Chapter01 UML 2007

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Chapter 1

Introduction: Reporting About Resources

In this chapter you will begin learning about the purpose and process ofaccounting. You will see that the information produced by a company's accounting

system is aimed at answering specific questions about the company's resources.Information for answering the questions is often provided in the form offinancial statements.

Goals

A goal is something to work toward. It is something you try to achieve.For example right now you may be trying to prepare yourself to earn a high gradein this accounting course. !n the other hand your goal for the next few minutesmight simply be to stay awake until it's time to go to dinner" #eople havenumerous goals. $any people strive to develop and maintain happy families. %omepeople work to get the highest paying &ob possible. %ome people try to be inperfect health or at least in great physical shape. %till other people have

earning a highquality education as their goal.%imilar to people companies have goals. (ealth centers and medicalpractices have as their goal the providing of quality affordable health care.)roadway theaters strive to provide diverse live entertainment. *lothing storestry to sell blouses slacks shirts pants and sweaters to customers.Automobile companies attempt to manufacture and sell cars. For an example of onecompany's goals see the following brief discussion of A+,+ Inc.

A+,+ Inc.

In its -/ annual report to owners A+,+ listed the following goals. )uild onour success in wireless by continuing to add subscribers generating higher datarevenues and boosting margins. 0eliver the value of the )ell%outh acquisition.%trengthen our ability to compete in the video market as we scale our new videoservices. 1row our enterprise business. *ontinue to build A+,+ as the brand thatour current and future customers rely on to meet all of their communications andentertainment needs. $ost important we2ll continue to work hard to delivervalue to our stockholders.

Goals and Resources

(ow do people and companies achieve their goals3 +he obvious answer isthrough hard work. (owever if hard work is the only requirement many morepeople and companies would be successful. %ome of the most importantrequirements for companies and people to achieve their goals are resources.4esources are the things you have to work with. #ersonally your resourcesconsist of things like cash textbooks pencils notebooks clothes car stereo

and *0s. A company's resources include cash land buildings and machines.

4esources and #ersonal 1oals 5hy do people want resources3 If cash is aresource in which you are interested consider what you can do with more of it.If you had only 6-7 you would be quite concerned about how you could buy foodclothes gasoline or pay your rent. !n the other hand if you had 68buying food or clothes probably wouldn't be a problem for a while. Furthermoreif you had 68 you would definitely not be concerned about food orclothes but would be able to consider such things as buying property taking

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2 Ch. 1: Reporting About Resources

trips providing for your relatives or helping friends.(ow do resources help you achieve your goals3 *onsider for example your

goal of achieving a highquality education. 5ithout sufficient resources youmight have to work at a parttime &ob 87- hours per week to attend school. Ifyou had sufficient resources you could avoid the parttime &ob and use the hoursto study. +he availability of enough resources would give you more time to studyand could lead to the achievement of your goal of earning a highqualityeducation.

4esources and )usiness 1oals *ompanies want resources for the same basic reasonpeople do9 the more resources a company has the more alternatives the companyhas and the better are its chances of achieving its goals. For example if acompany has resources of only 67 it may be limited in the si:e of thebuilding space it can buy or rent the number of employees it can hire and thevolume of products and services it can buy. If the same company had 67of resources it could afford to buy or rent much more space hire many moreemployees and buy many more products and services.

In a simplistic way a company's desire for resources can be understood byremembering your experiences with the game $onopoly. +o win at $onopoly youeither eliminated all other players or accumulated more cash at the end of the

game than any other player. As you played the game you tried to acquireproperty houses and hotels so that you could charge more rent. 5ithoutproperty you could not charge rent. 5ithout buildings you could only charge asmall amount of rent. In other words as you acquired more resources thealternatives available to you increased. As you acquired more property andbuildings and if you were fortunate enough to avoid your competitors' propertywhile they landed on yours your resources increased. If your resourcesincreased enough you eventually won the game.

