Chapter 1 The Role of Accounting in Business

1 Chapter 1 The Role of Accounting in BusinessTHELAW OFNAVIGATION Anyone can steer the ship, but ittakes a leader to chart the course. The 21 Irrefutable Laws of LeadershipDr. John C. MaxwellLearning Goals1 Describe the types and forms of businesses, Business strategies, valuechains, and the three Business activitiesof financing, investing, and Accounting and its role and illustrate the basic financial statements and how eight basic Accounting con-cepts underlying financial and illustrate how horizontalanalysis can be used to analyze andevaluate a company s Foods CorporationFor Milton Hershey, the founder of Hershey Foods Corporation, the ability to overcomefailure and to try, try again was a key to success. His first encounter with failure cameat the age of eighteen when a small candy shop he opened in Philadelphia failed after sixyears. His next two attempts at the candy-making Business also failed first in Chicagoand then in New York. After the New York failure, he returned to Lancaster, Pennsylva-nia, where once again he tried his luck in the candy Business by establishing the Lan-caster Caramel 1893, Hershey attended the Chicago International Exposition, where he became fas-cinated with German chocolate-making machinery.

2 He bought the equipment and soonbegan producing chocolate-coated caramels. The chocolate-coated caramels were so wellreceived that the Hershey Chocolate Company was organized as a subsidiary to the Lan-caster Caramel Company. In 1900, Milton Hershey sold the Lancaster Caramel Companyfor $1 million, but he retained the chocolate machinery and the rights to manufacturechocolate. He believed that a large market existed for chocolate candy that could be mass-produced at an affordable , Hershey Foods Corporation is America s leading chocolate manufacturer, pro-ducing more than a billion pounds of chocolate products each year. In addition to candy,the company has expanded to baking chocolate, chocolate drinks, chocolate milk mixes,ice cream toppings, cocoa mixes, and Reese s baking pieces. For the year ending Decem-ber 31, 2001, the company reported net sales of over $4 billion and net income of over$200 success of Hershey Foods brought wealth to the Hershey family.

3 So what did Mil-ton and his wife do with their wealth? First, they built a model town that included com-fortable homes and an inexpensive public transportation system for their Milton and his wife Catherine had no children of their own, they established aschool for orphan boys. Following Catharine s premature death in 1918, Milton endowedthe school with his stock in the Hershey Chocolate Company. Today, the 10,000-acreschool nurtures over 1,100 financially needy boys and girls in grades K-12. Through theHershey Trust Company, the school controls 76 percent of the voting shares of HersheyFoods Hershey Foundation was established in 1935. This foundation supports theHershey Museum, the Hershey Gardens, the Hershey Theatre, and the Hershey CommunityArchives. In addition, The Milton S. Hershey Medical Center of Pennsylvania State Uni-versity was established in 1963 with the aid of a $50 million award from The Milton Her-shey School Trust this Chapter and throughout this text, we focus on the corporate form of businessorganization and examples of corporations like Hershey Foods :Adapted from the Hershey Foods Corporation and Hershey, Pennsylvania, Web 1 The Role of Accounting in BusinessYour Need to KnowEvery day you interact with businesses like Hershey s.

4 You might buy a Hershey s candybar. You may eat lunch at McDonald sor Burger King, order a cup of coffee from Star-bucksor Seattle Coffee, or fill up your car with gas at an Exxonor BPgas station. Howdo these businesses influence you to buy their products? What are their underlying busi-ness strategies?As we begin our study of Accounting in this Chapter , we will first discuss the nature,types, activities, and strategies of businesses, such as Hershey, McDonald s, and doing so, we describe Business stakeholders and how businesses add value for their cus-tomers (you). We conclude the Chapter by discussing the role of Accounting in Business ,including financial statements, basic Accounting concepts, and how to use financial state-ments to evaluate a Business s Nature of BusinessYou are familiar with many large companies, such as General Motors, Barnes &Noble,and AT&T. You are also familiar with many local businesses, such as gas stations, gro-cery stores, and restaurants.

5 You may work for one of these businesses. But what do theyhave in common that identifies them as businesses?In general, a businessis an organization in which basic resources (inputs), such asmaterials and labor, are assembled and processed to provide goods or services (outputs)to come in all sizes, from a local coffee house to General Motors,which sells several billion dollars worth of cars and trucks each year. The customers of abusiness are individuals or other businesses who purchase goods or services in exchangefor money or other items of value. In contrast, a church is not a Business because thosewho receive its services are not obligated to pay for objective of most businesses is to maximize profits by providing goods or ser-vices that meet customer needs. Profit is the difference between the amount receivedfrom customers for goods or services provided and the amount paid for the inputs usedto provide the goods or services. Some businesses operate with an objective other thanto maximize profits.

