Chapter 1 Introduction to Accounting and Business Financial and Managerial Accounting 8 th Edition Warren Reeve Fess
Types of Businesses Manufacturing Business Product General Motors Intel Boeing Nike Coca-Cola Sony Cars, trucks, vans Computer chips Jet aircraft Athletic shoes and apparel Beverages Stereos and television
Types of Businesses Merchandising Business Product Wal-Mart Toys “R” Us Circuit City Lands’ End Amazon. com General merchandise Toys Consumer electronics Apparel Internet books, music, video retailer
Types of Businesses Service Business Product Disney Delta Air Lines Marriott Hotels Merrill Lynch Sprint Entertainment Transportation Hospitality and lodging Financial advice Telecommunication
There are three types of business organizations ü Proprietorship ü Partnership ü Corporation
A proprietorship is owned by one individual. Joe’s Advantages • Ease in organizing • Low cost of organizing Disadvantage • Limited source of financial resources • Unlimited liability
A partnership is owned by two or more individuals. Joe and Marty’s Advantages • More financial resources than a proprietorship. • Additional management skills. Disadvantage • Unlimited liability.
A corporation is organized under state or federal statutes as a separate legal entity. J & M, Inc. Advantage • The ability to obtain large amounts of resources by issuing stocks. Disadvantage • Double taxation.
Business Strategies A business strategy is an integrated set of plans and actions designed to enable the business to gain an advantage over its competitors, and in doing so, to maximize its profits.
Business Strategies Under a low-cost strategy, a business designs and produces products or services of acceptable quality at a cost lower than that of its competitors. Under a differential strategy, a business designs and produces products or services that possess unique attributes or characteristics which customers are willing to pay a premium price.
Business Stakeholders A business stakeholder is a person or entity having an interest in the economic performance of the business.
The Process of Providing Information 1 Identify stake -holders. STAKEHOLDERS External: Internal: Customers, Owners, creditors, managers, government employees 2 Assess stakeholders’ informational needs.
The Process of Providing Information 4 Record economic data about business activities and events. Accounting Information System 3 Design the accounting information system to meet stakeholders’ needs.
The Process of Providing Information STAKEHOLDERS Internal: Owners, managers, employees 5 Prepare accounting reports for stakeholders. Accounting Information System External: Customers, creditors, government
Profession of Accounting Accountants employed by a business firm or a not-for-profit organization are said to be engaged in private accounting. Accountants and their staff who provide services on a fee basis are said to be employed in public accounting.
Generally Accepted Accounting Principles (GAAP)
The business entity concept limits the economic data in the accounting system to data related directly to the activities of the business. The cost concept is the basis for entering the exchange price, or cost of an acquisition in the accounting records.
The objectivity concept requires that the accounting records and reports be based upon objective evidence. The unit-of-measure concept requires that economic data be recorded in dollars.
The Accounting Equation Assets = Liabilities + Owners’ Equity The resources owned by a business
The Accounting Equation Assets = Liabilities + Owners’ Equity The rights of the creditors, which represent debts of the business
The Accounting Equation Assets = Liabilities + Owners’ Equity The rights of the owners
What is a business transaction? 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, 2005, Chris Clark organized a corporation that will be known as Net. Solutions.
