Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned,

Prepared by: C. Douglas Cloud Professor Emeritus of AccountingPepperdine University

© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Introduction to Accounting and Business

Chapter 1Chapter 1


Learning Objectives1. Describe the nature of a business, the role of

accounting, and ethics in business.2. Summarize the development of accounting

principles and relate them to practice.3. State the accounting equation and define

each element of the equation.4. Describe and illustrate how business

transactions can be recorded in terms of the resulting change in the elements of the accounting equation.

5. Describe the financial statements of a corporation and explain how they interrelate.

6. Describe and illustrate the use of the ratio of liabilities to stockholders’ equity in evaluating a company’s financial condition.


Learning Objective 1

Describe the nature of a business, the role of accounting,

and ethics in business.


Nature of Business and Accounting A business is an organization in

which basic resources (inputs), such as materials and labor, are assembled and processed to provide goods or services (outputs) to customers.

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LO 1LO 1Nature of Business aand Accounting

The objective of most businesses is to earn a profit.

Profit is the difference between the amounts received from customers for goods or services and the amounts paid for the inputs used to provide the goods or services.


Types of Businesses

Service:Provide services rather than products

Merchandising:Sell products they purchase from other businesses to customers

Manufacturing:Change basic inputs into products that are sold to customers


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Types of Businesses

Personal computersDell

Transportation servicesDelta Air Lines

ServiceService Businesses

The Walt Disney Company Entertainment services

General merchandiseWalmart

ProductMerchandising Businesses

ProductManufacturing Businesses

Cars, trucks, vansFord Motor Company

Internet books, music, videos

Amazon.com


The Role of Accounting in Business AccountingAccounting can be defined as an

information system that provides reports to users about the economic activities and condition of a business.

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The process by which accounting provides information to users is as follows: Identify users. Assess users’ information needs. Design the accounting information

system to meet users’ needs. Record economic data about business

activities and events. Prepare accounting reports for users.

LO 1LO 1The Role of Accounting in Business


The Role of Accounting in Business

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Managerial Accounting

The area of accounting that provides internal users with information is called managerial accounting or management accounting.

Managerial accountants employed by a business are employed in private accounting.

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Financial Accounting

The area of accounting that provides external users with information is called financial accounting.

The objective of financial accounting is to provide relevant and timely information for the decision-making needs of users outside of the business.

General-purpose financial statements are one type of financial accounting report that is distributed to external users.

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Role of Ethics in Accounting and Business The objective of accounting is to

provide relevant, timely information for user decision making.

Accountants must behave in an ethical manner so that the information they provide users will be trustworthy and, thus, useful for decision making.

Ethics are moral principles that guide the conduct of individuals.

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Role of Ethics in Accounting and Business

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(continued)



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(continued)



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(concluded)


The answer to “What went wrong for these companies?” involves one or both of these factors. (Exhibit 2)

Failure of individual character

Firm culture of greed and ethical indifference

LO 1LO 1Role of Ethics in Accounting and Business


LO 1LO 1Role of Ethics in Accounting and Business


Institute of Management Accountants Standards of Ethical Conduct

1. Maintain an appropriate level of professional competence.

2. Refrain from disclosing confidential information.

3. Avoid conflicts of interest.

4. Communicate information fairly and objectively.


American Institute of Certified Public AccountantsCodes of Professional Conduct

1. Exercise sensitive professional and moral judgment.2. Act in a way that will serve the public interest, honor

the public trust, and demonstrate commitment to professionalism.

3. Perform all professional responsibilities with the highest sense of integrity.

4. Maintain objectivity and be free of conflicts of interest.5. Observe the profession's technical and ethical

standards and continually improve competency and quality of services.

6. Use ethical standards when determining the scope and nature of services to be provided.


ETHICS CASE

Lauren Smith is the controller for Sports Central, a chain of sporting goods stores. She has been asked to recommend a site for a new store. Lauren has an uncle who owns a shopping plaza in the area of town where the new store is to be located, so she decides to contact her uncle about leasing space in his plaza. Lauren also contacted several other shopping plazas and malls, but her uncle's store turned out to be the most economical place to lease. Therefore, Lauren recommended locating the new store in her uncle's shopping plaza. In making her recommendation to management, she did not disclose that her uncle owned the shopping plaza.


