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Accounting Chapter 1

BUSINESS
an organization in which basic resources (inputs), such as materials and labor, are assembled and processed to provide goods or services (outputs) to customers.
INPUTS
basic resources like materials and labor which an organization put in
OUTPUTS
assembled goods or services an organization provides
The objective of most businesses:
to earn a profit
PROFIT
the difference between the amounts received from customers for goods or services and the amounts paid for the inputs used to provide the goods or services
List the 3 types of for profit businesses
Service businesses
Merchandising businesses
Manufacturing businesses
Define Service Business and provide an example
provide services rather than products to customers.

examples:

Delta Air Lines (transportation services)
The Walt Disney Company (entertainment services)

Define Merchandising Business and provide an example
sell products they purchase from other businesses to customers.

examples:
Wal-Mart (general merchandise)
Amazon.com (Internet books, music, videos)

Define Manufacturing Business and provide an example
change basic inputs into products that are sold to customers.

ex: Ford Motor Co. (cars, trucks, vans)
Dell Inc. (personal computers)

What are the two roles of Accounting in Business?
1) to provide information for managers to use in operating the business.

2) to provide information to other users in assessing the economic performance and condition of the business.

ACCOUNTING
an information system that provides reports to users about the economic activities and condition of a business

( the means by which businesses’ financial information is communicated to users)

The five step process by which accounting provides information to users:
1. Identify users.
2. Assess users’ information needs.
3. Design the accounting information system to meet users’ needs.
4. Record economic data about business activities and events.
5. Prepare accounting reports for users.
Users of accounting information can be divided into
two groups:
internal users and external users
INTERNAL USERS
– Relay information to managers & employees

– These users are directly involved in managing and operating the business

EXTERNAL USERS
-Relay information to
-investors
-creditors
-customers
-government

-These users are not directly involved in managing and operating the business.

managerial accounting
The area of accounting that provides internal users with information
The objective of managerial accounting:
to provide relevant and timely information for managers’ and employees’ decision-making needs
What kind of accounting are managerial accountants are employed in?
in private accounting
Sensitive Information
Information that is not distributed outside the business

Ex: might include information about customers, prices, and plans to expand the business.

Financial Accounting
The area of accounting that provides external users with information
The objective of financial accounting:
to provide relevant and timely information for the decision-making needs of users outside of the business.

ex: financial reports on the operations and condition of the business are useful for banks and other creditors in deciding whether to lend money to the business

Why must accountants behave in an ethical manner?
so that the information they provide users will be trustworthy and, thus, useful for decision making.
Why must Managers and employees also behave in an ethical manner in managing and operating a business?
Otherwise, no one will be willing to invest in or loan money to the business.
Ethics
moral principles that guide the conduct of individuals
Ethical violations lead to:
fines, firings, and lawsuits. In some
cases, managers are criminally prosecuted, convicted, and sent to prison
2 Factors of fraud:
-Failure of Individual Character

– Company Culture of Greed and Ethical Indifference

Sarbanes-Oxley Act of 2002 (SOX)
– established a new oversight body for the accounting profession, called the Public Company Accounting Oversight Board (PCAOB).

– established standards for independence, corporate
responsibility, and disclosure.

Public Company Accounting Oversight Board (PCAOB).
a new oversight body for the accounting profession established by the Sarbanes-Oxley Act of 2002 (SOX)
Guidelines for behaving ethically:
1. Identify an ethical decision by using your personal ethical standards of honesty and fairness.

2. Identify the consequences of the decision and its effect on others.

3. Consider your obligations and responsibilities to those that will be affected by your decision.

4. Make a decision that is ethical and fair to those affected by it.

A Ponzi scheme
the investment manager uses funds received from new investors to pay a return to existing investors, rather than basing investment returns on the fund’s actual performance.
Public Accountant
– Accountants employed individually or within a public accounting firm in tax or audit services.
Certified Public Accountants (CPAs)
– Public accountants who have met a state’s education, experience, and examination requirements

– generally perform general accounting, audit, or tax services.

