1. Accounting as a Form of Communication
Chapter 1
Accounting as a Form of
Communication

2. Learning Objectives LO1 Explain what business is about.
LO2 Distinguish among the forms of organization.
LO3 Describe the various types of business activities.
LO4 Define accounting and identify the primary users of accounting information and their needs.
LO5 Explain the purpose of each of the financial statements and the relationships among them and prepare a set of simple statements.
LO6 Identify and explain the primary assumptions made in preparing financial statements.

3. Learning Objectives (continued)
LO7 Identify the various groups involved in setting accounting standards and the role of auditors in determining whether the standards are followed.
LO8 Explain the critical role that ethics plays in providing useful financial information.

4. Module 1 The Nature of Business
Business consists of all activities necessary to provide members of an economic system with goods and services
Module 1

5. Types of Businesses
Certain business activities focus on providing goods or products
Companies can:
produce or manufacture the products
distribute the products
sell directly to the consumer
Suppliers, manufacturers, wholesalers, and retailers are examples of product companies
Module 1: LO 1

6. Exhibit 1-1—Types of Businesses
Module 1: LO 1

7. Business Entities
Business Entity: organization operated to earn a profit
Sole Proprietorships: organization with a single owner
Partnerships: business owned by two or more individuals
Often used by accounting firms and law firms
Corporations: entity organized under the laws of a particular state
Ownership is established by acquiring shares of stock
Module 1: LO 2

8. Exhibit 1-2—Forms of Organization
Module 1: LO 2

9. Nonbusiness Entities
Organizations operated for some purpose other than to earn a profit
Do not have an identifiable owner
Fund accounting is used by nonbusiness entities
Module 1: LO 2

10. Organizations and Social Responsibility
U.S. business entities recognize the societal aspects of their overall mission and have established programs to meet these responsibilities
Module 1: LO 2

11. The Nature of Business Activity
All business activities can be categorized as operating, investing, or financing activities
Financing activities: raising money from owners’ contributions as well as obtaining loans from outsiders
Investing activities: investing the amounts raised from financing activities in various types of assets
Operating activities: providing goods and services to customers
Module 1: LO 3

12. Exhibit 1-3—A Model of Business Activities
Module 1: LO 3

13. Module 2 Accounting and Financial Statements
The primary users of financial statements depend on the economic information conveyed in those statements to make decisions
Accounting: the process of identifying, measuring, and communicating economic information to various users to permit informed judgments and decisions
Module 2

14. Users of Accounting Information
Primary users may be broadly classified as internal and external users
Internal users are usually managers of a company
External users include stockholders, investors, creditors, and government agencies
Module 2: LO 4

15. Management and Financial Accounting
Management accounting: the branch of accounting concerned with providing internal users with information to facilitate planning and control
Financial accounting: the branch of accounting concerned with the preparation of financial statements for external users
Module 2: LO 4

16. Exhibit 1-4—Users of Accounting Information
Module 2: LO 4

17. Financial Decision Framework
Formulate the question
Gather information from the financial statements and other sources
Analyze the information gathered
Make the decision
Monitor your decision
Module 2: LO 4

18. The Accounting Equation
Assets = Liabilities + Owners’ Equity
Left side: valuable economic resources that will provide future benefit to the company
Right side: indicates who provided, or has a claim to, the assets
Stockholders’ equity, or shareholders’ equity: used to refer to the owners’ equity of a corporation
Module 2: LO 5

19. Stockholders’ Equity
Created when a company issues stock to an investor
Retained earnings: earnings accumulated or retained by the company
Module 2: LO 5

20. The Balance Sheet
Financial statement that summarizes the assets, liabilities, and owners’ equity of a company
Sometimes called the statement of financial position
At any point in time, assets must equal liabilities and owners’ equity
Module 2: LO 5

21. Example 1-4—Preparing a Balance Sheet
Module 2: LO 5

22. Exhibit 1-5—The Accounting Equation and the Balance Sheet
Module 2: LO 5

23. The Income Statement
Summarizes the revenues and expenses of a company for a period of time
Module 2: LO 5

24. Example 1-5—Preparing an Income Statement
Module 2: LO 5

25. The Statement of Retained Earnings
Summarizes the income earned and dividends paid over the life of a business
Dividends: Distribution of the net income of a business to its owners
Module 2: LO 5

26. The Statement of Cash Flows
Summarizes a company’s cash receipts and cash payments during the period from operating, investing, and financing activities
Module 2: LO 5

27. Exhibit 1-6—Relationships Among the Financial Statements
Module 2: LO 5

28. Module 3 Conceptual Framework of Accounting
The usefulness of accounting information is enhanced through the various assumptions set forth in the conceptual framework developed by the accounting profession
This conceptual framework is the foundation for the methods, rules, and practices that make up generally accepted accounting principles (GAAP)
Module 3

29. Conceptual Framework for Accounting
Important assumptions in the conceptual framework are as follows:
Economic entity concept
Cost principle
Going concern
Monetary unit
Time period
Module 3: LO 6

30. Economic Entity Concept
Single, identifiable unit must be accounted for in all situations
Specific entity be the subject of a set of financial statements
Does not intermingle the personal assets and liabilities of the employees or any of the other stockholders
Module 3: LO 6

31. Cost Principle Assets are recorded at the cost to acquire them
Original cost or historical cost—until the company disposes them
More objective than market value
Module 3: LO 6

32. Going Concern Assume entity will continue indefinitely into the future
Justifies use of historical cost
Module 3: LO 6

