Principles of Accounting Chapter 1

Recognition and Measurement Criteria

Concepts: Accounting entity, Accounting period, Monetary unit, going concern Principles: Measurement, Revenue recognition, Expense recognition, Full disclosure Constrains: Materiality, Cost-benefit

Management's Discussion and Analysis

Contains management's interpretation of the company's recent performance and financial condition.

Activities of a business

Every business, regardless of its organizational form, its industry, or its size, is involved in three types of business activities - financing, investing, and operating.

Period-of-Time Statements

Financial statements presenting information covering a specific period of time. The income statement, the statement of stockholders' equity, and the statement of cash flows are all period-of-time statements.

Financial Reporting Objectives

Focus on information that... 1. is useful in making investment, credit, and similar decisions. 2. is helpful in assessing the ability of enterprises to generate future cash flows. 3. contains information about a company's economic resources, the claims on those resources, and the effects of events that change those resources and claims.

Certified Public Accountant (CPA)

Independent auditors with a license to conduct auditing work in a state. They express a professional opinion as to whether a financial statement is presented "in conformity with generally accepted accounting principles".

Creditors

Individuals or financial institutions that lend money to companies. Creditors are repaid the principal plus interest for the use of their funds.

Investing activities

Involve the acquisition an deposition of land, buildings, and equipment needed to carry out the company's business plans. These items are also referred to as assets. These assets can be purchased using financing activities or excess cash accumulated from operating the business profitably.

Debt Financing

Involves borrowing money from sources such as a bank by signing a note payable or directly from investors be issuing bonds payable.

Equity financing

Involves selling shares of stock to investors. In this form of financing, rather than receiving interest, investors are purchasing ownership interest in the company hoping that their stock will increase in value.

The Accounting Process

Measurment 1. Identify the relevant economic activities of a business. 2. Quantify these economic activities 3. Record the resulting measures in a systematic manner. Communication 1. Prepare financial reports to meet the needs of the user. 2. Help interpret the financial results for that user.

Annual Report (Form 10-K)

Must be reported by all publicly traded companies in the US to the SEC. Includes the financial report, and may also include notes to the financial statements, the auditor's report, and the Management's Discussion and Analysis.

Liabilities

Obligations or debits that a business must pay in cash or in goods and services at some future time as a consequence of a past transaction or event. Example: wages to be paid to employees for work preformed would be called wages payable and reported as a liability on a balance sheet.

Why does everything in accounting need an acronym?

1. The name is far to long. 2. The name resembles at least three other organizations/boards/standards/etc. 3. There are, one can infer from reason 2, too many organizations/boards/standards/etc. 4. Accountants have less creativity in their whole body than I have in my thumbnail. 5. Acronyms are fun. 6. Accounting is not fun and therefore acronyms are necessary. 7. Accountants get tired of numbers and occasionally try their hands at letters. It doesn't work (see Shitty Acronyms 1-infinity) 8. Acronyms are fun. IASB stands for "I am so boring".

Sole Proprietorship

A business owned by one person. Decisions are made by the owner. The business is not taxed, but the owner is. The sole proprietorship has a limited lifespan and is not a legal entity. Example: small business, restaurant, etc.

Partnership

A business owned by two or more people. The business is not taxed, but the partners are. The business has a limited life and is not a legal entity. Example: legal firm.

Blockchain

A distributed digital ledger that provides a secure means of viewing recorded transactions.

Revenue Recognition

A generally accepted accounting principle that identifies the specific conditions in which revenue is recognized and determines how to account for it.

Balance sheet

A listing of a firm's assets, liabilities, and stockholders' equity as of a given date.

Contributed Capital

A measure of the capital contributed by the stockholders of a company when they purchase ownership shares (also called common shares or common stock) in the company.

Earned Capital

A measure of the capital that is earned by the company, reinvested, in the business, and not distributed to stockholders, also referred to as retained earnings.

Generally Accepted Auditing Standards (GAAS)

A set of systematic guidelines used by auditors when conducting audits on companies' financial records. GAAS helps to ensure the accuracy, consistency, and certifiability of auditors' actions and reports. The Public Company Accounting Oversight Board (PCAOB) monitors the quality of financial statements and audits.

Generally Accepted Accounting Principles (GAAP)

A standardized set of rules for accountants to follow when preparing financial statements. These rules can change over time.