Private Accountant
– Accountants employed by companies, government,
and not-for-profit entities.
Career options for Private Accountants:
-Bookkeeper
-Payroll clerk
-General accountant
-Budget analyst
-Cost accountant
-Internal auditor
-Information technology auditor
Certified Payroll Professional (CPP)
certification required for a Payroll clerk
Certified Management Accountant (CMA)
certification required for a Cost accountant
Certified Internal Auditor (CIA)
certification required for an Internal auditor
Certified Information Systems Auditor (CISA)
certification required for an Information technology auditor
Career options for Public Accountants:
-Local firms

-National firms

The Financial Accounting Standards Board (FASB)
– Publishes Statements of Financial Accounting Standards as well as Interpretations of these Standards (In the US).

-has the primary responsibility for developing accounting principles (In the US).

The Securities and Exchange Commission (SEC)
– The U.S. government agency which has authority over
the accounting and financial disclosures for companies whose shares of ownership (stock) are traded and sold to the public.

– Normally accepts the accounting principles set forth by the FASB, but it may also the issue Staff Accounting Bulletins on accounting matters that may not have been addressed by the FASB.

Staff Accounting Bulletins
Bulletins issued by the Securities and Exchange Commission (SEC) on accounting matters that may not have been addressed by the FASB.
International Accounting Standards Board (IASB)
– Board which issues generally accepted accounting principles for many countries outside the United States.

-issues International Financial Reporting Standards (IFRSs)

International Financial Reporting Standards (IFRSs)
-General Accounting principles issued by the International Accounting Standards Board (IASB)
The FASB and IASB are working together to:
reduce and eliminate their differences into a single set of accounting principles.
Generally accepted accounting principles (GAAP)
-Principles financial accountants follow in preparing reports.

-These standardized reports allow investors and other users to compare one company to another, which would be very difficult to compare if financial accountants didn’t follow GAAP

The business entity concept
– The activities of a business are recorded separately from the activities of its owners, creditors, or
other businesses.

– limits the economic data in an accounting system to
data related directly to the activities of the business.

-ex: the accountant for a business with one owner would record the activities of the business only and would not record the personal activities, property, or debts of the owner.

Forms of Business Entities
– proprietorship
– partnership
– corporation
– limited liability company (LLC)
Proprietorship
• owned by one individual.
• 70% of business entities in the US
• Easy and cheap to organize.
• Resources are limited to those of the owner.
• Used by small businesses.
Partnership
• owned by two or more individuals.
• 10% of business organizations in the US
(combined with limited liability companies).
• Combines the skills and resources of more than one
person.
Corporation is
• organized under state or federal statutes as a separate legal taxable entity.
• Generates 90% of business revenues.
• 20% of the business organizations in the US
• Ownership is divided into shares called stock.
• Can obtain large amounts of resources by issuing stock.
• Used by large businesses.
Limited liability company
• combines the attributes of a partnership and a corporation.
• 10% of business organizations in the United States
(combined with partnerships).
• Often used as an alternative to a partnership.
• Has tax and legal liability advantages for owners.
Which Business entity form are most manufacturing businesses?
corporations
The cost concept
amounts are initially recorded in the accounting records at their cost or purchase price
The objectivity concept
amounts recorded in the accounting records must be based on objective evidence
The unit of measure concept
economic data must be recorded in dollars.
On August 25, Gallatin Repair Service extended an offer of $125,000 for land that had been priced for sale at $150,000. On September 3, Gallatin Repair Service accepted the seller’s counteroffer of $137,000. On October 20, the land was assessed at a value of $98,000 for property tax purposes. On December 4, Gallatin Repair Service was offered $160,000 for the land by a national retail chain. At what value should the land be recorded in Gallatin Repair Service’s records?
$137,000. Under the cost concept, the land should be recorded at the cost to Gallatin Repair Service.
Assets
The resources owned by a business
Examples of assets:
-Cash,
-land
-buildings
-equipment.
The rights or claims to the assets are divided into two
types:
(1) the rights of creditors
(2) the rights of owners.
The rights of creditors
the debts of the business and are called liabilities.
The rights of the owners
called owner’s equity.
a) Which equation shows the relationship among assets, liabilities, and owner’s equity?
b) What is this equation called?
a) Assets = Liabilities + Owner’s Equity

b) The accounting equation.

