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1 - 1©2002 Prentice Hall, Inc. Business Publishing Accounting, 5/E Horngren/Harrison/Bamber

Accounting and theBusiness

EnvironmentChapter

1


Objective 1

Use accounting vocabulary

for decision making.


is an information system that...is an information system that...

measures business activities,measures business activities,

processes information, and...processes information, and...

communicates financial information.communicates financial information.

Accounting...


is called the language of business.is called the language of business.

Accounting...

€


External usersmake decisionsabout the entity.

External usersmake decisionsabout the entity.

Internal usersmake decisionsfor the entity.

Internal usersmake decisionsfor the entity.

Users of Accounting Information


Management AccountingManagement Accounting

Financial AccountingFinancial Accounting

Fields of Accounting


Public Sector(SEC)

Public Sector(SEC)

Private Sector(FASB)

Private Sector(FASB)

Private Sector(AICPA) (IMA)

Private Sector(AICPA) (IMA)

GAAPGAAP

The Authority Underlying Accounting


AICPA’s Code ofProfessional

Conduct

AICPA’s Code ofProfessional

Conduct

Standards ofEthical

Conduct of theInstitute of

ManagementAccountants

Standards ofEthical

Conduct of theInstitute of

ManagementAccountants

Standards of Professional Conduct


ProprietorshipsProprietorships

PartnershipsPartnerships

CorporationsCorporations

Types of Business Organizations


ProprietorshipsProprietorships

What are some advantages?– total undivided authority– no restrictions on type of business – must

be legal What are some disadvantages?– unlimited liability– limitation on size – fund raising power


Partnerships

What are some advantages?– better credit standing – possibly– more brain power, but consultation with

partners required What are some disadvantages?– unlimited personal liability for general

partners– need for written partnership agreement


Corporations

What are some advantages?– separate legal existence– limited liability of stockholders– transferability of ownership relatively easy What are some disadvantages?– taxes – possible double taxation– extensive governmental regulation


Objective 2

Apply accountingconcepts and

principlesto business situations.


To provide information usefulfor making investment and

lending decisions

To provide information usefulfor making investment and

lending decisions

Generally AcceptedAccounting Principles

What is the primary objective of financial reporting?


The Entity Concept Example

Assume that John decides to open up a gas station and coffee shop.

The gas station made $250,000 in profits, while the coffee shop lost $50,000.


The Entity Concept Example

How much money did John make? At a first glance, we would assume that

John made $200,000. However, by applying the entity concept we

realize that the gas station made $250,000 while the coffee shop lost $50,000.


Information mustbe reasonably

accurate.

Information mustbe reasonably

accurate.

Information mustbe free from bias.Information mustbe free from bias.

Information must report what

actually happened.

Information must report what

actually happened.

Individuals wouldarrive at similar

conclusions usingsame data.

Individuals wouldarrive at similar

conclusions usingsame data.

The Reliability (Objectivity) Principle


Assets and servicesacquired

should be recordedat their actual cost.

Assets and servicesacquired

should be recordedat their actual cost.

The Cost Principle


The entity will continueto operate in the future.The entity will continueto operate in the future.

The Going Concern Concept


The dollar’s purchasingpower is relatively

stable.

The dollar’s purchasingpower is relatively

stable.

The Stable-Monetary-Unit Concept


Objective 3Objective 3

Use the accounting equationto describe an organization’s

financial position.


EconomicResources

Claims toEconomicResources

The Accounting Equation

Assets = Liabilities + Owner’s Equity


Assets

What is an asset? It is something a company owns which

has future economic value.– land– building– equipment– goodwill


Liability

What is a liability? It is something a company owes.– money– service – legal retainers– product – magazines


Owner’s Equity

What is owner’s equity? It is what’s left of the assets after liabilities

have been deducted.– the same as net assets– the owner’s claim on the entity’s assets


Transactions that AffectOwner’s Equity

OWNER’S EQUITYINCREASES

OWNER’S EQUITYDECREASES

Owner Investmentsin the Business

Revenues Expenses

Owner Withdrawalsfrom the Business

Owner’s Equity


Revenues

What are revenues? They are amounts received or to be received

from customers for sales of products or services.

– sales– performance of services– rent– interest


ExpensesExpenses

What are expenses? They are amounts that have been paid or will

be paid later for costs that have been incurred to earn revenue.

– salaries and wages– utilities– supplies used– advertising


Objective 4Objective 4Objective 4Objective 4

Use the accounting equation to analyze business transactions.


Accounting for Business Transactions

What is a transaction? It is any event that both affects the financial

position of the business and can be reliably recorded.



1 Gay Gillen invests $30,000 to begin Gay Gillen eTravel.

2 Gillen purchases an office location, paying $20,000 in cash.

3 She buys office supplies, agreeing to pay $500 in 30 days.

4 She earns and collects $5,500 revenues.



5 Gillen performs services, and the client agrees to pay $3,000 within one month.

6 During the month, she pays $3,100 for expenses incurred.

7 Gillen pays $300 to the store from which she purchased $500 worth of supplies.

What is the effect of these transactions on the accounting equation?


Owner’s Assets = Liabilities + Equity

1) Cash + $30,000 + $30,0002) Cash – 20,000

Land + 20,0003) Supplies + 500 + 5004) Cash + 5,500 + 5,5005) Receivable + 3,000 + 3,0006) Cash – 3,100 – 3,1007) Cash – 300 – 300 Totals + $35,600 + 200 + $35,400




Notice that the equation always stays in balance.

Each transaction affects at least two accounts, sometimes more.

Some transactions affect only one side of the equation; some affect both sides.



Other transactions that took place were as follows:

The business collected $1,000 from the client.

She sold some land at cost for $9,000. She withdrew $2,100 from the business.



Prepare and usefinancial statements.


– are the finalproduct of the

accounting process.

– are the finalproduct of the

accounting process.

– tell how thebusiness is performing

and where it stands.

– tell how thebusiness is performing

and where it stands.

Financial Statements...


Financial StatementsFinancial Statements

– income statement– statement of owner’s equity or retained

earnings– balance sheet– statement of cash flows



Evaluate the performanceof business.


Relationships Among the Statements:

Income StatementRevenue:

Fees earned $8,500

Expenses:

Salary expense $1,200

Utilities and telephone expense 400

Equipment rental expense 400

Office rent expense 1,100 3,100

Net income $5,400


G. Gillen, capital, April 1, 20xx $ 0

Contribution of capital 30,000

Net income $ 5,400

Cash distributions – 2,100

G. Gillen, capital, April 30, 20xx $33,300


Statement of Owner’s Equity



Balance Sheet

Assets

Cash $ 20,000

Accounts receivable 2,000

Supplies 500

Land 11,000

Total assets $ 33,500

Liabilities

Accounts payable $ 200

Owner’s equity,

G. Gillen, capital 33,300

Total liabilities and

owner’s equity $33,500



Statement Of Cash FlowsCash flows from operating activities:Cash receipts from services rendered $6,500Cash payments:

Supplies $ 300Operating expenses 3,100 3,400

Net cash flows fromOperating activities $3,100Cash flows from investing activitiesPurchase and sale of land

($11,000)


Cash Flows from Financing Activities:

Investment by Owner$30,000

Withdrawals 2,100

Net Cash Flows from Financing Activities$27,900

Cash at Beginning of Year 0

Cash at End of the Year $20,000


Statement Of Cash Flows


End of Chapter 1

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