CHAPTER 1

INTRODUCTION TO ACCOUNTING AND BUSINESS

CHAPTER OBJECTIVES
After studying the chapter, you should be able to: Describe the nature of a business and the role of ethics and 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 changes in the basic elements of the accounting equation. 5. Describe the financial statements of a proprietorship form of business and explain how the statements interrelate. 1. 2. 3. 4.

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Learning Objective 1: Describe the nature of a business and the role of ethics and accounting in business.

NATURE OF BUSINESS AND ACCOUNTING:

KEY TERMS:
Accounting Business Capital Market Stakeholders Corporation Ethics Government Stakeholders Internal Stakeholders Limited Liability Corporation Manufacturing Business Merchandising Business Partnership Profit Product or Service Market Stakeholders Proprietorship Stakeholder Service Business

NATURE OF BUSINESS AND ACCOUNTING:

What is a business? Everyone has heard the term business but what is it? 1. An organization in which basic resources (inputs), such as materials and labor, are assembled and processed to provide goods or services (outputs) to customers. 2. An economic unit that sells goods and/or services to customers in order to provide a return to its owners. Most businesses have similar goal: Maximize profit Profitability Difference between amounts received from customers and amounts paid in order to provide goods/services.

TYPES OF BUSINESSES:

1. SERVICE COMPANY - performs a service for a fee 2. MERCHANDISING COMPANY - buys goods and resells them to customers 3. MANUFACTURING COMPANY - buys materials, makes a product, and sells the product to customers

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BUSINESS ORGANIZATIONS
PROPRIETORSHIP:
ONE owner; Owner usually runs the business; Legally, the business is the same economic unit as the owner so the owner gets all profits/losses and is PERSONALLY liable for all of the debts of the business; They make up the largest number of businesses, but are typically the smallest in size.

PARTNERSHIP:
TWO OR MORE owners Partners usually run the business; Legally, the business is not separate from partners so the partners share profits/losses and at least one is PERSONALLY liable for all of the debts of the business. Partnership is dissolved if partner dies, withdraws, etc.

CORPORATION:
A business incorporated under the laws of a state; A separate legal entity business is legally separate from its owners (unlike proprietorships and partnerships); Issues shares of stock to its owners, who do NOT run the business day-to-day; Limited liability - stockholders are NOT personally liable for the corporation's debts; Ownership of the business and management of it are separate - stockholders elect board of directors, and the board then appoints managers to run company; Make up the smallest number of businesses, but are typically the largest in size;

LIMITED LIABILITY CORPORATION (LLC:)

Has the characteristics of both a partnership and a corporation. It is set up like a corporation but is treated for TAX purposes as a partnership.

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Some figures :

1. More than 70% of the businesses in the United States are organized as proprietorships. 2. About 10% of businesses are organized as partnerships. 3. About 20% of businesses are organized as corporations; however, they generate over 90% of the total dollars of business receipts.

WHO USES ACCOUNTING INFORMATION?

BUSINESS STAKEHOLDER:

a person or entity that has an interest in the economic

performance of the business; Includes owners, managers, employees, customers, creditors, and various government agencies; Use accounting data to gauge the economic performance of businesses.

FOUR CATEGORIES OF BUSINESS STAKEHOLDERS:

1. Capital market stakeholders: provide major financing (i.e. banks, long-term creditors) 2. Product or service market stakeholders: customers 3. Government stakeholders: local, state and federal 4. Internal stakeholders: employees, managers

MANAGEMENT:
People responsible for operating the business: Their goals are to ensure that the
business is profitable and liquid. They need accounting information to help them perform the following functions: 1. Finance the business

2. 3. 4. 5. 6.

Invest the resources of the business Produce goods and services Market goods and services Manage employees Provide information to decision makers, both inside and outside the

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company

BUSINESS ETHICS
WHAT IS BUSINESS ETHICS?
Moral principles that guide the conduct of individuals; Sometimes mangers/ employees can feel pressured into violating ethics. Normally develop a Conduct of Ethics Used to help accountants make difficult decisions.

THREE FACTORS THAT INFLUENCE ETHICAL BEHAVIOR:

1. Individual character. An ethical businessperson displays character by embracing honesty, integrity, and fairness in the face of pressure to hide the truth. 2. Firm culture. By their behavior and attitude, senior managers of a company set the firm culture. 3. Laws and enforcement. The lack of laws and enforcement has contributed to the financial reporting abuses. As a result, new laws were created, and enforcement efforts have increased since the early 2000s (in the US).

