Fundamental Accounting Principles-Chapter 1-Accounting in Business

Accounting

An information and measurement system that identifies, records, and communicates relevant, reliable, and comparable information about an organization's business activities. AKA...Language of Business

Purpose and importance of Accounting

It helps assess opportunities, products, investments, and social community responsibilities. Communicate data to help people make good decisions. For information to be to useful, it must be trusted.

Accounting Activities (exhibit 1.1 pg-4)

Identifying, Recording, Communicating

a. Identifying

select relevant transactions and events. Ex: Sale of iPhones by Apple and receipt of money TicketMaster

b. Recording

keep a chronological log of transactions and events measured in dollars. Input, Measure, and Log

c. Communicating

prepare accounting reports such as financial statements, which we analyze and interpret. Prepare, Analyze, and Interpret

Users of Accounting Information

External and Internal (exhibit 1.2 pg 5)

EXTERNAL USERS

are not directly involved in running the organization. Shareholders (investors), lenders, directors, customers, suppliers, regulators, lawyers, brokers, and the press. Limited assess to organization's information.

a. Lenders (creditors)

loan money or other resources to an organization. Ex: banks, savings and loans, co-ops, and mortgage and finance companies. Accounting reports assess whether an organization is likely to repay its loans with interest.

b. Shareholders (investors)

are the owners of the corporation. They use accounting reports for in deciding whether to buy, hold, or sell stock.

c. External (independent) auditors

examine financial statements to verify that they are prepared according to generally accepted accounting principles.

d. Nonexecutive employees and Labor unions

use financial statements to judge the fairness of wages, assess job prospects, and bargain better wages.

e. Regulators

have legal authority over certain activities of organizations. Ex: IRS, utility boards (use to set utility rates), security regulators (required for companies that sell stock to the public)

f. Voters, Legislators, and government

officials use accounting information to monitor and evaluate government receipts and expenses.

g. Contributors

to nonprofit organizations use accounting to evaluate the use and impact of their donations.

h. Suppliers

use accounting information to judge the soundness of a customer before making sales on credit.

i. Customers

use financial reports to assess the staying power of potential suppliers.

INTERNAL USERS

are directly involved in managing and operating an organization. CEO, CFO, CA-uditor E-executive, treasurer, and other executive and managerial-level employees.

a. Research and development managers

need information about projected costs and revenues of any proposed changes in products and services.

b. Purchasing mahnagers

need to what, when, and how much to purchase.

c. Human Resource managers

need information about employees' payroll, benefits, performance, and compensation.

d. Production managers

depend on information to monitor costs to ensure quality.

e. Distribution managers

need reports for timely, accurate, and efficient delivery of products and services.

f. Marketing managers

use reports about sales and costs to target consumers, set prices, and monitor consumer needs, tastes, and price concerns.

g. Service managers

require information on the costs and benefits of looking after products and services.

Financial Accounting

the area of accounting aimed at external users by providing them with general-purpose financial statements.

Opportunities in Accounting (exhibit 1.3-pg 6)

Financial, Managerial, Taxation, Accounting-related

Financial job Ex:

Preparation, Analysis, Auditing, Regulatory, Consulting, Planning, Criminal investigation

Managerial job Ex:

General accounting, Cost accounting, Budgeting, Internal auditing, Consulting, Controller, Treasurer, Strategy

Taxation job Ex:

Preparation, Planning, Regulatory, Investigations, Consulting, Enforcement, Legal services, Estate plans

Accounting-related Ex:

Lenders, Consultants, Analysis, Traders, Directors, Underwriters, Planners, Appraisers, FBI Investigators, Market researchers, Systems designers,

Ethics

Beliefs that distinguish right from wrong.

3 step process for making ethical decisions:

identify ethical concerns, analyze options, make ethical decision based off of weighing all good and bad consequences.

Fraud Triangle

Three factors must exist for a person to commit fraud: opportunity, pressure, rationalization

Internal controls

procedures set up to protect company property and equipment , ensure reliable accounting reports, promote efficiency, and encourage adherence to company policies. Ex: good records, physical controls (locks, passwords, guards), and independent reviews.

Generally Accepted Accounting Principles (GAAP)

the concepts and rules that govern financial accounting.

