Download Assets = Liabilities + Equity

Chapter 1
Business: What’s it all About?
Copyright 2003 Prentice Hall Publishing
1
Financial Accounting:
A Business Process
Approach
The first four chapters introduce the basics of the
business cycle and financial reporting. Then, Chapters
5-9 go through the business cycle – acquiring fixed
assets and inventory, selling the inventory, and
obtaining both debt and equity financing. The last two
chapters take a closer look at two topics that are
covered throughout the text: the statement of cash
flows and financial statement analysis.
Copyright 2003 Prentice Hall Publishing
2
Purpose of a Business
Copyright 2003 Prentice Hall Publishing
3
Simple Model of a Business
“The Firm”
INPUTS
Value
added
conversion
Acquisition/Payment Cycle
Capital (financing)
Property, Plant, Equipment
Raw Materials
Labor
Inventory
Goods & Services
OUTPUTS
Sales/Collection Cycle
Delivery of
Product or Service
Copyright 2003 Prentice Hall Publishing
4
What are Business Processes?

Series of activities that a company
performs to achieve its goals.
» ACQUISITION / PAYMENT: acquire, maintain,
and pay for the resources needed by the
organization.
» CONVERSION: convert the resources
acquired into goods and/or services.
» SALES / COLLECTIONS: sell and deliver
goods and/or services to customers and to
collect payment.
Copyright 2003 Prentice Hall Publishing
5
Types of Businesses

Service company


provides a service for customers
Sales company


» Special case: financial services
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)
Copyright 2003 Prentice Hall Publishing
6
Examples:
 Service
 accountants, attorneys, physicians
 Financial Service
 Citicorp, Merrill Lynch, American
Express
 Merchandising
 Wal-Mart, Safeway, The Gap
 Manufacturing
 General Motors, 3M, Reynolds Metals
[Obviously, some businesses provide more than
one of the functions listed above]
Copyright 2003 Prentice Hall Publishing
7
Ownership Structure of Businesses
Sole Proprietorship--a single owner
business
Partnership--a multiple-owner business
Corporation--a business whose ownership
is divided into "shares" and may
be owned by a large number of people
Copyright 2003 Prentice Hall Publishing
8
Corporations

A corporation is a popular form of
business because . . .
It is simple for individuals to purchase
small amounts of stock.
 It allows for an easy transfer of
ownership through established
markets, like the New York Stock
Exchange.
 It provides stockholders with limited
liability.

Copyright 2003 Prentice Hall Publishing
9
Corporations

Because a corporation is a separate
legal entity, it can . . .
Own assets.
 Incur liabilities.
 Sue and be sued.
 Enter into contracts independent of the
stockholder owners.


Many Americans own stock through a mutual
fund or pension program.
Copyright 2003 Prentice Hall Publishing
10
Characteristics of Different Forms
of Business Organization
Issues in deciding between sole
proprietorship, partnership, or corporation





Personal liability
Taxation
Transfer of ownership
Ability to raise capital
Government regulation
Copyright 2003 Prentice Hall Publishing
11
Ownership of a Corporation

Owners of common stock generally
receive the following rights:
Voting (in person or by proxy).
 Distributions of profits.
 Distributions of assets in a liquidation.
 Offers to purchase shares of a new stock
issue (pro rata basis).

Copyright 2003 Prentice Hall Publishing
12
Creating a Corporation
State laws govern the creation of
corporations.
 An application for a charter (or articles
of incorporation) must include the
corporation’s name and purpose, kinds
and amounts of capital stock
authorized, and other detailed
information.

Copyright 2003 Prentice Hall Publishing
13
Creating a Corporation
Once the state
issues a charter,
the stockholders
elect a board of
directors.
Copyright 2003 Prentice Hall Publishing
14
What Do All Business have
in Common?