WHAT IS ACCOUNTING?

DEFINITION: an information system that provides reports to stakeholders about the economic activities and condition of a business. The process by which accounting provides information to business stakeholders is as follows : 1. 2. 3. 4. Identify stakeholders. Assess stakeholders informational needs. Design the accounting information system to meet stakeholders needs. Record economic data about business activities and events.

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5. Prepare accounting reports for stakeholders.

THE ACCOUNTING PROFESSION

FINANCIAL ACCOUNTING VERSUS MANAGERIAL ACCOUNTING
FINANCIAL accounting that is primarily for owners, creditors, employees, government, etc.; Purpose - to provide financial statements (Report sent to external users are called financial statements) and other accounting info to third parties MANAGERIAL accounting that is primarily for INTERNAL use by management; To help them achieve their goals of profitability and liquidity by giving them information about their financing, investing, and operating activities

PRIVATE ACCOUNTING:

provide accounting services for a single business - their employer. Goal to give management the information it needs to make decisions. Includes controller (chief accountant), treasurer, internal auditor, financial accountant, cost accountant Professional Certifications: Certified Management Accountant (CMA) and Certified Internal Auditor (CIA)

PUBLIC ACCOUNTING:

Offer professional accounting services to many clients Professional Certifications : Certified Public Accountants (CPAs). Requirements include education, exam, experience . Primary Activities are: 1. AUDITING - examine client's financial statements to see if they comply with GAAP: Purpose - to lend credibility to the client's financial statements; Auditor is INDEPENDENT of the client - must have no financial, employment, or other compromising ties to the client 2. TAX SERVICES - planning and preparation 3. MANAGEMENT ADVISORY SERVICES - consulting, system design, etc. 4. SMALL BUSINESS SERVICES - bookkeeping, advising, etc.

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Learning Objective 2: Summarize the development of accounting principles and relate them to practice.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

KEY TERMS:
Business Entity Concept Objectivity Concept Cost Concept Unit of Measure Concept Financial Accounting Standards Board (FASB) Generally Accepted Accounting Principles (GAAP)

WHAT ARE GENERALLY ACCEPTED ACCOUNTING PRINCIPLES?

Guidelines accountants follow in preparing financial statements.
Accounting standards in the recording, reporting and presentation of financial transactions.

FINANCIAL ACCOUNTING STANDARDS BOARD (FASB): primary responsibility for developing accounting principles.

BASIC ACCOUNTING CONCEPTS

WHAT ARE THEY?
Four principles that govern how accounting data are accumulated! 1. Business Entity Concept 2. Cost Concept 3. Objectivity Concept 4. Unit of Measure Concept

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BUSINESS ENTITY CONCEPT:

For accounting purposes, business is separate and distinct from its owners, creditors, and customers. So it keeps a separate set of records, reports, etc. Business keeps its records separate from those of any other business and also separate from its owners personal records

COST CONCEPT:
For accounting purposes we need a basis for valuing and recording transactions The amount we use is the cost of the item in the transaction.

OBJECTIVITY CONCEPT:

Requires that the accounting records be based on objective evidence; this ensures reliability.

UNIT OF MEASURE CONCEPT

This concept prescribes that all economic data should be recorded in dollars. Because people measure, record and report transactions in terms of money and in the USA, they measure them in terms of dollars.

Learning objective 3: State the accounting equation and define each element of the equation.

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ASSETS, LIABILITIES AND OWNERS EQUITY

KEY TERMS:
Accounting Equation Assets Capital Drawing Expenses Liabilities Owners Equity Revenue Accounts

WHAT ARE ASSETS?

Resources owned by a business. Examples: 1. CASH - coins, currency on hand and in bank

2. LAND, BUILDING, EQUIPMENT, FURNITURE, etc.

WHAT ARE LIABILITIES?

Rights or claims to the resources by CREDITORS; Liabilities are our DEBTS, the amounts we OWE Examples: 1. ACCOUNTS PAYABLE PAYABLE, etc.

2. WAGES PAYABLE, TAXES PAYABLE, MORTGAGE

WHAT IS OWNER'S EQUITY?

Rights or claims to the resources by OWNERS.

