MGMT 200 Chapter 1: A Framework for Financial Accounting

Financial accounting

accounting information provided to external users

Two functions of financial accounting

measure business activities of a company and communicate those measurements to external parties for decision-making purposes

Three types of business activities

financing activities, investing activities, operating activities

Financing activities

transactions the company has with investors and creditors

Investing activities

transactions involving purchase and sale of resources that are expected to benefit the company for several years

Operating activities

transactions that relate to the primary operations of the company

The accounting equation

assets = liabilities + stockholders’ equity

Assets

total resources for the company

Liabilities

amounts owed to creditors

Stockholders’ equity

owners’ claims to resources

Revenues

amounts recognized when the company sells products or provides services to customers

Expenses

costs of providing products and services and other business activities during the current period

Net income

the difference between revenues and expenses, other common names include earnings or profit

Dividends

cash payments to stockholders, dividends are NOT expenses, may not declare dividends if they have a plan for their extra money

Corporation

a company that is legally separate from its owners, the advantage of being legally separate is that the stockholders have limited liability, disadvantages being government limitations and double taxation

Sole proprietorship

a business owned by one person, doesn’t offer limited liability

Partnership

a business owned by two or more persons, doesn’t offer limited liability

Financial statements

periodic reports published by the company to produce information to external users

Primary financial statements

income statement, statement of stockholders’ equity, balance sheet, statement of cash flows

Income statement

reports the company’s revenues and expenses over an interval of time, revenue > expenses means net income, revenue < expenses means net loss

Statement of stockholders’ equity

summarizes the changes in stockholders’ equity over an interval of time, taken from external and internal sources, stockholders’ equity = common stock + retained earnings

Balance sheet

presents the financial position of the company on a particular date, assets = liabilities + stockholders’ equity

Statement of cash flows

measures activities involving cash receipts and cash payments over an interval of time; includes operating cash flows, investing cash flows, and financing cash flows

Operating cash flows

cash transactions involving revenue and expense activities

Investing cash flows

cash transactions for the purchase and sale of investments and long-term assets

Financing cash flows

cash transactions with lenders and stockholders

Statement of stockholders’ equity

the amount of net income in the income statement reappears in the

Balance sheet

ending balance in the statement of stockholders’ equity reappears in the

Ending cash balance in the statement of cash flows

the amount of cash in the balance sheet reappears as the

Balance sheet through the balance in retained earnings

all transactions that affect revenues or expenses reported in the income statement ultimately affect the

Two other important components of the annual report are

management’s discussion and analysis and note disclosures to the financial statements

Management discussion and analysis (MD&A)

includes management’s views on significant events, trends, and uncertainties pertaining to the company’s operations and resources

Note disclosures

offer additional information either to explain the information presented in the financial statements or to provide information not included in the financial statements

Generally Accepted Accounting Principles (GAAP)

investors and creditors make their decision based on financial accounting information which should be based on formal standards

Accounting standards in the United States

the Financial Accounting Standards Board (FASB) is governed by the Securities and Exchange Commission (SEC)

Accounting standards globally

the International Accounting Standards Board (IASB)

File an annual report at the end of each fiscal year (a 12-month period), includes the four primary financial statements

the SEC requires all companies with publicly traded securities to

Other parts of annual reports

disclosure notes, Summary of Significant Accounting Policies, Management’s Discussion and Analysis (MD&A), executive compensation, business overview, risk factors, legal proceedings, related party transactions

Auditors

trained individuals hired by a company as an independent party to express a professional opinion of the extent to which financial statements are prepared in compliance with GAAP and are free of material misstatement

Role of auditors

help ensure that management has appropriately applied GAAP in preparing the company’s financial statements and play major role in investors’ and creditors’ decisions by adding credibility to financial statements