Accounting: Information for Decision-Making and Basic Financial Statements STUDY OBJECTIVES After studying these chapters, you should understand: Basic financial statements GAAP How business transactions affect the accounting equation Ethics as a fundamental business concept The accounting equation Uses and users of accounting Monetary unit & economic entity assumptions What accounting is
Accounting is an information system that
identifies, records, and communicates
the economic events (transactions)
of an organization to interested users.
STUDY OBJECTIVE 1 WHAT IS ACCOUNTING?
Identification Select economic events (transactions) Recording Record, classify and summarize Prepare accounting reports Analyze and interpret for users Communication THE ACCOUNTING PROCESS Accounting Reports SOFTBYTE Annual Report
STUDY OBJECTIVE 2 USERS AND USES OF ACCOUNTING Marketing managers Production supervisors Finance directors Company officers Investors Creditors Tax authorities Regulatory agencies Customers Labor unions Internal Users External Users
QUESTIONS ASKED BY INTERNAL USERS Is cash sufficient to pay bills? What is the cost of manufacturing each unit of product? Can we afford to give employee pay raises this year? Which product line is the most profitable?
QUESTIONS ASKED BY INTERNAL USERS Is the company earning satisfactory income? Will the company be able to pay its debts as they come due? How does the company compare in size and profitability with its competitors? What do we do if they catch us?
STUDY OBJECTIVE 3 ETHICS: A FUNDAMENTAL BUSINESS CONCEPT ETHICS: A set of standards by which one’s actions are deemed right or wrong, honest or dishonest.
STUDY OBJECTIVE 3 ETHICS: A FUNDAMENTAL BUSINESS CONCEPT
Steps for solving an ethical dilemma:
Recognize an ethical situation and the issues involved.
Identify the principal elements of the situation
Identify alternatives: weigh the impact on stakeholders
STUDY OBJECTIVE 4 GAAP ( Generally Accepted Accounting Principles )
What is GAAP?
A set of standards generally accepted and universally practiced by accountants
Indicates how economic events are reported
Generated by the Financial Accounting Standards Board (FASB) and Securities & Exchange Commission (SEC)
STUDY OBJECTIVE 5 BASIC ACCOUNTING ASSUMPTIONS MONETARY UNIT ASSUMPTION Only transaction data that can be expressed in terms of money is included in the accounting records. The unit of measure (the dollar in the USA) is assumed to remain constant in value
An economic entity
includes any organization
or unit in society.
All activities of an
entity are kept separate
from the activities
of its owners and
other economic entities.
A business owned by one person is generally a proprietorship .
A business owned by two or more persons associated as partners is a partnership .
A business organized as a separate legal entity under state corporation law and having ownership divided into transferable shares of stock is a corporation .
STUDY OBJECTIVE 6 THE BASIC ACCOUNTING EQUATION Assets Liabilities Stockholders’ Equity = + resources owned by a business claims against those assets owners’ residual claim on total assets
REVIEW QUESTION THE BASIC ACCOUNTING EQUATION As of December 31, 2006, Tetrick Company has assets of $3,500 and stockholders’ equity of $2,000. What are the liabilities for Tetrick Company as of December 31, 2006 ? Answer: $1,500 Assets – Liabilities = Stockholders’ Equity $3,500 = Liabilities + $2,000 Liabilities = $1,500
Stockholders’ equity is equal to total assets minus total liabilities. It is also referred to as residual equity. There are two general categories of stockholders’ equity:
STOCKHOLDERS’ EQUITY PAID-IN CAPITAL and RETAINED EARNINGS
Paid in Capital represents the total amount invested by stockholders in a corporation.
Stockholders invest cash or other assets in exchange for common or preferred stock.
Retained earnings represents cumulative profits (or losses) retained in the business over time.
Three items make up the balance in retained earnings:
RETAINED EARNINGS REVENUES EXPENSES DIVIDENDS
Revenues are the gross increases in stockholders’ equity from engaging in business activities entered into for the purpose of earning income.
Revenues result from sales of merchandise, performance of services, rental of property, or lending of money.
Expenses are the decreases in stockholders’ equity that result from operating the business.
They are the cost of assets consumed or services used in the process of earning revenue.
When a company is successful, it generates Net Income .
Dividends: the distribution of cash or other assets to stockholders that are available as a result of Net Income.
Dividends are NOT considered an expense of the corporation.
INCREASES & DECREASES IN STOCKHOLDERS’ EQUITY Investments by stockholders Revenues Stockholders’ Equity Dividends to stockholders Expenses Increases Decreases
REVIEW QUESTION STOCKHOLDERS’ EQUITY Rebecca Sherrick, Inc., had a stockholders’ equity balance of $164,000 at the beginning of the period. At the end of the period, the stockholders’ equity balance was $198,000. Assuming no additional investment or distributions During the period, what is the net income for the period? 0 Less: dividends $198,000 Ending balance $34,000 net income ($198,000-$164,000) 0 Add: investments $164,000 Beginning balance
STUDY OBJECTIVE 7 HOW BUSINESS TRANSACTIONS AFFECT THE ACCOUNTING EQUATION
Every transaction must have a dual effect on the accounting equation. Thus, if an asset is increased, there must be a corresponding:
Decrease in another asset, or
Increase in a liability, or
Increase in stockholders’ equity
Is the financial position (assets, liabilities, and stockholders’ equity) of the company changed?
TRANSACTION IDENTIFICATION PROCESS Answer telephone Purchase computer Pay rent Yes No Yes Record Don’t Record Record
TRANSACTION ANALYSIS TRANSACTION 1 There is an increase in the asset cash, $15,000, and an equal increase in the equity common stock. Ray and Barbara Neal open Softbyte, Inc., a programming company by investing $15,000 in exchange for common stock. +15000 +15000
TRANSACTION ANALYSIS TRANSACTION 2 Cash is decreased $7,000, and the asset Equipment is increased $7,000. After transaction #2, total assets =total liabilities + equity. Softbyte purchases computer equipment for $7,000 cash
TRANSACTION ANALYSIS TRANSACTION 3 The asset Supplies is increased $1,600, and the liability Accounts Payable is increased by the same amount. Softbyte purchases for $1,600 of supplies from Acme Supply. The supplies will last several months. Softbyte will pay the bill next month.
(4) +1,200 +1,200
TRANSACTION ANALYSIS TRANSACTION 4 Cash is increased $1,200, and retained earnings is increased $1,200. (Retained earnings is indirectly increased because revenue is increased). Softbyte receives $1,200 cash from customers, for providing programming services. Retained Earnings Assets = Liabilities + Stockholders Equity Accounts Common Cash + Supplies + Equipment = Payable + Stock Old Bal. $8,000 $1,600 $7,000 $1,600 $15,000 New Bal. $9,200 + $1,600 + $7,000 = $1,600 + $16,200 $17,800 $17,800
STUDY OBJECTIVE 8 BASIC FINANCIAL STATEMENTS Balance Sheet Income Statement Statement of Cash Flows Statement of Retained Earnings After all transactions for the period are recorded, financial data is summarized and that summary data is used to generate the basic financial statements
Net income of $2,750 will be added to retained earnings. FINANCIAL STATEMENTS
FINANCIAL STATEMENTS Dividends of $1,300 is deducted from retained earnings. The net change in retained earnings for the period is $1,450 .
Cash of $8,050 will be shown in the statement of cash flows. FINANCIAL STATEMENTS
Cash of $8,050 on the balance sheet and statement of cash flows is shown as the final total of the cash column of the Summary of Transactions. FINANCIAL STATEMENTS