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CHAPTER 1

ACCOUNTING AND ITS

USE IN BUSINESS
DECISIONS
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The Body of
Accounting Knowledge

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The Body of
Accounting Knowledge
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Chapter 1

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1-4

The Business Entity Concept

For
For accounting
accounting
purposes,
purposes, each
each
business
business organization,
organization,
or
entity
or entity,
entity,
has an
an
entity has
existence
existence separate
separate
from
from its
its owner(s).
owner(s).

1-5

Forms of Businesses
Single
Proprietorship

Partnership

Corporation

1-6

Single Proprietorships

One owner - the

simplest possible
form of business

1-7

Single Proprietorships
One owner - the
simplest possible
form of business
Is not considered a
separate legal entity.

1-8

Single Proprietorships
One owner - the
simplest possible form
of business
Is not considered a
separate legal entity.
Many other textbooks
start with this form
and then move on to
corporations.

1-9

Partnerships

Two or more owners

Also not considered a

separate legal entity.

Are not covered in this

course.

Advanced accounting

1-10

Corporations
Usually there are many owners.
Usually the owners do not exercise
direct control over the company.

Owners

1-11

Corporations
Usually there are many owners.
Usually the owners do not exercise
direct control over the company.

The owners interests are represented by

the board of directors.
directors

Board of Directors

Owners

1-12

Corporations
Usually there are many owners.
Usually the owners do not exercise
direct control over the company.

The owners interests are represented by

the board of directors.
directors

Reason used throughout this text.

Board of Directors

Owners

1-13

Corporations

A corporation is considered a separate

legal entity.
pays taxes, can sue and be sued, and is
subject to legal penalties.
More on this in Chapter 12.

Stockholders get dividends

corporation.
What are dividends?

from the

Distributions of profits

to owners
Owners

1-14

Three Types of Businesses

Service
Businesses

Merchandising
Businesses

Manufacturing
Businesses

(Chapters 1-4)

(Chapters 16-17)

(Last 2/3 of 2nd

semester)

Examples of each?

1-15

Terminology

Profitability:
Profitability:

The
The ability
ability to
to generate
generate income.
income.

Solvency:
Solvency:
The
The ability
ability to
to pay
pay debts
debts as
as they
they
become
become due.
due.

Why
Why are
are they
they important?
important?
Ostensibly,
Ostensibly, they
they are
are the
the primary
primary
objectives
objectives of
of every
every business
business

1-16

The Four Basic Financial Statements

Income
Statement

Which two are the

most important?

Statement
of
Retained
Earnings
Balance
Sheet
Statement
of Cash
Flows

Why are Income Statement and

Balance Sheet most important?

Because
Because they
they communicate
communicate the
the

profitability
profitability and
and solvency.
solvency.

Which
Which does
does which?
which?

Income
Income Statement
Statement -- Profitability
Profitability
Balance
Balance Sheet
Sheet -- Solvency
Solvency

Can
Can each
each be
be represented
represented with
with an
an

equation?
equation?

1-17

1-18

Income Statement Model

Net
Revenues - Expenses
=
Income
Inflows
Inflows of
of assets
assets
resulting
resultingfrom
fromthe
the
sale
saleof
of products
productsor
or
services.
services.

1-19

Income Statement Model

Net
Revenues - Expenses
=
Income
Costs
Costsincurred
incurredto
to
produce
producerevenues
revenues
or,
or,
Assets
Assetsused
usedup
upin
in
the
theprocess
process of
of
earning
earning revenues.
revenues.

1-20

Income Statement Model

Net
Revenues - Expenses
=
Income
Caution!

NET
NET INCOME
INCOME results
results
when
when Revenues
Revenues exceed
exceed
Expenses
Expenses for
for aa given
given
period.
period.

Must use the correct

accounting
definitions! Not
yours, not Websters
and not one from
Economics class.

1-21

Income Statement Model

Net
Loss

Revenues - Expenses

NET
NET LOSS
LOSS results
results when
when
Expenses
Expenses exceed
exceed
Revenues
Revenues for
for aa given
given
period.
period.