6 The objective of such not-for-profit businesses is to provide somebenefit to society, such as medical research or conservation of natural resources. Inother cases, governmental units such as cities operate water works or sewage treatmentplants on a not-for-profit basis. Our focus in this text will be on businesses operatedto earn a profit. However, many of the concepts and principles also apply to not-for-profit of BusinessesThere are three different types of businesses that are operated for profit: manufac-turing, merchandising, and service businesses. Each type of Business has unique change basic inputs into products that are sold to in-dividual customers. Examples of manufacturing businesses and some of their productsare shown the types and forms of busi-nesses, Business strategies, value chains,and A glossary of terms appears at the end of each Chapter in the 1 The Role of Accounting in BusinessManufacturing BusinessProductGeneral MotorsAutomobiles, trucks, vansGeneral MillsBreakfast cerealsBoeingJet aircraftNikeAthletic shoesCoca-ColaBeveragesSonyStereos, televisions, radiosMerchandisingbusinesses also sell products to customers.

7 However, they do notmake the products but purchase them from other businesses (such as manufacturers). Inthis sense, merchandisers bring products and customers together. Examples of merchan-dising businesses and some of the products they sell are shown BusinessProductWal-MartGeneral merchandiseToys R UsToysBarnes &NobleBooksBest BuyConsumer provide services rather than products to customers. Examples ofservice businesses and the types of services they offer are shown BusinessServiceDisneyEntertainmentDelta Air LinesTransportationMarriott HotelsHospitality and lodgingMerrill LynchFinancialSprintTelecommunicationsFo rms of BusinessA Business is normally organized as one of three different forms: proprietorship, partner-ship, or corporation. A proprietorshipis owned by one individual. More than 70 per-cent of the businesses in the United States are organized as proprietorships. The popularityof this form is due to the ease and low cost of organizing.

8 The primary disadvantage ofproprietorships is that the financial resources available to the Business are limited to theindividual owner s resources. Small local businesses such as hardware stores, repair shops,laundries, restaurants, and maid services are often organized as a Business grows and requires more financial and managerial resources, it may be-come a partnership. A partnershipis owned by two or more individuals. Like propri-etorships, small local businesses such as automotive repair shops, music stores, beauty shops,and men s and women s clothing stores may be organized as partnerships. Currently, about10 percent of the businesses in the United States are organized as proprietorships, a partnership may outgrow its ability to finance its operations. Asa result, it may become a corporation. A corporationis organized under state or fed-eral statutes as a separate legal entity. The ownership of a corporation is divided intoshares of stock.

9 A corporation issues the stock to individuals or other businesses, who thenbecome owners or stockholders of the primary advantage of the corporate form is the ability to obtain large amounts ofresources by issuing shares of stock, which are ownership rights in the corporation. For6 Chapter 1 The Role of Accounting in Businessthis reason, most companies that require large investments in equipment and facilities areorganized as corporations. For example, Toys R Ushas raised over $800 million by is-suing shares of common stock to finance its operations. Other examples of corporationsinclude General Motors, Ford, International Business Machines (IBM), Coca-Cola, andGeneral 20 percent of the businesses in the United States are organized as , since most large companies are organized as corporations, over 90 percent ofthe total dollars of Business receipts are received by corporations. Thus, corporations havea major influence on the three types of businesses we discussed earlier manufacturing, merchandising, andservice may be either proprietorships, partnerships, or corporations.

10 However, because ofthe large amount of resources required to operate a manufacturing Business , most manu-facturing businesses are corporations. Likewise, most large retailers such as Wal- mart ,Sears, and JC Penneyare corporations. Because most large businesses are corporations,they tend to dominate the economic activity in the United States. For this reason, we fo-cus our attention in this text on the corporate form of organization. However, many ofthe concepts and principles that we discuss also apply to proprietorships and StrategiesHow does a Business decide which products or services to offer its customers? For exam-ple, should Best Buyoffer warranty and repair services to its customers? Many factorsinfluence this decision, but ultimately the decision is made on the basis of whether it isconsistent with the overall Business strategy of the Business strategyis an integrated set of plans and actions designed to enablethe Business to gain an advantage over its competitors, and in doing so, to maximize itsprofits.