Accounting and the
Business Environment
Chapter 1
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1
Objective 1
Use accounting vocabulary
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2
Accounting
• Measures
• Processes
• Communicates……
Financial information to decision makers
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3
Decision Makers
•
•
•
•
•
Individuals
Businesses
Investors
Creditors
Taxing Authorities
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4
Financial vs. Managerial
Accounting
• Financial Accounting – Information for
people outside of the company
• Managerial Accounting – Information for
internal decision makers
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5
Governing Organizations
• FASB – Financial Accounting Standards
Board
• SEC – Securities and Exchange
Commission
• AICPA – American Institute of Certified
Public Accountants
• IMA – Institute of Management
Accountants
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6
Ethics
• Audit
– Examination of company’s financial situation
– Performed by independent accountants
• Sarbanes-Oxley Act – criminal offense to
falsify financial statements
• Public Companies Accounting Oversight
Board – monitors work of accountants
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7
Standards of Professional Conduct
• AICPA – Code of Professional Conduct for
Accountants
• IMA – Standards of Ethical Conduct
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8
Types of Business
Organizations
• Proprietorships
• Partnerships
• Corporations
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9
Objective 2
Apply accounting concepts and
principles
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GAAP
• Generally Accepted Accounting Principles
– Accounting guidelines that govern how
accountants measure, process, and
communicate financial information
• Formulated by Financial Accounting
Standards Board (FASB)
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11
GAAP
• Primary objective of financial accounting –
provide information that is useful for
making investment and lending decisions
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12
Entity Concept
• Accounting Entity – organization that
stands apart as a separate economic unit
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13
Reliability (Objectivity) Principle
• Accounting information is based on the
most reliable data available
– Verifiable
– Free from bias
– Individuals would arrive at similar conclusions
using same data
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14
Cost Principle
• Acquired assets and services should be
recorded at their actual cost (historical
cost)
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15
Going Concern Concept
• Assumes that the entity will remain in
operation for the foreseeable future
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16
Stable-Monetary-Unit Concept
• Assumes that the dollar’s purchasing
power is stable
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17
Objective 3
Use the accounting equation
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18
Assets
• Economic resources, expected to benefit
the business in the future
– Cash
– Accounts receivable
– Merchandise inventory
– Furniture
– Land
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19
Claims to the Assets
• Liabilities – economic obligations payable
to an individual or organization outside the
business
– Accounts payable
– Notes payable
– Salary payable
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20
Claims to the Assets
• Owner’s Equity (capital) – claim of
business owner to the assets of the
business
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21
The Accounting Equation
Assets
Economic
Resources
= Liabilities + Owner’s Equity
Claims to
Economic
Resources
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22
Transactions that Affect
Owner’s Equity
OWNER’S
EQUITY
INCREASES
OWNER’S EQUITY
DECREASES
Owner
Withdrawals
Owner
Investments
Owner’s Equity
Expenses
Revenues
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23
Revenues
• Amounts earned by delivering goods or
services to customers
– Sales revenue
– Service revenue
– Interest revenue
– Dividend revenue
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24
Expenses
• Decrease in owner’s equity that occurs
from using assets or increasing liabilities in
the course of delivering goods or services
to customers
– Salary expense
– Rent expense
– Utilities expense
– Interest expense
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25
Exercise 1-18
Assets
Pep Boys
Eddie Bauer
Benbrook
Exxon
Liabilities
Owner’s
Equity
$?
$81,000
$60,000
$21,000
72,000
?
32,000
40,000
100,000
79,000
?
21,000
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26
Objective 4
Analyze business transactions
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Transaction
• An event that affects the financial position
of a particular entity and can be recorded
reliably
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28
Exercise 1-17
a. Increased assets (cash)
b. No effect on total assets. Increase in land
offset the decrease in cash
c. Decreased assets (cash)
d. Increased assets (equipment)
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29
Exercise 1-17
e. Increased assets (accounts receivable)
f. Decreased assets (cash)
g. No effect on total assets. Increase in
cash offset the decrease in accounts
receivable
h. Increased assets (cash)
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30
Exercise 1-22
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31
Analyze this:
July 6: Lange invested $45,000 in the
business by opening a bank account in
the name of M. Lange, M.D.
What
Does the
accounts
account
areincrease
involved?
or decrease?
