Financial Accounting for Undergraduates: Chapter 1 - Financial Accounting and Business Decisions

accounting is

the language of business

How do companies rely upon accounting for success?

1. Using financial reports to judge its performance and that of its managers

2. Using accounting controls to monitor its inventory

3. Using accounting data to assess the amount and timing of dividend payments to shareholders

Forms of Business Organizations

1. Sole proprietorship

2. Partnership

3. Corporation

Business Activities

1. Financing

2. Investing

3. Operating

Accounting Information and Its Use

1. External users

2. Internal users

3. Ethics and accounting

Information Dissemination

1. Accounting process

2. Generally Accepted Accounting Principles

3. International Financial Reporting Standards

4. Financial statements

Other Annual Report Components

1. Notes to financial statements

2. Independent auditor's report

3. Management's Discussion and Analysis

FASB Conceptual Framework

1. Objectives

2. Elements

3. Characteristics

4. Recognition and measurement

Only the (BLANK) is viewed under the law as a legal entity separate and distinct from its owners

corporation

A (BLANK) has an unlimited life, which means that it will continue to exist indefinitely unless it is formally dissolved

corporation

The life of a sole proprietorship or partnership is

limited by the participation of the existing owners

If an owner dies or withdraws in a sole proprietorship or partnership

the business typically ends as well

Sole proprietorship

is a business owned by one person; most common

The primary advantage of the sole proprietorship is its

ease of formation

As the only owner, the sole proprietor

makes all of the decisions affecting the business

A sole proprietorship enjoys

certain income tax advantages relative to a corporation in that the income of that business is not taxed

In a sole proprietorship income

is included as part of the owner's income that is reported to the taxation authorities

A partnership

is a voluntary association of two or more persons for the purpose of conducting a business

Partnerships and sole proprietorships differ principally with respect to the

number of owners

Partnerships can be as small as

two people or as large as the biggest accounting or legal firms

Partnerships are also

easy to establish

Because a partnership involves multiple owners, the partners should

establish the rights and obligations of each partner to avoid any misunderstandings that might lead to disputes and lawsuits

An advantage of the partnership form over the sole proprietorship is the

broader skill set that multiple partners can bring to a business

Partnerships also enjoy

the same income tax advantage as sole proprietorships

A corporation

is a legal entity created under the laws of a state or the federal government

A corporation can have as

few as one owner but most have many owners

The owners of a corporation receive

shares of stock

Owners of a corporation are referred to as

stockholders or shareholders

Corporations are a

separate legal entity and must pay income taxes on their profits

Corporations face

double taxation because the income of the corporation is taxed and stockholders also pay taxes on dividends

The corporation is the

dominant organizational form in terms of the volume of business activity

Most businesses start off as either a sole proprietorship or as a partnership,

some outgrow and convert to the corporate form

Two primary reasons for converting a sole proprietorship or a partnership to the corporate form of business are

the relative ease of raising capital to grow the business and the protection afforded to stockholders against personal liability

An advantage of the corporate form is the

relative ease of selling ownership shares

Stock exchanges, such as the New York Stock Exchange (NYSE),

exist to enable stockholders to readily buy and sell their ownership shares

Selling an ownership interest in a sole proprietorship or a partnership is a more

difficult and time-consuming event

Proprietorship bullet points

1. One owner control

2. Business not taxed, but owner taxed

3. Not legal entity

4. Limited life

Partnership bullet points

1. Shared owner control

2. Business not taxed, but owners taxed

3. Not legal entity

4. Limited life

Corporation bullet points

1. All types of owner control

2. Business taxed and owners taxed

3. Separate legal entity

4. Unlimited life

Every business, regardless of its organizational form, its industry, or its size is involved in three types of business activities

1. financing

2. investing

3. operating

Financing activities are generally categorized as either

debt financing or equity financing

Debt financing involves

borrowing money from sources such as a bank by signing a note payable or directly from investors by issuing bonds payable

The individuals or financial institutions that lend money to companies are called their

creditors

Debt financing involves an obligation to

repay the creditor both the amount initially borrowed, called the principal, and an interest fee

Equity financing involves

selling shares of stock to investors

Investors that purchase shares of stock are buying

an ownership interest in the company

The owners of a company's stock may also receive

dividend payments when the company decides to distribute some of its profits

Investing activites

involve the acquisition and disposition of items that will be used to carry out the company's business plans

Items in investing activities are referred to as

assets

Land, buildings, and equipment is is often referred to as

property, plant, and equipment (PP&E)