)usinesses want resources for the same reason you wanted property housesand hotels when you played $onopoly. +he more resources a company has the morealternatives or opportunities it has. 5ithout resources it is virtuallyimpossible for a company to achieve its goals. A health center cannot providemedical care without examining rooms and medical supplies. An automobile

manufacturer cannot produce cars without buildings equipment and materials.+o get an idea of the importance of resources to companies examine ;xhibit

88 in which the 0ecember

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Ch. 1: Reporting About Resources 3

repaid to the person or company from whom the resources were borrowed. In manycases an additional dollar amount called interest is paid by the borrower forthe use of the resources. *ompanies borrow resources in several ways such asbank loans issuing bonds and notes and credit purchases.

)ank Boans )anks commonly lend money to companies. +o obtain a loan acompany usually must present an organi:ed plan detailing what the money will beused for and how the money will be repaid. An important feature of a loan is thefee or interest charged for the amount loaned by the bank. For example if acompany borrows 68 from a bank at the rate of =C per year the company wouldhave to pay the bank 6= @68 x .= per year interest for the use of thebank's money. At some agreed upon time the company would also have to returnthe 68 to the bank. An idea of the importance of borrowing as a source ofresources can be seen by examining ;xhibit 8- in which the 0ecember billion of resources through the use of longterm debt.

;xhibit 8$erchandise #urchased in -/

*ompany 4esources in )illions(ome 0epot 6/-.7

Hroger 67.

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+he importance of resources to the goals of companies has had a significantimpact on the development of financial reporting. Financial reporting isconcerned with gathering organi:ing and communicating information about acompany. 4esources and where they came from are at the heart of modern financialreporting systems. +hey are the basis around which the accounting systemexplored in this text is organi:ed.

%ince a company's resources must have come from somewhere the accountingsystem can be represented as the following simple equation.

+he total dollar amount of acompany's resources

K+he total dollar amount ofresources obtained from its

sources of resources

or more simply

4esources K %ources of 4esources

As stated earlier a company may acquire resources in three ways9 resourcesmay be borrowed resources may be invested by owners or resources may begenerated through management's operation of the company. +hus the aboveequation can be expanded to the following.

+he total dollaramount of acompany'sresources

Kthe dollaramount ofresourcesborrowed

L

the dollaramount ofresources

invested byowners

L

the dollaramount ofresourcesgeneratedthrough

managementoperations

or more simply

+otal4esources

K %ources of)orrowed4esources

L%ources of

!wnerInvested4esources

L%ources of$anagement1enerated4esources

+he above equation by showing the relationship between resources and theirsources provides information used to answer four basic questions9 @8 what isthe company's total dollar amount of resources @- where did the company get itsresources @were they borrowed invested by owners or generated throughmanagement operations @.

MM You now have the background to do exercises 8.8 and 8.-.

Financial Reporting Illustrated

Bet's assume that ick #arks decides to use his knowledge of computers by

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starting his own computer repair company on Euly 8. 5e will examine how severalevents of the #arks *omputer %ervice *orporation can be viewed in terms of thecompany's resources and sources of resources. You will see how the financialreporting system generates information to show what the company's resources areon Euly

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otice in the above equation the 67 increase in resources is shown as a L67 in the cash column and the 67 increase in sources of resources isshown as a L 67 in the common stock column. +he equation is in balancebecause we added 67 to both sides9 67 were added to resources and 67were added to sources of resources. Gsing this system we can see the companyhas resources of 67 cash. +he resources came from the owner's investment.In return for his 67 since the company was established as a corporation theowner received shares of common stock. *orporations and common stock areexamined in detail in *hapter 8-. At this point you should simply be aware ofthe fact that the owner's interest in a corporation is represented by stockcertificates. %tock certificates may be printed on paper or recorded in computerfiles. (opefully by the end of *hapter 8- you will know much more about stockand corporations.

In accounting systems the terms cash and common stock are known asaccounts. An account can be anything about which you want to gather information.As you will see as we examine more events of the #arks *omputer %ervice*orporation we can add appropriate accounts as we need them.