(1) Cash (asset)
(2) Owner’s Equity (equity)
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32
Exercise 1-22
Date
Liabilities Owner’s
Equity
Assets
July
Cash
6
45,000
Medical
Supplies
Land
Accounts
Payable
M.Lange,
Capital
Type of
Transaction
45,000 Investment
Assets = $45,000
Liabilities &
Owner’s Equity = $45,000
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33
Analyze this:
July 9: Paid $35,000 cash for land
DoesWhat
the account
increase
or decrease?
accounts
are involved?
(1) Cash (asset)
(2) Land (asset)
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34
Exercise 1-22
Date
Liabilities Owner’s
Equity
Assets
July
Cash
Medical
Supplies
Land
6
45,000
9
-35,000
35,000
Bal
10,000
35,000
Accounts
Payable
M.Lange,
Capital
Type of
Transaction
45,000 Investment
Assets = $45,000
45,000
Liabilities &
Owner’s Equity = $45,000
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35
Analyze this:
July 12: Purchased medical supplies
for $2,000 on account
DoesWhat
the account
increase
or decrease?
accounts
are involved?
(1) Medical Supplies (asset)
(2) Accounts Payable (liability)
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36
Exercise 1-22
Date
Liabilities Owner’s
Equity
Assets
July
Cash
Bal
10,000
Medical
Supplies
Land
Accounts
Payable
35,000
Type of
Transaction
45,000
12
2,000
2,000
Bal
10,000 2,000 35,000
2,000
Assets = $47,000
M.Lange,
Capital
45,000
Liabilities &
Owner’s Equity = $47,000
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37
Analyze This:
July 15-31: During the rest of the month,
Lange treated patients and earned
service revenue of $7,000, receiving cash
DoesWhat
the account
accounts
increase
are involved?
or decrease?
(1) Cash (asset)
(2) Revenues (equity)
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When the
owner
completes
work, her
interest in the
assets
increases
38
Exercise 1-22
Date
July
Bal
15-31
Bal
Liabilities Owner’s
Equity
Assets
Cash
Medical
Supplies
Land
10,000 2,000 35,000
Accounts
Payable
M.Lange,
Capital
2,000
45,000
7,000
Type of
Transaction
7,000 Revenue
17,000 2,000 35,000
Assets = $54,000
2,000
52,000
Liabilities &
Owner’s Equity = $54,000
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39
Analyze This:
July 15-31: Paid cash expenses
Does the
account
increase
or decrease?
What
accounts
are involved?
(1) Cash (asset)
(2) Expense (equity)
When an expense is
incurred, owner’s
equity decreases
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40
Exercise 1-22
Date
July
Bal
Liabilities Owner’s
Equity
Assets
Cash
Medical
Supplies
Land
17,000 2,000 35,000
Accounts
Payable
M.Lange,
Capital
2,000
52,000
15-31 -1,700
Bal
Type of
Transaction
-1,700 Salaries Exp
-1,000
-1,000 Rent Exp
- 300
- 300 Utilities Exp
14,000 2,000 35,000
2,000
Assets = $51,000
Liabilities &
Owner’s Equity = $51,000
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49,000
41
Analyze This:
July 28: Sold supplies to another
physician for the cost of those supplies
Does the
account
increase
or decrease?
What
accounts
are involved?
(1) Cash (asset)
(2) Medical Supplies (asset)
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42
Exercise 1-22
Date
July
Bal
28
Bal
Liabilities Owner’s
Equity
Assets
Cash
Medical
Supplies
Land
Accounts
Payable
M.Lange,
Capital
2,000
49,000
14,500 1,500 35,000
2,000
49,000
Assets = $51,000
Liabilities &
Owner’s Equity = $51,000
14,000 2,000 35,000
500
Type of
Transaction
-500
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43
Analyze This:
July 31: Paid $1,500 on account
Does the
account
increase
or decrease?
What
accounts
are involved?
