increase in liabilities and a decrease in owners equity.
(g) An increase in owners equity and a decrease in liabilities.

Natalie Koebel spent much of her childhood learning the art of cookie-making
from her grandmother. They passed many happy hours mastering every type
of cookie imaginable and later creating new recipes that were both healthy
and delicious. Now at the start of her second year in college, Natalie is
investigating various possibilities for starting her own business as part of the
requirements of the entrepreneurship program in which she is enrolled. A
long-time friend insists that Natalie has to somehow include cookies in her
business plan. After a series of brainstorming sessions, Natalie settles on the
idea of operating a cookie-making school. She will start on a part-time basis
and offer her services in peoples homes. Now that she has started thinking
about it, the possibilities seem endless. During the fall, she will concentrate
on holiday cookies. She will offer individual lessons and group sessions
(which will probably be more entertainment than education for the
participants). Natalie also decides to include children in her target market.
The first difficult decision is coming up with the perfect name for her
business. In the end, she settles on Cookie Creations and then moves on to
more important issues.

Carla Quentin started her own consulting firm, Quentin Consulting, on May 1, 2012. The
following transactions occurred during the month of May.
May 1 Carla invested $7,000 cash in the business.
Paid $900 for office rent for the month.
Purchased $600 of supplies on account.
Paid $125 to advertise in the County News.
Received $4,000 cash for services provided.
Withdrew $1,000 cash for personal use.
Performed $5,400 of services on account.
Paid $2,500 for employee salaries.
Paid for the supplies purchased on account on May 3.
Received a cash payment of $4,000 for services provided on account on May 15.
Borrowed $5,000 from the bank on a note payable.
Purchased office equipment for $4,200 on account.
Paid $275 for utilities.
Show the effects of the previous transactions on the accounting equation using the following

Exercise 5