1 Chapter 9: Accounting Basic Accounting Concepts Businesses engage in activities that concentrate on financial worth, such as money, spending, expenses, mergers, and costs. What Accountants Do Accountants make meaningful and effective decisions based on up to date and accurate records of a company. Accounting is the process of recording, analyzing, and interpreting the financial or economic activities of a business. Financial activities in business are recorded as transactions: recording something of value for something else of value. Bookkeeping is the recording of all transactions for a business in a specific format. Double-Entry Bookkeeping The principle that each transaction involves two changes is known as double-entry bookkeeping: one increase results in one decrease, two increases results in two decreases, and so on.

2 Chapter 9: Accounting Basic Accounting Concepts Accounting and Individuals Individuals need to keep accurate financial records. People often allow organizations to take preauthorized payments resulting in money taken automatically and on a regular basis from their bank accounts. Assets Assets are things of value that a business or person owns. Liabilities Liabilities are debts or amounts of money that are owed to others by an individual or a business. Personal Equity or Net Worth A person’s assets, after all liabilities are deducted, is known as personal equity or net worth.

3 Chapter 9: Accounting Basic Accounting Concepts Accounting and Businesses A businesses’ assets and liabilities are used to calculate the net worth— the owner’s equity. Owner’s Equity Owner’s equity is the owner’s investment in the business or the financial portion of the business that belongs to the owners or shareholders. Assets – Liabilities = Owner’s Equity Balance Sheet Equations The balance sheet equation can be expressed in two ways: 1. To determine owner’s equity: Assets – Liabilities = Owner’s Equity 2. To determine total assets: Assets = Liabilities + Owner’s Equity

4 Chapter 9: Accounting Basic Accounting Concepts Cost Principle and Depreciation The accounting practice of always recording an asset at the actual amount it costs the business is known as the cost principle. Even when an asset depreciates or loses value over time the asset value on the books remains the same. Mark’s Repair Shop Here are the assets of Mark’s Repair Shop. cash in the business and in a bank account ($6500) accounts receivable ($8100) invoicing supplies ($500) parts inventory ($4000) business equipment (truck) ($25 500) building and land ($ ) Total Assets = $

5 Chapter 9: Accounting Basic Accounting Concepts Mark’s Repair Shop Here are Mark’s debts or liabilities. accounts payable ($7350) bank loan for truck ($11 050) mortgage payable (on building) ($ ) Total Liabilities = $ Equity calculation for Mark’s net worth can be calculated as follows: Assets – Liabilities = Owner’s Equity $ $ = $91 200

6 Chapter 9: Accounting Preparing Financial Statements The balance sheet, the income statement, and the statement of cash flow helps owners and managers keep track of the financial health of the business. The financial statements provide outsiders with accurate information about the business. Preparing a Balance Sheet The balance sheet shows the financial position on any given day of the business, and provides information about its assets, liabilities, and equity. Balance Sheet Equation Method The balance sheet gets its name because the left side of the equation (assets) always equals the right side (liabilities plus owner’s equity). Assets are owned by one of two groups 1.owner(s) of the business (owner’s equity) 2.individuals or businesses owed money (liabilities)

7 Chapter 9: Accounting Preparing Financial Statements Mark’s Repair Shop Balance Sheet September 30, 20__ Assets Liabilities Cash $6 500 Accounts Payable Accounts Receivable Bank Loan Supplies 500 Mortgage Payable Parts Inventory Total Liabilities $ Equipment Building and Land Owner’s Equity Mark Bianchet, Equity $ Total Liabilities and Total Assets $ Owner’s Equity Step 1 Statement Headings Step 2 List Assets Step 3 List Liabilities Step 4 Calculate Owner’s Equity Step 5 Put It All Together

8 Chapter 9: Accounting Preparing Financial Statements Balance Sheet Report Form Method Computer programs easily complete the balance sheet using an up-and-down column format rather than a side-by-side format. Preparing an Income Statement The income statement is a financial statement that shows a business’s profit (or loss) over a stated period of time. The money, or the promise of money, received from the sale of goods or services is called revenue. Expenses are expenditures that help a business generate revenue.

9 Chapter 9: Accounting Preparing Financial Statements Income Statements for Service Businesses Mark’s Repair Shop Income Statement For the month ending September 30, 20__ Revenue Repairs Revenue$ Total Revenue$ Expenses Salaries$ Rent Advertising 850 Supplies 185 Utilities 235 Insurance 150 Delivery Expense 770 Total Expenses$ Net Income$ Step 1 Statement Headings Step 2 Organize Revenue Section Step 3 Organize Expenses Section Step 4 Calculate Net Income/Loss

10 Chapter 9: Accounting Preparing Financial Statements Income Statements for Retail Businesses Balance sheets for retail businesses are similar to those of service businesses. However, retail businesses need to take the cost of inventory (goods on hand to be sold) into account. Income Statement Equations Income statement equation for a service business. Revenue – Expenses = Net Income Income statement equation for a retail business. Revenue – Cost of Goods Sold = Gross Profit Gross Profit – Expenses = Net Income

11 Chapter 9: Accounting Preparing Financial Statements Income Statements and Inventory Tracking of inventory is critical. It saves the retail business money and increases customer satisfaction. When a physical count of inventory is taken, it is compared to the on-going count that is usually maintained by computer systems. Operating expenses are deducted from the gross profit to determine the net profit. Beginning Inventory, Jan.1, 20__ $ Inventory Purchased Costs of All Goods for Sale Ending Inventory, Dec. 20__ Costs of Goods Sold Sales Revenue$ Cost of Goods profit Gross Profit Gross Profit $ Expenses Net Profit $40 000

12 Chapter 9: Accounting Basic Accounting Concepts Owner’s Equity Account The net profit is calculated first then transferred to the balance sheet as part of owner’s equity. Creditors and owners have claims on the assets of the business. Preparing a Statement of Cash Flow Cash flow is the movement of cash-in and cash-out of a business. The statement of cash flow is a summary of the cash-in and cash-out transactions of a business that helps to predict the amount of cash it needs to meet obligations. Owner’s Equity C. Donahue, Capital, Jan. 1, 20__ $ Add: Net Income $ C. Donahue, Capital, Dec. 31, 20__ $ Projected Cash Flow Statement Mark’s Repair Shop October 31, 20__ TransactionIn (+)Out (-) Investment Income +$ Accounts Receivables Equipment to be Sold Payroll Not Yet Paid -$ Loan Repayment Insurance Due Projected Cash Flow “Capital” is added to identify the owner’s account

13 Chapter 9: Accounting Basic Accounting Concepts Ways to Increase Cash Flow A business must consider several ways to meet its obligations if cash flow is inefficient. A business might seek extra investments, reduce inventory purchases, and increase efforts to collect accounts receivables. Cash-flow Implications of Credit and Debit Cards Business that allow customers to use a credit and/or debit card do not have wait for their money (accounts receivables); they receive their money (sales revenue) up front. Since these businesses take a long time to pay their own bills, they invest the customers’ cash to make more money.

14 Chapter 9: Accounting Basic Accounting Concepts Interpreting Financial Statements Financial statement information allows accountants to make recommendations to owners regarding future business decisions. Accountants compare data over a set period of time, usually two or more years. A Final Measure of Success For a business to be successful, the return on the owner’s investment should be equal to or greater than the return for a savings account, bond, or mutual fund.