No matter what the
ownership structure of a
business, they all have
at least two main
business processes:
 Acquisition/Payment
 Sales/Collection
Copyright 2003 Prentice Hall Publishing
15
Acquisition/payment process
Activity
Identify need for
good/services
Possible Document(s)
Purchase Requisition
Identify vendor
Order
goods/services
Purchase Order
Receive and
Inspect Goods
Receiving Report
Pay for Goods
and/or Services
Check Requisition
Check
Copyright 2003 Prentice Hall Publishing
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Sales/collection process
Customer places an order (Customer order)
 Customer’s credit is approved
 Warehouse selects goods for shipment

(Picking slip)

Goods are shipped (Packing slip and
Shipping notice)
Customer is billed for goods (Invoice)
 Payment for goods is received (Check)

Copyright 2003 Prentice Hall Publishing
17
Business Transactions
Business transactions are exchanges.
 The two transactions that make up an
“exchange” are the GIVE part and the
GET part.
 The exchange occurs between the
business entity and a person or
business external to the entity.
 The business gives something and then
gets something in return.

Copyright 2003 Prentice Hall Publishing
18
Resources, Events, and Agents

We can model an exchange with these three
components:



the resources are the things being exchanged
(goods or services for money)
the event describes the business action (e.g. cash
disbursement, sale, etc.)
the agents are the people involved in the
exchange (e.g., the customer)
Copyright 2003 Prentice Hall Publishing
19
Acquisition and Payment for T-shirts
Cash Resource
GIVE
Cash Resource
Cash
Disbursement
Tom’s
EVENT
T-shirt
Wear
Company
AGENT
AGENT
EVENT
T-shirt Resource
Purchase
T-shirt Resource
GET
Copyright 2003 Prentice Hall Publishing
20
Acquisition and Payment for a Service
Cash Resource
GIVE
Cash Resource
Cash
Disbursement
Tom’s
EVENT
Wear
Advertising
Company
AGENT
AGENT
EVENT
Purchase
Advertisement
Resource
Advertisement
Resource
GET
Copyright 2003 Prentice Hall Publishing
21
Sales and Collections
T-shirt Resource
GIVE
T-shirt Resource
Sale
Tom’s
EVENT
Customer
Wear
AGENT
AGENT
EVENT
Cash Resource
Cash
Collection
Cash Resource
GET
Copyright 2003 Prentice Hall Publishing
22
Who needs accounting information?
A)
B)
Management
Those with direct financial interest
 Current or potential investors
 Current or potential creditors
C)
Those with an indirect financial interest
»
»
»
»
D)
Tax Authorities
Regulatory Agencies
Economic Planners
Labor unions, financial advisors, others.
Employees
Copyright 2003 Prentice Hall Publishing
23
Financial Accounting Information
Information related to:
Various views of the data:
Financial data for
external reports
Sales
Purchases
Collections
The
Company’s
Information
System
Product
information
Customer and
vendor information
Payments
Copyright 2003 Prentice Hall Publishing
24
The Accounting Equation
Assets = Claims
Assets = Liabilities + Equity
Asset: something of value
 Liability: something owed (creditors’
share of the assets)
 Equity: what remains (owner’s share of
the assets)

Equity: The Owner’s Share

There are two sources of equity



equity “contributed” by owners
equity “earned” by operations
Expanded accounting equation:
ASSETS =
LIABILITIES
+
CONTRIBUTED
+
CAPITAL
RETAINED
EARNINGS
Equity: The Owner’s Share
Expanded accounting equation:
ASSETS =
LIABILITIES +
CONTRIBUTED
+
CAPITAL
RETAINED
EARNINGS
Together, these are called Shareholders’ Equity,
Stockholders’ Equity, or Owners’ Equity. They are
all names for the same thing--the owners’ claims to
the firm’s assets.
Four Basic Financial Statements

Balance Sheet
Assets = Liabilities + Equity

Income Statement
Revenues - Expenses = Net income

Statement of Changes in
Owner’s Equity
Beginning equity + Contributions + Net income Distributions = Ending equity

Statement of Cash Flows
Cash inflow - Cash outflow = Net cash flow
Dates of Financial Statements
are Important!

