Chapter 1 Accounting Concepts and Procedures

Learning Objectives Explain Accounting, Business, and the Accounting Equation Prepare a Balance Sheet Record Transactions into the Expanded Accounting Equation Prepare the Three Financial Statements

Learning Objective 1 Explain Accounting, Business, and the Accounting Equation

Accounting Language of business Provides information to: Managers Owners Investors Governmental agencies Others inside and outside the organization

The accounting process: Accounting System The accounting process: Analyzes - Looking at what happened Records - Putting information into system Classifies - Grouping similar activities Summarizes - Totaling the results Reports - Issuing the statements Interprets - Examining the statements Communicates - Provides reports

Accounting Provides financial information for decision makers: Individuals Small businesses Large corporations Governmental agencies In a timely fashion

Business Organizations Sole proprietorship – one owner The owner makes all the decisions for the business Partnership – at least two owners Partners share the decision making and risks of the business Corporation – owned by stockholders A business owned by stockholders Liability Corporation (LLC) – owned by a few stockholders Liable only to the extent of their investment

Table 1.1 Types of Business Organizations

Business Classifications Service - actual services are provided for clients (e.g. consulting firms) Merchandising - make their own products or sell products made by another supplier (e.g. JCPenney) Manufacturing - Companies that make their own products (e.g. Ford Motor Co.)

Table 1.2 Examples of Service, Merchandise, and Manufacturing Businesses

GAAP Generally Accepted Accounting Principles Procedures and guidelines that must be followed during the accounting process Used to ensure everyone prepares and interprets financial reports the same way International Financial Reporting Standards (IFRS) Guidelines developed by the International Accounting Standards Board US is considering a change from GAAP to IFRS.

Difference between Bookkeeping and Accounting Is the recording function of the accounting process Enters accounting information in the company’s books Accounting Prepares the financial statements Involves many complex activities

The Accounting Equation A business is considered a separate business entity Finances are kept separate and distinct from personal finances All transactions use the accounting equation Assets = Liabilities + Owner’s Equity

Assets = Liabilities + Owner’s Equity Assets - properties of value owned by a business Cash, land, supplies, office equipment, buildings, and other properties of value Equities - rights of financial claim to the assets

Liabilities Liabilities - Obligations that come due in the future. Result in increasing the financial rights or claims of creditors to assets. Examples include accounts payable Companies that are owed money are called creditors. They have a claim to assets.

Assets = Liabilities + Owner’s Equity Liability – future obligation Total claims against the assets – Equities Accountants divide equities into two parts The claims of creditors The claims of owners

The Capital Account Capital - the owner’s investment in a company Does not always mean cash Includes any assets the owner has put into the business

Accounting Transactions Transaction A Aug. 28: Mia invests $6,000 in cash and $200 of office equipment into the business

Accounting Transactions Transaction B Aug. 29: Law practice buys office equipment for cash, $500 Shift in assets - the makeup of the assets has changed, but the total remains the same

Accounting Transactions Transaction C Aug. 30: Buys additional office equipment on account, $300. Accounts payable - unwritten promise to pay the creditor

Learning Objective 2 Prepare a Balance Sheet

Balance Sheet Shows the history of a company Reports financial position as of a particular date Presents ending balances in assets, liabilities, and owner’s equity Assets appear on the left side Liabilities and Equity appear on the right side

Figure 1.1 The Balance Sheet

Preparing a Balance Sheet The heading of the balance sheet provides the following information: The company name The name of the statement The date for which the report is prepared Use of the Dollar Sign Placed to the left of each column’s top figure and to the left of the column’s total

Learning Objective 3 Record Transactions into the Expanded Accounting Equation

The Accounting Equation Expanded: Revenue, Expenses, and Withdrawals Amount earned by performing services or selling goods to customers Increases owner’s equity Recorded when earned Assets increase Cash if the client pays right away Accounts receivable - client promises to pay in the future

The Accounting Equation Expanded: Revenue, Expenses, and Withdrawals Cost incurred in its efforts to create revenue Decreases owner’s equity Recorded when incurred Paid in cash or can be charged

Net Income/Net Loss Revenues – Expenses = If revenues > expenses = net income Increases equity If expenses > revenues = net loss Decreases equity

Withdrawals Cash or other assets removed from the business to pay personal expenses Decreases owner’s equity Not related to the business Not an expense

Figure 1.3 Owner’s Equity

Expanded Accounting Equation Transaction D Sept. 1–30: Provided legal services for cash, $2,000. INSERT TABLE ON p. 10

Expanded Accounting Equation Transaction E Sept. 1–30: Provided legal services on account, $3,000. INSERT FIRST TABLE ON p. 11

Expanded Accounting Equation Transaction F Sept. 1–30: Received $900 cash as partial payment from previous services performed on account.

