Week 1-2 chapter 2

Chapter Overview

The chapter focuses on linking personal accounting to business accounting, emphasizing the differences between personal and business accounts, types of businesses, and financial statements.

Learning Objectives

• LO 2-1: Differences between personal and business accounts

• LO 2-2: Describe the three main types of businesses

• LO 2-3: Record revenue based on accruals

• LO 2-4: Equity vs. Net Worth

• LO 2-5: Types of business

• LO 2-6: Record expenses based on accruals

• LO 2-7: Financial statements required

Types of Businesses

• Service Business: Provides intangible products or services (e.g., internet service provider).

• Merchandising Business: Retailers that sell goods purchased from manufacturers (e.g., office supplies store).

• Manufacturing Business: Produces products to sell (e.g., appliance manufacturer).

Revenue Recognition

• Accruals: Revenue is recorded regardless of cash timing.

  • Cash Received Before Service: Recognized as unearned revenue.

  • Cash Received During Service: Recognized immediately.

  • Cash Received After Service: Recorded as accounts receivable.

Expense Recognition

• Accruals: Expenses are recorded as incurred, not when paid.

  • Payment Before Expense: Recorded as prepaid expense.

  • Payment When Expense Is Incurred: Directly recorded as an expense.

  • Payment After Expense: Recorded as accounts payable.

Business Transactions

• Record using T-Accounts. Four required financial statements:

  • Income Statement: Reports revenues and expenses over a specific period, indicating profit or loss.

  • Statement of Owner's Equity: Captures changes in owner's equity.

  • Balance Sheet: Displays assets, liabilities, and equity at a point in time.

  • Statement of Cash Flows: Summarizes cash movements.

Page 2: Business Accounts Overview

Differences in Account Terminology

• Personal Balance Sheet vs. Business Balance Sheet: Balance Sheet and Income Statement, respectively.

• Cash: Business cash may have several different bank accounts; all amounts are included in cash.

• Accounts Receivable: Amounts owed to the business by its customers (e.g., Asset).

• Merchandise Inventory: Collection of physical goods purchased to sell to customers (e.g., Asset).

• Prepaid Expenses: Costs paid for by a business before incurred (e.g., Asset).

• Property, Plant, and Equipment: Noncurrent assets providing long-term benefits.

• Accounts Payable: Amount owed to suppliers (e.g., Unpaid Accounts).

• Unearned Revenue: Obligation to provide goods/services for payments received in advance.

• Bank Loan: Business liability for borrowed money (may have long-term debt).

• Owner's Equity vs. Net Worth: Owner's equity reflects ownership stake.

• Revenue: Called either Service Revenue or Sales Revenue.

• Net Income/Loss: Surplus (deficit) on personal income statement.

Page 3: Understanding Equity

Key Concepts of Equity

• Owner's Equity: Represents net worth in a business context; the leftover value after liabilities are paid.

• Owner’s Investments: Cash/assets contributed by the owner.

• Owner’s Withdrawals: Cash/assets removed by the owner, impacting equity but not included on income statements.

Components of Equity Calculation

• Beginning Capital, Investments, Net Income (Loss), Withdrawals.

• Ending balances tracked through the Statement of Owner's Equity.

Page 4: Types of Business Financial Statements

Overview of Business Financial Statements

• Service Business: Focus on service revenue and expenses.

• Merchandising Business: Identify sales revenue and costs of goods sold.

• Manufacturing Business: Detailed accounting for raw materials, work in progress, and finished goods costs.

Page 5: Revenue Tracking

Recording Revenue Scenarios

• Received Before Service: Recorded as unearned revenue.

• When Performed: Direct income increase.

• After Performance: Recorded as accounts receivable.

Page 6: Expense Tracking

Understanding Expense Recording

• Prepaid Expenses: Recognized when the service is performed.

• Immediate Payment: Direct impact on expenses and cash.

• Credit Expenses: Recognized immediately and tracked.

Page 7: Business Transactions

T-Account Transactions Overview

• Importance of documenting each transaction to ensure accounting equation balance.

Page 8: Reflecting on Transactions

Example Transactions Summary

• Detailed record-keeping of transactions and their impacts on financial health.

Page 9: Financial Statement Preparation

Essential Financial Statements

• Income Statement: Shows revenue and expense for a period.

• Statement of Owner's Equity: Captures changes in owner's equity.

• Balance Sheet: Displays assets, liabilities, and equity.

• Statement of Cash Flows: Summarizes cash movements.

Order of Preparation

1. Income Statement

2. Statement of Owner's Equity

3. Balance Sheet

4. Statement of Cash Flows

Page 10: Ethics in Financial Reporting

Ethical Considerations

• Integrity: Accounting must truthfully represent financial reality.

• Fraud Triangle: Elements leading to ethical misconduct.

• Corporate Accountability: Importance of adhering to ethical standards in financial reporting.