a. Chris Clark deposits $25, 000 in a bank account in the name of Net. Solutions in return for shares of stock in the corporation. Assets a. = Cash 25, 000 = Owners’ Equity Capital Stock 25, 000 Investment by stockholder
b. Net. Solutions exchanged $20, 000 for land. Assets Cash + Land Bal. 25, 000 b. – 20, 000 +20, 000 Bal. 5, 000 20, 000 = = Owners’ Equity Capital Stock 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). Assets = Cash + Supplies + Land Bal. 5, 000 c. Bal. 5, 000 20, 000 + 1, 350 20, 000 Owners’ Liabilities + Equity Accounts Capital Payable Stock = 25, 000 + 1, 350 25, 000
d. Net. Solutions provided services to customers, earning fees of $7, 500 and received the amount in cash. Assets = Cash + Supplies + Land Bal. 5, 000 1, 350 20, 000 d. + 7, 500 Bal. 12, 500 1, 350 20, 000 = Owners’ Liab. + Equity Accounts Capital Retained Payable + Stock + Earnings 1, 350 25, 000 + 7, 500 1, 350 25, 000 7, 500 Fees earned
e. Net. Solutions paid the following expenses: wages, $2, 125; rent, $800; utilities, $450; and miscellaneous, $275. Assets Cash + Supplies + Land Bal. 12, 500 1, 350 20, 000 e. – 3, 650 Bal. 8, 850 1, 350 20, 000 Owners’ = Liab. + Equity Accounts Capital Retained Payable + Stock + Earnings 1, 350 25, 000 7, 500 – 2, 125 = – 800 Expenses – 450 – 275 1, 350 25, 000 3, 850
f. Net. Solutions paid $950 to creditors during the month. Assets Cash + Supplies + Land Bal. 8, 850 1, 350 20, 000 f. – 950 Bal. 7, 900 1, 350 20, 000 = = Owners’ Liab. + Equity Accounts Capital Retained Payable + Stock + Earnings 1, 350 25, 000 3, 850 – 950 400 25, 000 3, 850
g. At the end of the month, the cost of supplies on hand is $550, so $800 of supplies were used. Assets Cash + Supplies + Land Bal. 7, 900 1, 350 20, 000 g. – 800 Bal. 7, 900 550 20, 000 = = Owners’ Liab. + Equity Accounts Capital Retained Payable + Stock + Earnings 400 25, 000 3, 850 Supplies – 800 Expense 400 25, 000 3, 050
h. At the end of the month, Net. Solutions pays $2, 000 to stockholders. Assets Cash + Supplies + Land Bal. 7, 900 550 20, 000 h. – 2, 000 Bal. 5, 900 550 20, 000 = = Owners’ Liab. + Equity Accounts Capital Retained Payable + Stock + Earnings 400 25, 000 3, 050 – 2, 000 Dividends 400 25, 000 1, 050
Effects of Transactions on Owners’ Equity Capital Stock Increased by Stockholders’ investments +
Effects of Transactions on Owners’ Equity Retained Earnings Decreased by Revenues Expenses Dividends + – – Increased by
Accounting reports, called financial statements, provide summarized information to the users.
Financial Statements • Income statement—A summary of the revenue and expenses for a specific period of time. • Retained earnings statement—A summary of the earnings retained in the corporation for a specific period of time. • Balance sheet—A list of the assets, liabilities, and stockholders’ equity as of a specific date. • Statement of cash flows—A summary of the cash receipts and disbursements for a specific period of time.
Statement of Cash Flows from Operating Activities—This section reports a summary of cash receipts and cash payments from operations. Cash Flows from Investing Activities—This section reports the cash transactions for the acquisition and sale of relatively permanent assets. Cash Flows from Financing Activities—This section reports the cash transactions related to cash investments by the owner, borrowings, and cash withdrawals by the owner.
Management Information Systems Terry De. Groff Burwell, Nebraska Books, Records & Controls
Management is… • Planning, organizing, directing, and controlling a business. The most important and challenging is control… the process of analyzing, evaluating and interpreting the production and financial performance of a business.
Information… • Can and does come from many sources. Some of the best and most needed information can come from each business’ own financial and production records.
Systems… • Need to be implemented that allow for only necessary record keeping and effective use of records. Summary information from these records should be invaluable in day to day business decisions.
