Chapter 1 Notes: Introduction to Accounting and Business

A business turns inputs (materials, labor) into outputs (goods/services) for customers.
Profit is calculated as: $\text{Profit} = \text{revenues} - \text{costs of inputs}$

GAAP = collection of accounting standards, principles, and assumptions for financial reporting.
FASB is the primary US standards-setter.
GAAP is codified in the Accounting Standards Codification (ASC).
Changes are issued as Accounting Standards Updates (ASUs).
SEC oversees disclosures for public companies.
Internationally, many countries follow IASB standards.

Assumptions:
- Monetary unit: reports in a single currency.
- Time period: reports are prepared for specific periods.
- Business entity: financial data pertains to the business, not its owners personally.
- Going concern: business is assumed to operate in the foreseeable future.
Principles:
- Measurement: amounts are determined by objective, verifiable measurements; arm's-length transactions.
- Historical cost: assets/liabilities recorded at initial transaction price.
- Revenue recognition: revenue when earned.
- Expense recognition (matching): expenses recorded in the same period as related revenue.

Proprietorship: owned by one person; easy to form; ~70% of US entities; limited resources; small businesses.
Partnership: two or more owners; often combined with LLCs; ~10%.
Corporation: separate legal entity; potential to issue stock; used by large firms (e.g., Alphabet, Apple, Ford).
LLC: blends partnership and corporation; tax and liability advantages; common alternative to partnership.

$\text{Assets} = \text{Liabilities} + \text{Owner's Equity}$
Liabilities are shown before Owner's Equity because creditors have first rights to assets.

A business transaction is an economic event that changes the entity's financial condition or results.
All transactions can be expressed as changes in the elements of the equation: Assets, Liabilities, Owner's Equity.
Typical dual effects (illustrative examples):
- Invest cash: Increases Assets (Cash) and increases Owner's Equity (Capital) by the same amount.
- Purchase on account: Increases Assets (e.g., Supplies) and increases Liabilities (Accounts Payable).
- Revenue in cash or on account: Increases Assets (Cash or Accounts Receivable) and increases Owner's Equity (via Fees Earned/Revenue).
- Expenses: Decreases Assets (Cash) or increases Liabilities (Accounts Payable for unpaid expenses) and decreases Owner's Equity.
- Owner withdrawals: Decreases Assets (Cash) and decreases Owner's Equity.

Primary statements for a proprietorship: Income Statement, Statement of Owner's Equity, Balance Sheet, Statement of Cash Flows.
Order of preparation: Income Statement

$\downarrow$

Statement of Owner's Equity

$\downarrow$

Balance Sheet

$\downarrow$

Statement of Cash Flows.

Interrelationships:
- Net income (or loss) from the Income Statement affects the Statement of Owner's Equity.
- Ending Owner's Equity on the Statement of Owner's Equity appears on the Balance Sheet.
- Cash on the Balance Sheet equals ending cash on the Statement of Cash Flows.

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Useful ratio for assessing financial condition; many large companies are analyzed this way.
Formula: $\frac{\text{Liabilities}}{\text{Owner's Equity}}$

Income Statement: Revenues and expenses for a period.
- $\text{Net Income} = \text{revenues} - \text{expenses}$ (A net loss occurs if expenses exceed revenues).
Statement of Owner's Equity: Changes in Owner's Equity for a period; linked to net income.
Balance Sheet: Assets, Liabilities, Owner's Equity at a date; report form; assets listed by liquidity; Liabilities listed; OE = difference.
Statement of Cash Flows: Operating, Investing, Financing activities; tracks cash receipts and payments in a period.

Core takeaways: nature of business and accounting's role; GAAP; accounting equation; recording transactions; financial statements and their interrelationships; ratio of Liabilities to Owner's Equity.