1-1 ©2006 Prentice Hall, Inc.

1-2 ©2006 Prentice Hall, Inc. LINK BETWEEN BUSINESS & ACCOUNTING (1 of 2)  Learning objectives Learning objectives  Definition of accounting Definition of accounting  Why accounting is important to business Why accounting is important to business  Using financial reports to make decisions Using financial reports to make decisions

1-3 ©2006 Prentice Hall, Inc. LINK BETWEEN BUSINESS & ACCOUNTING (2 of 2)  The accounting equation The accounting equation  Basic financial statements Basic financial statements  Financial statement analysis Financial statement analysis  Business risk, control, and ethics Business risk, control, and ethics

1-4 ©2006 Prentice Hall, Inc. Learning Objectives (1 of 2) 1. Define accounting and explain why accounting information is important 2. Identify the people who use accounting information and how financial accounting standards are determined

1-5 ©2006 Prentice Hall, Inc. Learning Objectives (2 of 2) 3. Explain the contents of the four basic financial statements 4. Explain financial statement analysis and the use of ratio analysis 5. Recognize the risks associated with being in business and how to control those risks

1-6 ©2006 Prentice Hall, Inc. Definition of Accounting  Accounting  The process of identifying, measuring, and communicating financial business information to various users  Transaction  A business activity that results in an economic exchange between a business entity and an outside partner

1-7 ©2006 Prentice Hall, Inc. Why Accounting Is Important to Business  What does a business do? What does a business do?  Accounting information needed to operate a firm Accounting information needed to operate a firm

1-8 ©2006 Prentice Hall, Inc. What does a business do?  For-profit businesses provide goods and services to make a profit for its owners  Profit is the value a business creates or adds to products or services it sells  Not-for-profit organizations provide goods and services solely to help people  A business may create its own goods and services or sell somebody else’s

1-9 ©2006 Prentice Hall, Inc. Accounting Information Needed to Operate a Firm (1 of 2)  Accounting in the News – HealthSouth  What does “cooking the books” mean?  How and why did HealthSouth cook the books?  Accounting information system  Provide a firm with information needed to plan, implement and evaluate its activities

1-10 ©2006 Prentice Hall, Inc. Accounting Information Needed to Operate a Firm (2 of 2)  Revenue  Amount a business earns from goods and services it provides  Expenses  Cost of providing goods and services to earn revenue  Profit  Difference between revenues & expenses  Value created by a business

1-11 ©2006 Prentice Hall, Inc. Using Financial Reports to Make Decisions  Accounting information needs for pre- opening business decisions Accounting information needs for pre- opening business decisions  Operating cycle Operating cycle  Internal and external financial statement users Internal and external financial statement users

1-12 ©2006 Prentice Hall, Inc. Accounting Information Needs for Pre-opening Business Decisions  What accounting information is needed to make these pre-opening decisions?  How to finance the business  Form of business  How much to produce  Which suppliers to use  How much to charge  How much to pay for advertising

1-13 ©2006 Prentice Hall, Inc. Operating Cycle (1 of 2)  Sequence of business activities for an accounting period  Getting cash  Using cash to purchase inputs  Changing inputs into products &/or services  Providing products/services to customers  Collecting cash from customers

1-14 ©2006 Prentice Hall, Inc. Operating Cycle (2 of 2)  Accounting Period  Any length of time a company uses to evaluate its performance Starts with cash; Ends with more cash Purchase inventory Make sales to customers Collect cash from customers

1-15 ©2006 Prentice Hall, Inc. Internal and External Financial Statement Users  Internal users Internal users  External users External users  Certified public accountants (CPAs) Certified public accountants (CPAs)  Setting rules for financial reporting Setting rules for financial reporting

1-16 ©2006 Prentice Hall, Inc. Internal Users  Management is the primary internal user of accounting information  Management accounting provides information for management  No specific rules or regulations for internal information  Information may not be available to external users

1-17 ©2006 Prentice Hall, Inc. Eternal Users (1 of 2)  Financial statements  Financial accounting  Communicates accounting information to external users  Reports financial position of a firm  Specific rules and regulations govern how information is reported

1-18 ©2006 Prentice Hall, Inc. Eternal Users (2 of 2)  Types of external users  Government  Creditors  Potential investors  Vendors, customers, and employees

1-19 ©2006 Prentice Hall, Inc. Certified Public Accountants (CPAs)  Perform a variety of accounting services  Only people who can perform an audit  Requirements to be a CPA  Education requirements  Pass CPA exam  Work experience & other requirements

1-20 ©2006 Prentice Hall, Inc. Setting Rules for Financial Reporting (1 of 2)  Generally Accepted Accounting Principles (GAAP)  Rules governing financial statements  Securities and Exchange Commission (SEC)  Monitor financial reporting of public companies

1-21 ©2006 Prentice Hall, Inc. Setting Rules for Financial Reporting (2 of 2)  Financial Accounting Standards Board (FASB)  Set accounting standards  Public Companies Accounting Oversight Board (PCAOB)  Oversee auditors of public companies

