Accounting in Business CHAPTER 1 PowerPoint Slides to accompany Fundamental Accounting Principles, 14ce Prepared by Joe Pidutti, Durham College © 2013 McGraw-Hill Ryerson Limited. Learning Objectives Describe the purpose and importance of accounting. (LO1) Describe forms of business organization. (LO2) Identify users and uses of, and opportunities in, accounting. (LO3) Identify and explain why ethics and social responsibility are crucial to accounting. (LO4) 1. 2. 3. 4. 2 © 2013 McGraw-Hill Ryerson Limited. Learning Objectives Identify, explain, and apply accounting principles. (LO5) Identify and explain the content and reporting aims of financial statements. (LO6) Analyze business transactions by applying the accounting equation. (LO7) Prepare financial statements reflecting business transactions. (LO8) 5. 6. 7. 8. 3 © 2013 McGraw-Hill Ryerson Limited. What is Accounting? • • Accounting is an information system that identifies, measures, records, and communicates information that has relevance and is a faithful representation of an organization’s economic activities. Its objective is to help people make better decisions. 4 © 2013 McGraw-Hill Ryerson Limited. (LO1) What is Recordkeeping? • • Recordkeeping, or bookkeeping, is the part of accounting that involves recording economic transactions, either electronically or manually. Accounting involves the recordkeeping process but is much more. 5 © 2013 McGraw-Hill Ryerson Limited. (LO1) Forms of Organization • • • Sole Proprietorship Partnership Corporation 6 © 2013 McGraw-Hill Ryerson Limited. (LO2) Sole Proprietorships • • • • • • One owner Separate entity for accounting purposes Not a separate legal entity from the owner Unlimited liability Limited life Owner taxed on profits 7 © 2013 McGraw-Hill Ryerson Limited. (LO2) Partnerships • • • • • • Two or more owners Separate entity for accounting purposes Not a separate legal entity from the owners Unlimited liability Limited life Owners taxed on profits 8 © 2013 McGraw-Hill Ryerson Limited. (LO2) Corporations • • • • • • One or more owners Separate entity for accounting purposes Separate legal entity from the owner(s) Limited liability Unlimited life Corporation taxed on profits 9 © 2013 McGraw-Hill Ryerson Limited. (LO2) Users of Accounting Information • Accounting is a service activity that provides information to help internal and external users make decisions. 10 © 2013 McGraw-Hill Ryerson Limited. (LO3) External Users External users of accounting information are not involved in running the organization. They include: • Lenders • Shareholders • Governments • Consumer groups • External auditors • Customers 3 11 © 2013 McGraw-Hill Ryerson Limited. (LO ) External Reporting • • • • Reports for external users are usually in the form of financial statements. The information in the statements needs to be relevant and faithfully represented. Generally accepted accounting principles (GAAP)are the underlying concepts that make up acceptable accounting practices. GAAP are important in increasing the usefulness of financial statements to users. 12 © 2013 McGraw-Hill Ryerson Limited. (LO3) Internal users • • Internal users are involved in managing and operating an organization. Accounting provides information to these users to help them improve the efficiency and effectiveness of the organization. 13 © 2013 McGraw-Hill Ryerson Limited. (LO3) Typical Questions Asked by Internal Users • • • • • What are the manufacturing expenses per unit of product? What is the most profitable mix of services? What level of revenues is necessary to show net income? Which service activities are most profitable? Which expenses change with a change in revenue? 