AMERICAN COLLEGE OF TECHNOLOGY

DEPARTMENT OF BUSINESS STUDIES

ONLINE MBA PROGRAM
Financial and Managerial Accounting
Individual Assignment (20%)

Instructor’s Name Habtamu Gemeda, Ph.D.

Submitted to: American College of Technonolgy

Student Name Teketel Tarekegn Ambaye

Student ID 277-21A

Feburary, 2022
Addis Ababa, Ethiopia
 1. What is accounting, why accounting is considered a means to an end?
Accounting is the systematic recording of financial transactions and presentation of the related
information of the appropriate persons. The basic features of accounting are as follows:
1. Accounting is a process: A process refers to the method of performing any specific job step
by step according to the objectives, or target. Accounting is identified as a process as it
performs the specific task of collecting, processing and communicating financial information. In
doing so, it follows some definite steps like collection of data recording, classification
summarization, finalization and reporting.
2. Accounting is an art: Accounting is an art of recording, classifying, summarizing and
finalizing the financial data. The word ‘art’ refers to the way of performing something. It is a
behavioral knowledge involving certain creativity and skill that may help us to attain some
specific objectives. Accounting is a systematic method consisting of definite techniques and its
proper application requires applied skill and expertise. So, by nature accounting is an art.
3. Accounting is means and not an end: Accounting finds out the financial results and position
of an entity and the same time, it communicates this information to its users. The users then take
their own decisions on the basis of such information. So, it can be said that mere keeping of
accounts can be the primary objective of any person or entity. On the other hand, the main
objective may be identified as taking decisions on the basis of financial information supplied by
accounting. Thus, accounting itself is not an objective, it helps attaining a specific objective. So
it is said the accounting is ‘a means to an end’ and it is not ‘an end in itself.’
4. Accounting deals with financial information and transactions; Accounting records the
financial transactions and date after classifying the same and finalizes their result for a definite
period for conveying them to their users. So, from starting to the end, at every stage, accounting
deals with financial information. Only financial information is its subject matter. It does not
deal with non-monetary information of non-financial aspect.
5. Accounting is an information system: Accounting is recognized and characterized as a
storehouse of information. As a service function, it collects processes and communicates
financial information of any entity. This discipline of knowledge has been evolved out to meet
the need of financial information required by different interested groups.
2. Discuss accounting from the user’s perspective (manager’s viewpoint)

The people who use accounting information to make decisions fall into three categories:
1. Those who manage a business
2. Those outside a business enterprise who have a direct financial interest in the business
3. Those who have an indirect financial interest in a business
These categories apply to governmental and not-for-profit organizations as well as to profit-
oriented ventures. Since we are required to discuss from manger’s viewpoint we only discuss
here about user perspective from management’s viewpoint.
Management
Management refers to the people who are responsible for operating a business and meeting its
goals of profitability and liquidity. In a small business, management may consist solely of the
owners. In a large business, managers must decide what to do, how to do it, and whether the
results match their original plans. Successful managers consistently make the right decisions
based on timely and valid information.
To make good decisions, managers at any companies need answers to such questions as:
 What were the company’s earnings during the past quarter?
  Is the rate of return to the owners adequate?
 Does the company have enough cash?
 Which products or services are most profitable?
Because so many key decisions are based on accounting data, management is one of the most
important users of accounting information.
In its decision-making process, management performs functions that are essential to the
operation of a business. The same basic functions must be performed in all businesses, and each
requires accounting information on which to base decisions. The basic management functions
are:
 Investing resources—investing assets in productive ways that support a company’s goals
 Producing goods and services—managing the production of goods and services
 Marketing goods and services—overseeing how goods or services are advertised, sold,
and distributed
 Managing employees—overseeing the hiring, evaluation, and compensation of
employees
 Providing information to decision makers—gathering data about all aspects of a
company’s operations, organizing the data into usable information, and providing reports
to managers and appropriate outside parties. Accounting plays a key role in this function.

