Summary of Chapter 1 – Warren Text
Focus of text is on businesses operated to earn a profit. Many of the same principles apply to
not-for-profit businesses. In general, a business is an organization in which basic resources
(inputs) such as material and labour are assembled and processed to provide goods and
services (outputs) to customers. The objective of most businesses is to maximize profits by
providing goods or services to meet customer needs.
Types of Businesses
1) Manufacturing - companies that change basic inputs into products that are sold to
2) Merchandising – companies that sell products to customers, however, they do not make
the products, but purchase them from other companies
3) Service – companies that provide service(s) rather than products to customers
Forms of Business
1) Proprietorship – a business owned by one individual
2) Partnership – a business owned by two or more individuals
3) Corporations – organized under provincial or federal statutes as a separate legal entity.
Ownership of a corporation is divided into shares of stock. The stock is issued to
individuals or other corporations who then become owners of the corporation
4) Limited liability company – combines attributes of the partnership and corporate forms
of ownership. This business type can be organized like a corporation but it can elect to
be taxed as a partnership. Liability of the owners is then limited to their investments in
Some features of the forms of business:
Sole Proprietorship Partnership Corporation
- Easy to form - Easy to form - More difficult to form
- Unlimited liability - Unlimited liability - Limited liability
- Limited life - Limited life - Unlimited life
- Limited access to - Moderate access to - Extensive capital
capital capital accessible
- Taxed as individual - Taxed as individuals - Taxed as an entity
How a Company Makes Money
The goal of a business is to make money by providing goods and services to its customers.
Ultimately, the decision is based on how the business plans to gain an advantage over its
competitors, and in doing so, to make money and maximize profits.
Generally, businesses gain an advantage over their competition by using either a low-cost or a
premium cost emphasis.
Under the low-cost emphasis, a business designs and produces products or services at a lower
cost than its competitors. These companies sell no-frill, standardized products and/or services.
Under the premium-price emphasis, a company tries to design and produce products or
services that serve unique market needs allowing it to charge premium prices.
There are also companies that will adopt both strategies as they look to attract customers at
both ends of the spectrum and broaden their appeal.
A business stakeholder is a person or entity that has an interest in the economic performance
and well-being of a business. See the list below-
1) Capital market stakeholders provide major financing for the business – e.g. banks,
2) Product or service market stakeholders are the buyers of products or services and
vendors to the business – e.g., customers and sullpiers
3) Government stakeholders collect taxes and fees from the business and its employees –
e.g., federal, provincial, city governments
4) Internal stakeholders are the individuals employed by the business and include the
employees and managers
All businesses engage in three activities:
1) Financing – involves obtaining funds to begin and operate a business. Financing may
take the form of borrowing or issuing shares of ownership. Most businesses use both
forms of financing. If a company borrow money, it incurs a liability ( a legal obligation to
repay the amount borrowed according to the terms of the agreement). Anything
described as payable is considered to be a company liability – eg., notes payable,
accounts payable, bank loan (payable by inference). If the business finances by issuing
shares of capital, it is rewarding these purchases by a share of company stock . This
suggests that people who hold shares in a company are the owners of the company.
They get their return on their investment in the form of a dividend payment.
Companies that finance with capital (i.e., shares of stock) use those funds for their
2) Investing – involves using the funds obtained from financing (i.e., cash, which is also an
asset) to obtain the necessary assets to start and operate a business. Any item that is a
receivable is an asset. Prepaid items are considered assets as are plant and equipment
3) Operating – involved using the acquired assets to facilitate the running (operating) of a
business. This is the phase of the business in which revenues are earned, operating
expenses (expenses incurred to run the business are incurred), and the residual is
considered to be the company profit. Of course, if the expenses exceed the revenue, it
can be said that the company is operating at a loss. The revenue from the sale of
products is called sales; the revenue earned from the sale of a service is called fees
Accounting and its Role in Business
Stakeholders get their information about the financing, investing and operating activities in a
business from accounting. Accounting provides the information for managers to use in
operating the business. Accounting also provides information to other stakeholders to use in
assessing the economic performance and condition of the business.
Accounting can be defined as an information system that provides reports to stakeholders
about the economic activity and condition of the business. Accounting is sometimes called the
language of business because this is the means by which accounting information is
communicated to stakeholders.
FYI – the branch of accounting that is associated with preparing reports for users external to the
business is called financial accounting.
The branch of accounting that is used to guide management in making decisions is called
The focus of this text is financial accounting; financial accounting has two major objectives:
1) To report the financial condition of a business at a point in time
2) To report changes in the financial condition of a business over a period of time
The objectives of accounting are satisfied by (1) recording the economic events affecting a
business and then (2) summarizing the impact of these events on the business in financial
reports called financial statements.
Financial statements report the financial condition of a business at a point in time and changes
in financial condition over a period of time. There are four basic financial statements that meet
Financial Statement Financial Statement Objective
Income Statement Reports change in financial condition
Retained Earnings Statement Reports change in financial condition
Balance Sheet Reports financial condition
Statement of cash flows Reports change in financial condition
The statements are normally prepared in the order given above.
Income statement summarizes the revenue earned and expenses incurred over a specific
period of time – a month, half-year or a year.
Formula for the Income Statement : Net Income (Loss) = Revenue - Expenses
Retained Earnings statements are a summary of the changes in the earnings retained by the
company for a specific period of time., e.g., a month or a year.
Formula for Retained Earnings:
Retained Earnings (end) = Ret. Earn.(begin) + Net Income – Dividends Paid
Balance Sheet is a list of assets, liabilities and stockholders’ equity as of a specific date, usually
at the close of a the last day of a month or year.
Formula for the Balance Sheet: Assets = Liabilities + Shareholder Equity
(please note that shareholder equity is made up of two parts – Capital stock and retained
earnings. The value of stockholder equity changes in total because of the changes that take
place in the retained earnings part of the equity account. The capital stock value will change
only if additional shares are issued and sold)
Statement of cash flows is a summary of the cash payments and cash receipts for a specific
period of time, usually a month or a year. For all intents and purposes, the statement of cash
flows is a review of all of the activity taking place in the cash account with respect to the
activities of financing, investing and operating.
There are rules for accounting (called generally accepted accounting principles or GAAP) that
determine the proper content of financial statements, so that stakeholders can compare the
financial condition and operating income and operating results across companies and over
The concepts are as follows:
1. Business Entity Concept – applies accounting to a specific entity for which stakeholders
2. Cost Concept – determines the amount in initially entered into the accounting records
for purchases. Other texts will call it the historical cost concept which means that you
use the purchase value of the item in your books, not the value that the item could be
3. Going Concern Concept – an assumption is made that a business is able to continue its
operations for an indefinite period of time
4. Matching Concept – in accounting revenues earned for a period are matched with the
expenses incurred in generating the revenue. When revenue is recorded , it is
generally referred to as revenue recognition
5. Objectivity Concept – infers that the entries in accounting records and the data reported
on financial statement be supported by objective evidence.
6. Unit of Measure Concept – since money is common to all business transactions, it is thus
considered to be the unit of measure for reporting
7. Adequate Disclosure – infers that the statements, related footnotes and other
disclosures should contain all relevant data a reader needs to understand the financial
condition and performance of a business
8. Accounting Period Concept – the process in which accounting data are recorded and
summarized in financial statements is a period process. After the accounting process is
completed for one cycle, a new period begins and the process repeats itself (from raw
data to the preparation of financials)