A Business Process Approach

Financial Accounting:
A Business Process Approach
Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1 - 1

Chapter 1
Business: What’s It All About?

Chapter 1 Learning Objectives
When you are finished studying Chapter 1, you
should be able to:
1. Describe what a business does and the
various ways a business can be organized.
2. Classify business transactions as operating,
investing, or financing activities.
3. Describe who uses accounting information
and why accounting information is important to
them.

Chapter 1 Learning Objectives
4. Identify the elements of the four basic
financial statements—the income statement,
the statement of changes in shareholders’
equity, the balance sheet, and the statement of
cash flows, explain the purpose of each, and be
able to use basic transaction analysis to
prepare each statement.
5. Identify the elements of a real company’s
financial statements.
6. Describe the risks associated with being in
business and the part that ethics plays in
business.

Ethics Matters
1. Is it legal?
2. Will it harm anyone?
3. Would you mind reading about your
decision in the morning newspaper?
Should Bernie Madoff have asked himself these
questions?

Learning Purpose of a Business
Objective 1
Obtain the resources needed to
1. Obtain capital
start and run a business
2. Add value
3. Sell to customers

Purpose and Organization of a Business
For-profit firms . . .
Make profits for investors.
Not-for-profit organizations . . .
provide goods and services to
people and use profits to
provide more goods and
services to people.

Simple Business Model
INPUTS
Cash from Capital,
Financing,
Property, Plant,
Equipment,
Raw Materials,
Labor,
Inventory,
Goods & Services
OUTPUTS
Product
Service
Value-added
conversion

Nature of Business Operations
Types of Companies:
Service :
 Provide services for customers
 Financial Services deal in services related to money.
Sales
 Merchandising—buys goods and resells them to other
businesses (wholesale) or to final customers (retail)
 Manufacturing—makes a product and sells it to other
businesses (wholesale) or to final consumers (retail)

Your Turn 1-1
The What main is purpose the main of purpose a business of a is business?
to make a
profit, increasing the value of the company for
the owners.
What are the four general types of
businesses?
Service company
Merchandising
company
Manufacturing
company
Financial services
company

Ownership Structure of Businesses
More Sole Proprietorship--than 2/3 of U. S. a single
businesses
are owner sole business
proprietorships.
Only partnerships, Partnership--2.5% of U. S. businesses are
and a multiple-they earn owner
less than
business
10% of all U. S. firms’ profits.
Corporation-a business whose ownership
is divided into "shares" and may be
owned by a large number of people.
More than 2/3 of U. S. companies’
profits are earned by corporations.

Characteristics of Different Forms of
Business
Personal liability
Taxation
Transfer of ownership
Ability to raise capital
Government regulation
1Liability
2 Taxation
3 Ownership
4 Capital
5 Regulation

Sole Proprietorship
Personal responsibility and
liability
Income reported on individual’s
tax return
Owned by one individual
Difficult to acquire capital
Minimal government
regulation

Partnerships
Partners share
personal responsibility and liability
Partners usually create an agreement that
describes how much work each will do
and how the profit and loss will be divided.
Income IS reported on each partner’s
individual tax return
Difficult to
acquire
capital
Minimal
government
regulation

Corporations
A corporation is a popular form of business
because . . .
Individuals can purchase small
amounts of stock.
Provides stockholders with
limited liability.
Allows for easy transfer of
ownership.
More than two-thirds of U.S. firm’s
profits are made by corporations.

Corporations
Once the state
issues a charter,
the stockholders
elect a board of
directors.
A corporation is a separate legal entity
that can . . .
Enter into
contracts
Own assets
Incur
liabilities
Sue and be sued

New Hybrid Forms of Business
Have characteristics of both
corporations and partnerships
Limited Liability
of a corporation
LLP
Limited
Liability
Partnership
LLC
Limited
Liability
Corporation
Tax advantages
of a partnership
Mostly used by law, medical, and accounting
profession

Your Turn 1-2
The three major forms of ownership are:
(1) sole proprietorships (single owner)
What are the three major forms of business ownership?
(2) partnerships (multiple owners)
(3) corporations (widespread ownership)
Disadvantages:
Advantages:
Sole Proprietorship and Partnership:
Liability, Difficulty to raise capital
From the owners’ point of view, what are the
advantages Sole Proprietorship and disadvantages and Partnership:
of each form of
Owner control, single taxation
Corporation:
ownership?
Corporation:
Conflict of interest between
management and owners,
Limited Liability, Ease of raising capital
Double taxation

