Chapter 1
Introduction to Accounting
and Business
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess
Types of Businesses
Manufacturing Business
Product
General Motors
Intel
Boeing
Nike
Coca-Cola
Sony
Cars, trucks, vans
Computer chips
Jet aircraft
Athletic shoes and apparel
Beverages
Stereos and television
Types of Businesses
Merchandising Business
Product
Wal-Mart
Toys “R” Us
Circuit City
Lands’ End
Amazon.com
General merchandise
Toys
Consumer electronics
Apparel
Internet books, music, video
retailer
Types of Businesses
Service Business
Product
Disney
Delta Air Lines
Marriott Hotels
Merrill Lynch
Sprint
Entertainment
Transportation
Hospitality and lodging
Financial advice
Telecommunication
There are three types of
business organizations
 Proprietorship
 Partnership
 Corporation
A proprietorship
is owned by one
individual.
Joe’s
Advantages
• Ease in organizing
• Low cost of
organizing
Disadvantage
• Limited source of
financial resources
• Unlimited liability
A partnership is
owned by two or
more individuals.
Joe and Marty’s
Advantages
• More financial
resources than a
proprietorship.
• Additional
management skills.
Disadvantage
• Unlimited liability.
A corporation is
organized under state
or federal statutes as a
separate legal entity.
J & M, Inc.
Advantage
• The ability to obtain
large amounts of
resources by issuing
stocks.
Disadvantage
• Double taxation.
Business Strategies
A business strategy is an integrated
set of plans and actions designed to
enable the business to gain an
advantage over its competitors, and
in doing so, to maximize its profits.
Business Strategies
Under a low-cost strategy, a business
designs and produces products or
services of acceptable quality at a cost
lower than that of its competitors.
Under a differential strategy, a business
designs and produces products or services
that possess unique attributes or
characteristics which customers are willing
to pay a premium price.
Business Stakeholders
A business stakeholder is a person or
entity having an interest in the
economic performance of the business.
The Process of Providing
Information
1
Identify
stakeholders.
STAKEHOLDERS
External:
Internal:
Customers,
Owners,
creditors,
managers,
government
employees
2
Assess
stakeholders’
informational
needs.
The Process of Providing
Information
4
Record
economic
data about
business
activities
and events.
Accounting
Information
System
3
Design the
accounting
information
system to meet
stakeholders’
needs.
The Process of Providing
Information
STAKEHOLDERS
Internal:
Owners,
managers,
employees
5
Prepare
accounting
reports for
stakeholders.
External:
Customers,
creditors,
government
Accounting
Information
System
Profession of Accounting
Accountants employed by a business firm or
a not-for-profit organization are said to be
engaged in private accounting.
Accountants and their staff who provide
services on a fee basis are said to be
employed in public accounting.
Generally Accepted
Accounting
Principles (GAAP)
The business entity concept
limits the economic data in
the accounting system to
data related directly to the
activities of the business.
The cost concept is the
basis for entering the
exchange price, or cost
of an acquisition in the
accounting records.
The objectivity concept
requires that the accounting
records and reports be based
upon objective evidence.
The unit-of-measure
concept requires that
economic data be
recorded in dollars.
The Accounting Equation
Assets = Liabilities + Owners’ Equity
The resources
owned by a
business
The Accounting Equation
Assets = Liabilities + Owners’ Equity
The rights of the
creditors, which
represent debts
of the business
The Accounting Equation
Assets = Liabilities + Owners’ Equity
The rights of the
owners
What is a business
transaction?
A business transaction is an economic event or
condition that directly changes an entity’s financial
condition or directly affects its results of operations.
On November 1,
2005, Chris
Clark organized
a corporation
that will be
known as
NetSolutions.
a. Chris Clark deposits $25,000 in a bank
account in the name of NetSolutions in
return for shares of stock in the
corporation.
a.
Assets
=
Cash
25,000
=
Owners’ Equity
Capital Stock
25,000 Investment by
stockholder
b. NetSolutions exchanged $20,000 for land.
Assets
Cash + Land
Bal. 25,000
b. –20,000
+20,000
Bal. 5,000
20,000
=
=
Owners’ Equity
Capital Stock
25,000
25,000
c. During the month, NetSolutions purchased
supplies for $1,350 and agreed to pay the
supplier in the near future (on account).
Assets
=
Cash + Supplies + Land
Bal. 5,000
c.
Bal. 5,000
20,000
+ 1,350
1,350
20,000
Owners’
Liabilities + Equity
Accounts
Capital
Payable
Stock
=
25,000
+ 1,350
1,350
25,000
d. NetSolutions provided services to
customers, earning fees of $7,500 and
received the amount in cash.
