Chapter 1: Accounting in Business

Accounting

an information and measurement system that identifies, records, and communicates an organization’s economic events, such as its business activities. 

Financial accounting

identifying, recording, and communicating information about a company’s financial performance and financial position.

Internal users

company’s management (e.g., company president), marketing personnel, purchasing personnel, production personnel, service personnel, finance personnel, human resource personnel, and its employees.

External users

company’s owners (e.g., stockholders), creditors, suppliers, customers, labor unions, regulatory authorities, tax authorities, and independent auditors.

Can the company pay its debts as they come due?

External

Does the company have enough cash to pay its employees?

Internal

Are the company’s financial statements prepared using the correct accounting rules?

External

Is buying a competitor’s company a good idea?  If so, what’s a fair price?

Internal

Can the company honor its warranties and return policies?

External

Ethical decision making involves:

a. Identifying ethical concerns

b. Analyzing options

c. Making ethical decisions

Descriptive analytics:

Summarize and describe events from year to year.

Diagnostic analytics:

Reveal causes of events from the past.

Predictive analytics:

Predicts likely events for the future.

Prescriptive analytics:

Creates action plans to achieve a desired future.

Generally Accepted Accounting Principles (GAAP)

the set of accounting rules used by publicly traded corporations. 

Securities and Exchange Commission (SEC)

is a federal government agency with the responsibility of regulating the stock and bond markets of the U.S. 

Financial Accounting Standards Board (FASB)

is a federal government agency with the responsibility of regulating the stock and bond markets of the U.S. 

Useful

The objective of financial accounting information is to provide information that is useful to users: investors, creditors, government regulators, etc. 

Relevance

Accounting information if it would make a difference in a business decision.

Faithful representation

Accounting information if it accurately depicts what really happened.

Measurement principle (Historical cost principle or Cost principle)

are recorded using the fair value principle which requires companies record assets at their market values.

Revenue recognition principle

are recorded at the amount expected to be received from the customer.

Expense recognition principle

are incurred in the period when they help generate revenue.

Full disclosure principle

report all the details or information that would affect a reader’s understanding of those statements.

Economic Entity

The recorded activities of a business entity should be kept separate from the recorded activities of its owners and all other business entities.

Monetary Unit Assumption

Transactions and events are to be reported in monetary units.

Periodicity

The life of a business entity can be divided into artificial time periods, such as years, quarters, months. 

Going Concern Assumption

report its assets at their historical cost rather than at their liquidation value.

Cost constraint

Accounting standard-setters weigh the cost that companies will incur to provide the information against the benefit that financial statement users will gain from having the information available.

Materiality

An item is material when its size makes it likely to influence the decision of an investor or creditor.

A quality accounting information where the information makes a difference in a business decision.

Relevance

Financial statements should include a balance sheet to report assets at their cost.

Measurement principle

An assumption that financial statements should disclose only those events that can be measured in dollars.

Monetary Unit Assumption

The information’s size makes it likely to influence the decision of an investor or creditor.

Materiality

The life of a company can be divided into artificial time periods.

Periodicity

A quality of accounting information where the information accurately depicts what really happened.

Faithful representation

Accounting standard-setters weigh the cost that companies will incur to provide the information against the benefit that financial statement users will gain from having the information available.

Cost constraint

An assumption that the business will remain in operation for the foreseeable future causing it to continue reporting its assets at their historical costs rather than at their liquidation values. 

Going Concern Assumption

Assets

owned by a business that it expects will provide a future benefit.

Liabilities

amounts owed by the company to its creditors in the form of debts and other obligations making the company a debtor.

Equities

are the owners’ claims on the company’s assets.  

Revenues

amounts earned by an entity resulting from performing for customers.

Expenses

the costs associated with operating a company incurs to generate revenue.

Dividends

are voluntary payments from a corporation paid out of its earnings to its owners.

Income statements

report revenues & expenses.

Statement of changes in owners’ equity

report dividends and summarize the changes in equity

Balance sheets

sheets report assets, liabilities, and equities.

The accounting equation

Assets = Liabilities + Equity

Expanded accounting equation

Assets = Liabilities + Common stock + Revenues – Expenses – Dividends

ΔAssets = ΔLiabilities + ΔCommon stock + ΔRevenues – ΔExpenses – ΔDividends

Statement of Cash Flows

of cash flows lists the cash inflows & cash outflows separately for three categories:

i. Operating activities

ii. Investing activities

iii. Financing activities

Balance Sheet

lists the asset, liability, and equity accounts and their balances as of the end of the period.

Statement of Stockholders’ Equity

lists beginning and ending of period balances of equity accounts, the dividend account & its balance, and net income.

Income Statement

statement lists the revenue and expense accounts and their balances as of the end of the accounting period.