1. Copyright 2003 Prentice Hall Publishing1 Chapter 1 Business: What’s it all About?

2. Copyright 2003 Prentice Hall Publishing2 Financial Accounting: A Business Process Approach The first four chapters introduce the basics of the business cycle and financial reporting. Then, Chapters 5-9 go through the business cycle – acquiring fixed assets and inventory, selling the inventory, and obtaining both debt and equity financing. The last two chapters take a closer look at two topics that are covered throughout the text: the statement of cash flows and financial statement analysis.

3. Copyright 2003 Prentice Hall Publishing3 Purpose of a Business

4. Copyright 2003 Prentice Hall Publishing4 Simple Model of a Business “The Firm” INPUTS Value added conversion OUTPUTS Capital (financing) Property, Plant, Equipment Raw Materials Labor Inventory Goods & Services Delivery of Product or Service Acquisition/Payment CycleSales/Collection Cycle

5. Copyright 2003 Prentice Hall Publishing5 l Series of activities that a company performs to achieve its goals. »ACQUISITION / PAYMENT: acquire, maintain, and pay for the resources needed by the organization. »CONVERSION: convert the resources acquired into goods and/or services. »SALES / COLLECTIONS: sell and deliver goods and/or services to customers and to collect payment. What are Business Processes?

6. Copyright 2003 Prentice Hall Publishing6 Types of Businesses  Service company n provides a service for customers  Sales company »Special case: financial services n Merchandising--buys goods and resells them to other businesses (wholesale) or to final customers (retail) n Manufacturing--makes a product and sells it to other businesses (wholesale) or to final consumers (retail)

7. Copyright 2003 Prentice Hall Publishing7Examples: l Service n accountants, attorneys, physicians l Financial Service n Citicorp, Merrill Lynch, American Express l Merchandising n Wal-Mart, Safeway, The Gap l Manufacturing n General Motors, 3M, Reynolds Metals [Obviously, some businesses provide more than one of the functions listed above]

8. Copyright 2003 Prentice Hall Publishing8 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

9. Copyright 2003 Prentice Hall Publishing9 l 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

10. Copyright 2003 Prentice Hall Publishing10 l Because a corporation is a separate legal entity, it can... n Own assets. n Incur liabilities. n Sue and be sued. n Enter into contracts independent of the stockholder owners. l Many Americans own stock through a mutual fund or pension program. Corporations

11. Copyright 2003 Prentice Hall Publishing11 Issues in deciding between sole proprietorship, partnership, or corporation l Personal liability l Taxation l Transfer of ownership l Ability to raise capital l Government regulation Characteristics of Different Forms of Business Organization

12. Copyright 2003 Prentice Hall Publishing12 l Owners of common stock generally receive the following rights: n Voting (in person or by proxy). n Distributions of profits. n Distributions of assets in a liquidation. n Offers to purchase shares of a new stock issue (pro rata basis). Ownership of a Corporation

13. Copyright 2003 Prentice Hall Publishing13 l State laws govern the creation of corporations. l An application for a charter (or articles of incorporation) must include the corporation’s name and purpose, kinds and amounts of capital stock authorized, and other detailed information. Creating a Corporation

14. Copyright 2003 Prentice Hall Publishing14 Once the state issues a charter, the stockholders elect a board of directors. Creating a Corporation

15. Copyright 2003 Prentice Hall Publishing15 l 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?

16. Copyright 2003 Prentice Hall Publishing16 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

17. Copyright 2003 Prentice Hall Publishing17 Sales/collection process l Customer places an order (Customer order) l Customer’s credit is approved l Warehouse selects goods for shipment (Picking slip) l Goods are shipped (Packing slip and Shipping notice) l Customer is billed for goods (Invoice) l Payment for goods is received (Check)

18. Copyright 2003 Prentice Hall Publishing18 Business Transactions l Business transactions are exchanges. l The two transactions that make up an “exchange” are the GIVE part and the GET part. l The exchange occurs between the business entity and a person or business external to the entity. l The business gives something and then gets something in return.

19. Copyright 2003 Prentice Hall Publishing19 Resources, Events, and Agents l We can model an exchange with these three components: n the resources are the things being exchanged (goods or services for money) n the event describes the business action (e.g. cash disbursement, sale, etc.) n the agents are the people involved in the exchange (e.g., the customer)

20. Copyright 2003 Prentice Hall Publishing20 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

21. Copyright 2003 Prentice Hall Publishing21 Acquisition and Payment for a Service GIVE Cash Disbursement EVENT GET Advertising Company AGENT Tom’s Wear AGENT Advertisement Resource Cash Resource Purchase

22. Copyright 2003 Prentice Hall Publishing22 Sales and Collections GIVE Sale EVENT GET Customer AGENT Tom’s Wear AGENT Cash Resource T-shirt Resource EVENT Cash Collection

