8/12/2019 Ch 1 Pp Slides 2001
1/49
Chapter 1
Uses of
AccountingInformation and
the Financial
Statements
8/12/2019 Ch 1 Pp Slides 2001
2/49
12Copyright Houghton Mifflin Company. All rights reserved.
What Is Accounting?
An information system that measures, processes,and communicates financial information about an
economic entity
Focuses on the needs of decision makers who use
financial information
8/12/2019 Ch 1 Pp Slides 2001
3/49
13Copyright Houghton Mifflin Company. All rights reserved.
Economic Entity
A unit that exists independently, such as a business,hospital, or government body
In this text, the focus is primarily on the business
entity
8/12/2019 Ch 1 Pp Slides 2001
4/49
14Copyright Houghton Mifflin Company. All rights reserved.
Business Activities and
Decision Makers
8/12/2019 Ch 1 Pp Slides 2001
5/49
8/12/2019 Ch 1 Pp Slides 2001
6/49
16Copyright Houghton Mifflin Company. All rights reserved.
Business Goals
Profitability
The ability to earn enough income to attract and
hold investment capital
Liquidity
Having enough cash available to pay debts when
they are due
8/12/2019 Ch 1 Pp Slides 2001
7/49
17Copyright Houghton Mifflin Company. All rights reserved.
Financial and Management
Accounting Accountings role is divided into two categories:
Management accounting
Financial accounting
The functions of both categories overlap
Primary difference between the two is the principal
users of the information
8/12/2019 Ch 1 Pp Slides 2001
8/49
18Copyright Houghton Mifflin Company. All rights reserved.
Financial Accounting
Generates reports and communicates them to
external decision makers so they can evaluate how
well the business has achieved its goals
Financial information of company is reported in the
financial statements Used to report directly on goals of profitability and
liquidity
8/12/2019 Ch 1 Pp Slides 2001
9/49
19Copyright Houghton Mifflin Company. All rights reserved.
Bookkeeping versus Accounting
Bookkeeping
Repetitive, mechanical
process of recording
financial transactions andkeeping financial records
A small part of accounting
Accounting
Includes design of an
information system to meet
users needs
Goals include the analysis,
interpretation, and use of
information
8/12/2019 Ch 1 Pp Slides 2001
10/49
110Copyright Houghton Mifflin Company. All rights reserved.
Ethical Financial Reporting
Ethics is a code of conduct that applies to everyday
life
Addresses the question of whether actions are right
or wrong
Financial reports must be prepared in good faith, beaccurate, and disclose all relevant facts
8/12/2019 Ch 1 Pp Slides 2001
11/49
111Copyright Houghton Mifflin Company. All rights reserved.
Fraudulent Financial Reporting
Intentional preparation of misleading financial
statements
Can result from the distortion of records (e.g., the
manipulation of inventory records), falsified
transactions (e.g., fictitious sales), or themisapplication of various accounting principles
8/12/2019 Ch 1 Pp Slides 2001
12/49
112Copyright Houghton Mifflin Company. All rights reserved.
Sarbanes-Oxley Act of 2002
Legislation impacting the accounting profession and
corporate governance
Chief executives and chief financial officers of all
publicly traded U.S. companies must attest to the
accuracy of their quarterly statements and annualreports
Violation can result in criminal penalties
8/12/2019 Ch 1 Pp Slides 2001
13/49
113Copyright Houghton Mifflin Company. All rights reserved.
Stop & Review
Q. What is the difference between profitabilityand
liquidity?
A. Profitability
Earning enough income (revenues minus
expenses) to attract and hold investors
Liquidity
Having enough funds available (cash) to paydebts when they are due
8/12/2019 Ch 1 Pp Slides 2001
14/49
114Copyright Houghton Mifflin Company. All rights reserved.
Who Are the Decision Makers?
Management
Those outside a business enterprise who have a
direct financial interest in the business
People, organizations, and agencies that have an
indirect financial interest in a business
8/12/2019 Ch 1 Pp Slides 2001
15/49
115Copyright Houghton Mifflin Company. All rights reserved.
Management
People who are responsible for operating a business and
meeting its goals of profitability and liquidity
Make key decisions using accounting information
Basic management functions require accounting
information for decision making
Financing the business
Investing resources
Producing goods and services
Marketing goods and services Managing employees
Providing information to decision makers
8/12/2019 Ch 1 Pp Slides 2001
16/49
116Copyright Houghton Mifflin Company. All rights reserved.
