1. Fundamentals of Financial Accounting 5e by Phillips, Libby, and Libby.

2. Business Decisions and Financial Accounting
Chapter 1
Business Decisions and Financial Accounting
PowerPoint Author:
Brandy Mackintosh, CA
Chapter 1: Business Decisions and Financial Accounting

3. Describe various organizational forms and business decision
Learning Objective 1-1
Describe various organizational forms and business decision
makers.
Learning objective 1 is to describe various organizational forms and business decision makers.

4. Organizational Forms Sole Proprietorship Partnership Corporation
Business organization owned by one person. The owner is personally liable for all debts of the business.
Partnership
Business organization owned by two or more people. Each partner is personally liable for all debts of the business.
Corporation
A separate legal entity. Owners of corporations (stockholders) are not personally liable for debts of the corporation.
Part I
There are three types of business organizations.
A sole proprietorship is a business organization owned by one person. The owner is personally liable for all the debts of the business.
Part II
A partnership is a business organization owned by two or more people. Each partner is personally liable for all the debts of the business.
Part III
A corporation operates a business separate from its owners from both a legal and accounting perspective. Owners of corporations (often called stockholders) are not personally responsible for debts of the corporation. Corporations may be either public companies or private companies. Public companies have their stock bought and sold on stock exchanges. Private companies have their stock bought and sold privately. Most corporations start out as private companies and will become public companies if they need a lot of financing, which they obtain from issuing new stock certificates to investors.

5. Organizational Forms Source: IRS.gov.
As this graphic shows, the majority (72%) of businesses are organized as sole proprietorships. Another 18% are organized as a corporation, followed by 4% as partnerships and 6% are organized as a limited liability company (LLC). Limited liability companies is a hybrid business entity that has certain characteristics of both a corporation and a partnership or sole proprietorship (depending on how many owners there are). The primary characteristic an LLC shares with a corporation is limited liability, and the primary characteristic it shares with a partnership or a sole proprietorship is the availability of pass-through income taxation. An LLC is often more flexible than a corporation and is well-suited for companies with a single owner.
Source: IRS.gov.

6. Operating, Investing and Financing Activities
The Accounting System
Operating, Investing and Financing Activities
Evaluate the company
Run the company
Accounting
System
Part I
Most companies exist to earn profits for their stockholders. They earn profits by selling goods or services to customers for more than they cost to produce. To know just how successful a company is, the company will need to establish and maintain a good system of financial recordkeeping—an accounting system.
Part II
Accounting is an information system designed by an organization to capture (analyze, record, and summarize) the activities affecting its financial condition and performance and then report the results to decision makers, both inside and outside the organization.
Part III
The accounting system produces two kinds of reports.
Part IV
Managerial accounting reports include detailed financial plans and continually updated reports about the operating performance of the company. These reports are made available only to the company’s employees (internal users) so that they can make business decisions related to production, marketing, human resources, and finance. For example, managerial accounting reports are needed when determining whether to build, buy, or rent a building; whether to continue or discontinue making particular products; how much to pay employees; and how much to borrow.
Part V
Financial accounting reports (called financial statements) are prepared periodically to provide information to people not employed by the business. These external financial statement users are not given access to the detailed internal records of the company, so they rely extensively on the financial statements. The four main groups of external users are (1) creditors, (2) investors, (3) directors, and (4) government.
Accounting Reports
External users
(creditors, investors, etc.)
Internal users
(managers, supervisors etc.)
Financial
Managerial
Accounting is a system of analyzing, recording, summarizing and reporting the results of a business’s activities.

7. Learning Objective 1-2
Describe the purpose, structure, and content of the four basic financial statements.
Learning objective 1-2 is to describe the purpose, structure, and content of the four basic financial statements.

8. The Basic Accounting Equation
Separate Entity Assumption
The financial reports of a business are assumed to include the results of only that business’s activities.
Part I
One of the central concepts to understanding financial reports is that what a company owns must equal what a company owes to its creditors and stockholders. In accounting, there are special names for what a company owns (assets) and the claims on these items by creditors (liabilities) and stockholders (equity). The relationship between assets (A), liabilities (L), and stockholders’ equity (SE) is known as the basic accounting equation.
Part II
The business itself, not the stockholders who own the business, is viewed as owning the assets and owing the liabilities. This is called the separate entity assumption, which requires that a business’s financial reports include only the activities of the business and not the personal dealings of its stockholders.