3. Identify and discuss the different types of accounting information

Accounting information system is a system designed to achieve a specific goal through
collection of inter-related parts. Every system has a specific goal to achieve. And hence the goal
accounting information system is to prepare a relevant and sufficient information for decision
maker.
The AIS is composed of three major subsystems: (1) the transaction processing system (TPS),
which supports daily business operations with numerous reports, documents, and messages for
users throughout the organization; (2) the general ledger/financial reporting system (GL/FRS),
which produces the traditional financial statements, such as the income statement, balance sheet,
statement of cash flows, tax returns, and other reports required by law; and (3) the management
reporting system (MRS), which provides internal management with special-purpose financial
reports and information needed for decision making such as budgets, variance reports, and
responsibility reports.
Transaction Processing System
The TPS is central to the overall function of the information system by converting economic
events into financial transactions, recording financial transactions in the accounting records
(journals and ledgers), and distributing essential financial information to operations personnel to
support their daily operations.
The TPS deals with business events that occur frequently. In a given day, a firm may process
thousands of transactions. To deal efficiently with such volume, similar types of transactions are
grouped together into transaction cycles. The TPS consists of three transaction cycles: the
revenue cycle, the expenditure cycle, and the conversion cycle. Each cycle captures and
processes different types of financial transactions.
General Ledger/Financial Reporting Systems
The general ledger system (GLS) and the financial reporting system (FRS) are two closely
related subsystems. However, because of their operational interdependency, they are generally
viewed as a single integrated system—the GL/FRS. The bulk of the input to the GL portion of
the system comes from the transaction cycles. Summaries of transaction cycle activity are
processed by the GLS to update the general ledger control accounts. Other, less frequent, events
such as stock transactions, mergers, and lawsuit settlements, for which there may be no formal
processing cycle in place, also enter the GLS through alternate sources.
The FRS measures and reports the status of financial resources and the changes in those
resources.
The FRS communicates this information primarily to external users. This type of reporting is
called nondiscretionary because the organization has few or no choices in the information it
provides. Much of this information consists of traditional financial statements, tax returns, and
other legal documents.
Management Reporting System
The MRS provides the internal financial information needed to manage a business. Managers
must deal immediately with many day-to-day business problems, as well as plan and control
their operations. Managers require different information for the various kinds of decisions they
must make. Typical reports produced by the MRS include budgets, variance reports, cost-
volume-profit analyses, and reports using current (rather than historical) cost data. This type of
reporting is called discretionary reporting because the organization can choose what information
to report and how to present it.

4. Determine the information needs of users (consider multiple scenarios).

It is important to find out about the people who will use the resource. This includes finding out
what information they need, what information is provided by other organizations, and how far
their needs for information are being met. This is known as carrying out a needs assessment.

After the resource has been available, a needs assessment should be carried out every one or two
years, to ensure that the resource centre continues to meet the information needs of its users.
A needs assessment looks at:
1. Who the users will be
Their age, sex, educational level, literacy level and type of work they do
2. What their information needs are
What main subjects they need information about
What other subjects they need information about
What they will use the materials in the resource centre for (in order of priority)
Which activities the materials will be most useful for
How important local/national/regional/international information is
What formats of materials will be useful:
 articles (for writing reports and getting new ideas for activities)
 books and other documents (for getting a comprehensive picture of a topic)
 personal advice (to help plan activities)
 training manuals (to assist with a training activity)
 videos (for training and health education)
 abstracts of published articles (to keep up-to-date on new developments and know what
to follow up)
 newsletters (to find out what new developments are taking place in the subject area, and
what other organisations are doing)
3. What materials are available
 What other sources of published and unpublished materials exist
 How much materials cost, and whether health workers can afford to buy them
 What gaps there are (in terms of subject, type of material, such as training manual,
reference material), language, format (such as book, audiovisual), and educational level
 What other sources of information exist:
 government services and departments
 non-governmental organisations (NGOs)
 mass media (newspapers, radio, television)
  e-mail and Internet services
4. How information can be disseminated
 What methods for disseminating information would best suit resource users (such as
resource lists, current awareness bulletins or document supply services)
 How feasible these methods are
A needs assessment can be carried out by interviewing people individually, organizing a focus
group discussion (a structured discussion with a small group of potential users) or by asking
potential users to complete a questionnaire. Interviews and discussions are better, as they provide
an opportunity to meet people and discuss their needs. If a questionnaire is used, it should be
made easy for people to complete. This can be done by listing the most likely answers, so that
people only need to tick a box or circle a word.
It is important to collect only essential information. Too much information can be confusing. As
well as assessing users’ information needs, it is important to find out what information is
provided by other organizations.