GAAP

aims to make information relevant, reliable, and comparable.

a. relevant

information affects decisions of users

b. reliable

information is trusted by users

c. comparable

information is helpful in contrasting organizations

Securities and Exchange Commission (SEC)

US government agency that has the legal authority to set the GAAP. SEC oversees proper use of GAAP by companies that raise money from the public through issuances of their stock and debt.

Financial Accounting Standards Board (FASB)

private sector group that sets both broad and specific principles

International Standards Accounting Board (ISAB)

demand arises when companies wish to raise money from lenders and investors in different countries. Independent group consisting of individuals from many countries

International Financial Reporting Standards (IFRS)

identify preferred accounting practices.

Principles and Assumptions of Accounting- 2 types (exhibit 1.7 pg-10)

1. General principles-basic assumptions, concepts, and guidelines for preparing financial statements (consist of at least 4 basic principles, four assumptions, and two constraints)

2. Specific principles-are detailed rules used in reporting business transactions and events.

ACCOUNTING PRINCIPLES-General principles (4)

1. Measurement

2. Revenue recognition

3. Expense recognition

4. Full disclosure

1. Measurement principle (AKA-Cost principle)

accounting information is based on actual cost. (if cash is given for a service, its cost is measured as the amount of cash paid.

2. Revenue recognition (ex of recording revenue pg-11; Decision Insight)

Revenues (sales) is the amount received from selling products and services. Principle provides guidance on when revenue must be recognized.

1. REVENUE is recognized when EARNED

2. Proceeds from revenue need nor be in cash

3. Revenue is measured by the amount of cash received plus the cash value of any other items received

3. Expense recognition (AKA-matching principle)

prescribes that a company record the expenses it incurred to generate the revenue reported.

4. Full disclosure

prescribes that a company report the details behind financial statements that would impact users' decisions.

ACCOUNTING ASSUMPTIONS-(4)

1. Going concern

2. Monetary unit

3. Time Period

4. Business entity

1. Going concern assumption

means that accounting information reflects a presumption that the business will continue operating instead of being closed or sold.

2. Monetary unit assumption

means that we can express transactions and events in monetary, or money, units.

3. Time period assumption

presumes that the life of a company can be divided into time periods, such as months and years, and that useful reports can be prepared from those periods.

4. Business entity assumption (exhibit 1.8 pg-11)

means that a business is accounted for separately from other business entities, including its owner.

3 legal forms: proprietorship, partnership, corporation.

a. Sole proprietorship

a business owned by one person. The business is not a separate entity from its owner. A court can order the owner to sell personal belongings...this UNLIMITED LIABILITY is a DISADVANTAGE.

ADVANTAGE- income is not subject to business income tax, but instead is reported on personal income tax.

b. Partnership

business owned by two or more people, called partners, which are jointly liable for tax and other obligations. (not legally separate from its owners). UNLIMITED LIABILITY for PARTNERS.

Three partnerships offer limited liability:

1. Limited Partnership (LP)-includes a general partner with unlimited liability and limited partner(s) with liability restricted to the amount invested.

2. Limited Liability Partnership (LLP)-restricts partners' liabilities to their own acts and the acts of individuals under their control. This protects an innocent partner from the negligence of another partner, yet all partners remain responsible for the partnership debts.

3. Limited Liability Company (LLC)-offers the limited liability of a corporation and the tax treatment of a partnership (and proprietorship).

c. Corporation

"C" corporation. business legally separate from its owner(s), it is responsible for its own acts and its own debts. A corporation acts through its managers, who are its legal agents.

Sarbanes-Oxley (SOX)

used to help curb financial abuses at companies that issue their stock to the public. SOX requires both accounting oversight and stringent internal controls. Results include transparency, accountability, and truthfulness in reporting transactions.

Dodd-Frank

1. Promote accountability and transparency 2. put an end to the notion of "too big to fail" 3. Protect the taxpayer by ending bailouts 4. Protect consumers from abusive financial services

Accounting Equation

ASSETS = LIABILITIES + EQUITY

The accounting system reflects two basic aspects of a company: what it owns and what it owes.

Assets

resources a company owns or controls expected to yield future benefits. cash, supplies, equipment, and land.