14 © 2013 McGraw-Hill Ryerson Limited. (LO3) Accounting Opportunities Broad fields of accounting include: • Financial accounting • Managerial accounting • Taxation • Accounting-related fields 15 © 2013 McGraw-Hill Ryerson Limited. (LO3) Accounting Opportunities Accountants may work as: • Private accountants • Public accountants • Government accountants 16 © 2013 McGraw-Hill Ryerson Limited. (LO3) Professional Certification Professional certifications in Canada: • Certified General Accountant (CGA) • Certified Management Accountant (CMA) • Chartered Accountant (CA) 17 © 2013 McGraw-Hill Ryerson Limited. (LO3) Ethics and Social Responsibility • • • Ethics are beliefs that differentiate right from wrong. Ethics and ethical behaviour are important to the accounting profession and to those who use accounting information. Ethical practices build trust, which promotes loyalty and long-term relationships with customers, suppliers, employees, and investors. 18 © 2013 McGraw-Hill Ryerson Limited. (LO4) Ethics in Accounting • • • One of the primary goals of accounting is to provide useful information for decision making. In order for the information to be useful, it must be trusted. Accountants must act in an ethical manner in order for the information they produce to be trusted. 19 © 2013 McGraw-Hill Ryerson Limited. (LO4) Ethical Obligations of Accountants • • • • Maintain a high level of professional competence. Treat sensitive information as confidential. Exercise due care and professional judgment. Must not be associated with deceptive information. 20 © 2013 McGraw-Hill Ryerson Limited. (LO4) Generally Accepted Accounting Principles (GAAP) • • • GAAP are the underlying concepts that make up acceptable accounting practices. Canada has recently adopted International Financial Reporting Standards (IFRS) for publicly accountable enterprises (PAE). There is also another set of standards called Accounting Standards for Private Enterprises (ASPE). 21 © 2013 McGraw-Hill Ryerson Limited. (LO5) IFRS • • IFRS was established to try to achieve global agreement on the use of a common set of accounting standards. This is intended to make accounting information more comparable from country to country. 22 © 2013 McGraw-Hill Ryerson Limited. (LO5) ASPE • • Private enterprises are privately owned so they have some different reporting needs than public enterprises. ASPE have significant parallels to IFRS but there are some differences. 23 © 2013 McGraw-Hill Ryerson Limited. (LO5) GAAP for Public vs. Private Enterprises GAAP to be used 24 Publicly Accountable Enterprises (PAEs) Private Enterprises (PEs) IFRS ASPE or IFRS © 2013 McGraw-Hill Ryerson Limited. (LO5) Purpose of GAAP • • • The primary purpose of GAAP is to ensure the usefulness of financial information. In order for it to be useful, it must have the characteristics of relevance and faithful representation. Usefulness is enhanced if the information is comparable, verifiable, timely, and understandable. 25 © 2013 McGraw-Hill Ryerson Limited. (LO5) GAAP GAAP includes the following principles: • Business entity principle • Cost principle • Going concern principle • Monetary unit principle • Revenue recognition principle 26 © 2013 McGraw-Hill Ryerson Limited. (LO5) Business Entity Principle • Every business is to be accounted for separately from its owner(s) or any other economic entity of the owner. 27 © 2013 McGraw-Hill Ryerson Limited. (LO5) Cost Principle • • All transactions are recorded based on the actual cash amount received or paid. In absence of cash, the cash equivalent amount of the exchange is recorded. 