Accounting Fundamentals

Dr. Yan Xiong

Department of Accountancy
CSU Sacramento
The lecture notes are primarily based on Reimers
(2003).
7/11/03
Chapter 1 Business Processes
Agenda
 Purpose of a Business and Types of
Businesses
 Ownership Structure of Businesses
 Business Processes
 The Accounting Equation
 Four Basic Financial Statements
 “ Accounting is process, process,
process”

Daniel O’ Leary
Accounting Professor and Author
University of Southern California
Purpose of a Business
Simple Model of a Business
“The Firm”

INPUTS Value OUTPUTS

added
(Give) conversion (Get)

Acquisition/Payment Cycle Sales/Collection Cycle

Capital (financing)
Property, Plant, Equipment Delivery of
Raw Materials Product or Service
Labor
Inventory
Goods & Services
What are Business Processes?
 Series of activities that a company
performs to achieve its goals.
 ACQUISITION / PAYMENT: acquire,
maintain, and pay for the resources
needed by the organization.
 CONVERSION: convert the resources
acquired into goods and/or services.
 SALES / COLLECTIONS: sell and
deliver goods and/or services to
customers and to collect payment.
 Types of Businesses
 Service company
 provides a service for customers
 Sales company
 Special case: financial services
 Merchandising--buys goods and resells them to
other businesses (wholesale) or to final
customers (retail)
 Manufacturing--makes a product and sells it to
other businesses (wholesale) or to final
consumers (retail)
 Examples:
 Service
 accountants, attorneys, physicians
 Financial Service
 Citicorp, Merrill Lynch, American
Express
 Merchandising
 Wal-Mart, Safeway, The Gap
 Manufacturing
 General Motors, 3M, Reynolds Metals
[Obviously, some businesses provide more than one of the
functions listed above]
Ownership Structure of Businesses
Sole Proprietorship--a single owner
business

Partnership--a multiple-owner business

Corporation--a business whose ownership

is divided into "shares" and may
be owned by a large number of people
Corporations
 A corporation is a popular form of
business because . . .
 It is simple for individuals to
purchase small amounts of stock.
 It allows for an easy transfer of
ownership through established
markets, like the New York Stock
Exchange.
 It provides stockholders with
limited liability.
Corporations
 Because a corporation is a separate legal
entity, it can . . .
 Own assets.
 Incur liabilities.
 Sue and be sued.
 Enter into contracts independent of the
stockholder owners.
 Many Americans own stock through a mutual
fund or pension program.
Characteristics of Different Forms of
Business Organization
Issues in deciding between sole proprietorship,
partnership, or corporation

 Personal liability
 Taxation

 Transfer of ownership

 Ability to raise capital

 Government regulation
What Do All Business have in Common?

 No matter what the

ownership structure of a
business, they all have at
least two main business
processes:

 Acquisition/Payment
 Sales/Collection
Acquisition/payment process
Activity Possible Document(s)

Identify need for Purchase Requisition

good/services
Identify vendor
Order Purchase Order
goods/services
Receive and Receiving Report
Inspect Goods
Pay for Goods Check Requisition
and/or Services
Check
 Sales/collection process
 Customer places an order (Customer order)
 Customer’s credit is approved

 Warehouse selects goods for shipment

(Picking slip)
 Goods are shipped (Packing slip and Shipping
notice)
 Customer is billed for goods (Invoice)
 Payment for goods is received (Check)
 Business Transactions
 Business transactions are exchanges.
 The two transactions that make up an

“exchange” are the GIVE part and the GET

part.
 The exchange occurs between the

business entity and a person or business

external to the entity.
 The business gives something and then

gets something in return.

