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.
Dividends paid to owners (stockholders)
Stockholders' equity is (1) increased by capital contributed by stockholders and by revenues earned
through operations and (2) decreased by expenses incurred in producing revenues. The payment of
cash or other assets to stockholders in the form of dividends also reduces stockholders' equity. Thus, if
the owners receive a cash dividend, the effect would be to reduce the retained earnings part of
stockholders' equity; the amount of dividends is not an expense but a distribution of income.
An ethical perspective: State university
James Stevens was taking an accounting course at State University. Also, he was
helping companies find accounting systems that would fit their information needs. He
advised one of his clients to acquire a software computer package that could record the
business transactions and prepare the financial statements. The licensing agreement
with the software company specified that the basic charge for one site was USD 4,000
and that USD 1,000 must be paid for each additional site where the software was used.
James was pleased that his recommendation to acquire the software was followed.
However, he was upset that management wanted him to install the software at eight
other sites in the company and did not intend to pay the extra USD 8,000 due the
software company. A member of management stated, "The software company will
never know the difference and, besides, everyone else seems to be pirating software. If
they do find out, we will pay the extra fee at that time. Our expenses are high enough
without paying these unnecessary costs". James believed he might lose this client if he
did not do as management instructed.
An accounting perspective: Uses of technology
Accountants and others can access the home pages of companies to find their annual
reports and other information, home pages of CPA firms to find employment
opportunities and services offered, and home pages of government agencies,
universities, and any other agency that has established a home page. By making on-
screen choices you can discover all kinds of interesting information about almost
anything. You can access libraries, even in foreign countries, newspapers, such as The
Wall Street Journal, and find addresses and phone numbers of anyone in the nation.
We have included some Internet Projects at the end of the chapters to give you some
experience at “surfing the net” for accounting applications.
| A. Summary of Transactions | |||||||||
| METRO COURIER, INC. Summary of Transactions Month of July 2010 | |||||||||
| Assets | -Liabilities+ | Stockholders' Equity | |||||||
| Transaction | Explanation | Cash | Accounts Receivable | Trucks | Office Equipment | Accounts Payable | Notes Payable + | Capital Stock | Retained Earnings |
| Beginning balances (Illustration 1.2) | $13,500 | $ -0- | $20,000 | $ 2,500 = | $ -0- | $ 6,000 + | $30,000 | $ -0- | |
| 1b | Earned service revenue and received cash | 4,800 | 4,800 (A) | ||||||
| $18,300 | $20,000 | $ 2,500 = | $ 6,000 + | $30,000 | $4,800 | ||||
| 2b | Earned service revenue on account | 900 | 900 (B) | ||||||
| $18,300 | $900 | $20,000 | $ 2,500 = | $ 6,000 + | $30,000 | $5,700 | |||
| 3b | Collected cash on account | 200 | -200 | ||||||
| $18,500 | $700 | $20,000 | $ 2,500 = | $ 6,000 + | $30,000 | $5,700 | |||
| 4b | Paid salaries | -2,600 | (2,600) (C) | ||||||
| $15,900 | $700 | $20,000 | $ 2,500 = | $ 6,000 + | $30,000 | $3,100 | |||
| 5b | Paid rent | -400 | (400) (D) | ||||||
| $15,500 | $700 | $20,000 | $ 2,500 = | $ 6,000 + | $30,000 | $2,700 | |||
| 6b | Received bill for gas and oil used | 600 | (600) (E) | ||||||
| End-of-month balances | $15,500 (F) | $ 700 (G) | $ 20,000 (H) | $ 2,500 = (I) | $ 600 (J) | $ 6,000 + (K) | $ 30,000 (L) | $ 2,100 (M) | |
| $38,700 | $6,600 | $32,100 | |||||||
| B. Balance Sheet |
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|---|---|---|---|
| METRO COURIER , INC. Balance Sheet 2010 July 31 |
|||
| Assets | Liabilities and Stockholder's Equity |
||
| Cash | (F) $15,500 | Liabilities: |
|
| Account receivables |
(G) 700 | Accounts payable | (J $600 |
| Trucks | (H) 20,000 | Notes payable | (K) 6,000 |
| Office equipment |
(I) 2,500 | Total liabilities | $6,600 |
| Stockholders equity: | |||
| Capital stock | (L) $30,000 | ||
| Retained earnings | (M) 2,100 |
||
| Total stockholders' equity | $32,100 | ||
| Total assets |
$38,700 |
Total liabilities and stockholders' equity | $38,700 |
| C. Income Statement |
||
|---|---|---|
| METRO COURIIER INC Income Statement For the Month Ended 2010 July 31 |
||
| Revenues: | ||
| Service revenue | ( A+B) $5,700 | |
| Expenses: | ||
| Salaries expense | (C) $2,600 |
|
| Rent expense | (D) 400 | |
| Gas and oil expense |
(F) 600 | |
| Total expenses | 3,600 | |
| Net income | $2,100 |
|