Chapter 1
Accounting and
Business
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
What are the Basic Functions of
Business?
• Marketing
 Products, pricing, promotion, distribution
• Human resources
 Jobs, people, salaries, benefits
• Production and operations
 Planning, directing, controlling, evaluating
• Finance
 Capital maintenance
• Accounting and information systems
 Information infrastructure
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How do the Functions Use
Accounting Information?
• Marketing
 Pricing, distribution costs
• Human resources
 Pay and fringe benefits, hiring costs
• Production and operations
 Production costs—actual and budgeted
• Finance
 Cost of borrowing, benefits expected
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How has Business Evolved?
• Sole proprietorship
 One owner
• Partnership
 Two or more owners
• Corporation
 Many owners
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• Merchandising
 Buy and sell products
• Service
 Provide service
• Manufacturing
 Make and sell
products
How has Accounting Evolved?
• Determination of wealth
 What am I worth today
• Determination of income
 How has my wealth changed
• On-going success
 How is the business doing
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What are the Characteristics of
Business Today?
• Customer-focused operations
• Global markets
 Products, labor, and capital
• Advanced manufacturing and
communications
• eBusiness
 B2B and B2C
• Hybrid organizational structures
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What are the Basic Concepts of
Accounting?
• Business entity
 Keep business and personal records separate
• Monetary unit
 Maintain business records in currency
• Going concern
 Business will continue past the current period
• Periodicity
 Profits/losses must be determined periodically
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What are the 5 Basic Elements of
Accounting?
• Asset
 Right to use resources with future benefit
• Liability
 Obligation to transfer resources in the future
to suppliers of goods and services
• Owners’ equity
 Net assets belong to owners
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5 Basic Elements Continued
• Revenues (accrual basis)
 Amounts earned from providing goods
and services
• Expenses (accrual basis)
 Amounts incurred in an attempt to
generate revenues
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Example
• A company provides $120,000 of services
during the year of which $100,000 were
received in cash. The company’s employees
earned $70,000 in wages, but due to the way
payroll is determined, they were only paid
$55,000 during the period.
• What is the accrual-based income?
• What is the cash-based income?
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Answers
Accrual-based income:
Revenues earned
Less expenses incurred
= Income
$120,000
70,000
$ 50,000
Cash-based income:
Revenues received
Less expenses paid
= Income
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$100,000
55,000
$ 45,000
What is GAAP and the IFRS?
• Generally Accepted Accounting Principles
• International Financial Reporting standards
• Financial Accounting Standards Board
 Current rule-making body in U.S.
• International Accounting Standards Board
 Current rule-making body internationally
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What are the Concepts
Statements?
• Concepts Statement #1
 Useful information for decision making
• Concepts Statement #2
 Characteristics of accounting information
• Concepts Statement #3 (superceded)
• Concepts Statement #4
 Objectives for nonbusiness organizations
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Concepts Continued
• Concepts Statement #5
 Financial statements
• Concepts Statement #6
 Elements of financial statements
• Concepts Statement #7
 Estimating value of future cash flows
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What Makes Information Useful?
• Relevance
 Capable of making a difference
• Reliability
 Dependable
• Benefits > Costs
 Benefits derived must be greater than
cost
• Materiality
 Large enough to have an impact on a
decision
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What are the 4 Basic Financial
Statements and Auditors’ Report?
• Income statement
 Indicates revenues less expenses = net
income for a period of time
• Statement of cash flows
 Indicates cash inflows and outflows from
operating, investing, and financing activities
for a period of time
• Statement of owners’ equity
 Indicates changes in owners’ equity for a
period of time
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Financial Statements Continued
• Balance sheet
 Indicates the ending balances of assets,
liabilities, and owners’ equity at a point in
time
• Auditor’s report
 Indicates whether the company followed
GAAP when preparing its financial statements
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What are the Purposes of the
Ratios?
• Current ratio
 Relationship between current assets and
current liabilities
• Debt to equity ratio
 Relationship between liabilities and owners’
equity
• Return on sales
 Relationship between net income and sales
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Example
Use the following information to calculate the ratios:
Accounts payable, $136
Accounts receivable, $876
Cash, $2,211
Common stock, $3,827
Cost of goods sold, $8,192 Inventory, $908
Long-term bank loan, $716
Miscellaneous payables, $529
Operating expenses, $5,436
Retained earnings, $373
Sales, $13,353
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Answers
Current ratio = ($876 + $908 + $2,211) /
($136 + $529) = 6.01 to 1
Debt to equity ratio = ($136 + $716 + $529) /
($3,827 + $373) = 0.33 to 1
Return on sales ratio = $275 / $13,353 =
2.06% ($13,353 - $8,192 - $5,436 = $275)
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