9. Assets
Economic resources presently controlled by the company that have measurable value and are expected to benefit the company by producing cash inflows or reducing cash outflows
in the future
Assets are economic resources presently controlled by the company that have measurable value and are expected to benefit the company by producing cash inflows or reducing cash outflows in the future. Assets include things like cash, supplies, furniture, and equipment.
Equipment
Cash
Supplies
Furniture

10. Measurable amounts that the company owes to creditors
Liabilities
Measurable amounts that the company owes to creditors
Liabilities are measurable amounts that the company owes to creditors. If a company borrows from a bank, it would owe a liability called a note payable because banks require borrowers to sign a legal document called a note that describes details about the company’s promise to repay the bank. The business is likely to owe suppliers who deliver goods and services to the business. When a company buys goods from another company, it usually does so on credit by promising to pay for them at a later date. The amount owed is called an Account Payable because purchases made using credit are said to be “on account.” As you may have noticed, anything with the word payable in its name is considered a liability.
Notes Payable
Accounts Payable

11. Owners’ claim to the business resources.
Stockholders’ Equity
Owners’ claim to the business resources.
Stockholders’ equity represents the owners’ claims on the business. These claims arise for two reasons.
1. First, the owners have a claim on amounts they contributed directly to the company in exchange for its stock (Common Stock).
2. Second, the owners have a claim on amounts the company has earned through profitable business operations (Retained Earnings).

12. Revenues, Expenses and Net Income
Revenues – Expenses = Net Income
Revenues
Sales of goods or services to customers. They are measured at the amount the business charges the customer.
Expenses
The costs of doing business necessary to earn revenues, including wages to employees, advertising, insurance, utilities, and supplies used in the office.
Part I
Revenues are the sales of goods or services to customers. They are measured at the amount the business charges the customer.
Part II
Expenses are the costs of business necessary to earn revenues, including wages to employees, advertising, insurance, utilities, and supplies used in the office.
Net income is equal to revenues minus expenses. By generating net income, a company increases its stockholders’ equity. Net income can either be left in the company to accumulate (called retained earnings) or paid out to the company’s stockholders for their own personal use (called dividends).
If revenues are less than expenses, the business would have a “net loss.”

13. Dividends are not an expense.
Distributions of a company’s earnings to its stockholders as a return on their investment.
Retained Earnings
(equity earned by the company)
Common Stock
(equity paid in by stockholders)
Part I
A company’s profits are accumulated in Retained Earnings until a decision is made to distribute them to stockholders.
Part II
Distributions to stockholders are called dividends. The simplest type of dividend, and the most common, is a dividend paid in cash.
Part III
Dividends are not an expense of the company. Rather, dividends are an optional distribution of earnings to stockholders, approved by the company's board of directors.
Dividends are not an expense.

14. Financial Statements
Financial statements are typically prepared in this order.
Income Statement
Statement of Retained Earnings
Balance Sheet
Assets, liabilities, stockholders’ equity, revenues, expenses, and dividends appear in different reports in the financial statements. The term financial statements refers to four accounting reports, typically prepared in the following order:
Income Statement
Statement of Retained Earnings
Balance Sheet
Statement of Cash Flows
Financial statements can be prepared at any time during the year, although they are most commonly prepared monthly, every three months (quarterly reports), and at the end of the year (annual reports). Companies are allowed to choose a calendar or fiscal year-end. A calendar year is a 12-month period ending on December 31, and a fiscal year is a 12-month period ending on a day other than December 31.
Statement of Cash Flows

