chapter 1 the role of accounting in starting a business © 2009 the mcgraw-hill companies, inc

Chapter 1

The Role of Accounting in The Role of Accounting in Starting a BusinessStarting a Business

© 2009 The McGraw-Hill Companies, Inc.

Business Types

Service Companies

Manufacturers

Merchandisers

Most businesses exist so their owners can earn a profit. Provide a service to

customers or clients.make

products from raw inputs.

sell goods that

manufacturers produce.

Organizational Forms

Corporations

are separate entities, both legally and from an accounting perspective. Owners of

corporations (stockholders) cannot be held liable for debts of

the corporation.

Sole Proprietorships

are owned by one individual who often manages the business and who is personally liable for all the

business’s debts.

Organizational Forms

Corporations

Public Companies

sell their stock on the stock market.

Private Companies

sell their stock privately.

Stockholders can sell all or part of their shares to someone else.

Accounting Defined

Captures (analyzes, records, and

summarizes) a business’s activities affecting its financial

performance

Communicates the resultsto decision

makers

Internaldecisionmakers

Externaldecisionmakers

Accounting is often referred to as the language of business.

Accounting Professionals

Public Accountants

charge a fee for their services to business

and nonprofit organizations.

Private Accountants

are employed by a single business or

nonprofit organization.

The Accounting System and Decision Makers

Accounting System

Financial Accounting SystemPeriodic financial statements and

related disclosures

Managerial Accounting SystemDetailed plans and continuous

performance reports

External Decision MakersInvestors, creditors,suppliers, customers

Internal Decision MakersManagers throughout the

organization

The Accounting EquationResources a

Business OwnsClaims to Resources a Business Owes

to creditors to the owner

Basic Accounting

Equation

AssetsResources controlled by the Resources controlled by the

business that have business that have measurable value and are measurable value and are expected to provide future expected to provide future benefits to the company.benefits to the company.

Cash

Supplies Furniture

Equipment

Liabilities

Amounts owed by the business to

creditors.

Notes Payable

Accounts Payable

Owner’s Equity

Owner’s claim to the business resources.

Ownership Profits

Owner’s Equity

- Expenses+ Revenues = Net Income

Revenues and Expenses

RevenuesSales of goods or services to

customers. They are measured at the amount the business charges the

customer.

ExpensesThe costs of business

necessary to earn revenues, including wages to employees, advertising,

insurance, and utilities.

Separate Entity Assumption

Requires that a business’s activities be recorded and reported separately from activities of its owners.

Pizza Aroma Illustration

= +1 Cash + 30,000 = M. Rosa, Capital + 30,000

Assets Liabilities Owner's Equity

Activity 1: Obtain Contributions from Owners. Mauricio contributes $30,000 of his personal funds to start the business.

= +2 Cash + 20,000 = Notes Payable + 20,000


Activity 2: Borrow from Bank. Pizza Aroma obtains a $20,000 loan from a local bank.


= +3 Equipment + 40,000

Cash - 40,000 = No Change


Activity 3: Purchase Equipment. Pizza Aroma buys ovens, chairs, tables, counters, a refrigerator, a computer, a cash register, and pots, all for $40,000 in cash.

Activity 4: Earn Revenues. Pizza Aroma sells pizza to customers at the restaurant for $10,000 cash and delivers $1,000 in pizza on account to local colleges.

= +4 Cash + 10,000

Accounts Receivable + 1,000 11,000 Pizza Revenue +=



= +5 Supplies Expense - 4,000

Rent Expense - 2,000 Wages Expense - 2,000 Utilities Expense - 600 Insurance Expense - 300 Advertising Expense - 100


Cash - 9,000 =

Activity 5: Incur Expenses. Pizza Aroma buys and uses $4,000 in supplies and pays $2,000 for rent, $300 for insurance, $100 for advertising, $2,000 in wages, and $600 in utilities. Pizza Aroma paid cash for all expenses.


= +6 Supplies + 3,000 = Accounts Payable + 3,000


Activity 6: Purchase Supplies on Account. Pizza Aroma purchases “on account” $3,000 of pizza ingredients and supplies (flour, tomatoes, cheese, napkins, pizza boxes, utensils, and cups).

Activity 7: Distribute Profits to Owner. Pizza Aroma distributes $1,000 to Mauricio at the end of the first month.