Receivable

an asset that promises a future inflow of resources. A company that provides a service or product on credit is said to have an account receivable from that customer

Liabilities

what a company owes its nonowners (creditors) in the future payments, products, or services. Creditors' claims on assets.Usually shown before equity in the equation because creditors claims must be paid before the claims owners

Payable

liability that promises a futuere outflow of resources.

Equity

EQUITY = ASSETS - LIABILITIES

"owner's equity or capital"; refers to claims of its owner. AKA-net assets or residual equity. Equity consists of 4 elements:

1. Owner, Capital

Owner Investments are inflows of resources such as cash and other net assets that an owner puts into the company.

2. Owner, Withdrawl

outflows of resources such as cash and other assets that an owner takes from the company for personal use

3. Revenues

increase equity from sales of products and services to customers. ex: Consulting services provided, facilities rented to others, commissions from services

4. Expenses

decrease equity

EXPANEDED ACCOUNTING EQUATION

ASSETS = LIABILITIES+(OWNER,CAPITAL-OWNER, WITHDRAWAL+REVENUES-EXPENSES)

NET INCOME

REVENUES-EXPENSES=NET INCOME

Bookkeeping/Recordkeeping

recording of transactions and events

External transaction

exchanges of value between two entities, which yield changes in the accounting equation.

Ex. the sale of the AppleCare Protective Plan by Apple

Internal transaction

are exchanges within an entity, which may or may not affect the accounting equation.

Ex. Twitter's use of its supplies, reported as expenses

Events

Refer to happenings happenings that affect the accounting equation and are reliably measured.

Transaction 1: Investment by Owner

'Owner Name', Capital; cash=equity

Transaction 2: Purchase supplies for cash

exchange of asset, cash for supplies. Decrease in cash equals the increase in supplies

Transaction 3: Purchase equipment for cash

exchange of asset, cash for equipment. Purchase of supplies and equipment changes the makeup of assets, but does not change the asset total.

Transaction 4: Purchase supplies on credit

acquires supplies in exchange for a promise to pay for them later. Increases assets in supplies, and liabilities (called accounts payable) increase in the same amount.

Transaction 5: Provide services for cash

**Revenue recognition principle requires that revenue is recognized when work is performed.

earn revenues by selling ad space to manufacturers and consulting clients. cash received at the time of the service is reflected in the accounting equation as increase in cash and in equity (revenue).

Transaction 6 and 7: Payment of expenses of cash

**Expense recognition principle requires that expenses are recognized when the revenue they help generate is recorded. Expenses are outflows of net assets which decrease equity.

the cost of rent and salary are expenses, as opposed to assets (the benefits are used within a certain time frame (monthly, weekly) and have no future benefit after that time...expense. reduce cash and equity,

Transaction 8: Provide services and facilities for credit

**(like transaction 5) records revenue when work is performed, not necessarily when cash is received

accounts receivable-bills client for rental of property

Transaction 9: Receipt of cast from accounts receivable

**involved no added client work, so no added revenue was recorded

**receipt of cash is not always arevenue

accounts receivable is paid. This does not change the total amount of assets and does not affect liabilities or revenue. Revenue was recognized when services were rendered (8), not when cash is now collected. The emphasis on the earning process instead of cash flows is a goal of the revenue recognition principle.

Transaction 10: Payment of accounts payable

decreases cash and decreases liability. Equity does not change. This event does not create an expense even though cash flows out.

Transaction 11: Withdrawal of cash by owner

withdrawal of cash for personal use decreases in equity are not reported as expenses because they are not part of the company's earning process. Withdrawals are not used in computing net income.

Financial Statements (4)

1. Income statement

2. Statement of owner's equity

3. Balance sheet

4. Statement of cash flows

1. Income statement

describes a company's revenues and expenses along with the resulting net income or loss over a period of time due to earning activities

2. Statement of owner's equity

explains changes in equity from net income (or loss) and from any owner investments and withdrawals over a period of time

3. Balance sheet

describes a company's financial position (types and amounts of assets, liabilities, and equity) at a point in time.

4. Statement of cash flows

identifies cash inflows (receipts) and cash outflows (payments) over a period of time