CHAPTER 1

ACCOUNTING
FUNDAMENTALS

Prepared by: Dr Peter Kamala

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Learning Objectives
 Discuss forms of business organizations

 Explain the main purpose of accounting

 Explain users and uses of accounting information

 Distinguish between financial and managerial accounting

 Prepare financial statements

 Demonstrate Interrelationships of the Financial Statements

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Forms of business  Sole proprietorship: A business owned by one

organizations person. Simplest and most common business (owner

operated). Main advantage-owner retains full
business control. Tax advantages

 Comprise 70%+ of the businesses USA/Canada

 Main disadvantage-financial resources are limited to

owner’s resources.

 Owner has unlimited liability

 Give examples??

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Forms of business  Partnership: A business owned by two or more

organizations people. Main advantage- Owner's pool resources

and combine skills sets, Tax advantages

 Main disadvantage-Profits are shared, Liability is

unlimited (Jointly & Severally Liable)

 A limited liability partnership (LLP) partner not

held liable for others misconduct

 Comprise 10% of the businesses in USA/Canada

 Examples????

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Forms of business  Corporation: A business structure that creates a

organizations separate legal entity.

 Owned by shareholders and may be traded on a stock

exchange E.g TSX or NYSE.

 Main advantages-Easy to raise capital, Liability is

limited

 Main disadvantages-Complex to form, highly regulated,

Higher taxes

 Comprise 20% of businesses in USA/Canada

 Examples????

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Forms of Business Organization

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Main purpose of accounting
 The objective of a business is to maximize profit and owners' investment

 How will the business determine that it is making a profit or maximizing owners'
investment ? It needs accounting information

 Purpose of accounting- To measure and communicate the financial activities of a

business in order to inform decisions made by stakeholders

 It thus provides information for decision-making

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Main purpose of accounting
Case Study

 One such successful company is Google, one of the most visible companies on the
Internet. Many of us cannot visit the Web without first stopping at Google to power our
search. Google is the closest thing the Web has to an ultimate answer machine." And yet,
Google is a free tool—no one asks for your credit card when you use any of Google’s
search tools. So, do you think Google has been a successful company? Does it make
money? How would you know? Accounting helps to answer these questions

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 Users and uses of accounting information

 The main objective of accounting is to prepare financial statements to help a wide variety of
users make decisions

 Who are the users of accounting information?

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Users and uses of accounting information

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Internal Users

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Users and uses of accounting information

 Managers (internal) –rely on accurate, timely, and

relevant information in their decision-making. Budgets for
planning and controlling, departmental reports for
performance evaluation, cost information for price setting

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Users and uses of
accounting
information

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External Users

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Users and uses of accounting information

• External Users
• Creditors/suppliers (external)- Banks and other lenders analyze risk and business
viability prior to extending credit. Calculate liquidity ratios from the balance sheet
•
Shareholders (external)- Investors rely on assets, business performance, etc. as a
predictor of future profitability. To determine whether to invest more or withdraw

Government/regulatory authorities (external)- taxation and regulation relies on

financial results. To determine tax liability
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Users and uses of accounting information
Fields of Accounting

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Financial vs managerial accounting

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Users and uses of accounting information
 Ethics in Financial Reporting

 Regulators and lawmakers were very concerned that the economy would suffer
if investors lost confidence in corporate accounting because of unethical
financial reporting.

 Do you know of any financial reporting scandal???

 As a result- legislation was passed Sarbanes-Oxley Act (SOX) 2002 (USA) and
The Canadian Bill 198

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Financial statements
Companies prepare four financial statements from the summarized accounting data:

 Income Statement

 Retained Earnings Statement (ASPE), Statement of changes in Equity (IFRS)

 Balance Sheet

 Statement of Cash Flows

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 Income Statement
 Income statement - reports a business' financial performance over a specific accounting period

 It reports a company’s revenues, expenses, and resulting net income/loss over a specific period of time
(month, quarter, year).
 The income calculation is as follows:
  Net Income/(loss)= Revenues –Expenses

Revenue: Amount of money earned through business activity, such as sales, services, or interest.

 Expense: Amount of money spent through business activity, such as salary, rent, or supplies.

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Income Statement
 Income statement

Example

1.B est Buy Inc. reported revenues of $45 million, cost of goods sold of $34 million, and selling and
administrative expenses of $9 million. What was its net profit?
2.$45 - $34 -$9 = $2M
3.If a business generated $50,000 in revenues and $40,000 in expenses last year, what was the net profit?
4.$50000-$40000 = $10000
5.If a business generated $30,000 in revenues and $40,000 in expenses last year, what was the net
profit/loss? $30000 -$40000 = ($10000)

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Income Statement
Income statement for Service Provider

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Income Statement
Income Statement for Retail business

THE RHYTHM SHOP

Income Statement—Acoustic Guitar Department
For the Quarter Ended March 31
Sales   $1,600,000
Cost of goods sold   800,000
Gross margin   800,000
Selling and administrative expenses:    
Selling expenses $ 400,000  
Administrative expenses 200,000 600,000
  Operating income   $ 200,000
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Income Statement

 Past net income provides information for predicting future earnings.

