Accounting Fundamentals

Accounting FundamentalsAccounting Fundamentals

Dr. Yan XiongDr. Yan XiongDepartment of AccountancyDepartment of Accountancy

CSU SacramentoCSU SacramentoThe lecture notes are primarily based on Reimers The lecture notes are primarily based on Reimers

(2003).(2003). 7/11/037/11/03

Chapter 1Chapter 1 Business ProcessesBusiness Processes

AgendaAgenda Purpose of a Business and Purpose of a Business and

Types of BusinessesTypes of Businesses Ownership Structure of Ownership Structure of

BusinessesBusinesses Business ProcessesBusiness Processes The Accounting EquationThe Accounting Equation Four Basic Financial Four Basic Financial

StatementsStatements

“ “ Accounting is process, process, Accounting is process, process, process”process”

Daniel O’ LearyDaniel O’ LearyAccounting Professor and Accounting Professor and

AuthorAuthorUniversity of Southern University of Southern

CaliforniaCalifornia

Purpose of a BusinessPurpose of a Business

Simple Model of a BusinessSimple Model of a Business“The Firm”

INPUTS

(Give)

Value added

conversion

OUTPUTS

(Get)

Capital (financing) Property, Plant, EquipmentRaw MaterialsLaborInventoryGoods & Services

Delivery of Product or Service

Acquisition/Payment Cycle Sales/Collection Cycle

Series of activities that a company Series of activities that a company performs to achieve its goals.performs to achieve its goals.

ACQUISITION / PAYMENT: acquire, ACQUISITION / PAYMENT: acquire, maintain, and pay for the resources maintain, and pay for the resources needed by the organization.needed by the organization.

CONVERSION: convert the resources CONVERSION: convert the resources acquired into goods and/or services.acquired into goods and/or services.

SALES / COLLECTIONS: sell and SALES / COLLECTIONS: sell and deliver goods and/or services to deliver goods and/or services to customers and to collect payment.customers and to collect payment.

What are Business Processes?What are Business Processes?

Types of BusinessesTypes of Businesses Service companyService company

provides a service for customersprovides a service for customers Sales companySales company

Special case: financial servicesSpecial case: financial services Merchandising--Merchandising--buys goods and resells them buys goods and resells them

to other businesses (wholesale) or to final to other businesses (wholesale) or to final customers (retail)customers (retail)

Manufacturing-Manufacturing--makes a product and sells it -makes a product and sells it to other businesses (wholesale) or to final to other businesses (wholesale) or to final consumers (retail)consumers (retail)

Examples:Examples:ServiceService

accountants, attorneys, physiciansaccountants, attorneys, physiciansFinancial ServiceFinancial Service

Citicorp, Merrill Lynch, American Express Citicorp, Merrill Lynch, American Express MerchandisingMerchandising

Wal-Mart, Safeway, The GapWal-Mart, Safeway, The GapManufacturingManufacturing

General Motors, 3M, Reynolds MetalsGeneral Motors, 3M, Reynolds Metals [Obviously, some businesses provide more than one of the [Obviously, some businesses provide more than one of the

functions listed above]functions listed above]

Ownership Structure of BusinessesOwnership Structure of Businesses

Sole Proprietorship--a single owner business

Partnership--a multiple-owner business

Corporation--a business whose ownership

is divided into "shares" and maybe owned by a large number of people

A corporation is a popular form of business because . . . A corporation is a popular form of business because . . . It is simple for individuals to It is simple for individuals to purchasepurchase small amounts of small amounts of

stock.stock. It allows for an easy It allows for an easy transfer of ownership transfer of ownership through through

established markets, like the New York Stock Exchange.established markets, like the New York Stock Exchange. It provides stockholders with It provides stockholders with limited liabilitylimited liability..

CorporationsCorporations

Because a corporation is a Because a corporation is a separate legal entityseparate legal entity, , it can . . . it can . . . Own assets.Own assets. Incur liabilities.Incur liabilities. Sue and be sued.Sue and be sued. Enter into contracts independent of the Enter into contracts independent of the

stockholder owners.stockholder owners. Many Americans own stock through a mutual fund or Many Americans own stock through a mutual fund or

pension program.pension program.