Assets
=
Cash + Supplies + Land
Bal. 5,000
1,350
20,000
d. + 7,500
Bal. 12,500
1,350
20,000
=
Owners’
Liab . + Equity
Accounts Capital Retained
Payable + Stock + Earnings
1,350 25,000
+ 7,500
1,350
25,000
7,500
Fees
earned
e. NetSolutions paid the following
expenses: wages, $2,125; rent, $800;
utilities, $450; and miscellaneous, $275.
Assets
Cash + Supplies + Land
Bal. 12,500
1,350
20,000
e. – 3,650
Bal. 8,850
1,350
20,000
Owners’
=
Liab . + Equity
Accounts Capital Retained
Payable + Stock + Earnings
1,350 25,000
7,500
–2,125
=
– 800
Expenses
– 450
– 275
1,350 25,000
3,850
f. NetSolutions paid $950 to
creditors during the month.
Assets
Cash + Supplies + Land
Bal. 8,850
1,350
20,000
f.
– 950
Bal. 7,900
1,350
20,000
=
=
Owners’
Liab . + Equity
Accounts Capital Retained
Payable + Stock + Earnings
1,350 25,000
3,850
– 950
400 25,000
3,850
g. At the end of the month, the cost
of supplies on hand is $550, so
$800 of supplies were used.
Assets
Cash + Supplies + Land
Bal. 7,900
1,350
20,000
g.
– 800
Bal. 7,900
550
20,000
=
=
Owners’
Liab . + Equity
Accounts Capital Retained
Payable + Stock + Earnings
400 25,000
3,850
Supplies
– 800
Expense
400 25,000
3,050
h. At the end of the month, NetSolutions
pays $2,000 to stockholders.
Assets
Cash + Supplies + Land
Bal. 7,900
550
20,000
h. –2,000
Bal. 5,900
550
20,000
=
=
Owners’
Liab . + Equity
Accounts Capital Retained
Payable + Stock + Earnings
400 25,000
3,050
–2,000
Dividends
400 25,000
1,050
Effects of Transactions on Owners’ Equity
Capital Stock
Increased by
Stockholders’
investments
+
Effects of Transactions on Owners’ Equity
Retained Earnings
Decreased by
Decreased by
Revenues
Expenses
Dividends
+
–
–
Increased by
Accounting reports, called
financial statements,
provide summarized
information to the users.
Financial Statements
• Income statement—A summary of the
revenue and expenses for a specific period of
time.
• Retained earnings statement—A summary of
the earnings retained in the corporation for a
specific period of time.
• Balance sheet—A list of the assets, liabilities,
and stockholders’ equity as of a specific date.
• Statement of cash flows—A summary of the
cash receipts and disbursements for a specific
period of time.
Statement of Cash Flows
Cash Flows from Operating Activities—This
section reports a summary of cash receipts and
cash payments from operations.
Cash Flows from Investing Activities—This section
reports the cash transactions for the acquisition and
sale of relatively permanent assets.
Cash Flows from Financing Activities—This
section reports the cash transactions related to cash
investments by the owner, borrowings, and cash
withdrawals by the owner.
Management Information
Systems
Terry DeGroff
Burwell, Nebraska
Books, Records & Controls
Management is…
• Planning, organizing, directing, and
controlling a business. The most
important and challenging is control…
the process of analyzing, evaluating
and interpreting the production and
financial performance of a business.
Information…
• Can and does come from many
sources. Some of the best and
most needed information can come
from each business’ own financial
and production records.
Systems…
• Need to be implemented that allow
for only necessary record keeping
and effective use of records.
Summary information from these
records should be invaluable in day
to day business decisions.
