Accounting Fundamentals Dr. Yan Xiong Department of Accountancy CSU Sacramento The lecture notes are primarily based on Reimers (2003). 7/11/03

Chapter 1Business Processes Agenda  Purpose of a Business and Types of Businesses  Ownership Structure of Businesses  Business Processes  The Accounting Equation  Four Basic Financial Statements

t “ Accounting is process, process, process” Daniel O’ Leary Accounting Professor and Author University of Southern California

Purpose of a Business

Simple Model of a Business “The Firm” INPUTS (Give) Value added conversion OUTPUTS (Get) Capital (financing) Property, Plant, Equipment Raw Materials Labor Inventory Goods & Services Delivery of Product or Service Acquisition/Payment CycleSales/Collection Cycle

t Series of activities that a company performs to achieve its goals. v ACQUISITION / PAYMENT: acquire, maintain, and pay for the resources needed by the organization. v CONVERSION: convert the resources acquired into goods and/or services. v SALES / COLLECTIONS: sell and deliver goods and/or services to customers and to collect payment. What are Business Processes?

Types of Businesses  Service company u provides a service for customers  Sales company v Special case: financial services u Merchandising-- buys goods and resells them to other businesses (wholesale) or to final customers (retail) u Manufacturing- -makes a product and sells it to other businesses (wholesale) or to final consumers (retail)

Examples: t Service u accountants, attorneys, physicians t Financial Service u Citicorp, Merrill Lynch, American Express t Merchandising u Wal-Mart, Safeway, The Gap t Manufacturing u General Motors, 3M, Reynolds Metals [Obviously, some businesses provide more than one of the functions listed above] [Obviously, some businesses provide more than one of the functions listed above]

Ownership Structure of Businesses Sole Proprietorship--a single owner business Partnership-- a multiple-owner business Corporation-- a business whose ownership is divided into "shares" and may be owned by a large number of people

t A corporation is a popular form of business because... Ê It is simple for individuals to purchase small amounts of stock. Ë It allows for an easy transfer of ownership through established markets, like the New York Stock Exchange.  It provides stockholders with limited liability. Corporations

t Because a corporation is a separate legal entity, it can... u Own assets. u Incur liabilities. u Sue and be sued. u Enter into contracts independent of the stockholder owners. t Many Americans own stock through a mutual fund or pension program. Corporations

Issues in deciding between sole proprietorship, partnership, or corporation Issues in deciding between sole proprietorship, partnership, or corporation t Personal liability t Taxation t Transfer of ownership t Ability to raise capital t Government regulation Characteristics of Different Forms of Business Organization

t No matter what the ownership structure of a business, they all have at least two main business processes: p Acquisition/Payment p Sales/Collection What Do All Business have in Common?

Acquisition/payment process ActivityPossible Document(s) Identify need for good/services Purchase Requisition Identify vendor Order goods/services Purchase Order Receive and Inspect Goods Receiving Report Pay for Goods and/or Services Check Requisition Check

Sales/collection process t Customer places an order (Customer order) t Customer’s credit is approved t Warehouse selects goods for shipment (Picking slip) t Goods are shipped (Packing slip and Shipping notice) t Customer is billed for goods (Invoice) t Payment for goods is received (Check)

Business Transactions t Business transactions are exchanges. t The two transactions that make up an “exchange” are the GIVE part and the GET part. t The exchange occurs between the business entity and a person or business external to the entity. t The business gives something and then gets something in return.

Resources, Events, and Agents t We can model an exchange with these three components: u the resources are the things being exchanged (goods or services for money) u the event describes the business action (e.g. cash disbursement, sale, etc.) u the agents are the people involved in the exchange (e.g., the customer)

Acquisition and Payment for T-shirts GIVE Cash Disbursement EVENT GET T-shirt Company AGENT Tom’s Wear AGENT T-shirt Resource Cash Resource Purchase

Acquisition and Payment for a Service GIVE Cash Disbursement EVENT GET Advertising Company AGENT Tom’s Wear AGENT Advertisement Resource Cash Resource Purchase

Sales and Collections GIVE Sale EVENT GET Customer AGENT Tom’s Wear AGENT Cash Resource T-shirt Resource EVENT Cash Collection

Who needs accounting information? A) Management B) Those with direct financial interest l Current or potential investors l Current or potential creditors C) Those with an indirect financial interest v Tax Authorities v Regulatory Agencies v Economic Planners v Labor unions, financial advisors, others. D) Employees

Financial Accounting Information Information related to: Various views of the data: The Company’s Information System Financial data for external reports Product information Customer and vendor information Sales Purchases Collections Payments

Assets = Claims Assets = Claims Assets = Liabilities + Equity t Asset: something of value t Liability: something owed (creditors’ share of the assets) t Equity: what remains (owner’s share of the assets) The Accounting Equation

t There are two sources of equity u equity “contributed” by owners u equity “earned” by operations t Expanded accounting equation: ASSETS = LIABILITIES CONTRIBUTED CAPITAL RETAINED EARNINGS ++ Equity: The Owner’s Share

