o Chapter 1: INTRODUCTION TO ACCOUNTING

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1 ACCOUNTING 2-MANAGERIAL ACCOUNTING o Chapter 1: INTRODUCTION TO ACCOUNTING AND BUSINESS Teacher Version

2 Learning Objectives 1. Describe the nature of a business and the role of accounting and ethics in business. 2. Summarize the development of accounting principles and relate them to practice. 3. State the accounting equation and define each element of the equation. 4. Describe and illustrate how business transactions can be recorded in terms of the resulting change in the elements of the accounting equation. 5. Describe the financial statements of a corporation and explain how they interrelate. 6. Describe and illustrate the use of the ratio of liabilities to stockholders equity in evaluating a company s financial condition.

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4 Nature of Business and Accounting o 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.

5 Nature of Business and Accounting o The objective of most businesses is to EARN a PROFIT. o Profit is the DIFFERENCE between the amounts RECEIVED from customers for goods or services and the amounts PAID for the INPUTS used to provide the goods or services.

6 TYPES OF BUSINESSES SERVICE BUSINESSES DELTA AIR LINES WALT DISNEY COMPANY MERCHANDISING BUSINESSES WALMART AMAZON.COM MANUFACTURING BUSINESSES FORD MOTOR COMPANY DELL SERVICE PROVIDED TRANSPORTATION SERVICES ENTERTAINMENT SERVICES PRODUCT PROVIDED GENERAL MERCHANDISE INTERNET BOOKS, MUSIC, VIDEOS PRODUCT PROVIDED CARS, TRUCKS, VANS PERSONAL COMPUTERS

7 The Role of Accounting in Business o ACCOUNTING can be defined as an information system that provides REPORTS to users about the ECONOMIC ACTIVITIES and CONDITION of a BUSINESS.

8 The Role of Accounting in Business o The process by which accounting provides information to users is as follows: IDENTIFY USERS ASSESS USERS INFORMATION NEEDS DESIGN THE ACCOUNTING INFORMATION SYSTEM TO MEET USERS NEEDS RECORD ECONOMIC DATA ABOUT BUSINESS ACTIVITIES AND EVENTS PREPARE ACCOUNTING REPORTS FOR USERS

9 MANAGERIAL Accounting o The area of accounting that provides internal users with information is called MANAGERIAL ACCOUNTING or MANAGEMENT ACCOUNTING. o MANAGERIAL accountants employed by a business are employed in PRIVATE accounting.

10 FINANCIAL Accounting o The area of accounting that provides external users with information is called FINANCIAL ACCOUNTING. o The objective of financial accounting is to provide RELEVANT and TIMELY information for the DECISION-MAKING needs of users OUTSIDE of the business. o General-purpose FINANCIAL STATEMENTS are one type of financial accounting report that is distributed to EXTERNAL users.

11 Role of Ethics in Accounting and Business o The objective of accounting is to provide relevant, timely information for user DECISION MAKING. o Accountants must behave in an ETHICAL manner so that the information they provide users will be TRUSTWORTHY and, thus, USEFUL for decision making. o ETHICS are MORAL principles that guide the CONDUCT of individuals.

12 Opportunities for Accountants o Accountants and their staffs who provide services on a FEE BASIS are said to be employed in PUBLIC accounting. o Accountants employed by a BUSINESS FIRM, or a NOT-FOR-PROFIT ORGANIZATION are said to be employed in PRIVATE accounting. o Public accountants who have met a STATES S EDUCATION, EXPERIENCE and EXAMINATION requirements may become CERTIFIED PUBLIC ACCOUNTANTS (CPA S)

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14 Generally Accepted Accounting Principles o Financial accountants follow GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) in preparing reports. o Within the U.S., the FINANCIAL ACCOUNTING STANDARDS BOARD (FASB) has the PRIMARY responsibility for DEVELOPING accounting principles.

15 Generally Accepted Accounting Principles o The SECURITY AND EXCHANGE COMMISSION(SEC), an AGENCY of the U.S. government, has authority over the accounting and financial DISCLOSURES for companies whose SHARES of OWNERSHIP (STOCK) are TRADED and sold to the PUBLIC. o Many countries OUTSIDE the United States use generally accepted accounting principles adopted by the INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB).

16 Business ENTITY Concept o Under the BUSINESS ENTITY concept, the ACTIVITIES of a business are recorded SEPARATELY from the activities of its OWNERS, CREDITORS, or OTHER BUSINESSES.

17 A PROPRIETORSHIP is owned by ONE individual. 70% of business entities in the U.S. are proprietorships. They are easy and cheap to organize. Resources are limited to those of the owner. Used by small businesses.

18 A PARTNERSHIP is similar to a PROPRIETORSHIP except that it is owned by TWO or MORE individuals. 10% of business organizations in the U.S. (combined with limited liability companies) are partnerships. Combines the skills and resources of more than one person.

19 A CORPORATION is organized under STATE or FEDERAL statutes as a separate LEGAL TAXABLE entity. Generates 90% of business revenues. 20% of the business organizations in the U.S. Ownership is divided into shares, called stock. Can obtain large amounts of resources by issuing stock. Used by large businesses.

