Chapter 1 - 3

The Role of Acct in Business, Basic Acct Systems: Cash Basis, & Accrual Basis

Types of Businesses

1. Service

2. Merchandising (aka Retail)

3. Manufacturing

What was a “service” type of business

it is a type of business that offers services; not products

(eg) Hair salon, law firm, Delta Airlines

What was a “merchandising” type of business

a type of business that sells products that it purchases from other businesses

(eg) Kohls, Target, Costco, used Car dealerships

What was a “Manufacturing” type of business

a type of business where changes are made to basic inputs that are sold to customers

(eg) Ford, Boeing, Burt’s Bees — I get a feeling that if it is a brand; then its likely a manufacturing business

what are the forms of businesses

1. proprietorship

2. partnership

3. corporation

4. Limited Liability Corporation (LLC)

what are the characteristics of a proprietorship

• owned by one individual

• financial resources limited to individual owner’s resources

• unlimited liability

what are the characteristics of a partnership

• 2+ owners

• unlimited liability

• financial resources limited to owners’ resources

• shared profits and losses

• formal agreement often required to define roles and responsibilities

what are the characteristics of a corporation

Separate legal entity

Limited liability for owners

Ownership divided through shares of stock

Access to lots of capital

what are the characteristics of a Limited Liability Corporation (LLC)

• 2+ owners

• limited liability for the owners

• financial resources limited to owners’ resources

which forms of businesses of the easiest to form

proprietorship and partnership

which forms of businesses have the least limitations on liability

proprietorship and partnership

which form of business have moderate/ average access to capital

partnership and LLCs

what is the primary objective of a business

to maximize profits

(aka generate high revenues while having low costs)

what are the names of the 2 strategies businesses use to try to get ahead of their competitors

1. low-cost strategy

2. premium-price strategy

give some examples of businesses that use low-cost strategy

Walmart, Spirit Airlines, McDonald's, Aldi, Costco

give examples of some businesses that use premium-price strategy

LuluLemon, BMW, Rolex, Starbucks

what is a business stakeholder

a person/ entity with an interest in the economic performance and well-being of a company

(aka anyone who has a “stake” in the business)

what are the different business activities

1. financial activities

2. investment activities

3. operating activities

financial activities

to obtain the necessary funds to start/ operate a business

investing activities

to obtain assets like buildings and equipment to begin/ operate the company

operating activites

to earn revenues and profits

examples of financial activities

• taking a loan out from the bank & paying back that loan

• paying dividends to shareholders

• selling shares of the company’s stocks & buying back those shares

investing activities examples

• buying/ selling a building

• buying/ selling equipment

examples of operating activites

• earning revenue from sales of products or services

• expenses like rent, insurance, salaries, utilities

what is accounting

the language of business — its how a business can communicate to its shareholders about its financial performance and condition

what are the 2 branches of acct

1. financial acct

2. managerial acct (aka Cost Accounting)

Financial Accounting

associated with preparing reports for external stakeholders

Managerial Accounting

used to guide management in making decisions for a company (internal stakeholders)

What is the objective of Financial Accounting

to report

• the financial condition of a business at a point in time

• the changes in the financial condition of a business over a period of time

What are the different types of financial statements

1. Balance Sheet (BS)

2. Income Statement (IS)

3. Statement of Cash Flows (CF)

4. Statement of Stockholders’ Equity (SE)

What does the Balance Sheet report

the financial condition as of a point in time (a date; Nov. 30, 2025)

What does the Income Statement report

the revenues and expenses for a defined period (ex. For the month of Nov)

What does the Statement of Cash Flows report

the cash inflows and outflows during a defined period of time

what does the Statement of Stakeholders’ Equity report

reports the changes in stockholders’ equity for a period

How do the BS and Statement of CF relate

the Cash balance on the BS should be the same as the balance of cash on the Statement of CF

How do the BS and Statement of SE relate

the equity balances (capital stock, retained earnings) on the BS should be the same as the balances on the Statement of SE

how do the Income Statement and the Statement of SE relate

the net income on the IS should be the same as the net income reported on the Statement of SE

T/F: The net cash flows per the Statement of Cash Flows = Net Income per the IS

false!

