Chapter 1 Introduction to Accounting and Business

Chapter 1 – Introduction to Accounting and Business After studying this chapter, you should be able to: 1. 2. 3. 4. 5. Describe the nature of a business and the role of accounting in business. Summarize the development of accounting principles and relate them to practice. State the accounting equation and define each element of the equation. Describe and illustrate how business transactions can be recorded in terms of the resulting change in the basic elements of the accounting equation. Describe the financial statements of a proprietorship 1

Objective #1 - Describe the nature of a business and the role of accounting in business. 1 -1 Types of Businesses Service Business The Walt Disney Company Atlas Air Marriott International Hotels Bank of America Corporation XM Satellite Radio Service Entertainment Transportation Hospitality and lodging Financial services Satellite radio 2

Types of Businesses 1 -1 Merchandising Business Product Wal-Mart General merchandise Game. Stop Corporation Video games and accessories Best Buy Consumer electronics Gap Inc. Apparel Amazon. com Internet books, music, video 3

Types of Businesses Manufacturing Business General Motors Corp. Samsung Dell Inc. Nike Pepsico Sony Corporation 1 -1 Product Cars, trucks, vans Cell phones Personal computers Athletic shoes and apparel Beverages and Snacks Stereos and televisions 4

Accounting can be defined as an information system that provides reports to stakeholders about the economic activities and condition of a business. 1 -1 Who are stakeholders? – anyone or any entity that has an interest in the economic performance and well-being of a business Bankers and other creditors – need to ensure that the business has the ability to repay loans, and on a timely basis Suppliers – need to ensure their customer (the business) will be around to purchase their supplies and then be able to pay for them Customers – are interested in the business to determine if they will always be around to provide a constant flow of goods and services Government – need to ensure that the business pays the correct amount of taxes Employees and Management– need to ensure that the business is doing well so that they will have a job 5

Different types of Accounting 1 -1 Financial accounting is primarily concerned with the recording & reporting of economic data and activities for a business to external parties. Managerial accounting uses both financial accounting and estimated data to aid management in running day-to-day operations and in planning future operations. Accountants employed by a business firm or a not-for-profit organization are said to be employed in private accounting. E. g. CFO, Controller, or Financial Analyst of Pepsico Accountants and their staff who provide services to the public (i. e. individuals and corporations) on a fee basis are said to be employed in public accounting. E. g. Pricewaterhouse. Coopers, Ernst & Young, KPMG, Deloitte 6

Objective #2 - Summarize the development of accounting principles and relate them to practice. 1 -2 GAAP – Generally Accepted Accounting Principles. These are the rules that govern how businesses record and report financial transactions FASB – Financial Accounting Standards Board. This body is the major one responsible for preparing US GAAP. IASB – International Accounting Standards Board. This body is the one responsible for preparing International GAAP, which is also known as ‘International Financial Reporting Standards (IFRS)’ The business entity concept limits the economic data in the accounting system to data related directly to the activities of the business. – i. e. nothing personal unless it has been given/assigned to the business The cost concept is the basis for entering the exchange price, or cost of an acquisition in the accounting records. – e. g. what was paid for it. 7

Common Forms of Business Entities 1 -1 ü Proprietorship ü Partnership ü Corporation ü Limited liability company 8

A proprietorship is owned by one individual and— § § 1 -1 Comprises 70% of business organizations in the United States. Requires low cost of organizing. Is limited to financial resources of the owner. Is used by small businesses. A partnership is similar to a proprietorship except that it is owned by two or more individuals and— § Comprises 10% of business organizations in the United States. § Combines the skills and resources of more than one person. 9

1 -1 A corporation is organized under state or federal statues as a separate legal taxable entity and— § Generates 90% of the total dollars of business receipts received. § Comprises 20% of the businesses. § Includes ownership divided into shares of stock, sold to shareholders (stockholders). § Is able to obtain large amounts of resources by issuing stock. § Is used by large businesses. 10