Users With a Direct
Financial Interest External users who depend on accounting to
measure and report information about how a
business has performed
Two most important outside groups are investors
and creditors
8/12/2019 Ch 1 Pp Slides 2001
17/49
117Copyright Houghton Mifflin Company. All rights reserved.
Investors and Creditors
Investors
Put money into a business to make money (by purchasing
and selling stocks and receiving dividends)
Use financial statements to judge the prospects for
profitable investments
Creditors
Loan money to a business to make money (by charging
interest)
Use financial statements to judge whether a company will
have enough cash to pay interest charges and repay debt
8/12/2019 Ch 1 Pp Slides 2001
18/49
118Copyright Houghton Mifflin Company. All rights reserved.
Users With an Indirect
Financial Interest Society as a whole has become one of the largest
and most important users of accounting information
Tax authorities
Use accounting information to determine the
amount of tax dueProcedures for tax reporting mandated by law
Government regulatory agencies
Federal, state, and local levels
Securities and Exchange Commission (SEC)
Regulates the issuing, buying, and selling ofstocks in the U.S.
8/12/2019 Ch 1 Pp Slides 2001
19/49
119Copyright Houghton Mifflin Company. All rights reserved.
Government and Not-For-Profit
Organizations Need accounting information just as for-profit
entities do
Must raise money, secure loans, pay taxes, and plan
for operations
Obligated to report their financial performance tolegislators, boards, and donors, as well as to deal
with tax authorities, regulators, and labor unions
8/12/2019 Ch 1 Pp Slides 2001
20/49
120Copyright Houghton Mifflin Company. All rights reserved.
Stop & Review
Q. Why are investors and creditors interested in
reviewing a companys financial statements?
A. Investors review statements to determine the prospects of a
profitable investment. They review their commitment eachyear after investing. Creditors are interested in whether
the company can repay the debt and make the interest
payment obligations.
8/12/2019 Ch 1 Pp Slides 2001
21/49
121Copyright Houghton Mifflin Company. All rights reserved.
Accounting Measurement
To make an accounting measurement, the accountant
must answer four basic questions:
What is measured?
When should the measurement be made?
What value should be placed on what is
measured?
How should what is measured be classified?
8/12/2019 Ch 1 Pp Slides 2001
22/49
122Copyright Houghton Mifflin Company. All rights reserved.
Business Transactions
Economic events that affect the financial position of a
business An exchange of value
Purchase
Sale
Payment Collection
Events that have the same effect as an exchange of value(nonexchange transactions)
Loss from fire, flood, theft Physical wear and tear on equipment
Accumulation of interest
8/12/2019 Ch 1 Pp Slides 2001
23/49
123Copyright Houghton Mifflin Company. All rights reserved.
Money Measure
Recording of all business transactions in terms of
money
Money is only factor common to all business
transactions
Basic unit of money determined by country inwhich business resides
Exchange rates used to translate transactions from
one currency to the other
8/12/2019 Ch 1 Pp Slides 2001
24/49
124Copyright Houghton Mifflin Company. All rights reserved.
Separate Entity
A business is considered distinct from its
Owner(s)
Creditors
Customers
Its financial records and reports should refer only to
its own financial affairs
8/12/2019 Ch 1 Pp Slides 2001
25/49
125Copyright Houghton Mifflin Company. All rights reserved.
Forms of Business Enterprises
Three basic forms of business enterprises
Sole proprietorshipbusiness owned by one
person. Owner takes all profits/losses and is
liable for all obligations.
Partnershiphas two or more owners. Partnersshare profits/losses. Personal resources of
partners can be used to settle obligations.
Corporationchartered by the state and legally
separate from its stockholders. Efficient in
raising capital.
8/12/2019 Ch 1 Pp Slides 2001
26/49
126Copyright Houghton Mifflin Company. All rights reserved.
Separate Entities
All three forms of businesses are economically
separate from their owners
Financial records and reports refer to the
financial affairs of the business only
Only the corporation is a legally separate entityfrom its owners
8/12/2019 Ch 1 Pp Slides 2001
27/49
127Copyright Houghton Mifflin Company. All rights reserved.
