ACCT 2310 Accounting Principles I

Dr. Robert R. OlivaProfessor and ChairpersonDepartment of Accounting

University of Arkansas at Little Rock

How to obtain class files:

• http://www.cba.ualr.edu/rroliva/

Chapter 1: Introduction to Accounting and Business

So you want to go into business?

• 1. What kind of a legal entity is the business going to use?

• 2. What business strategy will be implemented?• 3. What is the business going to sell?• 4. Who is going to be involved in the creation and

continuing support of the business (stakeholders)?• 5. What kind of data will the stakeholders want and

who will provide it?– Recording and Summarizing– Financial Statements– Financial Analysis

1. What kind of a legal entity is the business going to use?

Types of Business Entities

• Sole propietorships

• Pass-Through Entities– Partnerships– S corporations– LLCs

• Corporations

Sole propietorship

• One owner

• No separate existence

• Business MTR = individual’s MTR

Advantages

• No independent taxation

• Losses serve as tax shelter to other income

Disadvantages

• Net profit taxed to owner when reported whether received or not

• Owner is not an employee– Self-employment tax

• Same tax year

• No liability shield

Pass-Through Entities

• Partnerships

• S Corporations

• LLCs

Partnerships

• 2 or more persons

• Independent entity from owner

• Conduit/flow through: does not pay taxes

Advantages of a Partnership

• Entity is tax exempt• Partners able to withdraw and contribute

affecting only adjusted basis • Debt basis

Disadvantages

• Net profit taxed to owner when reported whether received or not

• Owner is not an employee– Self-employment tax

Types of partnership

– General – Limited– Family partnerships– Publicly traded partnership

Family Partnerships

• Real or sham?– Two kinds of partnerships based on what is

the material income producing factor• capital• services

• In service partnership, a partner family member must provide substantial services

• In capital intensive partnerships: no as much of a problem

LLCs: Limited Liability Companies

• State created entity

• Taxed as a partnership

• Unlike partnerships (and similar to corporations): members have limited liability

• Unlike limited partners: LLC members may participate in management

Advantages of LLC’s (versus S)

• not limited to a specific number of members

• not limited to one class of stock

• not limited to kinds of shareholders

• Non-shareholder debt basis

Advantages of LLC’s (v. LP’s)

• No need for GP with personal liability

• All members have limited liability

• All members may participate in management

Advantages of LLC’s (v. GP’s)

• LLC members do not have personal liability

Advantages of LLC’s (v. Sub C’s)

• LLC’s may be taxed as pass through entities

• Has similar provision as IRC 351, without the need of control and can be used at anytime without concern for control [IRC 721].

Limited Liability Partnership

• Like GP: severally and jointly liable for LLP’s liabilities arising out of other than malpractice.

• From partnership to LLC: no tax consequences

S Corporations

• Hybrid

• Advantages/disadvantages – Very similar to partnerships– Very similar to corporations

2. What business strategy will be implemented?

What is a “business strategy”? (6)

Business Strategies

• Low cost (7)

• Differentiation (8)

• Combination

Dangers

• Low cost: Competition offering lower prices or using a differentiation strategy.

• Differentiation: – Company may offer more than what the customer

wants, followed by competition offering what the customer wants at a lower price.

– Company is so successful that everyone has bought the product. Followed by competition offering a new twist.

• Combination: Trying to be too many things to too many customers.

3. What is the business going to sell?

The Value Chain

• Take “inputs”, apply a “process”, and end with a product or service to sell.

• Consider the “process”:– Manufacturing– Retailing– Service industry– Capital intensive– Service intensive.

4. Who is going to be involved in the birth, life, and, hopefully not,

death of the business?

Who are the “stakeholders”?Internal stakeholders?

External stakeholders?

Internal stakeholders

• Owners

• Managers

• Employees

What do they have in common?

A need for reliable data

Owners?

Managers?

Employees?

External stakeholders

• Customers

• Creditors

• Government

What do they have in common?