1 -1 A limited liability company (LLC) combines attributes of a partnership and a corporation in that it is organized as a corporation. However, a limited liability corporation can elect to be taxed as a partnership and— § Is a popular alternative to a partnership. § Has tax and liability advantages to the owners. 11

Objective #3 - State the accounting equation and define each element of the equation. 1 -3 The Accounting Equation Assets = Liabilities + Owner’s Equity The resources owned The rights of the by a business owners The rights of the creditors, which represent debts of the business 12

Objective #4 - Describe and illustrate how business transactions can be recorded in terms of the 1 -4 resulting change in the basic elements of the accounting equation. A business transaction is an economic event or condition that directly changes an entity’s financial condition or directly affects its results of operations. On November 1, 2007, Chris Clark begins a business that will be known as Net. Solutions. This business provides web design services, and computer repair services etc. 13

1 -4 Assets a. Cash 25, 000 = = Owner’s Equity Chris Clark, Capital 25, 000 Investment by Chris Clark a. Chris Clark deposits $25, 000 in a bank account in the name of Net. Solutions. 14

1 -4 Assets Cash + Land Bal. 25, 000 b. – 20, 000 +20, 000 Bal. 5, 000 20, 000 = = Owner’s Equity Chris Clark, Capital 25, 000 b. Net. Solutions purchased land for $20, 000. 15

1 -4 Owner’s Liabilities + Equity Accounts Chris Clark, Payable Capital Assets Cash + Supplies + Land Bal. 5, 000 c. Bal. 5, 000 20, 000 +1, 350 20, 000 = 25, 000 +1, 350 25, 000 c. During the month, Net. Solutions purchased supplies for $1, 350 and agreed to pay the supplier in the near future (on account). Note – these supplies e. g. wires, cables etc, will be used up later in the business 16

Revenue and expenses 1 -4 A company earns revenues by • selling products - Sales • providing services - Fees Earned • renting out premises - Rent Revenue • lending money - Interest Revenue The amounts used in earning revenue are called expenses. Note: Expenses that have paid for (or incurred) but not yet been used up are referred to as prepaid expenses e. g. supplies. When these prepaid expenses have been used up, they will then become regular expenses e. g. supplies expenses 17

1 -4 Assets Liabilities + Accounts Payable Cash + Supplies + Land Bal. d. 5, 000 +7, 500 1, 350 Bal. 12, 500 1, 350 20, 000 1, 350 Owner’s Equity Chris Clark, Fees + Capital + Earned 25, 000 +7, 500 = 20, 000 1, 350 25, 000 7, 500 d. Net. Solutions provided services to customers, earning fees of $7, 500 and received the amount in cash. Note – If the customers did not pay immediately, but opted to pay on account ( i. e. at a later date), then the asset that would have been increased would have been accounts receivable 18

Note………. 1 -4 1. Adding expenses to the owner’s equity section results in a space problem. To adjust for these added headings, the word “Bal. ” has been omitted from some slides. The bottom row still provides the balances after each transaction. 2. Beginning with entry (e) the asset section will be shown first, then the liabilities and owner’s equity will be shown in the following slide. 19

1 -4 Assets Cash + Supplies + Land Bal. 12, 500 1, 350 20, 000 e. – 3, 650 Bal. 8, 850 1, 350 20, 000 e. Net. Solutions paid the following expenses: wages, $2, 125; rent, $800; utilities, $450; and miscellaneous, $275. 20

1 -4 Liabilities + Owner’s Equity Accounts Chris Clark, Fees Wages Rent Utilities Misc. Payable + Capital + Earned Expense 1, 350 25, 000 7, 500 – 2, 125 1, 350 25, 000 7, 500 – 800 – 450 – 2, 125 – 800 – 450 e. – 275 e. Net. Solutions paid the following expenses: wages, $2, 125; rent, $800; utilities, $450; and miscellaneous, $275. 21

1 -4 Assets Cash + Supplies + Land Bal. 8, 850 1, 350 20, 000 f. – 950 Bal. 7, 900 1, 350 20, 000 f. Net. Solutions paid $950 to creditors during the month. 22

1 -4 Liabilities + Owner’s Equity Accounts Chris Clark, Fees Wages Rent Utilities Misc. Payable + Capital + Earned Expense – 800 – 450 – 275 1, 350 25, 000 7, 500 – 2, 125 f. – 950 400 25, 000 7, 500 – 2, 125 – 800 – 450 – 275 f. Net. Solutions paid $950 to creditors during the month. 23

1 -4 Assets Cash + Supplies + Land Bal. 7, 900 1, 350 20, 000 g. – 800 Bal. 7, 900 550 20, 000 g. At the end of the month, the cost of supplies on hand is $550, so $800 of supplies must have been used up 24

1 -4 Liabilities + Owner’s Equity Accounts Chris Clark, Fees Wages Payable + Capital + Earned Exp. 400 25, 000 7, 500 – 2, 125 Rent Supplies Util. Misc. Exp. – 800 – 450 – 275 g. At the end of the month, the cost of supplies on hand is $550, so $800 of supplies must have been used up 25

1 -4 Assets Cash + Supplies + Land Bal. 7, 900 550 20, 000 h. – 2, 000 Bal. 5, 900 550 20, 000 h. At the end of the month, Chris withdrew $2, 000 in cash from the business for personal use. 26

1 -4 Liabilities + Owner’s Equity Accounts Chris Clark, Chris Clark Fees Wages Payable + Capital + Drawing Earned Exp. 400 25, 000 7, 500 – 2, 125 Rent Supplies Util. Exp. – 800 Misc. Exp. – 800 – 450 – 275 h. – 2, 000 400 25, 000 – 2, 000 7, 500 – 2, 125 – 800 – 450 – 275 h. At the end of the month, Chris withdrew $2, 000 in cash from the business for personal use. 27

Summary 28

1 -4 Owner’s Equity Increased by Decreased by Owner’s investments Owner’s withdrawals Revenues Expenses 29

Objective #5 - Describe the financial statements of a proprietorship and explain how they interrelate. 1 -5 Accounting reports, called financial statements, provide summarized information to the owner. The 4 common financial statements are prepared in the following order: 1. Income Statement 2. Statement of Owner’s Equity 3. Balance Sheet 4. Statement of Cash Flow 30

1 -5 The income statement is a summary of the revenue and expenses for a specific period of time, such as a month or a year. The income statement is based on the matching concept. This concept is applied by matching expenses with the revenues they generated, only during the period that those revenues were generated. Note - The excess of revenue over the expenses is called net income or net profit. If the expenses exceed the revenue, the difference is a net loss. 31

Income Statement Net income is carried to the statement of owner’s equity 1 -5 32

1 -5 A statement of owner’s equity is a summary of the changes in the owner’s equity that have occurred during a specific period of time. 33

Statement of Owner’s Equity 1 -5 From the income statement To the balance sheet 34

1 -5 A balance sheet is a list of the assets, liabilities, and owner’s equity as of a specific date. 35

Balance Sheet This amount is compared to the net cash flow on the statement of cash flows 1 -5 From the statement of owner’s equity 36

1 -5 A statement of cash flows is a summary of the cash receipts and payments for a specific period of time. Note - It basically shows how the company spent its money, and the sources from which it received money. 37

Statement of Cash Flows 1 -5 This amount should match Cash on the balance sheet. 38

Example Exercise 1 -4, 1 -5 & 1 -6 1 -5 The assets and liabilities of Chickadee Travel Service at April 30, 2010, the end of the current year, and its revenue and expenses for the year are listed below. The capital of the owner, Adam Cellini, was $80, 000 at May 1, 2009, the beginning of the current year. Accounts payable Accounts receivable Cash Fees earned Land $ 12, 200 31, 350 53, 050 263, 200 80, 000 Miscellaneous expense $ 12, 950 Office expense 63, 000 Supplies 3, 350 Wages expense 131, 700 Adam Cellini invested an additional $50, 000 in the business during the year and withdrew cash of $30, 000 for personal use. For the current year ended April 30, 2010. a. Prepare an income statement b. Prepare a statement of owner’s equity c. Prepare a balance sheet 39

