Financial Accounting:

A Business Process Approach

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Chapter 1

Business: Whats It All About?

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Chapter 1 Learning Objectives

When you are finished studying Chapter 1, you
should be able to:
1. Describe what a business does and the
various ways a business can be organized.
2. Classify business transactions as operating,
investing, or financing activities.
3. Describe who uses accounting information
and why accounting information is important to
them.

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Chapter 1 Learning Objectives

4. Identify the elements of the four basic
financial statementsthe income statement,
the statement of changes in shareholders
equity, the balance sheet, and the statement of
cash flows, explain the purpose of each, and be
able to use basic transaction analysis to
prepare each statement.
5. Identify the elements of a real companys
financial statements.
6. Describe the risks associated with being in
business and the part that ethics plays in
business.
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Purpose of a Business

Learning
Objective 1

1. Obtain the resources needed to

1. and
Obtain
start
runcapital
a business
2.

Add value

3.

Sell to customers

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Purpose and Organization of a Business

For-profit firms . . .
Make profits for investors.
Not-for-profit organizations . . .
provide goods and services to
people and use profits to
provide more goods and
services to people.

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Simple Business Model

OUTPUTS
INPUTS
Cash from Capital,
Financing,
Property, Plant,
Equipment,
Raw Materials,
Labor,
Inventory,
Goods & Services

Product
Value-added
conversion

Service

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Nature of Business Operations

Service :
Types of Companies:
Provide services for customers
Financial Services deal in services related to money.
Sales
Merchandisingbuys goods and resells them to other
businesses (wholesale) or to final customers (retail)
Manufacturingmakes a product and sells it to other
businesses (wholesale) or to final consumers (retail)

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Your Turn 1-1

The main purpose
of apurpose
business
is to make a
What is the main
of a business?
profit, increasing the value of the company for
the owners.
What are the four general types of
businesses?
Service company

Manufacturing
company

Merchandising
company

Financial services
company

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Ownership Structure of Businesses

MoreProprietorship--a
Sole
than 2/3 of U. S. single
businesses
owner
are
sole
business
proprietorships.
Only 2.5% of U. S. businesses are
Partnership-a multiple-owner
partnerships, and they earn less than
business
10% of all U. S. firms profits.
Corporation-a business whose ownership
More
than
2/3
of
U.
S.
companies
is divided into "shares" and may be
profits
earned
corporations.
owned byare
a large
numberby
of people.

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Characteristics of Different Forms of

Business
Personal liability
Taxation
Transfer of ownership
Ability to raise capital

1Liability
2 Taxation
3 Ownership
4 Capital
5 Regulation

Government regulation

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Sole Proprietorship
Personal responsibility and
liability
Income reported on individuals
tax return
Owned by one individual
Difficult to acquire capital
Minimal government
regulation
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Partnerships
Partners share
personal responsibility and liability
Partners usually create an agreement that
describes how much work each will do
and how the profit and loss will be divided.
Income IS reported on each partners
individual tax return
Difficult to
acquire
capital

Minimal
government
regulation

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Corporations
A corporation is a popular form of business
because . . .
Individuals can purchase small
amounts of stock.
Provides stockholders with
limited liability.
Allows for easy transfer of
ownership.
More than two-thirds of U.S. firms
profits are made by corporations.
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Corporations
Once the state
issues a charter,
the stockholders
elect a board of
directors.

A corporation is a separate legal entity

that can . . .
Incur
liabilities
Sue and be sued

Enter into
contracts
Own assets

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New Hybrid Forms of Business

Have characteristics of both
corporations and partnerships
Tax advantages
of a partnership
LLP
Limited
Liability
Partnership

Limited Liability
of a corporation
LLC
Limited
Liability
Corporation

Mostly used by law, medical, and accounting

profession
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Your Turn 1-2

The three major forms of ownership are:
proprietorships
(single
owner)
What are(1)
thesole
three
major forms of
business
ownership?
(2) partnerships (multiple owners)
(3) corporations (widespread ownership)

Disadvantages:
Advantages:
Proprietorship
and
Partnership:
FromSole
the owners
point of
view,
what are the
Sole
Proprietorship
and
Partnership:
Liability,
to raise
advantages
andDifficulty
disadvantages
ofcapital
each form of
Owner control,
single taxation
Corporation:
ownership?
ConflictCorporation:
of interest between
Limitedmanagement
Liability, Ease
of owners,
raising capital
and
Double taxation