= +7 Cash - 1,000 = M. Rosa, Drawing - 1,000


Pizza Aroma Activity Summary

= +1 Cash + 30,000 = M. Rosa, Capital + 30,000 2 Cash + 20,000 = Notes Payable + 20,000 3 Equipment + 40,000

Cash - 40,000 4 Cash + 10,000

Accounts Receivable + 1,000 5 Supplies Expense - 4,000

Rent Expense - 2,000 Wages Expense - 2,000 Utilities Expense - 600 Insurance Expense - 300 Advertising Expense - 100

6 Supplies + 3,000 = Accounts Payable + 3,000 7 Cash - 1,000 = M. Rosa, Drawing - 1,000

Totals = + 31,000$

Cash - 9,000 =

54,000$ 23,000$


= Pizza Revenue + 11,000

No Change=

Here is a summary of the business activities for Pizza Aroma for the first month of operations.

Typical Account TitlesAssetsCashShort-Term InvestmentsAccounts ReceivableInventorySuppliesPrepaid ExpensesLandBuildingEquipmentLong-Term InvestmentsIntangible Assets“Specific type of” Asset

AssetsCashShort-Term InvestmentsAccounts ReceivableInventorySuppliesPrepaid ExpensesLandBuildingEquipmentLong-Term InvestmentsIntangible Assets“Specific type of” Asset

LiabilitiesAccounts PayableShort-term Notes PayableWages PayableTaxes PayableInterest PayableUnearned Revenues Long-term Notes PayableBonds Payable“Specific type of” Payable

LiabilitiesAccounts PayableShort-term Notes PayableWages PayableTaxes PayableInterest PayableUnearned Revenues Long-term Notes PayableBonds Payable“Specific type of” Payable

Owner’s Equity“Proprietor’s Name,” Capital“Proprietor’s Name,” Drawing

Owner’s Equity“Proprietor’s Name,” Capital“Proprietor’s Name,” Drawing

RevenuesSales RevenueFee RevenueInvestment RevenuePizza Revenue“Specific type of” Revenue

RevenuesSales RevenueFee RevenueInvestment RevenuePizza Revenue“Specific type of” Revenue

ExpensesCost of Goods SoldAdvertising ExpenseInsurance ExpenseRent ExpenseInterest ExpenseWages ExpenseSupplies ExpenseUtilities Expense“Specific type of” Expense

ExpensesCost of Goods SoldAdvertising ExpenseInsurance ExpenseRent ExpenseInterest ExpenseWages ExpenseSupplies ExpenseUtilities Expense“Specific type of” Expense

Here is a list of common account titles that most

business use.

Financial StatementsIncome

Statement

Statement of Owner’s

Equity

Balance Sheet

Statement of Cash Flows

Income Statement

RevenuesSales revenue 11,000$ Total revenue 11,000

ExpensesSupplies expense 4,000 Wages expense 2,000 Rent expense 2,000 Utilities expense 600 Insurance expense 300 Advertising expense 100 Total expenses 9,000 Net income 2,000$

For the Month Ended May 31, 2009Income Statement

PIZZA AROMA

Heading

Name of the entityTitle of the statement

Accounting period

Revenues earned from the sale /delivery of pizza to

customers

Expenses are costs incurred during the

period to earn revenue

Statement of Owner’s Equity

Purpose

Reports the changes in the capital account since the beginning of the period

M. Rosa, Capital, May 1, 2009 -$ Add: Investments by owner 30,000 Net income 2,000 Less: M. Rosa, Drawing (1,000) M. Rosa, Capital, May 31, 2009 31,000$

For the Month Ended May 31, 2009

PIZZA AROMAStatement of Owner's Equity

AssetsCash 10,000$ Accounts receivable 1,000 Supplies 3,000 Equipment 40,000 Total assets 54,000$

LiabilitiesAccounts payable 3,000$ Notes payable 20,000 Total liabilities 23,000

Owner's EquityM. Rosa, Capital 31,000 Total liabilities and owner's equity 54,000$

PIZZA AROMABalance SheetAt May 31, 2009

Balance Sheet

Purpose

Reports at a point in time:

1. What a business owns (assets)

2. What it owes to creditors (liabilities)

3. What is left over for the company’s owner(s).

BASIC ACCOUNTING EQUATION

Assets = Liabilities + Owner’s Equity

Statement of Cash Flows

Purpose

Summarizes how a business’s operating,

investing and financing activities caused its cash balance to change over a particular period of time.

Cash Flows from Operating ActivitiesCash collected from customers 10,000$ Cash paid to suppliers and employees (9,000)

Cash provided by operating activities 1,000 Cash Flows from Investing ActivitiesCash paid to buy equipment (40,000) Cash used in investing activities (40,000) Cash Flows from Financing ActivitiesInvestment by owner 30,000 Withdrawal by owner (1,000) Cash borrowed from the bank 20,000 Cash provided by financing activities 49,000 Change in cash 10,000 Beginning cash balance, May 1, 2009 - Ending cash balance, May 31, 2009 10,000$

PIZZA AROMAStatement of Cash Flows


Notes to the Financial Statements

Notes help financial statement users

understand how the amounts were

derived and what other information may affect their

decisions.

