Chapter

1
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Accounting in Business

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Importance of Accounting
is a Accounting
system that Identifies

Records information Relevant Reliable Comparable

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that is

Communicates

to help users make better decisions.

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Accounting Activities
Identifying Business Activities Recording Business Activities

Communicating Business Activities

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Users of Accounting Information

Internal Users

External Users

Lenders

Consumer Groups

Managers Officers

Sales Staff Budget Officers

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Shareholders External Auditors Governments Customers

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Internal Auditors Controllers

Users of Accounting Information

Internal Users

External Users

Financial accounting provides external users with financial statements.

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Managerial accounting provides information needs for internal decision makers.

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Opportunities in Accounting
Financial
Preparation Analysis Auditing Regulatory Consulting Planning Criminal investigation

Managerial
General accounting Cost accounting Budgeting Internal auditing Consulting Controller Treasurer Strategy Lenders Consultants Analysts Traders Directors Underwriters Planners Appraisers

Taxation
Preparation Planning Regulatory Investigations Consulting Enforcement Legal services Estate planning

Accountingrelated

FBI investigators Market researchers Systems designers Merger services Business valuation Human services Litigation support Entrepreneurs
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EthicsA Key Concept

Ethics
Beliefs that distinguish right from wrong
Accepted standards of good and bad behavior

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Guidelines for Ethical Decision Making

Identify ethical concerns Analyze options Make ethical decision

Use personal Consider all good ethics to and bad recognize ethical consequences. concern.
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Choose best option after weighing all consequences.

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Generally Accepted Accounting Principles

Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP).
Relevant Information Reliable Information Affects the decision of its users. Is trusted by users. Is helpful in contrasting organizations.
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Comparable Information
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Setting Accounting Principles

Financial Accounting Standards Board is the private group that sets both broad and specific principles.

The Securities and Exchange Commission is the government group that establishes reporting requirements for companies that issue stock to the public.
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Principles of Accounting

Objectivity Principle Accounting information is supported by independent, unbiased evidence.

Cost Principle Accounting information is based on actual cost.

Now

Future

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Going-Concern Principle Reflects assumption that the business will continue operating instead of being closed or sold.

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Principles of Accounting
Revenue Recognition Principle 1. Recognize revenue when it is earned. 2. Proceeds need not be in cash. 3. Measure revenue by cash received plus cash value of items received.

Monetary Unit Principle Express transactions and events in monetary, or money, units.

Business Entity Principle A business is accounted for separately from other business entities, including its owner.
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Business Entity Forms

Proprietorship

Partnership

Corporation

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Exh. 1.8

Characteristics of Businesses
Characteristics Proprietorship Partnership Corporation Business entity yes yes yes Legal entity no no yes Limited liability no* no* yes Unlimited life no no yes Business taxed no no yes One owner allowed yes no yes

* Proprietorships and partnerships that are set up as LLCs provide limited liability.
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Corporation

Owners of a corporation are called shareholders (or stockholders). When a corporation issues only one class of stock, we call it common stock (or capital stock).
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Accounting Equation Assets

Liabilities

Equity

Assets

Liabilities & Equity

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Assets
Cash Accounts Receivable Notes Receivable

Vehicles

Resources owned or controlled by a company

Land

Store Supplies
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Buildings

Equipment
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Liabilities
Accounts Payable Notes Payable

Creditors claims on assets

Taxes Payable Wages Payable
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Equity
Owner Investments Owner Withdrawals

Owners claims on assets

Revenues Expenses
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Expanded Accounting Equation Assets

=
_

Liabilities

+
Revenues

Equity

Owner Capital

Owner Withdrawals

Expenses

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Transaction Analysis Equation

The accounting equation must remain in balance after each transaction.

Assets

Liabilities

Equity

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Transaction Analysis
J. Scott, the owner, contributed $20,000 cash to start the business.
The accounts involved are: (1) Cash (asset) (2) J. Scott, Capital (equity)

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Transaction Analysis
J. Scott, the owner, contributed $20,000 cash to start the business.
Assets Cash Supplies Equipment (1) $ 20,000 = Liabilities Accounts Notes Payable Payable + Equity J. Scott, Capital $ 20,000

$ 20,000 $

$ $

20,000

$ 20,000

$ 20,000
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Transaction Analysis
Purchased supplies paying $1,000 cash.
The accounts involved are: (1) Cash (asset) (2) Supplies (asset)

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Transaction Analysis
Purchased supplies paying $1,000 cash.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 = Liabilities Accounts Notes Payable Payable + Equity J. Scott, Capital $ 20,000

$ 19,000 $ 1,000 $ $ 20,000

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$ $

20,000

$ 20,000

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Transaction Analysis
Purchased equipment for $15,000 cash.
The accounts involved are: (1) Cash (asset) (2) Equipment (asset)

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Transaction Analysis
Purchased equipment for $15,000 cash.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 = Liabilities Accounts Notes Payable Payable + Equity J. Scott, Capital $ 20,000

4,000 $ 1,000 $ $ 20,000

15,000 =

$ $

20,000

$ 20,000

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Transaction Analysis
Purchased Supplies of $200 and Equipment of $1,000 on account.
The accounts involved are: (1) Supplies (asset) (2) Equipment (asset) (3) Accounts Payable (liability)

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Transaction Analysis
Purchased Supplies of $200 and Equipment of $1,000 on account.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 (4) 200 1,000 $ 4,000 $ 1,200 $ $ 21,200
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Liabilities Accounts Notes Payable Payable

