Financial Accounting:

A Business Process Approach

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 1

 Chapter 1

Business: What’s It All About?

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 2

 Chapter 1 Learning Objectives

When you are finished studying Chapter 1, you

should be able to:
1. Describe what a business does and the
various ways a business can be organized.
2. Classify business transactions as operating,
investing, or financing activities.
3. Describe who uses accounting information
and why accounting information is important to
them.

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 3

 Chapter 1 Learning Objectives

4. Identify the elements of the four basic

financial statements—the income statement,
the statement of changes in shareholders’
equity, the balance sheet, and the statement of
cash flows, explain the purpose of each, and be
able to use basic transaction analysis to
prepare each statement.
5. Identify the elements of a real company’s
financial statements.
6. Describe the risks associated with being in
business and the part that ethics plays in
business.
Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 4
 Learning
Objective 1
Purpose of a Business

1. Obtain the resources needed to

1. and
start Obtain
runcapital
a business

2. Add value

3. Sell to customers

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 5

Purpose and Organization of a Business

For-profit firms . . .
Make profits for investors.

Not-for-profit organizations . . .
provide goods and services to
people and use profits to
provide more goods and
services to people.

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 6

 Simple Business Model

OUTPUTS
INPUTS
Product
Cash from Capital,
Financing,
Property, Plant, Value-added
conversion
Equipment,
Raw Materials,
Labor,
Service
Inventory,
Goods & Services
Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 7
 Nature of Business Operations

Types of Companies:
Service :
 Provide services for customers
 Financial Services deal in services related to money.

Sales
 Merchandising—buys goods and resells them to other
businesses (wholesale) or to final customers (retail)
 Manufacturing—makes a product and sells it to other
businesses (wholesale) or to final consumers (retail)

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 8

 Your Turn 1-1

TheWhat
mainispurpose of purpose
a business
of aisbusiness?
to make a
the main
profit, increasing the value of the company for
the owners.

What are the four general types of

businesses?

Manufacturing
Service company
company

Merchandising Financial services

company company

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 9

 Ownership Structure of Businesses

MoreProprietorship--a
Sole than 2/3 of U. S. single
businesses
owner
are sole
business
proprietorships.

Only 2.5% of U. S. businesses are

Partnership-- a multiple-owner
partnerships, and they earn less than
business
10% of all U. S. firms’ profits.

Corporation-a business whose ownership

More than 2/3 of U. S. companies’
is divided into "shares" and may be
profits
owned byare earned
a large numberby corporations.
of people.

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 10

Characteristics of Different Forms of
Business

Personal liability

Taxation

Transfer of ownership 1Liability

2 Taxation
3 Ownership
4 Capital
5 Regulation

Ability to raise capital

Government regulation

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 11

 Sole Proprietorship

Personal responsibility and

liability

Income reported on individual’s

tax return

Owned by one individual

Difficult to acquire capital

Minimal government
regulation
Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 12
 Partnerships

Partners share
personal responsibility and liability
Partners usually create an agreement that
describes how much work each will do
and how the profit and loss will be divided.

Income IS reported on each partner’s

individual tax return

Difficult to Minimal
acquire government
capital regulation

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 13

 Corporations

A corporation is a popular form of business

because . . .

Individuals can purchase small

amounts of stock.
Provides stockholders with
limited liability.
Allows for easy transfer of
ownership.

More than two-thirds of U.S. firm’s

profits are made by corporations.

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 14

 Corporations

Once the state

issues a charter,
the stockholders
elect a board of
directors.

A corporation is a separate legal entity

that can . . .
Incur Enter into
liabilities contracts

Sue and be sued Own assets

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 15
 New Hybrid Forms of Business

Have characteristics of both

corporations and partnerships

Tax advantages Limited Liability

of a partnership of a corporation

LLP LLC
Limited Limited
Liability Liability
Partnership Corporation

Mostly used by law, medical, and accounting

profession
Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 16
 Your Turn 1-2

The three major forms of ownership are:

What are(1)
thesole proprietorships
three major forms of(single owner)
business ownership?
(2) partnerships (multiple owners)
(3) corporations (widespread ownership)

Disadvantages:
FromSole owners’ Advantages:
the Proprietorship and
point of Partnership:
view, what are the
Sole Proprietorship
Liability,
advantages andDifficulty and Partnership:
to raise
disadvantages of capital
each form of
Owner control, single taxation
Corporation:
ownership?
ConflictCorporation:
of interest between
Limitedmanagement
Liability, Easeandof owners,
raising capital
Double taxation

