Chapter 1

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved


Chapter 1Business Decisions and Financial Accounting

PowerPoint Authors:Brandy MackintoshLindsay Heiser

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Learning Objective 1-1

Describe various organizational forms and

business decisionmakers.

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Organizational Forms

PartnershipBusiness organization owned by

two or more people. Each partner is personally liable for all debts of

the business.

Corporation

A separate legal entity. Owners of corporations (stockholders) are not personally liable for debts of

the corporation.

Sole Proprietorship

Business organization owned by one person. The owner is

personally liable for all debts of the business.

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Organizational Forms

Source: IRS.gov.

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The Accounting System

Operating, Investing and Financing Activities

AccountingSystem

Accounting ReportsFinancial ManagerialExternal users

(creditors, investors, etc.)

Internal users(managers, supervisors etc.)

Accounting is a system of analyzing, recording, summarizing and reporting the results of a business’s activities.

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Describe the purpose, structure, and content of the

four basic financial statements.

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The Basic Accounting EquationResources Owned . . .

by the company

Resources Owed . . .

to creditors to stockholders

Separate Entity Assumption

The financial reports of a business are assumed to include the results of only that business’s activities.

Assets = Liabilities + Stockholders’ Equity

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AssetsEconomic resources

controlled by the company that have measurable value and are expected to provide

future benefits to the company.

Cash

Supplies Furniture

Equipment

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Liabilities

Measurable amounts owed by the business to creditors.

Notes Payable

Accounts Payable

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Stockholders’ Equity

Owners’ claim to the business resources.

Stock Certificate

Contributed Capital

Retained Earnings

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Revenues, Expenses and Net Income

RevenuesSales of goods or services

to customers. They are measured at the

amount the business charges the customer.

ExpensesThe costs of doing

business necessary to earn revenues,

including wages to employees, advertising, insurance, and utilities.

Revenues – Expenses = Net Income

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Dividends

Distributions of a company’s earnings to its stockholders as a return

on their investment.

Dividends are not an expense.

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Financial Statements

Income Statement

Statement of Retained Earnings

Balance Sheet

Statement of Cash Flows

Financial statements are

typically prepared in this order.

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The Income Statement

Reports the amount

of revenues

less expenses

for a period of time.

The unit of measure

assumption states that results of business activities should be

reported in an appropriate

monetary unit.

PIZZA AROMA, INC.Income Statement

For the Month Ended September 30, 2013

RevenuesPizza RevenueTotal Revenue

ExpensesSupplies ExpenseWages ExpenseRent ExpenseUtilities ExpenseInsurance ExpenseAdvertising ExpenseIncome Tax ExpenseTotal ExpensesNet Income

$ 12,000 12,000

5,0002,0001,500

600300100

500 10,000$ 2,000

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The Statement of Retained Earnings

Reports the way that net income and the distribution of dividends affected the financial

position of the company during the period.

PIZZA AROMA, INC.Statement of Retained Earnings


Retained Earnings, Sept. 1, 2013Add: Net IncomeSubtract: DividendsRetained Earnings, Sept. 30, 2013

$ - 2,000

(1,000)$ 1,000

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The Balance SheetReports 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 owners of the company’s stock (stockholders’ equity).

BASIC ACCOUNTING EQUATION

Assets = Liabilities + Stockholders’ Equity

PIZZA AROMA, INC.Balance Sheet

At September 30, 2013

AssetsCashAccounts ReceivableSuppliesEquipmentTotal Assets

LiabilitiesAccounts PayableNotes PayableTotal Liabilities

Stockholders’ EquityContributed CapitalRetained EarningsTotal Stockholders’ EquityTotal Liabilities and Stockholders’ Equity

$ 14,0001,0003,000

40,000$ 58,000

$ 7,000 20,000 27,000

30,000 1,000 31,000$ 58,000

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The Statement of Cash Flows

Summarizes how a

business’s operating,

investing, and financing activities

caused its cash balance

to change over a particular

period of time.

PIZZA AROMA, INC.Statement of Cash Flows


Cash Flows from Operating ActivitiesCash received from customersCash paid to employees and suppliersCash Provided by Operating ActivitiesCash Flows from Investing ActivitiesCash used to buy equipmentCash Used in Investing ActivitiesCash Flows from Financing ActivitiesCapital contributed by stockholdersCash dividends paid to stockholdersCash borrowed from the bankCash Provided by Financing ActivitiesChange in CashBeginning Cash Balance, Sept. 1, 2013Ending Cash Balance, Sept. 30, 2013

$ 11,000 (6,000) 5,000

(40,000) (40,000)

30,000(1,000)

20,000 49,000

14,000 -$ 14,000

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Notes to the Financial Statements

Notes help financial statement users understand how the amounts were derived and what other information

may affect their decisions.

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Relationships Among the Financial Statements

Net income flows from the

Income Statement to

the Statement of Retained Earnings.

