1. Copyright © 2007 Prentice-Hall. All rights reserved 1 Accounting and the Business Environment Chapter 1

2. Copyright © 2007 Prentice-Hall. All rights reserved 2 Objective 1 Use accounting vocabulary

3. Copyright © 2007 Prentice-Hall. All rights reserved 3 AccountingAccounting Measures Processes Communicates…… Financial information to decision makers

4. Copyright © 2007 Prentice-Hall. All rights reserved 4 Decision Makers Individuals Businesses Investors Creditors Taxing Authorities

5. Copyright © 2007 Prentice-Hall. All rights reserved 5 Financial vs. Managerial Accounting Financial Accounting – Information for people outside of the company Managerial Accounting – Information for internal decision makers

6. Copyright © 2007 Prentice-Hall. All rights reserved 6 Governing Organizations FASB – Financial Accounting Standards Board SEC – Securities and Exchange Commission AICPA – American Institute of Certified Public Accountants IMA – Institute of Management Accountants

7. Copyright © 2007 Prentice-Hall. All rights reserved 7 EthicsEthics Audit –Examination of company’s financial situation –Performed by independent accountants Sarbanes-Oxley Act – criminal offense to falsify financial statements Public Companies Accounting Oversight Board – monitors work of accountants

8. Copyright © 2007 Prentice-Hall. All rights reserved 8 Standards of Professional Conduct AICPA – Code of Professional Conduct for Accountants IMA – Standards of Ethical Conduct

9. Copyright © 2007 Prentice-Hall. All rights reserved 9 Types of Business Organizations Proprietorships Partnerships Corporations

10. Copyright © 2007 Prentice-Hall. All rights reserved 10 Objective 2 Apply accounting concepts and principles

11. Copyright © 2007 Prentice-Hall. All rights reserved 11 GAAP GAAP Generally Accepted Accounting Principles –Accounting guidelines that govern how accountants measure, process, and communicate financial information Formulated by Financial Accounting Standards Board (FASB)

12. Copyright © 2007 Prentice-Hall. All rights reserved 12 GAAPGAAP Primary objective of financial accounting – provide information that is useful for making investment and lending decisions

13. Copyright © 2007 Prentice-Hall. All rights reserved 13 Entity Concept Accounting Entity – organization that stands apart as a separate economic unit

14. Copyright © 2007 Prentice-Hall. All rights reserved 14 Accounting information is based on the most reliable data available –Verifiable –Free from bias –Individuals would arrive at similar conclusions using same data Reliability (Objectivity) Principle

15. Copyright © 2007 Prentice-Hall. All rights reserved 15 Cost Principle Acquired assets and services should be recorded at their actual cost (historical cost)

16. Copyright © 2007 Prentice-Hall. All rights reserved 16 Going Concern Concept Assumes that the entity will remain in operation for the foreseeable future

17. Copyright © 2007 Prentice-Hall. All rights reserved 17 Stable-Monetary-Unit Concept Assumes that the dollar’s purchasing power is stable

18. Copyright © 2007 Prentice-Hall. All rights reserved 18 Objective 3 Use the accounting equation

19. Copyright © 2007 Prentice-Hall. All rights reserved 19 AssetsAssets Economic resources, expected to benefit the business in the future –Cash –Accounts receivable –Merchandise inventory –Furniture –Land

20. Copyright © 2007 Prentice-Hall. All rights reserved 20 Claims to the Assets Liabilities – economic obligations payable to an individual or organization outside the business –Accounts payable –Notes payable –Salary payable

21. Copyright © 2007 Prentice-Hall. All rights reserved 21 Claims to the Assets Owner’s Equity (capital) – claim of business owner to the assets of the business

22. Copyright © 2007 Prentice-Hall. All rights reserved 22 Economic Resources Claims to Economic Resources The Accounting Equation Assets = Liabilities + Owner’s Equity

