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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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
Limited Liability Partnerships
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9
Characteristics
• Separate legal entity
• Continuous life and transferability of
ownership
• No mutual agency
• Limited liability of stockholders
• Separation of ownership and management
• Corporate taxation
• Government regulation
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10
Organizing a Corporation
• Incorporators obtain charter from the state
• Charter authorizes corporation to:
– issue stock
– conduct business in accordance with state
law and the corporation’s bylaws
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11
Organizing a Corporation
• Stockholders elect board of directors
• Board
– Sets policy
– Appoints officers
– Elects a chairperson
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12
Objective 2
Apply accounting concepts and
principles
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13
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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14
GAAP
• Primary objective of financial accounting –
provide information that is useful for
making investment and lending decisions
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15
Entity Concept
• Accounting Entity – organization that
stands apart as a separate economic unit
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16
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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17
Cost Principle
• Acquired assets and services should be
recorded at their actual cost (historical
cost)
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18
Going Concern Concept
• Assumes that the entity will remain in
operation for the foreseeable future
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19
Stable-Monetary-Unit Concept
• Assumes that the dollar’s purchasing
power is stable
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20
Objective 3
Use the accounting equation
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21
Assets
• Economic resources, expected to benefit
the business in the future
– Cash
– Accounts receivable
– Merchandise inventory
– Furniture
– Land
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22
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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23
Claims to the Assets
• Owners’ Equity (stockholders’ equity) –
Owners’ claims to the assets of the
business
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The Accounting Equation
Assets =
Economic
Resources
Liabilities + Stockholders’ Equity
Claims to
Economic
Resources
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25
The Accounting Equation
Assets =
Liabilities + Stockholders’ Equity
Paid-in
Capital
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Retained
Earnings
26
The Accounting Equation
Stockholders’ Equity
Paid-in Capital
Retained Earnings
Common Stock
+ Net Income
- Dividends
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The Accounting Equation
Retained Earnings
Revenues
+ Net Income
- Expenses
- Dividends
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Revenues
• Amounts earned by delivering goods or
services to customers
– Sales revenue
– Service revenue
– Interest revenue
– Dividend revenue
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Expenses
• Decrease in retained earnings 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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30
Exercise 1-18
Assets
Pep Boys
Eddie Bauer
Benbrook
Exxon
Liabilities Stockholders’
Equity
$?
$81,000
$60,000
$21,000
72,000
32,000
?
40,000
100,000
79,000
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?
21,000
31
Objective 4
Analyze business transactions
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32
Transaction
• An event that affects the financial position
of a particular entity and can be recorded
reliably
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33
Exercise 1-17
a. Increased assets (cash)
b. No effect on total assets
c. Decreased assets (cash)
d. Increased assets (equipment)
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Exercise 1-17
e. Increased assets (accounts receivable)
f. Decreased assets (cash)
g. No effect on total assets
h. Increased assets (cash)
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35
Analyze this:
July 6: Lange invested $45,000 in the
business and was issued common stock
What
Does the
accounts
account
areincrease
involved?
or decrease?
(1) Cash (asset)
(2) Common stock (equity)
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36
Exercise 1-22
Date
July
6
Liabilities Stockholder’s Equity
Assets
Cash
Medical
Supplies
Land
45,000
Accounts Common Retained
Payable
Stock
Earnings
45,000
Assets = $45,000
Type of
Transaction
Issued stock
Liabilities &
Stockholders’
Equity = $45,000
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37
Analyze this:
July 9: Paid $35,000 cash for land
What accounts are involved?
Was cash received or paid?
Does the account increase or decrease?
(1) Cash (asset)
(2) Land (asset)
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38
Exercise 1-22
Date
July
6
Cash
Medical
Supplies
Land
45,000
9 (35,000)
Bal
Liabilities Stockholder’s Equity
Assets
10,000
Accounts Common Retained
Payable
Stock
Earnings
45,000
Type of
Transaction
Issued stock
35,000
35,000
Assets = $45,000
45,000
Liabilities &
Stockholders’
Equity = $45,000
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39
Analyze this:
July 12: Purchased medical supplies
for $2,000 on account
What accounts are involved?
Does the account increase or decrease?
(1) Medical Supplies (asset)
(2) Accounts Payable (liability)
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40
Exercise 1-22
Date
July
Cash
Bal
10,000
12
Bal
Liabilities Stockholder’s Equity
Assets
10,000
Medical
Supplies
Land
Accounts Common Retained
Payable
Stock
Earnings
35,000
45,000
2,000
2,000
2,000 35,000
2,000
Assets = $47,000
Type of
Transaction
45,000
Liabilities &
Stockholders’
Equity = $47,000
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41
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) Retained earnings (equity) When the
company
completes work,
the owners’
interest in the
assets increases.
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42
Exercise 1-22
Date
July
Bal
Liabilities Stockholder’s Equity
Assets
Cash
10,000
Medical
Supplies
Land
2,000 35,000
Accounts Common Retained
Payable
Stock
Earnings
2,000
45,000
15-31 7,000
Bal
17,000
7,000
2,000 35,000
Assets = $54,000
2,000
Type of
Transaction
45,000
Revenue
7,000
Liabilities &
Stockholders’
Equity = $54,000
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43
Analyze This:
July 15-31: Paid cash expenses
Does the
account
increase
or decrease?
