Introduction to Business Accounting
Introduction to Business Accounting
Course Introduction
Welcome to Introduction to Business Accounting, a foundational course for non-accounting majors.
The course aims to enhance understanding of managing, planning, evaluating, and controlling monetary transactions in both professional and personal financial decisions.
Course Sections
Section 1: History, Purpose, Ethics, and Regulatory Environment
Lesson 1: Explores the history and purpose of accounting, showing its evolution from recording past transactions to meeting changing business needs.
Lesson 2: Differentiates between financial and managerial accounting, highlighting the utility of managerial accounting for internal users and financial accounting for external stakeholders (stockholders, lenders, regulators).
Lesson 3: Covers the importance of ethics and regulations in maintaining ethical standards within accounting.
Section 2: Primary Financial Statements
Focuses on the three primary financial statements.
Lesson 1: Discusses the income statement, which details an organization's income over a period.
Lesson 2: Covers the balance sheet, illustrating what an organization owns (assets) and owes (liabilities).
Lesson 3: Explains the cash flow statement, presenting an organization's cash collection and usage during a period.
Lesson 4: Examines the relationship between these three historical financial statements and their role in future financial planning.
Section 3: Budgeting
Explores budgeting's critical role in organizations for financial resource management.
Lesson 1: Covers incremental budgeting (adjustments to historical results).
Lesson 2: Explores zero-based budgeting (justifying every expenditure from a zero base).
Lesson 3: Discusses comparing budgeted numbers to actual results and making operating adjustments.
Balances the effectiveness of zero-based budgeting with the practicality of incremental budgeting.
Section 4: Accounting Tools for Control and Evaluation
Focuses on accounting tools for controlling and evaluating business operations.
Lesson 1: Cost, profit, and investment centers.
Lesson 2: Cost types and behaviors (fixed, variable, product costs, period costs).
Lesson 3: Cost methodologies for assigning and accumulating product costs.
Lesson 4: Cost-volume-profit analysis and break-even analysis to understand how changes in costs and volume affect profitability.
MyEducator Learning Tools
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Glossary tool for key terms and definitions.
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Section 1: The Role of Financial and Managerial Accounting in Business
Lesson 1: History and Purpose of Accounting
Accounting developed to record past transactions and plan for future ones.
Early Bookkeeping
Early Mesopotamians, Babylonians, and Egyptians used simple recordkeeping to track goods.
Egypt had an early taxation system around 3,000 BCE.
Bartering was common until the Middle Ages when monetary systems emerged.
The Father of Accounting
Luca Pacioli, an Italian monk, developed a double-entry accounting system in the 15th century.
Pacioli's system and use of Arabic numerals enhanced accounting practices.
The Industrial Revolution and Capital Markets
The Industrial Revolution (1760-1840) led to increased capital needs and the development of capital markets and stock exchanges.
Investors wanted financial statements to assess company performance.
The Great Wall Street Crash of 1929
The crash led to the Great Depression (1929-1941).
Reasons included overinflated stock prices, bank failures, panic selling, and lack of standardized reporting rules.
"Pump and dump" schemes and dishonest information were significant issues.
Securities Acts of 1933 and 1934
The Securities Act of 1933 required companies to disclose relevant information and prohibited fraud in issuing securities.
The Securities Act of 1934 created the Securities and Exchange Commission (SEC) to govern secondary markets and trading, also requiring regular disclosures (Form 10-K, Form 10-Q, Form 8-K).
Increasing Regulation
The Sarbanes-Oxley Act of 2002 imposed new regulations on businesses and accounting firms after the dot-com bubble and corporate failures.
Requires risk management procedures, internal controls, and certification of financial statements by executives (CFO, CEO).
The Dodd-Frank Act was passed in 2008 to curb risky financial industry activities after the 2007-2008 financial crisis.
The goal is to ensure companies disclose risks and use generally accepted accounting practices.
Accounting profession also self-regulates through organizations like the American Institute of Certified Public Accountants (AICPA) in 1957.
The Financial Accounting Standards Board (FASB)
The primary organization that establishes accounting rules, termed generally accepted accounting principles (GAAP).
Lesson 2: The Difference Between Financial and Managerial Accounting
Accounting information users vary based on their role in the business world.
Financial accounting produces reports for external users or stakeholders.
