Accounting and the Business Environment Chapter 1 1

Learning Objectives Introduction review The accounting profession and the organizations that govern it Types of business organizations Characteristics and organization of a corporation The financial report that is at heart of the entire accounting universe 2 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Learning Objectives Accounting concepts and principles The balance sheet: the accounting equation, assets, liabilities, and equity. Use the accounting equation to analyze transactions Prepare financial statements Use financial statements to evaluate business performance 3 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

1 Introduction review 4 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Accounting is “the language of business. ” The information system that: Measures business activity Processes the data into reports Communicates the results to decision makers Presents information in monetary terms Knowing how to speak this language makes you a better decision maker, no matter what career path you choose in business. 5 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

The Income Statement All numbers in thousands Revenues Amounts earned by delivering goods or services to customers Expenses Decreases in equity that occur from using assets or increasing liabilities in the course of delivering goods or services to customers Net Income (Net Loss) Wealth created (consumed) by revenue and expense transactions. 6 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

2 The accounting profession and the organizations that govern it 7 Copyright © 2012

The Accounting Profession Lucrative career with many opportunities Certified Public Accountants (CPAs) Meet education and/or experience requirements Pass qualifying exam Certified Public Accountants, or CPAs Certified Management Accountants, or CMAs 8 • Licensed professional accountants who are approved to serve the general public • Certified professionals in accounting for a single company. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

California Society of Certified Public Accountants Cal. CPA, Silicon Valley Chapter http: //www. calcpa. org Career building resources Continuing education Professional networking & involvement Scholarships 9 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Governing Organizations SEC FASB • Securities and Exchange Commission • U. S. governmental agency that oversees U. S. financial markets. • Financial Accounting Standards Board • A privately funded organization, formulates accounting standards AICPA • American Institute of Certified Public Accountants • Private organization of public accountants • Source for ethical standards in many areas PCAOB • Public Company Accounting Oversight Board • Oversees auditing standards and practices IASB 10 • International Accounting Standards Board • Publishes the International Financial Reporting Standards, the international accounting rule book Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Audit: an opinioned examination Why Audit: Businesses want to look good Investors want reliable financial information Help uphold the faithful representation principle SEC requires companies to have financial statements examined by independent accountants Auditors provide an opinion on financial statements U. S. Government crackdown on fraud: Created the Public Company Accounting Oversight Board (PCAOB) Passed the Sarbanes-Oxley Act (SOX) A variety of Post-Madoff reforms 11 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

3 Types of business organizations 12 Copyright © 2012 Pearson Education, Inc. Publishing as

Types of Business Organizations Proprietorship Partnership Corporation LLC and LLP Not-for-profit 13 Copyright ©

4 Characteristics and organization of a corporation 14 Copyright © 2012 Pearson Education, Inc.

Organization of a Corporation Incorporators obtain charter from the state Charter authorizes corporation to: Issue stock Conduct business in accordance with state law Incorporators agreed to a set of bylaws Bylaws are the rule book that guides the corporation. Corporations begins to exist when stock is issued Stockholders vote on who will serve on Board of Directors 15 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Structure of a Corporation 16 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice

The good side of Incorporation Limited personal liability for stockholders. Fund-raising! Transferability of ownership. Continuity of existence. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

The dark side of Incorporation Greater regulation. Double taxation. Separation of ownership and management. Cost of formation. www. corporate. com Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Quiz Corp: Name two benefits of incorporating. Name two negatives of incorporating. Copyright ©

Organization types by the numbers Loads of Sole props, but not so much production Few Corporations, but producing loads of sales 21 http: //www. bizstats. com/reports/sales-structure. php Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

To incorporate or not? Why? You and areown 700 a manage doctor other You own & a people with own your aown chain askateboard small fruit-stand park of craft practice stores Incorporate Sole Proprietorship or Partnership Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

5 Accounting concepts and principles 23 Copyright © 2012 Pearson Education, Inc. Publishing as

GAAP Generally Accepted Accounting Principles Guidelines that govern accounting Based on a conceptual framework Goals include: Provide useful information for investment and lending decisions Must be relevant, reliable, and comparable US GAAP vs. IFRS Rules based vs. principles based IFRS demonstrates a user bias Convergence and conversion 24 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Accounting Principles Entity Concept • A business is separate from its owners Faithful Representation Principle • Accounting information is complete, neutral, and free from material error Cost Principle • Assets are recorded at purchase price • US GAAP reflects decreases, IFRS can reflect increases 26 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Accounting Principles (continued) Going-Concern • Assumption that business will remain in operation for the foreseeable future Stable Monetary Unit Concept • In the U. S. amounts are recorded in dollars • The dollar is considered a stable unit of measure 27 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

6 The Balance Sheet: the accounting equation, assets, liabilities, and equity 28 Copyright ©

The Accounting Equation ASSETS Economic Resources 29 LIABILITIES EQUITY Claims to Economic Resources Copyright