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ACCOUNTING EQUATION

ACCOUNTING EQUATION:

ASSETS = LIABILITIES + OWNER'S EQUITY

EXAMPLE:
if the assets owned by a business amount to $100,000 and the liability amount to $30,000, the owners equity is equal to $70,000

Learning objective 4: Describe and illustrate how business transactions can be recorded in terms of the resulting

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changes in the basic elements of the accounting equation. (page 13-16)

BUSINESS TRANSACTIONS AND THE ACCOUNTING EQUATION

KEY TERMS:
Account Payable Account Receivable Business Transaction Expenses Prepaid Expenses Revenue Supplies

BUSINESS TRANSACTIONS Economic events or condition that directly changes the entity's financial position or directly affects its results of operations."

EVENTS/CONDITIONS RECORDED IN ACCOUNTING RECORDS

1. 2. 3. 4. 5.

Receipt of cash Payment of cash Events that create a legal obligation to pay out cash (or other assets) in the future Events that obligate another party to pay you cash (or other assets) in the future Sale of a product or completion of a service for a customerthis is known as earning revenue 6. The use of products or services in running your businessthis is known as incurring an expense.

Some terms to know REVENUES: (doanh thu)

What we earn by selling a product or performing a service! The price charged for the sale of goods or services. Sometimes we are paid in cash, and other times people promise to pay us later (called Accounts Receivable). Either way, when we "do the work", we have earned the revenue (whether or not we are paid in cash then is irrelevant we record all revenue when we do the work)

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EXPENSES: (chi ph)

Costs we incur to produce revenue; The costs of doing business (i.e., using up goods and services in the process of producing revenue.) Sometimes we pay them in cash, and other times we promise to pay them later (called Accounts Payable)

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Learning Objective 5: Describe the financial statements of a proprietorship form of business and explain how the statements interrelate.

FINANCIAL STATEMENTS
WHAT ARE FINANCIAL STATEMENTS?
After transactions have been recorded and summarized, reports are prepared for users. The reports are called Financial Statements

FOUR BASIC FINANCIAL STATEMENTS:

1. Income statementA summary of the revenue and expenses for a specific period of time, such as a month or a year. 2. Statement of owners equityA summary of the changes in the owners equity that have occurred during a specific period of time, such as a month or a year. 3. Balance sheetA list of the assets, liabilities, and owners equity as of a specific date, usually at the close of the last day of a month or a year. 4. Statement of cash flowsA summary of the cash receipts and cash payments for a specific period of time, such as a month or a year.

INTERRELATIONSHIPS OF THE FOUR FINANCIAL STATEMENTS:

All four financial statements are interrelated; Each one ties into one of the other statements. For example the Income Statement provides a key figure for the Statement of Owners equity, which provides a key figure for the balance Sheet. The Statement of Cash Flow derives its accounts from both the Income Statement and the Balance Sheet. See example on page 23 in the textbook.

HEADINGS OF ALL FINANCIAL STATEMENTS

Need to provide the who, what, where and when! Every statement has the following 3-line heading-No exceptions! 1. FIRST LINE - company name

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2. SECOND LINE - name of the statement (Income Statement, Balance Sheet, etc.) 3. THIRD LINE - either a specific date (for the Balance Sheet) or a period of time
(for the Income Statement, Statement of Owners Equity, and Statement of Cash Flows)

Examples of specific dates: December 31, 2007; As of July 31, 2008 Examples of periods of time: For the month ended June 30, 2008; For the year Ended December 31, 2007; For the Quarter Ended March 31, 2008

INCOME STATEMENT
WHAT DOES IT TELLS US ABOUT THE BUSINESS?
The income statement reports the revenues and expenses for a period of time, based on the matching concept. This concept is applied by matching the expenses with the revenue generated during a period by those expenses.

INCOME STATEMENT FORMULA :

REVENUES - EXPENSES = NET INCOME ( or LOSS) If Revenues > Expenses, then the result is Net Income If Revenues < Expenses, then the result is Net Loss

INCOME STATEMENT FORMAT :

Name of Company Income Statement For the Year ended xx xx xxx xx xx

REVENUES: Rent Revenue Interest Income Total Revenues EXPENSES: Wage Expense Tax Expense

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Supply Expense Total Expenses NET INCOME

xx xxx xxx

Helpful hints: 1. List ALL types of revenues and expense under each heading.

2. Subtotal revenues and expense; the difference is Net income (or Net loss if a
negative number). If a net loss we do NOT use negative signs-instead you put the amount in brackets.