23. Copyright 2003 Prentice Hall Publishing23 Who needs accounting information? A) Management B) Those with direct financial interest lCurrent or potential investors lCurrent or potential creditors C) Those with an indirect financial interest »Tax Authorities »Regulatory Agencies »Economic Planners »Labor unions, financial advisors, others. D) Employees

24. Copyright 2003 Prentice Hall Publishing24 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

25. Assets = Claims Assets = Liabilities + Equity l Asset: something of value l Liability: something owed (creditors’ share of the assets) l Equity: what remains (owner’s share of the assets) The Accounting Equation

26. l There are two sources of equity n equity “contributed” by owners n equity “earned” by operations l Expanded accounting equation: ASSETS = LIABILITIES CONTRIBUTED CAPITAL RETAINED EARNINGS ++ Equity: The Owner’s Share

27. 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

28. Four Basic Financial Statements l Balance Sheet Assets = Liabilities + Equity l Income Statement Revenues - Expenses = Net income l Statement of Changes in Owner’s Equity Beginning equity + Contributions + Net income - Distributions = Ending equity l Statement of Cash Flows Cash inflow - Cash outflow = Net cash flow

29. Copyright 2003 Prentice Hall Publishing29 Dates of Financial Statements are Important ! l Balance sheet is “AS OF…” or “AT” a particular date, sometimes called a “snapshot” in time. l Income statement l Statement of changes in owner’s equity l Statement of cash flows n These last three cover a period of time, and thus are “FOR THE PERIOD ENDING”

30. Copyright 2003 Prentice Hall Publishing30 Acquiring Financing for a Business Date Jan. 1 Transactions l 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

31. Copyright 2003 Prentice Hall Publishing31 Acquiring Financing for a Business Date Jan. 1 Transactions l Tom’s Wear borrows $500 from Tom’s mom. Assets = Liabilities + CC + Retained Earnings +500 cash + 500 N/P

32. Copyright 2003 Prentice Hall Publishing32 Acquiring Financing for a Business Date Jan. 1 Transactions l Tom contributes $5,000 of his own money to start the business. l Tom’s Wear borrows $500 from Tom’s mom. Assets = Liabilities + CC + Retained Earnings +500 cash + 500 N/P +5,000 cash +5,000 common stock

33. Copyright 2003 Prentice Hall Publishing33 Acquiring Inventory Date Jan. 5 Transactions l Tom’s Wear buys 100 T- shirts for $400 cash.

34. Copyright 2003 Prentice Hall Publishing34 Acquiring Inventory Date Jan. 5 Transactions l Tom’s Wear buys 100 T- shirts for $400 cash. Assets = Liabilities + CC + RE (400) cash +400 inventory

35. Copyright 2003 Prentice Hall Publishing35 Acquiring a Service Date Jan. 10 Transactions l Tom’s Wear pays $50 for advertising. Assets = Liabilities + CC + RE (50) cash (50) expenses

36. Copyright 2003 Prentice Hall Publishing36 Sales and Collection Date Jan. 20 Transactions l Tom’s Wear sells 90 of the T-shirts to friends for cash, $10 each.

37. Copyright 2003 Prentice Hall Publishing37 Sales and Collection Date Jan. 20 Transactions l Tom’s Wear sells 90 of the T-shirts to friends for cash, $10 each. Assets = Liabilities + CC + RE +900 cash +900 revenue

38. Copyright 2003 Prentice Hall Publishing38 What else happens along with the sale? An expense…the cost of the goods sold. Date Jan. 20 Transactions l 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 90 shirts x $4 each

39. Copyright 2003 Prentice Hall Publishing39 Date Jan. 20 Transactions l 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.

40. Copyright 2003 Prentice Hall Publishing40 Payment for the acquired financing Date Jan. 30 Transactions l Tom’s Wear repays the debt of $500 plus $5 interest.

41. Copyright 2003 Prentice Hall Publishing41 Payment for the acquired financing Date Jan. 30 Transactions l Tom’s Wear repays the debt of $500 plus $5 interest. Assets = Liabilities + CC + RE (505) cash

42. Copyright 2003 Prentice Hall Publishing42 Payment for the acquired financing Date Jan. 30 Transactions l Tom’s Wear repays the debt of $500 plus $5 interest. Assets = Liabilities + CC + RE (505) cash (500) N/P

43. Copyright 2003 Prentice Hall Publishing43 Payment for the acquired financing Date Jan. 30 Transactions l Tom’s Wear repays the debt of $500 plus $5 interest. Assets = Liabilities + CC + RE (505) cash(500) N/P (5) expense Interest expense

44. Copyright 2003 Prentice Hall Publishing44 Payment for the acquired financing Date Jan. 31 Transactions l Tom’s Wear pays a dividend to Tom, the owner, for $100.

