Lecture 1 - Introduction

Chapter 1
Uses of Accounting Information and the Financial Statements
Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University
Learning Objectives
1. Define accounting, identify business goals and activities, and describe the role of accounting in making informed decisions. 2. Identify the many users of accounting information in society. 3. Explain the importance of business transactions, money measure, and separate entity to accounting measurement. 4. Describe the corporate form of business organization. 5. Define financial position, state the accounting equation, and show how they are affected by simple transactions. 6. Identify the four financial statements.
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Accounting as an Information System

Objective 1
Define accounting, identify business goals and activities, and describe the role of accounting in making decisions
Copyright Houghton Mifflin Company. All rights reserved.
13
Accounting
is an information system that measures processes communicates financial information about an identifiable, economic entity
14
Accounting
supplies the information decision makers need to make reasoned choices among alternative uses of scarce resources in the conduct of business and economic activities
15
Accounting
Is a link between business activities and decision makers
Decision makers use accounting information to make informed decisions about available alternatives
Measures business activities by recording data about them for future use Is communicated to decision makers through reports
Accounting as an Information System
17
Business Goals, Activities, and Performance Measures

Business
An economic unit that aims to sell goods and services to customers at prices that
will provide an adequate return to its

owners
18
Business Goals
Profitability
The ability to earn enough income to attract and hold investment capital
Liquidity
Having enough cash available to pay debts when they are due
19
Business Activities
Financing Activities Investing Activities
Operating Activities
110
Financing Activities
Activities associated with obtaining adequate funds, or capital, to begin and continue operations
Owner investments Paying a return to owners Obtaining loans from creditors Repaying amounts to creditors, plus interest
111
Investing Activities
Activities associated with spending funds to begin and continue operations
Buying resources such as land, buildings, and equipment needed in the operation of the business Selling these resources when no longer needed
112
Operating Activities
Activities associated with the course of running a business
Selling goods and services Employing managers and workers Buying goods and services Paying taxes
113
Financial and Management Accounting

Accountings role is divided into two categories
1. Management accounting 2. Financial accounting
The functions of both categories overlap
Primary difference between the two is the users of the information

114
Management Accounting
Focuses on internal decision makers
Managers and employees
Reporting format is flexible and based on the type of information needed, such as budgets and sales forecasts Used to report past performance and expected future performance
115
Financial Accounting
Focuses on external decision makers
Stockholders
Banks and other creditors Government regulators
Financial information of company is reported in the financial statements

Used to report directly on goals of profitability and liquidity
Discussion
Q. What is the difference between profitability and liquidity?
A. Profitability
Earning enough income (revenues minus expenses) to attract and hold investors Having enough funds available (cash) to pay debts when they are due
Liquidity
117
Decision Makers: The Users of Accounting Information

Objective 2
Identify the many users of accounting information in society
118
Decision Makers
fall into three categories
1. Those who manage a business
Finance Investment Operations and production Marketing Human resources Information systems Accounting
119
Decision Makers (contd)

2. Those with a direct financial interest
Investors
Creditors
3. Those with an indirect financial interest

Tax authorities
Labor unions Financial advisors
Customers
Economic planners
Management
Managers are internal users of accounting information
Make key decisions using accounting information Basic management functions require accounting information for decision making
Financing the business Investing resources Producing goods and services Marketing goods and services Managing employees Providing information to decision makers
121
Users With a Direct Financial Interest

are external users of accounting information Investors
Put money into a business in order to make money (by purchasing and selling stocks and receiving dividends) Use financial statements to judge the prospects for profitable investments
122
Users With a Direct Financial Interest (contd)