1-22

Balance Sheet Model

Assets
Assets

Liabilities
Liabilities
Stockholders
Stockholders
Equity
Equity

1-23

Balance Sheet Model

Assets
Assets == Liabilities
Liabilities ++ Stockholders
StockholdersEquity
Equity
Things
Thingsof
of
value
value
owned
owned by
by
the
the
business.
business.

Debts
Debtsowed
owed
by
bythe
the
business.
business.

(i.e.,
(i.e.,the
the
creditors
creditors
claims
claimsagainst
against
the
theassets)
assets)

Owners
Owners
interest
interest in
inthe
the
business.
business.

(i.e.,
(i.e.,the
theowners
owners
claims
claimsagainst
againstthe
the
assets)
assets)

Components of
Stockholders Equity

Capital
Capital stock
stock
Amount the owners have invested
Amount the owners have invested

in
in the
the corporation.
corporation.

Retained
Retained earnings
earnings
Net income earned since the
Net income earned since the

beginning
beginning of
of the
the company,
company,less
less
any
any dividends
dividends paid.
paid.

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1-25

Balance Sheet Model

Assets
Assets == Liabilities
Liabilities ++ Stockholders
StockholdersEquity
Equity
Retained
Retained
Earnings
Earnings

+
Net
NetIncome
Income

Capital
Capital
Stock
Stock

Dividends
Dividends

1-26

Balance Sheet Model

_____Sources of assets_____

Assets
Assets == Liabilities
Liabilities ++ Stockholders
StockholdersEquity
Equity
Why is it called a Balance Sheet?
Basic algebra

1-27

Balance Sheet Model

Equities (Claims against the assets)

Assets
Assets == Liabilities
Liabilities ++ Stockholders
StockholdersEquity
Equity
Note, however, that you cannot tag a dollar!

Timing of Balance Sheet and

Income Statement
Balance Sheet:
At 12-31
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1998
Income Statement:
For the year ended 12-31

12-31

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Financial Statements Covered

This Semester
Income Statement
Income Statement
Statement of Retained Earnings
Statement of Retained Earnings
Simple example
Simple example

Balance Sheet
Balance Sheet
Two types
Two types

Horizontal
Horizontaland
andvertical
vertical

19

1-29

1-30

Statement of Retained Earnings

Links
Links the
the Income
Income

Statement
Statement with
with the
the
Balance
Balance Sheet
Sheet

Summarizes
Summarizes changes
changes

in
in Retained
Retained Earnings
Earnings
(R/E)
(R/E) for
for the
the period
period

Statement of Retained Earnings:

More Complex Example (p. 20)
HEADING

R/E - Beginning of Period

$$$

Add: Net Income for

for the Period

$$$

Subtract: Dividends for

the Period

$$$

R/E - End of Period

$$$

1-31

1-32

Retained Earnings Model

B/R/E + NI - Dividends = E/R/E

1-33

Retained Earnings Model

B/R/E + NI - Dividends = E/R/E

This assumes that
the company in fact
has net income.

1-34

Retained Earnings Model

B/R/E - NL - Dividends = E/R/E

If the company
does not have net
income, subtract
the net loss.

1-35

Retained Earnings Model

B/R/E + NI - Dividends = E/R/E

A dividend is a
distribution of
income to the owners
of the corporation.

The Financial Statement

NOT Studied This Semester

Statement
Statement of
of Cash
Cash Flows
Flows

At
At this
this point,
point, simply
simply know
know that
that itit tells
tells

where
where cash
cash came
came from
from and
and where
where itit
went.
went.
Where got, where gone
Where got, where gone

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Balance Sheet Comparison

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Corporation vs. Proprietorship

(See Appendix, pp. 33-34)
CORPORATION
Stockholders' Equity:
Capital stock
$ 100,000
Retained earnings 50,000

PROPRIETORSHIP
Owner's Equity:
Smith, Capital $150,000
______

Total equity

Total equity

$150,000

$ 150,000

1-38

ROLL EM !