Equity J. Scott, Capital $ 20,000

$ 1,200 $ 1,200 $ = $ 21,200 $ 20,000

16,000

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Transaction Analysis
Borrowed $4,000 from 1st American Bank.
The accounts involved are: (1) Cash (asset) (2) Notes payable (liability)

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Transaction Analysis
Borrowed $4,000 from 1st American Bank.
Assets Cash Supplies Equipment (1) $ 20,000 (2) (1,000) $ 1,000 (3) (15,000) $ 15,000 (4) 200 1,000 (5) 4,000 $ 8,000 $ 1,200 $ 16,000 $ 25,200
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Liabilities Accounts Notes Payable Payable

Equity J. Scott, Capital $ 20,000

$ 1,200 $ $ 1,200 $ = $ 4,000 4,000 25,200 $ 20,000

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Transaction Analysis
The balances so far appear below. Note that the Balance Sheet Equation is still in balance.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity J. Scott, Capital $ 20,000

$ 8,000 $ 1,200 $ $ 25,200

16,000 =

1,200 $

4,000

$ 20,000

$ 25,200

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Now lets look at transactions involving revenue, expenses and withdrawals. The McGraw-Hill Companies, Inc., 2005

Transaction Analysis
Rendered consulting services receiving $3,000 cash.
The accounts involved are: (1) Cash (asset) (2) Revenues (equity)

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Transaction Analysis
Rendered consulting services receiving $3,000 cash.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000 = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity J. Scott, Capital Revenue $ 20,000 $ 3,000

$ 11,000 $

1,200 $

16,000 =

$ 1,200 $

4,000

$ 20,000 $ 3,000

$ 28,200

$ 28,200

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Transaction Analysis
Paid salaries of $800 to employees.
The accounts involved are: (1) Cash (asset) (2) Salaries expense (equity)
Remember that the balance in the salaries expense account actually increases.
But, equity actually decreases because expenses reduce equity.
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Transaction Analysis
Paid salaries of $800 to employees.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000 (7) (800) $ 10,200 $ 1,200 $ 16,000 = = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity J. Scott, Capital Revenue Expenses $ 20,000 $ 3,000 $ (800) $ 20,000 $ 3,000 $ (800)

$ 1,200 $

4,000

$ 27,400

$ 29,000

Remember that expenses decrease equity.

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Transaction Analysis
J. Scott withdrew $500 from the business for personal use.
The accounts involved are: (1) Cash (asset) (2) J. Scott, Withdrawals (equity)
Remember that the balance in the J. Scott, Withdrawals account actually increases.
But, equity actually decreases because withdrawals reduce equity.
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Transaction Analysis
J. Scott withdrew $500 from the business for personal use.
Assets Cash Supplies Equipment Bal. $ 8,000 $ 1,200 $ 16,000 (6) 3,000 (7) (800) (8) (500) $ 9,700 $ 1,200 $ 16,000 $ 26,900 = = Liabilities Accounts Notes Payable Payable $ 1,200 $ 4,000 + Equity J. Scott, J. Scott, Capital Withdrawal Revenue Expenses $ 20,000 $ 3,000 $ (800) $ (500) $ 20,000 $ (500) $ 3,000 $ (800)

$ 1,200 $

4,000

$ 29,500

Remember that withdrawals decrease equity.

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Financial Statements
Lets prepare the Financial Statements reflecting the transactions we have recorded.
1. Income Statement 2. Statement of Owners Equity 3. Balance Sheet 4. Statement of Cash Flows

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Scott Company Income Statement For Month Ended December 31, 2004 Revenues: Consulting revenue Expenses: Salaries expense Net income

3,000 800 2,200

Net income is the difference between Revenues and Expenses.

The income statement describes a companys revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities.
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Scott Company Income Statement For Month Ended December 31, 2004 Revenues: Consulting revenue Expenses: Salaries expense Net income

3,000 800 2,200

The net income of $2,200 increases Scotts capital by $2,200.

The Statement of Owners Equity explains changes in equity from net income (or net loss) and from owner investments and withdrawals for a period of time.
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Scott Company Statement of Owner's Equity For Month Ended December 31, 2004 J. Scott, Capital, Dec. 1, 2004 $ Plus: Investment by owner Net income Less: Withdrawals J. Scott, Capital, Dec. 31, 2004 $ 20,000 2,200 500 21,700

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The Balance Sheet describes a companys financial position at a point in time.

Scott Company Statement of Owner's Equity For Month Ended December 31, 2004 J. Scott, Capital, Dec. 1, 2004 Plus: Investment by owner Net income Less: Withdrawals J. Scott, Capital, Dec. 31, 2004 $ 20,000 2,200 500 21,700

Scott Company Balance Sheet December 31, 2004 Assets $ Liabilities & Equity Accounts payable $ Notes payable Total liabilities J. Scott, Capital Total liabilities and equity $

Cash Supplies Equipment

9,700 1,200 16,000 26,900

1,200 4,000 5,200 21,700 26,900

Total assets
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Scott Company Statement of Cash Flows For Month Ended December 31, 2004 Cash flows from operating activities: Cash received from clients $ 3,000 Purchase of supplies (1,000) Cash paid to employees (800) Net cash provided by operating activities Cash flows from investing activities: Purchase of equipment (15,000) Net cash used in investing activities Cash flows from financing activities: Investment by owner 20,000 Borrowed at bank 4,000 Withdrawal by owner (500) Net cash provided by financing activities Net increase in cash Cash balance, December 1, 2004 Cash balance, December 31, 2004

1,200

(15,000)

$ $

23,500 9,700 9,700

The Statement of Cash Flows identifies cash inflows and cash outflows over a period of time. The McGraw-Hill Companies, Inc., 2005 McGraw-Hill/Irwin