ACCOUNTING: The Language of Business Lecture 1

Learning Objectives (LO) After studying this chapter, you should be able to Explain how accounting information assists in making decisions Describe the components of the balance sheet Analyze business transactions and relate them to changes in the balance sheet Prepare a balance sheet from transactional data Compare the features of sole proprietorships, partnerships, and corporations

Learning Objectives (LO) After studying this chapter, you should be able to Identify how the owners’ equity section in a corporate balance sheet differs from that in a sole proprietorship or partnership Explain the regulation of financial reporting including differences between U.S. GAAP an IFRS Describe auditing and how it enhances the value of financial information 9. Evaluate the role of ethics in the accounting profession 3 of 35

LO 1 - Accounting and Decision-Making Accounting – the process of identifying, recording, summarizing, and reporting economic information to decision makers Types of Accounting: Tax – primarily used by the government Non-Profit (donors, governments) Managerial – insiders (budgets, planning, costing, pricing, managing product mix, etc.) Financial – outsiders (owners, creditors, suppliers, regulators, unions, others)

LO 1 - Accounting and Decision-Making Principal Components of Annual Financial Reports A letter from corporate management Management’s discussion and analysis of past and possible future transactions, events, circumstances Financial statements Footnotes explaining many elements of the financial statements in more detail Independent auditor’s report A statement of management’s responsibility for preparation of the financial statements Other corporate information

LO 1 - Accounting and Decision-Making Sequence of Events Leading to Financial Statements Found in Those Reports Measurable economic event occurs Private (work for the reporting entity) bookkeepers/accountants analyze event to determine what elements/accounts are affected, then record the event into records Records are summarized into financial statements Financial reports that include the statements are provided to users who make decisions

LO 1 - Accounting and Decision-Making Characteristics of Financial Reports Prepared by management Provided to outsiders quarterly and annually Primarily about past transactions and events Tell very little about future transactions, events, or circumstances Financial Statements (part of those reports) Balance Sheet Income Statement Statement of Cash Flows Statement of Stockholders’ Equity

LO 1 - Accounting and Decision-Making Accessing Financial Reports and Statements Available to all via the Internet from company’s website Formally sent or made available to owners by preparer Formally filed with the U.S. Government (Securities and Exchange Commission) (10-Q, 10-K, and numerous other forms) and subsequently accessible from the SEC’s EDGAR system

LO 2 - The Balance Sheet Assets = Liabilities + Owners’ equity The balance sheet (also called the statement of financial position) shows the financial status of a company at a particular instant in time Reflects the basic accounting equation, which is Resources = Claims against those resources Assets = Liabilities + Owners’ equity

LO 2 - The Balance Sheet Assets – economic resources that the company owns or controls from past transactions/events that it expects to help generate future benefits Accounts – subdivision of the element Assets Cash and cash equivalents Accounts Receivable (Customer bought it on credit) Inventories (Merchandise, Supplies, Parts) Prepaid Expenses (taxes, utilities, insurance) Property Plant Equipment Current Assets Long-term Assets

LO 2 - The Balance Sheet Liabilities – economic obligations of the organization to outsiders from past transactions /events that it expects to pay in the future Accounts – subdivision of the element Liabilities Accounts Payable (We bought it on credit) Notes Payable Long-term debt

LO 2 - The Balance Sheet Owners’ equity is the owners’ claim on the organization’s assets, i.e., assets minus liabilities Accounts – subdivision of the element Equity Sole Proprietorships - XX Capital – Partnerships - YY Capital Corporations - Capital (Common) Stock - Paid in Capital in excess of par/stated value (See LO 6)

LO 3 - Balance Sheet Transactions Every transaction of a company or entity affects the balance sheet equation An entity is an organization that stands apart from other organizations and individuals as a separate economic unit for which the balance sheet is being prepared A transaction is any event that affects the financial position of that entity and that can be reliably recorded in money terms At least two accounts will be affected for every entry recorded (compound entry = > 2 accounts)

LO 3 - Balance Sheet Transactions Transaction 1: Initial Investment of $400,000 Assets = Liabilities + Owners’ Equity Cash Lopez, Capital (1) + $400,000 = +$400,000 (Owner Investment)

LO 3 - Balance Sheet Transactions Transaction 2: Loan of $100,000 from Bank Assets = Liabilities + Owners’ Equity Cash Note payable Lopez, Capital (1) + $400,000 = +$400,000 (2) + $100,000 = + $100,000 Bal. $500,000 = $100,000 $400,000 $500,000 $500,000

LO 3 - Balance Sheet Transactions Transaction 3: Acquire Store Equipment for Cash, $15,000 Assets = Liabilities + Owners’ Equity Cash Store Equipment Note payable Lopez, Capital Bal. $500,000 = $100,000 $400,000 (3) –15,000 +15,000 = Bal. 485,000 15,000 = 100,000 400,000 $500,000 $500,000

LO 3 - Balance Sheet Transactions

LO 4 – Preparing the Balance Sheet

LO 5 – Comparative Ownership Features Sole proprietorship – a single owner Partnership – two or more co-owners Corporation – created under (U.S.) state laws Publicly owned – Owned by the public through the sale of shares; potentially thousands of owners Privately owned – Owned by families or a small group of shareholders; shares are not sold or traded

LO 5 – Comparative Ownership Features Advantages of a Corporation Limited liability (claims against corporate assets only – not personal assets of managers) Easy transfer of ownership Ability to raise capital from thousands Continuity of existence Prestige Disadvantages of a Corporation Unfavorable tax laws (double taxation on distributed earnings) Regulation