Financial Accounting: Tools for
Business Decision Making
Chapter 1
Overview Of Business
Copyright ©2022 John Wiley & Sons, Inc.
Business Organization and Accounting
Information Uses
Forms of Business Organization
Sole Proprietorship
Partnership
Corporation
LO 1
Sole Proprietorship
• Owned and controlled by one person
• Simple to establish
• Tax advantages
Examples
• Small owner-operated businesses
such as barber shops, law offices,
auto repair shops, farms, and small
retail stores
LO 1
Partnership
• Two more owners
• Simple to establish
• Shared control
• Broader skills and
resources
• Tax advantages
LO 1
Corporation
• A separate legal entity
• Easier to transfer ownership

Shares of stock are easy to sell on an organized stock
exchange
• Easier for corporations to raise funds

Individuals can become stockholders by investing
relatively small amounts of money
• No personal liability
• Income taxes are higher than proprietorships and
partnerships
LO 1
More About Corporations
• Stock is traded on an organized stock exchanges
 Such as the New York Stock Exchange
• Majority of U.S. business is done by corporations
 Number of total proprietorships and partnerships
exceeds the number of corporations
 Revenue produced by corporations is many times
greater than other forms of organization
LO 1
Users and Uses of Financial
Information
• Purpose of financial information
 To provide inputs for decision-making
• Accounting
 The information system that identifies, records, and
communicates the economic events of an
organization to interested users
 Users of accounting information
 Internal users
 External users
LO 1
Internal Users
• Managers who plan, organize, and run a business
• Questions asked by internal users
LO 1
External Users
• Investors (owners): buy, hold, or sell stock
• Creditors: risk of selling on credit or lending money
• Taxing authorities, such as the Internal Revenue
Service
• Customers: product warranties
• Labor unions
• Regulatory agencies
LO 1
Questions Asked by External Users
LO 1
Knowledge Check: Organization
Forms
Identify each of the following organizational characteristics
with the organizational form or forms (sole proprietorship,
partnership, corporation) with which it is associated.
1. Easier to raise funds
Corporation
2. Simple to establish
Sole proprietorship; partnership
3. No personal legal liability
4. Tax advantages
Corporation
Sole proprietorship; partnership
5. Easier to transfer ownership Corporation
LO 1
Knowledge Check: Users of Financial
Information
Which of the following consists of external users?
a. Managers and creditors
b. Investors and regulatory agencies
c. Employees and investors
d. Creditors and employees
LO 1
Explain the Three Principal Types of
Business Activity
LO 2
Three Types of Business Activity
• Financing activities
 Raising money through outside sources
• Investing activities
 Purchasing resources a company needs in order to
operate
• Operating activities
 Performing the day-to-day actions to produce and
sell a product or provide a service
LO 2
Financing Activities - Borrowing
• Debt financing

Borrowing money…

… to creating a liability
• Creditors

Are the party to whom amounts are owed
• Liabilities

Amounts that are owed

Notes payable – money borrowed as a loan

Bonds payable – debt securities sold to investors
LO 2
Financing Activities – Issuing Stock
• Equity financing
 Issuing (selling) shares of stock for cash
• Common stock
 The amount paid by stockholders for shares they
purchase
• Dividends
 Payments to stockholders
LO 2
How Claims of Creditors and
Stockholders Differ
Creditors
Stockholders
• Loan money to a
company
• Owners of the
company
• Legal right to be paid
• No claim to corporate
cash until creditors’
claims are paid
• May legally force the
corporation to sell
assets to pay its debt
LO 2
Investing Activities
• Purchase of resources a company needs in order
to operate
• Assets
 Resources owned by a business
• Property, plant, and equipment
•
Includes computers, delivery trucks, furniture, buildings
• Cash
• Investments in securities
• Stocks or bonds of other companies
LO 2
Operating Activities
• Activities that involve the day-to-day actions to
produce and sell a product, or provide a service
• Occur after a business obtains financing and
invests in assets required for operation
• Result in

Revenue
• Amounts generated from the sale of goods or
performance of services

Expenses
• Costs consumed or services used in the process of
generating revenue
LO 2
Operating Activities - Revenue
• The increase in assets or decrease in liabilities
resulting from the sale of goods or the performance
of services in the normal course of business
• Arises from different sources
• Identified by various names depending on the
nature of the business
• Common sources of revenue
o Sales revenue
o Service revenue
o Interest revenue
LO 2
Operating Activities – Assets with
Shorter Lives
• Result from operating activities
 Supplies
• Assets used in day-to-day operations rather than sold
to customers
 Inventory
• Goods available for sale to customers
 Accounts receivable
• Right to receive money in the future from a customer
as the result of a sale
LO 2
Operating Activities - Expenses
• Are the cost of assets
consumed or services used in
the process of generating
revenues
• Common expenses





