INTRODUCTION TO ACCOUNTING

The Role of Accounting in Starting a Business

Categorize business types and organizational forms.

• Business Types

Manufacturing businesses make products from raw inputs.
Merchandising businesses sell manufactured goods to customers.
Service businesses provide service to customers or clients; they do not make or sell products.

• Organizational Forms

Sole proprietorships are owned by one individual, are relatively inexpensive to form, and are not legally separate from their owners. Thus, all profits or losses become part of the taxable income of the owner, who is also personally responsible for all of the business's debts.
Partnerships are legally similar to proprietorships, but they have two or more owners.
Corporations are separate legal entities (thus, they pay taxes) that sell shares of stock to investors (stockholders). Corporations are more costly to establish than sole proprietorships and partnerships. Stockholders in corporations cannot be held liable for more than their investment in the corporation. Private corporations sell stock to a few individuals; public corporations sell stock on the stock market.

Describe accounting and its role in business decisions.

• Accounting Defined

Accounting is an information system designed to capture and communicate a business's financial condition and performance to decision makers inside and outside the organization.

• Accounting Professionals

Private accountants are employed by a single business or nonprofit organization. Many pursue the Certified Management Accountant certification.
Public accountants charge fees for services to a variety of businesses and nonprofit organizations. Staff members of CPA firms become licensed certified public accountants.

Identify users of financial information.

• Users of Financial Information

Internal users (primarily managers, sole proprietors, and partners) are those inside the organization who make business decisions affecting the organization's operating, investing, and financing activities.

• Management accounting is the area of accounting that produces financial information for internal users.

External users (primarily bankers, suppliers, governments, and stockholders in corporations) are not directly involved in running the business.

• Financial accounting is the area of accounting that produces financial information for external users.

Describe the fundamental accounting equation and elements of financial statements.

• The Accounting Equation

The fundamental accounting equation is Assets = Liabilities + Owner's Equity.

The five financial statement elements are:

• Assets are measurable economic resources that the business owns and are likely to provide future benefits.
• According to the historical cost principle, assets are initially measured at the total cost to acquire them.
• Liabilities are measurable and probable obligations that require the business to pay cash or deliver goods or services to others in the future.
• Owner's equity is the difference between the assets the business owns and the liabilities it owes.
• Revenues are the amounts that the business earned in delivering goods and services to customers.
• Expenses are the amounts of resources an entity used to earn revenues during a period.

Explain the structure of basic financial statements.

• Financial Statements

Income statement

• Its purpose is to report the performance of a business over a period of time.
• The income statement equation is Revenues – Expenses = Net Income (or Net Loss).

Statement of owner's equity

• Its purpose is to report the changes in owner's equity for a period of time and link the income statement to the balance sheet.
• The owner's equity equation is Beginning Owner's Equity + Additional Investments + Net Income (or – Net Loss) – Withdrawals = Ending Owner's Equity.

Balance sheet

• Its purpose is to report the amount of a business's assets, liabilities, and owner's equity at a particular point in time.
• The balance sheet equation is Assets = Liabilities + Owner's Equity

Statement of cash flows

• The purpose is to report the cash inflows and outflows for operating, investing, and financing activities during a period of time.
• The cash flow equation is ± Cash from Operating Activities ± Cash from Investing Activities ± Cash from Financing Activities = Change in cash during the period.
• Operating activities—those activities directly related to earning profits.
• Investing activities—buying and selling productive resources primarily with long lives.
• Financing activities—borrowing and repaying bank loans, receiving additional investments from owners, and withdrawing profits from the business by owners.
• According to the monetary unit assumption, financial information is reported in the standard monetary unit of the country in which the business operates.

Notes to the financial statements explain how amounts were measured and provide additional information that may affect users' decisions.

Understand the importance of ethical decisions in financial reporting and business.

• Generally Accepted Accounting Principles

The Financial Accounting Standards Board (FASB) sets the rules of accounting, which are the main source of generally accepted accounting principles (GAAP).
Financially useful information should be reliable, relevant, comparable, and consistent.
The Public Company Accounting Oversight Board (PCAOB) sets the rules for independent auditors.

• Ethical Conduct

Ethics in business and accounting refers to the standards of conduct used to judge right from wrong, honest from dishonest, and fair from unfair. Ethical dilemmas harm employees, the business's reputation, the corporation's stock price, lenders, and the public in general.
Companies need a strong system of internal controls to ensure the accuracy of their accounting records and to protect their assets from loss. An audit by independent auditors provides additional credibility regarding the strength of the companies' internal controls and the quality of their financial information.
Independent auditors (CPAs) must adhere to an ethics code, the Code of Professional Conduct, when providing services to clients.

Establishing a Business and the Balance Sheet

Identify what constitutes a business transaction and recognize common balance sheet account titles used in business.

• Nature of Business Transactions

Transactions include:
External exchanges—measurable exchanges of assets and services from one company for other assets or promises to pay from another company, and
Internal events—those that are not exchanges between the business and others, but which have a direct and measurable effect on the entity, including use of supplies and use of a building over many years.

• Balance Sheet Accounts

Typical balance sheet account titles include the following:
Assets: Cash, Accounts Receivable, Inventories, Supplies, Buildings, and Equipment.
Liabilities: Accounts Payable and Notes Payable.
Owner's Equity: "Owner's Name," Capital.

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