ACCT229 Chapter 1

Sole Proprietorship (ADV/DisADV)(Separate/Non Tax & Acct)

ADV: Easy to form. DisADV: "unlimited liability"

Separate for Acct, NOT separate for Tax

Unlimited Liability (Define)

Any owners/shareholders also share responsibility for the company and can be fined/sued accordingly.

Partnership (ADV/DisADV)(Separate/Non Tax & Acct)

2+ Owners.

DisADV: "unlimited liability"

Separate for Acct, NOT separate for Tax

Economic Entity Concept (Define)

Accounting principle that states that a business entity's finances should be kept separate from those of the owners, partners, shareholders, or related businesses.

Corporation (ADV/DisADV)(Separate/Non Tax & Acct)

Sell shares of stock to investors.

Separate for BOTH.

ADV: Limited liability, Continuity of life (Ease of transfer of ownership), opportunity to raise large capital through stock. DisADV: Double Taxation.

Continuity of Life (Define)

Transfer of ownership is easier.

Double Taxation (Define)

Corporation is taxed on its earnings/profits and shareholders are taxed on their dividends and capital gains they receive from those earnings.

3 Types of Business Activities

Financing, Investing, Operating

Financing (Define)

How a company pays for growth/expansion.

Borrowing (Define + examples)

(Liabilities) Debt (temporary)

Examples: Selling bonds (Gov’t, Corps), Notes payable (Bank).

Selling Ownership (Define + examples)

(SHE) Stock (Permanent)

Examples: Selling stock.

Investing (ID + Examples)

Purchasing resources (assets) to be used in our day to day operations (growth).

Examples: buying buildings, equipment, furniture, vehicles, etc. Investing in the business

Operating Activities (ID + Examples)

Activities that earn revenue & generate expenses. (day to day activities) Spend money to make money. (What are you in the business of doing?)

Examples: Utilities, rent, salary, advertisements, etc.

What is Accounting? (Definition Short and Long)

Short: An Information System. Long: To identify, measure (in money) & communicate information about a company that is useful in making economic decisions.

4 Financial Statements (in order)

Income Statement, Statement of Retained Earnings, Balance Sheet, Cash Flow Statement

Accounting Cycle (No start or end, but there is an order)

Financial Statements (Summarize last step) → Decision Maker (Analyze last step) → Identify Transaction occurs or Event (Act on last step) → Measure & Record Accounting Records (Record last step) → RESTART

2 User Groups (ID)

Internal (Managerial Acct) & External (Financial Acct)

Internal Examples (Only Internal, Information Needs, Methods of Communication)

Only Internal: Management, CEO/CFO. Information Needs: Budgets, Cash Flow, Controls. Methods of Communication: Managerial reports.

External Examples (Only External, Information Needs, Methods of Communication)

Only External: Shareholders, Gov’t (IRS, SEC), creditors. Information Needs: Profitability. Methods of Communication: 4 Financial Statements

IRS (What does it stand for)

Internal Revenue Service

SEC (What does it stand for?)

Securities and Exchange Commission

Creditors (Define)

People who lend us money

Balance Sheet (Purpose + Equation)

Shows the financial position of the company at a single point in time (snapshot). Equation: Assets = Liabilities + Stockholders’ Equity

Assets (Define and ID which of the F/Ss it’s from)

Resources that will produce a future economic benefit, held by the company. Part of the Balance Sheet

Liabilities (Define and ID which of the F/Ss it’s from)

(Payable) Debts owed to creditors, suppliers, employees, customers.

Stockholders Equity (Define & ID 2 subgroups)

Financing provided by owners and operations of the company. Subgroups: Common Stock & Retained Earnings

Common Stock (Define)

Investments made by owners (purchase stock)

Retained Earnings (Define)

Cumulative earnings of the company that have been retained (reinvested; not paid out) by the company (What the company has made since it’s beginning minus the dividends they’ve paid out

SHE Accounts on the Balance Sheet (ID)

Common Stock & Ending Retained Earnings

The Income Statement (Purpose + Equation)

Shows results of the company’s operations (flows of revenue and expenses) for a period of time. Equation: Revenues (includes Gains) minus Expenses (includes Losses) = Net Income.

Revenues (Define + examples, and ID the 2 methods that lead to revenue)

Inflows of assets (cash: now/accounts receivable: later) as a results of a. Performing a service or b. Delivering a good. (Must provide the good/service to be counted as revenue)

Performing a Service (ID type of revenue + Examples)

Service revenue (Ex. preparing taxes, walking dogs, etc.)

