Chapter 1 Summary: Introduction to Accounting and Business
Nature of Business and Accounting
A business assembles resources (inputs) to provide goods/services (outputs).
Profit = Revenues - Expenses
Types of businesses:
Service: Provides services.
Retail: Sells products purchased from other businesses.
Manufacturing: Converts inputs into products.
Role of Accounting and Ethics
Accounting provides information for:
Managers to operate the business.
Users to assess economic performance.
Accounting is an information system reporting on economic activities.
Accountants must be ethical for trustworthy information.
Ethics are moral principles guiding conduct.
Unethical behavior arises from:
Failure of individual character.
Culture of greed and ethical indifference.
Generally Accepted Accounting Principles (GAAP)
GAAP: Accounting standards, principles, and assumptions for financial reporting.
Accounting standards: Rules for individual transactions.
Principles/assumptions: Framework for standards.
FASB develops accounting standards in the U.S.
SEC oversees financial disclosures for publicly traded companies.
IASB sets standards outside the U.S.
Financial information should be:
Relevant: Impacts decision-making.
Faithful representation: Accurately reflects economic activity.
Enhanced by comparability, verifiability, timeliness, and understandability.
Assumptions in Financial Accounting
Monetary unit: Reports in a single currency.
Time period: Reports activities regularly for specific periods.
Fiscal year: Annual accounting period.
Natural business year: Ends when activities are at their lowest.
Business entity: Limits data to the business's activities.
Going concern: Assumes the entity will continue operating.
Forms of Business Entities
Proprietorship: Owned by one individual.
Partnership: Owned by two or more individuals.
Corporation: Organized under state/federal statutes; separate legal entity.
Limited liability company (LLC): Combines partnership and corporation attributes.
Principles of Financial Accounting
Measurement: Determines recorded amounts.
Arm’s-length transactions: Objective and verifiable amounts.
Historical cost principle: Record at initial transaction price.
Revenue recognition: Determines when revenue is recorded.
Expense recognition (matching principle): Record expenses in the same period as related revenue.
The Accounting Equation
Assets = Liabilities + Equity
Business Transactions
Economic events changing an entity’s financial condition.
Recorded in terms of changes in the accounting equation.
Examples:
Issuing common stock: Increases assets (Cash) and equity (Common Stock).
Purchasing land: Changes asset composition but not total assets.
Purchase on account: Increases assets (Supplies) and liabilities (Accounts Payable).
Providing services for cash: Increases assets (Cash) and equity (Fees Earned).
Paying expenses: Reduces assets (Cash) and equity.
Paying creditors: Reduces assets (Cash) and liabilities (Accounts Payable).
Supplies used: Decreases assets (Supplies) and equity (Expenses).
Paying dividends: Decreases assets (Cash) and equity.
Financial Statements
Primary statements:
Income statement: Revenues and expenses for a period.
Net income = Revenue - Expenses
Statement of stockholders’ equity: Changes in equity for a period.
Balance sheet: Assets, liabilities, and equity at a specific date.
Statement of cash flows: Cash inflows and outflows for a period, categorized by operating, investing, and financing activities.
Financial Statement Interrelationships
Net income from the income statement flows to the statement of stockholders’ equity.
Ending balances of common stock and retained earnings from the statement of stockholders’ equity flow to the balance sheet.
Cash balance on the balance sheet matches the ending cash balance on the statement of cash flows.
Ratio of Liabilities to Stockholders’ Equity
Used to evaluate a company’s financial condition.