chapter 1 accounting and the business environment

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Chapter 1

Accounting and The Business Environment

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Decision Makers

Individuals Businesses

Creditors Investors

Taxing Authorities

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Two Fields of AccountingFinancial AccountingProvides information for external decision makers

– Investors– Creditors– Taxing Authorities

Managerial AccountingFocuses on information for internal decision makers

ManagersBusiness OwnersEmployees

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S1-2: USERS OF FINANCIAL INFORMATION Suppose you are the manager of Greg’s Tunes, Inc. The company needs a bank loan in order to purchase music equipment. In evaluating the loan request, the banker asks about the assets and liabilities of the business. In particular, the banker wants to know the amount of the business’s stockholders’ equity.Requirements:1.Is the banker considered an internal or external user of financial information?

2.Which financial statement would provide the best information to answer the banker’s questions?

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The Accounting Profession• Lucrative career with many opportunities• Certified Public Accountants (CPAs)

Certified Public Accountants, or CPAs

Certified Management

Accountants, or CMAs

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Governing OrganizationsFASB

SEC

AICPA

GAAP

IASB

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Ethics in Accounting and Business

Investors and creditors want reliable financial information

Companies want to attract investors

Conflict of Interest

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Audit• SEC requires companies to have financial

statements examined by independent accountants– Auditors will provide an opinion on financial

statements, if possible• Recent accounting scandals hurt investor

confidence– SOX – PCAOB

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Standards of Professional Conduct

AICPA IMA

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Types of Business Organizations

Proprietorship Partnership

Corporation LLC and LLP

Not-for-profit

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Comparison of Business FormsProprietorship Partners Corporation LLC, LLP Not-for-

Profit

Owners Proprietor:One Owner

Partners: Two or more

Stockholders: usually many Members None

Life of Organization

Limited by owner's

choice or death

Limited by owners’

choice or death

Indefinite Indefinite Indefinite

Liability of owners for business debts

Proprietor: Owner is

personally liable

Partners are personally

liable

Stockholders not personally

liable

Members are not

personally liable

Fiduciary liabilityof board members

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Corporate CharacteristicsSeparate Legal Entity

Continuous Life/Transferability of Ownership

No Mutual Agency

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Corporate Characteristics(continued)

Limited Liability of Stockholders

Separation of Ownership and Management

Government Regulation

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Corporate Characteristics(continued)

Corporate Taxation

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Organization of a Corporation• Incorporators obtain charter from the state• Charter authorizes corporation to:

Issue stockConduct business in accordance with state law

• Incorporators agreed to a set of bylaws• Corporations begins to exist when stock is

issued

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Structure of a Corporation

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S1-4: TYPES OF BUSINESS ORGANIZATION

Chloe Michaels plans on opening Chloe Michaels’ Floral Designs. She is considering the various types of business organizations and wishes to organize her business with unlimited life and limited liability features. Additionally, Chloe wants the option to raise additional equity easily in the future. Which type of business organization will meet Chloe’s needs best?

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GAAP• Generally Accepted Accounting Principles

Guidelines that govern accountingBased on a conceptual framework

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Accounting Principles

Entity Concept

Faithful Representation

Principle

CostPrinciple

Going- Concern Concept

Stable Monetary Unit

Concept

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Accounting PrinciplesEntity Concept

Faithful Representation Principle

Cost Principle

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Accounting Principles(continued)

Going-Concern

Stable Monetary Unit Concept

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The Accounting Equation

ASSETS LIABILITIES EQUITY

EconomicResources

Claims to EconomicResources

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Assets• Economic resources • Benefit the business in the future

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Claims to AssetsLiabilities• Debts payable to

outsiders

Equity• Owners’ claims to the

assets of the business

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The Accounting Equation

AssetsLiabilities

Equity

Assets Liabilities Equity

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Equity of a Corporation

Assets Liabilities Stockholders’equity

Paid-in capital

Retained earnings

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Equity of a Corporation

Stockholders’ equity

Paid-in capital Common stock

Retained earnings

+ Net income(loss)

- Dividends

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Net Income

Retained earnings

+ Net income(loss)

- Dividends

+ Revenues

- Expenses

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Revenues• Amounts earned by delivering goods or

services to customersSales revenueService revenueInterest revenueDividend revenue

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Expenses• Outflows of assets or increasing liabilities in

the course of delivering goods or services to customers

Store or rent expenseSalary expenseAdvertising expenseUtilities expenseInterest expenseProperty tax expense

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E1-16: CHARACTERISTICS OF A CORPORATION, ACCOUNTING CONCEPTS, AND USING THE

ACCOUNTING EQUATIONSelect financial information for three corporations follows:

Requirements:1. Compute the missing amount in the accounting equation for each entity.