Managerial accounting produces information for internal users.
Financial Accounting
Focuses on stewardship, control, and reporting for external users.
Relies on three primary financial statements: income statement, balance sheet, and cash flow statement.
Income Statement: Reports net income over a period.
Balance Sheet: Shows assets, liabilities, and owners’ equity at a specific date; based on the accounting equation Assets = Liabilities + Owners’ Equity.
Cash Flow Statement: Details cash inflows and outflows.
Notes to financial statements provide additional information.
Ensuring the Integrity of Accounting Information for External Users
The SEC mandates audits of publicly traded companies’ financial statements by independent Certified Public Accountants (CPAs).
Internal auditors review corporate data before public disclosure.
Financial statement fraud can lead to strict regulations.
Managerial Accounting
Used by individuals within a company and encompasses the financial reports that the company’s management deems necessary.
Managerial accounting fulfills the competitive needs of the company; management accounting supports planning, controlling, and evaluating operations.
Companies often regard management accounting systems as valuable secrets and rarely disclose them in detail to the public.
Return on Investment (ROI) tool allowed the DuPont cousins to be hugely successful in managing the United States’ first diversified company by combining cost management with asset management and raising it to an art form.
ROI = \frac{Operating Profit}{Average Total Assets}
Planning, Controlling, and Evaluating Using Management Accounting
Planning
Management planning involves a process of recognizing problems or opportunities, identifying and analyzing alternatives, and then choosing and implementing the best alternatives.
*Strategic Planning: Identifying an organization's mission, the goals flowing from that mission, and strategies and action steps to accomplish those goals.
*Capital Budgeting: Planning the acquisition of assets.
Controlling
*Involves tracking actual performance.
*Real-time, day-to-day management of all the company’s business processes.
Evaluating
*Involves analyzing results, providing feedback to managers and other employees, rewarding performance, and identifying problems.
Ensuring the Integrity of Accounting Information for Internal Users
Internal auditors perform compliances audits to ensure adherence to local laws, etc.
Key management personnel include:
*Chief financial officer (CFO)
*Treasurer
*Controller
Lesson 3: Ethics and Regulatory Environment
Explores the importance of strong ethics and the regulatory environment in business and accounting.
Public Companies and Private Companies
Distinguishes between public companies (stocks traded on exchanges) and private companies (owned by founders, managers, or private investors).
Highlights the significant number of private companies in the U.S.
Structure of a Corporation
Defines a corporation as a legal entity separate from its owners.
Discusses initial public offerings (IPOs).
Shareholders elect the board of directors, who hire the CEO.
Characteristics of a Corporation
*Benefits include:
*Limited liability.
*Ease of transferability.
*Legal rights.
*Indefinite life.
*The ability to raise large sums of money.
*Highly skilled management.
The Difference Between Manager and Shareholder Goals
Management acts as stewards for shareholders in a principal-agent relationship.
Differences in goals can lead to agency problems. Management might misuse their stewardship to gain something for themselves in a way that prioritizes short-term performance instead of the long-term health of the company.
Incentives, stock ownership, and strong regulation can help align interests.
Creating a Culture of Ethics
Good corporate governance minimizes corruption and encourages ethical conduct.
A code of conduct is essential.
Accountants play a critical role in auditing financial statements.
The International Federation of Accountants (IFA) and the American Institute of Certified Public Accountants (AICPA) establish professional ethical standards.
The Four Levels of Ethics
Understanding of right and wrong.
Ability to translate personal ethics to the work environment.
Courage to act ethically.
Ethical leadership.
The Regulatory Environment of Accounting
Businesses are held accountable through competition, laws, professional associations, lawsuits, and corporate governance.
The regulatory environment includes:
Securities Exchange Commission (SEC)
Public Company Accounting Oversight Board (PCAOB)
Financial Accounting Standards Board (FASB)
Securities and Exchange Commission (SEC)
A government-regulatory body created by the 1934 Securities Act, that has imposed strict financial reporting, internal control, and antibribery requirements for publicly traded companies and their accountants.
Professional Associations
Largest is the: American Institute of Certified Public Accountants (AICPA).
Public Company Accounting Oversight Board (PCAOB)
Oversees accounting professionals who provide independent audit reports for publicly traded companies.
