Chapter 1 Introducing Accounting in Business Last Revised: 3/2/2010

Conceptual Chapter Objectives SELS-STUDY: C1: Explain the purpose and importance of accounting in the information age. C2: Identify users and uses of accounting. C3: Identify opportunities in accounting and related fields. C4: Explain why ethics are crucial to accounting. C5: Explain GAAP, and define and apply several key accounting principles. 1-2

Analytical Chapter Objectives A1: Define and interpret the accounting equation and each of its components. A2: Analyze business transactions using the accounting equation. SELF-STUDY A3: Compute and interpret return on assets. 1-3

Procedural Chapter Objectives P1: Identify and prepare basic financial statements and explain how they interrelate. 1-4

Identifies Records Communicates Relevant Reliable Comparable Importance of Accounting Accounting is a system that information that is to help users make better decisions. C1 1-5

 Identifying Business Activities  Recording Business Activities  Communicating Business Activities Accounting Activities C 1 1-6

Accounting Activities Recordkeeping, or bookkeeping, is the recording of transactions and events, either manually or electronically. As technology has changed the way we store, process, and summarize large masses of data, accounting has been freed to expand to include major consulting, planning and other financial areas => Communicating & Interpreting Business Information

Users of Accounting Information External Users Lenders Shareholders Governments Consumer Groups External Auditors Customers Internal Users Managers Officers Internal Auditors Sales Staff Budget Officers Controllers C 2 1-8

Users of Accounting Information External Users Financial accounting provides external users with financial statements. Internal Users Managerial accounting provides information needs for internal decision makers. C 2 1-9

Internal Users Internal operating functions and information they require include: a. Research and development managers need current and projected costs and sales to decide whether to pursue or continue research and development projects. b. Purchasing managers need both quality and quantity of purchases. c. Human Resources managers need current payroll costs, employee benefits, and other performance and compensation data. d. Production managers need costs and quality reports. e. Marketing managers need sales and costs to effectively target consumers and set prices.

Opportunities in Accounting Financial Preparation Analysis Auditing Regulatory Consulting Planning Criminal investigation Preparation Analysis Auditing Regulatory Consulting Planning Criminal investigation Managerial General accounting Cost accounting Budgeting Internal auditing Consulting Controller Treasurer Strategy General accounting Cost accounting Budgeting Internal auditing Consulting Controller Treasurer Strategy Taxation Preparation Planning Regulatory Investigations Consulting Enforcement Legal services Estate plans Preparation Planning Regulatory Investigations Consulting Enforcement Legal services Estate plans Accounting- related Lenders Consultants Analysts Traders Directors Underwriters Planners Appraisers Lenders Consultants Analysts Traders Directors Underwriters Planners Appraisers FBI investigators Market researchers Systems designers Merger services Business valuation Forensic accountant Litigation support Entrepreneurs FBI investigators Market researchers Systems designers Merger services Business valuation Forensic accountant Litigation support Entrepreneurs C

Accounting Jobs by Area C

Beliefs that distinguish right from wrong Accepted standards of good and bad behavior Ethics Ethics—A Key Concept C Ethical behavior is necessary in accounting if the information it provides is to be trusted. The AICPA and IMA have set up ethical codes of conduct to be followed.

 Identify ethical concerns  Analyze options  Make ethical decision Use personal ethics to recognize ethical concern. Consider all good and bad consequences. Choose best option after weighing all consequences. Guidelines for Ethical Decisions C

Exercise 4 (page 30)

Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP). Generally Accepted Accounting Principles Relevant Information Affects the decision of its users. Reliable Information Is trusted by users. C 5 Comparable Information Used in comparisons across years & companies. 1-16

The Securities and Exchange Commission is the government group that establishes reporting requirements for companies that issue stock to the public. Setting Accounting Principles The Financial Accounting Standards Board is the private group that sets both broad and specific principles. C 5 The International Accounting Standards Board (IASB) issues inter- national standards that identify preferred accounting practices in other countries. The IASB does not have authority to impose its standards on companies. 1-17

