Basic Accounting for Business Decision Dr. Surasakdi Bhamornsiri Certified Public Accountant (USA)

After studying this chapter, you should be able to: ACCOUNTING IN ACTION After studying this chapter, you should be able to: 1 Explain the meaning of accounting. 2 Identify the users and uses of accounting. 3 Explain the meaning of generally accepted accounting principles and the cost principle. 4 State the basic accounting equation and explain the meaning of assets, liabilities, and stockholder’s equity

After studying this chapter, you should be able to: ACCOUNTING IN ACTION After studying this chapter, you should be able to: 5 Analyze the effect of business transactions on the basic accounting equation. 6 Understand what the four financial statements are and how they are prepared.

Business Activities Financing Activities Investing Activities Operating Activities

WHAT IS ACCOUNTING? Accounting is a process of three activities: 1 Identifying 2 Recording 3 Communicating

Merchandising (Retailing) Manufacturing Types of Operations Service Merchandising (Retailing) Manufacturing

Select economic events ILLUSTRATION 1-1 ACCOUNTING PROCESS Communication Accounting Reports Identification Recording Prepare accounting reports SOFTBYTE Annual Report Select economic events (transactions) Record, classify and summarize Analyze and interpret for users

QUESTIONS ASKED BY INTERNAL USERS Is cash sufficient to pay bills? Can we afford to give employee pay raises this year? What is the cost of manufacturing each unit of product? Which product line is the most profitable?

QUESTIONS ASKED BY EXTERNAL USERS Is the company earning satisfactory income? Will the company be able to pay its debts as they come due? How does the company compare in size and profitability with competitors?

BUSINESS ENTERPRISES A business owned by one person is generally a proprietorship. A business owned by two or more persons associated as partners is a partnership. A business organized as a separate legal entity under state corporation law and having ownership divided into transferable shares of stock is called a corporation.

The Basic Accounting Equation ILLUSTRATION 1-5 THE BASIC ACCOUNTING EQUATION The Basic Accounting Equation Assets = Liabilities + Stockholders’ Equity

ASSETS AS A BUILDING BLOCK Assets are resources owned by a business. They are things of value used in carrying out such activities as production, consumption and exchange. The common characteristics possessed by all assets is the capacity to provide future services or benefits to the entities that use them.

LIABILITIES AS A BUILDING BLOCK Liabilities are claims against assets. They are existing debts and obligations. Most claims of creditors attach to total enterprise assets rather than to the specific assets provided by the creditor.

STOCKHOLDER’S EQUITY AS A BUILDING BLOCK The ownership claim on total assets is known as stockholder’s equity. It is equal to total assets minus total liabilities. The stockholders’ equity section of a corporation’s balance sheet consists of: 1 Paid-in (contributed) capital 2 Retained earnings

PAID-IN CAPITAL AS A BUILDING BLOCK Paid-in capital is the term used to describe the total amount paid in by stockholders. The principal source of paid-in-capital is the investment of cash and other assets in the corporation by stockholders in exchange for capital stock.

RETAINED EARNINGS AS A BUILDING BLOCK The retained earnings section of the balance sheet is determined by three items: 1 Revenues 2 Expenses 3 Dividends

REVENUES AS A BUILDING BLOCK Revenues are the gross increases in stockholder’s equity that result from operating the business. Generally, revenues result from the sale of merchandise, the performance of services, the rental of property, or the lending of money. Revenues usually result in an increase in an asset.

EXPENSES AS A BUILDING BLOCK Expenses are the decreases in stockholders’ equity that result from operating the business. They are the cost of assets consumed or services used in the process of earning revenue. Examples of expenses include utility expense, rent expense, supplies expense, and tax expense. When revenues exceed expenses, net income results. When expenses exceed revenues, a net loss results.

DIVIDENDS Net income represents an increase in net assets which then become available for distribution to stockholders. Cash or other assets that are distributed to stockholders are called dividends. Dividends reduce retained earnings but are not corporate expenses. A corporation decides whether or not to distribute a dividend after determining its net income or net loss.

ILLUSTRATION 1-6 INCREASE DECREASE INCREASES AND DECREASES IN STOCKHOLDERS’ EQUITY INCREASE DECREASE Investments by Stockholders Dividends to Stockholders Stockholders’ Equity Revenues Expenses

USING THE BUILDING BLOCKS TRANSACTION ANALYSIS Transactions are the economic events of the enterprise. They may be identified as external or internal. 1 External transactions involve economic events between the company and some outside enterprise or party. 2 Internal transactions are economic events that occur entirely within one company. My division needs 2,500 pounds from your division We need ten cases by Friday

TRANSACTION ANALYSIS TRANSACTION 1 Ray and Barbara Neal decide to open a computer programming company to be incorporated as Softbyte, Inc. They invest $15,000 cash in exchange for $15,000 of common stock.

TRANSACTION ANALYSIS TRANSACTION 2 Softbyte purchases computer equipment for $7,000 cash.

TRANSACTION ANALYSIS TRANSACTION 3 Softbyte purchases computer paper and other supplies expected to last several months from Acme Supply Company for $1,600. Acme Supply Company agrees to allow Softbyte to pay this bill in October, a month later. This transaction is often referred to as a purchase on account or a credit purchase. Acme Supply Company Softbyte, Inc.

TRANSACTION ANALYSIS TRANSACTION 4 Softbyte receives $1,200 cash from customers for programming services it has provided. This transaction represents the principal revenue-producing activity of Softbyte. Softbyte, Inc.

