AC 224 chapter 1

accounting

the process of identifying, recording, and communicating economic events of an organization to interested users

internal users

managers of a company; concerned with providing insider users with information to facilitate planning and control

external users

users who are not directly involved with operations of a business; obtain information from financial statements and filings with the government

examples of external users

• stockholders

• bondholders, bankers, and creditors

• government agencies

• trade associations

• stockbrokers

• financial analysts

financial accounting

provides economic and financial information to external users

ethical decision model

identification (recognize ethical dilemma)

analysis (analyze key elements in situation)

analysis (list alternatives and evaluate impact of those impacted)

resolution (select best alternative)

general accepted accounting principles (GAAP)

refers to the various methods, rules, practices and procedures that are needed to regulate prep of financial statements

Sarbanes-Oxley Act (SOX)

passed by congress in 2002; est. Public Company Accounting Oversight Board; required that external auditors report directly to company’s audit committee; clause prohibiting accounting firms from providing services to other audit clients

Financial Accounting Standards Board (FASB)

sets accounting standards for the US (determine rules for financial statements)

Securities and Exchange Commission (SEC)

oversees US financial markets and accounting standard setting boundaries (determine rules for financial statements)

International Accounting Standards Board (ISAB)

the board responsible for developing worldwide accounting standards (determine rules for financial statements)

how to know if quality of disclosed information is good or not?

information is good if it’s both relevant and a faithful representation

relevant information

information that is useful to decision making process (uses past financial events to help predict future and info is timely)

faithful representation

info is complete, neutral (free from bias), and free from error

2 measurement principles used by GAAP

• historical cost principle

• fair value principle

historical cost principle

• assets are recorded at cost when initially acquired

• assets continue to be recorded at cost on balance sheet until disposed by business

• we record at cost until we sell it

fair value principle

assets and liabilities are reported at fair value

fair value

the price received to sell an asset or settle a liability

something’s worth if sold right now

economic entity

assumption requires identifiable, specific entry be subject of set of financial statements (personal expenses —> personal excel and business expenses —> business excel)

going concern

assumption that a business is not in process of liquidation and that it will continue indefinitely into the future; justifies the use of cost as basis for valuation

time period assumption

assumption that it is possible to prepare an income statement that accurately reflects net income or earnings for a specific time period; most accurate point in time to measure earnings of a business is at end of life; cleanly slice of time to see operations

monetary unit

yardstick used to measure amounts in financial statements; assumes that monetary united used is relatively stable

business entities

a form of organization to distinguish those that are organized to earn money; sole proprietorships, partnership, and corporations

sole proprietorships

characterized by a single owner; affairs of owner and business must be kept separate; business profits taxes on individual’s tax return

economic entity concept

requires that a single, identifiable unit of organization be accounted for in all situations

partnership

a business owned by two or more individuals; an agreement is needed when the partnership begins to determine how much each partner will contribute to the business and profits will be divided; law firms and accounting firms

corporations

a form of entity organized under the laws of a particular state; owners have shares of stock

nonbusiness entities

operate for some purpose other than to earn a profit and do not have an identifiable owner; use fund accounting

accounting equation

assets = liabilities + stockholder’s equity

asset

a future economic benefit to a business; can be tangible (cash, equipment, buildings, etc.) or intangible (patents)

liability

an obligation of business (referred to as a payables or bonds); ownership ends when loan has been prepaid

equity (common stock)

the dollar amount of stock sold to public; ownership ends when stockholders sell their shares

what is stockholder’s equity made up of

common stock and retained earnings

retained earnings

the owners claims to the company’s assets that result from earnings that have not been paid out in dividends

revenues

the inflow of assets resulting from the sale of products or services; represents dollar amount of sales of products or services for a specific period of time

expenses

the outflow of assets resulting from the sale of goods and services; must be incurred to operate a business

dividends

the distribution of cash or other assets to stockholders; dividends reduced retained earnings; not an expense and not on income statement

accounting cycle

continuously

• collect and analyze business transactions from source documents

• journalize transactions

periodically

• post transactions to accounts in the ledger

end of the period

• prepare the trial balance

• record and post the adjusting entries

• prepare adjusted trial balance

• prepare financial statements

• close the accounts

event

a happening of consequence to an entity

external event

involves interaction between the entity and its environment

internal event

occurs within the entity

transaction

refers to any event, external, or internal that is recognized in a set of financial statements

what is required for an event in the records?

an event must be measured to be recognized

four major financial statements

• balance sheet

• income statement

• statement of retained earnings

• statement of cash flows

balance sheet

financial statement that summarizes assets, liabilities, and owner’s equity of a company; snapshot of the business at a certain date; assets must equal liabilities and owner’s equity

income statement

financial statement that summarizes the revenues and expenses of a company for a period of time, summarizes the flow of revenues and expenses for the year; revenues-expenses = net income

statement of retained earnings

change in retained earnings for the period; ending retained earnings = beginning retained earnings + net income - dividends

statement of cash flows

summarizes information about the cash inflows and outflows for a specific period of time