Principles of Accounting C 5 Cost principle means that accounting information is based on actual cost. Going-concern means that accounting information reflects a presumption the business will continue operating. Example: Property reported at cost Monetary unit means we can express transactions in money. In US: In Dollars =>Stable monetary unit. Revenue recognition principle provides guidance on when a company must recognize revenue. Business entity means that a business is accounted for separately from its owner or other business entities. Matching Principle prescribes that a company must record its expenses incurred to generate the revenue. Full disclosure principle requires a company to report the details behind financial statements that would impact users’ decisions. 1-18

Exercise 6 (page 30)

Business Entity Forms Sole Proprietorship Partnership Corporation C

Business Entity Forms i.Sole proprietorship is a business owned by one person that has unlimited liability. The business is not subject to an income tax but the owner is responsible for personal income tax on the net income of the entity. ii.Partnership is a business owned by two or more people, called partners, who are subject to unlimited liability. The business is not subject to an income tax, but the owners are responsible for personal income tax on their individual share of the net income of the entity. iii.Corporation is a business that is a separate legal entity whose owners are called shareholders or stockholders. These owners have limited liability. The entity is responsible for a business income tax.

Exercise 7 (page 30)

Sarbanes-Oxley (SOX) ACT Congress passes the Sarbanes-Oxley Act to help curb financial abuses at public companies. SOX requires accounting oversight and stringent internal controls.

Assets Liabilities & Equity Accounting Equation Liabilities Equity Assets =+ A1 1-24

Land Equipment Buildings Cash Vehicles Store Supplies Notes Receivable Accounts Receivable Resources owned or controlled by a company Assets A1 1-25

Taxes Payable Wages Payable Notes Payable Accounts Payable Creditors’ claims on assets Liabilities A1 1-26

Owner’s claim on assets Owner’s claim on assets Dividends Contributed Capital Retained Earnings Equity A1 1-27

Corporation’s Equity Called stockholders’ or shareholders’ equity—has two parts: contributed capital and retained earnings: a.Contributed capital refers to the amount that stockholders invest in the company—included under the title common stock. b.Retained earnings refer to income (revenues less expenses) that is not distributed to stockholders. The distribution of assets to stockholders is called dividends, which reduce retained earnings. Revenues increase retained earnings and are the assets earned from a company’s earnings activities. Expenses decrease retained earnings and are the cost of assets or services used to earn revenues.

Liabilities Equity Assets =+ Expanded Accounting Equation Revenues Expenses Common Stock Dividends __ ++ __ Retained Earnings Liabilities Equity Assets =+ A1 1-29

Transaction Analysis J. Scott invests $20,000 cash to start the business in return for stock. A2 1-30

Transaction Analysis Purchased supplies paying $1,000 cash. A2 1-31

Transaction Analysis Purchased equipment for $15,000 cash. A2 1-32

Transaction Analysis Purchased Supplies of $200 and Equipment of $1,000 on account. A2 1-33

Transaction Analysis Borrowed $4,000 from 1st American Bank. A2 1-34

Transaction Summary A2 1-35

Transaction Analysis The balances so far appear below. Note that the Balance Sheet Equation is still in balance. A2 1-36

Transaction Analysis Now, let’s look at transactions involving revenue, expenses and dividends. A2 1-37

Transaction Analysis Provided consulting services receiving $3,000 cash. A2 1-38

Transaction Analysis Remember that expenses decrease equity. Paid salaries of $800 to employees. A2 1-39

Transaction Analysis Remember that dividends decrease equity. Dividends of $500 are paid to shareholders. A2 1-40

Financial Statements Let’s prepare the Financial Statements reflecting the transactions we have recorded. 1.Income Statement 2.Statement of Retained Earnings 3.Balance Sheet 4.Statement of Cash Flows 1.Income Statement 2.Statement of Retained Earnings 3.Balance Sheet 4.Statement of Cash Flows P1 1-41

Net income is the difference between Revenues and Expenses. The income statement describes a company’s revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities. Income Statement P1 1-42

The net income of $2,200 increases Retained Earnings by $2,200. Statement of Retained Earnings P1 1-43

The Balance Sheet describes a company’s financial position at a point in time. Balance Sheet P1 1-44

Statement of Cash Flows (Not Covered) P1 1-45

ROA is viewed as an indicator of operating efficiency. Return on Assets (ROA) Net income Average total assets Return on assets = A Return on assets, also called return on investment (ROI), is a profitability measure; useful in evaluating management, analyzing and forecasting profits, and planning activities.