Notes: Financial Accounting, Capital, and Corporate Structures

exIntroduction to Business and Capital

  • Starting a business requires:

    • An idea or business concept that meets market demand

    • Capital (money/resources) to fund operations

  • Sources of capital:

    • Personal wealth/savings

    • Bank loans (difficult without a track record)

    • Investors who contribute capital for ownership

    • Crowdsourcing (like Kickstarter)

    • Bonds (loans from multiple individuals)

Business Organizational Forms

  • Four primary organizational structures:

    • Sole Proprietorship:

    • Owned by single individual

    • Not a separate legal entity

    • Owner's personal assets at risk

    • Taxed as personal income

    • General Partnership:

    • Similar to sole proprietorship but with multiple owners

    • Owners' personal assets at risk

    • Corporation:

    • Separate legal entity

    • Protects owners' personal assets

    • More costly to establish

    • Can result in double taxation

    • LLC:

    • Protects owners' personal assets

    • Avoids double taxation

    • Less easily transferred than corporations

Corporation and LLC Characteristics

  • Corporation

    • Exists in perpetuity

    • Ownership easily transferred via stocks

  • LLC

    • Protects owners' personal assets

    • Avoids double taxation

    • Less easily transferred than corporations

Capital Providers: Lenders vs. Investors

  • Lenders (Creditors):

    • Provide loans to earn interest

    • Return is capped at the interest rate

    • Lower risk, but limited reward

    • Have priority in bankruptcy proceedings

  • Investors (Equity Financers):

    • Purchase stock/ownership

    • Earn returns through dividends and stock price increases

    • Unlimited potential return

    • Higher risk, but greater potential reward

    • Lower priority in bankruptcy

Financial Accounting Purpose and Information

  • Financial accounting serves as a company's track record

  • Information investors/lenders want to know:

    • Assets (what the company owns/resources)

    • Liabilities (what the company owes)

    • Cash generation and spending

Financial vs. Managerial Accounting

  • Financial accounting:

    • Prepared for external parties (investors, lenders)

    • Follows standardized rules (GAAP)

    • Enables comparison between companies

    • Subject to audit

  • Managerial accounting:

    • Prepared for internal use (managers, executives)

    • Helps with strategic decision-making

    • No standardized rules required

    • Can be formatted however is most useful internally

Accounting Standards and Regulation

  • US Standards:

    • Generally Accepted Accounting Principles (GAAP)

    • Created by Financial Accounting Standards Board (FASB)

    • FASB is a private organization authorized by SEC

  • International Standards:

    • International Financial Reporting Standards (IFRS)

    • Created by International Accounting Standards Board (IASB)

    • Used by many countries globally

  • Some convergence with US GAAP, but differences remain

Audit Process and Assurance

  • Purpose of audits:

    • Provide reasonable assurance that financial information is accurate

    • Third-party verification of company claims

  • Audit challenges:

    • Companies pay for their own audits (potential conflict)

    • Auditors can be fired by the companies they audit

  • Audit oversight:

    • Securities and Exchange Commission (SEC)

    • AICPA (Association of Internationally Certified Public Accountants)

    • FBI investigates fraudulent audits

    • Legal consequences for misleading investors

  • Ethical/Practical implications:

    • Potential conflicts of interest when audits are paid by the client

    • Importance of independent verification to protect investors

Course Structure

  • Module 1: Overview of financial accounting concepts

  • Module 2: Process of creating financial accounting information

  • Future modules: Detailed examination of financial statements