Gsing resources to buy other resources !n Euly D7 cash and 6-7 supplies. +hus the use

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of one resource to purchase another did not change the company's total resourcesbut merely changed the form of the resources. +he 67 cash was converted into6>D7 cash and 6-7 supplies. From a business standpoint converting cash intosupplies was necessary if the company needs supplies to provide service to itscustomers. At this point the company has not borrowed any resources nor has itgenerated any resources through management providing computer services.

)orrowing resources !n Euly D the company buys additional supplies of 68

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providing service to a customer and receiving cash increases the company'sresources. +he increased resources are not borrowed nor invested by the owner.+hey are generated through management's operation of the company. As a resultthe company's resources and sources of resources both increase by 6- as shownbelow.

4esources K %ources of resources678

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After the 6D cash is paid only 6/7 of resources @supplies were obtained fromborrowing. 4emember 68

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+otal 4esources

K

%ources

of

)orrowed

4esource

s

L

%ources

of !wner

Invested

4esource

s

L

%ources of

$anagement

1enerated

4esources

;vent *ash L %upplies K

Accounts

#ayable L

*ommon

%tock L

4etained

;arnings

!wner's cash investment L 67 L 67

%upplies purchased for

cash 6-7 L 6-7

%upplies purchased on

account L 68

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+otal 4esources

K

%ources

of

)orrowed

4esource

s

L

%ources

of !wner

Invested

4esource

s

L

%ources of

$anagement

1enerated

4esources

;vent *ash L

Accounts

4eceivable L %upplies K

Accounts

#ayable L

*ommon

%tock L

4etained

;arnings

!wner's cash

investment L 67 L 67

%upplies

purchased

for cash 6-7 L 6-7

%upplies

purchased

on account L 687 were obtained through management providing computer services@retained earnings. 5e can also see the company's resources consist of 6787cash 6-7 accounts receivable and 68/ supplies.

*onverting one resource into another !n Euly -7 the company receives 68 ofcash from the customer serviced on Euly -. o additional work is done for theclient on Euly -7. %ince no additional work is performed for the customer thereceipt of the 68 cash does not increase the #arks *omputer %ervice*orporation's resources. +he form of the resources changes however as oneresource @cash increases and another resource @accounts receivable decreasesas reflected below.

4esources K %ources of resources67787 K 67787L 68 6867787 K 67787

+he 68 change in the form of resources from accounts receivable to cash wouldaffect the accounting system as follows.

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+otal 4esources

K

%ources

of

)orrowed

4esource

s

L

%ources

of !wner

Invested

4esource

s

L

%ources of

$anagement

1enerated

4esources

;vent *ash L

Accounts


Accounts

#ayable L

*ommon

%tock L

4etained

;arnings

!wner's cash


%upplies

purchased

for cash 6-7 L 6-7

%upplies

purchased

on account L 687were obtained through management providing computer services @retained earnings.5e can also see the company's resources now consist of 67-7 cash 687 accountsreceivable and 68/ supplies.

Gsing up resources in management operations !n Euly

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in the supplies account. %ince the resources are used up in order to provideservices to customers the retained earnings account would also decrease. +hisdecrease in retained earnings is often a difficult idea for students to accept.(owever remember how management generates resources through operations9 itgenerates resources by providing computer services to customers. 5hen thecompany received resources of 6>7 for services to customers in Euly resourcesincreased and retained earnings increased. Bogically then when resources suchas supplies are used up as part of providing services to customers resourcesshould decrease and retained earnings should decrease. +he accounting systemshows these effects as follows.

+otal 4esources

K

%ources

of

)orrowed

4esource

s

L

%ources

of !wner

Invested

4esource

s

L

%ources of

$anagement

1enerated

4esources

;vent *ash L

Accounts


Accounts

#ayable L

*ommon

%tock L

4etained

;arnings

!wner's cash


%upplies

purchased

for cash 6-7 L 6-7

%upplies

purchased

on account L 68/7 O K N 67>/7 O

otice in the above equation the 67 decrease in supplies is shown as a 67 inthe supplies column and the 67 decrease in retained earnings is shown as a 67in the retained earnings column. +he equation is in balance because wesubtracted 67 from both sides9 67 were subtracted from resources and 67 were

subtracted from sources of resources. After using supplies to service itscustomers the company has 67>/7 of resources. 6/7 of the resources wereobtained through borrowing @accounts payable 67 were obtained from theowner @common stock and 6> were obtained through management providingcomputer services @retained earnings. 5e can also see the company's resourcesnow consist of 67-7 cash 687 accounts receivable and 688 supplies.

