Financial Accounting: A Business Process Approach

Financial Accounting:
A Business Process Approach
Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 1

Chapter 1
Business: What’s It All About?

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.

Chapter 1 Learning Objectives
4. Identify the elements of the four basic

financial statements—the 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 company’s
financial statements.
6. Describe the risks associated with being in
business and the part that ethics plays in
business.

Learning
Objective 1 Purpose of a Business
1. Obtain the resources needed to

1. and
start Obtain
runcapital
a business
2. Add value
3. Sell to customers

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.

Simple Business Model
OUTPUTS
INPUTS
Product
Cash from Capital,
Financing,
Property, Plant, Value-added
conversion
Equipment,
Raw Materials,
Labor,
Service
Inventory,
Goods & Services

Nature of Business Operations
Service : Types of Companies:

 Provide services for customers
 Financial Services deal in services related to money.
Sales
 Merchandising—buys goods and resells them to other
businesses (wholesale) or to final customers (retail)
 Manufacturing—makes a product and sells it to other
businesses (wholesale) or to final consumers (retail)

Your Turn 1-1
The main purpose of apurpose

What is the main business is to make a
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 Financial services

company company

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
owned byare earned
a large numberby corporations.
of people.

Characteristics of Different Forms of
Business
Personal liability
Taxation
Transfer of ownership 1Liability

2 Taxation
3 Ownership
4 Capital
5 Regulation
Ability to raise capital
Government regulation

Sole Proprietorship
Personal responsibility and

liability
Income reported on individual’s

tax return
Owned by one individual
Difficult to acquire capital
Minimal government
regulation
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 partner’s

individual tax return
Difficult to Minimal
acquire government
capital regulation

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. firm’s

profits are made by corporations.

Corporations
Once the state

issues a charter,
the stockholders
elect a board of
directors.
A corporation is a separate legal entity

that can . . .
Incur Enter into
liabilities contracts
Sue and be sued Own assets

New Hybrid Forms of Business
Have characteristics of both

corporations and partnerships
Tax advantages Limited Liability

of a partnership of a corporation
LLP LLC
Limited Limited
Liability Liability
Partnership Corporation
Mostly used by law, medical, and accounting

profession
Your Turn 1-2
The three major forms of ownership are:

What are(1)
thesole proprietorships
three major forms of(single owner)
business ownership?
(2) partnerships (multiple owners)
(3) corporations (widespread ownership)
Disadvantages:
FromSole
the owners’ Advantages:
Proprietorship
point ofand Partnership:
view, what are the
Sole Proprietorship
Liability,
advantages andDifficulty and Partnership:
to raise
disadvantages ofcapital
each form of
Owner control, single taxation
Corporation:
ownership?
ConflictCorporation:
of interest between
Limitedmanagement
Liability, Easeandof owners,
raising capital
Double taxation

Learning
Objective 2 Business Transactions
Business transactions are economic exchanges

classified as:
Operating Investing Financing

Activities Activities Activities
Transactions Transactions
Transactions
related to that deal
related to
buying and with how a
the general
selling items the business
operations of
firm will gets it
the firm
use for more funding
than a year

How a Business Works
Transactions for Team Shirts’ First Month of Business
Team Shirts Sara contributes Team Shirts

repays $5,000 of her own borrows $500
the loan plus money to start her from Sara’s
interest to business. sister
Sara’s to help finance
Sister. the business.
Team Team Shirts Team Shirts

Shirts purchases
decides to
sells 90 T- advertise the 100 T-shirts from
shirts. a T-shirt maker.
new business.

Learning Information Needs of Decision
Objective 3
Makers
• Revenue from sales

• Expenses incurred
• Net income
• Inventory
• Reliability of
Vendors

Operating Cycle
End with more

Start with cash
cash
Collect cash Purchase

from inventory
customers
Make sales
to customers

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.
Your Turn 1-4
Revenues are the amounts a company

What are
earns from revenues
providing and
goods or services to
expenses?
its customers.
Expenses are the costs to earn those
revenues.
The four statements include the income

What are
statement, the four
balance basic of
sheet, statement
changes in shareholders’ equity, and the
financial
statement of statements?
cash flows.

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 Mandated by the Sarbanes-

the Accounting standard- Oxley Act. Created by the
setting responsibility to the SEC in response to 2001-
FASB. SEC retains and 2002 accounting scandals
sometimes exercises its to oversee audits of public
rights to set standards. companies.
Financial Accounting Public Company

Standards Board (FASB) Oversight Board (PCAOB)
Generally Accepted Accounting Principles Auditing Standards

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.

Learning
Objective 4 Four Basic Financial Statements
Accountants communicate financial information in

the form of four basic financial statements.
Income Balance Statement of Cash

Statement Sheet Flows
Assets = Cash inflow
Revenues Liabilities - Cash
- Expenses + Equity outflow
= Net income = Net cash flow
Statement of Changes in Owner’s Equity

Beginning equity + Contributions +/- Net income/loss -
Dividends = Ending equity

Financial Statements
Dates of Financial Statements are
Important!
The Balance Sheet is prepared “AS OF…”

or “AT” a particular date, a “snapshot” in
time.

Financial Statements
1. The Income Statement

2. Statement of Changes in Owner’s Equity
3. Statement of Cash Flows
cover a period of time:

“FOR THE PERIOD ENDING”

Balance Sheet
Assets = Claims
Assets = Liabilities + Equity

Things of Something owed
value Net Assets
Obligations/debt
(owner’s share
Economic (creditors’ share of the assets)
resources of the assets)
owned
Contributed Retained
Capital Earnings

Your Turn 1-5
TheWhat
two parts of shareholders’
are the equity are contributed
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 is apurposes.
reporting fiscal year?
It may begin
at any time and ends a year later.

Accounting Equation
Team Shirts
Shareholders' Equty
Assets All Liabilities + Contributed Capital Retained
Event Cash All other assets Account Account Common Stock Earnings
1 5000 5000
2 500 500 Note Payable
3 (400) 400 Inventory
4 (50) (50) Expense
5 900 900 Revenue
(360) Inventory (360) Expense
6 (505) (500) Note Payable (5) Expense
7 (100) (100) Dividends
Balances 5345 40 5000 385
--Income Statement, --Statement of Changes in Shareholders’ Equity,

--Balance Sheet, --Statement of Cash Flows

Income Statement
. . .describes Also called:

the activity of Statement of
a company earnings, statement
during a of operations, profit
period and loss statement
Revenue – Expenses = Net Income

The amount Costs Difference
earned from incurred to between
providing goods or generate revenues and
services to revenue expenses
customers
Your Turn 1- 6
The income
What statement
is included contains
on the incomerevenues and
statement?
expenses. The balance
What is included sheet
on the contains
balance assets,
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.

Statement of Changes in
Owners’ Equity
Beginning balance
+/- changes in contributed capital
+/- changes in retained earnings
= Ending balance
Contributed Retained
Capital: Earnings:
Contribution by investors Total of all net income

to obtain ownership in a earned by the business
corporation. Minus
Ownership is divided into Dividends Paid to owners
shares of stock. (Distributions to
owners)
Statement of Cash Flows
Cash from Cash from Cash from
From customers’
From sale of From issuing
purchases,
property long-term debt
interest or dividend
and or issuing stock
income
equipment
Cash Inflow

Statement of Cash Flows
Cash from Cash from Cash from
To suppliers for To purchase plant To repay long-term

inventory, and debt principal,
For employees’ equipment, To pay dividends to
salaries Investments in owners
other firms
Cash Outflow

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
Whyincome statement
is it necessary shows
to have all revenues
both an incomeand expenses
statement
for
andaaperiod of time—all
statement of cash the revenues that have been
flows?
earned
Look at and expenses incurred
the statements for Teamto Shirts
earn those revenues.
and explain why
The
theystatement of cash flows simply lists the cash inflows
are different.
and outflows during the period. Also, any transactions
with owners (contributions and dividends) are not
included on the income statement.

Learning Real Company’s Financial
Objective 5
Statements
Income Statements
Multi-step:
Single-step:
Calculates net
Groups all
income in steps
revenues
together and
deducts all
expenses from Revenues
total revenues - Cost of Goods
Gross Margin
+ Other Revenue
Revenue - Other
s Expenses
Operating Income
-Expense - Income
s Taxes Net
Net Income
Real Company’s 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: Shareholders’
Liabilities: Equity:
Current Contributed
Assets Current Capital,
Property, Liabilities Retained
Plant, and Long-term Earnings,
Equipment Liabilities Other
Comprehensive
Other Assets Income
Learning Business Risk, Control, and
Objective 6
Ethics
Risk: Anything that exposes us to potential
injury or loss.
Can turn into significant losses, scandals, or
total company failure.
Product Failure Strategic Risks

Theft of Assets Operating Risks
Purchase/sale of Financial Risks

poor quality
inventory Information Risks

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
firm’s 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.
All rights reserved. No part of this publication may
be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means,
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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Financial Accounting:

A Business Process Approach

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 1

Business: What’s It All About?

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 2

When you are finished studying Chapter 1, you

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 3

4. Identify the elements of the four basic

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 4

1. Obtain the resources needed to

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 5

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 6

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 7

Service : Types of Companies:

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 8

The main purpose of apurpose

What are the four general types of

Service company Manufacturing

Merchandising Financial services

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 9

Only 2.5% of U. S. businesses are

Corporation-a business whose ownership

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 10

Transfer of ownership 1Liability

Ability to raise capital

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 11

Personal responsibility and

Income reported on individual’s

Owned by one individual

Difficult to acquire capital

Income IS reported on each partner’s

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 13

A corporation is a popular form of business

Individuals can purchase small

More than two-thirds of U.S. firm’s

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 14

Once the state

A corporation is a separate legal entity

Sue and be sued Own assets

Have characteristics of both

Tax advantages Limited Liability

Mostly used by law, medical, and accounting

The three major forms of ownership are:

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 17

Business transactions are economic exchanges

Operating Investing Financing

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 18

Transactions for Team Shirts’ First Month of Business

Team Shirts Sara contributes Team Shirts

Team Team Shirts Team Shirts

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 19

• Revenue from sales

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 20

End with more

Collect cash Purchase

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 21

Revenues are the amounts a company

The four statements include the income

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 23

Securities and Exchange Commission (SEC):

The SEC delegates much of Mandated by the Sarbanes-

Financial Accounting Public Company

Generally Accepted Accounting Principles Auditing Standards