Video #1

Video #2

1-39

Final Points

P.
P.23
23 Underlying
Underlying Assumptions
Assumptions

Only know business entity concept for now

Only know business entity concept for now

1-40

Final Points

P.
P.23
23 Underlying
Underlying Assumptions
Assumptions

Only know business entity concept for now

Only know business entity concept for now

Dont
Dont read
read the
the chapters!
chapters!

Questions
Questions on
on pp.
pp. 23-30
23-30 Transactions?
Transactions?

1-41

Final Points

P.
P.23
23 Underlying
Underlying Assumptions
Assumptions

Only know business entity concept for now

Only know business entity concept for now

Dont
Dont read
read the
the chapters!
chapters!

Questions
Questions on
on pp.
pp. 23-28
23-28 Transactions?
Transactions?

P.
P.26
26 -- Subsequent
Subsequent use
use of
of Summary
Summary of
of

Transactions
Transactions in
in this
this course
course

1-42

Final Points

P.
P.23
23 Underlying
Underlying Assumptions
Assumptions

Only know business entity concept for now

Only know business entity concept for now

Dont
Dont read
read the
the chapters!
chapters!

Questions
Questions on
on pp.
pp. 23-28
23-28 Transactions?
Transactions?

P.
P.26
26 -- Subsequent
Subsequent use
use of
of Summary
Summary of
of

Transactions
Transactions in
in this
this course
course

P.
P.27
27 -- Transaction
Transaction 1b
1b -- Why...?
Why...?

1-43

Final Points

P.
P.23
23 Underlying
Underlying Assumptions
Assumptions

Only know business entity concept for now

Only know business entity concept for now

Dont
Dont read
read the
the chapters!
chapters!

Questions
Questions on
on pp.
pp. 23-28
23-28 Transactions?
Transactions?

P.
P.26
26 -- Subsequent
Subsequent use
use of
of Summary
Summary of
of

Transactions
Transactions in
in this
this course
course

P.
P.27
27 -- Transaction
Transaction 1b
1b -- Why...?
Why...?

P.
P.27
27 -- Transaction
Transaction 2b
2b -- Revenue?
Revenue?

1-44

Final Points

P.
P.23
23 Underlying
Underlying Assumptions
Assumptions

Only know business entity concept for now

Only know business entity concept for now

Dont
Dont read
read the
the chapters!
chapters!

Questions
Questions on
on pp.
pp. 23-28
23-28 Transactions?
Transactions?

P.
P.26
26 -- Subsequent
Subsequent use
use of
of Summary
Summary of
of

Transactions
Transactions in
in this
this course
course

P.
P.27
27 -- Transaction
Transaction 1b
1b -- Why...?
Why...?

P.
P.27
27 -- Transaction
Transaction 2b
2b -- Revenue?
Revenue?

P.
P.30
30 -- One
One more
more transaction
transaction

1-45

Final Points

P.
P.23
23 Underlying
Underlying Assumptions
Assumptions

Only know business entity concept for now

Only know business entity concept for now

Dont
Dont read
read the
the chapters!
chapters!

Questions
Questions on
on pp.
pp. 23-28
23-28 Transactions?
Transactions?

P.
P.26
26 -- Subsequent
Subsequent use
use of
of Summary
Summary of
of

Transactions
Transactions in
in this
this course
course

P.
P.27
27 -- Transaction
Transaction 1b
1b -- Why...?
Why...?

P.
P.27
27 -- Transaction
Transaction 2b
2b -- Revenue?
Revenue?

P.
P.30
30 -- One
One more
more transaction
transaction

P.
P.31
31 -- Analyzing
Analyzing and
and Using
Using Fin.
Fin. Results
Results

1-46

Caution!
One
One final
final caution,
caution, especially
especially for
for those
those
who
who have
have had
had some
some prior
prior accounting
accounting
High School
High School

One
Onecourse
course
Two
Twocourses
courses
College
College

Took
Tookitit and
anddropped
droppedthe
thecourse
course
Took
Tookitit and
andfailed
failedthe
thecourse
course

1-47

Thats the
end of the
topic, Bub!
Did you get
all that?