Creditors
Loan money to a business in order to make money (by charging interest)
Use financial statements to judge whether a company will have enough cash to
Pay interest charges Repay debt at appropriate time
123
Users With an Indirect Financial Interest

are external users of accounting information Tax authorities Government regulatory agencies
Other groups
Those advising investors and creditors Consumer groups Customers Economic planners
Discussion
Q.How do management accounting and financial accounting differ?
A. Management Accounting
Focus on internal users All types of information Communicated in format most suitable to purpose
Financial Accounting
Focus on external users as well as internal users Specific information Communicated in financial statements
Accounting Measurement
Objective 3
Explain the importance of business transactions, money measure, and separate entity to accounting measurement
126
Business Transactions
are economic events that affect the financial position of a business entity
Involve an exchange of value
Purchase Sale Payment Collection
Events that have the same effect as an exchange of value

Loss from fire, flood, theft Physical wear and tear on equipment
Money Measure
Recording of all business transactions in terms of money Money is the only factor common to all business transactions Basic unit of money determined by the country in which business resides
128
Separate Entity
A business is distinct from its
Owner(s)
Creditors Customers
Its financial records and reports should refer only to its own financial affairs
129
Discussion
Q. Identify each of the following as most closely related to a
a) business transaction, b) separate entity, or (b) 1. Partnership (c) 2. U.S. dollar (a) 3. Payment of an expense (b) 4. Corporation (a) 5. Sale of an asset
c) money measure
130
Forms of Business Organization

Objective 4
Describe the corporate form of business organization
131
Forms of Business Enterprises

Three basic forms of business enterprises
Sole proprietorship Partnership Corporation
132
Separate Entities
All three forms of businesses are economically separate entities from their owners
Financial records and reports refer to the financial affairs of the business only
Only the corporation is a legally separate entity from its owners
133
Sole Proprietorships
Business owned by one person
The owner
Receives all profits or losses Is liable for all obligations of the business
Life of business ends when the owner

Decides to stop operating business Dies
Is incapacitated
134
Partnerships
Business owned by more than one person
The partners share all profits or losses according to an agreed upon formula At least one partner is liable for all obligations of the business
Life of business ends when

Ownership changes
A partner leaves the business or dies
A new partner is admitted

A partnership is like a sole proprietorship in most ways, but with two or more owners
Corporations
Legally and economically separate from its owners
Business unit chartered by the state and legally separate from owners Owners (stockholders) do not directly control operations Elected board of directors run the corporation Owners risk of loss limited to amount paid for shares of stock
136
Number and Receipts of U.S. Proprietorships, Partnerships, and Corporations, 2000
137
Organization of a Corporation
Stockholders
Elect the board of directors
Board of directors
Set company policies Choose corporate officers
Corporate officers
Carry out corporate policies by managing the business
Financial Position and the Accounting Equation

Objective 5
Define financial position, state the accounting equation, and show how they are affected by simple transactions
139
Financial Position
The economic resources that belong to a company and the claims against those resources at a point in time Economic Resources = Equities
140
Developing the Accounting Equation

Economic Resources = Equities
Two types of equities
Creditors equities and owner's equities, therefore,
Assets Liabilities Economic Resources = Creditors Equities + Owners Equities In accounting terminology
Economic resources are called assets Creditors equities are called liabilities
Accounting Equation
Assets = Liabilities + Owners Equity
Two sides of equation are always in balance Assets
Economic resources owned by a company that are expected to benefit future operations
Liabilities
Obligations of a business to pay cash, transfer assets, or provide services to other entities in the future Represent claims of creditors to the assets of the business
Owners Equity
Represents the claims by owners to the assets of the business
Owners Equity
Equals the residual interest in a companys assets after deducting all liabilities Also called residual equity or net assets Defined by rearranging the accounting equation
Assets = Liabilities + Owners Equity Owners Equity = Assets Liabilities

Owners Equity (contd)

Stockholders equity
The owners equity of a corporation
Also called shareholders equity Has two components
Contributed capital Retained earnings
Assets = Liabilities + Stockholders Equity


Contributed capital
The amount that stockholders invest in the business
Represented by shares of capital stock
145

Contributed capital has two components
Par Value
Amount per share that is entered in the corporations capital stock account
Minimum amount that can be reported as contributed capital
Additional paid-in capital

