Accounting and the

Business Environment
Chapter 1

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 Objective 1

Use accounting vocabulary

for decision making.

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 Accounting...

is an information system that...

measures business activities,

processes information, and...

communicates financial information.

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 Accounting...

is called the language of business.

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 Users of Accounting Information

External users Internal users

make decisions make decisions
about the entity. for the entity.

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 Fields of Accounting

Financial Accounting

Management Accounting

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 The Authority Underlying Accounting

Public Sector
(SEC)

Private Sector Private Sector

(AICPA) (IMA) (FASB)

GAAP

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 Standards of Professional Conduct

Standards of
Ethical
AICPA’s Code of
Conduct of the
Professional
Institute of
Conduct
Management
Accountants

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 Types of Business Organizations

Proprietorships

Partnerships

Corporations

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 Proprietorships

 What are some advantages?

– total undivided authority
– no restrictions on type of business – must
be legal
 What are some disadvantages?
– unlimited liability
– limitation on size – fund raising power

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 Partnerships

 What are some advantages?

– better credit standing – possibly
– more brain power, but consultation with
partners required
 What are some disadvantages?
– unlimited personal liability for general
partners
– need for written partnership agreement
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 Corporations

 What are some advantages?

– separate legal existence
– limited liability of stockholders
– transferability of ownership relatively easy
 What are some disadvantages?
– taxes – possible double taxation
– extensive governmental regulation

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 Objective 2

Apply accounting
concepts and principles
to business situations.

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 Generally Accepted
Accounting Principles
 What is the primary objective of financial
reporting?

To provide information useful

for making investment and
lending decisions

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 The Entity Concept Example

 Assume that John decides to open up a

gas station and coffee shop.
 The gas station made $250,000 in profits,
while the coffee shop lost $50,000.

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 The Entity Concept Example

 How much money did John make?

 At a first glance, we would assume that
John made $200,000.
 However, by applying the entity concept we
realize that the gas station made $250,000
while the coffee shop lost $50,000.

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 The Reliability (Objectivity) Principle

Information must Information must

be reasonably be free from bias.
accurate.

Information must Individuals would

report what arrive at similar
actually conclusions using
happened. same data.
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 The Cost Principle

Assets and services

acquired
should be recorded
at their actual cost.

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 The Going Concern Concept

The entity will continue

to operate in the future.

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 The Stable-Monetary-Unit Concept

The dollar’s purchasing

power is relatively
stable.

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 Objective 3

Use the accounting equation

to describe an organization’s
financial position.

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 The Accounting Equation

Assets = Liabilities + Owner’s Equity

Economic Claims to
Resources Economic
Resources

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 Assets

 What is an asset?
 It is something a company owns which
has future economic value.
– land
– building
– equipment
– goodwill

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 Liability

 What is a liability?
 It is something a company owes.
– money
– service – legal retainers
– product – magazines

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 Owner’s Equity

 What is owner’s equity?

 It is what’s left of the assets after liabilities
have been deducted.
– the same as net assets
– the owner’s claim on the entity’s assets

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 Transactions that Affect
Owner’s Equity
OWNER’S EQUITY OWNER’S EQUITY
INCREASES DECREASES

Owner Investments Owner Withdrawals

in the Business from the Business

Owner’s Equity

Revenues Expenses

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 Revenues

 What are revenues?

 They are amounts received or to be
received from customers for sales of
products or services.
– sales
– performance of services
– rent
– interest
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 Expenses

 What are expenses?

 They are amounts that have been paid or
will be paid later for costs that have been
incurred to earn revenue.
– salaries and wages
– utilities
– supplies used
– advertising
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 Objective 4

Use the accounting equation to

analyze business transactions.

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 Accounting for Business Transactions

 What is a transaction?
 It is any event that both affects the financial
position of the business and can be reliably
recorded.

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 Accounting for Business Transactions

1 Gay Gillen invests $30,000 to begin Gay

Gillen eTravel.
2 Gillen purchases an office location, paying
$20,000 in cash.
3 She buys office supplies, agreeing to pay
$500 in 30 days.
4 She earns and collects $5,500 revenues.

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 Accounting for Business Transactions

5 Gillen performs services, and the client

agrees to pay $3,000 within one month.
6 During the month, she pays $3,100 for
expenses incurred.
7 Gillen pays $300 to the store from which
she purchased $500 worth of supplies.
 What is the effect of these transactions on
the accounting equation?
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 Accounting for Business Transactions
Owner’s
Assets = Liabilities + Equity
1) Cash + $30,000 + $30,000
2) Cash – 20,000
Land + 20,000
3) Supplies + 500 + 500
4) Cash + 5,500 + 5,500
5) Receivable + 3,000 + 3,000
6) Cash – 3,100 – 3,100
7) Cash – 300 – 300
Totals + $35,600 + 200 + $35,400
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 Accounting for Business Transactions

 Notice that the equation always stays in

balance.
 Each transaction affects at least two
accounts, sometimes more.
 Some transactions affect only one side of
the equation; some affect both sides.

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 Accounting for Business Transactions

 Other transactions that took place were

as follows:
 The business collected $1,000 from the
client.
 She sold some land at cost for $9,000.
 She withdrew $2,100 from the business.

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 Objective 5

Prepare and use

financial statements.

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 Financial Statements...

– are the final

product of the
accounting process.

– tell how the

business is performing
and where it stands.

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 Financial Statements

– income statement
– statement of owner’s equity or retained
earnings
– balance sheet
– statement of cash flows

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 Objective 6

Evaluate the performance

of business.

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 Relationships Among the Statements:
Income Statement
Revenue:
Fees earned $8,500
Expenses:
Salary expense $1,200
Utilities and telephone expense 400
Equipment rental expense 400
Office rent expense 1,100 3,100
Net income $5,400
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 Relationships Among the Statements:
Statement of Owner’s Equity

G. Gillen, capital, April 1, 20xx $ 0

Contribution of capital 30,000
Net income $ 5,400
Cash distributions – 2,100
G. Gillen, capital, April 30, 20xx $33,300

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 Relationships Among the Statements:
Balance Sheet

Assets Liabilities
Cash $ 20,000 Accounts payable $ 200
Accounts receivable 2,000 Owner’s equity,
Supplies 500 G. Gillen, capital 33,300
Land 11,000 Total liabilities and
Total assets $ 33,500 owner’s equity $33,500

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 Relationships Among the Statements:
Statement Of Cash Flows
Cash flows from operating activities:
Cash receipts from services rendered $6,500
Cash payments:
Supplies $ 300
Operating expenses 3,100 3,400
Net cash flows from
Operating activities $3,100
Cash flows from investing activities
Purchase and sale of land ($11,000)
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 Relationships Among the Statements:
Statement Of Cash Flows

Cash Flows from Financing Activities:

Beginning Balance 0
Investment by Owner $30,000
Withdrawals 2,100
Net Cash Flows from Financing Activities $27,900
Cash at Beginning of Year 0
Cash at End of the Year $20,000
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 End of Chapter 1

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