Resources, Events, and Agents
 We can model an exchange with these three
components:
 the resources are the things being exchanged
(goods or services for money)
 the event describes the business action (e.g.
cash disbursement, sale, etc.)
 the agents are the people involved in the
exchange (e.g., the customer)
Acquisition and Payment for T-shirts
Cash Resource
GIVE Cash Resource
Cash
Disbursement
EVENT
Tom’s T-shirt

Wear Company

AGENT AGENT

EVENT

T-shirt Resource
Purchase T-shirt Resource

GET
Acquisition and Payment for a Service
Cash Resource
GIVE Cash Resource
Cash
Disbursement
EVENT
Tom’s Advertising
Company
Wear

AGENT AGENT

EVENT

Purchase Advertisement
Advertisement
Resource Resource
GET
 Sales and Collections
T-shirt Resource
GIVE T-shirt Resource
Sale

EVENT Customer
Tom’s
Wear

AGENT AGENT

EVENT
Cash
Cash Resource
Cash Resource Collection
GET
 Who needs accounting information?
A) Management
B) Those with direct financial interest
 Current or potential investors
 Current or potential creditors
C) Those with an indirect financial interest
 Tax Authorities
 Regulatory Agencies
 Economic Planners
 Labor unions, financial advisors, others.
D) Employees
 Financial Accounting Information
Information related to: Various views of the data:

Sales Financial data for

external reports
The
Purchases Company’s
Product
Information
information
Collections System

Customer and
Payments
vendor information
The Accounting Equation

Assets = Claims
Assets = Liabilities + Equity

Asset: something of value

Liability: something owed (creditors’ share
of the assets)
Equity: what remains (owner’s share of the
assets)
 Equity: The Owner’s Share
 There are two sources of equity
 equity “contributed” by owners
 equity “earned” by operations

 Expanded accounting equation:

CONTRIBUTED RETAINED
ASSETS = LIABILITIES + CAPITAL
+ EARNINGS
 Equity: The Owner’s Share
Expanded accounting equation:
CONTRIBUTED RETAINED
ASSETS = LIABILITIES + CAPITAL
+ EARNINGS

Together, these are called Shareholders’ Equity,

Stockholders’ Equity, or Owners’ Equity. They are
all names for the same thing--the owners’ claims to
the firm’s assets.
 Four Basic Financial Statements
Balance Sheet
Assets = Liabilities + Equity
Income Statement
Revenues - Expenses = Net income
Statement of Changes in Owner’s Equity
Beginning equity + Contributions + Net income
- Distributions = Ending equity
Statement of Cash Flows
Cash inflow - Cash outflow = Net cash flow
 Dates of Financial Statements
are Important!
 Balance sheet is “AS OF…” or “AT” a
particular date, sometimes called a “snapshot” in
time.
 Income statement
 Statement of changes in owner’s equity

 Statement of cash flows

 These last three cover a period of time,

and thus are “FOR THE PERIOD
ENDING”
Acquiring Financing for a Business
Date Transactions
Jan. 1  Tom contributes $5,000 of

his own money to the

business.
Assets = Liabilities + Owner’s Equity
Contributed Capital + Retained Earnings

+5,000 cash +5,000 common stock

Acquiring Financing for a Business
Date Transactions
Jan. 1  Tom’s Wear borrows $500

from Tom’s mom.

Assets = Liabilities + CC + Retained Earnings

+500 cash + 500 N/P

Acquiring Financing for a Business
Transactions
Date  Tom contributes $5,000 of his

Jan. 1 own money to start the

business.
 Tom’s Wear borrows $500

from Tom’s mom.

Assets = Liabilities + CC + Retained Earnings
+5,000 cash +5,000 common stock
+500 cash + 500 N/P
Acquiring Inventory
Date Transactions
 Tom’s Wear buys 100 T-shirts
Jan. 5
for $400 cash.
Acquiring Inventory
Date Transactions
 Tom’s Wear buys 100 T-shirts
Jan. 5
for $400 cash.

Assets = Liabilities + CC + RE

(400) cash
+400 inventory
Acquiring a Service
Date Transactions
 Tom’s Wear pays $50 for
Jan. 10
advertising.

