Accounting Information for Decision Making and Basic Financial Statements

Flashcards covering Chapters 1 and 2 of Financial and Managerial Accounting, focusing on accounting information systems, financial statements, GAAP, internal controls, transaction analysis, and organizational forms.

What is the primary objective of accounting according to Chapter 1?

The primary objective of accounting is to provide information that is useful in making good decisions, which ultimately helps maximize societal prosperity and welfare.

What characterizes financial accounting information?

Financial accounting describes the financial resources, obligations, and activities of an economic entity. It assists external users, such as investors and creditors, in decision-making and is often referred to as general-purpose accounting information.

How does management accounting differ from financial accounting?

Management accounting involves developing and interpreting accounting information specifically intended to assist internal management in operating the business, setting overall goals, and making decision choices. It can be tailored specifically to management's needs.

What is the primary requirement for tax accounting information?

Tax accounting information must conform with income tax reporting requirements and governing laws, which are often different from the rules underlying financial accounting information.

What constitutes an accounting information system?

An accounting information system consists of the personnel, procedures, technology, and records used by an organization to develop information and communicate it to decision makers.

What are the three basic functions performed by every accounting information system?

1. Interpret and record the effects of business transactions.
2. Classify the effects of similar transactions to compute totals for reports.
3. Summarize and communicate the information contained in the system to decision makers.

What are the five components of internal control established by COSO?

The five components are:

1. Control Environment
2. Risk Assessment
3. Control Activities
4. Information and Communication
5. Monitoring

What role does the control environment play in an internal control system?

The control environment sets the tone of an organization by fostering ethical values, board independence, proper assignment of responsibility, development and retention of competent employees, and accountability at all levels.

What function does monitoring serve in internal control, and what specific requirement does the New York Stock Exchange (NYSE) enforce regarding internal audit?

Monitoring evaluates the ongoing effectiveness of internal controls through management and supervisory activities. The NYSE requires all listed companies to maintain an internal audit function.

What three building-block objectives define external financial reporting in the FASB conceptual framework pyramid?

1. Provide general information useful in making investment and credit decisions.
2. Provide information useful in assessing the amount, timing, and uncertainty of future cash flows.
3. Provide specific information about economic resources, claims to resources, and changes in resources and claims.

What are the three primary financial statements produced in financial accounting?

1. Balance sheet (also called the statement of financial position)
2. Income statement
3. Statement of cash flows

Why is externally reported financial accounting information described as historical and inexact?

It is historical because it reports on events from an accounting period that has already occurred. It is inexact because accounting measures rely on estimates, judgments, and assumptions about past and future events.

In a corporate organizational structure, which key financial officers report directly to the Chief Financial Officer (CFO)?

The Controller and the Treasurer report directly to the Chief Financial Officer (CFO).

What are Generally Accepted Accounting Principles (GAAP), and what is their origin?

GAAP provides the general framework determining what information is included in financial statements and how it is prepared and presented. GAAP originates from a combination of tradition, experience, and official decree.

What is the role of the Securities and Exchange Commission (SEC) in standard setting?

The SEC is a governmental agency with the legal authority to establish accounting principles and financial reporting requirements for publicly owned corporations. It delegates standard-setting responsibilities to the FASB but reviews financial statements and can initiate legal action.

What is the Financial Accounting Standards Board (FASB), and what codification does it maintain?

The FASB is an independent rule-making body recognized as the authoritative source of GAAP. It maintains the Accounting Standards Codification, which contains all standards representing official GAAP.

What standards are issued by the International Accounting Standards Board (IASB), and how are they recognized in U.S. markets?

The IASB issues International Financial Reporting Standards (IFRS). The SEC accepts IFRS financial statements from foreign companies cross-listed on U.S. stock exchanges, and the AICPA allows U.S. private companies to follow either FASB or IASB standards.

What is the Public Company Accounting Oversight Board (PCAOB), and how was it established?

The PCAOB was created by the Sarbanes-Oxley Act of 2002 to oversee the public accounting profession, set auditing standards for audits of publicly traded companies, inspect audit quality, conduct investigations, and administer penalties.

What is a financial statement audit, and who must conduct it?

A financial statement audit is an examination of a company's financial statements to determine their fairness in conformity with GAAP. It must be conducted by an independent Certified Public Accountant (CPA).

What educational and professional requirements must an individual meet to become and maintain status as a Certified Public Accountant (CPA)?

A CPA must be licensed by the state, complete $\text{150}$ semester hours of college work with an accounting major, pass the CPA exam, gain adequate professional experience, and complete at least $\text{40}$ hours of continuing professional education each year.

Which organization grants the Certified Management Accountant (CMA) designation, and which grants the Certified Internal Auditor (CIA) designation?

The Institute of Management Accountants (IMA) issues the CMA designation, and the Institute of Internal Auditors (IIA) issues the CIA designation.

How does bookkeeping differ from professional accounting?

Bookkeeping is the clerical side of accounting involving the routine recording of daily transactions. Professional accounting focuses on interpreting, analyzing, and using accounting information for decision-making.

What is a balance sheet (statement of financial position), and why is it described as a 'snapshot'?

A balance sheet describes where a business stands in financial terms on a specific date. It acts like a snapshot because it portrays the company's assets, liabilities, and equity at a single point in time.

What is the business entity concept?

The business entity concept states that a business is an economic unit separate from the personal activities of its owners, meaning its accounting records should include only transactions relevant to the operation of the business.

What are the three essential characteristics of an asset?

1. It is an economic resource.
2. It is owned by the business.
3. It is expected to benefit future operations (usually by generating positive future cash flows).

What is the cost principle, and how does it apply to assets versus accounts receivable?