Net Assets

Assets - Liabilities = Stockholders' Equity Net Assets = Stockholders' Equity

Cost Principle

Assets and liabilities are initially recorded at the amount paid or obligated to pay.

Income Statement

Reports the results of operations for a business for a given time period. The income statement lists the revenues and expenses of the business.

Full Disclosure Principle

Requires that a business disclose all significant financial facts and circumstances

Cost-Benefit Constraint

Requires that the benefit derived from the information outweighs the cost of providing it.

Cash Basis of Accounting

Revenues are recorded when cash is received from operating activities and expenses are recorded when cash payments are made for operating activities. Net income becomes the difference between operating cash recipts and operating cash payments.

Monetary Unit Concept

Specifies that a monetary unit (I.e. the dollar or euro) is to be used to measure and record and entity'd economic activity. Only items that can be expressed in these monetary units are included in the financial statements.

Recognition and Measurement Criteria

Specify the conditions that must be satisfied before a particular asset, liability, revenue, or expense can be recorded in the financial record.

Expense Recognition Principle

States that net income is determined by linking any expenses incurred with the related earned sales revenues.

Accounting Equation

States that the sum of a business's economic resources must equal the some of any claims on those resources. Resources of a company = Claims on resources A business obtains resources that it utilizes in its operations form outside sources (creditors and stockholders) who maintain claims on those resources. Assets = Liabilities + Stockholder's equity Assets are a company's resources, and liabilities are creditor claims on those resources and stockholder's equity is the owner's claim on those resources. In economic terms, this formula is: Resources = Creditor claims on resources + Stockholder claims on resources

Financial Accounting Oversight

The Financial Accounting Standards Board (FASB), AICPA, and the. U.S. Securities and Exchange Commission (SEC) help in the development of GAAP in the US. The SEC's primary focus is to regulate the interstate sale of stocks and bonds. The SEC requires companies under its jurisdiction to submit audited annual financial statements to the agency, which it makes public. The SEC has the power to set the accounting principles used, but has largely delegated that responsibility to the FASB.

International Financial Reporting Standards

The International Accounting Standards Board (IASB) formulates the accounting standards called the international Financial Reporting Standards (IFRS)

International Financial Reporting Standards (IFRS)

The accounting standards formulated by the IASB. The US is not allowed to report to the IASB, but the FASB and IASB coordinate to eliminate as many differences as possible.

Principal

The amount of money initially borrowed. This amount is usually accompanied by an interest fee.

Operating activities

The day-to-day activities of producing and selling a product or providing a service. If a company is unable to generate income from its operations, it is very likely to fail. This also involves buying supplies and conducting marketing.

Assets

The economic resources of a business that can be expressed in monetary terms. Assets represent a probable future economic benefit to a business.

Sales Revenue

The increases to a company's resources that results when goods or services are provided to customers. The amount of sales revenue earned is measured by the value of the assets received in exchange for the goods or services.

Stockholders' Equity

The ownership (stockholder) claims on the assets of the business. Stockholders' equity represents a residual claim on a business's assets; this residual claim is a claim on the assets of a business that remain after all liabilities to creditors have been satisfied.

Data Analytics

The process of examining sets of data with the goal of discovering useful information from patterns found in data.

Managerial accounting

The process of generating and analyzing data for decision making and efficient management. This information is generally reserved for use by a company's top management.

Accounting

The process of measuring economic activity of an entity in monetary terms and communicating results to users.

Auditor's Report

The report of the independent auditor describing the activities undertaken by a company's independent auditor and provides the auditor's opinion.

What portion of a company's current period net income is distributed to its stockholders and what portion is retained?

The statement of stockholders equity reports both a company's net income and the amount of dividends distributed to stockholders. Compare the company's dividends to its net income. A higher ratio of dividends to net income implies that a company is distributing more of its net income to its stockholders, whereas a lower ratio implies that it is retaining more of its income for purposes such as growing its business.

Financial accounting

The subset of accounting that produces publicly available statements quarterly and annually. These financial statements detail the result of a business's operations, cash flows, and financial position.

Ethics

The values, rules, and justifications that govern one's way of life. Increasingly, business managers recognize the importance and value of ethical behavior and often develop a written code of ethics. The American Institute of Certified Public Accountants (AICPA) and Institute of Management Accountants (IMA) are examples of professional organizations of accountants have written ethics.