Management
• Planning
• Organizing
• Directing
• Controlling
Management Control
• The Best Decisions
Require the Best
Information
Uses and Purposes of
Financial Records
Management
Decision
Making
Income Tax
Reporting
Credit
Acquisition
Keys to Successful
Record Keeping
Keys to Successful Record
Keeping
• Simple yet Useful
Keys to Successful Record
Keeping
• Excessive detail often ends in
Confusion, Frustration, and
Failure
Keys to Successful Record
Keeping
• Meet your Needs,
Abilities, &
Limitations
Keys to Successful Record
Keeping
• Know your Purpose for Keeping
Records
Management
Income
Taxes
Banking
Accounting Rules
• Standards of Communication
Accounting Rules
• Generally Accepted Accounting
Principles
– (GAAP)
Keys to Successful Record
Keeping
• Accurately Match Expenses
with Income
Cash and Accrual
Accounting
Refers to the timing of entries
into the accounting system
Cash Based Records
Transactions are recorded when
cash is received or paid out
Accrual Based Records
Transactions are recorded when
they take place
Regardless of whether cash is
involved
Accrual Adjusted
Statements
Cash based records are kept
throughout the year
Non-Cash adjustments are
made to the cash based income
statement at the end of the
year
Accrual Adjusted Income
Statement
Cash incomes and expenses must be
adjusted by:
• Changes in non-cash assets
• Inventories
• Pre paid expenses
• Receivables
• Changes in non-cash liabilities
• Payables
• Accrued interest
Financial Analysis
Requires
• Basic Set of Financial Statements
Basic Financial Statements
•
•
•
•
Balance Sheet
Income Statement
Statement of Owner Equity
Statement of Cash Flows
Assets = Liabilities + Equity
Equity = Assets - Liabilities
Beginning Balance Sheet
Assets
Liabilities
Ending Balance Sheet
Assets
Equity
Liabilities
Equity
+/- Net Income
+/- Valuation Changes
- Capital withdrawals
+ Capital contributions
Financial Analysis
Requires
• Basic Set of Financial Statements
• Understanding of how to Analyze
and Interpret the Financial
Statements
Ratio Analysis
• Liquidity
• Solvency
• Profitability
• Financial Efficiency
• Repayment Capacity
Financial Analysis
• Objectives
– Measure Financial
Condition
Financial Analysis
• Objectives
– Measure Financial Condition
– Measure Financial Performance
Financial Analysis
All business owners should have
a basic set of financial
statements at their disposal
and they should know how to
analyze and interpret them.
Technology is….
• Productivity enhancing
• Management intensive
• Capital intensive
• Not scale neutral
The End
Accounting
Information System
Major Accounting Bodies
• American Institute of Certified Public
Accountants
• Financial Accounting Standards Board
• Government Accounting Standards Board
• Securities and Exchange Commission
Ethics
The process that individuals use
Ethics
The process that individuals use to
evaluate their conduct
Ethics
The process that individuals use to
evaluate their conduct in light of
moral principles and values
Assets
• Anything of value held by an organization
• Assets have
Assets
• Anything of value held by an organization
• Assets have
–
Potential usefulness
Assets
• Anything of value held by an organization
• Assets have
–
–
Potential usefulness
Future usefulness
Assets
• Anything of value held by an organization
• Assets have
–
–
–
Potential usefulness
Future usefulness
Economic Value
Assets
•
•
•
•
Cost principle
Going-concern concept
Objectivity principle
Stable dollar concept
Equities
• Claims against the total assets of an
organization
• Liabilities
–
Claims of nonowners
• Owner's Equity
–
Claims of owners
Retained Earnings
• Cumulative total of net income, net loss,
and dividends since start of business
Revenues
• Inflows of assets that result from
performing services or selling goods
• Revenues are realized when
–
the service is performed or
Revenues
• Inflows of assets that result from
performing services or selling goods
• Revenues are realized when
–
–
the service is performed or
the goods are delivered
Expenses
• Outflows of assets or incurrence of
liabilities while earning revenues
• A business incurrs expenses to earn
revenues
The Accounting Equation
•
•
•
•
Things of Value = Claims
Assets = Equities
Assets = Liabilities + Owner's Equity
Assets - Liabilities = Net Assets
Analyzing Transactions
• Use accounting equation
• Is there a change in assets?
– Which asset?
– How much was the change?
• Is there another change in assets?
Analyzing Transactions
• Is there a change in liabilities?
– Which liability?
– How much was the change?
• Is there another change in liabilities?
• Is there a change in owners’ equity?
– How much was the change?
Four Basic Financial Statements
•
•
•
•
Income Statement
Statement of Owners’ Equity
Classified Balance Sheet
Statement of Cash Flows
Income Statement
• Reports changes in owners’ equity from
operating activities
• Revenues - Expenses = Net Income(Loss)
Statement of Owners’ Equity
• Changes in owners’ interest in assets
• Issuances of new stock
• Retained earnings
– Net income or loss
– Dividends
Classified Balance Sheet
• Classification - arrangement of financial
statement items into groupings that have
common basis
• Assets
– Current
– Property, plant, and equipment
Classified Balance Sheet
• Liabilities
– Current
– Long-tern
• Owners’ Equity
– Common stock
– Retained earnings
Statement of Cash Flows
• Reports cash flows during period
• Categories of activities
– Operating activities
– Investing activities
– Financing activities
Analyzing Information
Balance Sheet Analysis
• Are total assets higher or lower?
