CHAPTER 1
BUSINESS DECISIONS AND FINANCIAL ACCOUNTING
Student Learning Objectives and Related Assignment Materials
Student Learning Objectives
Mini–
Exercises
Exercises
Coached
Problems
Problems
(Groups
A & B)
Skills
Development
Cases
Continuing
Case
LO1-1 Describe various
organizational forms
and business decision
makers.
2
1*, 2, 3
LO1-2 Describe the
purpose, structure, and
content of the four basic
financial statements.
2, 3, 4, 5,
6, 7, 8, 9,
10, 11,
12*, 13,
14, 15^,
16
1, 2, 3*,
4, 5, 6*,
7, 8*, 9,
10, 11,
12
1, 3
A1, A3,
B1, B3
1*, 2, 3, 4,
6, 7
1†
LO1-3 Explain how
financial statements are
used by decision
makers.
16
3*, 4, 6*,
9, 10
2, 4
A2, A4,
B2, B4
1*, 2, 3, 4,
6
1†
LO1-4 Describe factors
that contribute to useful
financial information.
1, 2, 3
4, 5, 6
* Animated solution included in the PowerPoint Slides.
^ Particularly challenging; requires students to combine multiple concepts in order to advance to the
next level of accounting knowledge.
† Continuing Case 1-1 introduces Nicole Mackisey, who is thinking of forming her own spa business,
Nicole’s Getaway Spa. This case focuses on preparing a (forecasted) income statement, statement of
retained earnings, and balance sheet for the business. The case will be extended in future chapters.
Overview
A real entrepreneur meets with his local CPA, who walks him through the decisions he must make when
planning his business.
Students discover the role of accounting, with an emphasis on financial statement reporting and use.
Synopsis of Chapter Revisions
• New contemporary focus company: replaced pizza company with SonicGateway—a private company
that develops game apps for smartphones and tablets
• New description of financial statement users, with new illustration (Exhibit 1.2)
• Revision to account names to match streamlined chart of accounts
• Updated IFRS map in Spotlight on the World
• Expanded discussion of conceptual framework, with new illustration (Exhibit 1.9)
• Updated demonstration case featuring Under Armour
• Reviewed and updated all end-of-chapter material, including new exercise and problem formats to
expand number of algorithmic online problems
PowerPoint Slides
Student Learning Objective
PowerPoint® Slides
LO1-1 Describe various organizational forms and business decision makers.
1-3 through 1-6
LO1-2 Describe the purpose, structure, and content of the four basic financial
statements.
1-7 through 1-22
LO1-3 Explain how financial statements are used by decision makers.
1-23 through 1-24
LO1-4 Describe factors that contribute to useful financial information.
1-25 through 1-28
LO1-S1 Accounting Careers
1-29 through 1-30
Animated Builds and Animated Solutions
PowerPoint® Slides
Mini-Exercise 1-12
1-32 through 1-33
Exercise 1-3
1-34 through 1-35
Exercise 1-6
1-36 through 1-38
Exercise 1-8
1-39 through 1-40
Skills Development Case 1-6 (Requirement 1)
1-41 through 1-42
Chapter Summary
LO 1-1 Describe various organizational forms and business decision makers.
• Sole proprietorships are owned by one individual, are relatively inexpensive to form, and are not
treated legally as separate from their owners. Thus, all profits or losses become part of the taxable
income to the owner, who is also responsible personally for all debts of the business.
• Partnerships are businesses similar legally to proprietorships, but with two or more owners.
• Corporations are separate legal entities (thus, corporations pay taxes) that issue shares of stock to
investors (stockholders) and are more costly to establish. Stockholders cannot be held liable for
more than their investment in the corporation. Private corporations issue stock to a few individuals
while public corporations issue stock in the stock market.
• Business decision makers include creditors (banks, suppliers), investors (stockholders), customers,
governments, and other external users.
LO 1-2 Describe the purpose, structure, and content of the four basic financial statements.