15. Income Statement (Projected) For the Month Ended September 30, 2015
The Income Statement
SONICGATEWAY INC.
Income Statement (Projected)
For the Month Ended September 30, 2015
Revenues
Sales Revenue
Service Revenue
Total Revenues
Expenses
Salaries and Wages Expense
Rent Expense
Utilities Expense
Insurance Expense
Advertising Expense
Income Tax Expense
Total Expenses
Net Income
$ 9,000
3,000
12,000
5,000
2,500
1,600
300
100
500
10,000
$ 2,000
The unit of measure assumption states that results of business activities should be reported in an appropriate monetary unit.
Reports the amount of revenues less expenses for a period of time.
Part I
The purpose of the income statement is to report the amount of revenues less expenses for a period of time. For SonicGateway, revenues are earned from selling apps to customers. Expenses are the costs incurred during the period to earn the revenue. The income statement is prepared first in order for us to calculate the amount of net income, as net income then is placed on the statement of retained earnings.
Part II
The unit of measure assumption states that results of business activities should be reported in an appropriate monetary unit, which in the United States is the U.S. dollar.
The heading of every report answers three questions: who (name of the business), what (title of the report), and when (accounting period).

16. The Statement of Retained Earnings
SONICGATEWAY, INC.
Statement of Retained Earnings (Projected)
For the Month Ended September 30, 2015
Retained Earnings, September 1, 2015
Add: Net Income
Subtract: Dividends
Retained Earnings, September 30, 2015 $
2,000
(1,000)
$ 1,000
The statement of retained earnings reports the way that net income and the distribution of dividends affected the financial position of the company during the period. A more comprehensive statement of stockholders’ equity that explains changes in all stockholders’ equity accounts is provided by large corporations. For SonicGateway, most changes in stockholders’ equity relate to generating and distributing earnings, so a statement of retained earnings is just as informative as a detailed statement of stockholders’ equity.
Reports the way that net income and the distribution of dividends affected the financial position of the company during the period.

17. Balance Sheet (Projected)
The Balance Sheet
SONICGATEWAY, INC.
Balance Sheet (Projected)
At September 30, 2015
Assets
Cash
Accounts Receivable
Supplies
Equipment
Software
Total Assets
Liabilities
Accounts Payable
Notes Payable
Total Liabilities
Stockholders’ Equity
Common Stock
Retained Earnings
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
$ 13,000
2,500
500
14,000
6,000
$ 36,000
$ 5,000
20,000
25,000
10,000
1,000
11,000
Reports at a point in time:
What a business owns (assets).
What it owes to creditors (liabilities).
What is left over for the owners of the company’s stock (stockholders’ equity).
BASIC ACCOUNTING EQUATION
Assets = Liabilities + Stockholders’ Equity
Part I
The balance sheet’s purpose is to report the amount of a business’s assets, liabilities, and stockholders’ equity at a specific point in time. Think of the balance sheet as a picture or screen capture of SonicGateway’s resources and claims to resources at the end of a particular day (in this case, September 30, 2015).
Assets are listed in order of liquidity, that is, how quickly they are used up or converted into cash. Likewise, liabilities are listed in order of how soon each is to be paid or settled.
Part II
The balance sheet “balances” because the resources (assets) equal the claims to the resources (liabilities and stockholders’ equity).

18. The Statement of Cash Flows
Summarizes how a business’s operating, investing, and financing activities caused its cash balance to change over a particular period of time.
SONICGATEWAY, INC.
Statement of Cash Flows (Projected)
For the Month Ended September 30, 2015
Cash Flows from Operating Activities
Cash received from customers
Cash paid to employees and suppliers
Cash Provided by Operating Activities
Cash Flows from (Used in) Investing Activities
Cash used to buy equipment and software
Cash from (Used in) Investing Activities
Cash Flows from Financing Activities
Cash received for stock issuance
Cash dividends paid to stockholders
Cash borrowed from the bank
Cash Provided by Financing Activities
Change in Cash
Beginning Cash Balance, September 1, 2015
Ending Cash Balance, September 30, 2015
$ 9,500
(5,500)
4,000
(20,000)
10,000
(1,000)
20,000
29,000
13,000 -
$ 13,000
The fourth financial report of interest to external users is the statement of cash flows. It includes only those activities that result in cash changing hands. The statement of cash flows is divided into three types of activities. Operating activities are directly related to running the business to earn profit. They include selling apps and services, paying employee wages, buying advertising, renting a building, obtaining insurance coverage, and so on. Investing activities involve buying and selling productive resources with long lives (such as buildings, land, equipment, and software), purchasing investments, and lending to others. Financing activities include any borrowing from banks, repaying bank loans, receiving cash from stockholders for company stock, and paying dividends to stockholders.
SonicGateway’s projected income statement showed a positive net income of $2,000, however net income is not necessarily equal to cash because revenues are reported when earned and expenses when incurred regardless of when cash is received or paid.