0istributing resources to the owner !wners of companies have rights to theresources they invest in the companies. +hey also have rights to the resources

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generated through management operations. As the owner of #arks *omputer %ervice*orporation ick has a right to the 6> of resources generated throughmanagement operations in Euly. !wners usually receive the actual resources whenthe companies distribute them as dividends. A dividend is the distribution toowners of resources generated through management operations. 5hen the #arks*omputer %ervice *orporation pays a 6D7 dividend to ick the company's resourcesdecrease and its sources of resources decrease as the resources go to ick asshown below.

4esources K %ources of resources67>/7 K 67>/7 6D7 K 6D767

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otice in the above equation the 6D7 decrease in cash is shown as a 6D7 in thecash column and the 6D7 decrease in retained earnings is shown as a 6D7 in theretained earnings column. +he equation is in balance because we subtracted 6D7from both sides9 6D7 were subtracted from resources and 6D7 were subtracted fromsources of resources. After paying the dividend to the owner the company has67 by servicing its customers. +he company received

resources of 6>7 from customers and used resources of 67 in providing theservices. An increase in resources through management operations is called arevenue. +hus the company's source of the 6>7 of resources received fromcustomers could be called Fees 4evenue. A decrease in resources throughmanagement operations is called an expense. +hus the company's use of 67 ofsupplies could be called %upplies ;xpense. +he income statement for managementoperations of the company in Euly would appear as follows.

#arks *omputer %ervice *orporationIncome %tatement

For the $onth ;nded Euly 7

%upplies ;xpense 67et Income 6>

From the #arks *omputer %ervice *orporation's income statement we can see thatthe company's management used the company's resources in Euly to generate 6> ofadditional resources @net income. +he income statement shows that the companybrought in resources of 6>7 @fees revenue and used 67 of resources @suppliesexpense. 4emember generating resources through management operations is oneimportant way that companies get resources. *ompany owners are very interestedin the amount of resources generated through management operations because the

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owners have rights to such resources. +he more a company's resources increasethrough management operations the more resources its owners have rights to.

!ne question often asked about income statements is9 P5hy are a company'sdividends not reported on its income statement3P +he answer to this question isthat management is not responsible for dividends. +he company's board ofdirectorsis responsible for dividends. A company's board of directors is agroup of people elected by the company's owners to establish ma&or businesspolicies for the company. %ome of the specific responsibilities of directors areto determine the dollar amount of dividends and when they will be paid to theowners of the company. %ince the income statement reports on what management didwith the company's resources not what the directors did the company's dividendsare not reported on the income statement. $ore information about the differencesbetween management's responsibilities and those of the board of directors ispresented in chapter 8-.

Statement of Retained Earnings

+he financial statement that provides information about what a company didwith the resources management generated through operating the company is thestatement of retained earnings. In its simplest terms a company has two

alternatives from which to choose with regard to resources generated throughmanagement operations9 @8 the resources can be given to owners or @- they canbe kept in the business. +he dollar amount of resources given to owners iscalled dividends. +he dollar amount of resources kept in the company is calledretained earnings. +he #arks *omputer %ervice *orporation's Euly statement ofretained earnings would appear as follows.

#arks *omputer %ervice *orporation%tatement of 4etained ;arningsfor the $onth ;nded Euly

%ubtotal 6>Bess9 0ividends 6D74etained ;arnings Euly

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borrowed resources @called liabilities and both the amount of resourcesobtained from owners and the amount of resources generated by management and keptin the company @called stockholders' equity. +he #arks *omputer %ervice*orporation's Euly

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#arks *omputer %ervice *orporation)alance %heet

Euly more resources atthe end of Euly than it did at the beginning.