• The income statement reports the net amount that a business earned (net income) over a period of
time by subtracting the costs of running the business (expenses) from the total amount earned
(revenues).
• The statement of retained earnings explains changes in the Retained Earnings account over a
period of time by considering increases (from net income) and decreases (from dividends to
stockholders).
• The balance sheet reports what the business owns (reported as assets) at a particular point in time
and whether the financing for these assets came from creditors (reported as liabilities) or
stockholders (reported as stockholders’ equity).
• The statement of cash flows explains changes in the cash account over a period of time by
reporting inflows and outflows of cash from the business’s operating, investing, and financing
activities.
LO 1-3 Explain how financial statements are used by decision makers.
• Creditors are mainly interested in assessing whether the company (1) is generating enough cash to
make payments on its loan, and (2) has enough assets to cover its liabilities. Answers to these
questions are indicated by the statement of cash flows and the balance sheet.
• Investors look closely at the income statement for information about a company’s ability to
generate profits, and at the statement of retained earnings for information about a company’s
dividend distributions.
LO 1-4 Describe factors that contribute to useful financial information.
• Companies generate useful financial information by applying Generally Accepted Accounting
Principles (GAAP) or International Financial Reporting Standards (IFRS) in an ethical business
environment.
• To be useful, information must be relevant and a faithful representation of reality. Information is
more useful when it is comparable, verifiable, timely, and understandable.
Chapter Outline
Teaching Notes
Provide a learning strategy
Overview the textbook:
You Should Know
(marginal boxes)
Coach’s Tip (marginal
boxes)
Review the Chapter—
Demonstration Case
Chapter Summary
Key Terms
Highlight and demo the
student edition of the
textbook web site at
www.mhhe.com/phillips4e:
Practice Quizzes
Narrated slides
iPod Content
I. Understand the Business
LO 1-1 Describe various organizational forms and business decision makers.
A. Organizational Forms:
1. Sole proprietorship—A business owned (and usually
operated) by one individual.
2. Partnership—Similar to a sole proprietorship, except that
profits, taxes, and legal liability are the responsibility of
two or more owners instead of just one.
3. Corporation—A separate entity from both a legal and
accounting perspective. The corporation, not its owners,
is legally responsible for its own taxes and debts. Thus,
owners cannot lose more than their investment in the
corporation.
This textbook focuses on
corporations.
4. Other—Other organizational forms exist, such as a
limited liability company (LLC), which combines
characteristics of a partnership and a corporation.
B. Accounting for Business Decisions
1. Most companies exist to earn profits for their
stockholders; profits are earned by selling goods or
services to customers for more than they cost to produce.
2. Accounting—System of analyzing, recording, and
summarizing the results of a business’s activities and then
reporting the results to decision makers.
3. Business people talk about their companies using
accounting terms; accounting is the “language of
business.”
4. Every organization needs accountants to assist in
reporting financial information for decision making and
to help its owners understand the financial effects of those
business decisions.
Chapter Outline
Teaching Notes
5. The accounting system produces two kinds of reports:
a. Managerial accounting reports—Include detailed
financial plans and continually updated reports about
the financial performance of the company. These
reports are made available only to employees of the
company so that they can make business decisions.
b. Financial accounting reports—Called financial
statements:
i. Prepared periodically to provide information to
people not employed by the business.
ii. External financial statement users aren’t given
access to detailed internal records of the company,
so they rely extensively on the financial statements
6. Users of financial information:
Illustrated in Exhibit 1.2
a. Creditors—Suppliers, banks, and anyone to whom
money is owed.
b. Investors—Existing and potential future stockholders.
c. Directors—Members of a company’s board of
directors; elected by stockholders to oversee the
company’s managers.
c. Government agencies—Include the Securities and
Exchange Commission and Internal Revenue Service.
II. Study the Accounting Methods
LO 1-2 Describe the purpose, structure, and content of the four basic financial statements.