28 © 2013 McGraw-Hill Ryerson Limited. (LO5) Going Concern Principle • Financial statement users can safely assume that the statements reflect a business that is going to continue its operations instead of being closed or sold. 29 © 2013 McGraw-Hill Ryerson Limited. (LO5) Monetary Unit Principle • • • Requires that transactions be expressed using units of money as the common denominator. It assumes that the monetary unit is stable. Adjustments are not made for changes in currency value or inflation. 30 © 2013 McGraw-Hill Ryerson Limited. (LO5) Revenue Recognition Principle • • Requires that revenue be recorded at the time that it is earned regardless of whether cash or another asset has been exchanged. The amount of revenue to be recorded is measured by the cash plus the cash equivalent of any other assets received. 31 © 2013 McGraw-Hill Ryerson Limited. (LO5) Financial Statements • • Are an organization’s primary means of financial communication. An organization’s transactions are recorded, classified, sorted, and summarized in order to produce financial statements. 32 © 2013 McGraw-Hill Ryerson Limited. (LO6) Financial Statements There are four major financial statements: • Income statement • Balance sheet • Statement of changes in equity • The statement of cash flows These statements provide different information but are linked together. 33 © 2013 McGraw-Hill Ryerson Limited. (LO6) Financial Statements Balance Sheet (at the beginning of the period) Income Statement Statement of Changes in Equity Balance Sheet (at the end of the period) Statement of Cash Flows Point in time 34 Period of time © 2013 McGraw-Hill Ryerson Limited. Point in time (LO6) Income Statement The income statement reports: • • • Revenues of the organization. Expenses (costs incurred in earning the revenues). Net income or loss. The income statement covers a period of time. 35 © 2013 McGraw-Hill Ryerson Limited. (LO6) Income Statement Value of assets exchanged for products and services provided to customers. Vertically Inclined Rock Gym Income S tatement For Month Ended March 31, 2014 Revenues: Teaching revenue $3,800 Equipment rental revenue 300 Total revenues Operating Expenses: Rent expense $1,000 S alaries expense 700 Total operating expenses Net income 36 © 2013 McGraw-Hill Ryerson Limited. $ 4,100 1,700 $ 2,400 (LO6) Income Statement Vertically Inclined Rock Gym Income S tatement For Month Ended March 31, 2014 Costs incurred or the using up of assets from generating revenue Revenues: Teaching revenue $3,800 Equipment rental revenue 300 Total revenues Operating Expenses: Rent expense $1,000 S alaries expense 700 Total operating expenses Net income 37 © 2013 McGraw-Hill Ryerson Limited. $ 4,100 1,700 $ 2,400 (LO6) Statement of Owner’s Equity Equity is equal to total assets minus total liabilities. It represents how much of the assets belong to the owner. Owner’s equity increases with owner investments and net income. Owner’s equity decreases with owner withdrawals and net loss. • • • • 38 © 2013 McGraw-Hill Ryerson Limited. (LO6) Statement Of Owner’s Equity Covers a period of time. From the Income statement. 39 Vertically Inclined Rock Gym S tatement of Owner's Equity For Month Ended March 31, 2014 Virgil Klimb, capital, March 1 Add: Investment by owner Net income Total Less: Withdrawal by owner Virgil Klimb, capital, March 31 © 2013 McGraw-Hill Ryerson Limited. $ $10,000 2,400 - 12,400 $12,400 600 $11,800 (LO6) Balance Sheet The balance sheet reports the: • • • Assets Liabilities Owner’s equity of an organization at a point in time. It is linked to the Statement of Owner’s Equity. 