Business Transactions
Operating
Activities
Investing
Activities
Financing
Activities
Learning
Objective 2
Business transactions are economic exchanges
classified as:
Transactions
related to
the general
operations of
the firm
Transactions
related to
buying and
selling items the
firm will
use for more
than a year
Transactions
that deal
with how a
business
gets it
funding

How a Business Works
Transactions for Team Shirts’ First Month of Business
Sara contributes
$5,000 of her own
money to start her
business.
Team Shirts
borrows $500
from Sara’s
sister
to help finance
the business.
Team Shirts
purchases
100 T-shirts from
a T-shirt maker.
Team Shirts
decides to
advertise the
new business.
Team Shirts
the loan plus
interest to
repays
Sara’s
Sister.
Team
Shirts
sells 90 T-shirts.

Information Needs of Decision
Makers
• Revenue from sales
• Expenses incurred
• Net income
• Inventory
• Reliability of
Vendors
Learning
Objective 3

Operating Cycle
End with more
Start with cash
Purchase
inventory
Collect cash
cash
from
customers
Make sales
to customers

Who Needs Accounting
Information?
Management
Those with direct financial interest
 Current or potential investors
 Current or potential creditors
 Employees
Those with an indirect financial interest
 Tax Authorities
 Regulatory Agencies
 Economic Planners
 Labor unions, financial advisors,
others.

Your Turn 1-4
Revenues are the amounts a company
earns from providing goods or services to
its customers.
Expenses are the costs to earn those
revenues.
What are revenues and
expenses?
The four statements include the income
statement, balance sheet, statement of
changes in shareholders’ equity, and the
statement of cash flows.
What are the four basic
financial statements?

Who Sets the Guidelines?
Securities and Exchange Commission (SEC):
Created by the U.S. Congress in 1934 to set the rules for
corporations that trade on the public stock exchanges.
Mandated by the Sarbanes-
Oxley Act. Created by the
SEC in response to 2001-
2002 accounting scandals
to oversee audits of public
companies.
Public Company
Oversight Board (PCAOB)
The SEC delegates much of
the Accounting standard-setting
responsibility to the
FASB. SEC retains and
sometimes exercises its
rights to set standards.
Financial Accounting
Standards Board (FASB)
Generally Accepted Accounting Principles Auditing Standards

International Financial Reporting
Standards
International guidelines for
financial reporting, used in many
places around the world.
International Accounting Standards
Board (IASB) sets international
financial reporting standards.
The SEC plans implementation of
IFRS in the United States by 2014
so that one global set of standards
is used by all major economies.

Four Basic Financial Statements
Accountants communicate financial information in
the form of four basic financial statements.
Balance
Sheet
Assets =
Liabilities
+ Equity
Statement of Changes in Owner’s Equity
Beginning equity + Contributions +/- Net income/loss -
Dividends = Ending equity
Income
Statement
Revenues
- Expenses
= Net income
Statement of Cash
Flows
Cash inflow
- Cash
outflow
= Net cash flow
Learning
Objective 4

Financial Statements
Dates of Financial Statements are
Important!
The Balance Sheet is prepared “AS OF…”
or “AT” a particular date, a “snapshot” in
time.

Financial Statements
1. The Income Statement
2. Statement of Changes in Owner’s Equity
3. Statement of Cash Flows
cover a period of time:
“FOR THE PERIOD ENDING”

Balance Sheet
Assets = Claims
Assets = Liabilities + Equity
Things of
Something owed
value
Obligations/debt
Economic (creditors’ share
of the assets)
resources
of the assets)
owned
Net Assets
(owner’s share
Contributed
Capital
Retained
Earnings

Your Turn 1-5
TheW twhaot p aarret st hoef stwhaor ephaortlsd eorfs S’ heqarueithyo aldreer cso’ nEtqruibituyt?ed
capital and retained earnings (earned capital).
A fiscal year is a year in the life of a business for
What is a fiscal year?
financial reporting purposes. It may begin
at any time and ends a year later.