5. Discuss the basic functions of accounting information in decision making(consider

multiple scenarios)
An accounting information system takes all the data and figures from an organization's financial
records and arranges them into an orderly structure. The accounting information system serves
three basic functions: to collect and process data, to provide information to decision-makers
within the organization and to see that accounting personnel records information accurately and
protects the data.
Collection and Processing
In the collection phase of an accounting information system, accountants or bookkeepers gather
and record data from cash sales, receivables, cash purchases, payables and payroll, among other
transactions. In computerized systems, the software program processes all the debits and credits
into a complete information management database.
Reports for Management
Accounting personnel distribute reports to decision-makers within the organization, such as sales
and marketing managers, production managers, financial managers and all department heads.
Management uses the information generated from the accounting information system to analyze
the organization's current operations and financial condition and make plans and set goals for the
future. For example, a balance sheet created from the system can show management, owners,
creditors and investors where the organization stands financially at a particular point in time.
Accuracy and Security
Limiting the number of people who have access to the system best accomplishes the third
function of an accounting information system -- to ensure that the business maintains correct data
securely. The leaders of the organization must decide who that will be. For example, trained
clerks, bookkeepers or accountants require access to verify and enter data into the system and
generate reports. Other associates of the organization, both internal and external, generally have
no need to manipulate the data.
6. What are the internal and external users of accounting information?
Accounting information users are divided broadly in to two namely internal users and external
users. Internal users of accounting information are management, human resources, finance and
marketing department. And External users are investor, creditor, customer, labor union,
researcher and Government organization
7. Differentiate financial and management accounting information.
The key difference between managerial accounting and financial accounting relates to the
intended users of the information. Managerial accounting information is aimed at helping
managers within the organization make well-informed business decisions, while financial
accounting is aimed at providing financial information to parties outside the organization.
8. Outline the objectives of financial accounting and characteristics of management
accounting information.
The objective of financial accounting is designed to supply information in the form of profit and
loss account and balance sheet to external parties like shareholders, creditors, banks, investors
and Government. Information is supplied periodically.
Management accounting information should comply with a various number of characteristics
including verifiability, objectivity, timeliness, comparability, reliability, understandability and
relevance if it is to be useful in planning, control and decision-making.
9. Substantiate the need for accounting for business administrators and managers.
Accounting activities help administrators make important decisions regarding the operation of
the business. Areas of accounting such as financial reporting, budgeting and cost information
help managers make planning and controlling decisions. Executive managers use the information
presented by accountants to determine the company's financial health and the organizational
resources needed to operate. To take full advantage of the information presented by accounting
professionals, business owners should understand the importance of how accounting can help
administrators.
10. Discuss financial statements, their purposes, and their types.
The term financial statement refers to statement of Changes in financial position, Statement of
Retained Earnings, Balance Sheet, Profit and Loss Account, etc. It is observed that the mere
presentation of these statements does not serve the purpose of anybody in anyway. The
importance of these statements lies in their analysis and interpretation. In the beginning, analysis
was done only for extending credit, but now it is being used as most important function of
Management Accountant for providing various useful information to many persons. Some of the
schedules are prepared and submitted along with the financial statements for meaningful
presentation. Such schedules are schedule of fixed assets, schedule of debtors, schedule of
creditors, schedule of investments and the like. The different types of people are using the
financial statements. They need different types of information. Hence, the main objective of
financial statements is fulfilling the needs of such people. Even though, some other objectives
are briefly explained below. 1. To provide an accurate and reliable financial information about
the resources and usage in a business unit within the stipulated time. 2. To provide overall
changes made in the financial information relating to resources and usage for a particular period.
3. To provide accurate and reliable financial information relating to net changes made between
resources and usage for a particular period arising out of business activities.
4. To provide financial information which are helping the top management for estimating earning
potential of business.
11. Discuss the statement of financial position; identify its major parts and elements.
The balance sheet, or statement of financial position, shows a business’s assets, liabilities, and
equity at a point in time
Components of the Balance Sheet
The balance sheet contains statements of assets, liabilities, and shareholders’ equity.
Assets represent things of value that a company owns and has in its possession, or something
that will be received and can be measured objectively. They are also called the resources of the
business, some examples of assets include receivables, equipment, property and inventory.
Assets have value because a business can use or exchange them to produce the services or
products of the business.
Liabilities are the debts owed by a business to others–creditors, suppliers, tax authorities,
employees, etc. They are obligations that must be paid under certain conditions and time frames.
A business incurs many of its liabilities by purchasing items on credit to fund the business
operations.
A company’s equity represents retained earnings and funds contributed by its owners or
shareholders (capital), who accept the uncertainty that comes with ownership risk in exchange
for what they hope will be a good return on their investment.
Fundamental Relationship
The relationship of these items is expressed in the fundamental balance sheet equation:

Assets = Liabilities + Equity

The meaning of this equation is important. Generally, sales growth, whether rapid or slow,
dictates a larger asset base – higher levels of inventory, receivables, and fixed assets (plant,
property, and equipment). As a company’s assets grow, its liabilities and/or equity also tends to
grow in order for its financial position to stay in balance. How assets are supported, or financed,
by a corresponding growth in payables, debt liabilities, and equity reveals a lot about a
company’s financial health.
12. What are assets, liabilities, and shareholders’ equity/capital, owners’ equity,
dividends, drawing?
What Is an Asset?
Assets are economic resources that provide future benefits to the business. Examples include
cash, accounts receivable, prepaid expenses, equipment, and trucks. Cash is coins and currency,
usually held in a bank account, and is a financial resource with future benefit because of its
purchasing power. Accounts receivable represent amounts to be collected in cash in the future
for goods sold or services provided to customers on credit. Prepaid expenses are assets that are
paid in cash in advance and have benefits that apply over future periods. For example, a one-year
insurance policy purchased for cash on January 1, 2015 will provide a benefit until December 31,
2015 so is a prepaid asset. The equipment and truck were purchased on January 1, 2015 and will
provide benefits for 2015 and beyond so are assets.
What Is a Liability?
A liability is an obligation to pay an asset in the future. Accounts payable are obligations to pay
a creditor for goods purchased or services rendered. A creditor owns the right to receive payment
from an individual or business. Unearned revenue represents an advance payment of cash from a
customer for company’s services or products to be provided in the future.
What Is Equity?
Equity represents the net assets owned by the owners (the shareholders). Net assets are assets
minus liabilities. Equity consists of share capital and retained earnings.
Share capital represents how much the shareholders have invested in the business.
Retained earnings is the sum of all net incomes earned by a corporation over its life, less any
dividends distributed to shareholders. Distributions of net income to shareholders are called
dividends.
Drawings
If an owner drew a salary from the business, the payouts were recorded in the drawing account.
At the end of the accounting year, this account is credited the amount the owner withdrew for
salary, and the owner's equity account is debited. This shows the decrease in equity that the
owner used for his personal expenses.

13. Discuss the income statement; identify its purpose, types, major parts, and
elements.
An income statement communicates information about a business’s financial performance by
summarizing revenues less expenses over a period of time. Revenues are created when a
business provides products or services to a customer in exchange for assets. Assets are resources
resulting from past events and from which future economic benefits are expected to result.
Examples of assets include cash, equipment, and supplies.
Expenses are the assets that have been used up or the obligations incurred in the course of
earning revenues. When revenues are greater than expenses, the difference is called net income
or profit. When expenses are greater than revenue, a net loss results.

14. What are revenue, costs, expenditure, expenses, profit, loss, and income?
The term “revenue” is a measure of the financial impact on a company resulting from a
particular process. Revenue is not an asset; it is a measure of the increase in the company’s net
assets that results from sales of inventory and services.
Cost most closely equates to the term expenditure, so it means that you have expended
resources in order to acquire something, transport it to a location, and set it up. However, it
does not mean that the acquired item has yet been consumed. Thus, an item for which you
have expended resources should be classified as an asset until it has been consumed.
Examples of asset classifications into which purchased items are recorded are prepaid
expenses, inventory, and fixed assets.
Expenditure means the action of spending funds.
An expense is an outflow or reduction in net assets that was incurred by an organization in hopes
of generating revenues. Expense is a cost whose utility has been used up; it has been consumed.
When revenues are greater than expenses, the difference is called net income or profit. When
expenses are greater than revenue, a net loss results.

