Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 1 The Role of Accounting in Business 11

When a business borrows money, it incurs a liability. A liabilityis a legal obliga-
tion to repay the amount borrowed according to the terms of the borrowing agree-
ment. For example, when you use your credit card, you incur an obligation to pay the
issuer (bank). When a business borrows from a vendor or supplier, the liability is
called an account payable. In such cases, the business is buying on credit and promis-
ing to pay according to the terms set forth by the vendor or supplier. Most vendors
and suppliers require payment within a relatively short time, such as 30 days. As of
December 31, 2004, Hershey Foods Corporationreported approximately $472 million
of accounts payable.
A business may borrow money by issuing bonds. Bondsare sold to investors and
normally require repayment with interest at a specific time in the future. Bonds are a
type of long-term financing, with a face amount that is normally due after several years
have passed. In contrast, the interest on bonds is normally paid semiannually. Bond
obligations are reported as bonds payable, and any interest that is due is reported as
interest payable. Examples of well-known companies that have bonds outstanding
includeAmerican Telephone and Telegraph (AT&T),John Deere, and Xerox.
Most large corporations also borrow money by issuing a note payable. A note
payablerequires payment of the amount borrowed plus interest. Notes payable may
be issued either on a short-term or a long-term basis.
A business may finance its operations by issuing shares of ownership. For a cor-
poration, shares of ownership are issued in the form of shares of stock. Although cor-
porations may issue a variety of different types of stock, the basic type of stock issued
to owners is called common stock. For our purposes, we will use the term capital stock
to include all the types of stock a corporation may issue.^2 Investors who purchase the
stock are referred to as stockholders.

Bank and/or

Owners

Purchasing

Customers and

Suppliers

Business

Business Activities

FINANCING

ACTIVITIES

INVESTING

ACTIVITIES

OPERATING

ACTIVITIES

2 Types of stock are discussed in Chapter 11, “Stockholders’ Equity: Capital Stock and Dividends.”