23. Copyright © 2007 Prentice-Hall. All rights reserved 23 Transactions that Affect Owner’s Equity OWNER’S EQUITY INCREASES OWNER’S EQUITY DECREASES Owner Investments Revenues Expenses Owner Withdrawals Owner’s Equity

24. Copyright © 2007 Prentice-Hall. All rights reserved 24 RevenuesRevenues Amounts earned by delivering goods or services to customers –Sales revenue –Service revenue –Interest revenue –Dividend revenue

25. Copyright © 2007 Prentice-Hall. All rights reserved 25 ExpensesExpenses Decrease in owner’s equity that occurs from using assets or increasing liabilities in the course of delivering goods or services to customers –Salary expense –Rent expense –Utilities expense –Interest expense

26. Copyright © 2007 Prentice-Hall. All rights reserved 26 Exercise 1-18 AssetsLiabilitiesOwner’s Equity Pep Boys$ ?$60,000$21,000 Eddie Bauer72,000?40,000 Benbrook Exxon 100,00079,000? $81,000 32,000 21,000

27. Copyright © 2007 Prentice-Hall. All rights reserved 27 Objective 4 Analyze business transactions

28. Copyright © 2007 Prentice-Hall. All rights reserved 28 TransactionTransaction An event that affects the financial position of a particular entity and can be recorded reliably

29. Copyright © 2007 Prentice-Hall. All rights reserved 29 Exercise 1-17 a.Increased assets (cash) b.No effect on total assets. Increase in land offset the decrease in cash c.Decreased assets (cash) d.Increased assets (equipment)

30. Copyright © 2007 Prentice-Hall. All rights reserved 30 Exercise 1-17 e.Increased assets (accounts receivable) f.Decreased assets (cash) g.No effect on total assets. Increase in cash offset the decrease in accounts receivable h.Increased assets (cash)

31. Copyright © 2007 Prentice-Hall. All rights reserved 31 Exercise 1-22

32. Copyright © 2007 Prentice-Hall. All rights reserved 32 Does the account increase or decrease? (1) Cash (asset) (2) Owner’s Equity (equity) July 6: Lange invested $45,000 in the business by opening a bank account in the name of M. Lange, M.D. Analyze this: What accounts are involved?

33. Copyright © 2007 Prentice-Hall. All rights reserved 33 DateAssetsLiabilitiesOwner’s Equity JulyCashMedical Supplies LandAccounts Payable M.Lange, Capital Type of Transaction Exercise 1-22 45,000Investment Assets = $45,000 Liabilities & Owner’s Equity = $45,000 45,0006

34. Copyright © 2007 Prentice-Hall. All rights reserved 34 (1) Cash (asset) (2) Land (asset) Analyze this: July 9: Paid $35,000 cash for land Does the account increase or decrease? What accounts are involved?

35. Copyright © 2007 Prentice-Hall. All rights reserved 35 DateAssetsLiabilitiesOwner’s Equity JulyCashMedical Supplies LandAccounts Payable M.Lange, Capital Type of Transaction Exercise 1-22 45,000Investment 35,000 Assets = $45,000 Liabilities & Owner’s Equity = $45,000 45,0006 -35,0009 45,00035,00010,000Bal

36. Copyright © 2007 Prentice-Hall. All rights reserved 36 (1) Medical Supplies (asset) (2) Accounts Payable (liability) Analyze this: July 12: Purchased medical supplies for $2,000 on account Does the account increase or decrease? What accounts are involved?

37. Copyright © 2007 Prentice-Hall. All rights reserved 37 DateAssetsLiabilitiesOwner’s Equity JulyCashMedical Supplies LandAccounts Payable M.Lange, Capital Type of Transaction Exercise 1-22 2,000 Assets = $47,000 Liabilities & Owner’s Equity = $47,000 2,00012 45,00035,00010,000Bal 45,00035,00010,000Bal2,000

38. Copyright © 2007 Prentice-Hall. All rights reserved 38 Does the account increase or decrease? (1) Cash (asset) (2) Revenues (equity) Analyze This: July 15-31: During the rest of the month, Lange treated patients and earned service revenue of $7,000, receiving cash What accounts are involved? When the owner completes work, her interest in the assets increases

