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CHAPTER 1
ACCOUNTING AND ITS
USE IN BUSINESS
DECISIONS
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The Body of
Accounting Knowledge
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The Body of
Accounting Knowledge
Chapter 1
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The Business Entity Concept
For accounting
purposes, each
business organization,
or entity, has an
existence separate
from its owner(s).
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Forms of Businesses
Single
Proprietorship
Partnership
Corporation
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Single Proprietorships

One owner - the
simplest possible form
of business
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Single Proprietorships
One owner - the
simplest possible form
of business
 Is not considered a
separate legal entity.

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Single Proprietorships
One owner - the
simplest possible form
of business
 Is not considered a
separate legal entity.
 Many other textbooks
start with this form
and then move on to
corporations.

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Partnerships

Two or more owners

Also not considered a
separate legal entity.

Are not covered in this
course.

Advanced accounting
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Corporations
Usually there are many owners.
 Usually the owners do not exercise
direct control over the company.

Owners
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Corporations
Usually there are many owners.
 Usually the owners do not exercise
direct control over the company.


The owners’ interests are represented by
the board of directors.
Board of Directors
Owners
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Corporations
Usually there are many owners.
 Usually the owners do not exercise
direct control over the company.



The owners’ interests are represented by
the board of directors.
Reason used throughout this text.
Board of Directors
Owners
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Corporations

A corporation is considered a
separate legal entity.
pays taxes, can sue and be sued,
and is subject to legal penalties.
 More on this in Chapter 12.

Stockholders get dividends
from the corporation.
 What are dividends?


Distributions of profits
to owners
Owners
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Three Types of Businesses
Service
Businesses
Merchandising
Businesses
Manufacturing
Businesses
(Chapters 1-4)
(Chapters 16-17)
(Last 2/3 of 2nd
semester)
Examples of each?
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Terminology
Profitability:
The ability to generate income.
 Solvency:
The ability to pay debts as they
become due.
 Why are they important?
Ostensibly, they are the primary
objectives of every business

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The Four Basic Financial Statements
Income
Statement
Which two are the
most important?
Statement
of
Retained
Earnings
Balance
Sheet
Statement
of Cash
Flows
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Why are Income Statement and
Balance Sheet most important?
Because they communicate the
profitability and solvency.
 Which does which?




Income Statement - Profitability
Balance Sheet - Solvency
Can each be represented with an
equation?
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Income Statement Model
Net
Revenues - Expenses
=
Income
Inflows of assets
resulting from the
sale of products or
services.
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Income Statement Model
Net
Revenues - Expenses
=
Income
Costs incurred to
produce revenues
or,
Assets used up in
the process of
earning revenues.
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Income Statement Model
Net
Revenues - Expenses
=
Income
Caution!
NET INCOME results
when Revenues exceed
Expenses for a given
period.
Must use the correct
accounting
definitions! Not
yours, not Webster’s
and not one from
Economics class.
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Income Statement Model
Net
Loss
=
Revenues - Expenses
NET LOSS results when
Expenses exceed
Revenues for a given
period.
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Balance Sheet Model
Assets
Liabilities
Stockholders’
Equity
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Balance Sheet Model
Assets = Liabilities + Stockholders’ Equity
Things of
value
owned by
the
business.
Debts owed
by the
business.
Owners’
interest in the
business.
(i.e., the
creditors’
claims against
the assets)
(i.e., the owners’
claims against the
assets)
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Components of
Stockholders’ Equity
Capital stock

Amount the owners have invested
in the corporation.
Retained earnings

Net income earned since the
beginning of the company, less
any dividends paid.
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Balance Sheet Model
Assets = Liabilities + Stockholders’ Equity
Retained
Earnings
+
Net Income
Capital
Stock
Dividends
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Balance Sheet Model
_____Sources of assets_____
Assets = Liabilities + Stockholders’ Equity
Why is it called a “Balance Sheet”?
Basic algebra
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Balance Sheet Model
Equities (Claims against the assets)
Assets = Liabilities + Stockholders’ Equity
Note, however, that you cannot “tag a dollar”!
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Timing of Balance Sheet and
Income Statement
Balance Sheet:
At 12-31
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1998
Income Statement:
For the year ended 12-31
12-31
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Financial Statements Covered
This Semester