19. Notes to the Financial Statements
Notes help financial statement users understand how the amounts were derived and what other information may affect their decisions.
The four basic financial statements are not complete without notes to help financial statement users understand how the amounts were derived and what other information may affect their decisions. We will talk more about notes in a later chapter.

20. Relationships Among the Financial Statements
SONICGATEWAY, INC.
Income Statement
For the Month Ended September 30, 2015
Revenues
Sales Revenue
Service Revenue
Total Revenues
Expenses
Salaries and Wages Expense
Rent Expense
Utilities Expense
Insurance Expense
Advertising Expense
Income Tax Expense
Total Expenses
Net Income
$ 9,000
3,000
12,000
5,000
2,500
1,600
300
100
500
10,000
$ 2,000
Net income from the income statement is a component in determining ending Retained Earnings on the Statement of Retained Earnings. 1
The goal of the next few slides is to show how the four statements fit together. First, the income statement reports the results of business operations for the accounting period. The net income from the income statement is a component in determining ending Retained Earnings on the statement of retained earnings.
SONICGATEWAY, INC.
Statement of Retained Earnings
For the Month Ended September 30, 2015
Retained Earnings, September 1, 2015
Add: Net Income
Subtract: Dividends
Retained Earnings, September 30, 2015 $
2,000
(1,000)
$ 1,000

21. Relationships Among the Financial Statements
SONICGATEWAY, INC.
Balance Sheet
At September 30, 2015
Assets
Cash
Accounts Receivable
Supplies
Equipment
Software
Total Assets
Liabilities
Accounts Payable
Notes Payable
Total Liabilities
Stockholders’ Equity
Common Stock
Retained Earnings
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
$ 13,000
2,500
500
14,000
6,000
$ 36,000
$ 5,000
20,000
25,000
10,000
1,000
11,000
Ending Retained Earnings from the Statement of Retained Earnings is then reported on the Balance Sheet. 2
The ending retained earnings balance for the period is also reported on the balance sheet. If we did not report the ending retained earnings balance on the balance sheet, our balance sheet would not balance. So the statement of retained earnings must be prepared before the balance sheet may be completed.
SONICGATEWAY, INC.
Statement of Retained Earnings
For the Month Ended September 30, 2015
Retained Earnings, September 1, 2015
Add: Net Income
Subtract: Dividends
Retained Earnings, September 30, 2015 $
2,000
(1,000)
$ 1,000

22. Relationships Among the Financial Statements
SONICGATEWAY, INC.
Balance Sheet
At September 30, 2015
Assets
Cash
Accounts Receivable
Supplies
Equipment
Software
Total Assets
Liabilities
Accounts Payable
Notes Payable
Total Liabilities
Stockholders’ Equity
Common Stock
Retained Earnings
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
$ 13,000
2,500
500
14,000
6,000
$ 36,000
$ 5,000
20,000
25,000
10,000
1,000
11,000
SONICGATEWAY, INC.
Statement of Cash Flows
For the Month Ended September 30, 2015
Cash Flows from Operating Activities
Cash Flows from (Used in) Investing Activities
Cash Flows from Financing Activities
Change in Cash
Beginning Cash Balance, Sept. 1, 2015
Ending Cash Balance, Sept. 30, 2015
$ 4,000
(20,000)
29,000
13,000
$ 13,000
The Cash on the balance sheet is equal to the ending Cash reported on the statement of cash flows.
Cash on the Balance Sheet is equal to the ending Cash reported on the Statement of Cash Flows. 3

23. Explain how financial statements are used by decision makers.
Learning Objective 1-3
Explain how financial statements are used by decision makers.
Learning objective 1-3 is to explain how financial statements are used by decision makers.

