1. The Role of Accounting in Business
Chapter 1

2. Types of Businesses Service Business Manufacturing Business
Merchandising Business
Businesses come in all sizes—from your local hardware store to Lowes Home Improvement centers. The objective of most businesses is to earn a profit, or to receive more value for the goods or services provided than the cost to make or provide those goods and services.

3. Differences in Forms of Business Organization
Ease
Legal Liability
Taxation
Limited Life
Capital Access
Proprietorship
Simple
No limit
Nontaxable
Yes
Limited
Partnership
Average
Corporation
Complex
Taxable No
Extensive
Limited Liability Co.
Moderate
This table summarizes the similarities and differences among formats of organization discussed. While a manufacturing business, merchandising business, or service business can be organized under any of these formats, business that require a large amount of resources, such as a large manufacturer or merchandiser, usually are organized as corporations.

4. Premium Price Strategy
How Do Businesses Make Money?
By providing goods and services to customers so that they can make a profit. To maximize their profits, companies may use one of the following two strategies:
Low Cost Strategy
Premium Price Strategy
Companies try to maximize profits by earning high revenues while maintaining low costs. Increasing a company’s profits can be achieved by either increasing revenues, decreasing costs, or both. However, competitors usually try to do the same thing. Two general strategies are used to gain advantage over competitors.
(1) Low-cost strategy: here a company designs and produces products or services at a lower cost than its competitors.
(2) Premium-price strategy: here a company tries to design and produce products or services that serve unique market needs, allowing it to charge premium prices.

5. Common Business Activities
Investments by Owners
Loans from Creditors
contribute
Cash (Capital)
Retained earnings
Buy land, buildings,
equipment, patents
Purchase materials
Pay
employees
Pay other operating
expenses
Produce and market goods and services
results in
Monetary resources (revenues) from sale
of goods and services
used to
Pay dividends
Pay back loans/
interest
Pay taxes
Continue business
activity (market goods,
buy materials, etc.)

6. Business Stakeholders
Business stakeholders can come from several areas. Stakeholders can be generally classified into one of four categories:
Capital Market - Capital market stakeholders provide financing for a company to start up, expand, or continue business. Banks and creditors expect to recover the original amount loaned plus interest. Stockholders want to maximize the value of their investment in a business.
Product or Service Market - Product or service market shareholders purchase the company’s products and services or sell their products and services to the company. A customer has a stake in the continued health of a company in order to be assured they will receive their product or service. Likewise, a supplier has financial interest in the company; A supplier expects to be paid for the goods or services they provide to the company.
Government - Government stakeholders can be federal, state, country, city, or other regulatory bodies. The more successful a company, the more it will pay in taxes.
Internal - Finally, internal stakeholders include managers and employees who depend on the continued success of a company in order to remain employed.

7. The Role of Accounting in Business
Financial Accounting measures and communicates results of business activities to external stakeholders)
External stakeholders want to know:
The financial condition of a business at a point in time
Changes in the financial condition of a business over a period of time

8. The Role of Accounting in Business (continued)
Financial accounting answers four basic questions:
What is the company’s current financial status?
What were the company’s operating results for the period (income)?
How much of the income was retained in the business
How did the company obtain and use cash during the period?

9. Primary Financial Statements
Balance Sheet
Income Statement
Statement of Retained Earnings
Statement of Cash Flows

10. Sometimes referred to as a Statement of Financial Position
The Balance Sheet
Shows the financial position of a company at a point in time.
Assets: cash, accounts receivable, inventory, land, buildings, equipment, intangible items.
Liabilities: accounts payable, notes payable, mortgages payable.
Owners’ Equity: net assets after all debts have been satisfied.
What are the economic resources owned?
What are the company’s existing debts?
What are the company’s net assets?
Sometimes referred to as a Statement of Financial Position

11. A balance sheet reports the dollar amounts associated with the assets of a company and the sources of financing for those assets. As covered in the previous learning objective, a business can be financed by borrowing or owner investment. The balance sheet must therefore report the financial condition of a company at a point in time. The balance sheet is represented by the accounting equation of Assets = Liabilities + Stockholders’ Equity.
The balance sheet for Hershey shows total assets as of December 31, 2010 of $4,273 million. Total liabilities at the same point in time amount to $3,335 million and total stockholders’ equity is reported at $938 million. Total liabilities and equity add up to $4,273 million, which is equal to the total assets.