Income Statement

Statement of Retained Earnings


Simple example
Balance Sheet

Two types
Horizontal and vertical
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Statement of Retained Earnings

Links the Income
Statement with the
Balance Sheet

Summarizes changes
in Retained Earnings
(R/E) for the period
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Statement of Retained Earnings:
More Complex Example (p. 20)
HEADING
R/E - Beginning of Period
$
$$$
Add: Net Income for
for the Period
$$$
Subtract: Dividends for
the Period
$$$
R/E - End of Period
$
$$$
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Retained Earnings Model
B/R/E + NI - Dividends = E/R/E
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Retained Earnings Model
B/R/E + NI - Dividends = E/R/E
This assumes that
the company in
fact has net
income.
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Retained Earnings Model
B/R/E - NL - Dividends = E/R/E
If the company
does not have net
income, subtract
the net loss.
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Retained Earnings Model
B/R/E + NI - Dividends = E/R/E
A dividend is a
distribution of
income to the owners
of the corporation.
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The Financial Statement
NOT Studied This Semester
Statement of Cash Flows
 At this point, simply know that it tells
where cash came from and where it
went.


“Where got, where gone”
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Balance Sheet Comparison
Corporation vs. Proprietorship
(See Appendix, pp. 33-34)
CORPORATION
Stockholders' Equity:
Capital stock
$ 100,000
Retained earnings 50,000
PROPRIETORSHIP
Owner's Equity:
Smith, Capital $150,000
______
Total equity
Total equity
$150,000
$ 150,000
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ROLL ‘EM !
Video #1
Video #2
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Final Points

P. 23 “Underlying Assumptions”

Only know business entity concept for now
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Final Points

P. 23 “Underlying Assumptions”


Only know business entity concept for now
Don’t read the chapters!

Questions on pp. 23-30 Transactions?
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Final Points

P. 23 “Underlying Assumptions”


Don’t read the chapters!


Only know business entity concept for now
Questions on pp. 23-28 Transactions?
P. 26 - Subsequent use of Summary of
Transactions in this course
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Final Points

P. 23 “Underlying Assumptions”


Only know business entity concept for now
Don’t read the chapters!

Questions on pp. 23-28 Transactions?
P. 26 - Subsequent use of Summary of
Transactions in this course
 P. 27 - Transaction 1b - Why...?

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Final Points

P. 23 “Underlying Assumptions”


Only know business entity concept for now
Don’t read the chapters!

Questions on pp. 23-28 Transactions?
P. 26 - Subsequent use of Summary of
Transactions in this course
 P. 27 - Transaction 1b - Why...?
 P. 27 - Transaction 2b - Revenue?

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Final Points

P. 23 “Underlying Assumptions”


Only know business entity concept for now
Don’t read the chapters!

Questions on pp. 23-28 Transactions?
P. 26 - Subsequent use of Summary of
Transactions in this course
 P. 27 - Transaction 1b - Why...?
 P. 27 - Transaction 2b - Revenue?
 P. 30 - One more transaction

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Final Points

P. 23 “Underlying Assumptions”


Only know business entity concept for now
Don’t read the chapters!

Questions on pp. 23-28 Transactions?
P. 26 - Subsequent use of Summary of
Transactions in this course
 P. 27 - Transaction 1b - Why...?
 P. 27 - Transaction 2b - Revenue?
 P. 30 - One more transaction
 P. 31 - Analyzing and Using Fin. Results

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Caution!
One final caution, especially for those
who have had some prior accounting

High School
• One course
• Two courses

College
• Took it and dropped the course
• Took it and failed the course
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That’s the
end of the
topic, Bub!
Did you get
all that?