Ch 01 Warren Financial Accounting

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c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.

Learning Objectives
1.
2.
3.
4.
5.
6.

Describe the nature of a business and the role of
accounting and ethics 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 change in the elements
of the accounting equation.
Describe the financial statements of a corporation and
explain how they interrelate.
Describe and illustrate the use of the ratio of liabilities to
stockholders’ equity in evaluating a company’s financial
condition.

Lear
ning
Obje
ctive
Desc
r ibe
the n
and
at
tu
t he r
ole o re of a b
usine
f ac c
ethic ounting ss
and
s in b
usine
ss.

1


Nature of Business and Accounting

o

A business is an organization in which basic
resources (inputs), such as materials and
labor, are assembled and processed to
provide goods or services (outputs) to
customers.


Nature of Business and Accounting

o The objective of most businesses is to earn a
profit.

o Profit is 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.


TYPES OF
BUSINESSES
Service Business

Service

Delta Air Lines

Transportation services

The Walt Disney Company

Entertainment services

Merchandising Business

Product

Walmart

General merchandise

Amazon.com

Internet books, music, videos

Manufacturing Business

Product

Ford Motor Company

Cars, trucks, vans

Dell, Inc.

Personal computers

The Role of Accounting in Business

o

Accounting can be defined as an information
system that provides reports to users about
the economic activities and condition of a
business.


The Role of Accounting in Business

o The process by which accounting provides
information to users is as follows:
 Identify users.
 Assess users’ information needs.
 Design the accounting information system to meet

users’ needs.

 Record economic data about business activities and

events.

 Prepare accounting reports for users.


THE ROLE OF
ACCOUNTING IN
BUSINESS

Managerial Accounting

o

The area of accounting that provides internal
users with information is called managerial
accounting or management accounting.

o

Managerial accountants employed by a
business are employed in private accounting.


Financial Accounting

o
o

o

The area of accounting that provides external
users with information is called financial
accounting.
The objective of financial accounting is to
provide relevant and timely information for
the decision-making needs of users outside of
the business.
General-purpose financial statements are one
type of financial accounting report that is
distributed to external users.


Role of Ethics in Accounting and Business

o The objective of accounting is to provide

relevant, timely information for user decision
making.

o Accountants must behave in an ethical manner
so that the information they provide users will
be trustworthy and, thus, useful for decision
making.

o Ethics are moral principles that guide the
conduct of individuals.


ROLE OF ETHICS
IN ACCOUNTING
AND BUSINESS

ROLE OF ETHICS IN ACCOUNTING AND
BUSINESS
The answer to …



Failure of individual
character

“What went wrong for
these companies?”



Firm culture of greed
and ethical
indifference

involves one or both of
these factors.
(Exhibit 2)

Opportunities for Accountants

o

Accountants and their staffs who provide
services on a fee basis are said to be
employed in public accounting.

o

Accountants employed by a business firm or a
not-for-profit organization are said to be
employed in private accounting.

o

Public accountants who have met a state’s
education, experience, and examination
requirements may become Certified Public
Accountants (CPAs).

Lear
ning
Obje
ctive
Su m
acco marize th
u
e
e dev
nting
el op
pr i n
men
ciple
t of
s an d
them
r
to pr elate
actic
e.

2


Generally Accepted Accounting Principles

o

Financial accountants follow generally
accepted accounting principles (GAAP) in
preparing reports.

o

Within the U.S., the Financial Accounting
Standards Board (FASB) has the primary
responsibility for developing accounting
principles.


Generally Accepted Accounting Principles

o The Securities and Exchange Commission

(SEC), an agency of the U.S. government, has
authority over the accounting and financial
disclosures for companies whose shares of
ownership (stock) are traded and sold to the
public.

o Many countries outside the United States use
generally accepted accounting principles
adopted by the International Accounting
Standards Board (IASB).


Business Entity Concept

o

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


PROPRIETORSHIP
A proprietorship is
owned by one
individual.






70% of business
entities in the U.S.
are
proprietorships.
They are easy and
cheap to organize.
Resources are
limited to those of
the owner.
Used by small
businesses.

PARTNERSHIP
A partnership is
similar to a
proprietorship
except that it is
owned by two or
more individuals.



10% of business
organizations in the
U.S. (combined
with limited
liability
companies) are
partnerships.



Combines the skills
and resources of
more than one
person.

