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Accounting and the

Business Environment
Chapter 1

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Objective 1
Use accounting vocabulary

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Accounting
Measures
Processes
Communicates
Financial information to decision makers

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Decision Makers

Individuals
Businesses
Investors
Creditors
Taxing Authorities

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Financial vs. Managerial


Accounting
Financial Accounting Information for
people outside of the company
Managerial Accounting Information for
internal decision makers

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Governing Organizations
FASB Financial Accounting Standards
Board
SEC Securities and Exchange
Commission
AICPA American Institute of Certified
Public Accountants
IMA Institute of Management
Accountants
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Ethics
Audit
Examination of companys financial situation
Performed by independent accountants

Sarbanes-Oxley Act criminal offense to


falsify financial statements
Public Companies Accounting Oversight
Board monitors work of accountants

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Standards of Professional Conduct


AICPA Code of Professional Conduct for
Accountants
IMA Standards of Ethical Conduct

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Types of Business
Organizations
Proprietorships
Partnerships
Corporations

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Objective 2
Apply accounting concepts and
principles

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GAAP
Generally Accepted Accounting Principles
Accounting guidelines that govern how
accountants measure, process, and
communicate financial information

Formulated by Financial Accounting


Standards Board (FASB)

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11

GAAP
Primary objective of financial accounting
provide information that is useful for
making investment and lending decisions

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12

Entity Concept
Accounting Entity organization that
stands apart as a separate economic unit

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13

Reliability (Objectivity) Principle


Accounting information is based on the
most reliable data available
Verifiable
Free from bias
Individuals would arrive at similar conclusions
using same data

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14

Cost Principle
Acquired assets and services should be
recorded at their actual cost (historical
cost)

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15

Going Concern Concept


Assumes that the entity will remain in
operation for the foreseeable future

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16

Stable-Monetary-Unit Concept
Assumes that the dollars purchasing
power is stable

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17

Objective 3
Use the accounting equation

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18

Assets
Economic resources, expected to benefit
the business in the future
Cash
Accounts receivable
Merchandise inventory
Furniture
Land

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19

Claims to the Assets


Liabilities economic obligations payable
to an individual or organization outside the
business
Accounts payable
Notes payable
Salary payable

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20

Claims to the Assets


Owners Equity (capital) claim of
business owner to the assets of the
business

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21

The Accounting Equation


Assets

Economic
Resources

= Liabilities + Owners Equity

Claims to
Economic
Resources
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22

Transactions that Affect


Owners Equity
OWNERS
EQUITY
INCREASES

OWNERS EQUITY
DECREASES
Owner
Withdrawals

Owner
Investments
Owners Equity

Revenues

Expenses
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23

Revenues
Amounts earned by delivering goods or
services to customers
Sales revenue
Service revenue
Interest revenue
Dividend revenue

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Expenses
Decrease in owners equity that occurs
from using assets or increasing liabilities
in the course of delivering goods or
services to customers
Salary expense
Rent expense
Utilities expense
Interest expense

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25

Exercise 1-18
Assets

Pep Boys
Eddie Bauer
Benbrook Exxon

Liabilities

Owners
Equity

$?
$81,000

$60,000

$21,000

72,000

?
32,000

40,000

100,000

79,000

?
21,000

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26

Objective 4
Analyze business transactions

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Transaction
An event that affects the financial position
of a particular entity and can be recorded
reliably

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28

Exercise 1-17
a. Increased assets (cash)
b. No effect on total assets. Increase in land
offset the decrease in cash
c. Decreased assets (cash)
d. Increased assets (equipment)

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29

Exercise 1-17
e. Increased assets (accounts receivable)
f. Decreased assets (cash)
g. No effect on total assets. Increase in
cash offset the decrease in accounts
receivable
h. Increased assets (cash)

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30

Exercise 1-22

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31

Analyze this:
July 6: Lange invested $45,000 in the
business by opening a bank account in
the name of M. Lange, M.D.
What
Does the
accounts
account
areincrease
involved?
or decrease?