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Business Transactions

Learning
Objective 2

Business transactions are economic exchanges

classified as:
Operating
Activities

Transactions
related to
the general
operations of
the firm

Investing
Activities

Transactions
related to
buying and
selling items the
firm will
use for more
than a year

Financing
Activities

Transactions
that deal
with how a
business
gets it
funding

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How a Business Works

Transactions for Team Shirts First Month of Business
Team Shirts
repays
the loan plus
interest to
Saras
Sister.

Team
Shirts
sells 90 Tshirts.

Sara contributes
$5,000 of her own
money to start her
business.

Team Shirts
decides to
advertise the
new business.

Team Shirts
borrows $500
from Saras
sister
to help finance
the business.

Team Shirts
purchases
100 T-shirts from
a T-shirt maker.

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Learning
Objective 3

Information Needs of Decision

Makers

Revenue from sales

Expenses incurred
Net income
Inventory
Reliability of
Vendors

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Operating Cycle

End with more

Start with cash
cash
Collect cash
from
customers

Purchase
inventory

Make sales
to customers
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Who Needs Accounting

Information?
Management
Those with direct financial interest
Current or potential investors
Current or potential creditors
Employees
Those with an indirect financial interest
Tax Authorities
Regulatory Agencies
Economic Planners
Labor unions, financial advisors,
others.
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Your Turn 1-4

Revenues are the amounts a company

earns from
providing
goods or
services to
What
are
revenues
and
its customers.
expenses?
Expenses are the costs to earn those
revenues.
The four statements include the income
statement, balance sheet, statement of
What
are the four basic
changes in shareholders equity, and the
financial
statement of statements?
cash flows.
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Who Sets the Guidelines?

Securities and Exchange Commission (SEC):
Created by the U.S. Congress in 1934 to set the rules for
corporations that trade on the public stock exchanges.
The SEC delegates much of
the Accounting standardsetting responsibility to the
FASB. SEC retains and
sometimes exercises its
rights to set standards.

Mandated by the SarbanesOxley Act. Created by the

SEC in response to 20012002 accounting scandals
to oversee audits of public
companies.

Financial Accounting
Standards Board (FASB)

Public Company
Oversight Board (PCAOB)

Generally Accepted Accounting Principles

Auditing Standards

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International Financial Reporting

Standards
International guidelines for
financial reporting, used in many
places around the world.
International Accounting Standards
Board (IASB) sets international
financial reporting standards.
The SEC plans implementation of
IFRS in the United States by 2014
so that one global set of standards
is used by all major economies.
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Learning
Objective 4

Four Basic Financial Statements

Accountants communicate financial information in

the form of four basic financial statements.
Income
Statement
Revenues
- Expenses
= Net income

Balance
Sheet
Assets =
Liabilities
+ Equity

Statement of Cash
Flows
Cash inflow
- Cash
outflow
= Net cash flow

Statement of Changes in Owners Equity

Beginning equity + Contributions +/- Net income/loss Dividends = Ending equity
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Financial Statements
Dates of Financial Statements are
Important!
The Balance Sheet is prepared AS OF
or AT a particular date, a snapshot in
time.

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Financial Statements
1. The Income Statement
2. Statement of Changes in Owners Equity
3. Statement of Cash Flows
cover a period of time:
FOR THE PERIOD ENDING

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Balance Sheet
Assets

Claims

Assets
= Liabilities
+
Things of
Something owed
value
Obligations/debt
Economic
resources
owned

(creditors share
of the assets)

Equity
Net Assets
(owners share
of the assets)

Contributed Retained
Earnings
Capital

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Your Turn 1-5

TheWhat
two parts
of shareholders
equity are contributed
are the
two parts of Shareholders
Equity?
capital and retained earnings (earned capital).

A fiscal year is a year in the life of a business for

financialWhat
reporting
It may begin
is apurposes.
fiscal year?
at any time and ends a year later.