Delivering a Good (ID type of revenue + Examples)

Sales revenue (clothes, cake, lumber) (delivering: providing, so NOT a service)

Expenses (Define + Examples)

Resources used to generate revenue (using up assets). Ex. wages, rent, insurance, advertising, cost of goods sold (COGS), depreciation expense

Statement of Retained Earnings (Purpose + Equation)

Shows how net income & dividends cause change in a company’s financial position during a period of time. Equation: Beginning Retained Earnings + Net Income - Dividends = Ending Retained Earnings

Reminders About Dividends (List 3)

NOT an expense, NOT on income statement, DECREASE retained earnings

Statement of Cash Flows (Purpose + Equation)

Shows actual change in cash of a company for a period of time. Equation: C/F from Operating + C/F from Investing + C/F from Financing = Net Inc/Dec in Cash + Cash at Beginning of Period = Cash at End of Period. (Cash from 3 Business Activities = Net Cash + Beg of Period = Cash at End of Period)

Operating Activities (Cash Flow Definition)

Everyday activities needed to run business

Investing Activities (Cash Flow Definition)

Purchases/Sales of Long Term Assets

Financing Activities (Cash Flow Definition)

Changes in Stockholders’ Equity and Long Term Liabilities

How Income Statement and Statement of Retained Earnings are Linked (Account)

Net Income

How Statement of Retained Earnings and Balance Sheet are Linked (Account)

Retained Earnings (Ending R/E but not stated explicitly)

How Balance Sheet and Statement of Cash Flows are Linked (Account)

Cash (at end of the year)

Footnotes (Define)

Added notes in the financial statements to better explain the information in the statements without clouding the primary information in the financial statements.

4 subgroups of Assets (ID)

Current Assets, Long-term Investments, PP&E/Fixed Assets (Plant, Property & Equipment) & Intangible/Other Assets

Current Assets (Define + Method of Ordering)

Converted into cash, sold, used up or liquidated during current period (within 12 months). Ordered based on Liquidity.

Current Assets (List 6)

Cash & Cash Equivalents, Marketable Securities, Accounts Receivables, Inventory, Prepaid Expenses, Supplies.

Marketable Securities (Define)

Short term investments in OTHER companies.

Accounts Receivables (Define)

Customer owes money for goods/services received. (Accrued Revenue)

Inventory (Define)

Items purchased for resale

Prepaid Expenses (Define + ID F/S its on + A/L/SHE?)

Pay ahead of time for services not yet received. On balance sheet NOT income statement (Asset)

Supplies (Define)

Items purchased to use.

Long-term Investments

Investments in stocks & bonds of OTHER companies to be held for longer than 1 year

Plant, Property & Equipment/Fixed Assets (Define + 4 Examples w/Definitions)

Acquired for use in business rather than resale to customers. Relatively long useful lives. Examples: Land (no limited useful life), Buildings (can accumulate depreciation), Equipment/Vehicles/Furniture/Computers/etc. (can accumulate depreciation), Accumulated Depreciation on PP&E/Fixed Assets that have a “useful life”

Salvage Value (Define)

How much you think you can set for an item at the end of its life (similar to scrap value)

Contra Accounts (Define)

Accounts that decrease the overall value of related accounts.

Intangible/Other Assets (List 5)

Patent, Copyright, Trademark/Tradename, Franchise/Licenses, Goodwill

Patent (Define)

Exclusive right to manufacture or sell a product

Copyright (Define)

Protects artistic material

Trademark/Tradename (Define + Example)

Use a company’s name. Examples: Coca Cola

Franchise/License (Define)

Exclusive right to operate in a geographical area

Goodwill (Define)

When a company pays more than fair value of the assets of another company to purchase it

Liabilities (Define + ID 2 subgroups + How are they ordered?)

Debts owed (“payable”). Split into current and long-term liabilities. Ordered based off maturity

Maturity (Define)

What’s due first is listed first.

List Current Liabilities

Accounts Payable, Accrued Expenses, Unearned/Deferred Revenue, Short-term Note Payable

Accounts Payable (Define)

What we owe for products received assuming we haven’t paid yet. (The cost of the inventory and supplies are credited as accounts payable if they haven’t been paid for)

Accrued Expenses (Define + Examples)

Expenses that have been incurred but not yet paid. Only on the balance sheet if it has not been paid for.

Examples: Utilities Payable, Wages Payable.

Unearned Revenue (Define + Examples)

Customer has paid, but have not been delivered the good/service. Example: Gift Cards, Preorders, Season Tickets (Prepaid expense for a customer)

Short-term Note Payable (Define)

Borrowing money but paid back within 12 months. If due longer than 12 months, it is considered a long-term note payable.

Long-term Liabilities (List + Define)

Long-term Note Payable, Bond Payable, Mortgage Payable. All 3 are types of debt that should be paid back in more than 12 months.

Stockholders Equity (Define + ID 2 subgroups)

Claims of owners against the net assets of the firm (What stockholders have at stake). Split into Contributed Capital (CS) and Retained Earnings (Ending) on the balance sheet.

Contributed Capital/Common Stock (Define)

Investments made by owners (purchase of stock - Common Stock/Capital Stock)

Retained Earnings

Cumulative earnings of the company that have been retained (not paid out) by the company. (what the company has made since the beginning minus the dividends paid out)

The Income Statement (Purpose + Equation)

Shows results of the company’s operations (flows of revenue and expenses) for a period of time. Equation: Revenues (+ Gains) - Expenses (+ Losses) = Net Income

Operating Revenues (Define + ID Account)

Inflows of assets (cash or acct receivable) as a result of performing a service or delivering a good. Part of the Operating Income account on the Income Statement.

