Chapter 1
Accounting and
The Business
Environment
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 1 of 23
Decision Makers
Individuals
Businesses
Creditors
Investors
Taxing Authorities
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 2 of 23
Two Fields of Accounting
Financial
Accounting
Managerial
Accounting
Provides information for
external decision
makers
Focuses on information
for internal decision
makers
– Investors
– Creditors
– Taxing Authorities
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Managers
Business Owners
Employees
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S1-2: USERS OF FINANCIAL INFORMATION
Suppose you are the manager of Greg’s Tunes,
Inc. The company needs a bank loan in order to
purchase music equipment. In evaluating the loan
request, the banker asks about the assets and
liabilities of the business. In particular, the banker
wants to know the amount of the business’s
stockholders’ equity.
Requirements:
1.Is the banker considered an internal or external
user of financial information?
2.Which financial statement would provide the
best information to answer the banker’s
questions?
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 4 of 23
The Accounting Profession
• Lucrative career with many opportunities
• Certified Public Accountants (CPAs)
Certified Public
Accountants, or CPAs
Certified Management
Accountants, or CMAs
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 5 of 23
Governing Organizations
FASB
SEC
AICPA
GAAP
IASB
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 6 of 23
Ethics in Accounting and
Business
Investors and creditors
want reliable financial
information
Conflict of Interest
Companies want to
attract investors
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 7 of 23
Audit
• SEC requires companies to have financial
statements examined by independent
accountants
– Auditors will provide an opinion on financial
statements, if possible
• Recent accounting scandals hurt investor
confidence
– SOX
– PCAOB
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 8 of 23
Standards of Professional
Conduct
AICPA
IMA
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 9 of 23
Types of Business Organizations
Proprietorship
Partnership
Corporation
LLC and LLP
Not-for-profit
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 10 of 23
Comparison of Business Forms
Proprietorship
Partners
Corporation
LLC, LLP
Not-forProfit
Owners
Proprietor:
One Owner
Partners:
Two or
more
Stockholders:
usually many
Members
None
Life of
Organization
Limited by
owner's
choice or
death
Limited by
owners’
choice or
death
Indefinite
Indefinite
Indefinite
Liability of
owners for
business
debts
Proprietor:
Owner is
personally
liable
Partners are
personally
liable
Stockholders
not personally
liable
Members
are not
personally
liable
Fiduciary
liability
of board
members
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 11 of 23
Corporate Characteristics
Separate Legal Entity
Continuous Life/Transferability
of Ownership
No Mutual Agency
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 12 of 23
Corporate Characteristics
(continued)
Limited Liability of
Stockholders
Separation of Ownership
and Management
Government Regulation
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 13 of 23
Corporate Characteristics
(continued)
Corporate Taxation
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 14 of 23
Organization of a Corporation
• Incorporators obtain charter from the state
• Charter authorizes corporation to:
Issue stock
Conduct business in accordance with state law
• Incorporators agreed to a set of bylaws
• Corporations begins to exist when stock is
issued
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 15 of 23
Structure of a Corporation
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 16 of 23
S1-4: TYPES OF BUSINESS
ORGANIZATION
Chloe Michaels plans on opening Chloe
Michaels’ Floral Designs. She is considering
the various types of business organizations
and wishes to organize her business with
unlimited life and limited liability features.
Additionally, Chloe wants the option to raise
additional equity easily in the future. Which
type of business organization will meet
Chloe’s needs best?
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 17 of 23
GAAP
• Generally Accepted Accounting Principles
Guidelines that govern accounting
Based on a conceptual framework
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 18 of 23
Accounting Principles
Entity
Concept
Cost
Principle
Faithful
Representation
Principle
GoingConcern
Concept
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Stable
Monetary Unit
Concept
Slide 19 of 23
Accounting Principles
Entity Concept
Faithful Representation Principle
Cost Principle
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 20 of 23
Accounting Principles
(continued)
Going-Concern
Stable Monetary Unit Concept
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 21 of 23
The Accounting Equation
ASSETS
Economic
Resources
LIABILITIES
EQUITY
Claims to Economic
Resources
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 22 of 23
Assets
• Economic resources
• Benefit the business in the future
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 23 of 23
Claims to Assets
Liabilities
Equity
• Debts payable to
outsiders
• Owners’ claims to the
assets of the business
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 24 of 23
The Accounting Equation
Assets
Liabilities
Equity
Liabilities
Assets
Equity
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 25 of 23
Equity of a Corporation
Assets
Stockholders’
equity
Liabilities
Paid-in
capital
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Retained
earnings
Slide 26 of 23
Equity of a Corporation
Paid-in capital
Stockholders’
equity
Common stock
+ Net income
(loss)
Retained earnings
- Dividends
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 27 of 23
Net Income
Retained
earnings
+ Net income
(loss)
+ Revenues
- Expenses
- Dividends
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 28 of 23
Revenues
• Amounts earned by delivering goods or
services to customers
Sales revenue
Service revenue
Interest revenue
Dividend revenue
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 29 of 23
Expenses
• Outflows of assets or increasing liabilities in
the course of delivering goods or services
to customers
Store or rent expense
Salary expense
Advertising expense
Utilities expense
Interest expense
Property tax expense
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 30 of 23
E1-16: CHARACTERISTICS OF A CORPORATION,
ACCOUNTING CONCEPTS, AND USING THE
ACCOUNTING EQUATION
Select financial information for three corporations follows:
Liabilities
Equity
New Rock Gas
Assets
$?