Expanded Accounting Equation Transaction G Sept. 1–30: Paid salaries expense, $700.

Expanded Accounting Equation Transaction H Sept. 1–30: Paid rent expense, $400.

Expanded Accounting Equation Transaction I Sept. 1–30: Incurred advertising expenses of $200, to be paid next month.

Expanded Accounting Equation Transaction J Sept. 1–30: Mia withdrew $100 for personal use.

Learning Objective 4 Prepare the Three Financial Statements

Income Statement Shows business results Revenues Expenses Net income/loss Covers a certain period of time A month, a quarter, a year

Income Statement Preparing Statements The company name The name of the statement The period of time the statement covers

Figure 1.4 The Income Statement

Statement of Owner’s Equity Increased by: Owner Investment Net Income (Revenue - Expenses) and Revenue Greater Than Expenses Decreased by: Owner Withdrawals Net Loss (Revenue - Expenses) and Expenses Greater Than Revenue

Figure 1.5 Statement of Owner’s Equity—Net Income

Figure 1.6 Statement of Owner’s Equity—Net Loss

Figure 1.7 The Accounting Equation and the Balance Sheet

Table 1.3 What Goes on Each Financial Statement

Main Elements of the Income Statement, the Statement of Owner’s Equity, and the Balance Sheet The income statement is prepared first. Net income or loss is needed for the statement of owner’s equity. The statement of owner’s equity is prepared second. The net income or net loss comes from the income statement. The balance sheet is prepared last. The balance in Capital comes from the statement of owner’s equity.

Summary of the Chapter Defining and listing the functions of accounting. The functions of accounting involve analyzing, recording, classifying, summarizing, reporting, and interpreting financial information. Forms of business organization: A sole proprietorship is a business owned by one person. A partnership is a business owned by two or more persons. A corporation is a business owned by stockholders. An LLC is owned by a limited number of stockholders. The Sarbanes-Oxley Act helps prevent fraud at trading companies. GAAP and IFRS are guidelines established by U.S. (GAAP) and international (IFRS) accounting standard boards.

Summary of the Chapter Recording transactions in the basic accounting equation. Assets = Liabilities + Owner’s Equity is the basic accounting equation. Liabilities represent amounts owed to creditors. Capital does not mean cash. In a shift of assets the composition of assets changes but the total of assets does not change. Seeing how revenue, expenses, and withdrawals expand the basic accounting equation. Revenue generates an inward flow of assets. Expenses generate an outward flow of assets or a potential outward flow.

Summary of the Chapter When revenue totals more than expenses, net income is the result; when expenses total more than revenue, there is a net loss. Owner’s equity can be subdivided into four elements: capital, withdrawals, revenue, and expenses. Withdrawals and expenses will decrease owner’s equity. Preparing an income statement, a statement of owner’s equity, and a balance sheet. The income statement is a statement written for a specific period of time that lists earned revenue and expenses incurred to produce the earned revenue.

Summary of the Chapter The statement of owner’s equity is a statement written for a specific period of time that reveals the causes of a change in capital. The ending figure for capital will be used on the balance sheet. The balance sheet is a statement written for a specific point of time that uses the ending balances of assets and liabilities from the accounting equation and the capital from the statement of owner’s equity. The income statement should be prepared first because the information on it about net income or net loss is used to prepare the statement of owner’s equity, which in turn provides information about capital for the balance sheet.

Questions?

Figure 1.2 Partial Balance Sheet

Figure 1.8 Michael Brown’s Income Statement and Statement of Owner’s Equity

Figure 1.9 Michael Brown’s Balance Sheet