Chapter 1 - University of Arkansas at Little Rock

ACCT 2310
Accounting Principles I
Dr. Robert R. Oliva
Professor and Chairperson
Department of Accounting
University of Arkansas at Little Rock
How to obtain class files:
Chapter 1: Introduction to
Accounting and Business
So you want to go into business?
• 1. What kind of a legal entity is the business going
to use?
• 2. What business strategy will be implemented?
• 3. What is the business going to sell?
• 4. Who is going to be involved in the creation and
continuing support of the business (stakeholders)?
• 5. What kind of data will the stakeholders want and
who will provide it?
– Recording and Summarizing
– Financial Statements
– Financial Analysis
1. What kind of a legal entity is the
business going to use?
Types of Business Entities
• Sole propietorships
• Pass-Through Entities
– Partnerships
– S corporations
– LLCs
• Corporations
Sole propietorship
• One owner
• No separate existence
• Business MTR = individual’s MTR
• No independent taxation
• Losses serve as tax shelter to other
• Net profit taxed to owner when reported
whether received or not
• Owner is not an employee
– Self-employment tax
• Same tax year
• No liability shield
Pass-Through Entities
• Partnerships
• S Corporations
• LLCs
• 2 or more persons
• Independent entity from owner
• Conduit/flow through: does not pay taxes
Advantages of a Partnership
• Entity is tax exempt
• Partners able to withdraw and contribute
affecting only adjusted basis
• Debt basis
• Net profit taxed to owner when reported
whether received or not
• Owner is not an employee
– Self-employment tax
Types of partnership
– General
– Limited
– Family partnerships
– Publicly traded partnership
Family Partnerships
• Real or sham?
– Two kinds of partnerships based on what is
the material income producing factor
• capital
• services
• In service partnership, a partner family
member must provide substantial services
• In capital intensive partnerships: no as
much of a problem
LLCs: Limited Liability
• State created entity
• Taxed as a partnership
• Unlike partnerships (and similar to
corporations): members have limited
• Unlike limited partners: LLC members may
participate in management
Advantages of LLC’s (versus S)
• not limited to a specific number of
• not limited to one class of stock
• not limited to kinds of shareholders
• Non-shareholder debt basis
Advantages of LLC’s (v. LP’s)
• No need for GP with personal liability
• All members have limited liability
• All members may participate in
Advantages of LLC’s (v. GP’s)
• LLC members do not have personal
Advantages of LLC’s (v. Sub
• LLC’s may be taxed as pass through
• Has similar provision as IRC 351, without
the need of control and can be used at
anytime without concern for control [IRC
Limited Liability Partnership
• Like GP: severally and jointly liable for
LLP’s liabilities arising out of other than
• From partnership to LLC: no tax
S Corporations
• Hybrid
• Advantages/disadvantages
– Very similar to partnerships
– Very similar to corporations
2. What business strategy will be
What is a “business strategy”? (6)
Business Strategies
• Low cost (7)
• Differentiation (8)
• Combination
• Low cost: Competition offering lower prices or
using a differentiation strategy.
• Differentiation:
– Company may offer more than what the customer
wants, followed by competition offering what the
customer wants at a lower price.
– Company is so successful that everyone has bought
the product. Followed by competition offering a new
• Combination: Trying to be too many things to too
many customers.
3. What is the business going to
The Value Chain
• Take “inputs”, apply a “process”, and end
with a product or service to sell.
• Consider the “process”:
– Manufacturing
– Retailing
– Service industry
– Capital intensive
– Service intensive.
4. Who is going to be involved in
the birth, life, and, hopefully not,
death of the business?
Who are the “stakeholders”?
Internal stakeholders?
External stakeholders?
Internal stakeholders
• Owners
• Managers
• Employees
What do they have in common?
A need for reliable data
External stakeholders
• Customers
• Creditors
• Government
What do they have in common?
A need for reliable data
How are the business stakeholders
going to be provided the much
needed “reliable data”?
5 Steps
Who will implement?
Accounting as a Profession
• Private v. Public Accounting
• Specialties:
Financial: Report preparation under GAAP
Auditing: Evaluation of the representation
Management: Data providers to management
Cost: Determining product costs
Tax: Compliance and Planning
AIS: Designing computer financial systems to collect and
secure data.
– International: Collecting, analyzing, and reporting data involving
international trade
– NFP: Reporting operations of not for profit organizations
– Social Accounting: Measuring social costs and benefits for
(mostly) public and private actions.
Problem 1-2A: Chickadee
• How much money did it make last year?
– Prepare an income statement
Accounting Data: The need for
standardized procedures
• GAAP: Generally Accepted Accounting
– From research, to practice, to official
– Financial Accounting Standards Board (FASB)
• Statements of Financial Accounting Standards
• Interpretations
• Thus emphasis on principles and concepts
4 Basic Accounting concepts
Business entity
Unit of measure
Business entity concept
• Defines what is the business being
• If you own 4 different businesses, how do
you keep track of profitability?
Cost concept
• At what price should your “inputs” be
– Assume you bought a building for your
business, should it be recorded at the price
paid or the appraised value?
– Need to use exchange price
Objectivity concept
• Accounting records and reports must be
based on objective evidence.
– Using historical cost.
Unit of measure concept
• Record in dollars.
• We have a good idea about the cost of our
• But we have a harder time in determining
its current value.
The Accounting Equation (18)
• Assets = Liabilities + Owner’s Equity
• Every business transaction, e.g., one that
affects a business’ financial condition,
impact the Accounting equation.
– Every business transaction is an increase or
decrease in the equation variables.
– But the equation is always balanced.
Recording and Summarizing
Business Transactions Based on
the Accounting Education
• Chris Clark and Net Solutions (p. 14)
• Jim’s Lawn Care
Chris Clark and Net Solutions: p.
• Transactions:
– Investment of cash: a
– Buying an asset with cash: b
– Buying an asset with credit: c
– Income earning: d
– Withdrawal of cash: e
– Payment of a liability with cash: f
– Recording the use of supplies: g
– Recording the use of cash withdrawal: h
Jim’s Lawn Care: Consider the
effect of May transactions on
Accounts Receivable
Lawn Equipment
Accounts Payable
Jim’s Capital Account (Owner’s Equity)
Jim’s Capital Account (Owner’s
• Shows the effect of matching revenues
and expenses during a discrete period of
– Net Income: increases owner’s equity
– Net Loss: decreases owner’s equity
• Shows the effect of
– Investments: increase of Owner’s Equity
– Withdrawals: decrease in Owner’s Equity
Jim Lawn’s Care: May transactions
$800 deposited bank account
$1000 Sears lawnmower on credit
$50 cash paid for supplies
$700 IOU received from work performed
$700 IOU paid in cash
$1000 cash paid Sears for lawnmower
$150 cash paid for advertisement
$420 received for work performed
$85 paid to assistant for work performed
$600 IOU received for work performed
$110 on gas on credit, bill received, pay in June
$100 withdrawal from the business
Financial Statements (21)
Income Statement (22)
Statement of Owner’s Equity (23)
Balance Sheet (24)
Statement of Cash Flows (25)
Jim’s lawn Care: Financial
Financial Analysis
• Ratio of Liabilities to Owner’s Equity
• Which would you rather own?
– Company A:
• Assets: 100,000
• Liabilities: 95,000
• Owner’s Equity: 5,000
– Company B:
• Assets: 100,000
• Liabilities: 10,000
• Owner’s Equity: 90,000

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