Chapter 1: A Framework For Financial Accounting

Financial Accounting

  • Definition: accounting information provided to external users

  • 2 main functions:

    • Used to measure business activities of a company

    • Used to communicate those measurements to external parties for decision-making purposes

  • Every business decision leaves a financial footprint

  • Should be based on Generally Accepted Accounting Principles (GAAP)

    • U.S: Financial Accounting Standards Board (FASB), under the SEC

    • Global: Intentional Accounting Standards Board (IASB)

Business Activities

  • Financing Activities: transactions the company has with investors and creditors

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

    • Assets: resources that a company uses to make money (buying/selling equipment, buildings, etc.) and long-term assets (stock)

  • Operating Activities: transactions that relate to the primary operations of the company

    • Expenses, making money

Business Organizations

  • Corporation: a company that is legally separate from its owners

    • The stockholders have limited liability (if the company goes out of business, the people we owe money to are priority)

  • Sole Proprietorship: a business owned by one person

  • Partnership: a business owned by 2+ persons

  • Neither sole proprietorships nor partnerships offer limited liability

The Accounting Equation

  • Assets = Liabilities + Stockholders Equity

  • Assets: total resources of the company

  • Liabilities: amounts owed to creditors

  • Stockholders Equity: owner’s claims to resources

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

  • Expenses: the costs of providing products and services and other business activities during a current period

  • Net income = Revenues - Expenses

    • Net income is also known as earnings or profit

  • Dividends: cash payments to stockholders

    • NOT EXPENSES

Financial Statements

  • Definition: periodic (at least quarterly/annually, but most companies do monthly) reports published by the company for the purpose of providing information to external users

  • Income Statement: Revenues - Expenses = Net Income

  • Statement of Stockholders Equity: Common Stock + Retained Earnings = Stockholders Equity

    • Common Stock = Beginning Balance + Stock Issue = End Balance

  • Balance Sheet: Assets = Liabilities + Owners’ Equity

    • The financial position of the company on a particular date

    • Resources: claims to resources

  • Statement of Cash Flows: measures activities involving cash reciepts/payments over interval of time

    • Operating cash flows: revenue and expense

    • Investing cash flows: purchase/sale of investments and stock

    • Financing cash flows: lenders and stockholders

  • Statement of Comprehensive Income: measures changes in equity that arise from non-owner resources

    • Gains/losses associated with investments in certain types of debt securities

    • Certain types of derivatives

    • Foreign currency translations

    • Pensions

SOX

  • Definition: Sarbanes-Oxely Act, provides regulation of auditors and types of auditor services

  • Increases accountability of corporate executives

  • Addresses conflicts of interest for securities analysts

  • Provides for stiff criminal penalties for violators

  • Have increased the need for good accounting and highlighted a value of accounting information to investors and creditors

Auditors

  • Definition: 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 mistreatment

  • Help ensure that management has in fact appropriately applied GAAP

  • Formally state their professional opinion about the financial statements in a report called “Report of Independent Auditors,” also called Auditor’s Opinion

  • Types of auditor reports:

    • Unqualified

    • Unqualified + Explanatory/Emphasis Paragraph

    • Qualified

    • Adverse