(1) Cash (asset)
(2) Accounts Payable (liability)
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44
Exercise 1-22
Date
July
Bal
31
Bal
Liabilities Owner’s
Equity
Assets
Cash
Medical
Supplies
Land
14,500 1,500 35,000
-1,500
Accounts
Payable
M.Lange,
Capital
2,000
49,000
Type of
Transaction
-1,500
13,000 1,500 35,000
Assets = $49,500
500
49,000
Liabilities &
Owner’s Equity = $49,500
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45
Accounting for Business
Transactions
• Note: The equation always stays in
balance
• Each transaction affects at least two
accounts, sometimes more
• Some transactions affect only one side of
the equation; some affect both sides
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46
Objective 5
Prepare financial statements
Objective 6
Evaluate business performance
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47
Financial Statements
•
•
•
•
Income statement
Statement of owner’s equity
Balance sheet
Statement of cash flows
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48
Income Statement
• Summary of an entity’s revenues,
expenses, and net income or net loss for a
specific period
Revenues - Expenses
• Net Income: Revenues > Expenses
• Net Loss: Expenses > Revenues
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49
Statement of Owner’s Equity
• Summary of changes in an entity’s
owner’s equity during a specific period
Beginning owner’s equity
+ Owner’s investments
+ Net income
- Net loss
- Owner’s withdrawals
Ending owner’s equity
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Balance Sheet
• Reports the entity’s assets, liabilities, and
owner’s equity as of a specific date
Assets = Liabilities + Owner’s Equity
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51
Statement of Cash Flows
• Reports cash receipts and cash payments
during a period (covered in Chapter 17)
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52
Financial Statements
• Using the transactions from Exercise 1-22,
prepare the income statement, statement
of owner’s equity, and balance sheet
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53
Maria Lange, M.D.
Anytime
Income Statement
you
subtotal,
For the Month Ended July 31,
2006
create a
new column
to the left
Revenue:
Fees earned
Notice the
Expenses:
proper
heading$1,700
Salary expense
Double
Rent
expense
1,000
underline
for yourexpense
Utilities
300
final answer
Total Expenses
Net income
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$7,000
3,000
$4,000
54
Maria Lange, M.D.
Statement of Owner’s Equity
From income
statement
Dates
Forarethe Month Ended July 31,
2006
important to
the reader of
Maria
Lange,
the financial
reports
capital, July 1, 2006
Add: Investment by owner
Net income for the month
Less: Withdrawals by owner
Maria Lange, capital, July 31, 2006
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$
0
45,000
4,000
$49,000
0
$49,000
55
Details, Details
• Note the headings for both of these
statements
– Name of company
– Name of financial statement
– For the period ended …….
• Both of these statements report activity
over a period of time
• Final sums are double-underlined
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56
Details, Details
• Negative amounts are presented in
parentheses
• Net income is computed first because you
need that number to complete the ending
balance in owner’s equity
• When preparing a financial statement,
clearly label each line in the statement
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57
Details, details
• If you are using columnar paper, always
start your number columns in the far righthand column
• Numbers that are added or subtracted
from each other should be in the same
column
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58
Maria Lange, M.D.
Balance Sheet
July 31, 2006
From statement of
owner’s equity
Liabilities
Notice the
Accounts payable
$500
Cash
$13,000
proper
Medical suppliesheading1,500 Owner’s equity,
49,000
Land
35,000 M. Lange, capital
Assets
Total assets
Total liabilities and
$ 49,500 owner’s equity
$ 49,500
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59
Details, details
• Note the heading for the balance sheet is
different from the other statements
Name of company
Name of financial statement
Date
• This statement reports what the company
owns and who has claims to the assets at
a specific point in time
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60
Exercise 1-24
Allen Samuel Road Service
Balance Sheet
November 30, 2009
Liabilities
Assets
Cash
Accounts receivable
Supplies
Equipment
$2,000
6,000
500
15,500
Accounts payable
Note payable
Total liabilities
$24,000
5,000
$8,500
Owner’s Equity
A. Samuel, capital
Total Assets
$3,500
15,500
Total liabilities and
owner’s equity
$24,000
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61
Exercise 1-24
What does a balance sheet report – financial
position or operating results?
• Financial position
Which financial statement reports the other
information?
• The income statement summarizes revenues
and expenses
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62
Exercise 1-26
Ciliotta Design Studio
Income Statement
Year Ended December 31, 2006
Service revenue
Expenses:
Salary expense
Rent expense
Utilities expense
Supplies expense
Property tax expense
Total expenses
Net income
$158,100
$60,000
24,000
6,800
4,000
1,200
96,000
$62,100
Exercise 1-26
2. Owner’s withdrawals:
Ciliottas, capital, beginning of year
Add: Net income
Investment by owner
Subtotal
Less: Owner withdrawal
Ciliotta, capital, end of year
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$
0
62,100
15,000
$77,100
?
50,000
$27,100
64
End of Chapter 1
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65