(1) Cash (asset)


(2) Owners Equity (equity)

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32

Exercise 1-22
Date

Assets

July

Cash

45,000

Medical
Supplies

Liabilities Owners
Equity
Land

Accounts
Payable

M.Lange,
Capital

Type of
Transaction

45,000 Investment

Assets = $45,000

Liabilities &
Owners Equity = $45,000

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33

Analyze this:
July 9: Paid $35,000 cash for land
DoesWhat
the account
increase
or decrease?
accounts
are involved?

(1) Cash (asset)


(2) Land (asset)

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34

Exercise 1-22
Date

Assets
Medical
Supplies

Liabilities Owners
Equity

July

Cash

Land

45,000

-35,000

35,000

Bal

10,000

35,000

Accounts
Payable

M.Lange,
Capital

Type of
Transaction

45,000 Investment

Assets = $45,000

45,000
Liabilities &
Owners Equity = $45,000

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35

Analyze this:
July 12: Purchased medical supplies
for $2,000 on account
DoesWhat
the account
increase
or decrease?
accounts
are involved?

(1) Medical Supplies (asset)


(2) Accounts Payable (liability)

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36

Exercise 1-22
Date
July

Bal

Assets
Cash

Medical
Supplies

10,000

Liabilities Owners
Equity
Land

Accounts
Payable

35,000

Type of
Transaction

45,000

12

2,000

2,000

Bal

10,000 2,000 35,000

2,000

Assets = $47,000

M.Lange,
Capital

45,000

Liabilities &
Owners Equity = $47,000

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37

Analyze This:
July 15-31: During the rest of the month,
Lange treated patients and earned
service revenue of $7,000, receiving
cash
DoesWhat
the account
accounts
increase
are involved?
or decrease?
(1) Cash (asset)
(2) Revenues (equity)

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When the
owner
completes
work, her
interest in the
assets
increases
38

Exercise 1-22
Date
July

Bal
15-31

Bal

Assets
Cash

Medical
Supplies

Liabilities Owners
Equity
Land

10,000 2,000 35,000

Accounts
Payable

M.Lange,
Capital

2,000

45,000

7,000

Type of
Transaction

7,000 Revenue

17,000 2,000 35,000

Assets = $54,000

2,000

52,000

Liabilities &
Owners Equity = $54,000

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39

Analyze This:
July 15-31: Paid cash expenses
Does the
account
increase
or decrease?
What
accounts
are involved?
(1) Cash (asset)
(2) Expense (equity)
When an expense is
incurred, owners
equity decreases

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40

Exercise 1-22
Date
July

Bal

Assets
Cash

Medical
Supplies

Liabilities Owners
Equity
Land

17,000 2,000 35,000

Accounts
Payable

M.Lange,
Capital

2,000

52,000

15-31 -1,700

Bal

Type of
Transaction

-1,700 Salaries Exp

-1,000

-1,000 Rent Exp

- 300

- 300 Utilities Exp

14,000 2,000 35,000

2,000

Assets = $51,000

Liabilities &
Owners Equity = $51,000

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49,000

41

Analyze This:
July 28: Sold supplies to another
physician for the cost of those supplies
Does the
account
increase
or decrease?
What
accounts
are involved?
(1) Cash (asset)
(2) Medical Supplies (asset)

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42

Exercise 1-22
Date
July

Bal
28
Bal

Assets
Cash

Medical
Supplies

Liabilities Owners
Equity
Land

Accounts
Payable

M.Lange,
Capital

2,000

49,000

14,500 1,500 35,000

2,000

49,000

Assets = $51,000

Liabilities &
Owners Equity = $51,000

14,000 2,000 35,000


500

Type of
Transaction

-500

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43

Analyze This:
July 31: Paid $1,500 on account

Does the
account
increase
or decrease?
What
accounts
are involved?
(1) Cash (asset)
(2) Accounts Payable (liability)

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44

Exercise 1-22
Date
July

Bal
31
Bal

Assets
Cash

Medical
Supplies

Liabilities Owners
Equity
Land

14,500 1,500 35,000


-1,500

Accounts
Payable

M.Lange,
Capital

2,000

49,000

Type of
Transaction

-1,500

13,000 1,500 35,000


Assets = $49,500

500

49,000

Liabilities &
Owners Equity = $49,500

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45

Accounting for Business


Transactions
Note: The equation always stays in
balance
Each transaction affects at least two
accounts, sometimes more
Some transactions affect only one side of
the equation; some affect both sides