Financial Accounting Standards Board (FASB)
*The designated organization for establishing standards for financial accounting that govern the preparation of financial reports.
Financial Accounting Standards Board (FASB)
Department of business regulation that sets standards and licensing requirements for accountants, verifies and approves their work experience, establishes entry standards for becoming a Certified Public Accountant (CPA).
Case Studies
*FTX
*Enron
Section 2: Uses of Financial Statements
Lesson 1: Balance Sheet
The balance sheet tells readers what resources (called assets) a company owns and what obligations (called liabilities) a company owes to others.
If you were going to loan money to a company or invest in a company, you would want to know whether the company could pay back your money or whether it would go out of business and cause you to lose your investment.
Financial statements are the output from the accounting system.
The Accounting Equation
Assets = Liabilities + Owners’ Equity
Assets are what is owned, the liabilities are what is owed, and the owners’ equity shows what the owners’ interests in the business are.
Investors and creditors use the balance sheet to evaluate a company’s liquidity position and its solvency position
Assets
*Assets are economic resources that are owned or controlled by a company.
Assets are usually listed in order of their liquidity How quickly and easily an asset can be converted to cash.
Liabilities
*Liabilities are obligations to pay cash, transfer other assets, or provide services to someone else.
Owners Equity
Owners’ equity represents how much of the assets were funded by owner contributions and earnings that have not been returned to owners.
Lesson 2: Income Statement
*The income statement is used to assess a company’s profitability— how well is it doing what it is in the business to do?
The Income Statement
*Revenues, Expenses, Net Income (or Net Loss)
Revenues – Expenses = Net Income
Multi-Step Income Statement
*Income statement is divided into separate sections, and various subtotals are reported that reflect different levels of profitability.
Comparative Income Statement
*Enable users to analyze a company’s performance over multiple periods and identify significant trends that might affect future performance.
Common-Size Income Statement
*Income statement numbers have been standardized using a percentage of sales.
Lesson 3: Cash Flow Statement
Purpose Of The Statement Of Cash Flows
*Cash Flow Statement is to detail a company’s inflows and outflows of cash from all sources ─some from operations and some from financing and other activities.
Categorizing Cash Flows
The statement of cash flows always starts with cash from operating activities and then usually lists cash related to investing activities and then cash related to financing activities.
*Operating Activities: Activities that are part of the day-to-day business of a company.
*Investing Activities: Activities associated with buying and selling long-term assets.
Financing Activities: Activities whereby cash is obtained from or repaid to owners and creditors.
*Noncash Transactions: Transactions that do not increase or decrease cash but still need to be disclosed to users of the financial statements.
Preparing a Statement of Cash Flows
*Conceptually, the statement of cash flows is the easiest to prepare of the three primary financial statements.
Lesson 4: Relationships Between Financial Statements
The three major financial statements are interconnected, and the relationship between them is known as articulation The interrelationships among the financial statements..
Articulation
*Refers to the relationship between an operating statement (the income statement or the statement of cash flows) and comparative balance sheets.
In this relationship, an item on the operating statement helps explain the change in an item on the balance sheet from one period to the next.
*The cash flow statement ties together the cash balance on one period’s balance sheet to the cash balance on the succeeding period’s balance sheet.
*The income statement, along with any dividends the company paid, ties the retained earnings balance on the beginning balance sheet to the retained earnings balance on the succeeding balance sheet.
Section 3: Budgeting
Introduction: Budgeting
A budget is a financial spending and income plan for a defined period that outlines how a firm, an organization, or an individual will acquire and use financial resources.
This section will discuss three budgeting topics: (1) incremental budgeting, (2) zero-based budgeting, and (3) variance analysis.
Lesson 1: Budgeting and the Incremental Budgeting Process
*Incremental budgeting involves preparing budgets for the coming period by adjusting the past budgets by a small percentage increase or decrease or by adding or subtracting an absolute dollar amount from each line item of the previous budget.
Businesses that fail to budget spend their money in unplanned ways,are often short of cash, do not have the optimal number of workers.
Types of Budgeting
*Zero-based budgeting- A budgeting process in which every line item starts with a zero balance.
*Incremental budgeting- A budgeting process that involves making incremental changes to a current budget to produce a budget for a future period.
The Operations Budget
*The operations budget is used to manage spending and resources related to the operations of a company.
