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 Limited Liability Partnerships

10. Copyright © 2007 Prentice-Hall. All rights reserved 10 CharacteristicsCharacteristics Separate legal entity Continuous life and transferability of ownership No mutual agency Limited liability of stockholders Separation of ownership and management Corporate taxation Government regulation

11. Copyright © 2007 Prentice-Hall. All rights reserved 11 Organizing a Corporation Incorporators obtain charter from the state Charter authorizes corporation to: –issue stock –conduct business in accordance with state law and the corporation’s bylaws

12. Copyright © 2007 Prentice-Hall. All rights reserved 12 Organizing a Corporation Stockholders elect board of directors Board –Sets policy –Appoints officers –Elects a chairperson

13. Copyright © 2007 Prentice-Hall. All rights reserved 13 Objective 2 Apply accounting concepts and principles

14. Copyright © 2007 Prentice-Hall. All rights reserved 14 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)

15. Copyright © 2007 Prentice-Hall. All rights reserved 15 GAAPGAAP Primary objective of financial accounting – provide information that is useful for making investment and lending decisions

16. Copyright © 2007 Prentice-Hall. All rights reserved 16 Entity Concept Accounting Entity – organization that stands apart as a separate economic unit

17. Copyright © 2007 Prentice-Hall. All rights reserved 17 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

18. Copyright © 2007 Prentice-Hall. All rights reserved 18 Cost Principle Acquired assets and services should be recorded at their actual cost (historical cost)

19. Copyright © 2007 Prentice-Hall. All rights reserved 19 Going Concern Concept Assumes that the entity will remain in operation for the foreseeable future

20. Copyright © 2007 Prentice-Hall. All rights reserved 20 Stable-Monetary-Unit Concept Assumes that the dollar’s purchasing power is stable

21. Copyright © 2007 Prentice-Hall. All rights reserved 21 Objective 3 Use the accounting equation

22. Copyright © 2007 Prentice-Hall. All rights reserved 22 AssetsAssets Economic resources, expected to benefit the business in the future –Cash –Accounts receivable –Merchandise inventory –Furniture –Land

23. Copyright © 2007 Prentice-Hall. All rights reserved 23 Claims to the Assets Liabilities – economic obligations payable to an individual or organization outside the business –Accounts payable –Notes payable –Salary payable

24. Copyright © 2007 Prentice-Hall. All rights reserved 24 Claims to the Assets Owners’ Equity (stockholders’ equity) – Owners’ claims to the assets of the business

25. Copyright © 2007 Prentice-Hall. All rights reserved 25 Economic Resources Claims to Economic Resources The Accounting Equation Assets = Liabilities + Stockholders’ Equity

26. Copyright © 2007 Prentice-Hall. All rights reserved 26 The Accounting Equation Assets = Liabilities + Stockholders’ Equity Paid-in Capital Retained Earnings

27. Copyright © 2007 Prentice-Hall. All rights reserved 27 The Accounting Equation Stockholders’ Equity Paid-in Capital Retained Earnings Common Stock + Net Income - Dividends

28. Copyright © 2007 Prentice-Hall. All rights reserved 28 The Accounting Equation Retained Earnings + Net Income - Dividends Revenues - Expenses

29. Copyright © 2007 Prentice-Hall. All rights reserved 29 RevenuesRevenues Amounts earned by delivering goods or services to customers –Sales revenue –Service revenue –Interest revenue –Dividend revenue

30. Copyright © 2007 Prentice-Hall. All rights reserved 30 ExpensesExpenses Decrease in retained earnings 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

31. Copyright © 2007 Prentice-Hall. All rights reserved 31 Exercise 1-18 AssetsLiabilitiesStockholders’ Equity Pep Boys$ ?$60,000$21,000 Eddie Bauer72,000?40,000 Benbrook Exxon 100,00079,000? $81,000 32,000 21,000

32. Copyright © 2007 Prentice-Hall. All rights reserved 32 Objective 4 Analyze business transactions

33. Copyright © 2007 Prentice-Hall. All rights reserved 33 TransactionTransaction An event that affects the financial position of a particular entity and can be recorded reliably