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46

Objective 5
Prepare financial statements

Objective 6
Evaluate business performance

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47

Financial Statements

Income statement
Statement of owners equity
Balance sheet
Statement of cash flows

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48

Income Statement
Summary of an entitys revenues,
expenses, and net income or net loss for a
specific period
Revenues - Expenses
Net Income: Revenues > Expenses
Net Loss: Expenses > Revenues

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49

Statement of Owners Equity


Summary of changes in an entitys
owners equity during a specific period
Beginning owners equity
+ Owners investments
+ Net income
- Net loss
- Owners withdrawals
Ending owners equity
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50

Balance Sheet
Reports the entitys assets, liabilities, and
owners equity as of a specific date
Assets = Liabilities + Owners Equity

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51

Statement of Cash Flows


Reports cash receipts and cash payments
during a period (covered in Chapter 17)

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52

Financial Statements
Using the transactions from Exercise 1-22,
prepare the income statement, statement
of owners equity, and balance sheet

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53

Maria Lange, M.D.


Anytime
Income Statement
you
subtotal,
For the Month Ended July 31,
2006
create a
Revenue:
Fees earned
Expenses:
Salary expense
Double
Rent
expense
underline
for yourexpense
Utilities
final answer
Total Expenses
Net income

new column
to the left

$7,000
Notice the
proper
heading$1,700

1,000
300

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3,000
$4,000
54

Maria Lange, M.D.


Statement of Owners Equity
From income
statement
Dates
Forarethe Month Ended July 31,
2006

important to
the reader of
Maria
Lange,
the financial
reports

capital, July 1, 2006


Add: Investment by owner
Net income for the month
Less: Withdrawals by owner
Maria Lange, capital, July 31, 2006

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0
45,000
4,000
$49,000
0
$49,000

55

Details, Details
Note the headings for both of these
statements
Name of company
Name of financial statement
For the period ended .

Both of these statements report activity


over a period of time
Final sums are double-underlined
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56

Details, Details
Negative amounts are presented in
parentheses
Net income is computed first because you
need that number to complete the ending
balance in owners equity
When preparing a financial statement,
clearly label each line in the statement

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57

Details, details
If you are using columnar paper, always
start your number columns in the far righthand column
Numbers that are added or subtracted
from each other should be in the same
column

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58

Maria Lange, M.D.


Balance Sheet
July 31, 2006

From statement of
owners equity

Liabilities

Assets
Notice the
proper
heading

Accounts payable

$500

Owners equity,
M. Lange, capital

49,000

Total liabilities and


owners equity
$ 49,500

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59

Details, details
Note the heading for the balance sheet is
different from the other statements
Name of company
Name of financial statement
Date
This statement reports what the company
owns and who has claims to the assets at
a specific point in time
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60

Exercise 1-24
Allen Samuel Road Service
Balance Sheet
November 30, 2009
Liabilities

Assets
Cash
Accounts receivable
Supplies
Equipment

$2,000
6,000
500
15,500

Accounts payable
Note payable
Total liabilities

$24,000

5,000
$8,500

Owners Equity
A. Samuel, capital

Total Assets

$3,500

15,500

Total liabilities and


owners equity
$24,000

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61

Exercise 1-24
What does a balance sheet report
financial position or operating results?
Financial position

Which financial statement reports the other


information?
The income statement summarizes revenues
and expenses

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62

Exercise 1-26
Ciliotta Design Studio
Income Statement
Year Ended December 31, 2006
Service revenue
Expenses:
Salary expense
Rent expense

$60,000
24,000

Utilities expense

6,800

Supplies expense

4,000

Property tax expense

1,200

Total expenses
Net income

$158,100

96,000
$62,100

Exercise 1-26
2. Owners withdrawals:
Ciliottas, capital, beginning of year
Add: Net income
Investment by owner
Subtotal
Less: Owner withdrawal
Ciliotta, capital, end of year

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$
0
62,100
15,000
$77,100
?
50,000
$27,100

64

End of Chapter 1

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