ETHICS CASE

Tom Brown, the controller for MicroTech Software Company, is responsible for preparing the company's financial statements. He learns that sales for the first quarter of the year have dropped so dramatically that the company is in danger of bankruptcy. As a result, he applies for an accounting position with another software company that competes with MicroTech. During his job interview, Tom is asked why he wants to leave MicroTech. He replies truthfully, "The company's sales are down another 10% this quarter. I fear they will go out of business." At that time, MicroTech had not released its sales results to the public.


Opportunities for Accountants

Accountants and their staffs who provide services on a fee basis are said to be employed in public accounting.

Accountants employed by a business firm or a not-for-profit organization are said to be employed in private accounting.

Public accountants who have met a state’s education, experience, and examination requirements may become Certified Public Accountants (CPAs).

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Opportunities for AccountantsLO 1LO 1


SPECIALIZED FIELDS IN ACCOUNTING

Financial Accounting: Preparing reports that show the profits and financial health of the company using the rules of accounting, known as generally accepted accounting principles (GAAP)

Auditing: Evaluating financial records and reports to determine whether they present the results of a company's operations fairly

Management Accounting: Providing data to management to assist in running day-to-day operations

Cost Accounting: Tracking costs, particularly those to manufacture a product



Tax Accounting: Preparing tax returns and helping companies and individuals reduce the amount of taxes paid by carefully planning their business activities

Accounting Systems: Designing accounting systems that collect accurate data and protect a company's assets (cash, inventory, etc.) from misuse or theft; since most accounting systems today are maintained on a computer, this area requires computer hardware and software knowledge

International Accounting: Focusing on issues related to international trade; for example, buying or selling goods in a foreign currency


Not-for-Profit Accounting: Reporting on the operations of nonprofit organizations (such as churches, charities,educational institutions, and governmental agencies)

Social Accounting: Measuring the social costs and benefits of various actions

Accounting Instruction: Teaching accounting to students




Summarize the development of

accounting principles and relate

them to practice.


Generally Accepted Accounting Principles Financial accountants follow

generally accepted accounting principles (GAAP) in preparing reports.

Within the U.S., the Financial Accounting Standards Board (FASB) has the primary responsibility for developing accounting principles.

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Generally Accepted Accounting Principles The Securities and Exchange

Commission (SEC), an agency of the U.S. government, has authority over the accounting and financial disclosures for companies whose shares of ownership (stock) are traded and sold to the public.

Many countries outside the United States use generally accepted accounting principles adopted by the International Accounting Standards Board (IASB).

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Business Entity Concept

Under the business entity concept, the activities of a business are recorded separately from the activities of its owners, creditors, or other businesses.

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Business Entity Concept

Sally Vertrees purchased a personal computer for use at home. Sally owns a dental practice. She occasionally uses the computer for a task related to her dental practice; however, the computer is used primarily by Sally's children. Can the computer be recorded as an asset in the accounting records of Sally's dental office? Why or why not?


Proprietorship

A proprietorship is owned by one individual.

70% of business entities in the U.S. are proprietorships.

They are easy and cheap to organize.

Resources are limited to those of the owner.

Used by small businesses.

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Partnership

A partnership is similar to a proprietorship except that it is owned by two or more individuals.

10% of business organizations in the U.S. (combined with limited liability companies) are partnerships.

Combines the skills and resources of more than one person.

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Corporation

A corporation is organized under state or federal statutes as a separate legal taxable entity.

Corporations generate 90% of business revenues.

20% of the business organizations in the U.S. are corporations.

Ownership is divided into shares, called stock.

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(continued)


Corporation

A corporation is organized under state or federal statutes as a separate legal taxable entity.

Can obtain large amounts of resources by issuing stocks.

Used by large businesses.

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Limited Liability Company (LLC) A limited

liability company (LLC) combines the attributes of a partnership and a corporation.

10% of business organizations in the U.S. (combined with partnerships).

Often used as an alternative to a partnership.

Has tax and legal liability advantages for owners.