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 17

 Learning
Objective 2
Business Transactions

Business transactions are economic exchanges

classified as:

Operating Investing Financing

Activities Activities Activities

Transactions Transactions
Transactions related to that deal
related to buying and
the general with how a
selling items the business
operations of firm will
the firm gets it
use for more funding
than a year

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 18

 How a Business Works

Transactions for Team Shirts’ First Month of Business

Team Shirts Sara contributes Team Shirts

repays $5,000 of her own borrows $500
the loan plus money to start her from Sara’s
interest to business. sister
Sara’s to help finance
Sister. the business.

Team Team Shirts Team Shirts

Shirts decides to purchases
sells 90 T- advertise the 100 T-shirts from
shirts. new business. a T-shirt maker.

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 19

 Learning Information Needs of Decision
Objective 3
Makers

• Revenue from sales

• Expenses incurred
• Net income
• Inventory
• Reliability of
Vendors

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 20

 Operating Cycle

End with more

Start with cash
cash

Collect cash Purchase

from inventory
customers

Make sales
to customers

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 21

 Who Needs Accounting
Information?

Management
Those with direct financial interest
 Current or potential investors
 Current or potential creditors
 Employees
Those with an indirect financial interest
 Tax Authorities
 Regulatory Agencies
 Economic Planners
 Labor unions, financial advisors,
others.
Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 22
 Your Turn 1-4

Revenues are the amounts a company

What are
earns from revenues
providing and
goods or services to
expenses?
its customers.
Expenses are the costs to earn those
revenues.

The four statements include the income

What are
statement, the four
balance basic of
sheet, statement
changes in shareholders’ equity, and the
financial
statement of statements?
cash flows.

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 23

 Who Sets the Guidelines?

Securities and Exchange Commission (SEC):

Created by the U.S. Congress in 1934 to set the rules for
corporations that trade on the public stock exchanges.

The SEC delegates much of Mandated by the Sarbanes-

the Accounting standard- Oxley Act. Created by the
setting responsibility to the SEC in response to 2001-
FASB. SEC retains and 2002 accounting scandals
sometimes exercises its to oversee audits of public
rights to set standards. companies.

Financial Accounting Public Company

Standards Board (FASB) Oversight Board (PCAOB)

Generally Accepted Accounting Principles Auditing Standards

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 24

 International Financial Reporting
Standards

International guidelines for

financial reporting, used in many
places around the world.

International Accounting Standards

Board (IASB) sets international
financial reporting standards.

The SEC plans implementation of

IFRS in the United States by 2014
so that one global set of standards
is used by all major economies.

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 25

 Learning
Objective 4 Four Basic Financial Statements

Accountants communicate financial information in

the form of four basic financial statements.

Income Balance Statement of Cash

Statement Sheet Flows
Revenues Assets = Cash inflow
- Expenses Liabilities - Cash outflow
= Net income + Equity = Net cash flow

Statement of Changes in Owner’s Equity

Beginning equity + Contributions +/- Net income/loss -
Dividends = Ending equity

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 26

 Financial Statements

Dates of Financial Statements are

Important!

The Balance Sheet is prepared “AS OF…”

or “AT” a particular date, a “snapshot” in
time.

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 27

 Financial Statements

1. The Income Statement

2. Statement of Changes in Owner’s Equity
3. Statement of Cash Flows

cover a period of time:

“FOR THE PERIOD ENDING”

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 28

 Balance Sheet

Assets = Claims

Assets = Liabilities + Equity

Things of Something owed
value Net Assets
Obligations/debt
(owner’s share
Economic (creditors’ share of the assets)
resources of the assets)
owned
Contributed Retained
Capital Earnings

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 29

 Your Turn 1-5

TheWhat
two parts of shareholders’
are the equity are contributed
two parts of Shareholders’ Equity?
capital and retained earnings (earned capital).

A fiscal year is a year in the life of a business for

financialWhat is apurposes.
reporting fiscal year?
It may begin
at any time and ends a year later.