The value received for capital stock over its par value
146

Retained earnings
Represent the equity of the stockholders
Are generated from income-producing activities of the business Are kept for use in the business
147

Retained earnings are affected by three types of transactions
Revenues
Amounts customers agree to pay the company in return for a service or product Increase retained earnings
Expenses
Amounts the company pays out in the process of providing services or manufacturing products Decrease retained earnings
Dividends
Distributions to stockholders of assets (usually cash) generated by past earnings Decrease retained earnings It is important not to confuse
expenses and dividends

Net income
The difference when revenues exceed expenses
Net loss
The difference when expenses exceed revenues
Generally, a company is successful if its revenues exceed its expenses
Retained Earnings Accumulated Net Income(Loss)

Dividends Over theLife of the Business
Three Types of Transactions That Affect Retained Earnings
CONTRIBUTED CAPITAL
150
Illustrative Transactions for Shannon Realty
Effects of Transactions on the Accounting Equation
151
Owners Investments
1. Invested $50,000 in Shannon Realty, Inc., in exchange for 5,000 shares of $10 par value common stock
Assets = Liab. + Stockholders Equity
1.
Cash $50,000
Common Stock $50,000
A = $50,000
L + SE = $50,000
Notice that the accounting equation Assets = Liabilities + Stockholders Equity or A = L + SE is always in balance
152
Purchase of Assets with Cash

2. Purchased a lot for $10,000 and a small building on the lot for $25,000
Cash 1. $50,000 2. 35,000
Land $10,000 $10,000
Building $25,000 $25,000
Common Stock $50,000 $50,000
$15,000
A = $50,000
L + SE = $50,000
This transaction only affects one side of the accounting equation Assets Whenever a transaction affects only one side of the accounting equation, the total on each side of the equal sign remains unchanged
Purchase of Assets by Incurring a Liability

3. Purchased office supplies for $500 on credit
Cash 1. $50,000 2. 35,000 3. $15,000
Supplies
Land $10,000
Building $25,000
A/P
$500 $500 $10,000 $25,000
$500 $500 $50,000
A = $50,500
L + SE = $50,500
154
Payment of a Liability
4. Paid $200 of the $500 owed for supplies
Cash 1. $50,000 2. 35,000 3. 4. 200 $14,800
Supplies
Land $10,000
Building $25,000
A/P
$500 $500 $10,000 $25,000
$500 200 $300
$50,000
A = $50,300
L + SE = $50,300
155
Revenues
5. Earned and received a commission of $1,500 in cash
Cash 1. $50,000 2. 35,000 3. 4. 200 5. 1,500 $16,300
Supplies
Land $10,000
Building $25,000
A/P
Common Retained Stock Earnings $50,000
$500
$500 200 $10,000 $25,000 $300 $50,000 $1,500 $1,500
$500
A = $51,800
L + SE = $51,800
156
Revenues
6. Earned a commission of $2,000 to be received at a later date
Cash 1. $50,000 2. 35,000 3. 4. 200 5. 1,500 6. $16,300
A/R
Supplies
Land $10,000
Building $25,000
A/P
$500
$500 200 $1,500 2,000
$2,000 $2,000 $500 $10,000 $25,000 $300 $50,000
$3,500
A = $53,800
L + SE = $53,800
157
Collection of Accounts Receivable