Why are Liabilities usually shown before owner’s equity in the accounting equation?
because creditors have first rights to the assets.
Given any two amounts, the accounting equation may be solved for:
the third unknown amount.
a) If the assets owned by a business amount to $100,000 and the liabilities amount to $30,000, What is the owner’s equity is equal to?

b) Why?

a) $70,000

b) Assets – Liabilities = Owner’s Equity
$100,000 – $30,000 = $70,000

John Joos is the owner and operator of You’re A Star, a motivational consulting business. At the end of its accounting period, December 31, 2011, You’re A Star has assets of $800,000 and liabilities of $350,000.

Using the accounting equation, determine the following amounts:
a. Owner’s equity, as of December 31, 2011.
b. Owner’s equity, as of December 31, 2012, assuming that assets increased by $130,000 and liabilities decreased by $25,000 during 2012.

a. Assets = Liabilities + Owner’s Equity
$800,000 = $350,000 + Owner’s Equity
Owner’s Equity = $450,000

b. First, determine the change in Owner’s Equity during 2012 as follows:
Assets = Liabilities + Owner’s Equity
$130,000 = -$25,000 + Owner’s Equity
Owner’s Equity = $155,000

Next, add the change in Owner’s Equity on 12/31/11, to arrive at Owner’s Equity on 12/31/12, as shown below.
Owner’s Equity on 12/31/12 = $450,000 + $155,000

= $605,000

A Business Transaction
an economic event or condition that directly changes an entity’s financial condition or its results of operations
True or False

A change in a business’s credit rating can directly affect cash or any other asset, liability, or owner’s equity amount.

False
True or False

All business transactions can be stated in terms of changes in the elements of the accounting equation.

True
What is the effect of each of the following transaction on the accounting equation?

Nov. 1, 2011 Chris Clark deposited $25,000 in a bank account in the name of NetSolutions in return for shares of stock in the corporation.

This transaction increases the asset (cash) on the left side of the equation by $25,000.

To balance the equation, the stockholders’ equity (capital stock) on the right side of the equation increases by the same amount.

What is the effect of each of the following transaction on the accounting equation?

Nov. 5, 2011 NetSolutions paid $20,000 for the purchase of land as a future building site.

The purchase of the land changes the makeup of the assets, but it does not change the total assets.
What is the effect of each of the following transaction on the accounting equation?

Nov. 10, 2011 NetSolutions purchased supplies for $1,350 & agreed to pay the supplier in the near future

Both assets (Supplies) and liabilities increase (Accounts Payable) by $1,350
What is the effect of each of the following transaction on the accounting equation?

Nov. 18, 2011 NetSolutions received cash of $7,500 for providing services to customers.

The receipt of cash increases NetSolutions’ assets
and also increases the stockholders’ equity in the business. The revenues of $7,500 are recorded in a Fees Earned column to the right of Capital Stock.
What is the effect of each of the following transaction on the accounting equation?

Nov. 30, 2011 NetSolutions paid the following expenses during the month: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.

The effect of expenses is the opposite of revenues in that expenses reduce assets and stockholders’ equity. Like fees earned, the expenses are recorded in columns to the right of Capital Stock. However, since expenses reduce stockholders’ equity, the expenses are entered as negative amounts.
What is the effect of each of the following transaction on the accounting equation?

Nov. 30, 2011 NetSolutions paid creditors on account, $950.

When NetSolutions pays $950 to creditors during the month, it reduces assets and liabilities
What is the effect of each of the following transaction on the accounting equation?

Nov. 30, 2011 After purchasing $1,350 worth of supplies at the start of the month, Chris Clark determined that the cost of supplies on hand at the end of the month was $550

The cost of the supplies on hand (not yet used) at the end of the month is $550. Thus, $800 ($1,350 – $550) of supplies must have been used during the month. This
decrease in supplies is recorded as an expense.
What is the effect of each of the following transaction on the accounting equation?

Nov. 30, 2011 NetSolutions paid $2,000 to stockholders (Chris Clark) as dividends.