15. Discuss the different types of costs and give examples of each.
The costs included in cost accounting are as follows:
Direct Costs
Direct costs are related to producing a good or service. A direct cost includes raw materials,
labor, and expense or distribution costs associated with producing a product. The cost can easily
be traced to a product, department, or project. For example, Ford Motor Company (F)
manufactures cars and trucks. A plant worker spends eight hours building a car. The direct costs
associated with the car are the wages paid to the worker and the cost of the parts used to build the
car.
Indirect Costs
Indirect costs, on the other hand, are expenses unrelated to producing a good or service. An
indirect cost cannot be easily traced to a product, department, activity, or project. For example,
with Ford, the direct costs associated with each vehicle include tires and steel. However, the
electricity used to power the plant is considered an indirect cost because the electricity is used for
all the products made in the plant. No one product can be traced back to the electric bill.
Fixed Costs
Fixed costs do not vary with the number of goods or services a company produces over the short
term. For example, suppose a company leases a machine for production for two years. The
company has to pay $2,000 per month to cover the cost of the lease, no matter how many
products that machine is used to make. The lease payment is considered a fixed cost as it remains
unchanged.
Variable Costs
Variable costs fluctuate as the level of production output changes, contrary to a fixed cost. This
type of cost varies depending on the number of products a company produces. A variable cost
increases as the production volume increases, and it falls as the production volume decreases.
For example, a toy manufacturer must package its toys before shipping products out to stores.
This is considered a type of variable cost because, as the manufacturer produces more toys, its
packaging costs increase, however, if the toy manufacturer's production level is decreasing, the
variable cost associated with the packaging decreases.
Operating Costs
Operating costs are expenses associated with day-to-day business activities but are not traced
back to one product. Operating costs can be variable or fixed. Examples of operating costs,
which are more commonly called operating expenses, include rent and utilities for a
manufacturing plant. Operating costs are day-to-day expenses, but are classified separately from
indirect costs – i.e., costs tied to actual production. Investors can calculate a company's operating
expense ratio, which shows how efficient a company is in using its costs to generate sales.
Opportunity Costs
Opportunity cost is the benefits of an alternative given up when one decision is made over
another. This cost is, therefore, most relevant for two mutually exclusive events. In investing, it's
the difference in return between a chosen investment and one that is passed up. For companies,
opportunity costs do not show up in the financial statements but are useful in planning by
management. For example, a company decides to buy a new piece of manufacturing equipment
rather than lease it. The opportunity cost would be the difference between the cost of the cash
outlay for the equipment and the improved productivity vs. how much money could have been
saved in interest expense had the money been used to pay down debt.
Sunk Costs
Sunk costs are historical costs that have already been incurred and will not make any difference
in the current decisions by management. Sunk costs are those costs that a company has
committed to and are unavoidable or unrecoverable costs. Sunk costs are excluded from future
business decisions.
Controllable Costs
Controllable costs are expenses managers have control over and have the power to increase or
decrease. Controllable costs are considered so when the decision of taking on the cost is made by
one individual. Common examples of controllable costs are office supplies, advertising expenses,
employee bonuses, and charitable donations. Controllable costs are categorized as short-term
costs as they can be adjusted quickly.
16. Differentiate product costs and period costs.
Period costs and product costs are two categories of costs for a company that are incurred in
producing and selling their product or service. Below, we explain each and how they differ from
one another.
Product Costs
Product costs are the direct costs involved in producing a product. A manufacturer, for example,
would have product costs that include: Direct labor, Raw materials and Manufacturing supplies
Overhead that is directly tied to the production facility such as electricity. For a retailer, the
product costs would include the supplies purchased from a supplier and any other costs involved
in bringing their goods to market. In short, any costs incurred in the process of acquiring or
manufacturing a product are considered product costs.
Product costs are often treated as inventory and are referred to as "inventoriable costs" because
these costs are used to value the inventory. When products are sold, the product costs become
part of costs of goods sold as shown in the income statement.
Period Costs
Period costs are all costs not included in product costs. Period costs are not directly tied to the
production process. Overhead or sales, general, and administrative (SG&A) costs are considered
period costs. SG&A includes costs of the corporate office, selling, marketing, and the overall
administration of company business. Period costs are not assigned to one particular product or
the cost of inventory like product costs. Therefore, period costs are listed as an expense in the
accounting period in which they occurred.
Other examples of period costs include marketing expenses, rent (not directly tied to a
production facility), office depreciation, and indirect labor. Also, interest expense on a
company's debt would be classified as a period cost.
 17. Differentiate variable, fixed, and mixed costs.
Based on behavior, costs are categorized as either fixed, variable or mixed. Fixed costs are
constant regardless of activity level, variable costs change proportionately with output and mixed
costs are a combination of both.
Fixed Costs
Fixed costs are those which do not change with the level of activity within the relevant range.
These costs will be incurred even if no units are produced. For example rent expense, straight-
line depreciation expense, etc.
Fixed cost per unit decreases with increase in production.
Variable Costs
Variable costs change in direct proportion to the level of production. This means that total
variable cost increase when more units are produced and decreases when less units are produced.
Mixed costs or semi-variable costs have properties of both fixed and variable costs due to the
presence of both variable and fixed components in them. An example of mixed cost is telephone
expense because it usually consists of a fixed component such as line rent and fixed subscription
charges as well as variable cost charged per minute cost. Another mixed cost example is delivery
cost which has a fixed component of depreciation cost of trucks and a variable component of fuel
expense.

