Accounting 111ACCOUNTING 111Chapter 1 Accounting in Business Net Income is often linked to return. Return on assets (ROA) is stated in the Ratio form as income divided by assets invested. Return on Assets = Net IncomeAverageTotal AssetsHow do we decide among investment options?The answer depends on our Trade-Off between Return and Risk.What is risk?Risk is the uncertainty about the return we will earn. All business investments involve risks, but some investments involve more risks than others.The lower the risk of an investment, the lower our expected return.Example: US Treasury bonds and certificates of deposit.The higher risk implies higher, but less certain, returns.Example: Corporate bonds and stocks.The Trade-Off between return and risk is a normal part of business.To make better decisions, we use accounting information to asset both returns and risks.There are three major types of business activities:- Financing - Investing Planning is required.- Operating Planning involves defining organization’s ideas, goals, and actions.Financing activities: provide the means organizations use to pay for resources such as land, buildings, and equipment to carry out plans. Financial management involves planning how to obtain these resources and setting the right mix between owner and creditor financing. Investing activities are the acquiring and disposing of resources (Assets) that an organization uses to acquire and sell its products or services. Determining the amount and type of assets for operation is called assets management. Operating activities: involve using resources to research, develop purchase, produce, distribute, and market products and services. Strategic management is the process of determining the rightmix of operating activities for the type of organization, its plans, and its market. Financial accounting: governed by concepts and rules known as generally accepted accounting principles (GAAP).GAAP aims to make information in financial statements relevant and have faithful representation. Relevant information affects the decisions of its users.Expenses are the costs necessary to earn revenues. Expenses decrease equity.Examples: Costs of employee time, uses of supplies, advertising, utilities, and insurance services from others.Equity is the accumulated revenues and owner investments less the accumulates owner withdrawals and expenses since the company began.Business activities can be described in terms of transactions and events:- External transactions are exchanged of value between two entities, which yield changes in the accounting equation.- Internal transactions are exchanges within an entity, which may or may not affect the accounting equation.- Events refers to happenings that affect the accounting equations and are reliably measured. Events include business events such as changes in the market value of certainassets and liabilities and natural events such as floods and fires that destroy assets and create losses. o They do not include the signing of service of product contracts, which by themselves do not impact the accounting equation. Each transaction and event leaves the equation in balance and that assetsalways equal the sum of liabilities and equity.The four basic financial statements:- Income Statement- Statement of Owner’s Equity- Balance Sheet- Statement of Cash Flows.The income statement lists a company’s revenues and expenses along with the resulting net income or loss over a period due to earnings activities.All financial statements have identifying headings.- The heading of the income statement lists the company’s name, the name of the statement, and then describes the time period that is being covered.o Month, a quarter (3 months) or a year.The equation for the income statement is as follows:Revenues – Expenses = Net Income (Loss)If a company’s expenses exceed its revenues, there is a net loss for the period.The statement of owner’s equity explains changes in equity from net income (loss) and from owner withdrawals over the same period covered by the income statement.- The heading of the statement of owner’s equity lists the company’s name, the name of the statement, and then describes the time period that is being covered.Revenues increase equity, while expenses decrease equity.The net income (or loss) amount from the income statement is carried over as the net income amount on the statement of owner’s equity.Assumptions:The going-concern assumption means that accounting information reflects a presumption that the business will continue operating instead of being closed or sold.The time period assumption presumes that the life of a company can be divided into time periods, such as months and years, and that useful reports can be prepared for those periods.A business entity can take one of four legal forms:- Proprietorship- Partnership- Limited Liability Company (LLC)- CorporationThe business entity assumption means that a business is accounted for separately from other business entities, including its owner. The reason for this assumption is that separate information about each business is necessary for good decisions.The cost-benefit constraint prescribed that only information with benefits of disclosure greater than the costs of providing it need be disclosed.The accounting system reflects two basic aspects of a company:What it owns What it owesAssets are resources a company owns or controls =.Examples: cash, supplies, equipment, and land – where each carries expected benefits.The claims on a company’s assets, or what it owns, are separated into owner and nonownerclaims.Liabilities are what a company owes its nonowners (creditors) in future payments, products, orservices.Equity (also called net assets or residual equity) refers to the claims of its owner(s).Together, liabilities and equity are the sources of funds to acquire assets.The relations of assets, liabilities, and equity is reflected in the following accounting equation.Assets = Liabilities + [ Owner Capital – Owner Withdrawals + Revenue – Expenses](Equity)The accounting equation is used to record all transactions and events. It must be kept inbalance. Equity increases from owner investments and from revenues. It decreases from withdrawalsand expenses.Owner investments are inflows of resources such as cash and other net assets from ownercontributions, which increase equity.Owner Withdrawals are outflows of cash and