1 -5 Example Exercise 1 -4 &1 -5 & 1 -6 Example Exercise 1 -4, 1 -5 CHICKADEE TRAVEL SERVICE INCOME STATEMENT For the Year Ended April 30, 2010 Fees earned Expenses: Wages expense Office expense Miscellaneous expense Total expenses Net income $263, 200 $131, 700 63, 000 12, 950 207, 650 $ 55, 550 40

1 -5 Example Exercise 1 -4, 1 -5 & 1 -6 CHICKADEE TRAVEL SERVICE STATEMENT OF OWNER’S EQUITY For the Year Ended April 30, 2010 Adam Cellini, capital, May 1, 2009 Additional investment by owner during year Net income for the year Less withdrawals Increase in owner’s equity Adam Cellini, capital, April 30, 2010 $ 80, 000 $ 50, 000 55, 550 $105, 550 30, 000 75, 550 $155, 550 41

Balance Sheet 1 -5 The account form of balance sheet lists the assets on the left and the liabilities and owner’s equity on the right—similar to design of an account. The report form of balance sheet presents the liabilities and owner’s equity sections below the assets section. 42

1 -5 Example Exercise 1 -4, 1 -5 & 1 -6 Assets Cash Accounts receivable Supplies Land Total assets CHICKADEE TRAVEL SERVICE BALANCE SHEET April 30, 2010 Liabilities $ 53, 050 Accounts payable $12, 200 31, 350 3, 350 Owner’s Equity 80, 000 Adam Cellini, capital 155, 550 $167, 750 Total liab. & owner’s eq. $167, 750 43

Statement of Cash Flows 1 -5 The statement of cash flows consists of three sections: (1) Operating activities (2) Investing activities (3) Financing activities 44

The cash flows from operating activities section reports a summary of cash receipts and cash payments from operations. 1 -5 The cash flows from investing activities section reports the cash transactions for the acquisition and sale of relatively permanent assets. The cash flows from financing activities section reports the cash transactions related to cash investments by the owner, borrowings, and cash withdrawals by the owner. 45

1 -5 Example Exercise 1 -7 A summary of cash flows for Chickadee Travel Service for the year ended April 30, 2010, is shown below. Cash receipts: Cash received from customers Cash received from additional investment of owner Cash payments: Cash paid for expenses Cash paid for land Cash paid to owner for personal use $251, 000 50, 000 210, 000 80, 000 30, 000 The cash balance as of May 1, 2009, was $72, 050. Prepare a statement of cash flows for Chickadee Travel Service for the year ended April 30, 2010. 46

Follow My Example 1 -7 1 -5 CHICKADEE TRAVEL SERVICE STATEMENT OF CASH FLOWS For the Year Ended April 30, 2010 Cash flows from operating activities: Cash received from customers $251, 000 Deduct cash payments for expenses 210, 000 Net cash flows from operating activities Cash flows from investing activities: Cash payments for purchase of land Cash flows from financing activities: Cash received from owner as investment $ 50, 000 Deduct cash withdrawals by owner 30, 000 Net cash flows from financing activities Net decrease in cash during year Cash as of May 1, 2009 Cash as of April 30, 2010 $ 41, 000 (80, 000) 20, 000 $(19, 000) 72, 050 $ 53, 050 47

5 Financial Analysis and Interpretation Ratio of Liabilities to Owner’s Equity = For Net. Solutions: Ratio of Liabilities to Owner’s Equity = Total Liabilities Total Owner’s Equity (or Total Stockholders’ Equity) $400 $26, 050 = 0. 015 48 48