12. Sometimes referred to as a Statement of Earnings
The Income Statement
Shows the results of a company’s operations over a period of time.
Revenues
Assets (cash or AR) created through business operations
Expenses
Assets (cash or AP) consumed through business operations
Net Income or (Net Loss)
Revenues - Expenses
What goods were sold or services performed that provided revenue?
What costs were incurred to generate these revenues?
What are the earnings or company profit?
Sometimes referred to as a Statement of Earnings

13. The income statement summarizes revenue and expenses for a period of time in order to determine how well a company has performed and achieved its objective of generating profits. The time period covered by an income statement may vary depending on the needs of the stakeholders. This time period may also be called a fiscal period.
Since the objective of business operations is to generate a profit and profit can not be generated without revenue, the income statement begins by listing revenue. Revenue is followed by listing the expenses incurred in generating the revenue. By reporting the expenses and related revenues for a period, the expenses are said to be “matched” against the revenues. When revenues exceed expenses, the company has net income. A net loss results if expenses exceed revenues. The goal of a company is to maximize profits by either increasing revenues, decreasing costs or both. Businesses might survive net losses in the short run, but since a net loss decreases the overall assets of a company, in the long term, a business must earn net income to survive.
During 2010, Hershey generated sales of $5,671, expressed in millions of dollars. Following the revenues, Hershey’s expenses are listed and they include cost of sales, selling and administrative, interest, income taxes and other. During 2010, Hershey earned net income of $510 million. The net income can be good or bad depending on the user. A creditor may determine that the net income indicates sufficient profitability to repay an obligation. However, a stockholder may be disappointed that the $510 million of net income on $5,671 million of sales is not as successful when measured against a competitor’s performance.

14. Statement of Retained Earnings
Beginning retained earnings
+ Net income
– Dividends paid
= Ending retained earnings
An additional financial statement that identifies changes in retained earnings from one accounting period to the next.
Net income results in:
Increase in net assets
Increase in retained earnings
Increase in owners’ equity
Dividends result in:
Decrease in net assets
Decrease in retained earnings
Decrease in owners’ equity

15. Retained earnings represent the accumulated profits of a business that have been reinvested in the business rather than being paid out as dividends to the owners. Often times in growth companies, all earnings are retained in the business to fund expanding operations. Since retained earnings depend on net income, the time period covered by the retained earnings statement will be the same as the income statement.
In 2010, Hershey began the year with $4,148 million in retained earnings. The $510 million of net income is the same net income amount reported on the income statement. During 2010, Hershey also declared dividends of $283 million resulting in $4,375 remaining in retained earnings at the end of 2010.

17. The statement of cash flows reports events that affect a company’s cash account during a fiscal period. However, the statement itself is prepared as of a point in time, like the balance sheet. The statement of cash flows is organized around the three business activities of financing, investing, and operating.
During 2010, Hershey’s operating activities generated a positive cash flow of $901 million. Hershey’s investing activities used $199 million primarily to purchase property, plant, and equipment. Hershey’s financing activities used $71 million of cash, primarily due to repayment of debt and payment of dividends. Hershey also received $453 million by borrowing from creditors. Overall, during 2010, Hershey’s cash balance increased by $631 million to arrive at an end of period cash balance of $885 million. Another way to look at this statement is that Hershey generated $901 million of cash from operations which they used to expand operations and pay stockholders. This would indicated that Hershey is in a strong operating position.

18. Integrated Financial Statements
Preparing the financial statements in the order of income statement, retained earnings statement, balance sheet and statement of cash flows is important because the financial statements are integrated. Net income on the income statement links the income statement to the statement of retained earnings. Then, the final retained earnings balance from the statement of retained earnings is also reported on the balance sheet. Finally, the balance sheet and statement of cash flows are linked by the cash account.
For the Hershey Company, #1 shows the net income of $510 million on both the income statement and the statement of retained earnings. #2 then shows the ending retained earnings balance of $4,375 million both on the statement of retained earnings and also as a part of stockholders’ equity on the balance sheet. Finally, #3 integrates the balance sheet and the statement of cash flows by the cash balance of $885 million.
Statement of cash flows is linked to cash on the balance sheet.
Net income from the income statement is linked to the retained earnings statement.
Retained earnings is linked to the balance sheet in stockholders’ equity.

