Accounting and Its Use in Business Decisions
In this chapter, you will learn why accounting is important to the business community. You will learn the different types of businesses and how daily transactions are posted and how they affect the financial statements. This chapter also demonstrates how to prepare the income statement, balance sheet, and statement of stockholders' equity. Pay close attention to the steps involved in the accounting cycle from beginning to end. This chapter will introduce you to the framework of the entire accounting process, which may also be called the accounting equation. The fundamental accounting equation is the basic equation that accountants use to record business transactions. The equation states "assets = liabilities + owners' equity". This section gives the direct and alternative identifications of these elements to help you speak the language of accounting. Assets are things that expect to have future value to the company. For example, if the company buys a new car, this car has future value to the company. Liabilities are promises to pay. Some companies may not have all of the money to pay cash for the car, so they will typically finance, or obtain credit for, and borrow the difference between the down payment and the final price of the car. If approved, the company now promises to pay back the bank or business entity who gave the company money. Owners' equity is the owners' claims on assets. This basically means that, as an owner of the company, you have a claim on the asset that is now identified as the new car the company owns.
Summary of balance sheet and income statement transactions
Part A of Exhibit 4 summarizes the effects of all the preceding transactions on the assets, liabilities, and stockholders' equity of Metro Courier, Inc., in July. The beginning balances are the ending balances in Part A of Exhibit 3. The summary shows subtotals after each transaction; these subtotals are optional and may be omitted. Note how the accounting equation remains in balance after each transaction and at the end of the month.
The ending balances in each of the columns in Part A of Exhibit 4 are the dollar amounts in Part B
and those reported earlier in the balance sheet in Part C of Exhibit 2. The itemized data in the Retained
Earnings column are the revenue and expense items in Part C of Exhibit 4 and those reported earlier in
the income statement in Part A of Exhibit 2. The beginning balance in the Retained Earnings column
(USD 0) plus net income for the month (USD 2,100) is equal to the ending balance in retained earnings
(USD 2,100) shown earlier in Part B of Exhibit 2. Remember that the financial statements are not an
end in themselves, but are prepared to assist users of those statements to make informed decisions.
Throughout the text we show how people use accounting information in decision making.