Accounting Equation
Team Shirts
Shareholders' Equty
Contributed Capital Retained
Assets All Liabilities +
Event Cash All other assets Account Account Common Stock Earnings
1 5000 5000
2 500 500 Note Payable
3 (400) 400 Inventory
4 (50) (50) Expense
5 900 900 Revenue
(360) Inventory (360) Expense
6 (505) (500) Note Payable (5) Expense
7 (100) (100) Dividends
Balances 5345 40 5000 385
--Income Statement, --Statement of Changes in Shareholders’ Equity,
--Balance Sheet, --Statement of Cash Flows

Income Statement
. . .describes
the activity of
a company
The amount
earned from
providing goods or
services to
customers
Costs
incurred to
generate
revenue
Difference
between
revenues and
expenses
during a
period
Also called:
Statement of
earnings, statement
of operations, profit
and loss statement
Revenue – Expenses = Net Income

Your Turn 1- 6
The income statement contains revenues and
expenses. The balance sheet contains assets,
What is included on the income statement?
What is included on the balance sheet?
liabilities, and shareholders’ equity.
The time period captured by the income
statement is an accounting period, often a
fiscal year. The statement covers a period of
time. On the other hand, the balance sheet
describes the financial position of a
company at a given point in time.
Describe the difference in the time periods
captured by the income statement and the
balance sheet.

Statement of Changes in
Owners’ Equity
Beginning balance
+/- changes in contributed capital
+/- changes in retained earnings
= Ending balance
Contributed
Capital:
Contribution by investors
to obtain ownership in a
corporation.
Ownership is divided into
shares of stock.
Retained
Earnings:
Total of all net income
earned by the business
Minus
Dividends Paid to owners
(Distributions to
owners)

Statement of Cash Flows
Cash from
Operating
Activities
Cash from
Investing
Activities
Cash from
Financing
Activities
From customers’
purchases,
interest or dividend
income
From sale of
property
and
equipment
Cash Inflow
From issuing
long-term debt
or issuing stock

Statement of Cash Flows
Cash from
Investing
Activities
Cash Outflow
Cash from
Operating
Activities
Cash from
Financing
Activities
To suppliers for
inventory,
For employees’
salaries
To purchase plant
and
equipment,
Investments in
other firms
To repay long-term
debt principal,
To pay dividends to
owners

Your Turn 1 - 7
The income statement gives the revenues and expenses
for the period. The net amount, net income, is added to
retained earnings. So the income statement number
How is the income statement related to the balance
sheet? In other words, how does the amount of net
income affect the balance sheet?
becomes part of the retained earnings total on the
year-end balance sheet.
The Why income is it necessary statement to have shows both all revenues an income and statement
expenses
and for a a period statement of time—of cash all the flows?
revenues that have been
earned Look at and the statements expenses incurred for Team to Shirts earn those and explain revenues.
why
The they statement are different.
of cash flows simply lists the cash inflows
and outflows during the period. Also, any transactions
with owners (contributions and dividends) are not
included on the income statement.

Revenue
s
-Expense
s
Net
income
Multi-step:
Calculates net
income in steps
Learning
Objective 5
Real Company’s Financial
Statements
Single-step:
Groups all
revenues
together and
deducts all
expenses from
total revenues
Revenues
- Cost of Goods
Gross Margin
+ Other Revenue
- Other
Expenses
Operating Income
- Income
Taxes Net
Income
Income Statements

Real Company’s Financial
Statements
Classified Balance Sheet
Shows a subtotal for various classes of assets and
liabilities, including current and long-term assets
and liabilities, and shareholders’ equity
Assets:
Current
Assets
Property,
Plant, and
Equipment
Other Assets
Shareholders’
Equity:
Contributed
Capital,
Retained
Earnings,
Other
Comprehensive
Income
Liabilities:
Current
Liabilities
Long-term
Liabilities

Risk: Anything that exposes us to potential
injury or loss.
Can turn into significant losses, scandals, or
total company failure.
Learning
Objective 6
Business Risk, Control, and
Ethics
Product Failure
Theft of Assets
Purchase/sale of
poor quality
inventory
Strategic Risks
Operating Risks
Financial Risks
Information Risks

Business Risk, Control, and Ethics
Every risk brings a potential reward.
Firms’ managers want to minimize risks.
A manager must always put good ethical
behavior above putting a good face on the
firm’s financial position or performance.
Control: An activity performed to minimize or
eliminate risk. A firm must establish and maintain
control over its operations, assets, and information
systems.

All rights reserved. No part of this publication may
be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means,
electronic, mechanical, photocopying, recording,
or otherwise, without the prior written permission
of the publisher. Printed in the United States of
America.
Copyright © 2011 Pearson Education, Inc.
publishing as Prentice Hall

A Business Process Approach

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