CorporationsCorporations

Issues in deciding between sole Issues in deciding between sole proprietorship, partnership, or corporationproprietorship, partnership, or corporation

Personal liabilityPersonal liability TaxationTaxation Transfer of ownershipTransfer of ownership Ability to raise capitalAbility to raise capital Government regulationGovernment regulation

Characteristics of Different Forms of Characteristics of Different Forms of Business OrganizationBusiness Organization

No matter what the No matter what the ownership structure of a ownership structure of a business, they all have business, they all have at least two main at least two main business processes:business processes:

Acquisition/PaymentAcquisition/Payment Sales/CollectionSales/Collection

What Do All Business have in Common?What Do All Business have in Common?

Acquisition/payment processAcquisition/payment processActivity Possible 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

Sales/collection processSales/collection process

Customer places an order Customer places an order (Customer order)(Customer order) Customer’s credit is approvedCustomer’s credit is approved Warehouse selects goods for shipment Warehouse selects goods for shipment

(Picking slip)(Picking slip) Goods are shipped Goods are shipped (Packing slip and (Packing slip and

Shipping notice)Shipping notice) Customer is billed for goods Customer is billed for goods (Invoice)(Invoice) Payment for goods is received Payment for goods is received (Check)(Check)

Business TransactionsBusiness Transactions

Business transactions are exchanges. Business transactions are exchanges. The two transactions that make up an The two transactions that make up an

“exchange” are the GIVE part and the “exchange” are the GIVE part and the GET part.GET part.

The exchange occurs between the The exchange occurs between the business entity and a person or business entity and a person or business external to the entity.business external to the entity.

The business gives something and then The business gives something and then gets something in return.gets something in return.

Resources, Events, and AgentsResources, Events, and Agents We can model an exchange with these three We can model an exchange with these three

components:components: the the resourcesresources are the things being are the things being

exchanged (goods or services for money)exchanged (goods or services for money) the the eventevent describes the business action describes the business action

(e.g. cash disbursement, sale, etc.)(e.g. cash disbursement, sale, etc.) the the agentsagents are the people involved in the are the people involved in the

exchange (e.g., the customer)exchange (e.g., the customer)

Acquisition and Payment for T-shirtsAcquisition and Payment for T-shirts

GIVE

Cash Disbursement

EVENT

EVENT

GET

T-shirt

Company

AGENT

Tom’s

Wear

AGENT

T-shirt ResourceT-shirt Resource

Cash Resource Cash Resource

Purchase

Acquisition and Payment for a ServiceAcquisition and Payment for a Service

GIVE

Cash Disbursement

EVENT

EVENT

GET

Advertising Company

AGENT

Tom’s

Wear

AGENT

Advertisement Resource

Advertisement Resource

Cash Resource Cash Resource

Purchase

Sales and CollectionsSales and Collections

GIVE

Sale

EVENT

GET

Customer

AGENT

Tom’s

Wear

AGENT

Cash ResourceCash Resource

T-shirt Resource T-shirt Resource

EVENT

Cash Collection

Who needs accounting information?Who needs accounting information?A)A) ManagementManagementB)B) Those with direct financial interestThose with direct financial interest

Current or potential investorsCurrent or potential investors CurrentCurrent or potential creditorsor potential creditors

C)C) Those with an indirect financial interest Those with an indirect financial interest Tax AuthoritiesTax Authorities Regulatory AgenciesRegulatory Agencies Economic PlannersEconomic Planners Labor unions, financial advisors, others.Labor unions, financial advisors, others.

D)D) EmployeesEmployees

Financial Accounting InformationFinancial Accounting InformationInformation 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

Assets = Claims Assets = Claims Assets = Liabilities + EquityAssets = Liabilities + Equity

AssetAsset: something of value: something of valueLiabilityLiability: something owed (creditors’ : something owed (creditors’

share of the assets)share of the assets)EquityEquity: what remains (owner’s share of : what remains (owner’s share of

the assets)the assets)

The Accounting EquationThe Accounting Equation

There are two sources of equityThere are two sources of equity equity “contributed” by ownersequity “contributed” by owners equity “earned” by operationsequity “earned” by operations

Expanded accounting equation:Expanded accounting equation:

ASSETS =ASSETS = LIABILITIESLIABILITIESCONTRIBUTED CONTRIBUTED

CAPITALCAPITALRETAINED RETAINED EARNINGSEARNINGS++ ++

Equity: The Owner’s ShareEquity: The Owner’s Share

Expanded accounting equationExpanded accounting equation::

Together, these are called Shareholders’ Equity, Stockholders’ Equity, or Owners’ Equity. They are all names for the same thing--the owners’ claims tothe firm’s assets.

