Introduction to Accounting

Understanding Financial Statements– A Basic Overview

Introduction to Accounting and A Conceptual Overview

The Business Environment

• Sole Proprietorships• Partnerships (general and limited)• Limited liability companies

All countries have three All countries have three basic forms of business basic forms of business

organization:organization:


• Oldest form of business organization.• Business income is accounted for on the owner’s

personal income tax form.

Sole Proprietorship -- A business form for which there is one owner. This single owner has unlimited liability for all debts of the firm.

Summary for Sole Proprietorship

Advantages

• Simplicity• Low setup cost• Quick setup• Single tax filing on

individual form

Disadvantages

– Unlimited liability– Hard to raise additional

capital– Transfer of ownership

difficulties


• Business income is accounted for on each partner’s personal income tax form.

Partnership -- A business form in which two or more individuals act as owners.

Types of Partnerships

Limited Partnership -- Limited partners have liability limited to their capital contribution (investors only). In some countries like USA, at least one general partner is required and all general partners have unlimited liability. In some other countries, like India, all partners can have limited liabilities.

General Partnership -- All partners have unlimited liability and are liable for all obligations of the partnership. Maximum Number of Partners can be 20 (India)

Summary for Partnership

Advantages• Can be simple• Low setup cost, higher

than sole proprietorship• Relatively quick setup• Limited liability for limited

partners

Disadvantages• Unlimited liability for the

general partner• Difficult to raise

additional capital, but easier than sole proprietorship

• Transfer of ownership difficulties


• An artificial entity that can own assets and incur liabilities.

• Business income Business income is accounted for on the income tax form of the corporationincome tax form of the corporation.

Corporation -- A business form legally separate from its owners.

Summary for Corporation

AdvantagesAdvantages• Limited liability• Easy transfer of ownership• Unlimited life• Easier to raise large

quantities of capital

DisadvantagesDisadvantages• Double taxation• More difficult to

establish • More expensive to set

up and maintain

Accounting as an Information System

• Today’s accountant focuses on the ultimate needs of decision makers who use accounting information, whether those decision makers are inside or outside the business.


• Accounting “is not an end in itself,” but is an information system that measures, processes, and communicates financial information about an identifiable economic entity.


• Accounting provides a vital service by supplying the information that decision makers need in order to make “reasoned choices among alternative uses of scarce resources in the conduct of business and economic activities.”


• Accounting is a link between business activities and decision makers.– Accounting measures business activities by

recording data about them for future use.

– The data are stored until needed and then processed to become useful information.


• The information is communicated, through reports, to decision makers.


• Data about business activities are the input to the accounting system and useful information for decision makers is the output.

1-1

Data Information

ACCOUNTING

BUSINESSACTIVITIES

DECISIONMAKERS

MEASUREMENT

Accomplishedby recording ofdata

PROCESSING

Accomplishedby storage andpreparation ofdata

Communication

Accomplishedby reporting

Accounting as an Information SystemAccounting as an Information System

Users of Financial Information

• Internal Users - managers plan, organize and run a business.

• External Users - – Investors– Creditors– Others

• Taxing authorities• Regulatory agencies• Customers• Labor unions• Economic planners

The Users of Accounting Information1-3

THOSE WITH INDIRECT FINANCIAL INTEREST

Tax Authorities Regulators Labor Unions Customers Economic Planners

Investors Creditors

THOSE WITH DIRECT FINANCIAL INTEREST

Finance Operations and

Production Marketing Human Resources Information Systems Accounting

MANAGEMENT

DECISION MAKERS

Questions Asked by Internal Users

• Is cash sufficient to pay bills?• What is the cost of manufacturing each

unit of product?• Can we afford to give employee pay

raises this year?• What product line is most profitable?

Questions Asked by External Users

• Is the company earning satisfactory income?

• How does the company compare in size and profitability with competitors?

• Will the company be able to pay its debts when they become due?

Business Goals, Activities, and Performance Measures

• A business is an economic unit that aims to sell goods and services to customers at prices that will provide an adequate return to its owners.

• Businesses, though different, have similar goals and engage in similar activities.