Balance sheet is “AS OF…” or “AT”
a particular date, sometimes called a
“snapshot” in time.
Income statement
 Statement of changes in owner’s
equity
 Statement of cash flows


These last three cover a period of time,
and thus are “FOR THE PERIOD ENDING”
Copyright 2003 Prentice Hall Publishing
29
Acquiring Financing for a Business
Date
Jan. 1
Assets

=
Transactions
Tom contributes $5,000 of
his own money to the
business.
Liabilities + Owner’s Equity
Contributed Capital + Retained Earnings
+5,000 cash
+5,000 common stock
Copyright 2003 Prentice Hall Publishing
30
Acquiring Financing for a Business
Date
Jan. 1
Assets
+500 cash
=

Transactions
Tom’s Wear borrows $500
from Tom’s mom.
Liabilities + CC + Retained Earnings
+ 500 N/P
Copyright 2003 Prentice Hall Publishing
31
Acquiring Financing for a Business
Date
Jan. 1


Assets
=
+5,000 cash
+500 cash
Transactions
Tom contributes $5,000 of
his own money to start the
business.
Tom’s Wear borrows $500
from Tom’s mom.
Liabilities + CC + Retained Earnings
+5,000 common stock
+ 500 N/P
Copyright 2003 Prentice Hall Publishing
32
Acquiring Inventory
Date
Jan. 5

Transactions
Tom’s Wear buys 100 Tshirts for $400 cash.
Copyright 2003 Prentice Hall Publishing
33
Acquiring Inventory
Date
Jan. 5
Assets

=
Transactions
Tom’s Wear buys 100 Tshirts for $400 cash.
Liabilities + CC
+ RE
(400) cash
+400 inventory
Copyright 2003 Prentice Hall Publishing
34
Acquiring a Service
Date
Jan. 10
Assets

=
Transactions
Tom’s Wear pays $50 for
advertising.
Liabilities + CC
(50) cash
+ RE
(50) expenses
Copyright 2003 Prentice Hall Publishing
35
Sales and Collection
Date
Jan. 20

Transactions
Tom’s Wear sells 90 of the Tshirts to friends for cash, $10
each.
Copyright 2003 Prentice Hall Publishing
36
Sales and Collection
Date
Jan. 20
Assets

=
Transactions
Tom’s Wear sells 90 of the Tshirts to friends for cash, $10
each.
Liabilities + CC
+900 cash
+ RE
+900 revenue
Copyright 2003 Prentice Hall Publishing
37
What else happens along with the sale?
An expense…the cost of the goods sold.
Date
Jan. 20
Assets

=
Transactions
Tom’s Wear sells 90 of the Tshirts to friends for cash, $10
each.
Liabilities + CC + RE
+900 cash
+900 revenue
(360) inventory
90 shirts x $4 each
Copyright 2003 Prentice Hall Publishing
38
What else happens along with the sale?
An expense…the cost of the goods sold.
Date
Jan. 20
Assets

=
Transactions
Tom’s Wear sells 90 of the Tshirts to friends for cash, $10
each.
Liabilities + CC + RE
+900 cash
(360) inventory
+900 revenue
(360) expense
90 shirts x $4 each
Special expense called
cost of goods sold
Copyright 2003 Prentice Hall Publishing
39
Payment for the acquired financing
Date
Jan. 30

Transactions
Tom’s Wear repays the debt
of $500 plus $5 interest.
Copyright 2003 Prentice Hall Publishing
40
Payment for the acquired financing
Date
Jan. 30
Assets

=
Transactions
Tom’s Wear repays the debt
of $500 plus $5 interest.
Liabilities + CC + RE
(505) cash
Copyright 2003 Prentice Hall Publishing
41
Payment for the acquired financing
Date
Jan. 30
Assets
(505) cash

=
Transactions
Tom’s Wear repays the debt
of $500 plus $5 interest.
Liabilities + CC + RE
(500) N/P
Copyright 2003 Prentice Hall Publishing
42
Payment for the acquired financing
Date
Jan. 30
Assets
(505) cash

=
Transactions
Tom’s Wear repays the debt
of $500 plus $5 interest.
Liabilities + CC + RE
(500) N/P
(5) expense
Interest expense
Copyright 2003 Prentice Hall Publishing
43
Payment for the acquired financing
Date
Jan. 31