20 A LIMITED LIABILITY COMPANY (LLC) combines the attributes of a PARTNERSHIP and a CORPORATION. 10% of business organizations in the U.S. (combined with partnerships). Often used as an alternative to a partnership. Has tax and legal liability advantages for owners.

21 COST Concept o Under the COST concept, amounts are INITIALLY recorded in the accounting records at their COST or PURCHASE PRICE.

22 o Aaron Publishers purchased a building on February 20, 2012, for $150,000. Other amounts related to this purchased are shown. Price listed by seller on Jan. 1, 2012 $160,000 Aaron Publishers initial offer to buy on Jan. 31, ,000 Purchase price on Feb. 20, ,000 Estimated selling price on Dec. 31, ,000 Assessed value for property taxes, Dec. 31, ,000 At what price will this be recorded on the books of Aaron Publishers using the Cost Concept? $150,000

23 o The OBJECTIVITY concept requires that the amounts recorded in the accounting records be based on OBJECTIVE evidence. o Only the FINAL AGREED-UPON amount is OBJECTIVE enough to be recorded in the accounting records. The UNIT OF MEASURE concept requires that ECONOMIC DATA be recorded in DOLLARS.

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25 The ACCOUNTING EQUATION o The resources owned by a business are its ASSETS. o The rights of CREDITORS are the DEBTS of the business and are called LIABILITIES. o The rights of the OWNERS are called STOCKHOLDER S equity for a corporation and OWNER S equity for a proprietorship, partnership, or limited liability company. o The equation ASSETS = LIABILITIES + OWNER S EQUITY is called the ACCOUNTING EQUATION.

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27 o A BUSINESS transaction is an ECONOMIC event or CONDITION that DIRECTLY changes an entity s FINANCIAL condition or its results of OPERATIONS. o The liability created by a purchase on ACCOUNT is called an ACCOUNTS PAYABLE. o Items such as supplies that will be used in the business in the FUTURE are called PREPAID EXPENSES, which are assets.

28 o REVENUE from providing services is recorded as FEES EARNED. o Revenue from the SALE of merchandise is recorded as SALES. o Other examples of revenue include rent, which is recorded as RENT revenue, and INTEREST, which is recorded as interest revenue. o An account RECEIVABLE is a claim against a CUSTOMER, which is an ASSET.

29 You Should Note the Following: o The effect of every transactions is an INCREASE OR A DECREASE IN ONE OR MOR OF THE ACCOUNTING EQUATION ELEMENTS. o The two sides of the accounting equations are ALWAYS EQUAL. o The stockholders equity (owner s equity) is INCREASED BY AMOUNTS INVESTED by STOCKHOLDERS (CAPITAL STOCK).

30 You Should Note the Following: o The stockholders equity (owner s equity) is INCREASED BY REVENUE AND DECREASED BY EXPENSES. o The stockholders equity (OWNER S EQUITY) is decreased BY DIVIDENDS PAID to stockholders. o RETAINED EARNINGS is the STOCKHOLDERS EQUITY created from business operations through revenue and EXPENSE transactions.

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32 FINANCIAL Statements o After transactions have been RECORDED and SUMMARIZED, reports are prepared for users. The accounting REPORTS providing this information are called FINANCIAL STATEMENTS.

33 Income Statement o The INCOME STATEMENT reports the revenues and EXPENSES for a PERIOD of time, based on the MATCHING concept. o The MATCHING concept is applied by MATCHING the EXPENSES incurred during a period with the REVENUE that those EXPENSES generated. o The excess of the REVENUE over the EXPENSES is called NET income, NET PROFIT, or EARNINGS. If EXPENSES exceed REVENUE, the EXCESS is a NET loss.

34 Retained Earnings Statement o The RETAINED EARNINGS STATEMENT reports the changes in the RETAINED EARNINGS for a period of time. o It is prepared AFTER the income statement because the NET INCOME or NET LOSS for the PERIOD must be reported in this statement.

35 BALANCE SHEET o A balance sheet is a list of the ASSETS, LIABILITIES, and STOCKHOLDERS EQUITY as of a SPECIFIC DATE. o The ACCOUNT form of a BALANCE SHEET lists the assets on the LEFT and the LIABILITIES and STOCKHOLDERS EQUITY on the right. It resembles the basic format of the ACCOUNTING EQUATION.

36 STATGEMENT of Cash FLOWS o A STATEMENT OF CASH FLOWS is a summary of the cash RECEIPTS and cash PAYMENTS for a SPECIFIC PERIOD of time. It consists of three sections: (1) OPERATING ACTIVITIES (2) INVESTING ACTIVITIES (3) FINANCING ACTIVITIES

37 o The cash flows from OPERATING ACTIVITIES section reports a summary of cash RECEIPTS and cash PAYMENTS from operations. o The cash flows from INVESTING ACTIVITIES section reports the cash transactions for the ACQUISITION and SALE of relatively permanent assets. o The cash flows from FINANCING ACTIVITIES section reports the cash TRANSACTIONS related to cash INVESTMENTS by the OWNER, BORROWINGS, and cash dividends

38 This amount should match CASH on the BALANCE SHEET.

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40 RATIO OF LIABILITIES TO STOCKHOLDERS EQUITY = TOTAL LIABILITIES Total STOCKHOLDERS Equity Ratio of to Equity = $ $ =