Accounting Chapter 2

profitability

company's ability to generate net income from the business profitable operations increase owner's equity

liabilities

financial obligations or debts present future cash flows person or organization to who the debt is owed is called a creditor listed on balance sheet in the oder in which they are expected to be repaid represents claims against the borrower's assets

short run vs. long run

in short run, liquidity and profitability may be independent of each other over long term, liquidity and profitability go hand in hand key indicator of company's short term liquidity is the relationship between an entity's liquid assets and the liabilities requiring payment in the near future

stable dollar assumption

a limitation of measuring assets at historical cost is that the value of the monetary unit or dollar is not always stable inflation/deflation

liquidity

ability of the business to pay its debts as they come due critical to survival of the business business that isn't liquid may be forced into bankruptcy by its creditors

accounting equation

assets = liabilities + owner's equity

financial statements

declaration of what is believed to be true about an enterprise, communicated in terms of a monetary unit, such as the dollar describes in financial terms certain attributes of the enterprise that they believe fairly represent its financial activities creditors more likely to extend credit if Fia coal statements show a strong statement of financial position (little debt, large amount of liquid assets) window dressing occurs when management takes measures to make the company appear as strong as possible in its financial statmens

balance sheet

describes where the business stands at a specific date (snapshot of the business in financial or dollar terms) assets - listed in order of expected liquidity beginning with cash liabilities - listed on other side of balance sheet before owner's equity equity - divided into the categories of capital stock and retained earnings

statement of cash flows

details the company's sources and uses of cash during an accounting period enables financial statement use to better understand the change in cash balance on the balance sheet classifies cash flow into 3 categories - operating, investing, and financing

business entity concept

economic unit that engages in identifiable business activities activities of entity is separate from personal activities of owners should only include items related to operation of business

corporation

entity separate from its owners owners aren't personally liable for debts of the business owners can lose no more than the amounts they have invested in the business (limited liability) ownership is divided into transferable shares of capital stock dominant form of business organization in terms of dollar volume of business activity

partnership

incorporated business owned by two or more persons voluntarily acting as partners (co-owners) widely used for small businesses as well as some large professional practices, including CPA firms and law firms owners of partnership are personally responsible for all debts of the business viewed as a business entity separate from personal affairs of its owners

going concern assumption

indicates that we assume that a business will be a continuing enterprise which will operate for an indefinite period supports. principle of historical cost as most assets are not intended for resale but meant to assist the business in continuing their core operations

owner's equity

represents owner's claims on the assets of the business indicates a residual amount as creditors have legal priority over owners entitles owners to the residual assets once creditors have been paid in full always equal to total assets minus total liabilities

income statement

shows revenues and expenses for a designated period of time revenues have resulted or are expected to result in positive cash flows through transactions with customers expenses result in negative cash flows (outflows of cash) through business activities net income - difference between revenues and expenses

3 primary financial statements

statement of financial position (balance sheet) income statement statement of cash flows

cost principle

states that acquired assets and services should be recorded at their actual cost

inflation

value of the monetary unit decreases (it will purchase less than it did previously)

objectivity principle

objective describes info that is factual, definite, and verifiable objective info lacks subjectivity objectivity is a primary reason for reporting long term assets at historical cost as that value is verifiable

historical cost

original amount the entity paid to acquire the asset examples of assets reported at historical cost include merchandise inventory, land, buildings, and equipment examples of assets reported at net realizable value, or fair value, include accounts receivable and investments

assets

three basic characteristics - economic resources, owned by the business, expected to benefit future operations (directly - asset is converted into cash ; indirectly - asset is used in operating the business to create other assets that result in positive future cash flows

sole proprietorship

unincorporated business owned by one person often owner also acts as the manager common for small retail stores, farms, service businesses, and professional practices in law, medicine, and accounting most common form of business organization in our economy

adequate disclosure

users of financial statements are informed of all info necessary for proper interpretation of statements disclosures are made in the body of the financial statements and in the notes accompanying the statements common for the notes to the financial statements to be longer than the statements themselves

deflation

value of the monetary unit increases (it will purchase more than it did previously)