Financial Statements

There are four basic financial statements: the balance sheet, the income statement, the statement of stockholders' equity, and the statement of cash flows. The heading of each statement provides the name of the company, the name of the financial statement, and the date or time period of the statement.

Business Organization

There are three main types of business organization: the sole proprietorship, the partnership, and the corporation.

Relations Among the Financial Statements

Typically, financial statements are prepared in the following order: Income statement, Statement of stockholders' equity, Balance sheet, Statement of cash flows.

Net Loss

When total expenses exceed total revenue. Total Revenue - Total Expenses = Net Income where Total Revenue < Total Expenses

Net Income

When total revenue exceeds total expenses. Total Revenue - Total Expenses = Net Income where Total Revenue > Total Expenses

Conceptual Framework

a cohesive set of interrelated objectives and fundamentals for external financial reporting whose purpose is to guide the formulation of specific U.S. accounting principles.

Materiality

permits a firm to expense the cost of small assets (ex. tools, office equipment) when acquired as their cost is "immaterial" in amount.

Accounting Period

typically one year for the purposes of preparing financial statements.

Ethical dilemmas in accounting

1. Accountants face pressure to "improve" reported results to affect aspects of business like the amount of income tax to be paid, the amount of a bonus to be received, etc. These pressures should be ignored. 2. Accountants often have access to confidential information. This information should remain confidential. 3. Successful companies and ethical practices are directly related. To boost short-run profits, management and accountants may be tempted to allow unethical business practices. Both parties should recognize the importance of long-run perspective.

Elements of Financial Statements

1. Assets 2. Liabilities 3. Stockholders' Equity 4. Investments by Owners 5. Distributions to Owners 6. Revenues 7. Expenses 8. Gains 9. Losses 10. Comprehensive Income

Objectives of Financial Reporting

1. Provide information useful for investment and credit decisions. 2. Provide information useful in assessing cash flows. 3. Provide information about resources and claims on those resources.

Stockholder

Also called shareholders. Owners of a corporation who own stock as evidence of ownership. Stockholders pay taxes on dividends received from the corporation. Corporations are also the dominant organizational form in terms of volume of business activity.

Sarbanes-Oxley Act (2002)

An act passed in response to declining public confidence in financial statements due to misleading information. This legislation required that a company's top management certify in writing the accuracy of its reported financial statement information, risking criminal prosecution for fraudulent certification. Companies must also report internal controls put into place to deter errors in the financial reporting process and to detect them should they occur.

Accounting Entity

An economic unit with identifiable boundaries for which we accumulate and report financial information.

Corporation

Can be owned by one person or many people through stock. The business and owners are taxed. The business is a separate legal entity and has an unlimited life.

Financing Activities

Categorized as wither debt financing or equity financing. Financing activities refer to the acquisition of funds necessary to support the operation of the company either through issuing stock or obtaining loans.

Internal users of accounting

Data is needed for decision making and management of a business. Groups such as a marketing department, a management team, and a finance department may use accounting information.

Expenses

Decreases in a company's resources from generating revenue. Expenses are generally measured by the value of the assets used up or exchanged as a result of a business's operating activities.

Accrual Basis of Accounting

Defined by the revenue recognition principle and the expense recognition principle. The concept of recording revenues when earned and expenses as incurred, reflected on the balance sheet.

Statement of Stockholders' Equity

Reports the events causing an increase or decrease in stockholders' equity during a given time period. The statement consists of two parts: contributed capital and earned capital.

External users of accounting information

Potential investors, investment professionals, creditors, and stockholders are external users of accounting information. They primarily used financial statements to make decisions. Financial statements are typically audited by an independent public accountant. Publicly owned businesses are required to have their financial statements audited.

The Going Concern Concept

Presumes that an enterprise will continue to operate indefinitely and will not be sold or otherwise liquidated.

Qualitative Characteristics of Accounting Information

Qualities of useful qualitative accounting information are relevance and faithful representation as well as comparability and consistency.

Notes to the Financial Statements

Quantitative as well as qualitative information providing details behind summarized numbers.

Characteristics of Accounting Information

Relevance: Timeliness, Predictive, Confirmatory Faithful Representation: Complete, Neutral, Free from Error, Verifiable Comparability Understandability

Statement of Cash Flows

Reports a business's cash inflows and outflows during a given period of time. The cashflows are grouped into three business activities: operating, investing, and financing.

Point-in-Time Statements

Reports information as of a specific time. The balance sheet is a point-in-time statement.