Management • Planning • Organizing • Directing • Controlling
Management Control • The Best Decisions Require the Best Information
Uses and Purposes of Financial Records Management Decision Making Income Tax Reporting Credit Acquisition
Keys to Successful Record Keeping
Keys to Successful Record Keeping • Simple yet Useful
Keys to Successful Record Keeping • Excessive detail often ends in Confusion, Frustration, and Failure
Keys to Successful Record Keeping • Meet your Needs, Abilities, & Limitations
Keys to Successful Record Keeping • Know your Purpose for Keeping Records Management Income Taxes Banking
Accounting Rules • Standards of Communication
Accounting Rules • Generally Accepted Accounting Principles – (GAAP)
Keys to Successful Record Keeping • Accurately Match Expenses with Income
Cash and Accrual Accounting ØRefers to the timing of entries into the accounting system
Cash Based Records ØTransactions are recorded when cash is received or paid out
Accrual Based Records ØTransactions are recorded when they take place ØRegardless of whether cash is involved
Accrual Adjusted Statements ØCash based records are kept throughout the year ØNon-Cash adjustments are made to the cash based income statement at the end of the year
Accrual Adjusted Income Statement Ø Cash incomes and expenses must be adjusted by: • Changes in non-cash assets • Inventories • Pre paid expenses • Receivables • Changes in non-cash liabilities • Payables • Accrued interest
Financial Analysis Requires • Basic Set of Financial Statements
Basic Financial Statements • • Balance Sheet Income Statement of Owner Equity Statement of Cash Flows
Assets = Liabilities + Equity = Assets - Liabilities
Beginning Balance Sheet Assets Liabilities Ending Balance Sheet Assets Equity Liabilities Equity +/- Net Income +/- Valuation Changes - Capital withdrawals + Capital contributions
Financial Analysis Requires • Basic Set of Financial Statements • Understanding of how to Analyze and Interpret the Financial Statements
Ratio Analysis • Liquidity • Solvency • Profitability • Financial Efficiency • Repayment Capacity
Financial Analysis • Objectives – Measure Financial Condition
Financial Analysis • Objectives – Measure Financial Condition – Measure Financial Performance
Financial Analysis ØAll business owners should have a basic set of financial statements at their disposal and they should know how to analyze and interpret them.
Technology is…. • Productivity enhancing • Management intensive • Capital intensive • Not scale neutral
The End
Accounting Information System
Major Accounting Bodies • American Institute of Certified Public Accountants • Financial Accounting Standards Board • Government Accounting Standards Board • Securities and Exchange Commission
Ethics The process that individuals use
Ethics The process that individuals use to evaluate their conduct
Ethics The process that individuals use to evaluate their conduct in light of moral principles and values
Assets • Anything of value held by an organization • Assets have
Assets • Anything of value held by an organization • Assets have – Potential usefulness
Assets • Anything of value held by an organization • Assets have – – Potential usefulness Future usefulness
Assets • Anything of value held by an organization • Assets have – – – Potential usefulness Future usefulness Economic Value
Assets • • Cost principle Going-concern concept Objectivity principle Stable dollar concept
Equities • Claims against the total assets of an organization • Liabilities – Claims of nonowners • Owner's Equity – Claims of owners
Retained Earnings • Cumulative total of net income, net loss, and dividends since start of business
Revenues • Inflows of assets that result from performing services or selling goods • Revenues are realized when – the service is performed or
Revenues • Inflows of assets that result from performing services or selling goods • Revenues are realized when – – the service is performed or the goods are delivered
Expenses • Outflows of assets or incurrence of liabilities while earning revenues • A business incurrs expenses to earn revenues
The Accounting Equation • • Things of Value = Claims Assets = Equities Assets = Liabilities + Owner's Equity Assets - Liabilities = Net Assets
Analyzing Transactions • Use accounting equation • Is there a change in assets? – Which asset? – How much was the change? • Is there another change in assets?
Analyzing Transactions • Is there a change in liabilities? – Which liability? – How much was the change? • Is there another change in liabilities? • Is there a change in owners’ equity? – How much was the change?
Four Basic Financial Statements • • Income Statement of Owners’ Equity Classified Balance Sheet Statement of Cash Flows
Income Statement • Reports changes in owners’ equity from operating activities • Revenues - Expenses = Net Income(Loss)
Statement of Owners’ Equity • Changes in owners’ interest in assets • Issuances of new stock • Retained earnings – Net income or loss – Dividends
Classified Balance Sheet • Classification - arrangement of financial statement items into groupings that have common basis • Assets – Current – Property, plant, and equipment
Classified Balance Sheet • Liabilities – Current – Long-tern • Owners’ Equity – Common stock – Retained earnings
Statement of Cash Flows • Reports cash flows during period • Categories of activities – Operating activities – Investing activities – Financing activities
Analyzing Information
Balance Sheet Analysis • Are total assets higher or lower? • What is percent change in total assets? • Is the percent of total liabilities to total liabilities plus owner’s equity increasing or decreasing?
