Accounting Chapter 1: business decisions & financial accounting

The four main groups of external users for financial accounting are

(1) creditors, (2) investors, (3) directors, and (4) government

line items found on a statement of retained earnings for the month ended September 30th

-Add: Net Income - Retained Earnings, September 30 -Retained Earnings, September 1 -Subtract dividends

an income statement includes

-net income -revenues -expenses

The heading of an income statement should include

-the name of the business -accounting period covered by the statement -the title "income statement"

The statement of cash flows is divided into three types of activities:

1. Operating 2. Investing 3. Financing

These claims arise from two sources:

1. Paid-in capital 2. Earned capital

When faced with an ethical dilemma, you should follow a three-step process:

1.Identify who will be affected by the situation 2.Identify and evaluate the alternative courses of action. 3.Choose the alternative that is the most ethical

A calendar year is a 12-month period ending on December 31, and a fiscal year is a

12-month period ending on a day other than December 31

Partnership

A partnership is similar to a sole proprietorship, except that profits, taxes, and legal liability are the responsibility of two or more owners instead of just one. It is slightly more expensive to form than a sole proprietorship because a lawyer typically is needed to draw up a partnership agreement, which describes how profits are shared between partners and how that would Page 5change if new partners are added or existing partners leave. The key advantage of a partnership over a sole proprietorship is that, by having more owners, a partnership typically has more resources available to it, which can fuel the business's growth.

accounts:

A standardized format that organizations use to accumulate the dollar effects of transactions on each financial statement item.

Does the company have enough assets to cover its liabilities?

Answers to this question come from comparing assets and liabilities reported on the balance sheet. Noodlecake is expected to own more than it owes at September 30 (total assets of $36,000 versus total liabilities of $25,000).

Assets are listed in order of

How fast they can be converted to cash

financial statementsrefers to four accounting reports, typically prepared in the following order:

Income Statement Statement of Retained Earnings Balance Sheet Statement of Cash Flows

Creditors are mainly interested in assessing:

Is the company generating enough cash to pay what it owes? Does the company have enough assets to cover its liabilities?

what appears on both the income statement & statement of retained earnings?

Net Income

Statement of Retained Earnings

Reports the way that net income and the distribution of dividends affected the financial position of the company during the accounting period.

This is the unit of measure assumption

The financial results of a companies worldwide business activities should be measured and reported using a single monetary unit, such as the U.S. dollar

Paid-in capital.

The owners have a claim on amounts they contributed directly to the company in exchange for its stock (Common Stock).

Earned capital.

The owners have a claim on profits the company has earned for them through its business operations (Retained Earnings).

1. Operating:

These cash flows arise directly from running the business to earn profit. They include cash received from selling apps and services, and cash paid for wages, advertising, rent, insurance, supplies, and so on.

2. Investing:

These cash flows arise from buying and selling productive resources with long lives (such as buildings, land, equipment, and software), purchasing investments, and lending to others

3. Financing:

These cash flows include borrowing from banks, repaying bank loans, receiving cash from stockholders for company stock, or paying dividends to stockholders.

Sole Proprietorship

This is a form of business owned (and usually operated) by one individual. It is the easiest form of business to start because it doesn't require any special legal maneuvers. Just get a business license and you're good to go. A sole proprietorship is considered a part of the owner's life, with all profits (or losses) becoming part of the taxable income of the owner, and the owner being personally liable for all debts of the business.

Corporation

a corporation is a separate entity from both legal and accounting perspectives. This means the corporation, not its owners, is legally responsible for its own taxes and debts. Thus, owners cannot lose more than their investment in the corporation, which is a major advantage to the owners. Two disadvantages of incorporation are the legal fees for creating a corporation can be expensive and income taxes must be paid by both the corporation and its owners.

Expenses are

all costs of doing business that are necessary to earn revenues.

an asset is

an economic resource presently controlled by the company; it has measurable value and is expected to benefit the company by producing cash inflows or reducing cash outflows in the future.

Any account name containing "receivable" is an

asset

items a company owns

assets

According to the cost principle of accounting,

assets are initially reported on the balance sheet based on their original cost to the company.

cash is reported on what financial statements?

balance sheet & statement of cash flows

Net income is

calculated as revenues minus expenses.

