Accounting 229 Mays Business TAMU terms and formulas

What are the three forms of business organization

sole proprietorship, partnership, corporation

Sole Proprietorship Advantages

one single owner, easy to form

sole proprietorship disadvantages

Unlimited liability, separate entity for accounting purposes, but not separate for tax purposes

partnership disadvantages

unlimited liability, separate entity for accounting purposes but not for tax purposes

corporation advantages

limited liability, separate entity for tax and accounting, easy to transfer ownership, opportunity to gain capital through sale of stock

corporation disadvantages

Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)

types of business activities

operating, investing, financing

business operations

activities that earn revenue and generate expenses

business financing

how a company pays for growth :

borrowing (liabilities)

selling ownership (stock)

business investing

purchasing recourses (assets)

to be used in day to day operations and growth

What is accounting?

an information system with the purpose to identify, measure in $$ and communicate information about a company that is useful in making economic decisions

What are the 4 financial statements?

balance sheet, income statement, statement of stockholders equity, cash flow statement

balance sheet

"snapshot" of a companies finances at a single point in time

Assets = Liabilities + Shareholder(stockholder) Equity

A=L+SHE

Assets

Current assets:

cash

marketable securities

accounts receivable

supplies

inventory

prepaid expenses

Long Term Assets:

PPE/Fixed assets;

land

buildings

equipment

furniture

accumulated depreciation (contra asset)

Intangible assets (falls under Long term):

patents

copyright

trademark

franchise/license

goodwill

Liabilities

Current Liabilities:

accounts payable

accrued expenses such as;

wages payable, taxes payable, interest payable, income tax payable

unearned revenue

Short term notes payable

Long term liabilities;

Long term notes payable

bonds payable

mortgage payable

Shareholders equity

Contributed capital AKA common stock

Retained earnings

Income Statement

Revenue - expenses = net income

Statement of retained earnings

Beginning retained earnings

+ net income

- dividends

= ending retained earnings

statement of cash flows

cash flows from operating activities

+ cash flows from investing activities

+ cash flows from financing activities

= net increase or decrease in cash

+ cash at beginning of period

= cash at end of period

Multistep income statement

Sales revenue

- COGS

= gross profit

- operating expenses

= income from operations

+ other gains

+ interest revenue

- other losses

- interest expense

= income before taxes

- income tax expense

= net income

statement of shareholders equity

Beginning SHE

+ new stock

+ net income

- dividends

= ending SHE

Working capital

Current assets - current liabilities

current ratio

current assets / current liabilities

gross profit

Sales Revenue - COGS

gross profit ratio

( gross profit / sales revenue ) x 100

profit margin ratio

net income / sales revenue

GAAP

Generally Accepted Accounting Principles

a common set of rule used to report US financial statements

Who makes the accounting rules?

FASB, SEC, AIPCA

FASB

Financial Accounting Standards Board

Private sector body given the responsibility to develop GAAP

SEC

Securities and Exchange Commission

Federal government agency that has broad powers to prescribe accounting practices and standards to public companies that trade securities on the major exchanges like NASDAQ and NYSE

The SEC can influence or override any FASB ruling

AICPA

American Institute of Certified Public Accountants

professional organization of certified public accountants

what do non US companies use for accounting?

IASB

international accounting standards board

IASB (International Accounting Standards Board) does what

works towards a convergence of international financial reporting standards (IFRS) and GAAP

SOX act (Sarbanes-Oxley act)

aims to...

try and reduce unethical corporate behavior and financial reporting

decrease the likelihood of corporate scandals

As a result...

Top management must certify accuracy of the financial information

penalties for financial fraud by top management are much more severe

ALL PUBLICLY TRADED COMPANIES THAT TRADE ON THE US STOCK EXCHANGE MUST COMPLY WITH THIS LAW

There are 4 key provisions of the SOX act

Management, Board of Directors, External Auditors, Enforcement

4 provisions of Management ( SOX act )

1- management must asses and report on the effectiveness of the companies internal control structure and procedures over financial reporting

2- new rules require a code of ethics to be established and reported

3- new punishment exists for management if the financial statements are incorrect or incomplete. SOX requires both the CFO and CEO to certify the annual financial statements.

4- Firm must provide a mechanism for anonymous reporting of fraudulent activities, AKA whistleblower protection

2 provisions of Board of Directors ( SOX act )

1- SOX seeks to strengthen the board by implementing new rules for the composition of the board of directors, requiring some directors to be independent of management

2- SOX requires audit committee members (made up of the board of directors) t0 be independent from management

2 provisions of external auditors ( SOX act )

1- new rules for auditors include stronger rules regarding auditor independence (Audit firms can no longer provide management consulting services to its audit clients)

2- auditors report to the clients audit committee rather than to the clients management team

2 provisions of enforcement ( SOX act )

1- The new PCAOB -- public company accounting oversight board -- has the power to regulate auditing firms

2- all accounting firms that audit publicly traded companies must register with the PCAOB and follow its rules

primary objective for financial reporting

to provide economic information about a company that is useful in making an informed decision

this means that the stakeholder wants to be able to analyze financial statements to determine if they want to invest or not

for financial information to be useful it has these 7 characteristics

Understandability

relevance

faithful representation

comparability

consistency

verifiability

timeliness

materiality

understandability

info should be comprehensible to those willing to spend the time to understand it

Relevance

information makes a difference in the decision making

similar to materiality

faithful representation

complete, neutral, and free from error

comparability

between companies

disclosure of what accounting methods have been used by a company

being able to compare financial statements between companies because similar methods have been used

consistency

one company

using the same accounting techniques between different periods in the same company

verifiability

independent parties can agree upon measurement

timeliness

info is presented while still relevant and in a timely manner

materiality

$$$ amount of a transaction might effect how a transaction is recorded

taking into account the size of transactions and their relevance to decision makers

8 underlying assumptions and principals of accounting

help the decision maker to understand what accounting information reports as well as inherent limitations

economic entity

going concern

monetary unit

time period assumption

cost principal

conservatism principal

revenue recognition principal

expense principal

Economic Entity Assumption

business transactions are separate from the personal transactions of the owners

Going Concern Assumption

a company will continue to operate for the foreseeable future without forced liquidation

Monetary Unit Assumption

all information will be measured in USD

time period assumption

the long life of a company can be reported over a series of shorter time periods

Cost Principle

assets are recorded at their original or historical cost; what the company paid for them at that time

Conservatism Principle

never wanting to overstate assets or revenues or understate liabilities or expenses

revenue recognition principal

record revenue in the period in which we earn it

expense principal

expenses are recorded in the period which they are incurred

DEAD CLEAR

Debits increase

Expenses

Assets

Dividends

Credits increase

Liabilities

Equity (shareholders equity)

Accumulated depriciation

Revenues

Deferred revenue

cash is being paid or received BEFORE the revenue is recognized

C(cash) comes before D(deferral)

often seen as unearned revenues

liability

Deferred Expense

cash is being paid or received BEFORE the expense is recognized

C(cash) comes before D(deferral)

often seen as prepaid expenses

asset

accrued revenue

cash is being received AFTER revenue is recognized

A(accrued) comes before C(cash)

often seen as accounts receivable

asset

Accrued expense

cash is being received AFTER expense is recognized

A(accrued) comes before C(cash)

often seen as expense payable

liability