7. Received $1,000 from client for commission earned earlier in the month
Cash 1. $50,000 2. 35,000 3. 4. 200 5. 1,500 6. 7. 1,000 $17,300
A/R
Supplies
Land $10,000
Building $25,000
A/P
$500
$500 200 $1,500 2,000
$2,000 1,000 $1,000
$500
$10,000
$25,000
$300
$50,000
$3,500
A = $53,800
L + SE = $53,800
158
Expenses
8. Paid $1,000 to rent equipment for office
Cash 1. $50,000 2. 35,000 3. 4. 200 5. 1,500 6. 7. 1,000 8. 1,000 $16,300
A/R
Supplies
Land $10,000
Building $25,000
A/P
$500
$500 200 $1,500 2,000
$2,000 1,000 $1,000 $500 $10,000 $25,000 $300 $50,000
1,000 $2,500
A = $52,800
L + SE = $52,800
159
Expenses
9. Paid $400 in wages to part-time helper
Cash 1. $50,000 2. 35,000 3. 4. 200 5. 1,500 6. 7. 1,000 8. 1,000 9. 400 $15,900
A/R
Supplies
Land $10,000
Building $25,000
A/P
$500
$500 200 $1,500 2,000
$2,000 1,000
$1,000
$500
$10,000
$25,000
$300
$50,000
1,000 400 $2,100
A = $52,400
L + SE = $52,400
160
Expenses
10. Recorded utilities expense of $300 incurred in December but not yet paid
Cash 1. $50,000 2. 35,000 3. 4. 200 5. 1,500 6. 7. 1,000 8. 1,000 9. 400 10. $15,900
A/R
Supplies
Land $10,000
Building $25,000
A/P
$500
$500 200 $1,500 2,000
$2,000 1,000
$1,000
$500
$10,000
$25,000
300 $600
$50,000
1,000 400 300 $1,800
A = $52,400
L + SE = $52,400
161
Dividends
11. Declared and paid a $600 dividend
Cash 1. $50,000 2. 35,000 3. 4. 200 5. 1,500 6. 7. 1,000 8. 1,000 9. 400 10. 11. 600 $15,300
A/R
Supplies
Land $10,000
Building $25,000
A/P
$500
$500 200 $1,500 2,000
$2,000 1,000
300 $1,000 $500 $10,000 $25,000 $600 $50,000
1,000 400 300 600 $1,200
A = $51,800
L + SE = $51,800
162
Discussion
Q. What does the accounting equation represent?
A. The economic resources owned by a company and the claims against those resources at a point in time Assets = Liabilities + Stockholders Equity
163
Communications Through Financial Statements

Objective 6
Identify the four financial statements
164
Communications Through Financial Statements

Four Major Financial Statements
Income Statement
Statement of Retained Earnings Balance Sheet Statement of Cash Flows
165
Income Statement
Summarizes revenues earned and expenses incurred over a period of time Dated For the Month Ended
Purpose to measure a companys performance over a period of time

Shows whether or not a company achieved its profitability goal
Income Statement (contd)

Considered by many to be most important financial statement Also called
Statement of retained earnings Statement of operations Profit and loss statement
First financial statement to be prepared in a sequence Net income figure used to prepare statement of retained earnings
Income Statement
Date reflects revenues and expenses incurred over a period of time
Shannon Realty, Inc. Income Statement For the Month Ended December 31, 20xx Revenues Commissions earned Expenses Equipment rental expense Wages expense Utilities expense Total expenses Net income
$3,500 $1,000 400 300 1,700 $1,800

Net income figure used to prepare statement of retained earnings
168
Statement of Retained Earnings

Shows changes in retained earnings over a period of time Dated For the Month Ended Uses net income figure from income statement End of period balance in Retained Earnings account used to prepare balance sheet
Statement of Retained Earnings (contd)

Many companies use a statement of stockholders equity or shareholders equity in place of the statement of retained earnings
Is a more comprehensive statement
Incorporates changes in all stockholders equity accounts
170
Statement of Retained Earnings

Date reflects changes in retained earnings over a period of time
Shannon Realty, Inc. Statement of Retained Earnings For the Month Ended December 31, 20xx Retained earnings, December 1, 20xx Net income for the month Subtotal Less dividends Retained earnings, December 31, 20xx $ 0 1,800 1,800 600 $1,200
Ending retained earnings figure used to prepare the balance sheet

