ACCT 229 - Chapter 1

accounting

information system that identifies, measures, records, and communicates financial information about a company’s business activities so decision-makers can make informed decisions

financial accounting

Accounting info that satisfies the needs of external decision-makers like investors, creditors, govt. agencies, labor unions, and financial analysts

objectives: providing decision-makers with info that assists them in assessing amounts, timing, and uncertainties of a company’s future cash flows

sole proprietorship

owned by one person

pros - easy to form

cons - “unlimited liability” - if someone gets hurt, owner is completely liable

separate entity for accounting purposes but NOT tax purposes (Economic Entity concept)

partnership

two or more owners

pros - easy to form

cons - “unlimited liability” shared btwn two owners

separate entity for accounting purposes but NOT tax purposes (Economic Entity concept)

corporation

sell shares of stock to investors - owners are shareholders

pros - limited liability, continuity of life/ease in transfer of ownership, opportunity to raise large capital through stock

cons - double taxation (corporation is taxed and so are profits shared with shareholders)

full separate for BOTH accounting and tax purposes (Economic Entity concept)

separate legal entity - can sue or be sued

financing activities

how a company pays for growth/expansion

either borrowing or issuing stock

investing activities

purchase and sale of the assets that are used in operations

long-term assets (buildings, equipment, vehicles)

operating activities

activities that earn revenue and generate expenses

day to day activities resulting in changes to current assets and liabilities and/or generating revenues and incurring expenses

Profits (Net Income)

NI = Revenues - Expenses

balance sheet (classified)

reports the resources (assets) owned by a company and the claims against those resources (liabilities/stockholders’ equity) at a specific point in time

shows financial position of company at a single point in time

balance sheet

Assets = Liabilities + Stockholders’ Equity

income statement (multi-step)

reports how well a company has performed (revenues, expenses, and income) over a period of time.

income statement

Net Income = Revenues - Expenses

retained earnings statement

reports how much of the company’s income was retained in the business and how much was distributed to owners over a period of time

shows how net income and dividends cause change in a company’s financial position during a period of time

statement of retained earnings

Beginning Retained Earnings + Net Income - Dividends = Ending Retained Earnings

statement of cash flows

reports the sources and uses of a company’s cash over a period of time

generally accepted accounting principles (GAAP)

common set of “rules” used to report US financial statements

measurement rules that say how we account for things in the book of records

statement of stockholders’ equity

beginning stockholders equity + new stock + net income - dividends = ending stockholders equity

current assets (balance sheet)

converted into cash, sold, or used up during current period (12 months)

listed in order of liquidity

cash/cash equivalents

marketable securities (short term investments in other companies)

accounts receivables

inventory

prepaid expenses (like insurance)

supplies

non-operating assets (balance sheet)

long term investments (stocks/bonds held for more than 12 months

operating assets (balance sheet)

plant, property, & equipment (fixed assets) - acquired for us in business rather than resale to customers - tangible assets

• land

• buildings

• equipment, vehicles, furniture, computers, etc

• minus accumulated depreciation on PPE/fixed assets that have limited “useful life”

intangible assets

intangible assets (balance sheet)

patent - exclusive right to manufacture/sell a product

copyright - protects artistic material

trademark - ipod, coca cola

franchise/license - exclusive right to operate in geographic area

goodwill - duh

current liabilities (balance sheet)

requires use of current assets to settle within the next 12 months

list in order of when obligation comes due

accounts payable

accrued expenses - have been incurred but not yet paid (utilities, rent, salaries/wages)

unearned revenue (deferred rev) - customer has paid, but we have not yet delivered goods/services (gift cards, subscriptions, tickets)

short term note payable (legal borrowing supposed by promising note)

long term liabilities (balance sheet)

long term note payable

bond payable

mortgage payable

stockholders’ equity (balance sheet)

claims of owners against the net assets of the firm

• contributed capital - investments made by owners (purchase of stock - Common Stock) - publicly sold stock, IPO and secondary offerings

• retained earnings - cumulative earnings of the company that have been retained (reinvested) by company

operating revenues (income statement)

inflows of assets as a result of performing a service or delivering good/product

ex. service revenue, sales revenue, etc

other gains (income statement)

inflows of assets as a result of incidental transaction

ex. interest revenue

operating expenses (income statement)

resources used to generate revenue

ex. cost of goods sold, utilities expense, rent expense, advertising exp

other losses (income statement)

decreases in assets as a result of an incidental transaction

ex. interest expense

working capital

helps measure liquidity in terms of ability to pay creditors

= Current Assets - Current Liabilities

want to maintain balance

limitations - historical vs fair market value and omissions

current ratio

useful to compare liquidity among companies

= Current Assets / Current Liabilities (expressed as %)

bigger % means company is better off

limitations - historical vs fair market value and omissions

gross profit ratio

analyze profitability

gross profit / sales

profit margin (return on sales)

analyze profitability

= Net Income / Sales

elements of annual report (form 10K)

letter from pres, chairman of the board

description of products - what is the core business, risks they face, etc

financial section

• management report - management discussion and analysis

• financial statements (balance sheet, income stmt, Stmt RE/Stmt SHE, stmt of cash flows

• notes to financial statements - supplemental info you should know

• management report on internal controls over financial reporting (bc of sarbanes oxley rules so they can prosecute if you lying)

independent auditor’s reports - yes or no about fairly representing wtv auditor assumes no responsibility just giving their opinion

Financial Accounting Standards Board (FASB)

US priv sector body given responsibility to develop GAAP

Securities & Exchange Commission (SEC)

federal agency that has broad powers to prescribe acct practices and standards to public companies that trade securities on major exchanges

can influence/override any FASB ruling but does not set the standards

American Institute of Certified Public Accountants (AICPA)

basically a club with dues - they administer CPA exam so they can also take it away

International Accounting Standards Board (IASB)

working towards a convergence of int’l financial reporting standards (IFRS) and GAAP

differences in standards

• accounting for inventories

• accounting for losses on income stmt

• accounting for PPE

• accounting for Research and Development

Public company accounting oversight board

five member body that sets auditing standards

management’s responsibility

ultimately responsible for completeness and accuracy of the financial statements

purpose of an audit

prepare report (opinion) to attest to the fairness of the financial stmt in accordance with GAAP

sarbanes-oxley act

passed in 2002 to reduce unethical corporate behavior

top management must certify accuracy of financial info, penalties for fraud by top management are more severe, increased independence of auditors, increased responsibility of boards of directors in their oversight role

key provisions of sarbanes oxley - management

must assess/report on effectiveness of company’s internal control structure/procedures over financial reporting

new rules req. a code of ethics be established/reported

new penalties exist for them in stmts are inaccurate or incomplete - SOX required CEO/CFO to certify annual financial statements

anonymous reporting (whistle-blower protection)

key provisions of sarbanes oxley - board of directors

strengthening them by implementing new rules for composition of them, req some to be independent of management

req audit committee members be independent of management

audit committee members must be financial experts

key provisions of sarbanes oxley - external auditors

stronger rules regarding auditor independence

auditors report to client’s audit committee rather than client’s management team

key provisions of sarbanes oxley - enforcement

Pubic Company Accounting Oversight Board (PCAOB) has power to regulate auditing firms

all accounting firms that audit publicly traded companies must register with PCAOB and follow rules