Accounting 4-7 Final (A100)

Equity Investors

contributions from owners (cash for ownership)

-investors who invest in a company for a financial gain

*risk appetite- you can make different decisions

Debt Investors

creditors of the business (bank, bond holders, leasing companies)

-someone who loans money to a company in a lending agreement

*risk appetite- the more you own the louder your voice is

net income =

revenues - expenses

legal rights for equity investors

• contribute funds to company

• awarded shares of ownership (stocks + assets)

risks for equity investors

• potential of not receiving a satisfactory return on investment

• could lose some or all of the investment

• may expect dividend payments that are NOT tax deductible

benefits for equity investors

• may enjoy increases in value sheets

• may enjoy benefits if approved by the Board of Directors

legal rights for debt investors

• both interest and principal must be paid

• if a company doesn’t pay: creditor can “call” the loan and demand payment

risks for debt investors

• we may not be able to make payments on time

• companies may have to liquidate assets to make payments (sign of weakness)

benefits for debt investors

• to earn a return greater than that of the borrowed funds

• the net benefit will be retained by the owners of the company

assets

valuable things

liabilities

obligations to creditors, outsider claims to assets

stockholders’ equity

obligations to the investors, insider claims to assets

external users of accounting information

• owners

• creditors

• potential investors

• governmental agencies

• supplies

• customers

• general public

financing

transactions involving long term liabilities, stock, dividend payments

investing

transactions involving long term assets and investments

operating

everyday business transactions (including interest expense, dividend revenue)

Securities & Exchange Commission (SEC)

regulates and requires financial reporting from public companies while exempting private companies from such regulations

Generally Accepted Accounting Principles  (GAAP)

standards that give statements credibility and allow other companies’ reports to be comparable

Financial Statements

the financial “picture” of the company

• balance sheet

• income statement

• statement of retained earnings

• statement of cash flows

• notes to the financial statements

Income Statement

revenue

- cost of goods sold

= gross profit

- operating expenses

= net income from operations

+/- gain or loss of other assets

= net income

statement of retained earnings

beginning retained earnings

+ net income

- dividends paid

=ending retained earnings

balance sheet

liabilities

+ stockholders’ equity

= assets

accrual basis

• Records transactions in the period in which the events actually occurred, not when cash changes hands

• counting when cash is not exchanged yet

cash basis

• Records transactions in the period in which cash changes hands, not when actually occurred.  NOT GAAP

• only accounting for revenues AFTER you are paid

Accrual Basic Accounts

• accounts payable

• accounts receivable

• unearned revenue

• prepaid expenses

not on balance sheet

unearned revenue and prepaid expenses

auditing

assurance service - improves the quality of info for decisionmakers

* auditors DO NOT prepare financial statements (they just look over them)

What IS Auditing?

- systematic process

- objectively collecting and evaluating evidence

- assertations are made by management

- assertations should conform to specified rules

- results are reported to others

demands for auditing

- to raise capital (debt/equity investors)

- to fulfill a stewardship function (manage company assets)

- IMPORTANT role in the principal - agent relationship

principal - agent relationship

- principal: investors/absentee owner

- agent: manager/self-interested

- auditor: independent assurance (holds companies reliable)

audit opinion

provides reasonable assurance about whether the financial statements are fairly stated in accordance with GAAP in all material respects

audit risk

the risk the auditor gives a clean opinion on financial statements that are materially misstated

two types of fraud

(1) misappropriation of assets (i.e., stealing company assets)

(2) fraudulent financial reporting (i.e., earnings management; window-dressing F.S.)

auditors and companies

• the company pays the auditor’s bills

• relationships become STRONG

• auditors need to maintain INDEPENDENCE

the fraud triangle

• rationalization: justifications of dishonest actions

• pressure: motivation/incentive to commit fraud

• opportunity: ability to carry out misappropriation of cash of organizational assets

  * in the case of fraud - all three points must be prevalent

Major Sources of Tax Revenue

• Local Tax

• State Tax

• Federal Tax

local tax

country/city; school district

state tax

sales tax/individual income tax

federal tax

• individual income tax

• payroll taxes

• 21%

2 primary federal income tax payers

individuals

c corporations - a legal structure for a corporation in which the owners, or shareholder, are taxed separately from the entity

partnerships + S corporations

NOT income taxpayers

owners of dividends + C corporations

PAY

Federal Income Tax

income

- deductions

= taxable income

x 21%

= tax

- credits and prepayments

= amount owed or refunded

Tax Avoidance

structuring transactions in a manner to legally reduce their tax liability (LEGAL)

• purchasing assets for next year

• pushing off expenses till next year

Tax Evasion

knowingly misrepresenting a situation to reduce tax liability (ILLEGAL)

• not claiming revenue

• false tax deductions

bonds

- only revenue you don’t have to pay taxes on

- companies pay interest and pay back in 15 years

• investors lend money (low risk; low yields)