Relationships among the Financial Statements




PIZZA AROMA




Net income flows from the

Income Statement to

the Statement of Retained Earnings.





PIZZA AROMA













Cash on the Balance Sheet and Cash at End of Year on the

Statement of Cash Flows agree.

Cash Flows from Operating ActivitiesCash collected from customers 10,000$ Cash paid to suppliers and employees (9,000)

Cash provided by operating activities 1,000 Cash Flows from Investing ActivitiesCash paid to buy equipment (40,000) Cash used in investing activities (40,000) Cash Flows from Financing ActivitiesInvestment by owner 30,000 Withdrawal by owner (1,000) Cash borrowed from the bank 20,000 Cash provided by financing activities 49,000 Change in cash 10,000 Beginning cash balance, May 1, 2009 - Ending cash balance, May 31, 2009 10,000$

PIZZA AROMAStatement of Cash Flows


Summary of Four Basic Financial StatementsFinancial Statement Purpose: To report … Structure Examples of Content

Income Statement …the accountant's primary measure of economic performance during the accounting period .

Revenues- Expenses Net Income

Sales Revenue, Rent Expense, Wages Expense, Utilities Expense

Statement of Owner's Equity …the way that net income, owner investments, and owner withdrawals affected the financial position of the company during the accounting period .

Beginning Owner's Equity+ Additional Investments- Owner's Withdrawals+ Net Income (or - Net Loss) Ending Owner's Equity

Net Income is from the income statement

Balance Sheet …the financial position (economic resources and sources of financing) of a business at a point in time .

Assets = Liabilities + Owner's Equity

Cash, Receivables, Supplies, Equipment, Accounts Payable, Owner's Capital

Statement of Cash Flows …inflows (receipts) and outflows (payments) of cash during the accounting period in the operating, investing, and financing categories.

+/- Cash Flows from Operating Activities+/- Cash Flows from Investing Activities+/- Cash Flows from Financing Activities Change in Cash+ Beginning Cash Balance Ending Cash Balance

Cash Collected from Customers, Cash Paid to Suppliers, Cash Paid to Purchase Equipment, Cash Borrowed from Banks

Generally Accepted Accounting Principles

GAAP are the underlying rules for financial reporting and are established by the Financial Accounting Standards Board (FASB) under the authority granted by the Securities and

Exchange Commission (SEC).

FASBFASBSECSEC

GAAPGAAPAuditors report

whether companies used GAAP

PCAOBPCAOB

Auditing Rules

Auditing Rules

Under authority granted by the SEC, The Public Company Accounting Oversight Board (PCAOB) establishes the rules

used by auditors, who report on whether a company’s financial statements are, in fact, prepared following GAAP.

Ethical Conduct

AICPA Code of

Professional

Conduct

When faced with an ethical dilemma, follow this three-step process:

1.Identify who will benefit from the situation and how others will be harmed.

2.Identify the alternative courses of action.

3.Choose the alternative that is the most ethical – and that you would be proud to have reported in the news.

Addressing Ethical Dilemmas in the Workplace

Sarbanes-Oxley Act of 2002

Top managers sign a report certifying their

responsibilities for the financial statements

Maintain an audited system of internal controls

to ensure accuracy in accounting reports

Maintain an independent committee to ensure

managers cooperate with auditors

Private Accounting Public Accounting

Public companyPrivate company

Nonprofit organizationType of Organization CPA firm

MultinationalMid-sized

SmallSize of Organization

"Big 4" (international partnerships): Deloitte & Touche, Ernst & Young, KPMG, PricewaterhouseCoopersRegionalLocal (partnership or proprietorship)

General accountingBudgetingCost accountingTaxationInternal auditingOthers (e.g., finance, information systems, forecasting)

Functions and Specializations

Auditing (assurance services)TaxationConsulting such as forensic (fraud) accounting, computer systems security, outsourcing, bookkeeping services, and industry specialization (e.g., high tech, banking, mergers and acquisitions, and communications)

$30,000-$43,000*depending on type, size,

geographical location, and functional area

Starting Salaries

$36,000-$52,000*depending on size, geographicallocation, academic degrees, and

functional area orspecialization

Chief Financial Officer (CFO),Controller, Treasurer,Director of Accounting

Typical Senior PositionsSenior Accountant,

Manager,Partner

Overview of Career Choices for Accounting Professionals

End of Chapter 1

Slide 34

chapter 1 the role of accounting in starting a business © 2009 the mcgraw-hill companies, inc

Documents

pizza aroma purchases

pizza ingredients

pizza boxes

pizza aroma buys ovens

business activities

business resources

business use

language of business