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Accounting Equation

--Income Statement, --Statement of Changes in Shareholders

Equity,
--Balance Sheet, --Statement
of Cash Flows
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Income Statement
. . .describes
the activity of
a company
during a
period

Revenue
The amount
earned from
providing goods or
services to
customers

Also called:
Statement of
earnings, statement
of operations, profit
and loss statement

Expenses
Costs
incurred to
generate
revenue

= Net Income
Difference
between
revenues and
expenses

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Your Turn 1- 6
The
income
statement
contains
and
What
is included
on the
incomerevenues
statement?
expenses.
The balance
sheet
contains
assets,
What is included
on the
balance
sheet?
liabilities, and shareholders equity.

The time period captured by the income

Describe the difference in the time periods
statement is an accounting period, often a
captured by the income statement and the
fiscal year. The statement covers a period of
balance sheet.
time. On the other hand, the balance sheet
describes the financial position of a
company at a given point in time.
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Statement of Changes in
Owners Equity
Beginning balance
+/- changes in contributed capital
+/- changes in retained earnings
= Ending balance
Contributed
Capital:
Contribution by investors
to obtain ownership in a
corporation.

Retained
Earnings:
Total of all net income
earned by the business

Minus

Dividends Paid to owners

(Distributions to
owners)
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Ownership is divided into

shares of stock.

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Statement of Cash Flows

Cash from
Operating
Activities

From customers
purchases,
interest or dividend
income

Cash from
Investing
Activities

From sale of
property
and
equipment

Cash from
Financing
Activities

From issuing
long-term debt
or issuing stock

Cash Inflow
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Statement of Cash Flows

Cash from
Operating
Activities

To suppliers for
inventory,
For employees
salaries

Cash from
Investing
Activities

To purchase plant
and
equipment,
Investments in
other firms

Cash from
Financing
Activities

To repay long-term
debt principal,
To pay dividends to
owners

Cash Outflow
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Your Turn 1 - 7
The income statement gives the revenues and expenses
How is the income statement related to the balance
for the period. The net amount, net income, is added to
sheet? In other words, how does the amount of net
retained earnings. So the income statement number
income affect the balance sheet?
becomes part of the retained earnings total on the
year-end balance sheet.
The
statement
shows
all revenues
expenses
Whyincome
is it necessary
to have
both
an incomeand
statement
for
of timeall
revenues that have been
andaaperiod
statement
of cash the
flows?
earned
expenses incurred
to Shirts
earn those
revenues.
Look at and
the statements
for Team
and explain
why
The
of cash flows simply lists the cash inflows
theystatement
are different.
and outflows during the period. Also, any transactions
with owners (contributions and dividends) are not
included on the income statement.
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Learning
Objective 5

Real Companys Financial

Statements
Income Statements

Single-step:
Groups all
revenues
together and
deducts all
expenses from
total revenues

Multi-step:
Calculates net
income in steps

Revenues
- Cost of Goods
Gross Margin
+ Other Revenue
- Other
Revenue
Expenses
s
Operating Income
- Income
-Expense
s
Taxes
Net
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Hall
1 Income

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Real Companys Financial

Statements
Classified Balance Sheet
Shows a subtotal for various classes of assets and
liabilities, including current and long-term assets
and liabilities, and shareholders equity
Assets:
Current
Assets
Property,
Plant, and
Equipment
Other Assets

Liabilities:
Current
Liabilities
Long-term
Liabilities

Shareholders
Equity:
Contributed
Capital,
Retained
Earnings,
Other
Comprehensive
Income

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Learning
Objective 6

Business Risk, Control, and

Ethics

Risk: Anything that exposes us to potential

injury or loss.
Can turn into significant losses, scandals, or
total company failure.

Product Failure
Theft of Assets
Purchase/sale of
poor quality
inventory

Strategic Risks
Operating Risks
Financial Risks
Information Risks

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Business Risk, Control, and Ethics

Every risk brings a potential reward.
Firms managers want to minimize risks.
A manager must always put good ethical
behavior above putting a good face on the
firms financial position or performance.
Control: An activity performed to minimize or
eliminate risk. A firm must establish and maintain
control over its operations, assets, and information
systems.
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electronic, mechanical, photocopying, recording,
or otherwise, without the prior written permission
of the publisher. Printed in the United States of
America.

Copyright 2011 Pearson Education, Inc.

publishing as Prentice Hall
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