1-22 ©2006 Prentice Hall, Inc. The Accounting Equation (1 of 4)  Assets = Claims  Claims of creditors and owners  Assets = Liabilities + Owners’ Equity  Assets  Economic resources owned by a business  Will generate future value for the business  Receivable denotes an asset account  Stuff you own

1-23 ©2006 Prentice Hall, Inc. The Accounting Equation (2 of 4)  Liabilities  Amounts the business owes to creditors  The company’s debts  Payable denotes a liability  Stuff you owe to creditors

1-24 ©2006 Prentice Hall, Inc. The Accounting Equation (3 of 4)  Owners’ equity  Owners’ claims to the company’s assets  Stuff you owe to the owners  Residual interest  Assets – Liabilities = Owners’ Equity  Also called shareholders’ equity or stockholders’ equity  Owners of a corporation  Shareholders or stockholders

1-25 ©2006 Prentice Hall, Inc. The Accounting Equation (4 of 4)  Calculate retained earnings: Cash$2,500Liabilities$1,800 Inventory500 Land1,250Contrib. Capital 2,000 Other Assets600Retained Earnings ?????? Total Assets$4,850

1-26 ©2006 Prentice Hall, Inc. Basic Financial Statements (1 of 2)  Monetary unit assumption  Only information that can be expressed in terms of money is included in U.S. financial statements  Account  Items grouped together for the accounting records

1-27 ©2006 Prentice Hall, Inc. Basic Financial Statements (2 of 2)  Balance sheet Balance sheet  Income statement Income statement  Statement of changes in owners’ equity Statement of changes in owners’ equity  Statement of cash flows Statement of cash flows  Relationship among the financial statements Relationship among the financial statements  Financial statement question Financial statement question

1-28 ©2006 Prentice Hall, Inc. Balance Sheet  Financial position of a company at a specific point in time  Reports assets, liabilities, and owners’ equity  Owners’ equity  Contributed Capital  Common Stock  Retained Earnings

1-29 ©2006 Prentice Hall, Inc. Income Statement  Shows revenues and expenses for a specific accounting period  Net profit or net income  When revenues > expenses  Net loss  When revenues < expenses

1-30 ©2006 Prentice Hall, Inc. Statement Of Changes In Owners’ Equity  Summarizes +s & -s for owners’ equity accounts for an accounting period  Statement of retained earnings  Only summarizes activity in retained earnings account  Increases from net income  Decreases from net loss  Decrease from payment of dividends  Distributions of earnings to owners

1-31 ©2006 Prentice Hall, Inc. Statement Of Cash Flows (1 of 2)  Summarizes cash receipts and cash disbursements for an accounting period  Not the same as net income  Income measured when it is earned  Expenses measured when incurred  Timing of cash flow does not affect when to report income & expenses

1-32 ©2006 Prentice Hall, Inc. Statement Of Cash Flows (2 of 2)  Operating activities  Transactions resulting from primary business activities  Investing activities  Purchase and sale of long-term assets  Not purchase and sale of inventory  Financing activities  Transactions with long-term creditors, and owners

1-33 ©2006 Prentice Hall, Inc. Relationship Among Financial Statements (1 of 2)  Prepare income statement to determine net income  Revenue – Expenses = Net Income  Net income needed to compute retained earnings on Stmt. of Stockholders’ Equity  Contributed Capital  Retained Earnings

1-34 ©2006 Prentice Hall, Inc. Relationship Among Financial Statements (2 of 2)  Ending balance in equity accounts needed to prepare balance sheet  Cash balance from balance sheet needed to prepare statement of CF

1-35 ©2006 Prentice Hall, Inc. Financial Statement Question  Identify the effect on net income  Identify the cash flows as operating, investing or financing activities 1. Purchase equipment. 2. Pays for ad in newspaper. 3. Earns revenue by providing services. 4. Repays principle of loan to bank. 5. Pays dividends to shareholders.

1-36 ©2006 Prentice Hall, Inc. Financial Statement Analysis (1 of 2)  Comparisons across time periods and between companies  Ratio analysis  Using ratios to analyze a firm’s past performance and forecast future performance

1-37 ©2006 Prentice Hall, Inc. Financial Statement Analysis (2 of 2)  Financial analyst  Gather financial information  Analyze financial information  Make recommendations to their clients  Where do financial analyst’s get their information?

1-38 ©2006 Prentice Hall, Inc. Business Risk, Control, and Ethics (1 of 3)  Risk  Exposure to potential injury or loss  What are some business risks?  Reasons most small businesses fail  Lack of management systems  Lack of vision and purpose by the principles  Lack of financial planning and review

1-39 ©2006 Prentice Hall, Inc. Business Risk, Control, and Ethics (2 of 3)  Ethics in financial reporting and Sarbanes Oxley Act of 2002  Increase investor confidence  Establishes for corporate governance  Make corporations’ internal controls more effective  Increase understanding of financial reporting

1-40 ©2006 Prentice Hall, Inc. Business Risk, Control, and Ethics (3 of 3)  Audits  Examination of a company’s financial statements by independent CPAs  Provide assurance that financial statements are fairly presented  Allows investors to rely on the information provided in the financial statements  Audit opinion

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business 1-41 ©2006 Prentice Hall, Inc.