Chapter 1: Purpose and Importance of Accounting

Financial Accounting Standards Board

FASB - is in charge of setting GAAP

What are the four areas of opportunities of accounting?

Financial Managerial Taxation Accounting-Related

Income Statement

Financial statement showing net income. Revenues minus expenses equals net income or net loss.

Net Income

Found in the Income Statement. Revenues minus expenses.

Net Loss

Found in the Income Statement. Revenues minus expenses.

Types of Accounting Principles

General Principles: - Measurement Principle (cost principle) - Revenue Recognition Principle - Expense Recognition Principle (matching principle) - Full disclosure Principle

Internal Controls

Procedures to protect assets, ensure reliable accounting, promote efficiency, and uphold company policies. ie. good records, physical controls (locks), and independent reviews.

Securities and Exchange Commission

SEC - government agency that oversees proper use of GAAP by companies that sell stock and debt to the public.

Statement of Cash Flows

Shows the cash inflows and outflows. Cash flows from operating activities + Cash flows from investing activities + Cash flows from financing activities = Net increase in cash Net increase in cash + Beginning Cash balance = Ending Cash balance

Balance Sheet

Shows the financial position at the end of a business day. Assets = Liabilities + Equity

Private Accounting

(Most Popular) Employees working for businesses.

Return on Assets

(ROA) = Net Income / Average Total Assets Also called return on investment (ROI) This is used to analyze profitability.

Measurement Principle

(cost principle) Accounting info is based on actual cost. Cost is measured on a cash or equal-to-cash basis.

Sole Proprietorship

- 1 Owner - No business income tax. - Unlimited liability. Owner is personally liable for proprietorship debts. - Not a separate legal entity - Business ends with owner death or choice.

Limited Liability Company (LLC)

- 1 or more (members) - No additional business income tax - Limited liability. Owners, called members, are not personally liable for LLC debts. - A separate entity with the same rights and responsibilities as a person. - Business life is indefinite.

Corporation

- 1 or more stockholders - Additional corporate income tax - limited liability. Owners called stockholders or shareholders are not liable for corporate acts and debts - A separate entity with the same rights and responsibilities as a person - Business life is indefinite

Partnership

- 2 or more partners - No additional business income tax - Unlimited liability. Partners are jointly liable for partnership debts. - Not a separate legal entity. - Business ends with a partner death or choice

Expense Recognition Principle

Also known as the "Matching Principle": A company records the expenses it incurred to generate the revenue reported. ie. office space.

Why is accounting important today?

Because we live in an information age in which accounting information impacts us all.

Ethics

Beliefs that separate right from wrong. They are excepted standards of good and bad behavior.

External Transactions

exchanges of value between two entities, which cause changes in the accounting equation.

Internal Transactions

exchanges within an entity which may or may not affect the accounting equation.

Financial Accounting

focuses on the needs of external users

Managerial Accounting

focuses on the needs of internal users

Events

happenings that affect the accounting equation and are reliably measured.

External Users

- Lenders (creditors) loan money or other resources to an organization. They use the info to assess if an organization will repay its loans. - Shareholders (investors) are the owners of a corporation. They use the reports to decide whether to buy, hold or sell stock. - Boards of Directors oversee organizations. They use the info to evaluate the performance of executive management. - External (independent) auditors examine financial statements to verify that they are prepared according to generally accepted accounting principles. - Nonmanagerial and nonexecutive employees and labor unions use information to bargain for better wages. - Regulators have legal authority over certain activities of organizations. ie.(IRS) requires the reports for computing taxes. - Voters and government officials use information to evaluate government performance. - Contributors to nonprofits use information to evaluate the use and impact of donations. - Suppliers use info to analyze a customer before extending credit. - Customers use financial reports to assess the stability of potential suppliers.

Internal Users

- Purchasing managers need to know what, when, and how much to purchase. - Human resource managers need information about employees' payroll, benefits, and performance. - Production managers use information to monitor costs and ensure quality. - Distribution managers need reports for timely and accurate delivery of products and services. - Marketing managers use reports to target consumers, set prices, and monitor consumer needs. - Service managers use reports to provide better service to customers. - Research and development managers use into on projected costs and revenues of innovations.

Business Entity Assumption

A business is accounted for separately from other business entities and its owner.

Full Disclosure Principle

A company reports the details behind financial statements that would impact users' decisions. Those disclosures are often in footnotes to the statements.

Liabilities

A creditors' claims on assets. ~A payable is a liability that promises a future outflow of resources. (business pays with credit, notes (loans) payable to banks, wages payable to workers...)

Going-Concern Assumption

Accounting information presumes that the business will continue operating instead of being closed or sold. ie. property is reported at cost instead of liquidation value.

Accounting

Accounting is an information and measurement system that identifies, records, and communicates an organization's business activities.

Public Accounting

Accounting services such as auditing and taxation.

Accounting Equation

Assets = Liabilities + Equity This applies to all transactions and events, to all companies and organizations, and to all points in time.

Dodd-Frank Wall Street Reform and Consumer Protection Act

Clawback Mandates recovery (clawback) of excessive pay. Whistleblower SEC pays whistle blowers 10% to 30% of sanctions exceeding $1 million.

Generally Accepted Accounting Principles (GAAP)

Concepts and rules that govern financial accounting. GAAP wants information to have relevance and faithful representation.

Sarbanes-Oxley Act (SOX)

Created to stop financial abuses. It requires documentation and verification of internal controls and emphasizes effective internal controls. Management must issue a report stating that internal controls are effective.

Accounting Assumptions

Going-Concern Assumption Monetary Unit Assumption Time Period Assumption Business Entity Assumption

International Accounting Standards Board

IASB - issues International Financial Reporting Standards (IFRS).

International Financial Reporting Standards

IFRS - identify preferred accounting practices. These are similar to U.S. GAAP.

Cost-Benefit Constraint (Cost Constraint)

Information disclosed by an entity must have benefits to the user that are greater than the costs of providing it.

FASB Conceptual Framework

Objectives: provide info useful to investors, creditors, and others. Qualitative Characteristics: to require information that has relevance and faithful representation. Elements: to define items in financial statements. Recognition and Measurement: to set criteria for an item to be recognized as an element; and how to measure it.

Fraud Triangle

Opportunity: low risk of getting caught Rationalization: justifies fraud or doesn't see its criminal nature Pressure (incentive): the person must feel pressure or have an incentive

Recordkeeping/Bookkeeping

Recording of transactions and events.

Assets

Resources a company owns or controls. These resources are expected to yield future benefits. ~A receivable is an asset that promises a future inflow of resources (someone pays in credit)

Revenue Recognition Principle

Revenue is recognized when goods or services are provided to customers and at the amount expected to be received from the customer. (Cash or Credit)

Time Period Assumption

The life of a company can be divided into time periods. ie. months and years. Reports can be prepared for those periods.

Equity

The owner's claim on assets and is equal to assets minus liabilities. Also called "net assets or residual equity." +Contributed Capital (Common Stock) -Dividends +Revenues -Expenses

Statement of Retained Earnings

This report shows how retained earnings change over the reporting period. Beginning retained earnings + Net income - Dividends = Retained Earnings

Monetary Unit Assumption

Transactions and events are expressed in monetary, or money, units. ie. U.S. Dollar, Mexican Peso...

Auditors

Verify the effectiveness of internal controls. Ignoring SOX can lead to penalties and criminal prosecution of executives.

Materiality

ability of information to influence decisions. aka - constraint

Conservatism and Industry Practices

is an accounting constraint