3. Double line underscore Net Income or Net Loss amount

STATEMENT OF OWNERS EQUITY

WHAT DOES IT TELLS US ABOUT THE BUSINESS?
Connects the Income Statement and Balance Sheet :It is prepared after the income statement and before the balance sheet It shows the changes that have occurred in capital (the business' net worth) during a period of time

What affects the net worth of a business? Remember wire Withdrawals from the business by the owner make the business worth less Investments (contributions) into the business by the owner make the business worth more Earning Revenues make the business worth more Incurring Expenses make the business worth less

STATEMENT OF OWNERS EQUITY FORMULA :

FORMULA (BINWE) Just use the acronym BINWE to help remember what goes on the statement! Beginning OwnersCapital

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+ Investments by Owner Net Income/Net Loss (+ Net Income OR - Net Loss) - Withdrawals = Ending Owners Capital

STATEMENT OF OWNERS EQUITY FORMAT (MEMORIZE THIS!!!):

Name of Company Statement of Owners equity For the Year ended 12/31/08 Name of Owner, Capital, Beginning of period ADD: Investments by Owner xx Net Income xx LESS: Net Loss Withdrawals xx Increase or decrease in owners equity Name of Owner, Capital, End of period xxx

xxx xxx

Helpful Hints: 1. For example, dont just write Beginning Capital, but instead write the owners name, then the word Capital,, then the beginning date of the period; Do the same for Ending Capital but use the ending date for the period instead!

2. You cant have BOTH net Income and Net Loss; It has to be one or the other!
Remember, you use the Net income/Net loss you generated from the Income Statement!

3. If the owner didnt make any contributions and/or any withdrawals, just leave
it off the statement

BALANCE SHEET
WHAT DOES IT TELLS US ABOUT THE BUSINESS?
Shows the financial position of a business at a particular point in time

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What is financial position? The amount of Assets, Liabilities and Owners Equity at any given point in time. Remember, these amounts change daily so the statement is always at a point in time and not for a period of time. Third line of heading is as of a PARTICULAR DATE (not covering period of time); It is the last day of the period covered by the Income Statement For example: March 31, 2006 or December 31, 2006 CAPITAL - personal resources the owner has invested in the business; Terms "owner's equity" and "capital" used interchangeably WITHDRAWALS when the owner takes assets (usually cash) out of the business for personal use; This is NOT an expense and it is NOT shown on Income Statement; Not on Balance Sheet; it goes on Statement of Owners Equity To Summarize The Balance Sheet LEFT side = resources of the business (assets) RIGHT side = who provided these resources: creditors (liabilities) and owners (capital)

BALANCE SHEET FORMULA :

The formula is easy; we already learned it! It is the Accounting Equation (remember it is also called the Balance Sheet equation). Only Assets, Liabilities and Owners Equity account go the Balance Sheet. Since we only have ONE Owners Equity account (Capital) you can remember the formula by using these acronyms: Aliens Live Assets Liabilities On Earth Owners Equity or Aliens Assets Love Liabilities Cake Capital

BALANCE SHEET FORMAT (MEMORIZE THIS!!!):

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Name of Company Balance Sheet (date) ASSETS: Cash Accounts Receivable Land Building Total Assets LIABILITIES: Accounts Payable Taxes Payable Total Liabilities OWNERS EQUITY: Name of Owner, Capital Total Liabilities and Owners Equity Helpful hints: 1. The Capital Account amount is from the Statement of Owners Equity

2. Total Assets MUST equal Total Liabilities plus Owners Equity

(Remember the Accounting Equation)

3. Assets can be listed on the left, with Liabilities and Owner's Equity on
right (Know as the Account form)OR Assets can be listed on top, with Liabilities and Owner's Equity below (know as the report form)

4. If you only have ONE liability, then you do NOT need a line called
Total liabilities.

5. The Assets have a special order for listing the accounts; it is know as
the order of liquidity- cash first then A/R, Inventory, prepaids, Land, Building , Equipment.

IN WHAT ORDER DO WE PREPARE FINANCIAL STATEMENTS?

Because of the interrelationships that exist among the financial statement, we prepare them in the following order:
INCOME STATEMENT FIRST: Why? We need to know net income/loss to go on the Statement of Owner's Equity STATEMENT OF OWNER'S EQUITY SECOND: Why? We need to know the ending capital balance to go on the Balance Sheet BALANCE SHEET is completed last! (Remember we do not cover the Statement of Cash Flows in this course, therefore, the Balance Sheet is the last statement)

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DO YOU ONLY HAVE ONE OF AN ITEM (like only one expense)? Dont have to show a total for it also if there is only one