Chapter 1: Business Decisions and Financial Accounting
Chapter 1 Key Points
The Basic Business Activities
The Three Forms of Business Ownership
The Basic Accounting Equation
The Financial Statements – The Basic Components
The Relationship Between the Financial Statements
Sole Proprietorship – Business organizations owned by one person. The owner often is personally liable for business debts that cannot be paid. Personal assets may be affected.
Partnership – Business organizations owned by two or more people. Each partner often is personally liable for partnerships debts that cannot be paid. Personal assets are not affected.
Corporations – Operate a business separate from their owners. Owners of corporations (shareholders) are not personally responsible for debts of the corporation.
Accounting for business decisions:
Accounting is a system of analyzing, recording and summarizing the results of a business’s activities and then reporting the results to decision makers. There are several accounting designations in Canada including CA, CFE, CGA, CMA, and CIA.
Management accounting reports are used inside the company. They include detailed financial plans and reports about the operating performance of the organization.
Creditors, investors and others use financial accounting reports outside the company. These reports are the financial statements.
Business and Financing Activities Accounting System Accounting Reports [Financial – External users: evaluate the company] & [Managerial – Internal users: run the company]
Resources owned by the company = Resources owed to creditors and to shareholders
Assets = Liabilities + Shareholders’ Equity
Accounts accumulate and report the effects of each different business activity
Assets – Resources controlled by the company that have measureable value and are expected to provide future benefits to the company.
Liabilities – Amounts owed by business to creditors.
Shareholders’ Equity – Owners’ claims on the business resources. Contributed capital is the amount owners directly invested in the company in exchange for shares. Retained earnings are the amount the company has earned through profitable business operations.
Revenue – the amount earned by selling goods or services to customers
Expenses – the cost of doing business that is necessary to earn revenue
Revenue – Expenses = Net Income
It does not follow that Revenue equals cash, since it could be earned through a promise to receive payment. Likewise, Expenses does not mean cash has been expended, since it could be incurred through a promise to pay.
Dividends – the distribution of a company’s earnings to its shareholders as a return on their investment. Dividends are not an expense.
Retained earnings increase with net income (profit generated) and decrease with dividends (profit distributed)
Financial statements: Income statement, statement of retained earnings, balance sheet, statement of cash flows.
Income statement – reports the amount of revenues less expenses for a period of time.
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.
Balance sheet – Reports the amount of assets, liabilities, and shareholders’ equity of a business at a point in time.
Statement of cash flows – Reports the operating, investing, and financing activities that caused increases and decreases in cash during that period.
Relationships among the financial statements:
1. Net income, from the income statement, is a component in determining ending retained earnings on the statement of retained earnings.
2. Ending retained earnings from the statement of retained earnings is then reported on the balance sheet.
3. The cash on the balance sheet is