Assets = Liabilities + CC + RE

(50) cash (50) expenses

Sales and Collection
Date Transactions
 Tom’s Wear sells 90 of the T-
Jan. 20
shirts to friends for cash, $10
each.
Sales and Collection
Date Transactions
 Tom’s Wear sells 90 of the T-
Jan. 20
shirts to friends for cash, $10
each.
Assets = Liabilities + CC + RE

+900 cash +900 revenue

What else happens along with the sale? An
expense…the cost of the goods sold.

Date Transactions
 Tom’s Wear sells 90 of the T-
Jan. 20
shirts to friends for cash, $10
each.
Assets = Liabilities + CC + RE

+900 cash +900 revenue

(360) inventory (360) expense

90 shirts x $4 each Special expense called

cost of goods sold
Payment for the acquired financing

Date Transactions
 Tom’s Wear repays the debt of
Jan. 30
$500 plus $5 interest.
Payment for the acquired financing
Date Transactions
 Tom’s Wear repays the debt of
Jan. 30
$500 plus $5 interest.
Assets = Liabilities + CC + RE

(505) cash (500) N/P

Payment for the acquired financing
Date Transactions
 Tom’s Wear repays the debt of
Jan. 30
$500 plus $5 interest.
Assets = Liabilities + CC + RE

(505) cash (500) N/P (5) expense

Interest expense
Payment for the acquired financing

Date Transactions
 Tom’s Wear pays a dividend
Jan. 31
to Tom, the owner, for $100.
Payment for the acquired financing

Date Transactions
 Tom’s Wear pays a dividend
Jan. 31
of $100.

Assets = Liabilities + CC + RE
(100) cash (100)dividends
Payment for the acquired financing

 Tom’s Wear pays a dividend of $100. =

Tom’s Wear makes a distribution to Tom,

the owner, for $100.

In a corporation, a distribution to the

owners is called a dividend.

Assets = Liabilities + CC + RE

(100) cash (100) dividend

 Assets = Liabilities + Equity
1. +5,000 cash +$5,000 common stk.
2. +500 cash + 500 notes payable
3. -400 cash
+400 inv.
4. -50 cash - 50 expense
5. +900 cash + 900 revenue
-360 inventory - 360 CGS
6. -505 cash -500 notes payable - 5 interest exp.
7, -100 cash - 100 dividend

5,385 0 5,385
 Tom’s Wear, Inc.
Income Statement
For the month ended January 31, 2001

REVENUE

- EXPENSES

NET INCOME
 Assets = Liabilities + Equity
1. +5,000 cash +$5,000 common stk.
2. +500 cash + 500 notes payable
3. -400 cash These are the revenues
+400 inv. and expenses:
4. -50 cash - 50 expense
5. +900 cash + 900 revenue
-360 inventory - 360 CGS
6. -505 cash -500 notes payable - 5 interest exp.
7, -100 cash - 100 dividends

5,385 0 5,385
 Assets = Liabilities + Equity
1. +5,000 cash +$5,000 common stk.
2. +500 cash + 500 notes payable
3. -400 cash Net
+400 inv. Income
4. -50 cash = - 50 expense
5. +900 cash $485 + 900 revenue
-360 inventory - 360 CGS
6. -505 cash -500 notes payable - 5 interest exp.
7, -100 cash - 100 dividends

5,385 0 5,385
 Tom’s Wear, Inc.
Income Statement
For the Month Ended Jan. 31, 2001
Revenue
Sales $900
Expenses
Cost of sales 360
Advertising 50
Interest 5
Total expenses 415
Net income $485
 Tom’s Wear, Inc.
Statement of Changes in Owner’s Equity
For the month ended Jan. 31, 2001
Beginning CC $ 0
Common stock issued 5,000
Total Contributed Capital $ 5,000

Beginning RE $ 0
Net income
Dividends
Ending RE

Total Owners’ Equity

 Tom’s Wear, Inc.
Statement of Changes in Owner’s Equity
For the month ended Jan. 31, 2001
Beginning CC $ 0
Common stock issued 5,000
Total Contributed Capital $ 5,000

