Financial Management Summary
Chapter 1 – Introduction to Accounting and Business
1.1 Nature of Business and Accounting
A business is an organization in which basic resources such as material and labor are assembled and
processed to provide goods or services. Objective > earn profit: received amount – paid amount
There are 3 types of business:
• Service business > provides services rather than products (KLM)
• Merchandising business > sell products they purchase from the other businesses to
customers (Walmart)
• Manufacturing businesses > change basic into products that are sold to customers (Dell Inc.)
Accounting can be defined as an information system that provides reports to users about the
economics activities and conditions of a business.
The role of accounting in business is to provide information for users whether operating the
business or assessing the economic performance and condition of the business.
2 types of accounting:
1. Managerial Accounting / Management accounting > includes managers and employees,
directly involved in managing and operating the business, private accounting: information
about customers, prices and plans to expand the business
2. Financial Accounting > includes investors, creditors, customers and the government,
example General – purpose financial statements: balance sheet, income statement and
statement of cash flows
Ethics: are moral principles that guide the conduct of individuals. Are you doing the right or wrong
thing?
Two factors that affect why managers or companies acted wrong:
o Failure of Individual Character: Because of a lot of pressure managers and accountants are
justifying some small ethical violations to avoid pressure > financial problems become worse
o Culture of Greed and Ethical Indifference: Managers set the culture in a company >
indifference the truth
The measurement principle requires that amounts recorded in the financial statements be based on
independently verifiable evidence
To avoid these frauds > SOX (Sarbanes-Oxley Act) was established. They established PCAOB (Public
Company Accounting Oversight Board)
Opportunities for accountants:
Employed by external firms of accountants or individually > Public Accounting
Employed internally for companies, government or not-for-profit organisations > Private
Accounting
1.2 Generally Accepted Accounting Principles
2 important characteristics of financial information:
1. Relevant: information has the potential to impact decision making
2. Faithful representation: information accurately reflects an entity’s economic activity or
condition
,GAAP (Generally Accepted Accounting Principles) > collection of accounting standards, principles,
and assumptions that define how financial information will be reported.
• Accounting standards > Rules that determine the accounting policy – for example
depreciation policy
• Accounting principles > Provide the framework upon which accounting standards are
constructed
Assumptions
Financial accounting and GAAP are based upon the following assumptions:
• Monetary unit
• Time period
• Business entity
• Going concern
Principles
• Measurement
• Historical cost
• Revenue recognition
• Expense recognition
Forms of Business:
- Business entity assumption means that the entity is an individual economic unit for which
data are recorded, analyzed, and reported.
- For accounting purposes, the business entity should be considered separate from its owners
if the entity is a corporation, a partnership and a proprietorship
▪ Proprietorship
o Business that is owned by one individual
o Easy and inexpensive to organize
o Has employees
▪ Partnership
o Working together and they all take a direct share in the ownership
▪ Corporation
o The owners of a business are not directly owners of the assets of the business.
Instead they have a share in the total of those assets. That is why they are called
‘shareholders’ or ‘stockholders’
o Not responsible for the liabilities of the business
▪ (LLC) Limited liability company
o Combines partnership and corporation
o The partners are not personally responsible for the liabilities of the LLC
1.3 The Accounting Equation
Assets = Liabilities + Equity
Assets: the economic resources owned by a business
• Cash
• Accounts Receivable > Always to do with customers
• Land
• Buildings
• Equipment
, • Supplies
• Prepaid expense (Insurance)
• Buildings
• Patents
• Accumulated Depreciation-Equipment
Liabilities: the present obligations to pay cash, transfer assets, or provide services to
other entities
• Accounts Payable (A/P) > Always to do with creditors
• Unearned revenue/ rent > Fees earned
Stockholders’ Equity: the rights of owners > always with the shareholders
• Common stock
• Retained earnings
• Dividends
Owners’ Equity – equity owned by the owners of a proprietorship, partnership or limited liability
company
1.4 Business Transactions and the Accounting Equation
Business transactions: economic condition that changes an entity’s financial condition. For example,
purchasing land for $50,000.
Transactions:
A. Chris Clark deposit $25,000 in a bank in the name of Netsolutions (NS)
B. NS purchased and paid $20,000 for land
C. NS purchased supplies for $1,350 and will pay in the future
D. NS received cash $7,500 for customer service
E. Paid expenses: wages: $2,125; rent: $800; utilities: $450 and miscellaneous $275
F. NS paid creditors on account $950
G. Supplies at the end of the month was $550
H. Paid dividends $2,000
All transactions summarized:
Assets = Liabilities + Stockholders’ Equity
Cash + Supp + Land = A/P + Common – Dividends + Fees – Wages – Rent – Supplies – Utilities - Misc
stock Earned Exp Exp Exp exp exp
+25,000 (A) +25,000 (A)
-20,000 (B) +20,000 (B)
+1,350 (C) +1,350 (C)
+7,500 (D) +7500 (D)
-3,650 (E) -2,125 (E) -800 (E) -450 (E) -275 (E)
-950 (F) -950 (F)
-800 (G) -800 (G)
-2000 (H) -2000 (H)
5,900 550 20,000 400 25,000 -2,000 7,500 -2,125 -800 -800 -450 -275
26,450 26,450
Notes
For G = 1,350 – 550 = 800
There are different types of revenue:
