A100 Chapter 1: Introduction to Financial Accounting

Accounting

the recording of business transactions, the preparation of reports summarizing these transactions, and the analyzing of financial information

Financial Statements

reports prepared from the accounting system

To who are financial statements made available?

individuals both inside and outside the company

Financial Accounting

refers to the records and related reports that are available to people outside of the company

Impact on the Financial Statements

looking at the financial statements from the top down and paying particular attention to how various transactions impact the financial statements

What can every business transaction be classified as?

1) Financing Activity
2) Investing Activity
3) Operating Activity

Financing Activities

transactions that raise funds for the company to operate or expand

Investing Activities

transactions in which the company is investing in assets that it will use in its business operations

Operating Activities

all of the other transactions that a business engages in

What are the two basic methods a company can use to raise money to help finance its operations?

Equity and Debt

Equity

refers to ownership (for a corporation, the owners are stockholders)

Equity Investors (or stockholders or shareholders)

purchasers of the stock that a corporation issues

What are two ways an equity investor can benefit from their investment?

1) By receiving dividends from the company
2) By selling their stock at some time in the future at a higher price

Dividends

payments made from a corporation to its stockholders, but under no legal requirement to make these payments

Debt

borrowing money from investors or banks

Creditors

those who loan the company money

Principal

money loaned

Interest

the amount that the creditor is charging the borrower for loaning them the money

How are creditors different from stockholder?

creditors have the legal right to receive back the money loaned

Loan Contract

specific requirements of the loan

What do loan contracts specify?

maturity date, interest that will accrue, and collateral

Maturity Date

the date by which the loan is to be repaid

Collateral

assets that are pledged by the borrower to the creditor if the borrower is not able to repay the loan

Terms

requirements specified in loan contracts

Default

company unable to repay its loans

What are investing activity purchases?

land, buildings, and equipment

What is the purpose of the Securities and Exchange Commission (SEC)?

to maintain fair and truthful capital markets

To where does SEC's coverage extend?

to publicly held corporations

What does the SEC require corporations to file?

Form 10K annually and a Form 10Q quarterly

Annual Report

SEC requires that all publicly

What are the annual reports required to include?

1) Balance Sheet
2) Income Statement
3) Statement of Stockholders' Equity (or statement of retained earnings)
4) Statement of Cash Flows
5) Note from CEO of company discussing management's performance and goals
6) Notes

Notes to the Financial Statements

gives additional information supporting the data in the financial statements

Independent auditor (or external auditor)

accounting firm that specializes in public accounting

Public Accounting

company is in business to provide accounting services to other companies

Audit

to thoroughly examine an entities bookkeeping records, financial accounts, and the policies and procedures of that entity

T or F: auditors guarantee that the financial statements are absolutely correct?

No, they simply state that they have conducted sufficient tests to allow them to issue an opinion that the financial statements do not contain any material errors

Who is responsible for the preparation of the financial statements?

company being audited

Who is responsible for expressing an opinion on the statements that management has prepared?

Auditor

Cover Letter of Financial Statements

letter from the company's independent auditors which states the auditor's opinion as to whether or not the auditors have found the financial statements to have been prepared in accordance with the required accounting standards

Big Four

Most widely known accounting firms

What are the Big Four accounting firms?

Deloitte, KPMG, EY, PwC

Internal Auditors

Auditors employed by the company and that audit departments within the company

Internal Controls

rules and procedures that help ensure that the employees comply with the policies of the company as well as those of outside regulators

Corporate Governance

mechanisms in place within a company which inspire managers to report the truth in their financial statements

How does society exert pressures on management?

1) Reputation of managers and business
2) Threat of legal liability
3) Ethics

Generally Accepted Accounting Principals (GAAP)

gives direction on how to account for both common and uncommon transactions of companies

What is the goal of GAAP?

to establish rules so that outside readers of financial statements can trust that statements from different companies will be comparable

Rules Based System

GAAP gives specific directions for how to account for all types of transactions

What does the SEC requrie?

publicly held companies based in the United States have to prepare financial statements using GAAP

Financial Accounting Standards Board

Have to maintain the conceptual framework

Conceptual Framework

provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity

What are the two fundamental qualitative characteristics of the Framework in providing useful financial information?

relevance and faithful representations (to enhance usefulness: comparability, verifiability, timelines, and understandability)

International Financial Reporting Standards (IFRS)

accounting standards for companies based in most other countries

International Accounting Standards Board

take responsibility for the IFRS

What is the main difference between IFRS and GAAP?

IFRS gives less guidance and relies on interpretation (IFRS considered principles

Reporting Entities

organizations that prepare financial statements (ex: company or firm)

How can profit seeking entities be categorized?

1) Service
2) Retail
3) Manufacturing

Service

businesses whose main source of revenue is their knowledge and abilities rather than a product

Retail

companies that buy inventory from manufacturers or wholesalers and resell it to consumers at a higher price

Manufacturing

business which purchase inventory, process it in some way, and sell a different product than they had originally purchased

Corporation

Business that is incorporated

Incorporated

established as a separate legal entity

What is the main advantage to incorporating?

stockholders have limited liability (creditors of a corporation don't have the right to go against stockholders' personal assets)

In what ways are corporations taxed?

Regular or C corporation

Regular Corporations

Must pay income tax

Double Taxation

income of a corporation is taxed twice

Where is income of a corporation taxed?

once when its earned, gain to the stockholder if the corporation pays dividends