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 30

 Accounting Equation

Team Shirts
Shareholders' Equty
Assets All Liabilities + Contributed Capital Retained
Event Cash All other assets Account Account Common Stock Earnings

1 5000 5000
2 500 500 Note Payable
3 (400) 400 Inventory
4 (50) (50) Expense
5 900 900 Revenue
(360) Inventory (360) Expense
6 (505) (500) Note Payable (5) Expense
7 (100) (100) Dividends
Balances 5345 40 5000 385

--Income Statement, --Statement of Changes in Shareholders’ Equity,

--Balance Sheet, --Statement of Cash Flows

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 31

 Income Statement

. . .describes Also called:

the activity of Statement of
a company earnings, statement
during a of operations, profit
period and loss statement

Revenue – Expenses = Net Income

The amount Costs Difference
earned from incurred to between
providing goods or generate revenues and
services to revenue expenses
customers
Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 32
 Your Turn 1- 6

The income
What statement
is included contains
on the incomerevenues and
statement?
expenses. The balance
What is included sheet
on the contains
balance sheet?assets,
liabilities, and shareholders’ equity.

The time period captured by the income

Describe the difference in the time periods
statement is an accounting period, often a
captured by the income statement and the
fiscal year. The statement covers a period of
balance sheet.
time. On the other hand, the balance sheet
describes the financial position of a
company at a given point in time.

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 33

 Statement of Changes in
Owners’ Equity
Beginning balance
+/- changes in contributed capital
+/- changes in retained earnings
= Ending balance

Contributed Retained
Capital: Earnings:

Contribution by investors Total of all net income

to obtain ownership in a earned by the business
corporation. Minus
Ownership is divided into Dividends Paid to owners
shares of stock. (Distributions to owners)
Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 34
 Statement of Cash Flows
Cash from Cash from Cash from
Operating Investing Financing
Activities Activities Activities

From customers’
From sale of From issuing
purchases,
property long-term debt
interest or dividend
and equipment or issuing stock
income

Cash Inflow

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 35

 Statement of Cash Flows
Cash from Cash from Cash from
Operating Investing Financing
Activities Activities Activities

To suppliers for To purchase plant To repay long-term

inventory, and equipment, debt principal,
For employees’ Investments in To pay dividends to
salaries other firms owners

Cash Outflow

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 36

 Your Turn 1 - 7

The income statement gives the revenues and expenses

How is the income statement related to the balance
for the period. The net amount, net income, is added to
sheet? In other words, how does the amount of net
retained earnings. So the income statement number
income affect the balance sheet?
becomes part of the retained earnings total on the
year-end balance sheet.

The
Whyincome statement
is it necessary shows
to have all revenues
both an incomeand expenses
statement
for
andaaperiod of time—all
statement of cash the revenues that have been
flows?
earned
Look at and expenses incurred
the statements for Teamto Shirts
earn those revenues.
and explain why
The
theystatement of cash flows simply lists the cash inflows
are different.
and outflows during the period. Also, any transactions
with owners (contributions and dividends) are not
included on the income statement.

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 37

 Learning
Real Company’s Financial
Objective 5
Statements
Income Statements
Multi-step:
Single-step:
Calculates net
Groups all
income in steps
revenues
together and
deducts all
expenses from Revenues
total revenues - Cost of Goods
Gross Margin
+ Other Revenue
Revenues - Other Expenses
-Expenses Operating Income
Net - Income Taxes
income Net Income

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 38

 Real Company’s Financial
Statements
Classified Balance Sheet
Shows a subtotal for various classes of assets
and liabilities, including current and long-term
assets and liabilities, and shareholders’ equity

Assets: Shareholders’
Liabilities: Equity:
Current Contributed
Assets Current Capital,
Property, Liabilities Retained
Plant, and Long-term Earnings,
Equipment Liabilities Other
Comprehensive
Other Assets Income
Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 39
 Learning
Business Risk, Control, and
Objective 6
Ethics
Risk: Anything that exposes us to potential
injury or loss.
Can turn into significant losses, scandals, or
total company failure.

Product Failure Strategic Risks

Theft of Assets Operating Risks

Purchase/sale of Financial Risks

poor quality
inventory Information Risks

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 40

 Business Risk, Control, and Ethics

Every risk brings a potential reward.

Firms’ managers want to minimize risks.

A manager must always put good ethical

behavior above putting a good face on the
firm’s financial position or performance.

Control: An activity performed to minimize or

eliminate risk. A firm must establish and maintain
control over its operations, assets, and information
systems.
Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 41
All rights reserved. No part of this publication may
be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means,
electronic, mechanical, photocopying, recording,
or otherwise, without the prior written permission
of the publisher. Printed in the United States of
America.

Copyright © 2011 Pearson Education, Inc.

publishing as Prentice Hall

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 42