Cost of goods sold
Selling expenses
Marketing expenses
Administrative expenses
Interest expense
 Income taxes expense
LO 2
Operating Activities - Liabilities
• Often arising from expenses
 Accounts payable
• Goods purchased on credit from suppliers
 Interest payable
• On outstanding amounts owed to the bank
 Wages payable
• Amounts owed to employees
• Sales taxes payable, property taxes payable, and
income taxes payable owed to the government
LO 2
Operating Activities – Net Income or
Loss
• Compare revenues with expenses
for the period
• Results in the profit for the period
• Net income
 Exists when revenues exceed
expenses
• Net loss
 Exists when expenses exceed
revenues
LO 2
Concept Check: Business Activities
Classify each activity as operating, investing or
financing.
1. Performing a service for a customer
Operating
2. Issuing shares of stock in exchange for cash Financing
3. Purchasing equipment used in operations
Investing
4. Borrowing cash from a bank
Financing
5. Selling goods to a customer
Operating
LO 2
Concept Check: Classifying Items
Classify each item as an asset, liability,
common stock, revenue, or expense.
1. Cost of electric bill
Expense
2. Computers purchased
Asset
3. Notes payable
Liability
4. Issuance of ownership shares
Common stock
5. Amount recorded from performing services Revenue
6. Amounts owed to suppliers
Liability
7. Cash
Asset
LO 2
Describe the Four Financial Statements
and How They Are Prepared
LO 3
The Four Financial Statements
• Income statement

Success of the business during a period of time
• Retained earnings statement

How much income was distributed to owners and how
much was retained
• Balance sheet


A picture at a point in time of what a business owns and
what it owes
Statement of cash flows

Where a business obtained cash during a period of time
and how that cash was used
LO 3
Income Statement
• Are the company’s operations profitable?

Past net income provides information for predicting
future earnings
• Lists the company’s revenues followed by its
expenses for a specific period, for example a month
• Net income results when revenues exceed expenses
• Net loss results when expenses exceed revenues
LO 3
Income Statement Presentation
LO 3
Importance of Income Statement to
Financial Statement Users
• Investors

Buy and sell stock based on their beliefs about a
company’s future performance
• Creditors

Predict whether the company will be profitable
enough to repay amounts owed
LO 3
Knowledge Check: Determining Net
Income
Tua Corporation began operations on January 1, 2025. The following
information is available for Tua on December 31, 2025:
Accounts receivable
Supplies expense
Equipment
Rent expense
Dividends
Service revenue
Supplies
Determine
net income
for 2025.
$ 1,100
2,500
12,900
7,000
2,200
23,000
2,000
Retained earnings
Accounts payable
Cash
Insurance expense
Notes payable
Common stock
Salaries expense
$
0
1,400
2,400
800
5,700
8,000
7,200
Revenues
$23,000
Expenses ($2,500 + $7,000 + $800 + $7,200)
17,500
Net Income
$ 5,500
LO 3
Retained Earnings Statement
• Amounts and causes of changes in retained earnings for
a specific time period
• Net income increases retained earnings
• Net loss decreases retained earnings
• Dividends

Decrease retained earnings

Represent the portion of net income distributed to
owners
• Retained earnings ending balance

Represents cumulative net income retained to allow for
further expansion
LO 3
Importance of the Retained Earnings
Statement to Financial Statement Users
• Shows investors a company’s dividend payment
practices
• Enables investors to determine the portion of
earnings reinvested (retained) to increase growth
• Allows lenders to monitor their corporate
customers’ dividend payments

Dividends use cash that could reduce their ability to
repay debts
LO 3
Retained Earnings Statement
Illustrated
• Time period is the same as income statement
• Enables users to evaluate dividend payment practices
LO 3
Knowledge Check: Determining
Retained Earnings
Tua Corporation began operations on January 1, 2025. The
following information is available for Tua on December 31, 2025:
Accounts receivable
$ 1,100 Accounts payable
$1,400
Equipment
12,900 Cash
2,400
Dividends
2,200 Notes payable
5,700
Supplies
2,000 Common stock
8,000
0 Net income
Retained earnings, December 1
5,500
$
Retained earnings
Prepare a
retained
earnings
statement
(omit heading).
Add: Net income
0
5,500
5,500
Less: Dividends
2,200
Retained earnings, December 31
$3,300
LO 3
Balance Sheet
• Assets and claims to assets at a specific time
• Subdivides claims to assets into two categories


Claims of creditors (liabilities)
Claims of owners (stockholders’ equity)
• Based upon the basic accounting equation
• Lists assets first, followed by liabilities and
stockholders’ equity
LO 3
Components of the Balance Sheet
• Assets

Listed in order of liquidity, how quickly they can be
converted to cash
• Liabilities
• Stockholders’ equity

