Chapter 1 of Accounting Terms

Accounting consists of 3 basic activities:

• identifies

• records

• communicates

  • the economic events of an organization

Internal Users

• finance

• marketing

• human resources

• management

• company officers

External users

• investors

• creditors

Sarbanes - Oxly Act (SOX)

• regulators and lawmakers were concerned that the economy would suffer if investors lost confidence in corporate accounting

Effective financial reporting depends on:

• sound ethical behavior

1st step of Ethics in Financial Reporting

• Recognize an ethical situation and ethical issues involved

  • Use your personal ethics to identify ethical situations and issues.

    • Some businesses and professional organizations provide written codes of ethics for guidance in some business situations.

2nd Step of Ethics in Financial Reporting

• Identify Stakeholders and analyze the principal elements in the situation

  • stakeholders—persons or groups who may be harmed
    or benefited.

  • Ask the question:

    • What are the responsibilities

    • obligations of the parties involved?

3rd Step of Ethics in Financial Reporting

• identify alternatives and weigh the impact of each alternative on various stakeholders

  • Select the most ethical alternative, considering all the consequences.

  • Sometimes there will be one right answer.

  • Other situations involve more than one right solution; these
    situations require an evaluation of each and a selection of the best alternative.

Generally Accepted Accounting Principle (GAAP)

• standards that are generally accepted & universally practiced

• indicate how to report economic events

  • various users need financial information

Financial Statements

• Balance Sheet

• Income Statement

• Statement of Cash Flows

• Note Disclosure

Standard Setting Bodies

• financial accounting standards boards (FASB)

• securities & exchange commisions (SEC)

• International Accounting Standards Board (IASB)

  • over 115 countries use international standards (IFRS)

Forms of Business Ownership

• proprietorship

• partnership

• corporation

Measurement Principles

• Historical Cost Principal

• Fair Value Principal

Historical Cost Principle

• dictates that companies record assets at their cost

Fair Value Principle

• states that assets & liabilities should be reported at fair value (the price received to sell an asset or settle a liability)

How to determine which measurement principle to use:

• companies weigh the factual nature of cost figures vs. the relevance of fair value.

  • In general, most companies choose to use cost.

• Only in situations where assets are actively traded, such as investment securities, do companies apply the fair value principle extensively.

Monetary Unit Assumption

• companies include in the accounting records only transaction data that can be expressed in money term

Economic Entity Assumption

• activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities.

Proprietorship

• owned by one person

• owners is often manager/operator

• owner receives any profits, suffers any losses, and is personally liable for all debts

Partnership

• Owner by two or more people

• often retail and service type businesses

• generally liability

• Partnership Agreement

Corporation

• Ownership divided into shares of stock

• separate legal entity organized under state corporation law

• limited liability

Assets = Liabilities + Stockholders’ Equity

• Provides the underlying framework for recording and
  summarizing economic events.

  • If a business is liquidated, claims of creditors (liabilities)
    must be paid before ownership claims (stockholders’
    equity)

Assets

• resources a business owns

• provide future services or benefits

  • Cash, Supplies, Equipment, etc.

Liabilities

• claims against assets (debts & obligations)

• Creditors (party to whom money is owed)

  • Accounts payable, notes payable, salaries and wages
    payable, sales and real estate taxes payable, etc.

Stockholders Equity

• Ownership claim on total assets

• Referred to as residual equity

  • Common Stock & Retained Earnings

Increases Stockholder Equity

• investment by stockholders

• revenues

Decreases Stockholder equity

• dividends to stockholders

• expenses

Investment by Stockholders

• represents the total amount paid in by stockholders for the shares they purchase.

Revenues

• result from business activities entered into for the purpose of earning income.

Common sources of revenue are:

• sales fees

• services

• commissions

• interest

• dividends

• royalties

• rent.

Dividends

• are the distribution of cash or other assets to stockholders.

  • reduce retained earnings

    • not an expense

Expenses

• are the cost of assets consumed or services used in the process of earning revenue.

Common expenses are:

• salaries expense

• rent expense

• utilities expense

• tax expense, etc.

Measurement Principles:

• relevance

• faithful representation

Relevance

• financial information is capable of making a difference in a decision

faithful representation

• numbers & description match what really existed or happened

  • they are factual

Stockholder Equity

• common stock + retained earnings

Retained Earnings

• revenue - expense - dividends

Transactions

• are a businesses economic events recorded by accountants may be external or internal

  • not all activities represent transactions

  • have a dual effect on the accounting equation

External Transaction

• economic events between a company & outside enterprise

Internal Transaction

• economic events within one company

Companies Prepare 4 Financial Statements:

• Income Statement

• Balance Sheet

• Retained Earnings Statement

• Statement of Cash Flows

Net Income

• needed to determine the ending balance in retained earnings

Balance Sheet

• reports the assets, liabilities, and stockholders equity at a specific date

  • list assets at the top followed by liabilities and stockholders equity

• A snap shot of the company’s financial condition at a specific point in time

  • usually Month-end or year - end

Income Statement

• Reports the profitability of the company’s operations over a specific period of time

  • list revenue first then expenses

  • shows net income (or net loss)

  • does not include investment & dividend to transactions between stockholders & the business

Retained Earnings Statement

• reports the changes in retained earnings for a specific period of time

  • the time period is the same as that covered by the income statement

  • indicates the reasons why retained earnings increased or decreased during periods

Statement of Cash Flows

• provides financial information about the cash reciepts & payments for a specific period of time

  • Reports in the cash effects of a company’s

    • operating

    • investing

    • financial activities

Questions that need to be answered for the statement of cash flows:

• where did the cash come from?

• what was the change in the cash balance during the period?

• what was the cash used for?

Similarities of the Impact of International Accounting Standards in U.S. Financial Reporting:

• basic technique for recording business transactions are the same for U.S. & International Companies

• Both accounting standards emphasize transparency in financial reporting

  • both sets of standards are meeting the needs of investors & creditors

• 3 most common forms of business organizations

  • propiertorship

  • partnership

  • corporation

Differences of the Impact of International Accounting Standards in U.S. Financial Reporting:

• international standards are referred as International Financial Reporting Standards (IFRS) developed by the International Accounting Board

• Accounting standards in the U.S. are referred as GAAP & are developed by the financial Accounting Standards Board

  • IFRS tends to be simpler in accounting & disclosure; more “principle based”

  • GAAP is more “rules-based”

• The internal control standards applicable to Sarbanes-Oxly (SOX) apply only to large public companies listed on U.S. Exchange

Financial Accounting Standards Board (FASB)

• A private organization that establishes generally accepted accounting principles (GAAP) in the United States.

Securities and Exchange Commission (SEC)

• A governmental agency that oversees U.S. financial markets and accounting standard setting bodies.

International Accounting Standards Board (IASB)

• An accounting standard-setting body that issues standards adopted by many countries outside of the United States.

Summary of Transactions

1. Each transaction must be analyzed in terms of its effect on:

• The three components of the basic accounting equation.

• Specific types (kinds) of items within each component.

2. The two sides of the equation must always be equal.
3. The Common Stock and Retained Earnings columns
indicate the causes of each change in the stockholders
claim on assets