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Accounting Principles:

A Business Perspective, 8e
Chapter 1:
Accounting and Its
Use in Business
Decisions

Copyright 2005 Hermanson Edwards Maher

Chapter 1

Forms of Business Organizations


z A business entity is any business organization
that exists as an economic unit.
z Single or sole proprietorship
a business owned by an individual and often
managed by that same individual.

z Partnership
a business owned by two or more persons
associated as partners.
Accounting Principles: A Business Perspective 8e
Copyright 2005 Hermanson Edwards Maher

Chapter 1

Forms of Business Organizations


Continued

z Corporation
A business owned by a few persons or by
thousands of persons and is incorporated under the
laws of one of the 50 states.

Accounting Principles: A Business Perspective 8e


Copyright 2005 Hermanson Edwards Maher

Chapter 1

Activities Performed by Business


Organizations
z Service companies
Provide services for a fee.

z Merchandising companies
Purchase goods that are ready for sale and then
resell them to customers.

z Manufacturing companies
Buy materials, convert them into products, and then
sell the products to other companies or to final
customers.
Accounting Principles: A Business Perspective 8e
Copyright 2005 Hermanson Edwards Maher

Chapter 1

Primary Objectives of Every


Business
z Solvency
The ability to pay debts as they become due.

z Profitability
The ability to generate income.

Accounting Principles: A Business Perspective 8e


Copyright 2005 Hermanson Edwards Maher

Chapter 1

Financial Statements
The income statement
z Reports the profitability of a business
organization for a stated period of time.
Revenues are defined as the inflow of assets
resulting from the sale of products or the rendering
of services to customers.
Expenses are the costs incurred to produce
revenues.
Accounting Principles: A Business Perspective 8e
Copyright 2005 Hermanson Edwards Maher

Chapter 1

Financial Statements
Continued

The statement of retained earnings


z Reports the changes in retained earnings that
occurred between two balance sheet dates.
Net income increases retained earnings.
Net loss decreases retained earnings
Dividends (distributions of income to owners)
reduce retained earnings.

Accounting Principles: A Business Perspective 8e


Copyright 2005 Hermanson Edwards Maher

Chapter 1

Financial Statements
Continued

The balance sheet


z Reflects a firms solvency as of a specific
moment in time.
Assets are things of value, which are owned by a
business.
Liabilities are the debts owed by a firm.
Stockholders equity is the share of the business
that the stockholders (shareholders) own outright
z equal to assets minus liabilities.
Accounting Principles: A Business Perspective 8e
Copyright 2005 Hermanson Edwards Maher

Chapter 1

Financial Statements
Continued

The statement of cash flows


z Shows the cash inflows and cash outflows from
operating activities, investing activities, and
financing activities.
Operating activities generally include the cash
effects of transactions and other events that enter
into the determination of net income.

Accounting Principles: A Business Perspective 8e


Copyright 2005 Hermanson Edwards Maher

Chapter 1

Financial Statements
Continued

Investing activities generally include transactions


involving the acquisition or disposal of long-term
(noncurrent) assets such as land, buildings, and
equipment.
Financing activities generally include the cash
effects of transactions and other events involving
creditors and owners (stockholders).

Accounting Principles: A Business Perspective 8e


Copyright 2005 Hermanson Edwards Maher

Chapter 1

The Financial Accounting Process


z The accounting equation:
ASSETS = LIABILITIES + STOCKHOLDERS EQUITY
As a business engages in economic activity, the
dollar amounts and the composition of its assets,
liabilities, and stockholders equity change, but the
equality of the basic equation always holds.
Accounting Principles: A Business Perspective 8e
Copyright 2005 Hermanson Edwards Maher

Chapter 1

The Financial Accounting Process


Continued

z Transactions provide much of the raw data


entered in the accounting process. Some
underlying assumptions or concepts used by
the accountant in recording business
transactions include:
Business entitythe business is assumed to have an
existence separate from its owners, creditors,
employees, and other interested parties.
Accounting Principles: A Business Perspective 8e
Copyright 2005 Hermanson Edwards Maher

Chapter 1

The Financial Accounting Process


Continued

Money measurementeconomic activity is initially


recorded and reported in terms of a common unit of
measurement, such as the dollar.
Costmost assets are recorded at their acquisition
cost measured in terms of money paid.
Continuity (going-concern)unless strong evidence
exists to the contrary, the accountant assumes the
entity will continue operations into the indefinite
future.
Accounting Principles: A Business Perspective 8e
Copyright 2005 Hermanson Edwards Maher

Chapter 1

The Financial Accounting Process


Continued

Periodicityan entitys life can be subdivided into


time periods for purposes of reporting its economic
activities.

z Transaction analysis
A summary of transactions format is used to
summarize activity and provide a basis for
preparation of the income statement and balance
sheet

Accounting Principles: A Business Perspective 8e


Copyright 2005 Hermanson Edwards Maher

Chapter 1

The Equity Ratio


z The equity ratio:
stockholders equity
total equities or total assets
The higher the ratio, the more solvent is the
company.
If the ratio is very high, profitability may suffer
because borrowed funds usually earn more than the
interest cost.
Accounting Principles: A Business Perspective 8e
Copyright 2005 Hermanson Edwards Maher