45. Copyright 2003 Prentice Hall Publishing45 Payment for the acquired financing Date Jan. 31 Transactions l Tom’s Wear pays a dividend of $100. Assets = Liabilities + CC + RE (100) cash (100)dividends

46. Copyright 2003 Prentice Hall Publishing46 Payment for the acquired financing l Tom’s Wear pays a dividend of $100. l Tom’s Wear makes a distribution to Tom, the owner, for $100. l In a corporation, a distribution to the owners is called a dividend. Assets = Liabilities + CC + RE (100) cash (100) dividend =

47. Copyright 2003 Prentice Hall Publishing47 Assets = Liabilities + Equity 1. +5,000 cash +$5,000 common stk. 2. +500 cash+ 500 notes payable 3. -400 cash +400 inv. 4. -50 cash - 50 expense 5. +900 cash + 900 revenue -360 inventory - 360 CGS 6. -505 cash-500 notes payable - 5 interest exp. 7, -100 cash - 100 dividend 5,3850 5,385

48. Copyright 2003 Prentice Hall Publishing48 Tom’s Wear, Inc. Income Statement For the month ended January 31, 2001 REVENUE - EXPENSES = NET INCOME

49. Copyright 2003 Prentice Hall Publishing49 Assets = Liabilities + Equity 1. +5,000 cash +$5,000 common stk. 2. +500 cash+ 500 notes payable 3. -400 cash +400 inv. 4. -50 cash - 50 expense 5. +900 cash + 900 revenue -360 inventory - 360 CGS 6. -505 cash-500 notes payable - 5 interest exp. 7, -100 cash - 100 dividends 5,3850 5,385 These are the revenues and expenses:

50. Copyright 2003 Prentice Hall Publishing50 Assets = Liabilities + Equity 1. +5,000 cash +$5,000 common stk. 2. +500 cash+ 500 notes payable 3. -400 cash +400 inv. 4. -50 cash - 50 expense 5. +900 cash + 900 revenue -360 inventory - 360 CGS 6. -505 cash-500 notes payable - 5 interest exp. 7, -100 cash - 100 dividends 5,3850 5,385 Net Income = $485

51. Copyright 2003 Prentice Hall Publishing51 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

52. Copyright 2003 Prentice Hall Publishing52 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 Total Contributed Capital$ 5,000 Beginning RE$ 0 Net income Dividends Ending RE Total Owners’ Equity

53. Copyright 2003 Prentice Hall Publishing53 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 Total Contributed Capital$ 5,000 Beginning RE$ 0 Net income 485 Dividends (100) Ending RE $ 385 Total Owners’ Equity$5,385

54. Copyright 2003 Prentice Hall Publishing54 Assets = Liabilities + Equity 1. +5,000 cash +$5,000 common stk. 2. +500 cash+ 500 notes payable 3. -400 cash +400 inv. 4. -50 cash - 50 expense 5. +900 cash + 900 revenue -360 inventory - 360 CGS 6. -505 cash-500 notes payable - 5 interest exp. 7. -100 cash - 100 dividends 5,3850 5,385 Net Income = $485

55. Copyright 2003 Prentice Hall Publishing55 Tom’s Wear Balance Sheet At Jan. 31,2001 AssetsLiabilities + Shareholder’s Equity

56. Copyright 2003 Prentice Hall Publishing56 Tom’s Wear Balance Sheet At Jan. 31, 2001 Assets Liabilities + SHs Equity Cash$ 5,345 Inventory$ 40 Total Assets$ 5,385

57. Copyright 2003 Prentice Hall Publishing57 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

58. Copyright 2003 Prentice Hall Publishing58 Tom’s Wear Balance Sheet At Jan. 31, 2001 Assets Liabilities + Shareholder’s Equity Cash$5,345Note payable -0- Inventory$ 40 Common stock, T. Phillips $5,000 Total assets$ 5,385 Retained earnings 385 Total liabilities + $ 5,385 SH’s Equity

59. Copyright 2003 Prentice Hall Publishing59 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

60. Copyright 2003 Prentice Hall Publishing60 Assets = Liabilities + Equity Look at every CASH transaction and classify it as operating, investing, or financing. 1. +5,000 cash +$5,000 common stk. 2. +500 cash+ 500 notes payable 3. -400 cash +400 inv. 4. -50 cash - 50 expense 5. +900 cash + 900 revenue -360 inventory - 360 CGS 6. -505 cash-500 notes payable - 5 interest exp. 7. -100 cash - 100 dividends 5,3850 5,385 Net Income = $485

61. Copyright 2003 Prentice Hall Publishing61 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) Total cash from operations $445

62. Copyright 2003 Prentice Hall Publishing62 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-

63. Copyright 2003 Prentice Hall Publishing63 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

64. Copyright 2003 Prentice Hall Publishing64 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) Total Cash from Financing4,900

65. Copyright 2003 Prentice Hall Publishing65 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) Total Cash from Financing4,900 Net Increase in Cash $ 5,345