+he Euly statement of retained earnings shows that of the 6> of resourcesgenerated by management the company gave 6D7 to the owner. +he company retainedfor future use 6

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%ince a company may acquire resources in three ways borrowing owners'investments or generating through management operations the above equation wasexpanded to the following.

+otal4esources K %ources of)orrowed4esources

L

%ources of

!wnerInvested4esources

L

%ources of

$anagement1enerated4esources

Gsing business terms the above equation can be restated to its final formwhich has become known as the accounting euation as follows9

Assets K Biabilities L %tockholders' ;quity

+he accounting equation shows a company's resources @assets come fromeither borrowing @liabilities or from owners and management@stockholders'equity. At this point it is very important that you notice stockholders' equityincludesboththe dollar amount of resources invested by owners and the dollaramount of resources generated through management operations and retained in thecompany. %tudents often have a difficult time accepting the idea that the amountof resources generated through management operations and retained in the companyshould be included in stockholders' equity. 4emember one of the reasons ownersinvest in a company is that owners have rights to all resources generated throughmanagement operations of the company. %ince the owners have rights to suchresources the dollar amount of the source of such resources @retained earningsis included as part of stockholders' equity.

Importance of the Accounting Euation

to Financial Reporting

4emember the accounting process discussed earlier. )riefly the processinvolved @8 analy:ing events that affected a company @- interpreting the

events' effects on the company and the accounting equation and @

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%upplies

purchased

on account L 68

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+otal 4esources

K

%ources of

)orrowed

4esources

L

%ources

of !wner

Invested

4esource

s

L

%ources of

$anagement

1enerated

4esources


;vent *ash L

Accounts


Accounts

#ayable L

*ommon

%tock L

4etained

;arnings

%ervice

provided

to

customer L 6- L 6-

*ash payment

on account 6D 6D

%ervice

provided

to

customer L 6-7 L 6-7

*ash

collectedfrom

customer L 68 68

%upplies

used 67 67

*ash

dividend 6D7 6D7

+otals 678

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+otal 4esources

K

%ources of

)orrowed

4esources

L

%ources

of !wner

Invested

4esource

s

L

%ources of

$anagement

1enerated

4esources


;vent *ash L

Accounts


Accounts

#ayable L

*ommon

%tock L

4etained

;arnings

%upplies

purchased

for cash 6-7 L 6-7

%upplies

purchased

on account L 68

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et Income 6D

After the error the above income statement shows fees revenue of 6D7 suppliesexpense of 67 and net income of 6D. 4emember without the error net incomewas 6>.

#arks *omputer %ervice *orporation%tatement of 4etained ;arningsfor the $onth ;nded Euly

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cash account by 6- but we mistakenly increased the retained earnings accountby only 6-. +he equation below shows what would happen as a result of ourerror.

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+otal 4esources

K

%ources of

)orrowed

4esources

L

%ources

of !wner

Invested

4esource

s

L

%ources of

$anagement

1enerated

4esources


;vent *ash L

Accounts


Accounts

#ayable L

*ommon

%tock L

4etained

;arnings

!wner's cash


%upplies

purchased

for cash 6-7 L 6-7

%upplies

purchased

on account L 68

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After the error the above income statement shows fees revenue of 6-D suppliesexpense of 67 and net income of 6--. 4emember without the error netincome was 6>.

#arks *omputer %ervice *orporation

%tatement of 4etained ;arningsfor the $onth ;nded Euly 7.4emember without the error the ending retained earning balance was 67

+otal %tockholders' ;quity 678>7+otal Biabilities , %tockholders' ;quity 67-8

After the error the above balance sheet shows assets of 67

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makers would not use the #arks *omputer %ervice *orporation's financialstatements if its balance sheet reported assets of 67

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. 5hen companies borrow money from banks what is the name of the fee thatthe companies are charged for using the banks' money3

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7. 5hy do owners invest their money in companies3

/. Bist the four questions for which financial reporting systems provideinformation.