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Cost Concept

Under the cost concept, amounts are initially recorded in the accounting records at their cost or purchase price.

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Cost ConceptLO 2LO 2

Aaron Publishers purchased a building on February 20, 2010, for $150,000. Other amounts related to this purchased are shown on the next slide.


Cost Concept

Price listed by seller on January 1, 2010

$160,000 Aaron Publishers’ initial offer to buy

on January 31, 2010 140,000

Purchase price on February 20, 2010 150,000

Estimated selling price on December 31, 2012 220,000

Assessed value for property taxes,

December 31, 2012190,000

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Objectivity Concept

The objectivity concept requires that the amounts recorded in the accounting records be based on objective evidence.

Only the final agreed-upon amount is objective enough to be recorded in the accounting records.

So the correct answer is $150,000

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Objectivity Concept

Jason Thompson purchased an office building 10 years ago for $780,000. The building was just appraised at $1.25 million. What value should be used for the building in Jason's accounting records?


Unit of Measure Concept

The unit of measure concept requires that economic data be recorded in dollars.

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State the accounting equation and define each element of the

equation.


The Accounting Equation

The resources owned by a business are its assets.

The rights of creditors are the debts of the business and are called liabilities.

The rights of the owners are called owner’s equity.

The equation Assets = Liabilities + Owner’s Equity is called the accounting equation.

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The resources owned by a

business

Assets = Liabilities + Owner’s Equity

The Accounting EquationLO 3LO 3




The rights of creditors are the

debts of the business


The rights of the owners




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Describe and illustrate how business transactions can be recorded in terms of the

resulting change in the elements of the accounting

equation.


Business Transaction

A business transaction is an economic event or condition that directly changes an entity’s financial condition or its results of operations.

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EVENTS/CONDITIONS RECORDED IN ACCOUNTING RECORDS

1. Receipt of cash 2. Payment of cash3. Events that create a legal obligation to pay out cash

(or other assets) in the future4. Events that obligate another party to pay you cash

(or other assets) in the future5. Sale of a product or completion of a service for a

customer––this is known as earning revenue6. The use of products or services in running your

business––this is known as incurring an expense


On November 1, 2011, Chris Clark deposited $25,000 in a bank account in the name of NetSolutions in return for shares of stock in the corporation.

Transaction ALO 4LO 4


Stock issued to owners (stockholders), such as Chris Clark, is referred to as capital stock. The owner’s equity in a corporation is called stockholders’ equity.

Transaction A


On November 5, 2011, NetSolutions paid $20,000 for the purchase of land as a future building site.

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Transaction B

The new amounts are called balances.


On November 10, 2011, NetSolutions purchased supplies for $1,350 and agreed to pay the supplier in the near future.

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Transaction C


Transaction C

The liability created by a purchase on account is called an account payable.

Items such as supplies that will be used in the business in the future are called prepaid expenses, which are assets.

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Transaction DLO 4LO 4

On November 18, 2011, NetSolutions received cash of $7,500 for providing services to customers. A business earns money by selling goods or services to its customers. This amount is called revenue.


Revenue from providing services is recorded as fees earned.

Revenue from the sale of merchandise is record as sales.

Other examples of revenue include rent, which is recorded as rent revenue, and interest, which is recorded as interest revenue.

An account receivable is a claim against a customer, which is an asset.

Transaction DLO 4LO 4


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Transaction E

During the month, NetSolutions spent cash or used up other assets in earning revenue. Assets used in this process of earning revenue are called expenses.


On November 30, 2011, NetSolutions paid the following expenses: wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.

Transaction ELO 4LO 4


On November 30, 2011, NetSolutions paid creditors on account, $950.

Transaction FLO 4LO 4


On November 30, 2011, Chris Clark determined that the cost of supplies on hand at the end of the period was $550; therefore, the amount of supplies used amounted to $800 ($1,350 – $550 = $800).

Transaction GLO 4LO 4


On November 30, 2011, NetSolutions paid $2,000 to stockholders as dividends.

Transaction HLO 4LO 4

Dividends are distributions of earnings to stockholders.


SummaryLO 4LO 4


You Should Note the Following: The effect of every transactions is an

increase or a decrease in one or more of the accounting equation elements.