Assets Economic resources Benefit the business in the future Examples: Cash Accounts receivable Merchandise inventory Furniture Land 30 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Claims to Assets Liabilities Equity Debts payable to outsiders Examples: Accounts payable Salaries payable Bank loans Mortgages Unearned revenue Owners’ claims to the assets of the business In a corporation, stockholders’ equity Two forms: Earned capital Eg: Retained earnings Paid-In Capital Eg: Capital stock Let’s make a company on the board 31 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

7 Use the accounting equation to analyze transactions 32 Copyright © 2012 Pearson Education,

Transaction An event that affects the financial position of the business Can be measured reliably Every transaction impacts at least two items The accounting equation balances before and after each transaction 33 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Let’s use the accounting equation to make up a business and record some transactions Write up basic accounting equation Create initial transactions to prepare for business Record revenue & expense transactions Translate to reports If this doesn’t get too messy, we can make some simple financial statements from the data. 34 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

9 Prepare financial statements 38 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice

Preparing the Financial Statements Income Statement Balance Sheet Statement of Retained Earnings Statement of

Income Statement 40 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Statement of Retained Earnings 41 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice

Balance Sheet 42 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Statement of Cash Flows 43 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice

Studio Photography, Inc. , works weddings and prom-type parties. The balance of retained earnings was $16, 000 at December 31, 2011. At December 31, 2012, the business’s accounting records show these balances: Insurance expense $ 8, 000 Accounts receivable $ 8, 000 Cash 37, 000 Note payable 12, 000 Accounts payable 7, 000 Retained earnings Advertising expense 3, 000 Salary expense ? 25, 000 Service revenue 80, 000 Equipment 50, 000 Dividends 31, 000 Common stock 29, 000 Prepare the following financial statements for Studio Photography, Inc. for the year ended December 31, 2012: a. Income statement b. Statement of retained earnings c. Balance sheet 44 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Studio Photography, Income Statement Year Ended December 31, 2012 Revenue: Service revenue Expenses: Salary expense Insurance expense Advertising expense Total expenses Net income 45 $ 80, 000 $ 25, 000 8, 000 36, 000 $ 44, 000 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Studio Photography, Inc. Statement of Retained Earnings Year Ended December 31, 2012 Retained earnings, December 31, 2011 Add: Net income Subtotal Less: Dividends $ 16, 000 44, 000 $ 60, 000 (13, 000) Retained earnings, December 31, 2011 $ 47, 000 46 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Studio Photography, Inc. Balance Sheet December 31, 2012 Assets Cash Accounts receivable Equipment Liabilities $37, 000 8, 000 50, 000 Accounts payable $ 7, 000 Note payable 12, 000 Total liabilities 19, 000 Stockholders’ Equity Common stock Total assets 47 $95, 000 $29, 000 Retained earnings 47, 000 Total stockholders’ equity 76, 000 Total liabilities and stockholders’ equity $95, 000 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

10 Use financial statements to evaluate business performance 48 Copyright © 2012 Pearson Education,

Decision Guidelines Income Statement Demonstrates profitability Statement of Retained Earnings Balance Sheet Shows changes in retained earnings Demonstrates economic resources as well as debts the company owes www. yahoo. com/finance Income statement: Earnings power Balance Sheet: Financial strength/standing 49 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 1 Summary Accounting is the language of business. Financial statements report a company’s activities in monetary terms. Different users—including individuals, business owners, managers, investors, creditors, and tax authorities—review a company’s financial statements for different reasons. Each user’s goal will determine which pieces of the financial statements he or she will find most useful. 50 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 1 Summary Most U. S. businesses follow generally accepted accounting principles (GAAP). If the company is publicly traded, then it must also follow SEC guidelines. If the company operates internationally, then international financial reporting standards (IFRS) will apply. The goal is that, eventually, all public U. S. companies will report using IFRS rules. There are five main forms of business organizations: proprietorships, partnerships, corporations, LLPs/LLCs, and not-for-profits. Each is unique in its formation, ownership, life, and liability exposure. 51 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 1 Summary Corporations are formed with a specific state by issuance of a charter. The stockholders own the corporation, but they have no liability for the corporation’s actions. Corporations usually raise capital more easily than other forms of business, but have the disadvantage of additional regulation and additional taxes. The accounting concepts are the underlying assumptions used when recording financial information for a business. Think of the concepts like rules of a game. You have to play by the rules. 52 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 1 Summary The accounting equation must always equal. That is, Assets (what you own) must equal Liabilities (what you owe) + Equity (net worth). In a corporation, equity is composed of paid-in capital (by outsiders) and retained earnings (earnings kept for use by the company). The accounting equation is Assets = Liabilities + Equity. Every business transaction affects various parts of the equation, but after each transaction is recorded, the equation must ALWAYS balance (equal). 53 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

Chapter 1 Summary Financial statements are prepared from the ending balances of each account. Each financial statement shows a different view of the company’s overall results. Financial statements are prepared from the transaction analyses (summary of events) reported in each account (Exhibit 1 -6) in the order shown in Exhibit 1 -7. No one financial statement shows everything about a company. It is the financial statements AND the relationships the statements show that give users the overall picture for a specific company. 54 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.