18. Discuss the statement of cash flow; identify its purpose, major parts, and sections.
A cash flow statement is a financial statement that provides aggregate data regarding all cash
inflows a company receives from its ongoing operations and external investment sources. It also
includes all cash outflows that pay for business activities and investments during a given period.
A company's financial statements offer investors and analysts a portrait of all the transactions
that go through the business, where every transaction contributes to its success. The cash flow
statement is believed to be the most intuitive of all the financial statements because it follows the
cash made by the business in three main ways—through operations, investment, and financing.
The sum of these three segments is called net cash flow.
Cash Flows From Operations
This is the first section of the cash flow statement covers cash flows from operating activities
(CFO) and includes transactions from all operational business activities. The cash flows from
operations section begins with net income, then reconciles all noncash items to cash items
involving operational activities. So, in other words, it is the company's net income, but in a cash
version.
This section reports cash flows and outflows that stem directly from a company's main business
activities. These activities may include buying and selling inventory and supplies, along with
paying its employees their salaries. Any other forms of in and outflows such as investments,
debts, and dividends are not included.
Companies are able to generate sufficient positive cash flow for operational growth. If there is
not enough generated, they may need to secure financing for external growth in order to expand.
For example, accounts receivable is a noncash account. If accounts receivable go up during a
period, it means sales are up, but no cash was received at the time of sale. The cash flow
statement deducts receivables from net income because it is not cash. The cash flows from the
operations section can also include accounts payable, depreciation, amortization, and numerous
prepaid items booked as revenue or expenses, but with no associated cash flow.
Cash Flows From Investing
This is the second section of the cash flow statement looks at cash flows from investing (CFI)
and is the result of investment gains and losses. This section also includes cash spent on
property, plant, and equipment. This section is where analysts look to find changes in capital
expenditures (capex).

When capex increases, it generally means there is a reduction in cash flow. But that's not always
a bad thing, as it may indicate that a company is making investment into its future operations.
Companies with high capex tend to be those that are growing.
While positive cash flows within this section can be considered good, investors would prefer
companies that generate cash flow from business operations—not through investing and
financing activities. Companies can generate cash flow within this section by selling equipment
or property.
Cash Flows From Financing
Cash flows from financing (CFF) is the last section of the cash flow statement. The section
provides an overview of cash used in business financing. It measures cash flow between a
company and its owners and its creditors, and its source is normally from debt or equity. These
figures are generally reported annually on a company's 10-K report to shareholders .
Analysts use the cash flows from financing section to determine how much money the company
has paid out via dividends or share buybacks. It is also useful to help determine how a company
raises cash for operational growth. Cash obtained or paid back from capital fundraising efforts,
such as equity or debt, is listed here, as are loans taken out or paid back. When the cash flow
from financing is a positive number, it means there is more money coming into the company
than flowing out. When the number is negative, it may mean the company is paying off debt, or
is making dividend payments and/or stock buybacks.