Beginning RE $ 0
Net income 485
Dividends (100)
Ending RE $ 385

Total Owners’ Equity $5,385

 Assets = Liabilities + Equity
1. +5,000 cash +$5,000 common stk.
2. +500 cash + 500 notes payable
3. -400 cash Net
+400 inv. Income
4. -50 cash = - 50 expense
5. +900 cash $485 + 900 revenue
-360 inventory - 360 CGS
6. -505 cash -500 notes payable - 5 interest exp.
7. -100 cash - 100 dividends

5,385 0 5,385
 Tom’s Wear
Balance Sheet
At Jan. 31,2001

Assets Liabilities + Shareholder’s Equity

 Tom’s Wear
Balance Sheet
At Jan. 31, 2001
Assets Liabilities + SHs Equity

Cash $ 5,345
Inventory $ 40

Total Assets $ 5,385

 Tom’s Wear
Balance Sheet
At Jan. 31, 2001
Assets Liabilities + Shareholder’s Equity

Cash $5,345 Note Payable -0-Inventory

40

Total Assets $5,385

 Tom’s Wear
Balance Sheet
At Jan. 31, 2001

Assets Liabilities + Shareholder’s Equity

Cash $5,345 Note payable -0-

Inventory $ 40
Common stock, T. Phillips $5,000
Total assets $ 5,385 Retained earnings 385

Total liabilities + $ 5,385

SH’s Equity
 Tom’s Wear, Inc.
Statement of Cash Flows
For the month ending Jan. 31, 2001

Cash from Operating Activities

Cash from Investing Activities

Cash from Financing Activities

 Assets = Liabilities + Equity
Look at every CASH transaction and classify it as
operating, investing, or financing.
1. +5,000 cash +$5,000 common stk.
2. +500 cash + 500 notes payable
3. -400 cash
Net
+400 inv.
Income
4. -50 cash = - 50 expense
5. +900 cash $485 + 900 revenue
-360 inventory - 360 CGS
6. -505 cash -500 notes payable - 5 interest exp.
7. -100 cash - 100 dividends

5,385 0 5,385
 Tom’s Wear, Inc.
Statement of Cash Flows
For the month ended Jan. 31,2001
Cash from operating activities
Cash from customers $ 900
Cash paid to vendor for T-shirts (400)
Cash paid for advertising (50)
Interest paid ( 5)
Total cash from operations $445
 Tom’s Wear, Inc.
Statement of Cash Flows
For the month ended Jan. 31, 2001

Cash from operating activities

Cash from customers $ 900
Cash paid to vendor for T-shirts (400)
Cash paid for advertising (50)
Cash paid for interest ( 5)

Total cash from operations $445

Cash from investing activities -0-
 Tom’s Wear, Inc.
Statement of Cash Flows
For the month ended Jan. 31, 2001

Cash from operating activities

Cash from customers $ 900
Cash paid to vendor for T-shirts (400)
Cash paid for advertising (50)
Cash paid for interest ( 5)

Total cash from operations $445

Cash from investing activities -0-
Cash from financing activities
 Tom’s Wear, Inc.
Statement of Cash Flows
For the month ended Jan. 31, 2001
Cash from operating activities
Cash from customers $ 900
Cash paid to vendor for T-shirts (400)
Cash paid for advertising (50)
Cash paid for interest ( 5)
Total cash from operations $445
Cash from investing activities -0-
Cash from financing activities
Owner’s contributions 5,000
Dividends (100)
Total Cash from Financing 4,900
 Tom’s Wear, Inc.
Statement of Cash Flows
For the month ended Jan. 31, 2001
Cash from operating activities
Cash from customers $ 900
Cash paid to vendor for T-shirts (400)
Cash paid for advertising (50)
Cash paid for interest (5)
Total cash from operations $445
Cash from investing activities -0-
Cash from financing activities
Owner’s contributions 5,000
Dividends (100)
Total Cash from Financing 4,900
Net Increase in Cash $ 5,345