Assets Liabilities EquityNew Rock Gas $24,000 $50,000DJ Video Rentals $75,000 $32,000Corner Grocery $100,000 $53,000

$ ?

$ ?$ ?

$74,000

$43,000$47,000

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E1-16: CONTINUED2. List the seven main characteristics of a corporation.

3. Which accounting concept tells us that the previous three corporations will continue to exist in the future?

Continuous Life and transferabilityCorporate taxation

Government regulationLimited Liability of Stockholders

No Mutual AgencySeparate Legal Entity

Separation of ownership and managers

Going Concern Concept

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Transaction• An event that affects the financial

position of the business• Can be measured reliably• Every transaction impacts at least two

items• The accounting equation balances

before and after each transaction

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E1-21: USING THE ACCOUNTING EQUATION TO ANALYZE TRANSACTIONS

Caren Smith opened a medical practice. During July, the first month of operation, the business, titled Caren Smith, M.D., P.C. (Professional Corporation), experienced the following events:1. Analyze the effects of these events on the accounting

equation of the medical practice of Caren Smith, M.D., P.C. Assets Liabilities Stockholders’

Equity

Date Cash Medical

supplies Land Accounts payable

Common stock

Retained earnings

Jul 6 $ 55,000 $

55,000

Bal $ 55,000 $ 0 $ 0 $ 0 $ 55,000 $ 0

9 (46,000) 46,000

Bal $9,000 $ 0 $46,000 $ 0 $55,000 $ 0

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E1-21: CONTINUEDAssets Liabilities Stockholders’

Equity

Date Cash Medical supplies Land Accounts

payableCommon stock

Retained earnings

Jul 12 $1,800 $1,800

Bal $9,000 $1,800 $46,000 $1,800 $55,000 $0

15

Bal $9,000 $1,800 $46,000 $1,800 $55,000 $0

15-31 8,000 8,000

Bal $17,000 $1,800 $46,000 $1,800 $55,000 $8,000

29(1,600)

(900)(100)

(1,600)(900)(100)

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E1-21: CONTINUED

Assets Liabilities Stockholders’ Equity

Date Cash Medical supplies Land Accounts

payableCommon stock

Retained earnings

Bal $14,400 $1,800 $46,000 $1,800 $55,000 $5,400

30 (700) (700)

Bal $14,400 $1,100 $46,000 $1,100 $55,000 $5,400

31 (1,100) (1,100)

Bal $13,300 $1,100 $46,000 $ 0 $55,000 $5,400

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Preparing the Financial Statements

Income Statement

Statement of Retained Earnings

Balance Sheet

Statement of Cash Flows

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Income Statement

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Statement of Retained Earnings

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Balance Sheet

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Statement of Cash Flows

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P1-36A: PREPARING FINANCIAL STATEMENTS

42

Studio Photography, Inc., works weddings and prom-type parties. The balance of retained earnings was $16,000 at December 31, 2011. At December 31, 2012, the business’s accounting records show these balances:

Prepare the following financial statements for Studio Photography, Inc. for the year ended December 31, 2012:a. Income statementb. Statement of retained earningsc. Balance sheet

Insurance expense $ 8,000 Accounts receivable $ 8,000Cash 37,000 Note payable 12,000Accounts payable 7,000 Retained earnings 47,000 Advertising expense 3,000 Salary expense 25,000Service revenue 80,000 Equipment 50,000Dividends 31,000 Common stock 29,000

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P1-36A: CONTINUED

43

Studio Photography, Inc.Income Statement

Year Ended December 31, 2012

Revenue: Service revenue $ 80,000Expenses: Salary expense $ 25,000 Insurance expense 8,000 Advertising expense 3,000

Total expenses 36,000Net income $ 44,000

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Studio Photography, Inc.Statement of Retained EarningsYear Ended December 31, 2012

P1-36A: CONTINUED

Retained earnings, December 31, 2011 $ 16,000 Add: Net income 44,000 Subtotal $ 60,000 Less: Dividends (13,000)Retained earnings, December 31, 2011 $ 47,000

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Studio Photography, Inc.Balance Sheet

December 31, 2012

P1-36A: CONTINUED

Assets LiabilitiesCash $37,000 Accounts payable $ 7,000Accounts receivable 8,000 Note payable 12,000Equipment 50,000 Total liabilities 19,000

Stockholders’ EquityCommon stock $29,000Retained earningsTotal stockholders’ equity

Total assets $95,000 Total liabilities and stockholders’ equity $95,000

47,000

76,000

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Decision Guidelines

Income Statement

Statement of Retained Earnings

Balance Sheet