24. Using Financial Statements
Creditors
Investors
Is the company generating enough cash to make payments on its loans?
Does the company have enough assets to cover its liabilities?
What is the immediate return (through dividends) on my contributions?
What is the long-term return (through stock price increases resulting from the company’s profits)?
… SCF
… SRE
Part I
Here is how creditors and investors use financial statements.
Part II
Creditors are mainly interested in assessing two things:
Is the company generating enough cash to make payments on its loans?
Part III
Creditors will find this information on the statement of cash flows.
Part IV
Does the company have enough assets to cover its liabilities?
Part V
Creditors will find this information on the balance sheet by comparing assets and liabilities reported.
Part VI
Investors expect a return on their contributions to a company. The return may be immediate (through dividends) or long-term (through selling stock certificates at a price higher than their original cost). Dividends and higher stock prices are more likely if a company is profitable.
Part VII
As a result, investors look closely at the income statement (and statement of retained earnings) for information about the company’s ability to generate profits (and distribute dividends).
… B/S
.. I/S

25. Describe factors that contribute to useful financial information.
Learning Objective 1-4
Describe factors that contribute to useful financial information.
Learning objective 1-4 is to describe factors that contribute to useful financial information.

26. External Financial Reporting
Main Goal: Provide useful financial information to external users for decision making.
Useful
Relevant
Relevant
Faithful
Representation
Faithful
Representation
Part I
The main goal of external financial reporting is to ensure companies produce financial information that is useful to present and potential investors, lenders, and other creditors in making decisions in their capacity as capital providers.
Part II
For financial information to be judged useful, it must be relevant and a faithful representation. Information is relevant if it makes a difference in decision making and it is a faithful representation if it fully depicts the economic substance of business activities.
Part III
The usefulness of financial information is enhanced when it is comparable (to prior periods and other companies), verifiable, timely, and understandable.
Comparable Verifiable Timely Understandable

27. Accounting Standards World United States Where? FASB Who? IASB GAAP
The system of financial statement reporting in use today has a long history—all the way back to a publication in 1494 by an Italian monk and mathematician, Luca Pacioli. Currently, in the United States, the Financial Accounting Standards Board (FASB) has the primary responsibility for setting the underlying rules of accounting. As a group, these rules are called Generally Accepted Accounting Principles, or GAAP for short (pronounced like the name of the clothing store). The accounting rules in the United States are similar, for the most part, to those used elsewhere in the world, but some important differences exist. The FASB is working alongside the International Accounting Standards Board (IASB) to eliminate these differences. The accounting rules developed by the IASB are called International Financial Reporting Standards, or IFRS for short.
GAAP
What?
IFRS

28. Ethical Conduct When faced with an ethical dilemma:
Identify who will benefit from the situation and how others will be harmed.
Identify the alternative courses of action.
Ethics refers to the standards of conduct for judging right from wrong, honest from dishonest, and fair from unfair. Intentional financial misreporting is both unethical and illegal. As you will see throughout this course, some accounting and business issues have clear answers that are either right or wrong. However, many situations require accountants, auditors, and managers to weigh the pros and cons of alternatives before making final decisions. To help ensure these decisions are made in a professional and ethical manner, the American Institute of Certified Public Accountants (AICPA) requires all its members to adhere to a Code of Professional Conduct.
Not all ethical dilemmas are clear-cut. Some situations will require you to weigh one moral principle (e.g., honesty) against another (e.g., loyalty). When faced with an ethical dilemma, you should follow a three-step process:
Identify who will benefit from the situation (often the manager or employee) and how others will be harmed (other employees, the company’s reputation, owners, creditors, and the public in general).
Identify the alternative courses of action.
Choose the alternative that is the most ethical —and that you would be proud to have reported in the news.
Often, there is no one right answer to ethical dilemmas and hard choices will need to be made. In the end, however, following strong ethical practices is a key factor in business success and in ensuring good financial reporting.
Choose the alternative that is the most ethical.

29. Careers That Depend on Accounting Knowledge
Chapter 1 Supplement
Careers That Depend on Accounting Knowledge
Chapter 1 Supplement: Careers that depend on accounting knowledge

30. Accounting knowledge can make the difference in your ability to land a dream job, whether you hope to work in production and operations management, human resources, finance, or marketing. Accounting knowledge is not just for Accountants. Accounting knowledge is vital to other positions as it provides valuable information for people in these positions to make day to day decisions. Such as a Customer Business Developer with Procter & Gamble will need to collaborate with the accounting department on enhancing customer profits and cash flows.

31. End of Chapter 1
End of chapter 1.