Formation of a Corporation
Most states require individuals, called incorporators,
to sign an application and file it with the proper
state official
Articles of incorporation form the company charter
and become a contract between the state and theincorporators
Th C ti
8/12/2019 Ch 1 Pp Slides 2001
28/49
128Copyright Houghton Mifflin Company. All rights reserved.
The Corporation as a
Separate Entity Legally and economically separate from its owners
Owners (stockholders) do not directly control
operations
Elected board of directors run the corporation
Owners risk of loss limited to amount paid for
shares of stockowners are not liable for the
obligations of the business
8/12/2019 Ch 1 Pp Slides 2001
29/49
129Copyright Houghton Mifflin Company. All rights reserved.
Organization of a Corporation
Stockholders
Invest in shares of stock
Elect board of directors
Board of Directors
Decide major business policies Declare dividends
Appoint managers
Management
Carry out corporations policies
Run day-to-day operations
Prepare financial reports (used by stockholders)
8/12/2019 Ch 1 Pp Slides 2001
30/49
130Copyright Houghton Mifflin Company. All rights reserved.
Stop & Review
Q.How do a sole proprietorship, partnership,and corporation differ?
A. Sole proprietorship
B. Partnership
C. Corporation
One ownerOwner legally obligated to pay company liabilities
Multiple ownersOwners legally obligated to pay company liabilities
Owned by stockholdersStockholders notlegally obligated to pay company liabilities
8/12/2019 Ch 1 Pp Slides 2001
31/49
131Copyright Houghton Mifflin Company. All rights reserved.
Financial Position
A companys economic resources, such as
cash, inventory, and buildings
and the claims against those resourcesat a particular time
Economic Resources = Equities
D l i th
8/12/2019 Ch 1 Pp Slides 2001
32/49
132Copyright Houghton Mifflin Company. All rights reserved.
Developing the
Accounting Equation
Economic
Resources =
Creditors
Equities + Stockholders Equity
In accounting terminologyEconomic resources are called Assets
Creditors equities are called Liabilities
Assets = Liabilities + Stockholders Equity
8/12/2019 Ch 1 Pp Slides 2001
33/49
133Copyright Houghton Mifflin Company. All rights reserved.
Accounting Equation
Assets = Liabilities + Stockholders Equity
Two sides of equation must always stay in balance
Assets
Economic resources owned by a company that are
expected to benefit future operations
Liabilities
Present obligations of a business to pay cash, transfer
assets, or provide services to other entities in the future
Represent claims of creditors to the assets of the business Stockholders Equity
Represents the claims of the owners of a corporation to
the assets of the business
8/12/2019 Ch 1 Pp Slides 2001
34/49
134Copyright Houghton Mifflin Company. All rights reserved.
Stockholders Equity
Stockholders Equity =
Contributed Capital + Retained Earnings
Contributed capitalAmount invested in the business by the stockholders
Retained earnings
Stockholders equity that has been generated by operationsand kept for use in the business
8/12/2019 Ch 1 Pp Slides 2001
35/49
135Copyright Houghton Mifflin Company. All rights reserved.
Stop & Review
Q. What does the accounting equation represent?
A. The economic resources owned by a company and
the claims against those resources at a particular
timeAssets = Liabilities + Stockholders Equity
8/12/2019 Ch 1 Pp Slides 2001
36/49
136Copyright Houghton Mifflin Company. All rights reserved.
Four Major Financial Statements
Income Statement
Statement of Retained Earnings
Balance Sheet
Statement of Cash Flows
8/12/2019 Ch 1 Pp Slides 2001
37/49
137Copyright Houghton Mifflin Company. All rights reserved.
Income Statement
Summarizes revenues earned and expenses incurred
over an accounting period
Dated For the Month Ended or For the Year
Ended
Shows whether a company achieved its profitabilitygoal
8/12/2019 Ch 1 Pp Slides 2001
38/49
138Copyright Houghton Mifflin Company. All rights reserved.
Ramirez Agency, Inc.
Income Statement
For the Month Ended December 31, 20xx
Revenues
Commissions earned $7,000
Expenses
Equipment rental expense $2,000
Wages expense 800Utilities expense 600
Total expenses 3,400Net income $3,600
Income Statement
Net income figure used to prepare
statement of retained earnings
Date reflects revenues
and expenses incurred
over a period of time
8/12/2019 Ch 1 Pp Slides 2001
39/49
139Copyright Houghton Mifflin Company. All rights reserved.