D. Identify the two things that a company can do with any resourcesmanagement generates through operations.

=. 5hat are the pieces of paper called that owners receive when they investin corporations3

. 5hat is the name of the source of resources account that shows a companyowes money to a supplier3

8. 5hat is the name of the resource account that shows a company's customersowe it money3

88. 5hat is the name of the source of resources account that shows the dollaramount of resources generated through operations and kept in thebusiness3

8-. (ow do owners actually receive from companies some of the resourcesgenerated through management operations3

8

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8=. 5hat is the name of the financial statement that provides informationabout what the company did with resources generated by management'soperation of the business3

8. 5hat is the dollar amount of resources generated through managementoperations and given to owners called3

-. 5hat is the dollar amount of resources generated through managementoperations and kept in the business called3

-8. ame the two financial statements on which a company's net incomeappears.

--. 5hat is the name of the financial statement that provides informationabout the company's resources and where they came from3

-

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Chapter "ne E$ercises

;xercise 8.89 4esources K %ources of 4esources

*urven *orporation began business on %eptember 7. 67of resources had been invested by owners and 6-7-.6-7 of resources had been borrowed and 6.6

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;xercise 8.

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-. An analysis of the %tryker *orporation's retained earnings account showedrevenues of 6-- and dividends of 6 and dividends of 6-7. 0etermine the corporation'srevenues for the year.

;xercise 8.79 Assets K Biabilities L %tockholders' ;quity

*alculate the appropriate amount for the 4ui: *orporation in each of thefollowing independent situations.

8. +he corporation's liabilities are 6. At the beginning of the year the corporation's assets were 67= andits liabilities were 6

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;xercise 8./9 Accounting ;quation

0uring the first week in August the %ok *orporation experienced theevents presented below. For each event determine the effects on thecorporation's assets liabilities and stockholders' equity. +he first eventhas been done for you.

8. +he owners invested 68= in the business.Assets K Biabilities L %tockholders' ;quity

L 68= L 68=

-. +he corporation provided 68= services to a customer for cash.Assets K Biabilities L %tockholders' ;quity

of supplies on account.Assets K Biabilities L %tockholders' ;quity

>. +he corporation paid its employees wages of 67.


7. +he corporation paid for half the supplies purchased on account in part (K 6

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+otal %tockholders' ;quity ;K K 5K+otal Biabilities and %tockholders' ;quity FK 6-

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;xercise 8.=9 Financial %tatements

+he following information concerning the 0arling *orporation becameavailable at the end of its first year of operations. Accounts #ayable67/S Accounts 4eceivable 67S *ash 67S *ommon %tock 6=7S0ividends 6>S ;xpenses 68=7S 4evenues 6-8S %upplies 68D.

0etermine the following for the 0arling *orporation.

8. et income for the year.

-. 4etained earnings at the end of the year.

. +otal liabilities at the end of the year.

7. +otal stockholders' equity at the end of the year.

Chapter "ne !roblem

#roblem 8.89 Accounting ;quation9 ;ffects of +ransactions

)elanger's *onsulting Inc. engaged in the following transactions in Eune.

A. 0an )elanger invested 6/7 in )elanger's *onsulting Inc. 0an received/7 shares of 68 par common stock in return for his investment.

). )elanger's *onsulting provided 68

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;. 6D7 cash was received from the customer mentioned in part ) above. +heremaining 6

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+otals T6D= TTTT6

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. +he dollar amount of resources on hand at the end of Eune that )elanger's*onsulting Inc. obtained through borrowing is 6TTTTTTTTTTTTTTT.

7. +he dollar amount of resources on hand at the end of Eune that )elanger's*onsulting Inc. obtained through owner's investments is 6TTTTTTTTTTTTTTT.

/. )elanger's *onsulting Inc.'s net income for Eune is 6TTTTTTTTTTTTTTT.

D. +he net dollar amount of resources that )elanger's *onsulting Inc. generatedthrough management operations in Eune is 6TTTTTTTTTTTTTTT.

=. +he dollar amount of resources on hand at the end of Eune that )elanger's*onsulting Inc. obtained through management operations and kept in thecompany is 6TTTTTTTTTTTTTTT.

Chapter01 UML 2007

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