A need for reliable data

Customers?Creditors?

Government?

How are the business stakeholders going to be provided the much

needed “reliable data”?

5 Steps

(11)-(13)

Who will implement?

ACCOUNTANTS!

Accounting as a Profession

• Private v. Public Accounting

• Specialties: – Financial: Report preparation under GAAP

– Auditing: Evaluation of the representation

– Management: Data providers to management

– Cost: Determining product costs

– Tax: Compliance and Planning

– AIS: Designing computer financial systems to collect and secure data.

– International: Collecting, analyzing, and reporting data involving international trade

– NFP: Reporting operations of not for profit organizations

– Social Accounting: Measuring social costs and benefits for (mostly) public and private actions.

Problem 1-2A: Chickadee Travel

• How much money did it make last year?– Prepare an income statement

Accounting Data: The need for standardized procedures

• GAAP: Generally Accepted Accounting Principles– From research, to practice, to official

pronoumcement– Financial Accounting Standards Board

(FASB)• Statements of Financial Accounting Standards• Interpretations

• Thus emphasis on principles and concepts

4 Basic Accounting concepts

• Business entity

• Cost

• Objectivity

• Unit of measure

Business entity concept

• Defines what is the business being measured.

• If you own 4 different businesses, how do you keep track of profitability?

Cost concept

• At what price should your “inputs” be recorded?– Assume you bought a building for your

business, should it be recorded at the price paid or the appraised value?

– Need to use exchange price

Objectivity concept

• Accounting records and reports must be based on objective evidence.– Using historical cost.

Unit of measure concept

• Record in dollars.

Exercise:

• We have a good idea about the cost of our car.

• But we have a harder time in determining its current value.

The Accounting Equation (18)

• Assets = Liabilities + Owner’s Equity

• Every business transaction, e.g., one that affects a business’ financial condition, impact the Accounting equation.– Every business transaction is an increase or

decrease in the equation variables.– But the equation is always balanced.

Recording and Summarizing Business Transactions Based on

the Accounting Education

• Chris Clark and Net Solutions (p. 14)

• Jim’s Lawn Care

Chris Clark and Net Solutions: p. 14

• Transactions: – Investment of cash: a– Buying an asset with cash: b– Buying an asset with credit: c– Income earning: d– Withdrawal of cash: e– Payment of a liability with cash: f– Recording the use of supplies: g– Recording the use of cash withdrawal: h

Jim’s Lawn Care: Consider the effect of May transactions on

• Cash

• Accounts Receivable

• Supplies

• Lawn Equipment

• Accounts Payable

• Jim’s Capital Account (Owner’s Equity)

Jim’s Capital Account (Owner’s Equity)

• Shows the effect of matching revenues and expenses during a discrete period of time– Net Income: increases owner’s equity– Net Loss: decreases owner’s equity

• Shows the effect of – Investments: increase of Owner’s Equity– Withdrawals: decrease in Owner’s Equity

Jim Lawn’s Care: May transactions

• $800 deposited bank account• $1000 Sears lawnmower on credit• $50 cash paid for supplies• $700 IOU received from work performed• $700 IOU paid in cash• $1000 cash paid Sears for lawnmower• $150 cash paid for advertisement • $420 received for work performed• $85 paid to assistant for work performed• $600 IOU received for work performed• $110 on gas on credit, bill received, pay in June• $100 withdrawal from the business

Financial Statements (21)

• Income Statement (22)

• Statement of Owner’s Equity (23)

• Balance Sheet (24)

• Statement of Cash Flows (25)

Jim’s lawn Care: Financial Statements

Financial Analysis

• Ratio of Liabilities to Owner’s Equity• Which would you rather own?

– Company A:• Assets: 100,000• Liabilities: 95,000• Owner’s Equity: 5,000

– Company B: • Assets: 100,000• Liabilities: 10,000• Owner’s Equity: 90,000

• Which one has more risk?