The main goal of GAAP and IFRS is to ensure

companies produce financial information that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the companies.

A company's profits are accumulated in Retained Earnings until a decision is made to distribute them to stockholders in what is called a

dividend

Cash on the balance sheet is equal to the

ending Cash on the statement of cash flows.

Net Income, from the income statement, is a component in determining

ending Retained Earnings on the statement of retained earnings.

2. Investors include

existing and potential stockholders. Stockholders look to accounting information to assess the financial strength of a business and, ultimately, to estimate its value.

Dividends are not an

expense incurred to generate earnings. Rather, dividends are an optional distribution of earnings to stockholders, approved by the company's board of directors.

Banks use

financial statements to evaluate the risk they will not be repaid the money they've loaned to a company. Because banks take a risk when they loan money to a company, they want periodic financial reports to evaluate how well the company is doing so they can intervene if it looks like the company will have trouble repaying its loan.

Through these profits, owners can

get more money back from the company than they paid in (a return on their investment).

It will be profitable if the total amount earned from selling goods and services is

greater than the costs incurred to generate those sales.

The first financial statement prepared is the

income statement

Accounting is an

information system designed by an organization to capture (analyze, record, and summarize) the activities affecting its financial condition and performance and then report the results to decision makers, both inside and outside the organization. It's such a key part of business that business people typically talk about their companies using accounting terms, which is why they often call it the "language of business."

3. Directors is the

is the short title for the members of a company's board of directors. The stockholders of public companies or large private companies elect directors to oversee the company's managers. Directors use financial statements to ensure the company's managers make decisions that are in the best financial interests of its stockholders.

Ending Retained Earnings from the statement of retained earnings

is then reported on the balance sheet.

This net income can be left in the company to accumulate (with earnings that have been retained from prior years) or

it can be paid out to the company's stockholders for their own personal use (called dividends)

By generating net income, a company increases

its stockholders' equity

any containing "payable" is a

liability

the claims on these items (assets) by creditors

liability

4. Government agencies

look closely at companies' financial statements. (IRS) and state and local governments use financial statement information to ensure taxes are computed using correct amounts.

Liabilities are

measurable amounts the company owes to creditors

Parentheses are used on the statement of cash flows to indicate

negative cash flows (outflows rather than inflows)

what causes retained earnings to increase?

net income & revenues

a business can survive

only if it is profitable

retained earnings are the

profits that have accumulated in the company over time.

Dividends are reported as a

reduction in Retained Earnings

for financial information to be judged useful, it must possess two fundamental characteristics:

relevance and faithful representation

statement of cash flows

reports inflows and outflows of cash during the accounting period in the categories of operating, investing, and financing

balance sheet

reports the amount of assets, liabilities, and stockholders' equity of an accounting entity at a point in time

what appears on both the statement of retained earnings and the balance sheet?

retained earnings

What is found on a balance sheet?

retained earnings, cash, accounts receivable, notes payable

Revenues are earned by

selling goods or services to customers.

The business itself, not the stockholders who own the business, is viewed as owning the assets and owing the liabilities. This separation between stockholders and business is called the

separate entity assumption

This format, which groups revenues separately from expenses and reports a single measure of income, is called a

single-step income statement

A share of the corporation's ownership is indicated on a legal document called a

stock certificate

1. Creditors include

suppliers, banks, and anyone to whom money is owed

Suppliers want to be

sure they will be paid for the goods and services they deliver, so they will evaluate a company's financial statements and check its credit history before allowing it to buy on credit.

The relationship between assets (A), liabilities (L), and stockholders' equity (SE) is known as

the basic accounting equation

Stockholders' equity represents

the owners' claims on the business

The balance sheet "balances" because

the resources equal the claims on Page 13the resources.

Is the company generating enough cash to pay what it owes?

the statement of cash flows helps answer this question. In particular, creditors would be interested in seeing whether operating activities are producing positive cash flows.

Corporations can raise large amounts of money for growth because

they divide ownership of the corporation into shares that can be sold to new owners.

Theoretically, these profits belong to the company's owners, so

they increase stockholders' equity.

what a company owns must equal

what a company owes to its creditors and stockholders

Most corporations start out as private companies and

will apply to become public companies ("go public") if they need a lot of financing, which they obtain from issuing new stock certificates to investors.