Financial Accounting: Tools for Business Decision Making Chapter 1

sole proprietorship

a business owned by one person

Pros of a sole proprietorship

•It is simple to set up

• It gives you control over the business, and

• More favorable tax treatment than corporations

Cons of forming a sole proprietorship

The proprietor is personally liable for all debts and legal obligations of the business

Partnership

A business owned by two or more persons associated as partners.

Reason for setting up a partnership

One individual does not have enough economic resources to initiate or expand the business.

Pros of forming a partnership

• Partners sometimes bring unique skills or resources to the partnership

• More favorable tax treatment than corporations

Cons of forming a partnership

Partners are personally liable for all debts and legal obligations of the business

Corporation

A business organized as a separate legal entity owned by stockholders

Pros of forming a corporation

• Shares of stock are easy to sell (transfer ownership)

• Individuals can become stock holders by investing relatively small amounts of money

• It is easier for corporations to raise funds

• Corporate stockholders have no personal legal liability

Cons of forming a corporation

• Corporate stockholders generally pay higher taxes

What is the purpose of financial information?

To provide inputs for decision-making.

What is accounting?

The information system that identifies, records and communicates the economic events of an organization to interested users.

Who are the users of financial information?

They can be divided broadly into two groups: internal users and external users.

Who are internal users?

Managers who plan, organize and run a business.

What information does accounting provide to its internal users?

Accounting provides internal reports, such as financial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year.

Who are the external users?

• Investors

• Creditors

• Taxing authorities

• Customers

• Labour unions

• Regulatory agencies

Why do investors use accounting information?

To make decisions to buy, hold, or sell stocks.

Why do creditors use accounting information?

To evaluate the risks of selling on credit or lending money.

Why do taxing authorities use accounting information?

To know whether the company complies with the tax laws.

Why do customers use accounting information?

To know whether a company will continue to honor product warranties and otherwise support its product line.

Why do labour unions use accounting information?

To know whether the owners have the ability to pay increased wages and benefits.

Why do regulatory agencies use accounting information?

To know whether the company is operating within prescribed rules.

What are the steps to solving an ethical dilemma?

• Recognize an ethical situation and the ethical issues involved

• Identify end analyze the principal elements in the situation

• Identify the alternatives and weigh the impact of each alternative on various stakeholders

What are the three principal types of business activity?

Financing, investing, and operating.

What are financing activities?

Transactions with creditors or investors used to fund either company operations or expansions.

What are the two primary sources of outside funds for corporations?

• Borrowing money (debt financing)

• Issuing/selling shares in exchange for cash (equity financing)

Creditors

Persons or entities to whom a company owes money

Liabilities

The amounts owed to creditors—in the form of debt and other obligations

Note payable

A written promissory agreement in which a borrower obtains a specific amount of money from a lender and promises to pay it back with interest over a predetermined time period

Bond Payable

A long-term liability that must be repaid at a particular date some years in the future

Common Stock

The total amount paid in by stockholders for the shares they purchase.

Dividends

Payments of cash from a corporation to its stockholders.

What are investing activities?

The purchase of the resources a company needs in order to operate.

Assets

Assets are the resources owned by a business.

Revenue

Revenue is the increase in assets or decrease in liabilities resulting from the sale of goods or the performance of services in the normal course of business.

What are the types of revenues?

Sources of revenue common to many businesses are sales revenue, service revenue, and interest revenue.

Inventory

Inventory is assets in the form of goods available for future sales to customers.

Account Receivables

Account receivables is right to receive payment in the future for the sale of goods or services that were not immediately paid for in cash.

Expenses

Expenses are the cost of assets consumed or services used in the process of generating revenues.

Net income

When revenues exceed expenses, net income results.

Net loss

When expenses exceed revenues, a net loss results.