33. Monetary Unit
Yardstick used to measure amounts in financial statements
The dollar is used because it is the recognized medium of exchange in the United States
Assumes monetary unit is relatively stable; no adjustment for inflation made in financial statements
Module 3: LO 6

34. Time Period Assumption
Artificial segment on the calendar used as the basis for preparing financial statements
Accountants assume that it is possible to prepare an income statement that accurately reflects net income or earnings for a specific time period
Module 3: LO 6

35. Setting Accounting Standards
Financial statements are the responsibility of management. Various groups are involved in setting the standards that are used in preparing the statements
Although the SEC has the ultimate authority to determine the rules, the FASB currently sets the standards in the United States
Module 3: LO 7

36. Setting Accounting Standards
Generally accepted accounting principles (GAAP)
Various methods, rules, practices, and other procedures—preparing financial statements
Securities and Exchange Commission (SEC)
Federal agency with ultimate authority to determine the rules for preparing statements
Financial Accounting Standards Board (FASB)
Authority to set accounting standards
Module 3: LO 7

37. Setting Accounting Standards (continued)
American Institute of Certified Public Accountants (AICPA)
Professional organization of Certified Public Accountants (CPAs)
Public Company Accounting Oversight Board (PCAOB)
Five-member body created by an act of Congress in 2002 to set auditing standards
International Accounting Standards Board (IASB)
Develop worldwide accounting standards
Module 3: LO 7

38. The Audit of Financial Statements
Most stockholders are not actively involved in the daily affairs of the business
Auditing: examining whether financial statements are fairly presented
External auditor performs various tests and procedures to render an opinion as to whether the financial statements of a company are fairly presented
Auditors’ report is an opinion, not a statement of fact
Module 3: LO 7

39. Introduction to Ethics in Accounting
Ethics plays a critical role in providing useful financial information
Investors and other users must have confidence in a company, its accountants, and its outside auditors that the information presented in financial statements is relevant, complete, neutral, and free from error
Module 3: LO 8

40. Why Should Accountants Be Concerned with Ethics?
Moral and social ethical behavior must be considered while decision making
Recent news of questionable accounting practices has placed increased scrutiny on the accounting profession
Professional judgment is often needed to arrive at appropriate decisions when some question arises about the application of GAAP
Module 3: LO 8

41. Exhibit 1-9—Ethics and Accounting: A Decision-Making Model
Module 3: LO 8

42. Review LO1 Explain what business is about.
Business consists of all activities necessary to provide members of an economic system with goods and services. Suppliers, manufacturers, wholesalers, and retailers are examples of product companies.
LO2 Distinguish among the forms of organization.
Some entities are organized to earn a profit, while others are organized to serve various segments of society.
The three forms of business entities are sole proprietorships, partnerships, and corporations.

43. Review LO3 Describe the various types of business activities.
All business activities can be categorized as operating, investing, or financing activities.
Financing activities involve raising money from contributions made by the owners of a business as well as obtaining loans from outsiders.
Companies invest the amounts raised from financing activities in various types of assets, such as inventories, buildings, and equipment.
Once funds are obtained and investments are made in productive assets, a business can begin operations. Operating activities involve providing goods and services to customers.

44. Review
LO4 Define accounting and identify the primary users of accounting information and their needs.
The primary users of financial statements depend on the economic information conveyed in those statements to make decisions. Primary users may be broadly classified as internal and external users.
Internal users are usually managers of a company.
External users include stockholders, investors, creditors, and government agencies.

45. Review
LO5 Explain the purpose of each of the financial statements and the relationships among them and prepare a set of simple statements.
Four major financial statements are covered in this chapter: balance sheet, income statement, statement of retained earnings, and statement of cash flows.
The balance sheet is a snapshot of a company’s financial position at the end of the period. It reflects the assets, liabilities, and stockholders’ equity accounts.
The income statement summarizes the financial activity for a period of time. Items of revenues, expenses, gains, and losses are reflected on the income statement.
Ultimately, all net income (loss) and dividends are reflected in retained earnings on the balance sheet. The statement of retained earnings links the income statement to the balance sheet by showing how net income (loss) and dividends affect the Retained Earnings account.
The statement of cash flows summarizes the cash flow effects of a company’s operating, investing, and financing activities.

46. Review
LO6 Identify and explain the primary assumptions made in preparing financial statements.
The usefulness of accounting information is enhanced through the various assumptions set forth in the conceptual framework developed by the accounting profession. This conceptual framework is the foundation for the methods, rules, and practices that make up generally accepted accounting principles (GAAP).
Important assumptions in the conceptual framework are as follows:
Economic entity concept
Cost principle
Going concern
Monetary unit
Time period

47. Review
LO7 Identify the various groups involved in setting accounting standards and the role of auditors in determining whether the standards are followed.
Financial statements are the responsibility of management. Various groups are involved in setting the standards that are used in preparing the statements. Although the SEC has the ultimate authority to determine the rules, the FASB currently sets the standards in the United States.
The role of the external auditor is to perform various tests and procedures to render an opinion as to whether the financial statements of a company are fairly presented.
LO8 Explain the critical role that ethics plays in providing useful financial information.
All decision makers must consider the moral and social implications of their decisions.
Recent news of questionable accounting practices has placed increased scrutiny on the accounting profession. Professional judgment is often needed to arrive at appropriate decisions when some question arises about the application of GAAP.

48. End of Chapter 1