Introduction to Accounting and Business

• An information system providing reports on a business's economic activities and condition is the definition of accounting.
• Accounting helps managers, investors, creditors, and regulators make informed decisions.
• Key stakeholders using accounting information include managers for strategic decisions, investors and creditors to evaluate financial health, and government agencies (SEC, IRS) for regulatory compliance.

Nature of Business

• A business is an entity that combines resources (inputs, like materials and labor) to deliver goods or services (outputs) to customers.
• Profit is the difference between a business's revenues and its expenses.

Types of Businesses

• Service businesses provide services rather than products (Southwest Airlines, law firms)
• Retail Businesses sell products purchased from suppliers (Walmart, Starbucks).
• Manufacturing businesses transform raw materials into finished goods (Ford Motor Company).

Generally Accepted Accounting Principles (GAAP)

• GAAP consists of accounting standards, principles, and assumptions governing financial reporting.
• The Financial Accounting Standards Board (FASB) develops accounting standards in the U.S.
• The Securities and Exchange Commission (SEC) oversees financial disclosures of publicly traded companies.
• The International Accounting Standards Board (IASB) establishes standards for international financial reporting.

Characteristics of Financial Information

• Relevance means the information is useful for decision-making.
• Faithful representation means the information is accurate and truthful.

Enhancing Qualities

• Comparability is consistency in reporting.
• Verifiability confirms reported information.
• Timeliness means reports are available when needed.
• Understandability requires clear presentation for users.

Assumptions in Accounting

• The monetary unit assumption says transactions are recorded in a single currency.
• The period assumption means business activities are reported over standard periods (months, years).
• The business entity assumption states the business is separate from its owners.
• The going concern assumption means the business will continue operating indefinitely.

Key Accounting Principles

• The measurement principle says transactions are recorded based on actual, verifiable amounts.
• The historical cost principle states assets are recorded at their purchase price.
• The revenue recognition principle mentions revenue is recorded when earned, not necessarily when received.
• The expense recognition (matching) principle means expenses are recorded in the same period as related revenues.

Forms of Business Ownership

• A sole proprietorship has one owner and unlimited liability.
• A partnership has two or more owners and shared liability.
• A corporation is a separate legal entity with limited liability and the ability to issue stock.
• A limited liability company (LLC) is a hybrid structure offering liability protection with partnership flexibility.

The Accounting Equation

• Assets = Liabilities + Owner's Equity
• Assets are resources owned by the business.
• Liabilities are debts or obligations.
• Owner's equity is the owner's claim to assets after liabilities are paid.

Examples

• Business assets are cash, equipment, inventory, while personal assets are cash, home, and car.
• Business liabilities are loans and accounts payable, while personal liabilities are mortgages and student loans.

Business Transactions and Their Impact on the Accounting Equation

• Transaction A: Owner invests $25,000, which increases cash (asset) and owner's equity.
• Transaction B: Purchase of land increases land (asset) and decreases cash (asset).
• Transaction C: Purchasing supplies on credit increases supplies (asset) and accounts payable (liability).
• Transaction D: Earning revenue increases cash (asset) and fees earned (revenue, affecting owner's equity).
• Transaction E: Payment of expenses decreases cash and owner's equity.
• Transaction F: Payment of accounts payable decreases cash and liabilities.
• Transaction G: Supplies used (converted into expenses) decreases owner's equity.
• Transaction H: Owner withdraws cash, which decreases cash and owner's equity.

Financial Statements

Income Statement

• Reports revenues and expenses.
• Shows net income (profit) or net loss.

Statement of Owner's Equity

• Reports changes in owner's equity over a period.
• Includes net income and withdrawals by the owner.

Balance Sheet

• Reports a business's financial position at a specific point in time.
• Lists assets, liabilities, and owner's equity.

Statement of Cash Flows

• Summarizes cash transactions related to operating activities (day-to-day business operations), investing activities (buying/selling assets), and financing activities (owner investments, loans, and withdrawals).

Analyzing Financial Condition: Ratio of Liabilities to Owner's Equity

• Formula: Total Liabilities / Total Owners' (Stockholders') Equity
• Purpose: Evaluates financial risk.
• Example: If liabilities are $50,000 and owner's equity is $100,000, the ratio = (lower ratio indicates lower risk).

Key Takeaways

• Accounting provides critical information for decision-making.
• Businesses can be structured as sole proprietorships, partnerships, corporations, or LLCs.
• GAAP ensures financial information is reliable and consistent.
• Financial statements interconnect to provide a complete financial picture.
• The accounting equation serves as the foundation for recording transactions.
• Ethical considerations in accounting help maintain trust in financial reporting.