Expanded accounting equation : Together, these are called Shareholders’ Equity, Stockholders’ Equity, or Owners’ Equity. They are all names for the same thing--the owners’ claims to the firm’s assets. ASSETS = LIABILITIES CONTRIBUTED CAPITAL RETAINED EARNINGS ++ Equity: The Owner’s Share

Four Basic Financial Statements t Balance Sheet Assets = Liabilities + Equity t Income Statement Revenues - Expenses = Net income t Statement of Changes in Owner’s Equity Beginning equity + Contributions + Net income - Distributions = Ending equity t Statement of Cash Flows Cash inflow - Cash outflow = Net cash flow

Dates of Financial Statements are Important ! t Balance sheet is “AS OF…” or “AT” a particular date, sometimes called a “snapshot” in time. t Income statement t Statement of changes in owner’s equity t Statement of cash flows u These last three cover a period of time, and thus are “FOR THE PERIOD ENDING”

Acquiring Financing for a Business Date Jan. 1 Transactions t Tom contributes $5,000 of his own money to the business. Assets = Liabilities + Owner’s Equity +5,000 cash +5,000 common stock Contributed Capital + Retained Earnings

Acquiring Financing for a Business Date Jan. 1 Transactions t Tom’s Wear borrows $500 from Tom’s mom. Assets = Liabilities + CC + Retained Earnings +500 cash N/P

Acquiring Financing for a Business Date Jan. 1 Transactions t Tom contributes $5,000 of his own money to start the business. t Tom’s Wear borrows $500 from Tom’s mom. Assets = Liabilities + CC + Retained Earnings +500 cash N/P +5,000 cash +5,000 common stock

Acquiring Inventory Date Jan. 5 Jan. 5 Transactions t Tom’s Wear buys 100 T- shirts for $400 cash.

Acquiring Inventory Date Jan. 5 Jan. 5 Transactions t Tom’s Wear buys 100 T- shirts for $400 cash. Assets = Liabilities + CC + RE (400) cash +400 inventory

Acquiring a Service Date Jan. 10 Jan. 10 Transactions t Tom’s Wear pays $50 for advertising. Assets = Liabilities + CC + RE (50) cash (50) expenses

Sales and Collection Date Jan. 20 Jan. 20 Transactions t Tom’s Wear sells 90 of the T-shirts to friends for cash, $10 each.

Sales and Collection Date Jan. 20 Jan. 20 Transactions t Tom’s Wear sells 90 of the T-shirts to friends for cash, $10 each. Assets = Liabilities + CC + RE +900 cash +900 revenue

Date Jan. 20 Jan. 20 Transactions t Tom’s Wear sells 90 of the T-shirts to friends for cash, $10 each. Assets = Liabilities + CC + RE +900 cash +900 revenue (360) inventory (360) expense 90 shirts x $4 each Special expense called cost of goods sold What else happens along with the sale? An expense…the cost of the goods sold.

Payment for the acquired financing Date Jan. 30 Jan. 30 Transactions t Tom’s Wear repays the debt of $500 plus $5 interest.

Payment for the acquired financing Date Jan. 30 Jan. 30 Transactions t Tom’s Wear repays the debt of $500 plus $5 interest. Assets = Liabilities + CC + RE (505) cash (500) N/P

Payment for the acquired financing Date Jan. 30 Jan. 30 Transactions t Tom’s Wear repays the debt of $500 plus $5 interest. Assets = Liabilities + CC + RE (505) cash(500) N/P (5) expense Interest expense

Payment for the acquired financing Date Jan. 31 Jan. 31 Transactions t Tom’s Wear pays a dividend to Tom, the owner, for $100.

Payment for the acquired financing Date Jan. 31 Jan. 31 Transactions t Tom’s Wear pays a dividend of $100. Assets = Liabilities + CC + RE (100) cash (100)dividends

Payment for the acquired financing t Tom’s Wear pays a dividend of $100. t Tom’s Wear makes a distribution to Tom, the owner, for $100. t In a corporation, a distribution to the owners is called a dividend. Assets = Liabilities + CC + RE (100) cash (100) dividend =

Assets = Liabilities + Equity 1. +5,000 cash +$5,000 common stk cash+ 500 notes payable cash +400 inv cash - 50 expense cash revenue -360 inventory CGS cash-500 notes payable - 5 interest exp. 7, -100 cash dividend 5,3850 5,385

Tom’s Wear, Inc. Income Statement For the month ended January 31, 2001 REVENUE - EXPENSES = NET INCOME

Assets = Liabilities + Equity 1. +5,000 cash +$5,000 common stk cash+ 500 notes payable cash +400 inv cash - 50 expense cash revenue -360 inventory CGS cash-500 notes payable - 5 interest exp. 7, -100 cash dividends 5,3850 5,385 These are the revenues and expenses:

Assets = Liabilities + Equity 1. +5,000 cash +$5,000 common stk cash+ 500 notes payable cash +400 inv cash - 50 expense cash revenue -360 inventory CGS cash-500 notes payable - 5 interest exp. 7, -100 cash dividends 5,3850 5,385 Net Income = $485

Tom’s Wear, Inc. Income Statement For the Month Ended Jan. 31, 2001 Revenue Sales $900 Expenses Cost of sales 360 Advertising 50 Interest 5 Total expenses 415 Net income $485

Tom’s Wear, Inc. Statement of Changes in Owner’s Equity For the month ended Jan. 31, 2001 Beginning CC$ 0 Common stock issued 5,000 Common stock issued 5,000 Total Contributed Capital$ 5,000 Beginning RE$ 0 Net income Dividends Ending RE Total Owners’ Equity

Tom’s Wear, Inc. Statement of Changes in Owner’s Equity For the month ended Jan. 31, 2001 Beginning CC$ 0 Common stock issued 5,000 Common stock issued 5,000 Total Contributed Capital$ 5,000 Beginning RE$ 0 Net income 485 Dividends (100) Ending RE $ 385 Total Owners’ Equity$5,385

Assets = Liabilities + Equity 1. +5,000 cash +$5,000 common stk cash+ 500 notes payable cash +400 inv cash - 50 expense cash revenue -360 inventory CGS cash-500 notes payable - 5 interest exp cash dividends 5,3850 5,385 Net Income = $485

Tom’s Wear Balance Sheet At Jan. 31,2001 AssetsLiabilities + Shareholder’s Equity

Tom’s Wear Balance Sheet At Jan. 31, 2001 Assets Liabilities + SHs Equity Cash$ 5,345 Inventory$ 40 Total Assets$ 5,385

Tom’s Wear Balance Sheet At Jan. 31, 2001 Assets Liabilities + Shareholder’s Equity Cash $5,345Note Payable-0- Inventory 40 Total Assets$5,385

Tom’s Wear Balance Sheet At Jan. 31, 2001 Assets Liabilities + Shareholder’s Equity Assets Liabilities + Shareholder’s Equity Cash$5,345Note payable -0- Inventory$ 40 Common stock, T. Phillips $5,000 Common stock, T. Phillips $5,000 Total assets$ 5,385 Retained earnings 385 Total liabilities + $ 5,385 SH’s Equity

Tom’s Wear, Inc. Statement of Cash Flows For the month ending Jan. 31, 2001 Cash from Operating Activities Cash from Investing Activities Cash from Financing Activities

Assets = Liabilities + Equity Look at every CASH transaction and classify it as operating, investing, or financing ,000 cash +$5,000 common stk cash+ 500 notes payable cash +400 inv cash - 50 expense cash revenue -360 inventory CGS cash-500 notes payable - 5 interest exp cash dividends 5,3850 5,385 Net Income = $485

Tom’s Wear, Inc. Statement of Cash Flows For the month ended Jan. 31,2001 Cash from operating activities Cash from customers$ 900 Cash paid to vendor for T-shirts (400) Cash paid for advertising (50) Interest paid ( 5) Interest paid ( 5) Total cash from operations $445

Tom’s Wear, Inc. Statement of Cash Flows For the month ended Jan. 31, 2001 Cash from operating activities Cash from customers$ 900 Cash from customers$ 900 Cash paid to vendor for T-shirts (400) Cash paid for advertising (50) Cash paid for interest ( 5) Cash paid for interest ( 5) Total cash from operations$445 Cash from investing activities -0-

Tom’s Wear, Inc. Statement of Cash Flows For the month ended Jan. 31, 2001 Cash from operating activities Cash from customers$ 900 Cash from customers$ 900 Cash paid to vendor for T-shirts (400) Cash paid for advertising (50) Cash paid for interest ( 5) Cash paid for interest ( 5) Total cash from operations$445 Cash from investing activities -0- Cash from financing activities

Tom’s Wear, Inc. Statement of Cash Flows For the month ended Jan. 31, 2001 Cash from operating activities Cash from customers$ 900 Cash paid to vendor for T-shirts (400) Cash paid for advertising (50) Cash paid for interest ( 5) Total cash from operations$445 Cash from investing activities -0- Cash from financing activities Owner’s contributions5,000 Dividends (100) Dividends (100) Total Cash from Financing4,900

Tom’s Wear, Inc. Statement of Cash Flows For the month ended Jan. 31, 2001 Cash from operating activities Cash from customers$ 900 Cash paid to vendor for T-shirts (400) Cash paid for advertising (50) Cash paid for interest (5) Total cash from operations$445 Cash from investing activities -0- Cash from financing activities Owner’s contributions5,000 Dividends (100) Dividends (100) Total Cash from Financing4,900 Net Increase in Cash $ 5,345 Net Increase in Cash $ 5,345