What
accounts
are involved?
(1) Cash (asset)
(2) Retained earnings (equity)
When an expense is
incurred, the
owners’ claims to
the assets
decrease.
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44
Exercise 1-22
Date
July
Liabilities Stockholder’s Equity
Assets
Medical
Land Accounts Common Retained
Supplies
Payable
Stock
Earnings
17,000
2,000 35,000
2,000
45,000 7,000
Type of
Transaction
15-31 (1,700)
(1,700)
Salaries Exp
(1,000)
(1,000)
Rent Exp
( 300)
( 300)
Utilities Exp
Bal
Bal
Cash
14,000
2,000 35,000
Assets = $51,000
2,000
45,000
4,000
Liabilities &
Stockholders’
Equity = $51,000
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45
Analyze This:
July 28: Sold supplies to another
physician for the cost of those supplies
What accounts are involved?
Does the account increase or decrease?
(1) Cash (asset)
(2) Medical Supplies (asset)
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46
Exercise 1-22
Date
July
Liabilities Stockholder’s Equity
Assets
Cash
Bal
14,000
28
500
Bal
14,500
Medical
Supplies
Land
2,000 35,000
Accounts Common Retained
Payable
Stock
Earnings
2,000
45,000
4,000
2,000
45,000
4,000
Type of
Transaction
(500)
1,500 35,000
Assets = $51,000
Liabilities &
Stockholders’
Equity = $51,000
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47
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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48
Exercise 1-22
Date
July
Liabilities Stockholder’s Equity
Assets
Cash
Bal
14,500
31
(1,500)
Bal
13,000
Medical
Supplies
Land
1,500 35,000
Accounts Common Retained
Payable
Stock
Earnings
2,000
45,000
Type of
Transaction
4,000
(1,500)
1,500 35,000
Assets = $49,500
500
45,000
4,000
Liabilities &
Stockholders’
Equity = $49,500
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Objective 5
Prepare financial statements
Objective 6
Evaluate business performance
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50
Financial Statements
•
•
•
•
Income statement
Statement of retained earnings
Balance sheet
Statement of cash flows
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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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52
Statement of Retained Earnings
• Summary of changes in an entity’s
retained earnings during a specific period
Beginning retained earnings
+ Net income or
- Net loss
- Dividends
Ending retained earnings
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53
Balance Sheet
• Reports the entity’s assets, liabilities, and
stockholders’ equity as of a specific date
Assets = Liabilities + Stockholders’ Equity
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54
Statement of Cash Flows
• Reports cash receipts and cash payments
during a period (covered in subsequent
chapter)
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55
Maria Lange, M.D., P.C
Anytime you
Income Statement subtotal,
create a new
For the Month Ended July 31,
2004
column to the
Revenue:
Fees earned
Notice the
Expenses:
proper
heading.$1,700
Salary expense
Double
Rent
expense
1,000
underline for
your finalexpense
Utilities
300
answer.
Total Expenses
Net income
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left.
$7,000
3,000
$4,000
56
Maria Lange, M.D., PC. From income
statement
Dates
are
Statement
of Retained Earnings
important to
the For
readerthe
of Month Ended July 31, 2004
the financial
reports.
Retained earnings, July 1, 2004
Add: Net income for the month
Subtotal
Less: Dividends
Retained earnings, July 31, 2004
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$
0
4,000
$4,000
0
$4,000
57
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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58
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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59
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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60
statement of
Maria Lange, M.D., From
P.C.
retained earnings
Balance Sheet
July 31, 2004
Assets
Cash
$13,000
Notice the
Medical supplies proper
1,500
Heading. 35,000
Land
Total assets
$ 49,500
Liabilities
Accounts payable
Stockholders’ Equity
Common stock
Retained earnings
Total stockholders’ equity
Total liabilities and
stockholder’s equity
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$500
$45,000
4,000
49,000
$ 49,500
61
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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62
Exercise 1-24
Cash
Allen Samuel Road Service, Inc.
Balance Sheet
November 30, 2009
Assets
Liabilities
$2,000 Accounts payable
Accounts receivable
Supplies
Equipment
$3,500
6,000 Note payable
500
15,500
5,000
Total liabilities
$8,500
Stockholders’ Equity
Common stock
Retained earnings
$10,000
5,500
Total stockholders’ equity
Total Assets
Total liabilities &
$24,000
stockholders
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15,500
$24,000
63
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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64
Exercise 1-25
Ciliotta Design Studio, Inc.
Income Statement
Year Ended December 31, 2006
Service revenue
Expenses:
Salary expense
Rent expense
Utilities expense
Supplies expense
$158,100
$60,000
24,000
6,800
4,000
Property tax expense
Total expenses
Net income
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1,200
96,000
$62,100
65
Exercise 1-25
2. Stockholder’s equity:
Common stock
Retained earnings
Total stockholders’ equity
Retained earnings, beginning
Add: Net income
Deduct: Dividends
Retained earnings, ending
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$15,000
12,100
???
$27,100
$
0
62,100
(50,000)
?????
$12,100
66
End of Chapter 1
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67