Chapter Eight Key Terms Business 101

Accounting is?

The “language of business”

Accounting

A system for recognizing, organizing, analyzing, and reporting information about the financial transactions that affect an organization

Accounting’s goal

To provide users with relevant, timely information that can help them make better economic decisions

Who uses accounting?

• managers

• stockholders

• employees

• creditors

• suppliers

• government agencies

• news

• media

• competitors

• unions

Public accountants

Provide services such as tax preparation, external auditing, and management consulting to clients on a fee basis

Management accountants

Work within a company and provide analysis, prepare reports and financial statements, and assist managers

Government accountants

Perform accounting functions for local, state, or federal government agencies

Financial accounting

The branch of accounting that prepares financial statements for use by owners, creditors, suppliers, and other external stakeholders

Generally accepted accounting principles (GAAP)

A set of accounting standards that is used in the preparation of financial statements

Financial Accounting Standards Board (FASB)

The private board that establishes the generally accepted accounting principles used in the practice of financial accounting

Through GAAP, the FASB aims to ensure that financial statements are

• Relevant

• Reliable

• Consistent

• Comparable

Ethics in Accounting

Because of accounting improprieties and scandals, state accounting boards include ethics-related requirements

Three basic financial statements

balance sheet, income statement, and statement of cash flows

Three basic financial statements do what?

• Provide external stakeholders with a view of an organization’s financial condition

• Must appear in publicly traded companies’ annual reports

• Part of companies’ quarterly and annual filings with the Securities and Exchange Commission (SEC)

Balance sheet

A financial statement that reports the financial position of a firm by identifying and reporting the value of the firm’s assets, liabilities, and owners’ equity

Accounting equation

Assets = Liabilities + Owners’ Equity

Assets

Resources owned by a firm

Liabilities

Claims that outsiders have against a firm’s assets

Owners’ equity

The claims a firm’s owners have against their company’s assets (often called “stockholders’ equity” on balance sheets of corporations)

Income statement

The financial statement that reports the revenues, expenses, and net income that resulted from a firm’s operations over an accounting period

Revenue

Increases in a firm’s assets that result from the sale of goods, provision of services, or other activities intended to earn income

Expenses

Resources that are used up as the result of business operations

Net income

The difference between the revenue a firm earns and the expenses it incurs in a given time period

Statement of cash flows

The financial statement that identifies a firm’s sources and uses of cash in a given accounting period

Where does cash flow from?

• operating activities

• investing activities

• financing activities

Statement of retained earnings

Shows how retained earnings have changed from one accounting period to the next

Stockholders’ equity statement

• Shows how net income and dividends affect retained earnings

• Shows changes in stockholders’ equity, such as changes that arise from the issuance of additional shares of stock

The Independent Auditor’s Report

• Prepared after conducting an annual external audit of the financial statements

• Verifies that financial statements

• Are prepared in accordance with generally accepted accounting principles, Fairly present the firm’s financial condition

• Included in the annual report that a firm sends its stockholders

Checking Out the Notes to Financial Statements

• Disclose additional information about a firm’s operations, accounting practices, and special conditions

• Explain the specific accounting methods used to recognize revenue, value inventory, and depreciate fixed assets

• Disclose changes in accounting methods or any risks that a firm may face

Comparative Statements

• Put the balance sheet, income statement, and statement of cash flows of two or more years side by side

• Trace what happened to key assets and liabilities through several time periods

• Show increases or decreases in revenues or expenses

Horizontal analysis

Analysis of financial statements that compares account values reported on these statements through two or more years to identify changes and trends

Budgeting

A management tool that explicitly shows how a firm will acquire and use the resources needed to achieve its goals over a specific time period

Budgeting facilitates planning by requiring managers to?

• Translate goals into measurable quantities

• Identify the specific resources needed to achieve goals

Advantages of budgeting

• Helps managers specify how they intend to achieve goals set during the planning process

• Encourages communication and coordination among managers and employees

• Serves as a motivational tool

• Helps managers evaluate progress and performance

Top-down budgeting

Top management prepares the budget with little or no input from middle and supervisory managers

Bottom-up (or participatory) budgeting

• Middle and supervisory managers are allowed to participate actively in the creation of the budget

• Overstatement of needs or low budget goals creates budgetary slack

Operating budgets

Budgets that communicate an organization’s sales and production goals and the resources needed to achieve these goals

Financial budgets

Budgets that focus on the firm’s financial goals and identify the resources needed to achieve these goals

Master budget

A presentation of an organization’s operational and financial budgets that represent the firm’s overall plan of action for a specified time period

A static budget is based on?

a single assumed level of sales

Problems result when real-world sales vary considerably from the forecasted value

• Figures become inaccurate

• Can be avoided by preparing a flexible budget

A flexible budget is developed through?

A range of possible sales levels and appropriate budgeted level of costs

Managerial (or management) accounting

The branch of accounting that provides reports and analysis to managers to help them make informed business decisions

Cost

The value of what is given up in exchange for something

Out-of-pocket cost

A cost that involves the payment of money or other resources

Implicit cost

The opportunity cost that arises when a firm uses owner-supplied resources

Fixed costs

Costs that remain the same when the level of production changes within some relevant range

Variable costs

Costs that vary directly with the level of production

Direct cost

Costs that are incurred directly as a result of some specific cost object

Indirect costs

Costs that are the result of a firm’s general operations and are not directly tied to any specific cost object

Activity-based costing (ABC)

A technique to assign product costs based on links between activities that drive costs and the production of specific products