CORPORATION
A corporation is
organized under state
or federal statutes as a
separate legal taxable
entity.







Corporations generate
90% of business
revenues.
20% of the business
organizations in the U.S.
are corporations.
Ownership is divided
into shares, called
stock.
Can obtain large
amounts of resources
by issuing stocks.
Used by large
businesses.

LIMITED LIABILITY COMPANY
(LLC)
A limited liability
company (LLC)
combines the
attributes of a
partnership and a
corporation.



10% of business
organizations in the
U.S. (combined
with partnerships).



Often used as an
alternative to a
partnership.



Has tax and legal
liability advantages
for owners.

Cost Concept

o Under the cost concept, amounts are initially
recorded in the accounting records at their
cost or purchase price.


Cost Concept

o Aaron Publishers purchased a building on

February 20, 2012, for $150,000. Other amounts
related to this purchased are shown on the next
slide.


Cost Concept
• Price listed by seller on January 1, 2012

$160,000

• Aaron Publishers’ initial offer to buy on
January 31, 2012

140,000

• Purchase price on February 20, 2012

150,000

• Estimated selling price on
December 31, 2014

220,000

• Assessed value for property taxes,
December 31, 2014

190,000

Under the cost concept, Aaron Publishers records the purchase of the
building on February 20, 2012, at the purchase price of

$150,000
The other amounts listed above have no effect on the accounting records.

Objectivity Concept

o

The objectivity concept requires that the
amounts recorded in the accounting records
be based on objective evidence.

o

Only the final agreed-upon amount is
objective enough to be recorded in the
accounting records.


Unit of Measure Concept

o

The unit of measure concept requires that
economic data be recorded in dollars.


Lear
ning
Obje
State
ctive
th e a
ccou
nt
in
defin
e ea g equat
ch e l
ion a
e me
n
nt of d
equa the
tion.

3


The Accounting Equation

o
o

The resources owned by a business are its assets.

o

The rights of the owners are called stockholders’
equity for a corporation and owner’s equity for a
proprietorship, partnership, or limited liability
company.

o

The equation Assets = Liabilities + Stockholders’
Equity is called the accounting equation.

The rights of creditors are the debts of the
business and are called liabilities.


THE
ACCOUNTING
EQUATION
Assets = Liabilities + Stockholders’ Equity

The resources
owned by a
business

THE
ACCOUNTING
EQUATION

The rights of
creditors are the
debts of the
business

THE
ACCOUNTING
EQUATION
The rights of the
owners

Lear
ning
Obje
Desc
ctive
ribe
trans
actio and illus
o
t
n
f the

n
r
resu s can be ate how
lting
busi
reco
ness
rded
chan
g
in
of th
e acc e in the e terms
l
ount
ing e ements
quat
io n .

4


Business Transaction

1. A business transaction is an economic event or
condition that directly changes an entity’s
financial condition or its results of operations.

TRANSACTION A

On November 1, 2013, Chris Clark deposited
$25,000 in a bank account in the name of
NetSolutions.

TRANSACTION B

On November 5, 2013, NetSolutions paid
$20,000 for the purchase of land as a future
building site.

TRANSACTION C

On November 10, 2013, NetSolutions
purchased supplies for $1,350 and agreed to
pay the supplier in the near future.

Transaction C

o The liability created by a purchase on account
is called an account payable.

o Items such as supplies that will be used in the
business in the future are called prepaid
expenses, which are assets.


TRANSACTION D
On November 18, 2013, NetSolutions received cash of
$7,500 for providing services to customers. A business
earns money by selling goods or services to its
customers. This amount is called revenue.

Transaction D

o Revenue from providing services is recorded
as fees earned.

o Revenue from the sale of merchandise is
recorded as sales.

o Other examples of revenue include rent, which

is recorded as rent revenue, and interest, which
is recorded as interest revenue.

o An account receivable is a claim against a
customer, which is an asset.


TRANSACTION E

During the month, NetSolutions spent cash or
used up other assets in earning revenue.
Assets used in this process of earning revenue
are called expenses.

TRANSACTION E

On November 30, 2013, NetSolutions paid the
following expenses: wages, $2,125; rent, $800;
utilities, $450; and miscellaneous, $275.

TRANSACTION F

creditors on account, $950.

TRANSACTION G

On November 30, 2013, Chris Clark
determined that the cost of supplies on
hand at the end of the period was $550.