A. The Basic Accounting Equation
Assets = Liabilities + Stockholders’ Equity
Describe as “what a
company owns must equal
1. Separate entity assumption—The financial reports of a
business are assumed to include the results of only that
business’s activities.
what a company owes to its
creditors and stockholders.”
2. Asset—Economic resource presently controlled by the
company; it has measureable value and is expected to
benefit the company by producing cash inflows or
reducing cash outflows in the future.
To decide: Does company
own/have legal rights to it? If
yes, will it have benefit
beyond the end of the current
3. Liabilities—Measurable amounts that the company owes
to creditors.
month? If so, it’s an asset.
4. Stockholders’ Equity—Represents the owners’ claims on
the business; claims arise for two reasons:
a. First, the owners have a claim on amounts they
contributed directly to the business in exchange for its
stock (Common Stock).
b. Second, the owners have a claim on amounts the
company has earned through profitable business
operations (Retained Earnings).
Chapter Outline
Teaching Notes
c. Profits are generated when the total amount earned
from selling goods and services (revenues) is greater
than all the costs incurred to generate those sales
(expenses).
i. Revenues—Earned by selling goods or services to
customers.
ii. Expenses—All costs of doing business that are
necessary to earn revenues.
iii. Net Income (or profit)—Revenues minus expenses
(net loss if revenues are less than expenses); net
income increases stockholders’ equity.
iv. Dividends—Distribution of a company’s profits to
its stockholders; not an expense incurred to
generate earnings.
B. Financial Statements
✓ Supplemental Enrichment
1. Reports prepared at any time during year.
Activity (Activity) #1
a. Most commonly monthly, quarterly, and annually
using calendar year or fiscal year (a 12-month period
ending on a day other than December 31).
b. Each financial statement has a heading (name of
company, name of statement, and time period).
c. Each major caption has an underlined subtotal;
“bottom line” amount has a double underline.
d. A dollar sign appears at the top and bottom of each
column of numbers.
2. There are four basic financial statements:
Summarized in Exhibit 1.8
a. Income statement—Reports the amount of revenues
less expenses for a period of time.
i. Unit of measure assumption—Results of business
activities should be reported in an appropriate
monetary unit.
ii. Accounts—Accumulate and report the effects of
each different business activity.
iii. When listing the accounts on the income statement,
revenues are on top (largest, most relevant revenue
listed first), then expenses are subtracted, from
largest to smallest (except that Income Tax
Expense is the last expense listed).
Illustrated in Exhibit 1.3
Other income statement
formats are possible, as
explained in Chapter 6.
iv. Revenues – Expenses = Net Income (or Net Loss)
b. Statement of retained earnings—Reports the way
that net income and the distribution of dividends
affected the financial position during the period.
Illustrated in Exhibit 1.4
i. Retained earnings are profits that have
accumulated over a period of time.
ii. Beginning balance of retained earnings + Net
income (or – Net loss) – Dividends = Ending
balance of retained earnings
Chapter Outline
Teaching Notes
c. Balance sheet—Reports the amount of assets,
liabilities, and stockholders’ equity of a business at a
specific point in time; it “balances.”
Illustrated in Exhibit 1.5
✓ Activity #2
i. Assets = Liabilities + Stockholders’ equity
ii. Assets listed in order of how soon they are to be
used or converted into cash; liabilities in order of
how soon each is to be paid or settled.
d. Statement of cash flows—Reports the operating,
investing, and financing activities that caused
increases and decreases in cash during the period.
Illustrated in Exhibit 1.6
✓ Activity #3
i. Operating—Activities directly related to running
the business to earn profit.
ii. Investing—Activities involving buying and selling
productive resources with long lives, purchasing
investments, and lending to others.
iii. Financing—Any borrowing from banks, repaying
bank loans, receiving cash from stockholders for
company stock, or paying dividends to
stockholders.
e. Notes to the Financial Statements (footnotes)—Help
financial statement users understand how the amounts
were derived and what other information may affect
their decisions.