Helpful Hint

1. The financial statement heading identifies the company, the type of statement, and the
time period covered.

2. Dollar sign on first number of each column

3. The Net income has a $ sign and Double score

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Income Statement

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Income Statement

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Income Statement

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Retained Earnings Statement
 Like the income statement, the retained earnings statement covers a specific
time period. This statement shows changes in retained earnings. Let’s have a
look at an example:
• Shows amounts and causes of changes in retained earnings during the period.
• Time period is the same as income statement.
• Users can evaluate dividend payment practices.

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Retained Earnings Statement

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Retained Earnings Statement
 Attempt Example 1 Chapter 1, Retained Earnings Statement

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Retained Earnings Statement
 Note the following:

1. Once again, note the lines at top (similar to the income statement).

2. Ending retained earnings balance of the past year is the beginning retained
earnings balance of the current year.

3. The net income number is carried in from the income statement, but the
retained earnings balance only increases by the net amount remaining after
dividends are paid out.

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Retained Earnings Statement
CSU Corporation began operations on January 1, 2022. The
following information is available for CSU on December 31, 2022:
Accounts receivable 1,800 Retained earnings $ 0
Supplies expense 200 Accounts payable 2,000
Equipment 16,000 Cash 1,400
Rent expense 9,000 Insurance expense 1,000
Dividends 600 Notes payable 5,000
Service revenue 17,000 Common stock 10,000
Supplies 4,000

Prepare a retained earnings statement.

LO 3 Copyright ©2020 John Wiley & Sons, Inc. 32

Retained Earnings Statement

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Balance Sheet
 Reports the financial position of the business
 Reports assets and claims to assets at a specific point in time.
 Assets = Liabilities + Stockholders’ Equity.
 Lists assets first, followed by liabilities and stockholders’ equity.
Helpful Hint The heading of a balance sheet must identify the
company, the statement, and the date.

Question: If a business has $100,000 worth of assets and bank debt of

$30,000, how much equity does it have?
Assets –Liabilities = Owners Equity = $100000-$30000= $70000
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Balance Sheet
 Assets: economic resources controlled by an entity that are expected to
provide current/future benefit to the business     ex) cash, office
supplies, merchandise inventory, land, machinery/equipment
 Liabilities/Debt: debts payable to outside parties such as creditors,
suppliers, employees, governments         ex) accounts payable, notes
payable, salaries payable, taxes payable
 Owner’s equity/Equity: the amount of an entity’s assets which remain
after the liabilities are subtracted (can also be called net assets).

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Balance Sheet
 To understand equity at a fundamental level, we should define two basic terms:  

 Owner investment: When an owner or investor adds funds or other assets into the
business, this results in an increase in equity.

 Owner withdrawal: When an owner or investor takes funds or other assets out of
the business, this results in a decrease in equity.

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Balance Sheet
 Question 1: If the business owner withdraws $20,000 from the company for home repairs, how
much equity is now in the business?

 $70000 -$20000 = $50000

 Question 2: If the business owner transfers her old vehicle (worth $5,000) to the business, how
much equity is now in the business? Assume there was $70,000 of equity before the transfer.

 $70000 +$5000=$75000

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Balance Sheet

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Balance Sheet

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Balance Sheet

 Attempt Example 1 Chapter 1, Balance sheet

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Balance Sheet
 Notes
 There a period difference between the balance sheet and the two previous
statements

 Balance sheet shows the financial position at a specific date (single day) other
statements cover a whole year

 Balance sheet is a “snapshot” of the company’s financial position at a given

point in time

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Cash Flow Statement

 Cash flow statement provides details about cash inflows and outflows of a
business.

Provides answers to:

 Where did cash come from during the period?

 How was cash used during the period?

 What was the change in the cash balance during the period?

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Cash Flow Statement
 This financial statement has three major sections:

 Operating activities: Cash flows from a company’s core business

activities (operations). Cash receipts from sales – Cash payments for
goods and operating expenses (Requires Direct or Indirect methods to
calculate)
Investing activities: Cash flows from a company’s purchase or sale of
Assets (excluding inventory)

 Financing activities: Cash flows from a company’s equity and debt

financing
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Cash Flow Statement- Direct Method

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Interrelationships of the Financial Statements

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Interrelationships of the Financial Statements

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Interrelationships of the Financial Statements

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Financial Statements
Final points about the financial statements:

• Organization of financial statement items in a readable and

understandable format
• Use of appropriate headings which clearly state the name of the
financial statement type, business name, and date/period being reported
• Dollar symbol ($) only shown with the first and last items of a financial
statement
• A double underline beneath the major totals of a financial statement
• Negative numbers presented in Brackets
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Summary

 Forms of business organizations

 The main purpose of accounting

 Users and uses of accounting information

 Distinguished between financial and managerial accounting

 Financial statements

 Interrelationships of Financial Statements

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Questions
 ????

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