The payment of dividends decreases cash and stockholders’ equity. Like expenses, dividends are recorded in a separate column to the right of Capital Stock as a negative amount.
Capital Stock
Stock issued to owners (stockholders)
Stockholders’ Equity
The owner’s equity in a corporation
a) What is a purchase on account transaction?

b) How is it described?

a) When you received an asset and incurred a liability to pay a future bill.

b) It is described as follows: Purchased supplies on account, $1,350.

Account payable
The liability created by a purchase on account
Prepaid expenses
– Items that will be used in the business in the future
– they are considered assets
Revenue
money earned by a business from selling goods or services to its customers
a) How are the 4 different types of revenues obtained?

b)How is each of them recorded?

a)
1. providing services
2. the sale of merchandise
3. rent
4. interest

b)
1. Fees earned
2. Sales
3. Rent revenue
4. Interest revenue

Fees earned on account
or
Sales on account.
-Instead of receiving cash at the time services are provided or goods are sold, the business is accepting payment at a later date.
– form of revenue
account receivable
-a business’s claim against the customer (from customer having promised payment at a later date at time of purchase)
-an asset to the bushiness
How is the revenue earned and recorded for an account receivable
the revenue is earned and recorded as if cash had been received
What happens when customers pay their account receivable?
Cash increases and Accounts Receivable decreases
a) What are expenses?

b) Provide some examples of expenses

a) Assets used in this process of earning revenue
b)
-supplies used
-payments for employee wages
-utilities
-other services
How is paying an amount on account different from paying an expense?
The paying of an expense reduces stockholders’ equity. Paying an amount on account reduces the amount owed on a liability.
Dividends
distributions of earnings to stockholders
What effect does the payment of dividends have on the accounting equation?
decreases both cash and stockholders’ equity
How is the payment of dividends recorded?
dividends are recorded in a separate column to the right of Capital Stock as a negative amount
The effect of every transaction is an increase or a decrease in one or more of the accounting equation elements.
The two sides of the accounting equation are always equal.
The stockholders’ equity (owner’s equity) is increased by amounts invested by stockholders
(capital stock)
The stockholders’ equity (owner’s equity) is increased by revenues and decreased by
expenses.
The stockholders’ equity (owner’s equity) is decreased by dividends paid to stockholders.
Stockholders’ equity is classified as:
1. Capital Stock
2. Retained Earnings.
Capital stock
– shares of ownership distributed to investors in a corporation
– represents the portion of stockholders’ equity contributed by investors
Retained earnings
the stockholders’ equity created from business operations through revenue and expense transactions.
Stockholders’ equity created by investments by stockholders (capital stock) and
by business operations (retained earnings) are reported separately.
What effect do dividends have on retained earnings? Why?
dividends reduce retained earnings since dividends are distributions of earnings to stockholders,
Types of Transactions that Affect Stockholders’ Equity:
-Stockholders’ Investments
-Dividends
-Revenues
-Expenses
How do each of the following transactions affect Stockholders’ equity?

a) Stockholders’ Investments
b) Dividends
c) Revenues
d) Expenses

a) Stockholders’ Investments – Increase
b) Dividends – Decrease
c) Revenues – Increase
d) Expenses – Decrease
Financial statements
accounting reports prepared for users, which summarizes transactions made
The primary financial statements of a corporation:
-the income statement
-the retained earnings statement
-the balance sheet
-the statement of cash flows
List the 4 financial statement in the order in which they are prepared
1. Income statement
2. Retained earnings statement
3. Balance sheet
4. Statement of cash flows
Income statement
A summary of the revenue and expenses for a specific period of time, such as a month or a year
Retained earnings statement
A summary of the changes in retained earnings that have occurred during a specific period of time, such as a month or a year
Balance sheet
A list of the assets, liabilities, and stockholders’ equity as of a specific date, usually at the close of the last day of a month or a year
Statement of cash flows
A summary of the cash receipts and cash payments for a specific period of time, such as a month or a year
All financial statements are identified by: are for a period of time. .
the name of the business, the title of the statement, and the date or period of time.
Which financial statement(s) present data for a period of time?
The data presented in
-the income statement
-the retained earnings statement
-the statement of cash flows
Which financial statement(s) presents data for a specific date?
The data presented in the balance sheet

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