Things You Should Know

F1-27

1. 1. Why is accounting important?

   • Accounting is the language of business.

   • Accounting is used by decision makers including individuals, businesses, investors, creditors, and taxing authorities.

   • Accounting can be divided into two major fields: financial accounting and managerial accounting.

   • Financial accounting is used by external decision makers, and managerial accounting is used by internal decision makers.

   • All businesses need accountants. Accountants work in corporate or industry accounting, public accounting, financial services, and governmental accounting.

   • Accountants can be licensed or certified as a Certified Public Accountant (CPA), Chartered Global Management Accountant (CGMA), Certified Management Accountant (CMA), or Certified Financial Planner (CFP).

2. 2. What are the organizations and rules that govern accounting?

   • Generally Accepted Accounting Principles (GAAP) are the rules that govern accounting in the United States.

   • The Financial Accounting Standards Board (FASB) is responsible for the creation and governance of accounting standards.

   • Economic entity assumption: Requires an organization to be a separate economic unit such as a sole proprietorship, partnership, corporation, or limited-liability company.

   • Cost principle: Acquired assets and services should be recorded at their actual cost.

   • Going concern assumption: Assumes that an entity will remain in operation for the foreseeable future.

   • Monetary unit assumption: Assumes financial transactions are recorded in a monetary unit.

3. 3. What is the accounting equation?

   • Assets: Items the business owns or controls (examples: cash, furniture, land)

   • Liabilities: Items the business owes (examples: accounts payable, notes payable, salaries payable)

   • Equity: Stockholders’ claims to the assets through contributed capital and retained earnings (examples: common stock, dividends, revenues, expenses)

4. 4. How do you analyze a transaction?

   • A transaction affects the financial position of a business and can be measured with faithful representation.

   • Transactions are analyzed using three steps:

     1. Step 1: Identify the accounts and account type (Asset, Liability, or Equity).

     2. Step 2: Decide whether each account increases or decreases.

     3. Step 3: Determine whether the accounting equation is in balance.

5. 5. How do you prepare financial statements?

   1. Income statement:

      • Reports the net income or net loss of a business for a specific period.

   2. Statement of retained earnings:

      • Reports on the changes in retained earnings for a specific period.

   3. Balance sheet:

      • Reports on an entity’s assets, liabilities, and stockholders’ equity as of a specific date.

   4. Statement of cash flows:

      • Reports on a business’s cash receipts and cash payments for a specific period.

      • Includes three sections:

        • Cash flows from operating activities: Involves cash receipts for services and cash payments for expenses.

        • Cash flows from investing activities: Includes the purchase and sale of land and equipment for cash.

        • Cash flows from financing activities: Includes cash contributions by stockholders, cash dividends paid to the stockholders, cash received from borrowing, and cash paid to repay loans.

6. 6. How do you use financial statements to evaluate business performance?

   • Income statement evaluates profitability.

   • Statement of retained earnings shows the amount of earnings that were kept and reinvested in the company.

   • Balance sheet details the economic resources the company has, the debts the company owes, and the company’s net worth.

   • Statement of cash flows shows the change in cash.

   •  Return on Assets (ROA) = Net Income/Average total assets