Accounting and the Business Environment Chapter 1

Use accounting vocabulary Objective 1 Use accounting vocabulary

What’s accounting

Accounting is an information system

Accounting information system... INPUT PROCESS OUTPUT Data Data processing Information Recording Classifying Summarizing Analysing Etc. Source documents Checks Purchase Orders Bank Statement Sales Invoices Reporting & Communicating (Financial Statements) A key product of accounting is a set of documents called financial statements. FS report on a business in monetary terms.

Accounting: The Language of Business In fact… Accounting: The Language of Business The better you understate the language, the better you manage the business.

The Accounting System: The Flow of Information Businesses prepare reports to show the results of their operations. People make decisions Business transaction occur

Fields of Accounting & Sub-systems... Financial Accounting Management Accounting output Accounting information

Accounting... is an information system that... measures business activities, processes information, and... communicates financial information.

to help users make better decisions. Accounting... is a system that Accounting Identifies Records information that is Relevant Communicates Reliable to help users make better decisions. Comparable

Accounting... language of business. The better you understate the language, The better you manage the business.

Users of Accounting Information External users make decisions about the entity. Internal users make decisions for the entity.

Users of Accounting Information Exh. 1.8 Users of Accounting Information FINANCIAL ACCOUNTING (External Users) MANAGEMENT ACCOUNTING (Internal Users) Individuals Businesses Investors Creditors Government Regulatory Agencies Taxing Authorities Owners Managers All those are the decision makers for their own objectives

Types of Business Organizations Proprietorships Partnerships Corporations

Types of Business Organizations Proprietorship Sally’s Grocery Corporation Partnership Proprietorship Partnership Corporation Owner (s) Properietor Only one owner Partners Two or more owners Stockholders Generally many owners Life of the organization Limited by the owner’s choice, or death Indefinite Personal liability of the owner(s) for the business’s debts Properietor is personally liable. Stockholders are not personally liable.

Concepts and Principles Objective 2 Apply Accounting Concepts and Principles

Generally Accepted Accounting Principles What is the primary objective of financial reporting? To provide information useful for making investment and lending decisions

Basic Accounting Concepts and Principles The Entity Concept A business is accounted for separately from its owner or owners. The Reliability (Objectivity) Principle Financial statement information is supported by independent, unbiased evidence. Cost Principle Financial statements are based on actual costs incurred in business transactions. Going-Concern Concept A business continues operating instead of being closed or sold. Monetary Unit Principle Express transactions and events in monetary units.

The Entity Concept Example Assume that John decides to open up a gas station and coffee shop. The gas station made $250,000 in profits, while the coffee shop lost $50,000.

The Entity Concept Example How much money did John make? At a first glance, we would assume that John made $200,000. However, by applying the entity concept we realize that the gas station made $250,000 while the coffee shop lost $50,000.

The Reliability (Objectivity) Principle Information must be reasonably accurate. Information must be free from bias. Information must report what actually happened. Individuals would arrive at similar conclusions using same data.

The Reliability (Objectivity) Principle Example Suppose you want to open an gas station. For location of the business, you trasfer a small land to the business. You beleive the land is worth YTL 100.000. To confirm its cost to the business, you ask a real state company to estimate the value of the land. The company values the land at YTL 70.000 . Which is the more reliable estimate of the land’s value, your estimate of YTL 100.000 or YTL 70.000 professional appraisal? The appraisal of YTL 70.000 is more reliable because it is supported by an independent observation.

The Cost Principle Assets and services acquired should be Recorded at their actual cost (historical cost). The item is recorded at the price actually paid Not at the “expected” cost.

The Cost Principle Example Suppose an entity purchases some spare parts from a supplier who is going out of business. Assume that the entity get a good deal and pay only YTL 10.000 for the parts that would have cost the entity YTL 15.000 elsewhere. The cost principle requires the entity to record the parts at its actual cost of YTL 10.000 not the YTL 15.000 that the entity believe the equipment is worth.