39. Copyright © 2007 Prentice-Hall. All rights reserved 39 DateAssetsLiabilitiesOwner’s Equity JulyCashMedical Supplies LandAccounts Payable M.Lange, Capital Type of Transaction Exercise 1-22 Assets = $54,000 Liabilities & Owner’s Equity = $54,000 7,000 15-31 7,000 Revenue 52,00035,00017,000Bal2,000 45,00035,00010,000Bal2,000

40. Copyright © 2007 Prentice-Hall. All rights reserved 40 Does the account increase or decrease? (1) Cash (asset) (2) Expense (equity) Analyze This: July 15-31: Paid cash expenses What accounts are involved? When an expense is incurred, owner’s equity decreases

41. Copyright © 2007 Prentice-Hall. All rights reserved 41 DateAssetsLiabilitiesOwner’s Equity JulyCashMedical Supplies LandAccounts Payable M.Lange, Capital Type of Transaction Exercise 1-22 Assets = $51,000 Liabilities & Owner’s Equity = $51,000 52,00035,00017,000Bal2,000 -1,700 15-31 -1,700 Salaries Exp -1,000 Rent Exp - 1,000 - 300 Utilities Exp - 300 49,00035,00014,000Bal2,000

42. Copyright © 2007 Prentice-Hall. All rights reserved 42 Does the account increase or decrease? (1) Cash (asset) (2) Medical Supplies (asset) Analyze This: July 28: Sold supplies to another physician for the cost of those supplies What accounts are involved?

43. Copyright © 2007 Prentice-Hall. All rights reserved 43 DateAssetsLiabilitiesOwner’s Equity JulyCashMedical Supplies LandAccounts Payable M.Lange, Capital Type of Transaction Exercise 1-22 Assets = $51,000 Liabilities & Owner’s Equity = $51,000 500 28 -500 49,00035,00014,500Bal2,0001,500 49,00035,00014,000Bal2,000

44. Copyright © 2007 Prentice-Hall. All rights reserved 44 Does the account increase or decrease? (1) Cash (asset) (2) Accounts Payable (liability) Analyze This: July 31: Paid $1,500 on account What accounts are involved?

45. Copyright © 2007 Prentice-Hall. All rights reserved 45 DateAssetsLiabilitiesOwner’s Equity JulyCashMedical Supplies LandAccounts Payable M.Lange, Capital Type of Transaction Exercise 1-22 Assets = $49,500 Liabilities & Owner’s Equity = $49,500 -1,500 31 -1,500 49,00035,00014,500Bal2,0001,500 49,00035,00013,000Bal 5001,500

46. Copyright © 2007 Prentice-Hall. All rights reserved 46 Accounting for Business Transactions Note: The equation always stays in balance Each transaction affects at least two accounts, sometimes more Some transactions affect only one side of the equation; some affect both sides

47. Copyright © 2007 Prentice-Hall. All rights reserved 47 Objective 5 Prepare financial statements Evaluate business performance Objective 6

48. Copyright © 2007 Prentice-Hall. All rights reserved 48 Financial Statements Income statement Statement of owner’s equity Balance sheet Statement of cash flows

49. Copyright © 2007 Prentice-Hall. All rights reserved 49 Income Statement Summary of an entity’s revenues, expenses, and net income or net loss for a specific period Revenues - Expenses Net Income: Revenues > Expenses Net Loss: Expenses > Revenues

50. Copyright © 2007 Prentice-Hall. All rights reserved 50 Statement of Owner’s Equity Summary of changes in an entity’s owner’s equity during a specific period Beginning owner’s equity + Owner’s investments + Net income - Net loss - Owner’s withdrawals Ending owner’s equity

51. Copyright © 2007 Prentice-Hall. All rights reserved 51 Balance Sheet Reports the entity’s assets, liabilities, and owner’s equity as of a specific date Assets = Liabilities + Owner’s Equity

