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Accounting and the Business Environment Chapter 1 Why Is Accounting Important? Accounting is the information system that measures business activities, processes the information into reports, and communicates the results to decision makers. Financial Accounting Managerial Accounting Financial vs. Managerial Financial accounting: ◦ Reporting financial information related to the financial position of the company ◦ The results of its operation ◦ Cash flows to external stakeholders Managerial accounting: ◦ The processes that generate information that can be used by internal management to make better decisions about the day-to-day operations of the company ◦ The specific kinds of information and reports often differs depending upon the company and situation. Users of Financial Information The Organizations That Govern Accounting FASB • • • Financial Accounting Standards Board Privately funded Creates the rules and standards that govern financial accounting SEC • • Securities and Exchange Commission Oversees the US financial markets Generally Accepted Accounting Principles (GAAP) Issued by the FASB. • Establishes the rules for recording transactions and preparing financial statements. • Published online as part of the Accounting Standards Codification. • Requires that information be useful. • Relevant = The info allows users to make a decision. Faithfully Representative = The info is complete, neutral, and free from material error. Accounting Assumptions Economic Entity Assumption Monetary Unit Assumption Cost Principle Going Concern Assumption Business Organization The Accounting Equation Assets = Liabilities + Equity Rule: The Balance Sheet Equation must ALWAYS be in balance. The Accounting Equation Assets = Liabilities + Equity • An asset is an economic resource that is expected to benefit the business in the future. Examples: Cash Merchandise inventory Furniture Land The Accounting Equation Assets = Liabilities are debts that are owed to creditors. Liabilities + Equity The Accounting Equation Assets = Liabilities + Equity • The owners’ claims to the assets of the business are called equity. • Also called stockholders’ equity Increases in equity result from: Contributed capital (owner contributions) Revenues Decreases in equity result from: Dividends (owner distributions) Expenses The Accounting Equation Assets = Liabilities + Equity • Equity consists of two components: 1. Contributed capital 2. Retained earnings Contributed capital: • Also called paid-in capital, it is the amount invested in the corporation by its owners, the stockholders. • Common stock represents the basic ownership of every corporation. The Accounting Equation Assets = Liabilities • Revenues are economic resources that have been earned by delivering products or services to customers. • Earnings are separate from collections + Equity Common Stock – Dividends + Revenues - Expenses The Accounting Equation Assets = Liabilities Expenses are the costs associated with selling goods or services. + Equity Common Stock – Dividends + Revenues - Expenses The Accounting Equation Assets = Liabilities • When Revenues > Expenses = Net Income. • When Revenues < Expenses = Net Loss. + Equity Common Stock – Dividends + Revenues - Expenses Using the expanded accounting equation, solve for the missing amount. Assets Liabilities Common Stock Dividends Revenues Expenses $ 71,288 2,260 ? 14,420 53,085 28,675 How Do You Analyze A Transaction? A transaction is any event that changes the financial position of a company. 1. Involves the exchange of economic resources. 2. Must be able to measure the economic impact in monetary units. Is it a transaction? Buying a copying machine for the office for $4,000 cash. xMeeting with a potential customer. How Do You Analyze A Transaction? When analyzing a transaction – follow these steps: 1. Identify the account classification(s) and specific accounts affected by the transaction. There must be at least two accounts affected 2. How is each account affected (increased or decreased)? 3. Determine if the accounting equation is still in balance The left side must always equal the right side Assets = Liabilities + Equity How Do You Analyze A Transaction? Smart Touch Learning starts a new business. The company sells $30,000 of Common Stock. How does this impact the Accounting Equation? How Do You Analyze A Transaction? Next, Smart Touch purchases land for $20,000 cash. In this transaction, all the change occurred on the left side of the equation. One asset was converted into a different asset. How Do You Analyze A Transaction? In Transaction #3, Smart Touch buys $500 of office supplies, offering to pay in 30 days. Remember, in business it is quite common for a business to purchase something now, and pay for it later. How Do You Analyze A Transaction? In Transaction #4, Smart Touch provides training services to customers for $5,500 cash. How Do You Analyze A Transaction? In Transaction #5, Smart Touch performs $3,000 of services for a customer who will pay in one month. This promise is an asset called accounts receivable How Do You Analyze A Transaction? In Transaction #6, Smart Touch pays $3,200 in cash expenses; $2,000 for office rent and $1,200 for employee salaries. How Do You Analyze A Transaction? In Transaction #7, Smart Touch pays $300 to the store from which it purchased office supplies in Transaction #3. How Do You Analyze A Transaction? In Transaction #8, Smart Touch collects $2,000 from the client for which Smart Touch performed services in Transaction #5. Preparing Financial Statements Income Statement Statement of Retained Earnings Balance Sheet Statement of Cash Flows The same four financial statements are prepared by companies as a way to communicate with stakeholders. 130 Income Statement Reports the success or failure of the company’s operations for a period of time. SMART TOUCH LEARNING Income Statement Month Ended November 30, 2014 Revenues Service Revenue $ Expenses Rent expense $ 2,000 Salaries Expense 1,200 Total expenses Net income $ 8,500 3,200 5,300 132 Statement of Retained Earnings Shows amounts and causes of changes in Retained Earnings during the period. The ending balance in Retained Earnings will also appear in the Stockholders’ Equity section of the Balance Sheet. SMART TOUCH LEARNING Statement of Retained Earnings Month Ended November 30, 2014 Retained Earnings, Nov. 1, 2014 $ Net income for the month Dividends Retained Earnings, Nov. 30, 2014 $ 5,300 5,300 (5,000) 300 134 The balance sheet reports on the assets, liabilities, and stockholders’ equity of the business as of a specific date. 135 136 Evaluate Business Performance Evaluate Business Performance Return on Assets (ROA) Formula: __Net Income Average Total Assets Average Total Assets = (Beginning total assets + Ending total assets) 2