40 © 2013 McGraw-Hill Ryerson Limited. (LO6) Balance Sheet Vertically Inclined Rock Gym Balance Sheet March 31, 2014 Properties or economic resources owned by a business Assets Cash $ 8,400 Supplies 3,600 Equipment 6,000 Total assets $ 18,000 41 Liabilities Accounts payable $ 200 Notes payable 6,000 Total liabilities $ 6,200 Owner's Equity Virgil Klimb,capital 11,800 Total liabilities and owner's equity $ 18,000 © 2013 McGraw-Hill Ryerson Limited. (LO6) Balance Sheet Vertically Inclined Rock Gym Balance Sheet March 31, 2014 Debts or obligations of the business Assets Cash $ 8,400 Supplies 3,600 Equipment 6,000 Total assets $ 18,000 42 Liabilities Accounts payable $ 200 Notes payable 6,000 Total liabilities $ 6,200 Owner's Equity Virgil Klimb,capital 11,800 Total liabilities and owner's equity $ 18,000 © 2013 McGraw-Hill Ryerson Limited. (LO6) Balance Sheet Owner’s claim on the assets From the Statement of Owner’s Equity Vertically Inclined Rock Gym Balance Sheet March 31, 2014 Assets Cash $ 8,400 Supplies 3,600 Equipment 6,000 Total assets $ 18,000 43 Liabilities Accounts payable $ 200 Notes payable 6,000 Total liabilities $ 6,200 Owner's Equity Virgil Klimb,capital 11,800 Total liabilities and owner's equity $ 18,000 © 2013 McGraw-Hill Ryerson Limited. (LO6) Cash Flow Statement Reports the sources and uses of cash for a period of time. Organized by the company’s major activities: • • • • • 44 Operating Investing Financing © 2013 McGraw-Hill Ryerson Limited. (LO6) Cash Flow Statement Vertically Inclined Rock Gym Cash Flow Statement For Month Ended March 31, 2014 From the balance sheet 45 Cash flows from operating activities: Cash received from clients Cash paid for supplies Cash paid for rent Cash paid to employee Net cash used by operating acitivities Cash flows from investing activities: Cash flows from financing activities: Investment by owner Withdrawal by owner Net cash provided by financing activities Net increase in cash Cash balance, January 1 Cash balance, January 31 © 2013 McGraw-Hill Ryerson Limited. $4,100 (3,400) (1,000) (700) ($1,000) 0 $10,000 (600) 9,400 $8,400 $8,400 (LO6) The Accounting Equation Assets = Liabilities + Equity Describe what an organization has invested in. 46 © 2013 McGraw-Hill Ryerson Limited. (LO7) The Accounting Equation Assets Describe what an organization has invested in. 47 = Liabilities + Equity Describe non-owner financing (borrowing) © 2013 McGraw-Hill Ryerson Limited. (LO7) The Accounting Equation Assets Describe what an organization has invested in. 48 = Liabilities Describe non-owner financing (borrowing). © 2013 McGraw-Hill Ryerson Limited. + Equity Describe owner financing . (LO7) The Accounting Equation Assets = Liabilities + Equity The accounting equation is used to keep track of changes in a company’s assets, liabilities, and equity. 49 © 2013 McGraw-Hill Ryerson Limited. (LO7) The Accounting Equation Assets = Liabilities + Equity Business transactions cause changes in assets, liabilities, and equity. 50 © 2013 McGraw-Hill Ryerson Limited. (LO7) Transaction Analysis We need to determine: 1. 2. 