52. Copyright © 2007 Prentice-Hall. All rights reserved 52 Statement of Cash Flows Reports cash receipts and cash payments during a period (covered in Chapter 17)

53. Copyright © 2007 Prentice-Hall. All rights reserved 53 Financial Statements Using the transactions from Exercise 1-22, prepare the income statement, statement of owner’s equity, and balance sheet

54. Copyright © 2007 Prentice-Hall. All rights reserved 54 Maria Lange, M.D. Income Statement For the Month Ended July 31, 2006 Revenue: Fees earned$7,000 Expenses: Salary expense $1,700 Rent expense1,000 Utilities expense300 Total Expenses3,000 Net income$4,000 Notice the proper heading Anytime you subtotal, create a new column to the left Double underline for your final answer

55. Copyright © 2007 Prentice-Hall. All rights reserved 55 Maria Lange, capital, July 1, 2006$ 0 Add: Investment by owner45,000 Net income for the month4,000 $49,000 Less: Withdrawals by owner 0 Maria Lange, capital, July 31, 2006$49,000 Maria Lange, M.D. Statement of Owner’s Equity For the Month Ended July 31, 2006 Dates are important to the reader of the financial reports From income statement

56. Copyright © 2007 Prentice-Hall. All rights reserved 56 Details, Details Note the headings for both of these statements –Name of company –Name of financial statement –For the period ended ……. Both of these statements report activity over a period of time Final sums are double-underlined

57. Copyright © 2007 Prentice-Hall. All rights reserved 57 Details, Details Negative amounts are presented in parentheses Net income is computed first because you need that number to complete the ending balance in owner’s equity When preparing a financial statement, clearly label each line in the statement

58. Copyright © 2007 Prentice-Hall. All rights reserved 58 Details, details If you are using columnar paper, always start your number columns in the far right- hand column Numbers that are added or subtracted from each other should be in the same column

59. Copyright © 2007 Prentice-Hall. All rights reserved 59 Maria Lange, M.D. Balance Sheet July 31, 2006 Assets Cash$13,000 Medical supplies1,500 Land 35,000 Total assets$ 49,500 Liabilities Accounts payable$500 Owner’s equity, M. Lange, capital 49,000 Total liabilities and owner’s equity$ 49,500 From statement of owner’s equity Notice the proper heading

60. Copyright © 2007 Prentice-Hall. All rights reserved 60 Details, details Note the heading for the balance sheet is different from the other statements Name of company Name of financial statement Date This statement reports what the company owns and who has claims to the assets at a specific point in time

61. Copyright © 2007 Prentice-Hall. All rights reserved 61 Cash$2,000 Accounts receivable6,000 Supplies500 Equipment15,500 Total Assets$24,000 Allen Samuel Road Service Balance Sheet November 30, 2009 Liabilities Accounts payable$3,500 Note payable5,000 Total liabilities$8,500 Owner’s Equity A. Samuel, capital15,500 Total liabilities and owner’s equity$24,000 Assets Exercise 1-24

62. Copyright © 2007 Prentice-Hall. All rights reserved 62 Exercise 1-24 What does a balance sheet report – financial position or operating results? Financial position Which financial statement reports the other information? The income statement summarizes revenues and expenses

63. Exercise 1-26 Ciliotta Design Studio Income Statement Year Ended December 31, 2006 Service revenue$158,100 Expenses: Salary expense$60,000 Rent expense24,000 Utilities expense6,800 Supplies expense4,000 Property tax expense1,200 Total expenses96,000 Net income$62,100

64. Copyright © 2007 Prentice-Hall. All rights reserved 64 Exercise 1-26 2.Owner’s withdrawals: Ciliottas, capital, beginning of year $ 0 Add: Net income62,100 Investment by owner15,000 Subtotal$77,100 Less: Owner withdrawal? Ciliotta, capital, end of year$27,100 50,000

65. Copyright © 2007 Prentice-Hall. All rights reserved 65 End of Chapter 1