Net income figure from income statement
171
Balance Sheet
Shows the financial position of a company on a certain date Dated as of a certain date Also called the statement of financial position
Presents view of business as holder of assets that are equal to the claims against those assets
Claims consist of liabilities and stockholders equity
172
Balance Sheet
Shannon Realty, Inc. Balance Sheet December 31, 20xx Assets Cash Accounts receivable Supplies Land Building $15,300 1,000 500 10,000 25,000 Accounts payable
Date reflects account balances as of a certain date
Liabilities $ 600
Stockholders Equity Common Stock $50,000 Retained earnings 1,200 Total stockholders equity Total liabilities and stockholders equity
51,200 $51,800
Total assets
$51,800
Balance in Cash account used in statement of cash flows

Retained earnings figure from the statement of retained earnings
173
Statement of Cash Flows

Shows cash flows into and out of a business over a period of time Dated For the Month Ended
Focuses on whether the business met its liquidity goal

Explains how the Cash account changed during the period
Statement of Cash Flows

Shannon Realty, Inc. Statement of Cash Flows For the Month Ended December 31, 20xx Cash flows from operating activities Net income Adjustments to reconcile net income to net cash flows from operating activities Increase in accounts receivable Increase in supplies Increase in accounts payable Net cash flows from operating activities Cash flows from investing activities Purchase of land Purchase of building Net cash flows from investing activities Cash flows from financing activities Investments by stockholders Dividends Net cash flows from financing activities Net increase (decrease) in cash Cash at beginning of month Cash at end of Cash at end of month
Date reflects cash flows over a period of time

$ 1,800
($1,000) (500) 600
(900) $ 900
($10,000) (25,000) (35,000) $50,000 (600) 49,400 $15,300 0 $15,300
Begins with net income from income statement
month same as Cash account balance on balance sheet
Dividends from the statement of retained earnings

175
Discussion
Q. The balance sheet is often referred to as the statement of financial position. What does financial position mean?
A. Financial position is the resources, or assets, owned by a business as of a certain date These resources are offset by claims against them and stockholders equity, as shown on the balance sheet
176
Time for Review

1. 2. 3. 4. Define accounting, identify business goals and activities, and describe the role of accounting in making informed decisions Identify the many users of accounting information in society Explain the importance of business transactions, money measure, and separate entity to accounting measurement Describe the corporate form of business organization Define financial position, state the accounting equation, and show how they are affected by simple transactions Identify the four financial statements
177
5.
6.

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Chapter 1

Uses of Accounting Information and the Financial Statements

Accounting as an Information System

Copyright Houghton Mifflin Company. All rights reserved.

Copyright Houghton Mifflin Company. All rights reserved.

Copyright Houghton Mifflin Company. All rights reserved.

Accounting as an Information System

Copyright Houghton Mifflin Company. All rights reserved.

Business Goals, Activities, and Performance Measures

will provide an adequate return to its

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Copyright Houghton Mifflin Company. All rights reserved.

Financing Activities Investing Activities

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Copyright Houghton Mifflin Company. All rights reserved.

Financial and Management Accounting

The functions of both categories overlap

Primary difference between the two is the users of the information

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Copyright Houghton Mifflin Company. All rights reserved.

Financial information of company is reported in the financial statements

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Decision Makers: The Users of Accounting Information

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Decision Makers (contd)

3. Those with an indirect financial interest

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Users With a Direct Financial Interest

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Users With a Direct Financial Interest (contd)

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Users With an Indirect Financial Interest

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Events that have the same effect as an exchange of value

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Forms of Business Organization

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Forms of Business Enterprises

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Only the corporation is a legally separate entity from its owners

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Life of business ends when the owner

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Life of business ends when

A new partner is admitted

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Number and Receipts of U.S. Proprietorships, Partnerships, and Corporations, 2000

Copyright Houghton Mifflin Company. All rights reserved.

Financial Position and the Accounting Equation

Copyright Houghton Mifflin Company. All rights reserved.

Copyright Houghton Mifflin Company. All rights reserved.

Developing the Accounting Equation

Assets = Liabilities + Owners Equity Owners Equity = Assets Liabilities

Owners Equity (contd)

Assets = Liabilities + Stockholders Equity

Owners Equity (contd)

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Owners Equity (contd)