19. Paul’s Valet Parking
Given list of Account titles: (Note: the business started March 1st.)
Cash $2,000 Note Payable $1,200
Fees Earned $3,600 Retained Earnings $1,600
Rent Expense $500 Wage Expense $800
Land $1,500 Capital Stock $1,300
Dividends $700 Supplies $600
Complete the following Statements:

20. For the Month Ended March 31, 20__
Paul’s Valet Parking
Income Statement
For the Month Ended March 31, 20__
____________________________________________
Fees Earned $
Operating Expenses
Wage Expense $
Rent Expense $
Total Operating Expenses $
Net Income $

21. Retained Earnings Statement For the Month Ended March 31, 20__
Paul’s Valet Parking
Retained Earnings Statement
For the Month Ended March 31, 20__
____________________________________________
Retained Earnings, March 1 $ -0-
Net Income for March $
Less Dividends $
Retained Earnings, March 31 $

22. For the Month Ended March 31, 20__
Paul’s Valet Parking
Balance Sheet
For the Month Ended March 31, 20__
Assets
Cash $
Land $
Supplies $
Total Assets $
Liabilities
Note Payable $
Stockholders Equity
Capital Stock $
Retained Earnings $
Total Liabilities and Stockholders’ Equity $

23. Information for the Statement of Cash Flows for Paul’s Valet Parking
Cash borrowed on a note $1,200
Cash received from customers $3,600
Cash paid for wages $ 800
Cash paid for supplies $ 600
Cash paid for land $1,500
Cash received from issuing capital stock $1,300
Cash paid for rent $ 500
Cash paid in dividends $ 700

24. SOCF For the Month Ended March 31, 20__
Cash flows from Operating Activities:
Cash received from customers $
Cash paid for supplies $
Cash paid for wages $
Cash paid for rent $
Total cash from operating activities $
Cash flows form Investing Activities:
Cash paid for land $
Cash flows from Financing Activities:
Cash from issuance of stock $
Cash from note payable $
Cash paid for dividends $
Total cash from financing activities $
Total cash inflows $
Beginning cash $ -0-
Ending cash $

25. The Accounting “Rules”
Financial statements illustrated in the preceding section are prepared using accounting “rules” called generally accepted accounting principles or “GAAP”. These rules are necessary in order for stakeholders to be able to compare among companies and across time. Within the United States, the Financial Accounting Standards Board or “FASB” has the primary responsibility for developing accounting principles. The FASB publishes Statements of Financial Accounting Standards as well as interpretations of these standards. Many countries outside of the United States use generally accepted accounting principles adopted by the International Financial Reporting Standards Board or IASB. Currently, the FASB and IASB are working together to reduce and eliminate deficiencies and develop a single set of accounting principles.

26. Accounting Environment
Accountants follow generally accepted accounting principles (GAAP), which are authoritative guidelines that define accounting practice at a particular time
WHY?
Financial statements must be comparable and reliable.
External users need to understand the rules and assumptions used by companies when constructing financial statements.

27. Eight Concepts BUSINESS ENTITY COST CONCEPT ACCOUNTING PERIOD
GOING CONCERN
ADEQUATE DISCLOSURE
MATCHING CONCEPT
UNIT OF MEASURE
OBJECTIVITY CONCEPT
The business entity concept limits the economic data recorded in an accounting system to data related to the activities of the company. A company is viewed as an entity separate from its owners, managers, and other creditors.
The cost concept only considers the amount initially entered into the accounting records for purchases, usually their cost or purchase price. Property values assessed for taxes, market values, and other appraised values are not used for recording assets by a company.
The going concern concept assumes that a company will continue in business indefinitely. While it is unknown how long a business will continue, unless information exists that raises doubts about a company’s ability to continue, the company is assumed to be a going concern.
The matching principle requires companies to recognize the expenses used to generate revenue in the same accounting period in which the revenues are recognized. Revenue recognition relates to when revenue would be recorded. Revenues are normally recorded at the time a product is sold or service is rendered. At the point of sale, the sales price has been agreed on, the buyer acquires ownership, and the seller has a legal claim against the buyer for payment.
The objectivity concept requires that entries in the accounting records and data reported on financial statements be based on verifiable or objective evidence. In some cases, estimates and judgment factors would have to be used, but the most objective evidence available should be used.
In the United States, since the dollar is our national currency, all economic data must be recorded in dollars. Even though relevant non-financial data can be used in financial statements, transactions and activities of a business are measured, summarized, reported, and compared using dollars.
Financial statements are required to include any necessary footnotes or other disclosures that would contain all the necessary and relevant data for a stakeholder would need to understand the financial condition and performance of a company.
The accounting period and concept requires that accounting data be recorded and summarized in financial statements for periods of time. The financial history of a company can be traced through a series of balance sheet and income statements over a period of time.

28. Accounting Principles
1. 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. Could the computer be recorded as an asset in the accounting records of Sally’s dental office? Why or why not?

29. Accounting Principles (Continued)
2. 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? Support your answer.