Other Gains (Define + Example)

Result of an incidental (minor) transaction. Example: Gain from sale of building

Operating Expenses (Define + ID Account)

Resources used to generate revenue. Part of Operating Income account on the Income Statement

Other Losses (Define + Example)

Result of an incidental transaction. Example: Loss from sale of land

Multistep Income Statement Equation

Sales Revenue

=

Gross Profit

=

Operating Income

\+ Other Gains



\+ Interest Revenue

=

Income before Taxes

=

Net Income

Statement of Stockholders’ Equity (not one of the 4) (Purpose + Equation + When is equation used?)

Shows how net income, dividends, and changes in stock causes change in a company’s financial position during a period of time.

Equation:

Beginning SHE

\+ New Stock (ΔCS)

\+ Net Income

(NI and D are ΔRE)

= Ending SHE

Equation is used when there is a change in a company’s stock during the period.

Balance Sheet Ratios (Define + List)

Help analyze liquidity. Working Capital, Current Ratio, Limitations.

Working Capital (Purpose + Issues + Equation)

Helps to measure liquidity in terms of the ability to pay creditors. Balance is necessary (Too little: not enough to cover debts, Too much: not using assets efficiently. Equation: Working Capital = Current Assets - Current Liabilities.

Current Ratio (Purpose + Equation)

Useful to compare liquidity among companies (Higher the ratio, higher the liquidity). Current Ratio = Current Assets divided by Current Liabilities

Limitations (Examples + Definitions)

Historical vs Fair Market Value. Omissions: general state of economy & where we stand in the industry.

Income Statement Ratios (Purpose and 2 sub-ratios)

Used to analyze profitability. Gross Profit Ratio: Gross Profit / Sales. Profit Margin: Net Income / Sales.

GAAP (ID + Define)

Generally Accepted Accounting Principles. The measurement rules used to report U.S. financial statements

3 Organizations that Make the Rules in the US

FASB (Financial Standards Board), SEC (Securities & Exchange Commission), AICPA (American Institute of Certified Public Accountants)

FASB (ID + Define)

Financial Accounting Standards Board. Private (non-gov) body given responsibility to develop GAAP (Generally Accepted Accounting Principles)

SEC (ID + Define)

Federal (gov) agency that has broad powers to prescribe accounting practices and standards to public companies that trade securities on the major exchanges (NYSE & NASDAQ). \*The SEC can influence or override ANY FASB ruling.

AICPA (ID + Define)

American Institute of Certified Public Accountants. A professional organization of certified public accountants.

Organization that Makes the Rules Non-US (ID + Define + ID the 2 Orgs They Want to Combine)

IASB (International Accounting Standards Board). Works towards a convergence of IFRS (International Financial Reporting Standards) & GAAP (Generally Accepting Accounting Principles).

Global Differences in Accounting Standards

Some IFRS (International Financial Reporting Standards) principles differ from GAAP (Generally Accepted Accounting Principles).

Examples: Accounting for Inventories, Accounting for Losses on Income Statement, Accounting for Plant, Property & Equipment, Accounting for Research & Development.

PCAOB (ID + Define)

Public Company Accounting Oversight Board. Five member body that sets auditing standards

Management’s Responsibility (Define)

Ultimately responsible for the accuracy of the financial statements.

Purpose of an Audit (Define + 3 terms they use)

Prepare report to attest to the fairness of the financial statements in accordance with GAAP (did they follow the rules). Must be UNBIASED.

Unqualified :)

Qualified :|

Adverse :(

SOX (ID + Year + Condensed Definition)

Sarbanes-Oxley Act 2002. Created to help reduce unethical financial reporting and corporate behavior in response to 2001 & 2002 scandals (Enron, Tyco, Worldcom, Arthur Anderson).

Who is SOX named after?

Senator Paul Sarbanes of Maryland & Congressman Michael Oxley of Ohio.

Management Provisions of SOX (Define 4 Points)

1. Management must assess and report on the effectiveness of the company’s internal control structure and procedures over financial reporting.
2. New rules require a code of ethics be established and reported.
3. New penalties exist for management if the financial statements are inaccurate or incomplete (includes fines and imprisonment). SOX requires the CEO and the CFO to certify the annual financial statements.
4. Firms must provide a mechanism for anonymous reporting of the fraudulent activities in the company (whistle-blower protection).

Board of Directors Provisions of SOX (Define 2 Points)

1. SOX requires some directors to be independent of management.
2. SOX requires audit committee members (made up of members of the Board of Directors) be independent of management.

External Auditors Provisions of SOX (Define 2 Points)

1. New Rules for auditors include stronger rules regarding auditor independence (Audit forms can no longer provide management consulting services to its audit clients).
2. Auditors report to the client’s audit committee rather than to the client’s management team.