Types of Business Activities. Who Cares About the Business ? (“Stakeholders”). Types of Business Organizations. Corporations. What is Accounting ?. Accounting is the Information System that collects and provides economic information on a business to interested parties. Accounting Concepts.
Types of Business Activities
Accounting is the Information System that collects and provides economic information on a business to interested parties.
The Accounting Identity states that Assets = Liabilities + Owners’ Equity. This is always true!.
Accounts are ways that businesses classify specific types of things of value, or of transactions involving things of value.
These Accounts and Account Categories are presented on a Balance Sheet as shown below
The Balance Sheet
There are five (5) Categories of accounts….
Are things of positive value.
These can be physical
(e.g. a computer) or financial
Are things of negative value.
These are financial – usually debts to banks and other creditors
Represents the Owners’ Net Worth in the business….
Including investments in the business and profits
Account Categories (continued)
The final two categories are Revenues generated by the business’s operations, offset against Expenses incurred in operating the business.
The difference between the two is Net Income (also called “profit”), and is shown on the Income Statement (also known as the “Profit and Loss (P & L) Statement”).
Equals Net Income (Net Profits)
31/12/(xx + 1)
Over the accounting period, time moves on……
and Revenues and Expenses grow.
At the end of the accounting period (year), the temporary Income Statement accounts are closed (zeroed out) and the Net Income balance is transferred to Owners’ Equity on the Balance Sheet.
This well-established old business has a lot of Assets, Liabilities and Owners Equity.
But, at the beginning of the accounting period (year), the Income Statement is “clean”, and all accounts show zero balances.
…And, the next year, the process starts all over again!
Closing the Accounting Period is actually much more difficult than what was shown above. It will be introduced in full later.
Before looking at the Accounting Period, it’s best to understand certain accounts that appear on almost all business’s accounting statements.
Starting with the Income Statement…..
The Income Statement – Standard Format
We are now going to separate out and identify explicitly two other Expense Accounts…
Interest Expense is money paid to banks and other creditors for lending money to the business.
We’ve already seen the standard format of the Income Statement …
- Expenses (S, G &A)
= Net Income
And Tax Expense is the amount of taxes the business must pay the government, based on after-interest Net Income.
The Income (“Earnings”) before subtracting out Interest and Tax Expenses is known as Earnings Before Interest and Taxes (EBIT)
And the Income (“Earnings”) after Interest but before taxes is known as Earnings Before Taxes (EBT)
Sales is Revenue from selling stuff in the regular course of business. It is by far the largest source of revenue. (The Revenue heading is omitted here.)
The Income Statement – Standard Format
Cost of Goods Sold (COGS) is the direct cost of selling stuff. Not important for service businesses.
S, G & A includes all indirect expense, like executive salaries, electricity, rent, advertising, etc.
Interest paid to banks and other creditors for borrowing money.
Taxes on Income (EBT) paid to the government.
The Balance Sheet – Standard Format
Liquidity is the ability to turn an Asset into cash, or the need to pay a Liability with cash. On the Balance Sheet, both Assets and Liabilities are written with the most liquid on top, followed below by the less liquid.
Both Assets and Liabilities are divided into Current (short-term) and Non-Current (long-term) portions. Current Assets are those that can/will be converted into cash within one year. Current Liabilities are those that must be paid within one year.
As shown before, the balance sheet consists of Assets on the left side, and Liabilities and Owners’ Equity on the right side.
And, of course, Assets must always equal Liabilities plus Owners’ Equity.
Least Liquid Most Liquid
Assets = Liabilities + Owners’ Equity
Standard Asset Accounts
Every business creates its own accounts. But there are certain accounts that appear on every business’s Balance Sheet. These include…..
Standard Liability Accounts
Every business has Liabilities (also known as “Debt”) of some kind. But the debt can have many different names.
Registered Share Capital is shown on the balance sheet, but it is not added to other equity accounts. Only Issued Share Capital is counted.
When a business owns more than 50% of another business, it will provide both “company” (parent) and “consolidated” accounts. Consolidated accounts are simply added together.
Standard Owners’ Equity Accounts
The part of the consolidated business not owned by the parent is called Minority Interest. In Thailand, Minorities are an Equity account. In the USA, they are treated as a liability.
Some Retained Earnings might be “Appropriated”, meaning that they are set aside for a special purpose. “Unappropriated” Retained Earnings can be spent or paid out as Dividends to shareholders.
Standard Balance Sheet
Next we look at how accountants actually record account transactions.