3. The four basic financial statements connect to one
another:
✓ Activity #4
a. Net income, from the income statement, is a
component in determining ending Retained Earnings
on the statement of retained earnings.
Illustrated in Exhibit 1.7
b. Ending Retained Earnings is then reported on the
balance sheet.
c. Cash on the balance sheet is equal to the ending Cash
reported on the statement of cash flows.
III. Evaluate the Results
LO 1-3 Explain how financial statements are used by decision makers.
A. Using Financial Statements
1. Creditors—Interested in assessing two things:
a. Is the company generating enough cash to make
payments on its loans? Answers come from statement
of cash flows.
b. Does the company have assets to cover its liabilities?
Answers come from comparing assets and liabilities
reported on the balance sheet.
Chapter Outline
Teaching Notes
2. Investors—Expect a return on their contribution to the
company:
a. Return may be immediate (through dividends) or long-
term (through selling stock certificates at a price
higher than their original cost).
b. Looks closely at the income statement (and statement
of retained earnings) for information about the
company’s ability to generate profits (and distribute
dividends).
LO 1-4 Describe factors that contribute to useful financial information.
B. Useful Financial Information
1. Generally Accepted Accounting Principles (GAAP)—
Rules of accounting created by the Financial Accounting
Standards Board for use in the United States.
a. Financial Accounting Standards Board (FASB)—
Currently has primary responsibility for setting the
underlying rules of accounting.
b. Accounting rules in U.S. are similar to those used
elsewhere, with some important differences; FASB
works alongside International Accounting Standards
Board (IASB) to eliminate differences.
2. Main goal of GAAP and IFRS is to ensure companies
produce financial information that is useful to existing
and potential investors, lenders, and other creditors in
making decisions about providing resources to the
companies.
3. For financial information to be judged useful, it must
possess two fundamental characteristics:
Illustrated in Exhibit 1.9
a. Relevance—Information makes a difference in
decision making.
b. Faithful representation—Information fully depicts the
economic substance of business activities.
4. Usefulness is enhanced when it is:
a. Timely—If it is available in time to influence decision
makers.
b. Verifiable—If others, such as external auditors, reach
similar values using similar methods.
c. Comparable—If the same accounting principles are
used over time and across companies.
d. Understandable—If reasonably informed users can
comprehend and interpret it.
Chapter Outline
Teaching Notes
5. Ethical Conduct
✓ Activity #5
a. Ethics—The standards of conduct for judging right
from wrong, honest from dishonest, and fair from
unfair.
b. Intentional financial misreporting is both unethical and
illegal.
c. The American Institute of Certified Public
Accountants (AICPA) requires all its members to
adhere to a Code of Professional Conduct to help
ensure these decisions are made in a professional and
ethical manner.
d. Regardless of the above, some individuals have been
involved in accounting scandals and fraud.
e. Sarbanes-Oxley Act (SOX)—A set of laws
established to strengthen corporate reporting in the
United States; it requires top managers of public
companies to:
i. Sign a report certifying their responsibilities for
the financial statements,
ii. Maintain an audited system of internal controls to
ensure accuracy in the accounting reports, and
Iii. Maintain an independent committee to ensure
that managers cooperate with auditors.
f. Ethical conduct is just as important for small private
businesses as it is for large public companies.
g. When faced with an ethical dilemma, follow a three-
step process:
The “Stoplight on Ethics”
feature summarizes recent
i. Identify who will benefit from the situation (often
the manager or employee) and how others will be
harmed (other employees, the company’s
reputation, owners, creditors, and the public in
general).
scandals.
ii. Identify the alternative courses of action.
iii. Choose the alternative that is the most ethical; that
you would be proud to have reported in the news.
IV. Supplement 1A – Careers That Depend on Accounting
Knowledge
Overviewed in Exhibit 1S.1