51 Which accounts are being affected. If the accounts are increasing or decreasing. © 2013 McGraw-Hill Ryerson Limited. (LO7) Transaction Analysis (1) Virgil Klimb invests $10,000 cash in the business. Analysis: Cash increases by $10,000. Owner’s capital increases by $10,000. Assets = (1) Cash Supplies Equipment $10,000 New bal. $10,000 $0 $10,000 52 $0 Liabilities Accounts Notes Payable Payable $0 = © 2013 McGraw-Hill Ryerson Limited. $0 Owner's + Equity V.Klimb Capital $10,000 $10,000 $10,000 (LO7) Transaction Analysis (2) Purchased supplies for $2,500 cash. Analysis: Supplies increase by $2,500. Cash decreases by $2,500. Assets = Cash Supplies Equipment $10,000 -$2,500 $2,500 $7,500 $2,500 $0 Old bal. (2) New bal. $10,000 53 Liabilities Accounts Notes Payable Payable $0 = © 2013 McGraw-Hill Ryerson Limited. $0 Owner's + Equity V.Klimb Capital $10,000 $10,000 $10,000 (LO7) Transaction Analysis (3a) Purchased $1,100 of supplies on credit. Analysis: Supplies increase by $1,100. Accounts Payable increases by $1,100 Owner's Assets = Liabilities + Equity Accounts Notes V.Klimb, Cash Supplies Equipment Payable Payable Capital $7,500 $2,500 $10,000 $1,100 $1,100 $7,500 $3,600 $0 $1,100 $0 $10,000 Old bal. (3a) New bal. $11,100 54 = © 2013 McGraw-Hill Ryerson Limited. $11,100 (LO7) Transaction Analysis (3b) Purchased $6,000 of equipment on credit. A promissory note was signed. Analysis: Equipment increases by $6,000. Notes payable increases by $6,000. Old bal. (3b) New bal. Owner's Assets = Liabilities + Equity Accounts Notes V.Klimb, Cash Supplies Equipment Payable Payable Capital $7,500 $2,500 $10,000 $1,100 $6,000 $1,100 $6,000 $7,500 $3,600 $6,000 $1,100 $6,000 $10,000 $17,100 55 = © 2013 McGraw-Hill Ryerson Limited. $17,100 (LO7) Transaction Analysis (4) Services rendered for $2,200 cash. Analysis: Cash increases $2,200 Owner’s equity increases $2,200 Old bal. (4) New bal. Owner's Assets = Liabilities + Equity Accounts Notes V.Klimb, Cash Supplies Equipment Payable Payable Capital $7,500 $3,600 $6,000 $1,100 $6,000 $10,000 $2,200 $2,200 $9,700 $3,600 $6,000 $1,100 $6,000 $12,200 $19,300 56 = © 2013 McGraw-Hill Ryerson Limited. $19,300 (LO7) Transaction Analysis (5) Payment of $1,000 rent expense in cash. Analysis: Cash decreases $1,000 Owner’s equity decreases $1,000 Old bal. (5) New bal. Owner's Assets = Liabilities + Equity Accounts Notes V.Klimb, Cash Supplies Equipment Payable Payable Capital $9,700 $3,600 $6,000 $1,100 $6,000 $12,200 -$1,000 -$1,000 $8,700 $3,600 $6,000 $1,100 $6,000 $11,200 $18,300 57 = © 2013 McGraw-Hill Ryerson Limited. $18,300 (LO7) Transaction Analysis (6) Payment of $700 salaries expense in cash. Analysis: Cash decreases $700 Owner’s equity decreases $700 Old bal. (6) New bal. Owner's Assets = Liabilities + Equity Accounts Notes V.Klimb, Cash Supplies Equipment Payable Payable Capital $8,700 $3,600 $6,000 $1,100 $6,000 $11,200 -$700 -$700 $8,000 $3,600 $6,000 $1,100 $6,000 $10,500 $17,600 58 = © 2013 McGraw-Hill Ryerson Limited. $17,600 (LO7) Transaction Analysis (7) Service contract signed for April. Analysis: No economic exchange has taken place All accounts remain unaffected Owner's Assets = Liabilities + Equity Accounts Notes V.Klimb, Cash Supplies Equipment Payable Payable Capital $8,000 $3,600 $6,000 $1,100 $6,000 $10,500 Old bal. (7) New bal. $8,000 $3,600 $17,600 59 $6,000 $1,100 = © 2013 McGraw-Hill Ryerson Limited. $6,000 $10,500 $17,600 (LO7) Transaction Analysis (8)Services and rental revenues of $1,900 rendered for credit. ($1,600 Teaching Revenue and $300 Equipment Rental Revenue) Analysis: Accounts receivable increases $1,900 Owner’s equity increases $1,900 Asse ts Ca sh Old bal. (8) New bal. A/ R $8,000 S upplie s Equipme nt $3,600 $6,000 Lia bilitie s Note s A/ P P a ya ble $ 1, 10 0 $6,000 $ 1, 9 0 0 $ 8 , 0 0 0 $ 1, 9 0 0 $ 10 , 5 0 0 $ 1, 9 0 0 $3,600 $ 19 , 5 0 0 60 = O wne r's + Equity V . Klimb, Ca pita l $6,000 $ 1, 10 0 = © 2013 McGraw-Hill Ryerson Limited. $6,000 $ 12 , 4 0 0 $ 19 , 5 0 0 (LO7) Transaction Analysis (9) Receipt of $1,900 cash on account. Analysis: Cash increases $1,900 Accounts receivable decreases $1,900 Assets Cash A/ R Old bal. $ 8,000 $ 1,900 (9) $ 1,900 -$ 1,900 New bal. $ 9,900 $0 Supplies Equipment Liabilities Notes A/ P P ayable $ 3,600 $ 6,000 $ 1,100 $ 6,000 $ 12,400 $ 3,600 $ 6,000 $ 1,100 $ 6,000 $ 12,400 $ 19,500 61 = Owner's + Equity V.Klimb, Capital = © 2013 McGraw-Hill Ryerson Limited. $ 19,500 (LO7) Transaction Analysis (10) Payment of $900 accounts payable. Analysis: Cash decreases $900 Accounts payable decreases $900 Assets Cash Old bal. $ 9,900 A/ R $0 = Supplies Equipment $ 3,600 $ 6,000 $ 1,100 (10) -$ 900 New bal. $ 9,000 $ 6,000 $ 12,400 $ 6,000 $ 12,400 -$ 900 $0 $ 3,600 $ 18,600 62 Liabilities Notes A/ P P ayable Owner's + Equity V.Klimb, Capital $ 6,000 $ 200 = © 2013 McGraw-Hill Ryerson Limited. $ 18,600 (LO7) Transaction Analysis (11) Withdrawal of $600 cash by owner. Analysis: Cash decreases $600 Owner’s capital decreases $600 Assets Cash Old bal. $ 9,000 A/ R $0 = Supplies Equipment $ 3,600 $ 6,000 Liabilities Notes A/ P P ayable $ 200 $ 6,000 (11) -$ 600 New bal. $ 8,400 $ 12,400 -$ 600 $0 $ 3,600 $ 18,000 63 Owner's + Equity V.Klimb, Capital $ 6,000 $ 200 = © 2013 McGraw-Hill Ryerson Limited. $ 6,000 $ 11,800 $ 18,000 (LO7) Financial Statement Preparation The final balances of the accounts after all of the transactions have been recorded are as follows: A ssets C ash Fin a l b a l. $ 8 ,4 0 0 A/R $0 = S upplie s E quipm e nt $ 3 ,6 0 0 $ 6 ,0 0 0 $ 18 ,0 0 0 Lia bilit ie s N o tes A/P P a ya ble $ 200 = $ 6 ,0 0 0 O wne r' s E quit y + V .Klim b, C a pit a l $ 11,8 0 0 $ 18 ,0 0 0 This information will be used to prepare the financial statements. 64 © 2013 McGraw-Hill Ryerson Limited. (LO7) Financial Statement Preparation The Income Statement is prepared first by using revenue and expense information from the Equity column. Ve rti cal l y Incl i ne d Rock Gym Income State me nt For Month Ende d March 31, 2014 Re ve nue s: Transactions 4 and 8 Transaction 8 Te achi ng re ve nue Equi pme nt re ntal re ve nue $ 3,800 300 Total re ve nue s $ 4,100 O pe rati ng Expe nse s: Transaction 5 Transaction 6 Re nt e xpe nse Sal ari e s e xpe nse Total ope rati ng e xpe nse s Ne t i ncome 65 © 2013 McGraw-Hill Ryerson Limited. $ 1,000 700 1,700 $ 2,400 (LO8) The Statement of Owner’s Equity is prepared next Ve rti cal l y Incl i ne d Rock Gym Income State me nt For Month Ende d March 31, 2014 Re ve nue s: Te achi ng re ve nue Equi pme nt re ntal re ve nue $ 3,800 300 Total re ve nue s $ 4,100 O pe rati ng Expe nse s: Re nt e xpe nse Sal ari e s e xpe nse $ 1,000 700 Total ope rati ng e xpe nse s 1,700 Ne t i ncome $ 2,400 Vertically Inclined Rock Gym S tatement of Owner's Equity For Month Ended March 31, 2014 Transaction 1 Income Statement Transaction 11 Virgil Klimb, capital, March 1 Add: Investment by owner Net income Total Less: Withdrawal by owner Virgil Klimb, capital, March 31 66 © 2013 McGraw-Hill Ryerson Limited. $ $10,000 2,400 - 12,400 $12,400 600 $11,800 (LO8) The Balance Sheet is prepared using the final balances of the accounts Ve rtically Incline d Rock Gym Balance She e t March 31, 2014 Asse ts Cash $ Supplie s Equipme nt 8,400 3,600 6,000 From the Statement of Owner’s Equity Total asse ts $ 18,000 67 Liabilitie s Accounts payable $ 200 Note s payable 6,000 Total liabilitie s $ 6,200 Owne r's Equity Virgil Klimb,capital 11,800 Total liabilitie s and owne r's e quity $ 18,000 © 2013 McGraw-Hill Ryerson Limited. (LO8) End of Chapter 68 © 2013 McGraw-Hill Ryerson Limited.