ASSETS =ASSETS = LIABILITIESLIABILITIESCONTRIBUTED CONTRIBUTED

CAPITALCAPITALRETAINED RETAINED EARNINGSEARNINGS++ ++

Equity: The Owner’s ShareEquity: The Owner’s Share

Four Basic Financial StatementsFour Basic Financial StatementsBalance SheetBalance Sheet

Assets = Liabilities + EquityAssets = Liabilities + EquityIncome StatementIncome Statement

Revenues - Expenses = Net incomeRevenues - Expenses = Net incomeStatement of Changes in Owner’s EquityStatement of Changes in Owner’s Equity

Beginning equity + Contributions + Net Beginning equity + Contributions + Net income - Distributions = Ending equityincome - Distributions = Ending equity

Statement of Cash FlowsStatement of Cash FlowsCash inflow - Cash outflow = Net cash flowCash inflow - Cash outflow = Net cash flow

Dates of Financial Statements Dates of Financial Statements are Importantare Important!!

Balance sheetBalance sheet is “AS OF…” or “AT” is “AS OF…” or “AT” a a particular date, sometimes called a particular date, sometimes called a “snapshot” in time.“snapshot” in time.

Income statementIncome statement Statement of changes in owner’s equityStatement of changes in owner’s equity Statement of cash flowsStatement of cash flows

These last three cover a period of These last three cover a period of time, and thus are “FOR THE PERIOD time, and thus are “FOR THE PERIOD ENDING”ENDING”

Acquiring Financing for a BusinessAcquiring Financing for a Business

DateDateJan. 1Jan. 1

TransactionsTransactions Tom contributes $5,000 of Tom contributes $5,000 of

his own money to the his own money to the business.business.

Assets = Liabilities + Owner’s Equity

+5,000 cash +5,000 common stock

Contributed Capital + Retained Earnings



TransactionsTransactions Tom’s Wear borrows $500 Tom’s Wear borrows $500

from Tom’s mom.from Tom’s mom.

Assets = Liabilities + CC + Retained Earnings

+500 cash + 500 N/P



TransactionsTransactions Tom contributes $5,000 of Tom contributes $5,000 of

his own money to start the his own money to start the business.business.

Tom’s Wear borrows $500 Tom’s Wear borrows $500 from Tom’s mom.from Tom’s mom.

Assets = Liabilities + CC + Retained Earnings

+500 cash + 500 N/P

+5,000 cash +5,000 common stock

Acquiring Inventory Acquiring Inventory DateDate

Jan. 5Jan. 5TransactionsTransactions

Tom’s Wear buys 100 T-Tom’s Wear buys 100 T-shirts for $400 cash.shirts for $400 cash.

Acquiring Inventory Acquiring Inventory DateDate


Tom’s Wear buys 100 T-Tom’s Wear buys 100 T-shirts for $400 cash.shirts for $400 cash.

Assets = Liabilities + CC + RE

(400) cash

+400 inventory

Acquiring a Service Acquiring a Service DateDate


Tom’s Wear pays $50 for Tom’s Wear pays $50 for advertising.advertising.


(50) cash (50) expenses

Sales and Collection Sales and Collection DateDate

Jan. 20 Jan. 20 TransactionsTransactions

Tom’s Wear sells 90 of the Tom’s Wear sells 90 of the T-shirts to friends for cash, T-shirts to friends for cash, $10 each.$10 each.

Sales and Collection Sales and Collection DateDate

Jan. 20 Jan. 20 TransactionsTransactions

Tom’s Wear sells 90 of the Tom’s Wear sells 90 of the T-shirts to friends for cash, T-shirts to friends for cash, $10 each.$10 each. Assets = Liabilities + CC + RE

+900 cash +900 revenue

DateDate Jan. 20 Jan. 20

TransactionsTransactions Tom’s Wear sells 90 of the Tom’s Wear sells 90 of the

T-shirts to friends for cash, T-shirts to friends for cash, $10 each.$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 What else happens along with the sale? An expense…the cost of the goods sold.expense…the cost of the goods sold.

Payment for the acquired financingPayment for the acquired financing

DateDate Jan. 30Jan. 30

TransactionsTransactions Tom’s Wear repays the debt Tom’s Wear repays the debt

of $500 plus $5 interest. of $500 plus $5 interest.