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PIZZA AROMA, INC.Income Statement


RevenuesPizza RevenueTotal Revenue

ExpensesSupplies ExpenseWages ExpenseRent ExpenseUtilities ExpenseInsurance ExpenseAdvertising ExpenseIncome Tax ExpenseTotal ExpensesNet Income

$ 12,000 12,000

5,0002,0001,500

600300100

500 10,000

$ 2,000




$ - 2,000

(1,000)$ 1,000

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Ending Retained Earnings flows from

the Statement of Retained Earnings to

the Balance Sheet.

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$ - 2,000

(1,000)$ 1,000






$ 14,0001,0003,000

40,000$ 58,000

$ 7,000 20,000 27,000

30,000 1,000 31,000$ 58,000

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Cash on the Balance Sheet and Cash at End of Year on the Statement of Cash Flows agree.

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$ 14,0001,0003,000

40,000$ 58,000

$ 7,000 20,000 27,000

30,000 1,000 31,000$ 58,000

PIZZA AROMA, INC.Statement of Cash Flows


Cash Flows from Operating ActivitiesCash received from customersCash paid to employees and suppliersCash Provided by Operating ActivitiesCash Flows from Investing ActivitiesCash used to buy equipmentCash Used in Investing ActivitiesCash Flows from Financing ActivitiesCapital contributed by stockholdersCash dividends paid to stockholdersCash borrowed from the bankCash Provided by Financing ActivitiesChange in CashBeginning Cash Balance, Sept. 1, 2013Ending Cash Balance, Sept. 30, 2013

$ 11,000 (6,000) 5,000

(40,000) (40,000)

30,000(1,000)

20,000 49,000

14,000 -$ 14,000

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Explain how financial statements are used by

decision makers.

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Using Financial Statements

Creditors1. Is the company

generating enough cash to make payments on its loans?

2. Does the company have enough assets to cover its liabilities?

Investors1. What is the

immediate return (through dividends) on my contributions?

2. What is the long-term return (through stock price increases resulting from the company’s profits)?

… SCF

… B/S

… SRE

.. I/S

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Describe factors that contribute to useful financial

information.

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External Financial Reporting

Main Goal: Provide useful financial information to external users for decision making.

RelevantRelevant

UsefulUseful

Faithful Representation


Comparable Verifiable Timely UnderstandableComparable Verifiable Timely Understandable


Relevant

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WorldWorld

Accounting Standards

Where?Where?

Who?Who?

What?What?

IASBIASB

IFRSIFRS

FASBFASB

United States

United States

GAAPGAAP

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Ethical Conduct

When faced with an ethical dilemma:

Identify who will benefit from the

situation and how others will be

harmed.

Identify the alternative courses

of action.

Choose the alternative that is the

most ethical.


Chapter 1Supplement

Careers That Depend on Accounting Knowledge

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Chapter 1Solved Exercises

M1-12, E1-3, E1-6, E1-8, S1-6 (Req. 1)

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M1-12 Preparing a Statement of Retained EarningsStone Culture Corporation was organized on January 1, 2012. For its first two years of operations, it reported the following:

On the basis of the data given, prepare a statement of retained earnings for 2012 (its first year of operations) and 2013. Show computations.

Net Income for 2012Net Income for 2013Dividends for 2012Dividends for 2013Total assets at the end of 2012Total assets at the end of 2013

$ 40,00045,00015,00020,000

125,000242,000

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M1-12 Preparing a Statement of Retained Earnings

STONE CULTURE CORPORATIONStatement of Retained Earnings

For the Year Ended December 31, 2012

Retained Earnings, January 1, 2012Add: Net IncomeSubtract: DividendsRetained Earnings, December 31, 2012

$ -40,000

(15,000)$ 25,000

STONE CULTURE CORPORATIONStatement of Retained Earnings

For the Year Ended December 31, 2013

Retained Earnings, January 1, 2013Add: Net IncomeSubtract: DividendsRetained Earnings, December 31, 2013

$ 25,00045,000

(20,000)$ 50,000

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E1-3 Preparing a Balance SheetDSW is a designer shoe warehouse, selling some of the most luxurious and fashionable shoes at prices that people can actually afford. Its balance sheet, at January 29, 2011, contained the following items (listed alphabetically, amounts in thousands).

Required:1. Prepare the balance sheet as of January 29, 2011 solving for the

missing amount.2. As of January 29, did most of the financing for assets come from

creditors or stockholders?

Accounts Payable

Accounts Receivable

Cash

Contributed Capital

Notes Payable

Other Assets

Other Liabilities

Retained Earnings

Property, Plant, and Equipment

Total Assets

Total Liabilities and Stockholders’ Equity

$ 149,722

12,514

93,617

314,382

95,589

692,375

122,822

210,391

326,382

1,008,897

?

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E1-3 Preparing a Balance Sheet

Most of the financing as of January 29

came from stockholders. The stockholders have

financed $640,764 of the total assets and

creditors have financed only

$368,133 of the total assets of the

company.