What information can be found on a BS

1. Assets

2. Liabilities

3. Stockholders’ Equity

What are current assets

assets that the company expects to be turned into cash or views within one year

accounts recievable

the money a company’s customers owes to the company

fixed assets are…

noncurrent assets or long term physical assets a company uses for a number of years such as equipment, machinery, land, buildings, furniture

what is liquidity

how easily said asset can be converted into cash

how are assets organized on a balance sheet

in order of their liquidity (aka how current the asset amount is)

what is the most liquid asset of them all

cash

why are fixed assets listed last

these would be more difficult to quickly sell for their cash value

What are the elements of a financial accounting system

rules, framework, controls

What do rules do

they govern how a transaction is recorded

what is a framework

how all the individual transactions are compiled together into account balances and then financial statements

what do controls do

they prevent and detect errors

what are transactions

they are economic events companies experience such as buying equipment or selling machinery

what set of rules do many US companies follow

US Generally Accepted Accounting Principles (GAAP)

what is the purpose of having a standardized set of rules

it helps users of financial statements to understand how balanced were calculated and what they represent

Framework Formula

Assets = Liabilities + Stockholders’ Equity

(Assets - Liabilities = SE)

assets

what a company has or is owed

different types of assets

• cash

• accounts receivable

• prepaid insurance

• office equipment

• accumulated depreciation

• land

liabilities

what a company owes to others (can be cash, goods, services, etc)

equity

the stockholder’s right to net assets (or the company’s worth)

examples of liabilities

• accounts payable

• wages payable

• unearned revenue

• notes payable

2 types of Stockholder’s Equity

1. common stock

2. retained earnings

what affects retained earnings

• + revenues

• - Expenses

• - Dividends

accounts payable

what a company owes to the suppliers

wages payable

what the company owes to the employees

unearned revenue

what a company owes to customers (can be goods, services, etc)

notes payable

what a company owes to a lender such as the bank (ex. loans)

current liabilities

liabilities that a company expects to pay within 1 year

non-current liabilities/ long-term liabilities

liabilities that will be paid back in a time later than 1 year (ex. notes payable [for this class])

common stock

the amount the company’s owners (or shareholders/stockholders) have invested into the company (by buying its shares)

what is retained earnings

represents the value of the company; it represents the company’s net income it has earned since it began that’s still retained in the business

T/F: a company’s retained earnings value is strongly correlated with the amount of cash that company has

false because RE is a metaphorical value that represents the net income of a company

When a company pays its dividends (gives money to stockholders), does it affect the common stock value

no because it does not change how much the investors invested in the company (think about paying the dividends as the company giving thanks to investors for investing; NOT a repayment)

when is common stock affected

when a stockholders buys or shares their stocks of the company

how are revenue earnings or expenses incurred listed on the income statement

the larger items are listed first (most to least money order)

how are the expenses and revenues broken down in an income statement

operating and non-operating items

what will the activity on the income statement affect on the balance sheet

the activity on an income statement will affect the retained earnings part of the balance sheet

why aren’t revenues and expenses shown on the balance sheet

because they are factored into the retained earnings value?

why aren’t dividends shown on the income statement

because dividends are not considered an expense

operating cash activity

cash received or paid related to the company’s core operations

investing cash activity

cash paid or received when a company buys/sells a long-term asset

cash financing activities

activities where the company obtains/ releases funds to finance its business (ex. taking loans, paying dividends to stockholders)

how are cash inflows and outflows written

inflows → positive numbers and outflows or expenses are in parentheses

what does the statement of stockholders’ equity have at the top of its receipt

it has the amount of common stock and retained earning as of the beginning of the indicated period

current assets

assets that are expected to be converted to cash, sold, or used up in normal operations within one year

ex. cash, accounts receivable, prepaid insurance, inventory

noncurrent assests

assets that are NOT expected to be converted to cash, sold, or used up in normal operations within one year

ex. fixed assets (equipment, machinery, building, land, etc) or intangible assets

Since a balance sheet lists assets in order of liquidity, which comes first: current or noncurrent assets

current assets THEN noncurrent assets

current liabilities

liabilities due within one year
ex. accounts payable, wages payable, unearned revenue

noncurrent liabilities

liabilities that are NOT due within one year

ex. Notes Payable, Bonds Payable

when can notes payable be considered a current liability

when the loan (or whatever) is due in within one year

what is the accrual method of acct

requires companies to log revenues when it is earned and when expenses are incurred

(aka record revenue/expense when activity is actually happnes; don’t care if paid)

what kind of accounting method is used when revenues are recorded before it the cash is received or the expenses are recorded before it has been paid

accrual method of acct

what is cash basis method of acct

logging revenue/expense when cash is gained or lost

which is more complex method of acct: accrual or cash basis

accrual

deferrals

cash first, then revenue/expense (paid up front or prepaid)

• the company receives cash before revenue is earned

• the company pays cash before expense is incurred

accruals

revenue/expense first, cash last (pay later, bill me, send me an invoice)

• the company earns revenue before it receives the cash

• the company incurs the expense before it pays the cash

what 2 terms are associated with deferrals

unearned revenue and prepaid expenses

unearned revenue

a company receives cash from client before the good/service is provided

(ex. a relator gets cash from client buying the house before they get the house)

where is unearned revenue in the balance sheet

it is listed as a unearned revenue liability

prepaid expense

a company pays the cash to the supplier before the good/service is provided

(ex. a realtor pays a cleaning lady to clean the house he’s gonna do for a showing before she cleans the house)

how does a prepaid expense look on a balance sheet

it goes in as a prepaid expense asset