Business Goals1. Profitability - A business must take in

enough money to pay all the costs of doing business, with enough left over as profit for the owners to want to stay in business.

2. Liquidity - A business must have enough funds available to pay debts when they are due.

Business Goals and Activities1-2

BUSINESS GOALS BUSINESS ACTIVITIES

FINANCING OPERATING

INVESTING

PROFITABILITY

LIQUIDITY

Business Activities1. Financing Activities.

• Obtaining capital from owners and creditors.• Repaying creditors and paying a return to

owners.

2. Investing Activities.• Spending the capital it receives in ways that are

productive and will help the business achieve its objectives.

• Buying and selling resources to be used in the business.

Business Activities

3. Operating Activities.• Selling goods and services to customers.• Employing managers and workers,

buying and producing goods and services, and paying taxes.

3 Types of Business Activity

•Financing•Investing•Operating

Financing ActivitiesIt

Takes

MONEY to

Make

MONEY!

Two Ways of Outside Financing of a Corporation

• Borrowing money(Outside liabilities)

• Issuing shares ofstock in exchange for cash (Equity)

Basic Terms• Assets - resources owned by a business• Liabilities - debts and obligations of the

business - represents claims of creditors on the assets of the business

• Common stock - stock representing the primary ownership interest in a corporation

Investing Activities

• Cash• Accounts Receivable• Inventory• Buildings, Equipment, Furniture

Obtaining the Resources or Assets needed to operate the

businessExamples of assets...

Investing Activities - Examples

• Purchase or sale of computers, delivery trucks, furniture, buildings

• Purchase or sale of investments

What Are Revenues?

Revenues are the assets that result from sale of a product or service.

Examples of Revenues

Taxi Company - sells services

Theatre - sells services & products

Retail Store - sells products

Expenses are the costs of assets consumed or services used to generate revenues. Examples...

What Are Expenses?

• Cost of sales• Store operating expenses• General and administrative expenses• Interest expense

Examples of Expenses

• Taxi Company - fuel, maintenance, insurance

• Theatre - salaries, supplies, film rental, concessions to resale

• Retail Store - utilities, taxes, rent, supplies, salaries

Net IncomeNet Income is the excess of revenues over expenses.

Revenue Rs 10,000Expenses 3,000Net income Rs 7,000

Summary of Business Activities

Long Term Short Term Short Term Long Term Land, Buildings, Cash Banks Long-Term and Equipment Accounts Suppliers Creditors Contractual Receivable Employees Owners Rights Inventories Governments Stocks and Stocks and Bonds Bonds

Purchasing Production Marketing Administration

Goals andStrategies

FinancingInvesting

Operating

• Financial Statements– Income Statement– Statement of Retained Earnings– Balance Sheet– Statement of Cash Flows

• Management Discussion and Analysis• Notes to Financial Statements• Auditor's Report

Elements of an

Management Discussionand Analysis

Covers three aspects of a company: – liquidity - ability to pay near-term

obligations– capital resources - ability to fund

operations and expansions– results of operations

Notes to Financial Statements

• Provide additional information not included in body of statements

• Does not have to be numeric• Examples:

– Description of accounting policies or explanation of uncertainties and contingencies

– Statistics and voluminous details

Auditor's Report• Auditor, a professional accountant who conducts

an independent examination of the financial accounting data presented by a company.

• Auditor gives an unqualified opinion if the financial statements present the financial position, results of operations, and cash flows in accordance with GAAP.

Relation between Business Activities and Balance Sheet and Income Statement

Noncurrent Current Current Noncurrent Land, Buildings, Cash Notes Payable Bonds Payable and Equipment Accounts Accounts Common Stock Patents Receivable Payable Retained Earnings Investments Inventories Salaries in Securities Marketable Payable

Securities Income Taxes Payable

Assets Sales Revenue Liabilities and(Balance Sheet) Cost of Goods Sold Shareholders’ Equity

Selling Expense (Balance Sheet) Administrative Expenses Interest Expense Income Tax Expense

Net Income (Income Statement)

Goals andStrategies

FinancingInvesting

Operating

Documents

Introduction to Accounting