Separated into two components
• Common stock
• Results when the company sells new shares of stock
• Retained earnings
• Is the net income retained in the corporation
LO 3
Importance of the Balance Sheet to
Financial Statement Users
Financial statements are used
• To determine the likelihood the company will repay
debt
• To evaluate the nature of the company’s assets and
liabilities
• To determine whether cash on hand is sufficient
• To evaluate the relationship between debt and
stockholders’ equity
LO 3
Balance Sheet Illustrated
LO 3
Knowledge Check: Calculate Total
Assets
Tua Corporation began operations on January 1, 2025. The following
information is available for Tua on December 31, 2025:
Accounts receivable
$ 1,100 Accounts payable
$1,400
Equipment
12,900 Cash
2,400
Dividends
2,200 Notes payable
5,700
Supplies
2,000 Common stock
8,000
Retained earnings, Dec. 31
3,300 Net income
5,500
Cash
Calculate total
assets.
$ 2,400
Accounts receivable
1,100
Supplies
2,000
Equipment
12,900
Total assets
$18,400
LO 3
Knowledge Check: Calculate Total
Liabilities
Tua Corporation began operations on January 1, 2025. The following
information is available for Tua on December 31, 2025:
Accounts receivable
$ 1,100 Accounts payable
$1,400
Equipment
12,900 Cash
2,400
Dividends
2,200 Notes payable
5,700
Supplies
2,000 Common stock
8,000
Retained earnings, Dec. 31
3,300 Net income
5,500
Calculate total
liabilities.
Accounts payable
$1,400
Notes payable
5,700
Total liabilities
$7,100
LO 3
Knowledge Check: Calculate
Stockholders’ Equity
Tua Corporation began operations on January 1, 2025. The following
information is available for Tua on December 31, 2025:
Accounts receivable
$ 1,100 Accounts payable
$1,400
Equipment
12,900 Cash
2,400
Dividends
2,200 Notes payable
5,700
Supplies
2,000 Common stock
8,000
Retained earnings, Dec. 31
3,300 Net income
5,500
Calculate
stockholders’
equity.
Common stock
$ 8,000
Retained earnings
3,300
Total stockholders’ equity
$11,300
LO 3
Statement of Cash Flows
• Provides financial information about the cash
receipts and payments for a specific period of time
• Reports the cash effects of a company’s operating,
investing, and financing activities
• Shows the net increase or decrease in cash during
the period, and the amount of cash at the end of the
period
Cash is a company’s most important asset.
LO 3
Importance of the Statement of Cash
Flows to Financial Statement Users
• Does the company generate enough cash from
operations to fund its investing activities?
• Provides answers to



Where did cash come from during the period?
How was cash used during the period?
What was the change in the cash balance during the
period?
LO 3
Statement of Cash Flows Illustrated
LO 3
Interrelationships of Statements
• The retained earnings statement shows net income
amount from the income statement
• The ending balance of retained earnings is reported
on the balance sheet in the stockholders’ equity
section
• The cash balance on the balance sheet also appears
on the statement of cash flows
LO 3
Interrelationship of Income Statement
to the Retained Earnings Statement
LO 3
Interrelationship of Retained Earnings
Statement to the Balance Sheet
Ending balance in
retained earnings is
needed in preparing
the balance sheet.
LO 3
Interrelationship of Balance Sheet
with the Statement of Cash Flows
The cash amount on the balance
sheet equals the end of period
cash reported on the statement of
cash flows.
LO 3
Knowledge Check: Part 1
Use Accounting Equation
At June 1, WestCo had total assets of $40,000 and
total liabilities of $15,000.
1. If total assets increased $12,000 in June and total
liabilities decreased $5,000, what is the amount of
stockholders’ equity at June 30?
Assets, June 30 = $40,000 + $12,000 = $52,000
Liabilities, June 30 = $15,000 − $5,000 = $10,000
Stockholders’ equity, June 30 = $52,000 − $10,000 = $42,000
LO 3
Knowledge Check: Part 2
Use Accounting Equation
At June 1, WestCo had total assets of $40,000 and
total liabilities of $15,000.
2. During the year, total liabilities decreased $3,000
and stockholders’ equity increased $4,000 in June.
What is the amount of total assets at June 30?
Liabilities, June 30 = $15,000 − $3,000 = $12,000
Stockholders’ equity, June 1 = $40,000 − $15,000 = $25,000
Stockholders’ equity, June 30 = $25,000 + $4,000 = $29,000
Assets, June 30 = $12,000 + $29,000 = $41,000
LO 3
Knowledge Check: Net Income
Net income will result during a time period when
a. assets exceed liabilities.
b. assets exceed revenues.
c. expenses exceed revenues.
d. revenues exceed expenses.
LO 3
Knowledge Check: Financial Statements
Which of the following financial statements is
prepared as of a specific point in time?
a. Balance sheet
b. Income statement
c. Retained earnings statement
d. Statement of cash flows
LO 3
Elements of an Annual Report
Publicly traded U.S. companies must provide
shareholders with an annual report.
• Aids users in performing a complete financial analysis
• Report elements




Financial statements
Management discussion and analysis
Notes to the financial statements
Independent auditor's report
LO 3