34. Copyright © 2007 Prentice-Hall. All rights reserved 34 Exercise 1-17 a.Increased assets (cash) b.No effect on total assets c.Decreased assets (cash) d.Increased assets (equipment)

35. Copyright © 2007 Prentice-Hall. All rights reserved 35 Exercise 1-17 e.Increased assets (accounts receivable) f.Decreased assets (cash) g.No effect on total assets h.Increased assets (cash)

36. Copyright © 2007 Prentice-Hall. All rights reserved 36 Does the account increase or decrease? (1) Cash (asset) (2) Common stock (equity) July 6: Lange invested $45,000 in the business and was issued common stock Analyze this: What accounts are involved?

37. Copyright © 2007 Prentice-Hall. All rights reserved 37 DateAssetsLiabilitiesStockholder’s Equity JulyCashMedical Supplies LandAccounts Payable Common Stock Retained Earnings Type of Transaction Exercise 1-22 45,000Issued stock Assets = $45,000 Liabilities & Stockholders’ Equity = $45,000 45,0006

38. Copyright © 2007 Prentice-Hall. All rights reserved 38 (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? Was cash received or paid?

39. Copyright © 2007 Prentice-Hall. All rights reserved 39 DateAssetsLiabilitiesStockholder’s Equity JulyCashMedical Supplies LandAccounts Payable Common Stock Retained Earnings Type of Transaction Exercise 1-22 35,000 Assets = $45,000 (35,000)9 45,00035,00010,000Bal Liabilities & Stockholders’ Equity = $45,000 45,000Issued stock45,0006

40. Copyright © 2007 Prentice-Hall. All rights reserved 40 (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?

41. Copyright © 2007 Prentice-Hall. All rights reserved 41 DateAssetsLiabilitiesStockholder’s Equity JulyCashMedical Supplies LandAccounts Payable Common Stock Retained Earnings Type of Transaction Exercise 1-22 2,000 Assets = $47,000 2,00012 45,00035,00010,000Bal2,000 Liabilities & Stockholders’ Equity = $47,000 45,00035,00010,000Bal

42. Copyright © 2007 Prentice-Hall. All rights reserved 42 Does the account increase or decrease? (1) Cash (asset) (2) Retained earnings (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 company completes work, the owners’ interest in the assets increases.

43. Copyright © 2007 Prentice-Hall. All rights reserved 43 DateAssetsLiabilitiesStockholder’s Equity JulyCashMedical Supplies LandAccounts Payable Common Stock Retained Earnings Type of Transaction Exercise 1-22 Assets = $54,000 7,000 15-31 7,000 Revenue Liabilities & Stockholders’ Equity = $54,000 45,00035,00010,000Bal2,000 45,00035,00017,000Bal2,000 7,000

44. Copyright © 2007 Prentice-Hall. All rights reserved 44 Does the account increase or decrease? (1) Cash (asset) (2) Retained earnings (equity) Analyze This: July 15-31: Paid cash expenses What accounts are involved? When an expense is incurred, the owners’ claims to the assets decrease.

45. Copyright © 2007 Prentice-Hall. All rights reserved 45 DateAssetsLiabilitiesStockholder’s Equity JulyCashMedical Supplies LandAccounts Payable Common Stock Retained Earnings Type of Transaction Exercise 1-22 Assets = $51,000 (1,700) 15-31 (1,700) Salaries Exp (1,000) Rent Exp ( 1,000) ( 300) Utilities Exp ( 300) Liabilities & Stockholders’ Equity = $51,000 45,00035,00017,000Bal2,000 7,000 45,00035,00014,000Bal2,000 4,000

46. Copyright © 2007 Prentice-Hall. All rights reserved 46 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?

47. Copyright © 2007 Prentice-Hall. All rights reserved 47 DateAssetsLiabilitiesStockholder’s Equity JulyCashMedical Supplies LandAccounts Payable Common Stock Retained Earnings Type of Transaction Exercise 1-22 Assets = $51,000 500 28 (500) Liabilities & Stockholders’ Equity = $51,000 45,00035,00014,000Bal2,000 4,000 45,00035,00014,500Bal2,0001,500 4,000