TRANSACTION ANALYSIS TRANSACTION 5 Softbyte receives a bill for $250 from the Daily News for advertising the opening of its business but postpones payment of the bill until a later date. Softbyte, Inc. Daily News Bill

TRANSACTION ANALYSIS TRANSACTION 6 Softbyte provides programming services of $3,500 for customers. Cash amounting to $1,500 is received from customers, and the balance of $2,000 is billed to customers on account. Softbyte, Inc. Bill

TRANSACTION ANALYSIS TRANSACTION 7 Expenses paid in cash for September are store rent, $600, salaries of employees, $900, and utilities, $200. Softbyte, Inc. $600 $900 $200

TRANSACTION ANALYSIS TRANSACTION 8 Softbyte pays its Daily News advertising bill of $250 in cash. Softbyte, Inc. Daily News

TRANSACTION ANALYSIS TRANSACTION 9 The sum of $600 in cash is received from customers who have previously been billed for services in Transaction 6. Softbyte, Inc.

TRANSACTION ANALYSIS TRANSACTION 10 The corporation pays a dividend of $1,300 in cash to Ray and Barbara Neal, the stockholders of Softbyte, Inc. Softbyte, Inc. $1,300

FINANCIAL STATEMENTS After transactions are identified, recorded, and summarized, four financial statements are prepared from the summarized accounting data: 1 An income statement presents the revenues and expenses and resulting net income or net loss of a company for a specific period of time. 2 A retained earnings statement summarizes the changes in retained earnings for a specific period of time. 3 A balance sheet reports the assets, liabilities, and stockholders’equity of a business enterprise at a specific date. 4 A statement of cash flows summarizes information concerning the cash inflows (receipts) and outflows (payments) for a specific period of time.

ILLUSTRATION 1-9 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS Net income of $2,750 shown on the income statement is added to the beginning balance of retained earnings in the retained earnings statement. SOFTBYTE, INC. Income Statement Net income of $2,750 is determined from the information in the retained earnings column of the Summary of Transactions (Illustration 1-8). For the Month Ended September 30, 2002 Revenues Service revenue $ 4,700 Expenses Salaries expense $ 900 Rent expense 600 Advertising expense 250 Utilities expense 200 Total expenses 1,950 Net income $ 2,750 SOFTBYTE, INC. Retained Earnings Statement For the Month Ended September 30, 2002 Retained earnings, September 1 $ –0– Add: Net income 2,750 2,750 Less: Dividends 1,300 Retained earnings, September 30 $ 1,450

ILLUSTRATION 1-9 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS SOFTBYTE, INC. Retained Earnings Statement For the Month Ended September 30, 2002 Retained earnings, September 1 $ –0– Retained earnings of $1,450 at the end of the reporting period shown in the retained earnings statement is shown on the balance sheet. Add: Net income 2,750 2,750 The retained earnings of $1,450 at the end of the reporting period is shown as the final total of the retained earnings column of the Summary of Transactions (Illustration 1-8). Less: Dividends 1,300 Retained earnings, September 30 $ 1,450 SOFTBYTE, INC. Balance Sheet September 30, 2002 Assets Cash $ 8,050 Accounts receivable 1,400 Supplies 1,600 Equipment 7,000 Total assets $ 18,050 Liabilities and Stockholders’ Equity Liabilities Accounts payable $ 1,600 Stockholders’ equity Common stock $ 15,000 Retained earnings 1,450 16,450 Total liabilities and stockholders’ equity $ 18,050

ILLUSTRATION 1-9 FINANCIAL STATEMENTS AND THEIR INTERRELATIONSHIPS SOFTBYTE, INC. Balance Sheet September 30, 2002 Assets Cash $ 8,050 Accounts receivable 1,400 Supplies 1,600 Equipment 7,000 Cash of $8,050 on the balance sheet and statement of cash flows is shown as the final total of the cash column of the Summary of Transactions (Illustration 1-8). Total assets $ 18,050 Liabilities and Stockholders’ Equity Liabilities Accounts payable $ 1,600 Cash of $8,050 on the balance sheet is reported on the statement of cash flows. Stockholders’ equity Common stock $ 15,000 Retained earnings 1,450 16,450 Total liabilities and stockholders’ equity $ 18,050 SOFTBYTE, INC. Statement of Cash Flows For the Month Ended September 30, 2002 Cash flows from operating activities Cash receipts from revenues $ 3,300 Cash payments for expenses (1,950) Net cash provided by operating activities 1,350 Cash flows from investing activities Purchase of equipment (7,000) Cash flows from financing activities Sale of common stock $ 15,000 Payment of cash dividends (1,300) 13,700 Net increase in cash 8,050 Cash at the beginning of the period –0– $8,050 Cash at the end of the period

APPENDIX A THE ACCOUNTING PROFESSION In public accounting, you would offer expert service to the general public. Areas of public accounting: Auditing Taxation Management consulting

APPENDIX A THE ACCOUNTING PROFESSION In private (managerial) accounting, you would be involved in one of the following activities: General accounting Cost accounting Budgeting Accounting information systems Tax accounting Internal auditing

APPENDIX A THE ACCOUNTING PROFESSION Not-for profit organizations also need sound financial reporting and control. Donors want information about how well the organization has met its objectives and whether continued support is justified. Hospitals and colleges must make decisions about the allocation of funds. Governmental units must provide information to citizens, employees, creditors and legislators.