Accounting and Its Use in Business Decisions
This chapter introduces the three basic forms of business organization and the three types of business activity. It explains the purpose of the income statement, statement of retained earnings, balance sheet, and statement of cash flows, states the basic accounting equation, and shows how everyday transactions are analyzed and translated into these four financial statements.
Forms and activities of business organizations
A business is normally organized as a sole proprietorship, a partnership, or a corporation, and each form carries different implications for ownership, liability, and how the entity is taxed. Every business, regardless of form, engages in financing activities to raise funds, investing activities to acquire the resources it needs, and operating activities to run its day-to-day operations, and accounting exists to record and communicate the financial results of all three.
The four financial statements
The income statement reports revenues and expenses to show whether a period was profitable. The statement of retained earnings shows how those profits are retained in the business or distributed to owners as dividends. The balance sheet lists assets, liabilities, and owners’ equity at a point in time, tied together by the basic accounting equation, assets equal liabilities plus owners’ equity. The statement of cash flows then explains how cash actually moved during the period.
Analyzing transactions with accounting and its use in business decisions
Underlying assumptions and concepts, such as the business entity and the monetary unit, govern how a transaction is recognized and measured for financial reporting. Each transaction changes at least two elements of the accounting equation, and the chapter works step by step through preparing an income statement, a statement of retained earnings, and a balance sheet directly from a company’s own recorded business transactions.