TRANSACTION H

$2,000 to stockholders (Chris Clark) as
dividends.

You Should Note the Following:

o The effect of every transactions is an increase

or a decrease in one or more of the accounting
equation elements.

o The two sides of the accounting equation are
always equal.

o The stockholders’ equity (owner’s equity) is
increased by amounts invested by
stockholders (capital stock).


You Should Note the Following:

increased by revenues and decreased by
expenses.


decreased by dividends paid to stockholders.

o Retained earnings is the stockholders’ equity
created from business operations through
revenue and expense transactions.


TYPES OF
TRANSACTIONS
AFFECTING OWNER’S
EQUITY

Lear
ning
Obje
De s c
ctive
ribe
the f
a c or
inan
po r
c
ation
ci
and al statem
expl
ain h ents of
ow th
ey
inter
relat
e.

5


Financial Statements

o

After transactions have been recorded and
summarized, reports are prepared for users.
The accounting reports providing this
information are called financial statements.


Income Statement

o

The income statement reports the revenues and
expenses for a period of time, based on the
matching concept.

o

The matching concept is applied by “matching”
the expenses incurred during a period with the
revenue that those expenses generated.

o

The excess of the revenue over the expenses is
called net income, net profit, or earnings. If
expenses exceed revenue, the excess is a net loss.


Retained Earnings Statement

o

The retained earnings statement reports the
changes in the retained earnings for a period
of time.

o

It is prepared after the income statement
because the net income or net loss for the
period must be reported in this statement.


Retained Earnings Statement

o To illustrate, assume that NetSolutions earned net
income of $4,155 and paid dividends of $2,000
during December. The following statement would
be prepared.


INCOME
STATEMENT

Net income is carried to the
retained earnings statement

RETAINED
EARNINGS
STATEMENT
From the income statement

To the balance sheet

Balance Sheet

o

A balance sheet is a list of the assets,
liabilities, and stockholders’ equity as of a
specific date.


Account Form

o

The account form of a balance sheet lists the
assets on the left and the liabilities and
stockholders’ equity on the right. It resembles
the basic format of the accounting equation.


BALANCE SHEET

This amount is compared
to the net cash flow on the
statement of cash flows.

From the retained
earnings statement

Statement of Cash Flows

o

A statement of cash flows is a summary of the
cash receipts and cash payments for a specific
period of time.
 It consists of three sections:

(1) operating activities
(2) investing activities
(3) financing activities


STATEMENT OF
CASH FLOWS

This amount should match
Cash on the balance sheet.

Cash Flows from Operating Activities

o

The cash flows from operating activities
section reports a summary of cash receipts
and cash payments from operations.


Cash Flows from Investing Activities

o

The cash flows from investing activities section
reports the cash transactions for the
acquisition and sale of relatively permanent
assets.


Cash Flows from Financing Activities

o

The cash flows from financing activities
section reports the cash transactions related to
cash investments by stockholders,
borrowings, and cash dividends.


INTERRELATIONS
HIPS AMONG
FINANCIAL
STATEMENTS

Interrelationships Among Financial Statements

o In Exhibit 6, NetSolutions’ net income of $3,050
for November is added to the beginning retained
earnings on November 1, 2013, in the retained
earnings statement.



o In Exhibit 6, NetSolutions’ retained earnings of
$1,050 as of November 30, 2013, on the retained
earnings statement also appears on the November
30, 20l3, balance sheet as retained earnings.



o In Exhibit 6, cash of $5,900 reported on the
balance sheet as of November 30, 2013, is also
reported on the November statement of cash flows
as the end-of-period cash.


Lear
ning
Obje
Desc
ctive
r ibe
and
illu
sto
ockh
s
olde the ratio trate the
us e o
of lia
com rs’ equi
f
biliti
pany
ty i n
es to
’s fin
e
ancia valuatin
ga
l con
ditio
n.

6


RATIO OF
LIABILITIES TO
STOCKHOLDERS’
EQUITY
Ratio of Liabilities
to Stockholders’
Equity
Ratio of Liabilities
to Stockholders’
Equity

=

Total Liabilities
Total Stockholders’ Equity

=

$400
$26,050

= 0.015

to
ion
ct
du
tro ing and
In
unt iness
cco Bus
A
nd
eE
Th

Ch 01 Warren Financial Accounting

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Ch 01 Warren Financial Accounting