Payment for the acquired financingPayment for the acquired financing DateDate


Tom’s Wear repays the debt Tom’s Wear repays the debt of $500 plus $5 interest. of $500 plus $5 interest.


(505) cash (500) N/P

Payment for the acquired financingPayment for the acquired financing DateDate


Tom’s Wear repays the debt Tom’s Wear repays the debt of $500 plus $5 interest. of $500 plus $5 interest.


(505) cash (500) N/P (5) expense

Interest expense



TransactionsTransactions Tom’s Wear pays a dividend Tom’s Wear pays a dividend

to Tom, the owner, for $100. to Tom, the owner, for $100.



TransactionsTransactions Tom’s Wear pays a dividend Tom’s Wear pays a dividend

of $100. of $100.


(100) cash (100)dividends


Tom’s Wear pays a dividend of $100.Tom’s Wear pays a dividend of $100.Tom’s Wear makes a distribution to Tom’s Wear makes a distribution to

Tom, the owner, for $100.Tom, the owner, for $100.In a corporation, a distribution to the In a corporation, a distribution to the

owners is called a dividend.owners is called a dividend. Assets = Liabilities + CC + RE

(100) cash (100) dividend

=

Assets = Liabilities + EquityAssets = Liabilities + Equity1. +5,000 cash +$5,000 common stk.2. +500 cash + 500 notes payable3. -400 cash +400 inv.4. -50 cash - 50 expense5. +900 cash + 900 revenue -360 inventory - 360 CGS6. -505 cash -500 notes payable - 5 interest exp.7, -100 cash - 100 dividend

5,385 0 5,385

Tom’s Wear, Inc.Tom’s Wear, Inc.Income StatementIncome Statement

For the month ended January 31, 2001For the month ended January 31, 2001

REVENUE

- EXPENSES

=

NET INCOME

Assets = Liabilities + Assets = Liabilities + EquityEquity

1. +5,000 cash +$5,000 common stk.2. +500 cash + 500 notes payable3. -400 cash +400 inv.4. -50 cash - 50 expense5. +900 cash + 900 revenue -360 inventory - 360 CGS6. -505 cash -500 notes payable - 5 interest exp.7, -100 cash - 100 dividends

5,385 0 5,385

These are the revenuesand expenses:

Assets = Liabilities + EquityAssets = Liabilities + Equity1. +5,000 cash +$5,000 common stk.2. +500 cash + 500 notes payable3. -400 cash +400 inv.4. -50 cash - 50 expense5. +900 cash + 900 revenue -360 inventory - 360 CGS6. -505 cash -500 notes payable - 5 interest exp.7, -100 cash - 100 dividends

5,385 0 5,385

NetIncome

=$485

Tom’s Wear, Inc.Tom’s Wear, Inc.Income StatementIncome Statement

For the Month Ended Jan. 31, 2001For the Month Ended Jan. 31, 2001

RevenueRevenueSalesSales $900 $900

ExpensesExpensesCost of salesCost of sales 360 360

AdvertisingAdvertising 50 50

InterestInterest 5 5

Total expensesTotal expenses 415415Net incomeNet income $485$485

Tom’s Wear, Inc.Tom’s Wear, Inc.Statement of Changes in Owner’s EquityStatement of Changes in Owner’s Equity

For the month ended Jan. 31, 2001For the month ended Jan. 31, 2001

Beginning CCBeginning CC $ 0$ 0 Common stock issuedCommon stock issued 5,0005,000Total Contributed CapitalTotal Contributed Capital $ 5,000$ 5,000

Beginning REBeginning RE $ 0$ 0Net incomeNet income DividendsDividends Ending REEnding RE

Total Owners’ EquityTotal Owners’ Equity

Tom’s Wear, Inc.Tom’s Wear, Inc.Statement of Changes in Owner’s EquityStatement of Changes in Owner’s Equity


Beginning CCBeginning CC $ 0$ 0 Common stock issuedCommon stock issued 5,0005,000Total Contributed CapitalTotal Contributed Capital $ 5,000$ 5,000

Beginning REBeginning RE $ 0$ 0Net incomeNet income 485 485DividendsDividends (100)(100)Ending REEnding RE $ 385$ 385