Transactions
Tom’s Wear pays a dividend
to Tom, the owner, for $100.
Copyright 2003 Prentice Hall Publishing
44
Payment for the acquired financing
Date
Jan. 31
Assets

=
Transactions
Tom’s Wear pays a dividend
of $100.
Liabilities + CC + RE
(100) cash
(100)dividends
Copyright 2003 Prentice Hall Publishing
45
Payment for the acquired financing
Tom’s
Wear pays a dividend of $100.
=
Tom’s Wear makes a distribution to Tom,
the owner, for $100.
In a corporation, a distribution to the
owners is called a dividend.
Assets
(100) cash
= Liabilities + CC + RE
(100) dividend
Copyright 2003 Prentice Hall Publishing
46
Assets = Liabilities + Equity
1.
2.
3.
4.
5.
6.
7,
+5,000 cash
+$5,000 common stk.
+500 cash
+ 500 notes payable
-400 cash
+400 inv.
-50 cash
- 50 expense
+900 cash
+ 900 revenue
-360 inventory
- 360 CGS
-505 cash
-500 notes payable
- 5 interest exp.
-100 cash
- 100 dividend
5,385
0
Copyright 2003 Prentice Hall Publishing
5,385
47
Tom’s Wear, Inc.
Income Statement
For the month ended January 31, 2001
REVENUE
- EXPENSES
=
NET INCOME
Copyright 2003 Prentice Hall Publishing
48
Assets = Liabilities + Equity
1.
2.
3.
4.
5.
6.
7,
+5,000 cash
+$5,000 common stk.
+500 cash
+ 500 notes payable
-400 cash
These are the revenues
+400 inv.
and expenses:
-50 cash
- 50 expense
+900 cash
+ 900 revenue
-360 inventory
- 360 CGS
-505 cash
-500 notes payable
- 5 interest exp.
-100 cash
- 100 dividends
5,385
0
Copyright 2003 Prentice Hall Publishing
5,385
49
Assets = Liabilities + Equity
1.
2.
3.
4.
5.
6.
7,
+5,000 cash
+$5,000 common stk.
+500 cash
+ 500 notes payable
-400 cash
+400 inv.
Net
-50 cash
- 50 expense
Income
=
+900 cash
+ 900 revenue
$485
-360 inventory
- 360 CGS
-505 cash
-500 notes payable
- 5 interest exp.
-100 cash
- 100 dividends
5,385
0
Copyright 2003 Prentice Hall Publishing
5,385
50
Tom’s Wear, Inc.
Income Statement
For the Month Ended Jan. 31, 2001
Revenue
Sales
Expenses
Cost of sales
Advertising
Interest
Total expenses
Net income
$900
360
50
5
415
$485
Copyright 2003 Prentice Hall Publishing
51
Tom’s Wear, Inc.
Statement of Changes in Owner’s Equity
For the month ended Jan. 31, 2001
Beginning CC
Common stock issued
Total Contributed Capital
$
0
5,000
Beginning RE
Net income
Dividends
Ending RE
$
$ 5,000
0
Total Owners’ Equity
Copyright 2003 Prentice Hall Publishing
52
Tom’s Wear, Inc.
Statement of Changes in Owner’s Equity
For the month ended Jan. 31, 2001
Beginning CC
Common stock issued
Total Contributed Capital
$
0
5,000
Beginning RE
Net income
Dividends
Ending RE
$
$ 5,000
0
485
(100)
$ 385
Total Owners’ Equity
Copyright 2003 Prentice Hall Publishing
$5,385
53
Assets = Liabilities + Equity
1.
2.
3.
4.
5.
6.
7.
+5,000 cash
+$5,000 common stk.
+500 cash
+ 500 notes payable
-400 cash
+400 inv.
Net
-50 cash
- 50 expense
Income
=
+900 cash
+ 900 revenue
$485
-360 inventory
- 360 CGS
-505 cash
-500 notes payable
- 5 interest exp.
-100 cash
- 100 dividends
5,385
0
Copyright 2003 Prentice Hall Publishing
5,385
54
Tom’s Wear
Balance Sheet
At Jan. 31,2001
Assets
Liabilities + Shareholder’s Equity
Copyright 2003 Prentice Hall Publishing
55
Tom’s Wear
Balance Sheet
At Jan. 31, 2001
Assets
Cash
Inventory