48. Copyright © 2007 Prentice-Hall. All rights reserved 48 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?

49. Copyright © 2007 Prentice-Hall. All rights reserved 49 DateAssetsLiabilitiesStockholder’s Equity JulyCashMedical Supplies LandAccounts Payable Common Stock Retained Earnings Type of Transaction Exercise 1-22 Assets = $49,500 (1,500) 31 (1,500) Liabilities & Stockholders’ Equity = $49,500 45,00035,00014,500Bal2,0001,500 4,000 45,00035,00013,000Bal 5001,500 4,000

50. Copyright © 2007 Prentice-Hall. All rights reserved 50 Objective 5 Prepare financial statements Evaluate business performance Objective 6

51. Copyright © 2007 Prentice-Hall. All rights reserved 51 Financial Statements Income statement Statement of retained earnings Balance sheet Statement of cash flows

52. Copyright © 2007 Prentice-Hall. All rights reserved 52 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

53. Copyright © 2007 Prentice-Hall. All rights reserved 53 Statement of Retained Earnings Summary of changes in an entity’s retained earnings during a specific period Beginning retained earnings + Net income or - Net loss - Dividends Ending retained earnings

54. Copyright © 2007 Prentice-Hall. All rights reserved 54 Balance Sheet Reports the entity’s assets, liabilities, and stockholders’ equity as of a specific date Assets = Liabilities + Stockholders’ Equity

55. Copyright © 2007 Prentice-Hall. All rights reserved 55 Statement of Cash Flows Reports cash receipts and cash payments during a period (covered in subsequent chapter)

56. Copyright © 2007 Prentice-Hall. All rights reserved 56 Maria Lange, M.D., P.C Income Statement For the Month Ended July 31, 2004 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.

57. Copyright © 2007 Prentice-Hall. All rights reserved 57 Retained earnings, July 1, 2004$ 0 Add: Net income for the month4,000 Subtotal$4,000 Less: Dividends 0 Retained earnings, July 31, 2004$4,000 Maria Lange, M.D., PC. Statement of Retained Earnings For the Month Ended July 31, 2004 Dates are important to the reader of the financial reports. From income statement

58. Copyright © 2007 Prentice-Hall. All rights reserved 58 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

59. Copyright © 2007 Prentice-Hall. All rights reserved 59 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

60. Copyright © 2007 Prentice-Hall. All rights reserved 60 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

61. Copyright © 2007 Prentice-Hall. All rights reserved 61 Maria Lange, M.D., P.C. Balance Sheet July 31, 2004 Assets Cash$13,000 Medical supplies1,500 Land 35,000 Total assets$ 49,500 Liabilities Accounts payable$500 Stockholders’ Equity Common stock$45,000 Retained earnings 4,000 Total stockholders’ equity49,000 Total liabilities and stockholder’s equity$ 49,500 From statement of retained earnings Notice the proper Heading.

62. Copyright © 2007 Prentice-Hall. All rights reserved 62 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

63. Copyright © 2007 Prentice-Hall. All rights reserved 63 Cash$2,000 Accounts receivable6,000 Supplies500 Equipment15,500 Total Assets$24,000 Allen Samuel Road Service, Inc. Balance Sheet November 30, 2009 Liabilities Accounts payable$3,500 Note payable5,000 Total liabilities$8,500 Stockholders’ Equity Common stock$10,000 Retained earnings5,500 Total stockholders’ equity 15,500 Total liabilities & stockholders $24,000 Assets Exercise 1-24

64. Copyright © 2007 Prentice-Hall. All rights reserved 64 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

65. Copyright © 2007 Prentice-Hall. All rights reserved 65 Exercise 1-25 Ciliotta Design Studio, Inc. 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

66. Copyright © 2007 Prentice-Hall. All rights reserved 66 Exercise 1-25 2.Stockholder’s equity: Common stock$15,000 Retained earnings??? Total stockholders’ equity$27,100 Retained earnings, beginning$ 0 Add: Net income62,100 Deduct: Dividends????? Retained earnings, ending$12,100 (50,000) 12,100

67. Copyright © 2007 Prentice-Hall. All rights reserved 67 End of Chapter 1