Chapter 1: Business Decisions + Financial Accounting

Sole proprietorship

Business owned by one person. Easiest to start, but the owner is personally liable for business debts.

Partnership

Business owned by two or more people. Partners share profits, taxes, and generally personal liability.

Corporation

Separate legal entity from its owners. Owners have limited liability, but forming a corporation can be expensive, and double taxation may occur.

Stockholders

Owners of a corporation.

Private corporation

Shares are not publicly traded.

Public corporation

Shares can be traded publicly on a stock exchange.

LLC (limited liability company)

Combines characteristics of partnerships and corporations.

Accounting

An information system that records, summarizes, and reports financial activities to help people make decisions. Known as the language of business.

Managerial accounting

Reports for internal users (managers and employees) to plan, control costs, and make business decisions.

Financial accounting

Financial statements for external users to evaluate a company's financial condition and performance.

Creditors

Evaluate whether the company can repay debts.

Investors

Evaluate financial strength and company value.

Directors

Oversee managers and protect stockholders' interests.

Government agencies

Monitor financial reporting and taxes.

Private accountant

Works for one business.

Public accountant

Provides accounting services to multiple clients.

Basic Accounting Equation

Assets = Liabilities + Stockholders' Equity

Assets

Resources the company owns, such as cash, equipment, and software.

Liabilities

Amounts the company owes to creditors, such as loans and unpaid bills.

Stockholders' equity

The owners' claims on the company's assets after liabilities are paid.

Paid-in capital (Common Stock)

Money owners contribute in exchange for stock.

Earned capital (Retained Earnings)

Profits kept in the business over time.

Revenues

Money earned by selling goods or services.

Expenses

Costs incurred to earn revenues, such as rent, wages, and advertising.

Net income

Revenues minus expenses.

Net loss

When expenses are greater than revenues.

Dividends

Profits distributed to stockholders. Dividends are not expenses because they distribute profits rather than help generate them

Separate entity assumption

A business's financial records include its own activities, not its owners' personal activities.

Financial statements

Communicate a company's financial performance, financial position, and cash activity.

Income Statement

Shows whether a company earned a profit or experienced a loss over a period of time.

Formula: Revenues − Expenses = Net Income

Statement of Retained Earnings

Shows how retained earnings change during a period.

Beginning Retained Earnings + Net Income − Dividends = Ending Retained Earnings

Balance Sheet

Shows a company's assets, liabilities, and stockholders' equity at a specific point in time.

Assets = Liabilities + Stockholders' Equity

Accounts Receivable

Money customers owe the business. This is an asset.

Accounts Payable

Money the business owes suppliers. This is a liability.

Notes Payable

Money owed under a written loan agreement. This is a liability.

Cost principle

Assets are initially recorded at their original cost to the company.

Statement of Cash Flows

Shows the cash coming into and going out of a business during a period.

Operating activities

Cash related to the main business operations, such as collecting money from customers and paying wages.

Investing activities

Cash related to buying or selling long-term assets, such as equipment and software.

Financing activities

Cash related to borrowing money, repaying loans, issuing stock, and paying dividends.

Income statement

Calculates net income.

Calendar year

A 12-month period ending December 31.

Fiscal year

A 12-month period ending on a date other than December 31.

Unit of measure assumption

Financial information is reported using a common monetary unit, such as U.S. dollars.

Notes to financial statements

Provide additional details to help users understand the reported amounts and make decisions.

Creditors

Mainly concerned with whether a company can repay its debts.

Investors

Want to earn a return on the money they contribute to a company.

Selling stock

Selling their shares for more than they originally paid.

Statement of retained earnings

Shows how much profit is kept in the business and how much is distributed as dividends.

Generally Accepted Accounting Principles (GAAP)

Set of accounting rules and standards businesses in the United States follow when preparing financial statements.

FASB (Financial Accounting Standards Board)

Primarily responsible for setting U.S. accounting standards.

IASB (International Accounting Standards Board)

Develops international accounting standards called IFRS (International Financial Reporting Standards).

Sarbanes-Oxley Act

Introduced in response to major accounting fraud scandals.

IFRS

International accounting standards.

Independent auditor

An outside professional who examines financial statements and related records.

Internal controls

Procedures designed to protect assets and improve the accuracy and reliability of financial records.

Accounting fraud

Deliberately misrepresenting financial information.

IPO

The first public offering of a company's shares.

Direct listing

A process allowing existing stockholders to sell shares to public investors.

Public company

A company whose shares are available for public trading.

SEC

Government agency that oversees U.S. securities markets and public company financial reporting.

Form 10-K

Annual filing.

Form 10-Q

Quarterly filing.

Form 8-K

Filing for significant events.