• What is percent change in total assets?
• Is the percent of total liabilities to total
liabilities plus owner’s equity increasing or
decreasing?
Income Statement Analysis
• Are revenues higher or lower?
• What is the precentage change in total
revenues?
• Is the percentage of total expenses to total
revenues increasing or decreasing?
Integrative Analysis
• Is the business operating efficiently by
using the least amount of asset investment
to generate a given level of total revenues?
• Calculate Total Asset Turnover
– Total revenues
– divided by
– Average total assets
Using Accounting
Information
Business Planning Activities
• Individual Point of View
• Business Point of View
– Planning
– Budgeting
Accounting Information System
Resources and procedures in a business
Accounting Information System
Resources and procedures in a business that
change economic data
Accounting Information System
Resources and procedures in a business that
change economic data into financial
information
Users of Accounting Information
•
•
•
•
•
•
Owners
Lenders
Labor Organizations
Customers
Society groups
Government Regulatory Agencies
Entity Concept
Any organization unit for which we gather
and process
Entity Concept
Any organization unit for which we gather
and process financial and economic data
Entity Concept
Any organization unit for which we gather
and process financial and economic data for
the purpose of decision making
Types of Ownership
• Single proprietorship
• Partnership
• Corporation
Financial Statements
• Balance Sheet
• Income Statement
• Statement of Cash Flows
Balance Sheet
• Summarizes assets, liabilities, and owners’
equities as of a specific moment in time
– Assets - economic resources or items of value a
business owns
– Liabilities - claims against the assets by
nonowners
– Owners’ equity - claims against the assets by
owners
Basic Accounting Equation
Assets = Liabilities + Owners’ Equity
Income Statement
• Presents the results of operations for a
period of time
– Revenues - inflow of assets from performing
services or selling goods
– Expenses - use of assets or incurrence of
liabilities when earning revenues
Statement of Cash Flows
• Presents the reasons why cash on the
balance sheet changed from one date to
another
• Presents cash flows from
– Operating activities
– Investing activities
– Financing activities
Published Annual Reports
•
•
•
•
Letter to stockholders
Management’s discussion and analysis
Financial statements and notes
The report of the independent accountant
Analyzing Information
• Common-size statement
– Express each item as a percent of the total for
that statement
• Balance sheet - total assets
• Income statement - total revenues
Balance Sheet Analysis
• Are total assets higher or lower?
• What is percent change in total assets?
• Is the percent of total liabilities to total
liabilities plus owner’s equity increasing or
decreasing?
Income Statement Analysis
• Are revenues higher or lower?
• What is the precentage change in total
revenues?
• Is the percentage of total expenses to total
revenues increasing or decreasing?
Integrative Analysis
• Is the business operating efficiently by
using the least amount of asset investment
to generate a given level of total revenues?
• Calculate Total Asset Turnover
– Total revenues
– divided by
– Average total assets
Interpreting Company Accounts
Interpreting Company
Interpreting Company Accounts
Accounts
Window Dressing
Window Dressing
• ‘Window dressing’ refers to attempts by business
to present its accounts in the best light
• Has become more of a necessity as pressure to
please shareholders and the City increases
• It is NOT illegal
• Deliberate deception in the accounts is fraud
Window Dressing
• How do firms ‘massage’ the accounts?
• Timing of reporting
• Balance sheet – snapshot of a business at a point
in time, therefore:
– Delay major payment
– Include large injection of cash/assets
• Exploit accounting procedures – often a wide
range in the definition
Window Dressing
• Exploiting other definitions – extraordinary
items – what counts as ‘extraordinary’?
• Depreciation – different results gained using
different methods – which is the ‘best’ and
the most accurate?
– Residual values – could be altered
Depreciation
Depreciation
• When businesses buy fixed assets (those that will
last longer than one year) the value of the asset
will change
• Depreciation seeks to take account of such
changes in the accounts
• An imprecise science allows different
interpretations
Depreciation
• Take the machine here:
– What is its life span?
– How much did it cost originally?
– How much will it be worth at the end
of its useful life?
– What will be its value after 1 year?
– After 2 years, 4 years, 15 years?
– Would anyone else want to buy it?
– How specialised is it?
– What would it cost to replace after 5
years?
Mill Drill Machine Copyright: Kenn Kiser,
http://www.sxc.hu
Methods
• Key terms:
• Historical Value - initial purchase price
• Value at the end of the life of the asset - the Residual
Value (RV)
• Life span of the asset
• Straight Line
– Historic cost - RV/Useful life
• Declining Balance
– Depreciating assets at a constant rate each year