The Going Concern Concept The entity will continue to operate in the future. Under this concept, accountant assume that the business will remain in operation long nough to use existing resources for their intended pupose. A store holding a going out of business sale is trying to sell everything. In that case, instead of historical cost, the relevant measure is current market value. But going out of business is the exception rather than the rule.

Use the Accounting Equation Objective 3 Use the Accounting Equation

The Accounting Equation = Liabilities + Owner’s Equity Assets Economic Resources Claims to Economic Resources

The Accounting Equation Exh. 1.5 The Accounting Equation _ _ _ LIABILITIES + OWNER’S EQUITY (Capital) ASSETS The two sides maust always be equal

The Accounting Equation Exh. 1.5 The Accounting Equation = ASSETS OWNER’S EQUITY+LIABILITIES ASSETS - LIABILITIES OWNER’S EQUITY = = ASSETS-OWNER’S EQUITY LIABILITIES

The Accounting Equation Exh. 1.5 The Accounting Equation LIABILITIES + OWNER’S EQUITY Bono ASSETS Cash Merchandise inventory Furniture Land Building Equipment Goodwill Account receivable Notes receivable Account payable Notes payable Owner’s equity

Assets What is an asset? It is something a company owns which has future economic value. Cash Merchandise inventory Furniture land building equipment Goodwill Receivable Account receivable: A promise to receive cah from customers to whom the business has sold goods or for whom the business has performed services Notes receivable: A written promise for future collection of cash.

Liability What is a liability? It is something a company owes. An economic obligation (a dept) payable to an individual or organization outside the business. All payables are liabilities. Account payable: A liability backed by the general reputation and credit standing of the deptor. Notes payable: A written promise of future payment.

Owner’s Equity What is owner’s equity? It is what’s left of the assets after liabilities have been deducted. Owner’s equity is the amount of an antity’s assets that remain after its liabilities are subtracted. the same as net assets the owner’s claim on the entity’s assets = ASSETS - LIABILITIES OWNER’S EQUITY

Transactions that Affect Owner’s Equity INCREASES OWNER’S EQUITY DECREASES Owner Withdrawals from the Business Owner Investments in the Business Owner’s Equity Expenses Revenues OWNER’S EQUITY + Owner investments in the business + Revenues - Owner withdrawals from the business - Expenses

Revenues What are revenues? They are amounts received or to be received from customers for sales of products or services. sales performance of services rent interest

Expenses What are expenses? They are amounts that have been paid or will be paid later for costs that have been incurred to earn revenue. salaries and wages utilities supplies used advertising

Analyze Business Transactions Objective 4 Analyze Business Transactions

Accounting for Business Transactions What is a transaction? It is any event that both affects the financial position of the business and can be reliably recorded.

Accounting for Business Transactions 1. Gay Gillen invests $30,000 to begin Gay Gillen eTravel. What is the effect of these transactions on the accounting equation? Owner’s Assets = Liabilities + Equity Cash 1) 30,000 G&G, Capital 30,000 For each transaction, the amount on the left side of the equation must equal the amount on the right side. First transaction increases both the assets (in this case, Cash) and the owner’s equity.

Accounting for Business Transactions Gillen purchases an office location, paying $20,000 in cash. Owner’s Assets = Liabilities + Equity Cash + Land 30,000 -20,000 + 20,000 Bal. 10,000 20,000 G&G, Capital 30,000 Bal. 30,000 30,000 30,000

Accounting for Business Transactions 3 She buys office supplies, agreeing to pay $500 in 30 days. Owner’s Assets = Liabilities + Equity Cash + Land + Supplies 30,000 -20,000 + 20,000 500 Bal. 10,000 20,000 500 Accounts Payable + G&G, Capital 30,000 500 Bal. 500 30,000 30,500 30,500