The day-to-day activities of producing and selling a product or providing a service are referred to as

operating activities

If a company's operating activities generate excess cash, then the excess cash can be used to either

finance additional investments, repay the company's creditors, or pay dividends to shareholders

purchase factory, acquire land, buy equipment

Investing Activities

sell products, buy supplies, conduct marketing

Operating activities

issue stock, obtain loans

financing activities

The users of accounting information are classified by their relation to a business as either

external users or internal users

By U.S. law, publicly owned businesses must publish financial statements

annually and quarterly

The subset of accounting that produces publicly available financial statements that detail results of operations, cash flows, and financial position is referred to as

financial accounting

To establish the validity of financial statements, most businesses have their financial data

audited by an independent public accountant

Publicly owned businesses are required to have their

financial statements audited

The independent auditor expresses a professional opinion as to whether the financial statements are fairly presented

in conformity with generally accepted accounting principles

The four largest U.S. public accounting firms, referred to as the Big Four

1. Deloitte & Touche

2. Ernst & Young

3. KPMG, LLP

4. PricewaterhouseCoopers

User Group for: How does the profitability of Target compare to that of WalMart?, How does Bank of America Corporation compare with Wells Fargo & Company in terms of firm size?

Potential investors and current stockholders (external)

User group for: Will Delta Airlines be able to repay its creditors in a timely fashion?, Is it safe to provide a bank loan to the Federal Express Corporation?

Creditors and lenders (external)

User group for: Is Tesla Motors, Inc. reporting the proper amount of taxable income?, Is Duke Energy's rate hike justified by its operating costs?

Taxation authorities and regulators (external)

To provide the internal management of a company with the data needed for decision making and the efficient management of the business.

managerial accounting

User group for: What is the optimal price to sell the Samsung Galaxy phone to maximize the company's sales revenue?, Was the promotional campaign by Netflix successful in promoting the company's Stranger Things series?

Marketing Department (internal)

User group for: How much is the Olive Garden restaurant chain contributing to the overall profitability of its parent company, the Darden Restaurant Group?, What is the projected profitability of the General Motors' Chevrolet brand for the coming year?

Management Team (internal)

User group for: Is there sufficient cash available for Hewlett Packard to buy back a large amount of its outstanding common stock?, Will General Electric have sufficient cash flow to pay its short-term expenses?

Finance Department (internal)

deals with the values, rules, and justifications that govern one's wat of life

Ethics

Well-known accounting scandals

Enron, WorldCom, and Lehman Brothers

Professional organization for CPAs

American Institute of Certified Public Accountants (AICPA)

Professional organization for accountants employed in the private sector

Institute of Management Accountants (IMA)

U.S. Congress passed in 2002 with the goal of restoring investor trust by reducing the likelihood of future accounting scandals

Sarbanes-Oxley Act

Often referred to as SarBox or SOX

Sarbanes-Oxley Act

Some changes required by the Sarbanes-Oxley Act

1. Company's top management must certify in writing the accuracy of its reported financial statement information, and these executives risk criminal prosecution for fraudulent certification

2. Companies must now report on the internal controls put into place to help deter errors in the financial reporting process

vitally important in many types of criminal investigations, from financial statement fraud, to money laundering, to massive investment frauds

forensic accounting

the process of measuring economic activity of an entity in monetary terms and communicating results to users

accounting

The accounting process consists of two principle activities

measurement and communication

must (1) identify the relevant economic activities of a business, (2) quantify these economic activities, and (3) record the resulting measures in a systematic manner.

Measurement process

Measurement process is done in

monetary terms

(1) prepares financial reports to meet the needs of the user and (2) helps interpret the financial results for that user.

communication process

financial statements in the currency and language of other countries so that potential foreign investors can more readily understand the company's financial performance and conditiong

convenience translations

financial statements are prepared under the same standards and procedures

generally accepted accounting principles (GAAP)

Who develops generally accepted accounting principles in the United States?

Financial Accounting Standards Board (FASB), American Institute of Certified Public Accountants (AICPA), and the U.S. Securities and Exchange Commission (SEC)

Regulates the interstate sale of stocks and bonds and requires companies under its jurisdiction to submit audited annual financial statements to the agency which it then makes available to the general public.

U.S. Securities and Exchange Commission (SEC)

a nongovernmental entity whose pronouncements establish U.S. GAPP

Financial Accounting Standards Board (FASB)

approves auditing standards known as generally accepted auditing standards (GAAS) and monitors the quality of financial statements and audits

Public Company Accounting Oversight Board (PCAOB)

the organization that has taken the lead in formulating international accounting principles

International Accounting Standards Board (IASB)

The accounting standards formulated by the International Accounting Standards Board (IASB) are referred to as the

International Financial Reporting Standards (IFRS)

IFRS is pronounced as

eye furs

Was organized in 1984 to formulate generally accepted accounting principles for state and local governments

Governmental Accounting Standards Board (GASB)

4 basic financial statements

balance sheet, income statement, statement of stockholders' equity, and statement of cash flows

The balance sheet is also referred to as the

statement of financial position

a listing of a firm's assets, liabilities, and stockholders' equity as of a given date, usually the end of an accounting period

balance sheet

The balance sheet depicts a framework called the

accounting equation

company's resources

assets

creditor claims on those resources

liabilities

owner claims on those resources

stockholders' equity

Assets = Liabilities + Stockholders' equity or Resources of a company = Claims on resources

accounting equation