The two sides of the accounting equations are always equal.

The stockholders’ equity (owner’s equity) is increased by amounts invested by stockholders (capital stock).

(continued)

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You Should Note the Following: The stockholders’ equity (owner’s

equity) is increased by revenue and decreased by expenses.

The stockholders’ equity (owner’s equity) is decreased by dividends paid to stockholders.

Retained earnings is the stockholders’ equity created from business operations through revenue and expense transactions.

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Types of Transactions Affecting Stockholders’ Equity

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Describe the financial statements of a corporation

and explain how they interrelate.


Financial Statements

After transactions have been recorded and summarized, reports are prepared for users. The accounting reports providing this information are called financial statements.

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Financial StatementsLO 5LO 5


Income Statement The income statement reports the

revenues and expenses for a period of time, based on the matching concept.

The matching concept is applied by “matching” the expenses incurred during a period with the revenue that those expenses generated.

The excess of the revenue over the expenses is called net income, net profit, or earnings. If expenses exceed revenue, the excess is a net loss.

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Retained Earnings Statement

The retained earnings statement reports the changes in the retained earnings for a period of time.

It is prepared after the income statement because the net income or net loss for the period must be reported in this statement.

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Retained Earnings StatementLO 5LO 5

To illustrate, assume that NetSolutions earned net income of $4,155 and paid dividends of $2,000 during December. The following statement would be prepared.


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Net income is carried to the retained earnings

statement

Income StatementLO 5LO 5

(continued)


From the income statement

To the balance sheet

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Retained Earnings Statement


Balance Sheet

A balance sheet is a list of the assets, liabilities, and stockholders’ equity as of a specific date.

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Account Form

The account form of a balance sheet lists the assets on the left and the liabilities and stockholders’ equity on the right. It resembles the basic format of the accounting equation.

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This amount is compared to the net

cash flow on the statement of cash flows.

From the retained earnings statement

Balance SheetLO 5LO 5


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Statement of Cash Flows

A statement of cash flows is a summary of the cash receipts and cash payments for a specific period of time. It consists of three sections:

(1) operating activities(2) investing activities(3) financing activities

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This amount should match Cash on the balance sheet.

Statement of Cash FlowsLO 5LO 5


Cash Flows from Operating Activities The cash flows from operating

activities section reports a summary of cash receipts and cash payments from operations.

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Cash Flows from Investing Activities The cash flows from investing

activities section reports the cash transactions for the acquisition and sale of relatively permanent assets.

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Cash Flows from Financing Activities The cash flows from financing

activities section reports the cash transactions related to cash investments by the owner, borrowings, and withdrawals by the owner.

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LO 5LO 5Interrelationships Among Financial Statements

Income Statement and Retained Earnings Statement

Net income or net loss reported on the income statement is also reported on the retained earnings statement as either an addition (net income) to or deduction (net loss) from the beginning retained earnings.


In Exhibit 6, NetSolutions’ net income of $3,050 for November is added to the beginning retained earnings on November 1, 2011, in the retained earnings statement.



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Retained Earnings Statement and and Balance Sheet

Retained earnings at the end of the period reported on the retained earnings statement is also reported on the balance sheet as retained earnings.

Interrelationships Among Financial Statements


In Exhibit 6, NetSolutions’ retained earnings of $1,050 as of November 30, 2011, on the retained earnings statement also appears on the November 30, 20l1, balance sheet as retained earnings.



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Balance Sheet and Statement of Cash Flows

The cash reported on the balance sheet is also reported as the end-of-period cash on the statement of cash flows.

Interrelationships Among Financial Statements


In Exhibit 6, cash of $5,900 reported on the balance sheet as of November 30, 2011, is also reported on the November statement of cash flows as the end-of-period cash.




Describe and illustrate the use of the ratio of

liabilities to stockholders’ equity in

evaluating a company’s financial condition.


Ratio of Liabilities to Stockholders’ Equity

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=Total Liabilities

Total Stockholders’ Equity


=$400

$26,050= 0.015


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Prepared by: C. Douglas Cloud Professor Emeritus of AccountingPepperdine University


Introduction to Accounting and Business

The EndThe End


Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned,

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