19. What is the relationship among financial statements (clearly indicate which
financial statement should be prepared first and why)?
The financial statements are comprised of the income statement, balance sheet, and statement of
cash flows. These three statements are interrelated in several ways, as noted in the following
bullet points:

 The net income figure in the income statement is added to the retained earnings line item
in the balance sheet, which alters the amount of equity listed on the balance sheet.
 The net income figure also appears as a line item in the cash flows from operating
activities section of the statement of cash flows.
 Changes in various line items in the balance sheet roll forward into the cash flow line
items listed on the statement of cash flows. For example, an increase in the outstanding
amount of a loan appears in both the liabilities section of the balance sheet (as an ongoing
balance) and in the cash flows from financing activities section of the statement of cash
flows (in the amount of the incremental change).
 The ending cash balance in the balance sheet also appears in the statement of cash flows.
 The purchase, sale, or other disposition of assets appears on both the balance sheet (as an
asset reduction) and the income statement (as a gain or loss, if any).
In short, the financial statements are highly interrelated. Consequently, when reviewing the
financial statements of an organization, one should examine all of the financial statements in
order to obtain a complete picture of its financial situation.
The income statement, sometimes called an earnings statement or profit and loss statement,
reports the profitability of a business organization for a stated period of time. In accounting, we
measure profitability for a period, such as a month or year, by comparing the revenues earned
with the expenses incurred to produce these revenues. This is the first financial statement
prepared as you will need the information from this statement for the remaining statements.
 20. Identify and discuss the different forms of business organizations and indicate what
types of financial statements they are expected to prepare (use types of activities
and form of ownership as a basis of classification).

An organization is a group of individuals who come together to pursue a common set of goals
and objectives. There are two types of business organizations: business and non-business. A
business organization sells products and/or services for profit. A non-business organization, such
as a charity or hospital, exists to meet various societal needs and does not have profit as a goal.
All businesses, regardless of type, record, report, and, most importantly, use accounting
information for making decisions. This book focuses on business organizations. There are three
common forms of business organizations — a proprietorship, a partnership, and a corporation.
Proprietorship
A proprietorship is a business owned by one person. It is not a separate legal entity, which means
that the business and the owner are considered to be the same entity. This means, for example,
that from an income tax perspective, the profits of a proprietorship are taxed as part of the
owner’s personal income tax return. Unlimited liability is another characteristic of a sole
proprietorship meaning that if the business could not pay its debts, the owner would be
responsible even if the business’s debts were greater than the owner’s personal resources.
Partnership
A partnership is a business owned by two or more individuals. Like the proprietorship, it is not a
separate legal entity and its owners are typically subject to unlimited liability.
Corporation
A corporation is a business owned by one or more owners. The owners are known as
shareholders.
A shareholder owns shares of the corporation. Shares are units of ownership in a corporation. For
example, if a corporation has 1,000 shares, there may be three shareholders where one has 700
shares, another has 200 shares, and the third has 100 shares. The number of shares held by a
shareholder represents how much of the corporation they own. A corporation can have different
types of shares; this topic is discussed in a later chapter. When there is only one type of share, it
is usually called common shares.
A corporation’s shares can be privately held or available for public sale. A corporation that holds
its shares privately and does not sell them publicly is known as a private enterprise (PE). A
corporation that sells its shares publicly, typically on a stock exchange, is called a publicly
accountable enterprise (PAE).
Unlike the proprietorship and partnership, a corporation is a separate legal entity. This means, for
example, that from an income tax perspective, a corporation files its own tax return. The owners
or shareholders of a corporation are not responsible for the corporation’s debts so have limited
liability meaning that the most they can lose is what they invested in the corporation.
In larger corporations, there can be many shareholders. In these cases, shareholders do not
manage a corporation but participate indirectly through the election of a Board of Directors. The
Board of Directors does not participate in the day-to-day management of the corporation but
delegates this responsibility to the officers of the corporation.