Chapter 1 Lecture Notes

I. Forms of Business Organization:

Sole Proprietorship
Owned by one person
Least regulated form of organization; simple to establish
Owner controlled
Difficult to transfer ownership
Ex: barber shops

Partnership
Owned by two or more persons
Shared gain and loss
Broader skills and resources
Simple to establish
Difficult to transfer ownership
Ex: Certified public accountants (CPA firms), Law firms

Corporation
A separate legal identity owned by stockholders
Easier to raise funds: can sell new shares of stock to attract new investors
Easier to transfer ownership
Corporations can be public or private depending on whether their stocks are
publicly traded at a stock exchange, such as New York Stock Exchange (NYSE).
Public companies must meet stringent reporting requirements, including the
public disclosure of financial statements and annual reports (10-K) discussing the
state of the company. Ex: Apple, Walmart

II. Primary Users of Accounting Information:

What is Accounting?

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 Internal Users managers who plan, organize and run a business
Easier access to information than external users
Provides managers with information needed to plan and control their areas of
responsibility
Examples:
Finance Manager Is cash sufficient to pay dividends to shareholders?
Marketing Manager What product price will maximize income?
Human Resource Manager Can company afford employee raise?
Management Which product line is most profitable? Should any product
line be eliminated?

External Users
Limited access to information
Financial accounting prepares information primarily for outside users
Examples:
Stockholders Is company earning satisfactory income? How does the
company compare to other companies?
Creditors Will company be able to pay its debts as they come due?
Govt. Agencies Is company operating under prescribed rules?
Others Suppliers, trade-associations, stockbrokers/analysts

III. Business Activities

Financing Activities
Two primary sources of outside funds:
1. Borrowing money
Amounts owed are called liabilities.
Party to whom amounts are owed are creditors.
Firms can borrow money from banks or issuing corporate bonds.
2. Issuing shares of stock for cash.
Common Stock: the total amount paid in by stockholders for the
shares they purchase.
Payments to stockholders are called dividends.

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 Investing Activities
Purchase of resources a company needs to operate.
Computers, delivery trucks, furniture, buildings, etc.
Resources owned by a business are called assets.

Operating Activities
Revenue: The amount earned on the sale of products or services in the normal
course of business.
Expense: The cost of assets consumed or services used in the process of
generating revenues (cost of goods sold, selling, marketing, administrative,
interest, and income taxes expense).
Net income when revenues exceed expenses.
Net loss when expenses exceed revenues.

IV. How Accountants Communicate

The Accounting Equation is the foundation for the entire accounting system:

Assets = Liabilities + Stockholders Equity

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V. The Four Financial Statements

1) Income Statement

Reports the success or failure of the companys operation for a specific period of
time.
Summarize revenues and expenses for a period of time.

2) Statement of Retained Earnings

Retained earnings is the net income retained in the corporation.

The retained earnings statement shows the amounts and causes of changes in retained
earnings during the period.
Income increases retained earnings; dividends decrease retained earnings.
Will dividends decreases income?

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3) Balance Sheet

Reports assets and claims to assets at a specific of point in time.

Claims to assets: claims of creditors (Liabilities) and claims of owners (Stockholders
Equity).
Lists Assets first, followed by Liabilities and Stockholders Equity.

4) Statement of Cash Flows

Summarizes the cash inflows and outflows for a specific period of time.
Shows the net increase or
decrease in cash during a
period.
Shows the amount of cash
at the end of a period.

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Short Summary

Income Statement

Statement of Retained Earnings

Balance Sheet

Statement of Cash Flows

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Example 1
The following information is available from the records of Kaplan Landscape Design Inc. at the
end of the 2011 calendar year:

Accounts Payable $6,000 Office Equipment $ 7,500

Accounts receivable 5,000 Rent expense 5,500
Common stock 7,000 Retained earnings,
Cash 12,000 Beginning of year 8,500
Dividends 3,000 Salary Expense 12,000
Landscaping Revenues 24,000 Supplies 500

Required:
1. What was Kaplans Net Income for the year ended Dec 31, 2011?

2. What is Kaplans Retained Earnings balance at the end of the year?

3. Prepare Kaplans Balance Sheet as of December 31, 2011.

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Example 2
One item is omitted in each of the following summaries of balance sheet and income statement
data for three different corporations, A, B, and C.

Determine the amounts of the missing items, identifying each corporation by letter.

Corporation
A B C
Beginning of the Year:
Assets $410,000 $150,000 $199,000
Liabilities 250,000 115,000 166,000
End of the Year:
Assets 430,000 195,000 195,000
Liabilities 280,000 95,000 169,000
During the Year:
Additional Investment by stockholders ? 79,000 78,000

Dividends 70,000 83,000 ?

Revenue 195,000 ? 187,000

Expenses 155,000 113,000 183,000

Hint:
End. SHE = End. Retained Earnings + End. Common Stock

-) Beg. SHE = Beg. Retained Earnings + Beg. Common Stock

(End. SHE Beg. SHE)

= (End. Retained Earnings Beg. Retained Earnings)
+ (End. Common Stock Beg. Common Stock)

That is, Change in SHE = Change in Retained Earnings + Change in Common Stock