Total Owners’ EquityTotal Owners’ Equity $5,385$5,385

Assets = Liabilities + EquityAssets = Liabilities + Equity

1. +5,000 cash +$5,000 common stk.2. +500 cash + 500 notes payable3. -400 cash +400 inv.4. -50 cash - 50 expense5. +900 cash + 900 revenue -360 inventory - 360 CGS6. -505 cash -500 notes payable - 5 interest exp.7. -100 cash - 100 dividends

5,385 0 5,385

NetIncome

=$485

Tom’s WearTom’s WearBalance SheetBalance SheetAt Jan. 31,2001At Jan. 31,2001

AssetsAssets Liabilities + Shareholder’s EquityLiabilities + Shareholder’s Equity

Tom’s WearTom’s WearBalance SheetBalance Sheet

At Jan. 31, 2001At Jan. 31, 2001AssetsAssets Liabilities + SHs EquityLiabilities + SHs Equity

CashCash $ 5,345$ 5,345 InventoryInventory $ 40$ 40

Total AssetsTotal Assets $ 5,385$ 5,385


At Jan. 31, 2001At Jan. 31, 2001


CashCash $5,345 $5,345 Note PayableNote Payable-0-Inventory-0-Inventory 4040

Total AssetsTotal Assets $5,385$5,385


At Jan. 31, 2001At Jan. 31, 2001


CashCash $5,345$5,345 Note payableNote payable - -0-0-

InventoryInventory $ 40$ 40 Common stock, Common stock, T. PhillipsT. Phillips

$5,000$5,000Total assetsTotal assets $ 5,385$ 5,385 Retained earningsRetained earnings

385385

Total liabilities + Total liabilities + $ $ 5,3855,385 SH’s EquitySH’s Equity

Tom’s Wear, Inc.Tom’s Wear, Inc.Statement of Cash FlowsStatement of Cash Flows

For the month ending Jan. 31, 2001For the month ending Jan. 31, 2001

Cash from Operating ActivitiesCash from Operating Activities

Cash from Investing ActivitiesCash from Investing Activities

Cash from Financing ActivitiesCash from Financing Activities

Assets = Liabilities + EquityAssets = 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 payable3. -400 cash +400 inv.4. -50 cash - 50 expense5. +900 cash + 900 revenue -360 inventory - 360 CGS6. -505 cash -500 notes payable - 5 interest exp.7. -100 cash - 100 dividends

5,385 0 5,385

NetIncome

=$485


For the month ended Jan. 31,2001For the month ended Jan. 31,2001

Cash from operating activitiesCash from operating activitiesCash from customersCash from customers $ 900$ 900

Cash paid to vendor for T-shirtsCash paid to vendor for T-shirts (400) (400)

Cash paid for advertisingCash paid for advertising (50) (50)

Interest paidInterest paid ( 5) ( 5)Total cash from operationsTotal cash from operations

$445$445



Cash from operating activitiesCash from operating activities Cash from customersCash from customers $ 900$ 900



Cash paid for interestCash paid for interest ( 5) ( 5)

Total cash from operationsTotal cash from operations $445$445

Cash from investing activitiesCash from investing activities -0- -0-



Cash from operating activitiesCash from operating activities Cash from customersCash from customers $ 900$ 900



Cash paid for interestCash paid for interest ( 5) ( 5)


Cash from investing activitiesCash from investing activities -0- -0-Cash from financing activitiesCash from financing activities


For the month ended Jan. 31, 2001For the month ended Jan. 31, 2001Cash from operating activitiesCash from operating activities

Cash from customersCash from customers $ 900$ 900


Cash paid for advertisingCash paid for advertising (50) (50)Cash paid for interest Cash paid for interest ( 5) ( 5)



Owner’s contributionsOwner’s contributions 5,0005,000

DividendsDividends (100) (100)

Total Cash from FinancingTotal Cash from Financing 4,9004,900


For the month ended Jan. 31, 2001For the month ended Jan. 31, 2001Cash from operating activitiesCash from operating activities

Cash from customersCash from customers $ 900$ 900Cash paid to vendor for T-shirtsCash paid to vendor for T-shirts (400) (400)

Cash paid for advertisingCash paid for advertising (50) (50)Cash paid for interest Cash paid for interest (5) (5)



Owner’s contributionsOwner’s contributions 5,0005,000 DividendsDividends (100) (100)

Total Cash from FinancingTotal Cash from Financing 4,9004,900

Net Increase in CashNet Increase in Cash $ 5,345$ 5,345

Accounting Fundamentals

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