$74,000
$24,000
$50,000
DJ Video Rentals
$75,000
$?
$43,000
$32,000
Corner Grocery
$100,000
$53,000
$?
$47,000
Requirements:
1. Compute the missing amount in the accounting
equation for each entity.
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 31 of 23
E1-16: CONTINUED
2. List the seven main characteristics of a
corporation.
Continuous Life and transferability
Corporate taxation
Government regulation
Limited Liability of Stockholders
No Mutual Agency
Separate Legal Entity
Separation of ownership and managers
3. Which accounting concept tells us that the
previous three corporations will continue to exist
in the future?
Going Concern Concept
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 32 of 23
Transaction
• An event that affects the financial
position of the business
• Can be measured reliably
• Every transaction impacts at least two
items
• The accounting equation balances
before and after each transaction
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 33 of 23
E1-21: USING THE ACCOUNTING EQUATION TO
ANALYZE TRANSACTIONS
Caren Smith opened a medical practice. During July, the first
month of operation, the business, titled Caren Smith, M.D., P.C.
(Professional Corporation), experienced the following events:
1. Analyze the effects of these events on the accounting
equation of the medical practice of Caren Smith, M.D., P.C.
Assets
Dat
e
Cash
Medical
supplies
Land
Liabilitie
s
Stockholders’
Equity
Accounts
payable
Commo Retained
n stock earnings
Jul
$ 55,000
6
Bal $ 55,000
9
(46,000)
Bal
$9,000
$
55,000
$
0
$
0
$
0
$
55,000
$
0
$
0
$55,000
$
0
46,000
$
0
$46,000
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 34 of 23
E1-21: CONTINUED
Assets
Date
Cash
Jul 12
Bal
Medical
supplies
Land
$1,800
Liabilitie
s
Stockholders’
Equity
Accounts
payable
Commo Retained
n stock earnings
$1,800
$9,000
$1,800
$46,000
$1,800
$55,000
$0
Bal
$9,000
$1,800
$46,000
$1,800
$55,000
$0
15-31
8,000
Bal
$17,00
0
29
(1,600)
(900)
(100)
15
8,000
$1,800
$46,000
$1,800
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
$55,000
$8,000
(1,600)
(900)
(100)
Slide 35 of 23
E1-21: CONTINUED
Assets
Date
Cash
Bal $14,400
30
$1,800
Land
$46,000
(700)
Bal $14,400
31
Medical
supplies
$1,100
Stockholders’
Equity
Accounts
payable
Commo Retained
n stock earnings
$1,800
$55,000
$5,400
$55,000
$5,400
$55,000
$5,400
(700)
$46,000
(1,100)
Bal $13,300
Liabilitie
s
$1,100
(1,100)
$1,100
$46,000
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
$
0
Slide 36 of 23
Preparing the Financial
Statements
Income
Statement
Balance
Sheet
Statement of
Retained
Earnings
Statement of
Cash Flows
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 37 of 23
Income Statement
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 38 of 23
Statement of Retained
Earnings
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 39 of 23
Balance Sheet
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 40 of 23
Statement of Cash Flows
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 41 of 23
P1-36A: PREPARING FINANCIAL STATEMENTS
Studio Photography, Inc., works weddings and prom-type parties. The
balance of retained earnings was $16,000 at December 31, 2011. At
December 31, 2012, the business’s accounting records show these
balances:
Insurance expense
$ 8,000 Accounts receivable
$ 8,000
Cash
37,000 Note payable
12,000
Accounts payable
7,000 Retained earnings
47,000
Advertising expense
3,000 Salary expense
25,000
Service revenue
80,000 Equipment
50,000
Dividends
31,000 Common stock
29,000
Prepare the following financial statements for Studio Photography, Inc.
for the year ended December 31, 2012:
a. Income statement
b. Statement of retained earnings
c. Balance sheet
42
Financial & Managerial
Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 42 of 23
P1-36A: CONTINUED
Studio Photography, Inc.
Income Statement
Year Ended December 31, 2012
Revenue:
Service revenue
Expenses:
Salary expense
Insurance expense
Advertising expense
Total expenses
Net income
43
Financial & Managerial
Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
$ 80,000
$ 25,000
8,000
3,000
36,000
$ 44,000
Slide 43 of 23
Studio Photography, Inc.
Statement of Retained Earnings
Year Ended December 31, 2012
Retained earnings, December 31, 2011
Add: Net income
Subtotal
Less: Dividends
Retained earnings, December 31, 2011
44
Financial & Managerial
Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
$ 16,000
44,000
$ 60,000
(13,000)
$ 47,000
Slide 44 of 23
P1-36A: CONTINUED
Studio Photography, Inc.
Balance Sheet
December 31, 2012
Assets
Cash
Accounts receivable
Equipment
Liabilities
$37,000
8,000
50,000
Accounts payable
$ 7,000
Note payable
12,000
Total liabilities
19,000
Stockholders’ Equity
Common stock
Retained earnings
Total assets
$95,000
$29,000
47,000
Total stockholders’
equity
76,000
Total liabilities and
stockholders’ equity
$95,000
45
Financial & Managerial
Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Slide 45 of 23
Decision Guidelines
Income
Statement
Statement of
Retained
Earnings
Financial & Managerial Accounting by C. Horngren, W. Harrison & M. S. Oliver, 3rd ed. Pearson
Balance Sheet
Slide 46 of 23