ACCOUNTING
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CHARAK RAYACCOUNTING
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CHARAK RAYAccounting: The Language
of Business
CHARAK RAY
libra.charak@gmail.com
Learning Objectives
After studying this chapter, you should be
able to:
Explain how accounting information assists in
making decisions.
Describe the components of the balance
sheet.
Analyze business transactions and relate them
to changes in the balance sheet.
Compare features of proprietorships,
partnerships, and corporations.
Introduction
Accounting - a process of identifying,
recording, summarizing, and reporting
economic information to decision makers
in the form of financial statements
Financial accounting - focuses on the
specific needs of decision makers external
to the organization, such as stockholders,
suppliers, banks, and government agencies
The Nature of
Accounting
The accounting system is a series of
steps performed to analyze, record,
quantify, accumulate, summarize,
classify, report, and interpret
economic events and their effects on
an organization and to prepare the
financial statements.
The Nature of
Accounting
Accounting systems are designed to
meet the needs of the decisions makers
who use the financial information.
Every business has some sort of
accounting system.
These accounting systems may be very
complex or very simple, but the real value
of any accounting system lies in the
information that the system provides.
Accounting as an Aid to
Decision Making
Accounting information is useful to
anyone who makes decisions that have
economic results.
• Managers want to know if a new product will be
profitable.
• Owners want to know which employees are
productive.
• Investors want to know if a company is a good
investment.
• Creditors want to know if they should extend credit,
how much to extend, and for how long.
• Government regulators want to know if financial
statements conform to requirements.
Accounting as an Aid to
Decision Making
Fundamental relationships in the
decision-making process:
Accountant’s
Financial
Event analysis & Users
Statements
recording
Financial and
Management Accounting
The major distinction between financial
and management accounting is the
users of the information.
Financial accounting serves external users.
Management accounting serves internal
users, such as top executives, management,
and administrators within
organizations.
Financial and
Management Accounting
The primary questions about an
organization’s success that decision
makers want to know are:
What is the financial picture of the
organization on a given day?
How well did the organization do during a
given period?
Financial and
Management Accounting
Accountants answer these primary questions
with three major financial statements.
Balance Sheet - financial picture on a given
day
Income Statement - performance over a given
period
Statement of Cash Flows - performance over
a given period
Financial and
Management Accounting
Annual report - a document prepared
by management and distributed to
current and potential investors to
inform them about the company’s past
performance and future prospects.
The annual report is one of the most
common sources of financial information
used by investors and managers.
Financial and
Management Accounting
The annual report usually includes:
a letter from corporate management
a discussion and analysis of recent
economic events by management
footnotes that explain many elements of the
financial statements in more detail
the report of the independent auditors
a statement of management’s responsibility
for preparation of the financial statements
other corporate information
The Balance Sheet
What are the different sections
of the Balance Sheet?
The Balance Sheet
Sections of the balance sheet:
Assets - resources of the firm that are expected
to increase or cause future cash flows
(everything the firm owns)
Liabilities - obligations of the firm to outsiders
or claims against its assets by outsiders (debts
of the firm)
Owners’ Equity - the residual interest in, or
remaining claims against, the firm’s assets
after deducting liabilities (rights of the owners)
The Balance Sheet
The balance sheet equation:
Assets = Liabilities + Owners’
Equity
or
Owners’ Equity = Assets -
Liabilities
The Balance Sheet
HAMILTON COMPANY
Balance Sheet
December 31, 1997
Assets Liabilities
Current assets: Current liabilities:
Cash $ 4,525 Accounts payable $
9,800
Accounts receivable 2,040 Wages payable
3,765
Total current assets $ 6,565 Total liabilities
$13,565
Plant assets:
Land $ 9,755
Equipment 6,500 Owners’ Equity
Total plant assets 16,255 Hamilton, capital
9,255
Total liabilities and
Total assets $22,820 Owners’ equity $22,820
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Balance Sheet
Transactions
The balance sheet is affected by every
transaction that an entity encounters.
Each transaction has counterbalancing
entries that keep total assets equal to
total liabilities and owners’ equity, i.e.,
the balance sheet equation must
always be balanced.
Balance Sheet
Transactions
Just as the balance sheet equation must
always balance, the balance sheet
must also always balance.
A balance sheet could be prepared after
every transaction, but this practice
would be awkward and unnecessary.
Therefore, balance sheets are usually
prepared monthly or on some other
periodic schedule.
Transaction Analysis
Transactions are recorded in
accounts, which are summary
records of the changes in particular
assets, liabilities, or owners’ equity.
The account balance is the total of
all entries to the account.
Transaction Analysis
For each transaction, the accountant
must determine:
which specific accounts are affected
whether the account balances are
increased or decreased
the amount of the change
in each account
Types of Ownership
Three basic forms of ownership:
Sole proprietorships
Partnerships
Corporations
Types of Ownership
Sole Proprietorship
A separate organization with a single
owner
Tend to be small retail establishments and
individual professional or service business
- for example, a single dentist, attorney, or
public accountant
The sole proprietorship is an individual
entity that is separate and distinct from
the owner.
Types of Ownership
Partnership
An organization that joins two or more
individuals who act as co-owners
Dentists, doctors, attorneys, and accountants
tend to conduct their activities as partnerships.
Some can be large international firms.
The partnership is an individual entity that is
separate and distinct from each of the
partners.
Types of Ownership
Corporation
An “artificial entity” created under state
laws
Corporations have limited liability -
corporate creditors have claims against
corporate assets only.
Individual investors are at risk only up to the
amount they have invested in the
corporation. Creditors cannot hold investors
liable for the corporation’s debts.
Types of Ownership
Corporation
Owners are called shareholders or
stockholders.
Publicly owned vs. privately owned
corporations
Public - Shares in the ownership are sold to the
public on a stock exchange; the corporation can
have many thousands of shareholders.
Private - Shares in the ownership are owned by
families, small groups of shareholders, and shares
are not sold to the public.
Types of Ownership
Management by the owners:
Sole proprietorship - The owner is an active
manager in day-to-day operation of the
business.
Partnership - Partners are usually active
managers in day-to-day operations of the
business.
Corporation - Shareholders usually do not
participate in the day-to-day operations of the
business.
Disadvantages of Forms
of Ownership
Corporations
Advantages
limited liability
easy transfer of ownership - shares of stock
can be bought and sold easily (stock
exchanges)
ease of raising ownership capital - many
potential stockholders
continuity of existence - life of the corporation
continues even if its ownership changes
Disadvantages of Forms
of Ownership
Corporations
Disadvantages
possibility of double taxation -
corporation pays tax at the entity level
and its owners pay taxes on
distributions of earnings to them
Disadvantages of Forms
of Ownership
Proprietorships and Partnerships
Advantages
no taxation at the entity level - income
of sole proprietorship and partnership
is attributed to the owners as individual
taxpayers
Disadvantages of Forms
of Ownership
Proprietorships and Partnerships
Disadvantages
unlimited liability - creditors of the business can
look to the owners’ personal assets for repayment
not easy to transfer ownership
not easy to raise ownership capital - few, if any
individuals interested in a particular proprietorship
or partnership
no continuity of existence - changes in ownership
terminate the proprietorship or partnership
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