Introduction to Accounting and Business Chapter 1 Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University
Learning Objectives 1. Describe the nature of a business, 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.
Learning Objective 1 Describe the nature of a business, the role of accounting, and ethics in business.
LO 1 Nature of Business and Accounting A business is an organization in which basic resources (inputs), such as materials and labor, are assembled and processed to provide goods or services (outputs) to customers.
LO 1 Nature of Business and Accounting The objective of most businesses is to earn a profit. Profit is the difference between the amounts received from customers for goods or services and the amounts paid for the inputs used to provide the goods or services.
LO 1 Types of Businesses Service Businesses Delta Air Lines The Walt Disney Company Merchandising Businesses Walmart Amazon.com Manufacturing Businesses Ford Motor Company Dell Service Transportation services Entertainment services Product General merchandise Internet books, music, videos Product Cars, trucks, vans Personal computers
LO 1 The Role of Accounting in Business Accounting can be defined as an information system that provides reports to users about the economic activities and condition of a business.
LO 1 The Role of Accounting in Business 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.
LO 1 The Role of Accounting in Business
LO 1 Managerial Accounting The area of accounting that provides internal users with information is called managerial accounting or management accounting. Managerial accountants employed by a business are employed in private accounting.
LO 1 Financial Accounting The area of accounting that provides external users with information is called financial accounting. The objective of financial accounting is to provide relevant and timely information for the decision-making needs of users outside of the business. General-purpose financial statements are one type of financial accounting report that is distributed to external users.
Role of Ethics in Accounting and Business The objective of accounting is to provide relevant, timely information for user decision making. Accountants must behave in an ethical manner so that the information they provide users will be trustworthy and, thus, useful for decision making. Ethics are moral principles that guide the conduct of individuals. LO 1
Role of Ethics in Accounting and Business LO 1 (continued)
Role of Ethics in Accounting and Business LO 1 (continued)
Role of Ethics in Accounting and Business LO 1 (concluded)
Role of Ethics in Accounting and Business LO 1 The answer to What went wrong for these companies? involves one or both of these factors. (Exhibit 2) Failure of individual character Firm culture of greed and ethical indifference
Role of Ethics in Accounting and Business LO 1
LO 1 Opportunities for Accountants Accountants and their staffs who provide services on a fee basis are said to be employed in public accounting. Accountants employed by a business firm or a not-for-profit organization are said to be employed in private accounting. Public accountants who have met a state s education, experience, and examination requirements may become Certified Public Accountants (CPAs).
LO 1 Opportunities for Accountants
Learning Objective 2 Summarize the development of accounting principles and relate them to practice.
Generally Accepted Accounting Principles Financial accountants follow generally accepted accounting principles (GAAP) in preparing reports. Within the U.S., the Financial Accounting Standards Board (FASB) has the primary responsibility for developing accounting principles. LO 2
Generally Accepted Accounting Principles The Securities 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. Many countries outside the United States use generally accepted accounting principles adopted by the International Accounting Standards Board (IASB). LO 2
LO 2 Business Entity Concept Under the business entity concept, the activities of a business are recorded separately from the activities of its owners, creditors, or other businesses.
LO 2 Proprietorship 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.
LO 2 Partnership 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.
LO 2 Corporation A corporation is organized under state or federal statutes as a separate legal taxable entity. Corporations generate 90% of business revenues. 20% of the business organizations in the U.S. are corporations. Ownership is divided into shares, called stock. (continued)
LO 2 Corporation A corporation is organized under state or federal statutes as a separate legal taxable entity. Can obtain large amounts of resources by issuing stocks. Used by large businesses.
LO 2 Limited Liability Company (LLC) 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.
LO 2 Cost Concept Under the cost concept, amounts are initially recorded in the accounting records at their cost or purchase price.
LO 2 Cost Concept Aaron Publishers purchased a building on February 20, 2010, for $150,000. Other amounts related to this purchased are shown on the next slide.
LO 2 Cost Concept Price listed by seller on January 1, 2010 $160,000 Aaron Publishers initial offer to buy on January 31, 2010 140,000 Purchase price on February 20, 2010 150,000 Estimated selling price on December 31, 2012 220,000 Assessed value for property taxes, December 31, 2012 190,000
LO 2 Objectivity Concept The objectivity concept requires that the amounts recorded in the accounting records be based on objective evidence. Only the final agreed-upon amount is objective enough to be recorded in the accounting records.
LO 2 Unit of Measure Concept The unit of measure concept requires that economic data be recorded in dollars.
EE 1-1
Learning Objective 3 State the accounting equation and define each element of the equation.
LO 3 The Accounting Equation The resources owned by a business are its assets. The rights of creditors are the debts of the business and are called liabilities. The rights of the owners are called owner s equity. The equation Assets = Liabilities + Owner s Equity is called the accounting equation.
LO 3 The Accounting Equation Assets = Liabilities + Owner s Equity The resources owned by a business
LO 3 The Accounting Equation Assets = Liabilities + Owner s Equity The rights of creditors are the debts of the business
LO 3 The Accounting Equation Assets = Liabilities + Owner s Equity The rights of the owners
EE 1-2
Learning Objective 4 Describe and illustrate how business transactions can be recorded in terms of the resulting change in the elements of the accounting equation.
LO 4 Business Transaction A business transaction is an economic event or condition that directly changes an entity s financial condition or its results of operations.
LO 4 Transaction A On November 1, 2011, Chris Clark deposited $25,000 in a bank account in the name of NetSolutions in return for shares of stock in the corporation.
Transaction A Stock issued to owners (stockholders), such as Chris Clark, is referred to as capital stock. The owner s equity in a corporation is called stockholders equity.