Statement of Retained Earnings
Shows changes in retained earnings over an
accounting period
Dated For the Month Ended or For the Year
Ended
Uses net income figure from income statement Retained Earnings end of period balance used to
prepare balance sheet
8/12/2019 Ch 1 Pp Slides 2001
40/49
140Copyright Houghton Mifflin Company. All rights reserved.
The Ramirez Agency, Inc.
Statement of Retained Earnings
For the Month Ended December 31, 20xx
Retained earnings, December 1, 20xx $ 0
Net income for the month 3,600Subtotal $3,600Less dividends 1,200
Retained earnings, December 31, 20xx $2,400
Statement of Retained Earnings
Net income figure comes
from income statement
Ending balance of retained
earnings used to prepare the
balance sheet
8/12/2019 Ch 1 Pp Slides 2001
41/49
141Copyright Houghton Mifflin Company. All rights reserved.
Balance Sheet
Shows the financial position of a business on a
certain date
Often called the statement of financial position
Presents view of business as holder of assets that are
equal to the claims against those assets Claims consist of the companys liabilities and the
stockholders equity
8/12/2019 Ch 1 Pp Slides 2001
42/49
142Copyright Houghton Mifflin Company. All rights reserved.
The Ramirez Agency, Inc.
Balance SheetDecember 31, 20xx
Assets Liabilities
Cash $30,600 Accounts payable $ 1,200Accounts receivable 2,000
Supplies 1,000 Stockholders EquityLand 20,000
Building 50,000 Common stock $100,000
Retained earnings 2,400
Total stockholders equity 102,400
Total assets $103,600Total liabilities andstockholders equity $ 103,600
Balance Sheet Date reflects accountbalances as of a
certain date
Ending balance of Retained Earnings comes
from statement of retained earnings
8/12/2019 Ch 1 Pp Slides 2001
43/49
143Copyright Houghton Mifflin Company. All rights reserved.
Statement of Cash Flows
Shows cash flows into and out of a business during
an accounting period
Shows important investing and financing
transactions of the period
Focuses on liquidity Explains how the cash account changed during the
period
8/12/2019 Ch 1 Pp Slides 2001
44/49
144Copyright Houghton Mifflin Company. All rights reserved.
Stop & Review
Q. The balance sheet is often referred to as the
statement of financial position. What does
financial position mean?
A. Financial position is the resources, or assets,owned by a business as of a certain date. These
resources are offset by claims against them and
stockholders equity, as shown on the balance
sheet.
Generally Accepted Accounting
8/12/2019 Ch 1 Pp Slides 2001
45/49
145Copyright Houghton Mifflin Company. All rights reserved.
Generally Accepted Accounting
Principles (GAAP) The conventions, rules, and procedures necessary to
define accounting practice at a particular time
Developed to provide guidelines for financial
accounting
Evolve as better methods emerge or ascircumstances change
GAAP and the Independent
8/12/2019 Ch 1 Pp Slides 2001
46/49
146Copyright Houghton Mifflin Company. All rights reserved.
GAAP and the Independent
CPAs Report Public companies must have their financial
statements audited by a Certified Public Accountant
Audit determines whether the financial statements
have been prepared in accordance with GAAP
8/12/2019 Ch 1 Pp Slides 2001
47/49
147Copyright Houghton Mifflin Company. All rights reserved.
Professional Ethics
Accountants have a responsibility to their
employers, clients, and society to uphold highest
ethical standards
AICPA and each state have adopted codes of
professional conduct for certified public accountants Key to the accountants reputation for independence
and competence
8/12/2019 Ch 1 Pp Slides 2001
48/49
148Copyright Houghton Mifflin Company. All rights reserved.
Chapter Review
1. Define accounting, identify business goals and
activities, and describe the role of accounting in
making informed decisions.
2. Identify the users of accounting information.
3. Explain the importance of business transactions,money measure, and separate entity.
8/12/2019 Ch 1 Pp Slides 2001
49/49
Chapter Review (contd)
4. Describe the characteristics of a corporation.
5. Define financial position, state the accounting
equation.
6. Identify the four financial statements.
7. Explain how generally accepted accountingprinciples (GAAP) relate to financial statements
and the independent CPAs report, and identify the
organizations that influence GAAP.