SALES BUDGET, PRODUCTION, SELLING & ADMINISTRATIVE EXPENSE BUDGET, DIRECT MATERIALS BUDGET, MANUFACTURING OVERHEAD BUDGET, DIRECT LABOR BUDGET, CASH BUDGET, BUDGETED INCOME, BUDGETED BALANCE SHEET.
Factors Influencing the Sales Budget
Sales can be affected by both uncontrollable external variables and controllable internal variables.
Cost Budgets
*These budgets include production budgets for companies producing their own products and inventory purchase budgets for organizations buying goods from other companies.
Cash Budget
*A schedule of expected cash receipts and disbursements during the budget period.
Lesson 2: Zero-Based Budgeting
*Gets its name from the fact that every expense starts with a zero balance, and every dollar that is planned to be spent must be justified.
No expense is assumed to be necessary without specific, current justification.
Steps In Zero Based Budgeting
Managers identify activities that have historically been or could be performed by the company.
*. Different ways to perform the activities are considered.A decision package or analysis is prepared for each possible activity.
Management ranks the packages (analyses) in order of most benefits to least benefits to the organization.
Resources are then allocated based on the ordering of priorities up to the approved spending level.
Lesson 3: Variance Analysis
Types of Variances
*Revenue variances are the differences between actual revenues and budgeted revenues.
*Price variance: A variance that occurs when the amounts received from the sale of products or services is higher or lower than expected.
*Volume variance: A variance that occurs when more or fewer units are sold than expected.
*Mix variance A variance that occurs when the mix of products sold is not as expected.
Favorable variances: A variance that occurs when actual costs or expenses are lower than budgeted costs or when actual revenues are higher than budgeted revenues.
Unfavorable variances: A variance that occurs when costs or expenses are higher than budgeted costs and expenses or when actual revenues are lower than budgeted revenues.
Section 4: Managing Costs and Profits
Lesson 1: Cost, Profit, and Investment Centers
Every business must plan, control, and evaluate its operations.
Three Types of Businesses
*Manufacturing businesses: Any organization whose main economic activity involves using components or raw materials to make finished goods for sale to customers.
Cost, Profit, and Investment Centers
*Service businesses: Any organization whose main economic activity involves producing a nonphysical product that provides value to a customer.
Examples of Service businesses:
*Accounting/legal
*Architectural/engineering
*Banking/financial
*Healthcare
*Merchandising businesses: Any organization whose main economic activity involves purchasing finished goods and reselling them to customers.
Examples: Retail stores (Walmart) , Internet retailers (Amazon)
Lesson 2: Cost Types and Behaviors
In terms of costs and behaviors:
*Variable Cost increases in direct proportion to, changes in activities. Variable cost= constant per unit.
*Fixed Cost Remains the same in total, but decreases per unit, As production increases in total; regardless of activity level, at least over a certain range of activity.
*Mixed Cost Is a cost that has a fixed component and a variable component.
*Product Costs: Include Direct, materials, direct labor, and manufacturing cost also become an expense called cog.
All these costs should have close relationship to manufacturing unit..
*Period Costs: Are charged in the period when are being incurred. - All selling and Admin activity.
Lesson 3: Cost Methodologies
*Job order costing: Is use when the product being manufactured, must be clearly specified and must be unique.
*Activity-based costing (ABC): It identifies business activities that create overhead costs, such as worker turnover or design changes, and then assigns overhead to products or divisions based on the level of those activities.
*Process Costing: Is manufacturing similar product and it will be more applicable than tracking individual project costs.
Lesson 4: Cost, Volume, Profit Analysis (CVP)
Lesson 4.1: Cost-Volume-Profit Analysis
Understanding Basic Cost Behavior Patterns for Cost-Volume-Profit Analysis
*It is necessary to understand the behavior of costs as fixed, variable, or mixed costs.
C-V-P is a critically important tool to help businesses (and individuals) plan their operations and profitability.
C-V-P equation
Sales Revenue − Variable Costs − Fixed Costs = Profit
Contribution margin equation
Sales Revenue – Variable Costs = Contribution Margin
Break-Even Point
Sales Revenue − Variable Costs = Fixed Costs
Target Income Equations
Sales Revenue − Variable Costs = Profit + Fixed Costs
Contribution Margin = Profit + Fixed Costs