Liabilities + SHs Equity
$ 5,345
$
40
Total Assets $ 5,385
Copyright 2003 Prentice Hall Publishing
56
Tom’s Wear
Balance Sheet
At Jan. 31, 2001
Liabilities + Shareholder’s Equity
Assets
Cash
Inventory
$5,345
40
Note Payable
-0-
Total Assets $5,385
Copyright 2003 Prentice Hall Publishing
57
Tom’s Wear
Balance Sheet
At Jan. 31, 2001
Liabilities + Shareholder’s Equity
Assets
Cash
Inventory
Total assets
$5,345
$ 40
$ 5,385
Note payable
-0-
Common stock, T. Phillips
Retained earnings
$5,000
385
Total liabilities +
SH’s Equity
$ 5,385
Copyright 2003 Prentice Hall Publishing
58
Tom’s Wear, Inc.
Statement of Cash Flows
For the month ending Jan. 31, 2001
Cash from Operating Activities
Cash from Investing Activities
Cash from Financing Activities
Copyright 2003 Prentice Hall Publishing
59
Assets = Liabilities + Equity
Look at every CASH transaction and classify it as
operating, investing, or financing.
1. +5,000 cash
+$5,000 common stk.
2. +500 cash
+ 500 notes payable
3. -400 cash
Net
+400 inv.
Income
4. -50 cash
- 50 expense
=
5. +900 cash
$485 + 900 revenue
-360 inventory
- 360 CGS
6. -505 cash
-500 notes payable
- 5 interest exp.
7. -100 cash
- 100 dividends
5,385
0
Copyright 2003 Prentice Hall Publishing
5,385
60
Tom’s Wear, Inc.
Statement of Cash Flows
For the month ended Jan. 31,2001
Cash from operating activities
Cash from customers
Cash paid to vendor for T-shirts
Cash paid for advertising
Interest paid
Total cash from operations
Copyright 2003 Prentice Hall Publishing
$ 900
(400)
(50)
( 5)
$445
61
Tom’s Wear, Inc.
Statement of Cash Flows
For the month ended Jan. 31, 2001
Cash from operating activities
Cash from customers
Cash paid to vendor for T-shirts
Cash paid for advertising
Cash paid for interest
Total cash from operations
Cash from investing activities
Copyright 2003 Prentice Hall Publishing
$ 900
(400)
(50)
( 5)
$445
-0-
62
Tom’s Wear, Inc.
Statement of Cash Flows
For the month ended Jan. 31, 2001
Cash from operating activities
Cash from customers
Cash paid to vendor for T-shirts
Cash paid for advertising
Cash paid for interest
Total cash from operations
Cash from investing activities
Cash from financing activities
Copyright 2003 Prentice Hall Publishing
$ 900
(400)
(50)
( 5)
$445
-0-
63
Tom’s Wear, Inc.
Statement of Cash Flows
For the month ended Jan. 31, 2001
Cash from operating activities
Cash from customers
Cash paid to vendor for T-shirts
Cash paid for advertising
Cash paid for interest
Total cash from operations
Cash from investing activities
Cash from financing activities
Owner’s contributions
Dividends
Total Cash from Financing
Copyright 2003 Prentice Hall Publishing
$ 900
(400)
(50)
( 5)
$445
-05,000
(100)
4,900
64
Tom’s Wear, Inc.
Statement of Cash Flows
For the month ended Jan. 31, 2001
Cash from operating activities
Cash from customers
Cash paid to vendor for T-shirts
Cash paid for advertising
Cash paid for interest
Total cash from operations
Cash from investing activities
Cash from financing activities
Owner’s contributions
Dividends
Total Cash from Financing
Net Increase in Cash
Copyright 2003 Prentice Hall Publishing
$ 900
(400)
(50)
(5)
$445
-05,000
(100)
4,900
$ 5,345
65