Income Statement Analysis • Are revenues higher or lower? • What is the precentage change in total revenues? • Is the percentage of total expenses to total revenues increasing or decreasing?
Integrative Analysis • Is the business operating efficiently by using the least amount of asset investment to generate a given level of total revenues? • Calculate Total Asset Turnover – Total revenues – divided by – Average total assets
Using Accounting Information
Business Planning Activities • Individual Point of View • Business Point of View – Planning – Budgeting
Accounting Information System Resources and procedures in a business
Accounting Information System Resources and procedures in a business that change economic data
Accounting Information System Resources and procedures in a business that change economic data into financial information
Users of Accounting Information • • • Owners Lenders Labor Organizations Customers Society groups Government Regulatory Agencies
Entity Concept Any organization unit for which we gather and process
Entity Concept Any organization unit for which we gather and process financial and economic data
Entity Concept Any organization unit for which we gather and process financial and economic data for the purpose of decision making
Types of Ownership • Single proprietorship • Partnership • Corporation
Financial Statements • Balance Sheet • Income Statement • Statement of Cash Flows
Balance Sheet • Summarizes assets, liabilities, and owners’ equities as of a specific moment in time – Assets - economic resources or items of value a business owns – Liabilities - claims against the assets by nonowners – Owners’ equity - claims against the assets by owners
Basic Accounting Equation Assets = Liabilities + Owners’ Equity
Income Statement • Presents the results of operations for a period of time – Revenues - inflow of assets from performing services or selling goods – Expenses - use of assets or incurrence of liabilities when earning revenues
Statement of Cash Flows • Presents the reasons why cash on the balance sheet changed from one date to another • Presents cash flows from – Operating activities – Investing activities – Financing activities
Published Annual Reports • • Letter to stockholders Management’s discussion and analysis Financial statements and notes The report of the independent accountant
Analyzing Information • Common-size statement – Express each item as a percent of the total for that statement • Balance sheet - total assets • Income statement - total revenues
Balance Sheet Analysis • Are total assets higher or lower? • What is percent change in total assets? • Is the percent of total liabilities to total liabilities plus owner’s equity increasing or decreasing?
Income Statement Analysis • Are revenues higher or lower? • What is the precentage change in total revenues? • Is the percentage of total expenses to total revenues increasing or decreasing?
Integrative Analysis • Is the business operating efficiently by using the least amount of asset investment to generate a given level of total revenues? • Calculate Total Asset Turnover – Total revenues – divided by – Average total assets
Interpreting Company Accounts
Interpreting Company Accounts
Window Dressing
Window Dressing • ‘Window dressing’ refers to attempts by business to present its accounts in the best light • Has become more of a necessity as pressure to please shareholders and the City increases • It is NOT illegal • Deliberate deception in the accounts is fraud
Window Dressing • How do firms ‘massage’ the accounts? • Timing of reporting • Balance sheet – snapshot of a business at a point in time, therefore: – Delay major payment – Include large injection of cash/assets • Exploit accounting procedures – often a wide range in the definition
Window Dressing • Exploiting other definitions – extraordinary items – what counts as ‘extraordinary’? • Depreciation – different results gained using different methods – which is the ‘best’ and the most accurate? – Residual values – could be altered
Depreciation
Depreciation • When businesses buy fixed assets (those that will last longer than one year) the value of the asset will change • Depreciation seeks to take account of such changes in the accounts • An imprecise science allows different interpretations
Depreciation • Take the machine here: – What is its life span? – How much did it cost originally? – How much will it be worth at the end of its useful life? – What will be its value after 1 year? – After 2 years, 4 years, 15 years? – Would anyone else want to buy it? – How specialised is it? – What would it cost to replace after 5 years? Mill Drill Machine Copyright: Kenn Kiser, http: //www. sxc. hu
Methods • Key terms: • Historical Value - initial purchase price • Value at the end of the life of the asset - the Residual Value (RV) • Life span of the asset • Straight Line – Historic cost - RV/Useful life • Declining Balance – Depreciating assets at a constant rate each year
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