ACCT chapter 2 a

Chapter 2: Investing and Financing Decisions and the Accounting System

• Looking Ahead

  • Chapter 2 Connect Homework due Friday

  • Chapter 2 ALA due Friday

Introduction to Accounting

• Definition

  • Accounting is the conversion of complex economic phenomena into abstract representations.

Purpose and Customization of Accounting Information

• User Types and Reports

  • Accounting information can be customized to serve different purposes:

    • Financial Users: Investors & Creditors

      • Report Type: 10-K, Rules: U.S. GAAP, Rule Maker: FASB, Audit Type: External

    • Managerial Users: Managers

      • Report Type: Sales, Inventory, etc., Audit Type: Internal

    • Tax Users: Government

      • Report Type: Tax Return, Rule Maker: Tax Law, Audit Type: Congress

    • International Users: Governed by International Financial Reporting Standards (IASB)

  • Financial reporting aims to provide information useful to existing and potential investors and lenders in decision-making about resources allocation.

Reliability of Accounting Information

• Reliability Assurance

  • Accounting helps ensure that information is reliable.

Key Qualities of Useful Information

• Decision Usefulness

  • Information must be relevant and faithfully represented.

  • Faithful Representation:

    • Complete, Neutral, Free from Error

  • Relevance:

    • Capable of making a difference in user decisions.

  • Enhancing Qualities:

    • Comparability, Verifiability, Timeliness, Understandability.

    • Benefits must outweigh costs.

Fundamental Recognition and Measurement Assumptions

• Key Assumptions

  • Separate Entity Assumption: Business transactions are separate from owners’ transactions.

  • Going Concern Assumption: Business will continue to operate into the foreseeable future.

  • Monetary Unit Assumption: Information reported using national monetary unit.

  • Time Period Assumption: Long life of a company can be reported in shorter periods.

Recognition and Measurement Principles

• Key Principles

  • Mixed-Attribute Measurement Model: Most balance sheet elements recorded at historical cost but can be adjusted.

  • Revenue and Expense Recognition: Covered in Chapter 3.

  • Full Disclosure: Covered through ALA.

Balance Sheet Elements Definitions

• Balance Sheet Equation: A = L + SE

  • Assets: Probable future economic benefits obtained or controlled by the entity from past transactions/events.

  • Liabilities: Probable future sacrifices of economic benefits arising from present obligations to transfer assets or provide services.

  • Stockholders’ Equity: Residual interest in the assets after subtracting liabilities, divided into:

    • Contributed Capital

    • Retained Earnings

Types of Events Affecting Accounting

• External Events: Exchanges of assets, goods, or services between parties.

  • Example: Purchasing machinery.

• Internal Events: Events that have measurable effects on the entity without exchanges.

  • Example: Using up supplies purchased previously.

Identification of Assets and Liabilities

• Examples:

  • Purchase of a machine as an asset.

  • Hiring staff resulting in future salary obligations is not recorded as an asset.

• Concept Checks:

  • Events recorded based on whether they meet asset/liability definitions.

Asset Accounts Overview

• Typical Asset Accounts Include:

  • Cash, Accounts Receivable, Inventory, Equipment, Intangibles.

  • Prepaid Expenses represent future benefits for amounts already paid.

Liability Accounts Overview

• Typical Liability Accounts Include:

  • Accounts Payable, Accrued Expenses, Notes Payable, Unearned Revenue.

Equity Accounts Overview

• Components of Equity:

  • Contributed Capital (Common Stock, Additional Paid-in Capital)

  • Retained Earnings.

Concept Checks on Asset Measurement

• Examples of Asset Recording:

  • Truck recorded at cash amount paid.

  • Land recorded at the signed note amount.