DSW, Inc.Balance Sheet

At January 29, 2011(In thousands)

Assets Cash Accounts Receivable Property, Plant, and Equipment Other AssetsTotal Assets

$ 93,61712,514

210,391 692,375$ 1,008,897

Liabilities Accounts Payable Notes Payable Other Liabilities Total LiabilitiesStockholders’ Equity Contributed Capital Retained Earnings Total Stockholders’ EquityTotal Liabilities and Stockholders’ Equity

$ 149,72295,589

122,822 368,133

314,382 326,382 640,764$ 1,008,897

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E1-6 Preparing an Income Statement and Inferring Missing ValuesCinemark Holdings, Inc. operates movies and food concession counters throughout the United States. Its income statement for the quarter ended March 31, 2011, reported the following amounts (listed alphabetically in thousands):

Required:1. Solve for the missing amounts and prepare an Income

Statement for the quarter ended March 31, 2011. 2. What are Cinemark’s main source of revenue and two biggest

expenses?

Net IncomeOther ExpensesOther RevenuesRent ExpenseTotal Expenses

Admissions RevenuesConcessions ExpensesConcessions RevenuesFilm Rental ExpensesGen. & Admin. Expenses

$ 311,69223,282

146,681165,153179,047

$ ? 24,265

24,76366,426

?

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Cinemark Holdings, Inc.Income Statement

For the Quarter Ended March 31, 2011(in thousands)

RevenuesAdmissions RevenuesConcessions RevenuesOther RevenuesTotal Revenues

ExpensesConcessions ExpensesFilm Rental ExpensesGen. and Admin. ExpensesRent ExpenseOther ExpensesTotal ExpensesNet Income

$ 311,692146,681

24,763

23,282165,153179,04766,426

24,265

$ 483,136

458,173$ 24,963

E1-6 Preparing an Income Statement and Inferring Missing Values

?

?

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Cinemark Holdings, Inc.Income Statement

For the Quarter Ended March 31, 2011(in thousands)

RevenuesAdmissions RevenuesConcessions RevenuesOther RevenuesTotal Revenues

ExpensesConcessions ExpensesFilm Rental ExpensesGen. and Admin. ExpensesRent ExpenseOther ExpensesTotal ExpensesNet Income

$ 311,692146,681

24,763

23,282165,153179,04766,426

24,265

$ 483,136

458,173$ 24,963

E1-6 Preparing an Income Statement and Inferring Missing Values

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E1-8 Inferring Values Using the Income Statement and Balance Sheet EquationsReview the chapter explanations of the income statement and the balance sheet equations. Apply these equations in each of the following independent cases to compute the two missing amounts for each case. Assume that it is the end of the first full year of operations for the company.

TIP: First identify the numerical relations among the columns using the balance sheet and income statement equations. Then compute the missing amounts.

D

Independent Cases

Total Revenues

Total Expenses

Net Income (Loss)

Total Assets

Total Liabilities


E

C

B

A $110,000

80,000

50,000

81,000

86,000

80,000

$82,000

(6,000)

20,000

12,000

104,000

112,000

$150,000

73,000

22,000

26,000

$70,000

28,000

77,000

70,000

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E1-8 Inferring Values Using the Income Statement and Balance Sheet Equations

R – E = NI A = L + SE

D

Independent Cases

Total Revenues

Total Expenses

Net Income (Loss)

Total Assets

Total Liabilities


E

C

B

A $110,000

92,000

80,000

50,000

75,000 81,000

30,000

86,000

80,000

$82,000

(6,000)

20,000

(6,000)

12,000

$28,000

101,000

99,000

104,000

112,000

$150,000

73,000

22,000

26,000

42,000

$70,000

28,000

77,000

78,000

70,000

$80,000

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S1-6 (Req. 1) Critical Thinking: Developing a Balance SheetOn September 30, Ashley and Jason started arguing about who is better off. Jason said he was better off because he owned a PlayStation console that he bought last year for $250. He figures that, if needed, he could sell it to a friend for $180. Ashley argued that she was better off because she had $1,000 cash in her bank account and a piece of art that she bought two years ago for $800 but could now sell for $1,400. Jason countered that Ashley still owed $250 on her car loan and that Jason’s dad promised to buy him a Porsche if he does really well in his accounting class. Jason said he had $6,000 cash in his bank account right now because he just received a $4,800 student loan. Ashley knows that Jason also owes a tuition installment of $800 for this term.Required:1. Prepare a financial report that compares what Ashley and Jason

each own and owe on September 30. Make a list of any decisions you had to make when preparing your report.

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What is owned

What is owed

“Net worth”

Cash

Car loan

Ashley Jason

$1,000 $6,000ConsoleArtTOTAL

Tuition PayableStudent Loan

-0- 800$1,800

TOTAL

$ 250 -0-

-0- 250 1,550

250 -0-$6,250

$ -0- 800

4,800 5,600 650

TOTAL $1,800 $6,250

ASSETS

LIABILITIES

EQUITY

Balance SheetS1-6 (Req. 1) Critical Thinking: Developing a Balance Sheet

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End of Chapter 1

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Chapter 1