The cost principle states that assets are recorded at their original historical acquisition cost (e.g., land, buildings, equipment, inventory). In contrast, assets like accounts receivable are reported at net realizable value or fair value.

How do the going-concern assumption and objectivity principle relate to historical cost accounting?

The going-concern assumption assumes the enterprise will continue operating, supporting historical cost because assets are kept for operational use rather than immediate liquidation. The objectivity principle values historical cost because it provides factual, verifiable information.

What is the stable-dollar assumption, and how does Mexican corporate law differ from it?

The stable-dollar assumption treats the monetary unit as stable over time despite inflation or deflation. However, Mexican corporate law requires companies to adjust balance sheet items using government price indexes to compensate for high inflation.

What are liabilities, and in what order are they typically presented on the balance sheet?

Liabilities are financial obligations or debts representing negative future cash flows owed to creditors. They are listed on the balance sheet in order of expected repayment, preceding owners' equity.

What is owners' equity, and what is the basic accounting equation?

Owners' equity is the residual claim of owners on total assets after creditors have been paid in full. The basic accounting equation is: $\text{Assets} = \text{Liabilities} + \text{Owners' Equity}$

What two transactions increase owners' equity, and what two transactions decrease it?

Increases:

1. Investments of cash/assets by owners.
2. Earnings from profitable operations.

Decreases:

1. Payments of cash/assets to owners.
2. Net losses from unprofitable operations.

In Transaction 1 for Overnight Auto Service, Michael McBryan and his family invested $\$80{,}000$ cash for $8{,}000$ shares of stock. How did this impact the accounting equation?

Cash (an asset) increased by $\$80{,}000$, and Capital Stock (owners' equity) increased by $\$80{,}000$, maintaining balance at $\$80{,}000 = \$80{,}000$.

In Transaction 2, Overnight Auto Service purchased land for $\$52{,}000$ cash. What was the net effect on total assets?

Net total assets remained $\$80{,}000$. Cash decreased by $\$52{,}000$ (to $\$28{,}000$) and Land increased by $\$52{,}000$.

In Transaction 3, Overnight Auto Service bought a building for $\$36{,}000$, paying $\$6{,}000$ cash down and issuing a $\$30{,}000$ note payable. What were the resulting total assets and liabilities?

Total assets increased to $\$110{,}000$ (Cash $\$22{,}000$, Building $\$36{,}000$, Land $\$52{,}000$) and Notes Payable (liabilities) increased to $\$30{,}000$.

In Transaction 4, Overnight Auto Service purchased tools and equipment for $\$13{,}800$ on account. What were the totals for assets, liabilities, and owners' equity?

Total Assets: $\$123{,}800$ Total Liabilities: $\$43{,}800$ (Accounts Payable $\$13{,}800$, Notes Payable $\$30{,}000$) Owners' Equity: $\$80{,}000$ (Capital Stock)

In Transaction 6, Ace Towing paid $\$600$ cash to Overnight Auto Service as partial settlement of its accounts receivable. How did this affect the balance sheet?

Cash increased by $\$600$ (to $\$22{,}600$) and Accounts Receivable decreased by $\$600$ (to $\$1{,}200$). Total assets remained unchanged at $\$123{,}800$.

What formula defines net income, and how was it calculated for Overnight Auto Service during January 20–31, 2024?

Formula: $\text{Net Income} = \text{Revenues} - \text{Expenses}$ For Overnight Auto Service: \text{Net Income} = \2{,}200 \text{ (Sales Revenue)} - \1{,}400 \text{ (Operating Expenses: Wages } \1{,}200 \text{ + Utilities } \$200) = \$800$

What three activity classifications form the Statement of Cash Flows?

1. Operating activities (cash effects of revenue and expense transactions)
2. Investing activities (cash effects of purchasing and selling assets like land and equipment)
3. Financing activities (cash effects of raising capital from owners and creditors, and repayments)

How can a company like Kimberly Clark Corporation generate positive cash flow from operations ($\$3{,}729$ million) but experience an overall cash decrease ($\$139$ million)?

This occurs when total cash spent on investing activities (capital expenditures, acquisitions) and financing activities (dividends, debt payments) exceeds the cash generated by core operating activities.

What is meant by financial statement articulation, and how does net income link the statements?

Financial statement articulation means that all three statements are based on the same underlying transactions and relate directly to one another. Net income from the Income Statement increases Retained Earnings on the Balance Sheet, while ending cash from the Statement of Cash Flows matches the Cash balance on the Balance Sheet.

How do sole proprietorships, partnerships, and corporations differ regarding owner liability?

Sole proprietors and partners are personally liable for all business debts. Corporate owners (stockholders) have limited liability, meaning they can lose no more than their investment in capital stock.

How is equity presented differently on the statement of financial position for a sole proprietorship, a partnership, and a corporation?

Sole Proprietorship: Presented as Owner's equity: Michael McBryan, Capital $80,800. Partnership: Presented as Partners' equity listing individual partner capital balances (e.g., Michael McBryan, Capital $40,400 and Rebecca McBryan, Capital $40,400). Corporation: Presented as Stockholders' equity divided into Capital Stock $80,000 and Retained Earnings $800.

What is the distinction between liquidity and profitability?

Liquidity is the business's ability to pay its debts as they come due. Profitability is the business's ability to generate net income over time.

What is the principle of adequate disclosure in financial reporting?

Adequate disclosure requires that financial statement users be informed of all necessary financial information for proper interpretation. Disclosures appear both in the body of the statements and in comprehensive accompanying notes.

What is 'window dressing' in financial reporting?

Window dressing refers to measures taken by management near the end of a reporting period to make the company's financial position appear as strong as possible in its financial statements.