LO 4 Transaction B On November 5, 2011, NetSolutions paid $20,000 for the purchase of land as a future building site. The new amounts are called balances.
LO 4 Transaction C On November 10, 2011, NetSolutions purchased supplies for $1,350 and agreed to pay the supplier in the near future.
LO 4 Transaction C The liability created by a purchase on account is called an account payable. Items such as supplies that will be used in the business in the future are called prepaid expenses, which are assets.
LO 4 Transaction D On November 18, 2011, NetSolutions received cash of $7,500 for providing services to customers. A business earns money by selling goods or services to its customers. This amount is called revenue.
LO 4 Transaction D Revenue from providing services is recorded as fees earned. Revenue from the sale of merchandise is record as sales. Other examples of revenue include rent, which is recorded as rent revenue, and interest, which is recorded as interest revenue. An account receivable is a claim against a customer, which is an asset.
LO 4 Transaction E During the month, NetSolutions spent cash or used up other assets in earning revenue. Assets used in this process of earning revenue are called expenses.
LO 4 Transaction E On November 30, 2011, NetSolutions paid the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.
LO 4 Transaction F On November 30, 2011, NetSolutions paid creditors on account, $950.
LO 4 Transaction G On November 30, 2011, Chris Clark determined that the cost of supplies on hand at the end of the period was $550; therefore, the amount of supplies used amounted to $800 ($1,350 $550 = $800).
LO 4 Transaction H On November 30, 2011, NetSolutions paid $2,000 to stockholders as dividends. Dividends are distributions of earnings to stockholders.
LO 4 Summary
LO 4 You Should Note the Following: The effect of every transactions is an increase or a decrease in one or more of the accounting equation elements. The two sides of the accounting equations are always equal. The stockholders equity (owner s equity) is increased by amounts invested by stockholders (capital stock). (continued)
LO 4 You Should Note the Following: The stockholders equity (owner s equity) is increased by revenue and decreased by expenses. The stockholders equity (owner s equity) is decreased by dividends paid to stockholders. Retained earnings is the stockholders equity created from business operations through revenue and expense transactions.
LO 4 Types of Transactions Affecting Stockholders Equity
EE 1-3
Learning Objective 5 Describe the financial statements of a corporation and explain how they interrelate.
LO 5 Financial Statements After transactions have been recorded and summarized, reports are prepared for users. The accounting reports providing this information are called financial statements.
LO 5 Financial Statements
LO 5 Income Statement The income statement reports the revenues and expenses for a period of time, based on the matching concept. The matching concept is applied by matching the expenses incurred during a period with the revenue that those expenses generated. 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.
EE 1-4
LO 5 Retained Earnings Statement The retained earnings statement reports the changes in the retained earnings for a period of time. It is prepared after the income statement because the net income or net loss for the period must be reported in this statement.
LO 5 Retained Earnings Statement To illustrate, assume that NetSolutions earned net income of $4,155 and paid dividends of $2,000 during December. The following statement would be prepared.
EE 1-5
Income Statement LO 5 Net income is carried to the retained earnings statement (continued)
Retained Earnings Statement LO 5 From the income statement To the balance sheet
LO 5 Balance Sheet A balance sheet is a list of the assets, liabilities, and stockholders equity as of a specific date.
LO 5 Account Form 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.
LO 5 Balance Sheet This amount is compared to the net cash flow on the statement of cash flows. From the retained earnings statement
LO 5
LO 5 Statement of Cash Flows 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
LO 5 Statement of Cash Flows This amount should match Cash on the balance sheet.
Cash Flows from Operating Activities The cash flows from operating activities section reports a summary of cash receipts and cash payments from operations. LO 5
Cash Flows from Investing Activities The cash flows from investing activities section reports the cash transactions for the acquisition and sale of relatively permanent assets. LO 5
Cash Flows from Financing Activities The cash flows from financing activities section reports the cash transactions related to cash investments by the owner, borrowings, and withdrawals by the owner. LO 5
EE 1-7
EE 1-7
Interrelationships Among Financial Statements LO 5 Income Statement and Retained Earnings Statement Net income or net loss reported on the income statement is also reported on the retained earnings statement as either an addition (net income) to or deduction (net loss) from the beginning retained earnings.
Interrelationships Among Financial Statements LO 5 In Exhibit 6, NetSolutions net income of $3,050 for November is added to the beginning retained earnings on November 1, 2011, in the retained earnings statement.
Interrelationships Among Financial Statements LO 5 Retained Earnings Statement and and Balance Sheet Retained earnings at the end of the period reported on the retained earnings statement is also reported on the balance sheet as retained earnings.
Interrelationships Among Financial Statements LO 5 In Exhibit 6, NetSolutions retained earnings of $1,050 as of November 30, 2011, on the retained earnings statement also appears on the November 30, 20l1, balance sheet as retained earnings.
Interrelationships Among Financial Statements LO 5 Balance Sheet and Statement of Cash Flows The cash reported on the balance sheet is also reported as the end-of-period cash on the statement of cash flows.
Interrelationships Among Financial Statements LO 5 In Exhibit 6, cash of $5,900 reported on the balance sheet as of November 30, 2011, is also reported on the November statement of cash flows as the end-of-period cash.
Learning Objective 6 Describe and illustrate the use of the ratio of liabilities to stockholders equity in evaluating a company s financial condition.
Ratio of Liabilities to Stockholders Equity LO 6 Ratio of Liabilities to Stockholders Equity = Total Liabilities Total Stockholders Equity Ratio of Liabilities to Stockholders Equity = $400 $26,050 = 0.015
EE 1-8
Introduction to Accounting and Business The End Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University