Accounting for Business Transactions 4. She earns and collects $5,500 revenues. Owner’s Assets = Liabilities + Equity Cash + Land + Supplies 30,000 -20,000 + 20,000 500 5,500 Bal. 15,500 20,000 500 Accounts Payable + G&G, Capital 30,000 500 5,500 Bal. 500 35,500 35,500 35,500

Accounting for Business Transactions Gillen performs services, and the client agrees to pay $3,000 within one month. Owner’s Assets = Liabilities + Equity Cash + Land + Supplies + Receivable 30,000 -20,000 + 20,000 500 5,500 3,000 Bal. 15,500 20,000 500 3,000 Accounts Payable + G&G, Capital 30,000 500 5,500 3,000 Bal. 500 38,500 39,000 39,000

Accounting for Business Transactions 6. During the month, she pays $3,300 for expenses incurred. Salary expense $1,200, Utilities and telephone expense 400, Equipment rental expense 600 Office rent expense 1,100 Owner’s Assets = Liabilities + Equity Cash + Land + Supplies + Receivable 30,000 -20,000 + 20,000 500 5,500 3,000 -3,300 Bal. 12,200 20,000 500 3,000 Accounts Payable + G&G, Capital 30,000 500 5,500 3,000 -3,300 Bal. 500 35,200 35,700 35,700

Accounting for Business Transactions 7 .Gillen pays $300 to the store from which she purchased $500 worth of supplies. Owner’s Assets = Liabilities + Equity Cash + Land + Supplies + Receivable 30,000 -20,000 + 20,000 500 5,500 3,000 -3,300 - 300 Bal. 11,900 20,000 500 3,000 Accounts Payable + G&G, Capital 30,000 500 5,500 3,000 -3,300 -300 Bal. 200 35,200 35,400 35,400

Accounting for Business Transactions Notice that 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.

Accounting for Business Transactions Other transactions that took place were as follows: 8. The business collected $1,000 from the client. 9. She sold some land at cost for $9,000. 10. She withdrew $2,000 from the business. Owner’s Assets = Liabilities + Equity Transferred Balance Cash + Land + Supplies + Receivable Bal. 11,900 20,000 500 3,000 1,000 -1,000 9,000 -9,000 -2,000 Bal. 19,900 11,000 500 2,000 Accounts Payable + G&G, Capital Bal. 200 35,200 -2,000 Bal. 200 33,200 33,400 33,400

Prepare Financial Statements Objective 5 Prepare Financial Statements

business is performing Financial Statements... – are the final product of the accounting process. – tell how the business is performing and where it stands.

Financial Statements income statement statement of owner’s equity or retained earnings balance sheet statement of cash flows

Relationships Among the Statements: Income Statement Exh. 1.7 Relationships Among the Statements: Income Statement An income statement reports on operating activities. It lists sales (revenues), costs, and expenses over a period of time. The relationship is expressed: Net Income = Revenues - Expenses

Relationships Among the Statements: Statement of Owner’s Equity G. Gillen, capital, April 1, 20xx $ 0 Contribution of capital 30,000 Net income $ 5,200 Cash distributions – 2,000 G. Gillen, capital, April 30, 20xx $33,200

Assets = Liabilities + Equity Exh. 1.7 Balance Sheet A balance sheet reports on investing and financing activities. It lists amounts for assets, liabilities, and equity at a point in time. The relationship is reflected in the Balance Sheet equation: Assets = Liabilities + Equity

Relationships Among the Statements: Statement Of Cash Flows Cash flows from operating activities: Cash receipts from services rendered $6,500 Cash payments: Supplies $ 300 Operating expenses 3,300 -3,600 Net cash flows from Operating activities $2,900 Cash flows from investing activities: Sale of Land 9,000 Purchase of land ($20,000) Net cash flows from investing activities $(11,000) Cash Flows from Financing Activities: Investment by Owner $30,000 Withdrawals (2,000) Net Cash Flows from Financing Activities $28,000 Cash at Beginning of Year 0 Cash at End of the Year $19,900

End of Chapter 1