Financial Accounting- Chapter 1

What four general-purpose financial statements do business enterprises use?

(1) Income Statement - measures the difference between the asset increases and the asset decreases that were associated with operating a business during a particular accounting period. (2) Statement of Changes in Stockholders' Equity - explains the effects of transactions on stockholders' equity during the accounting period. (3) Balance Sheet - lists the assets and the corresponding claims against the entity as of a particular date. (4) Statement of Cash Flows - explains how a company obtained and used cash during the accounting period.

What three categories of cash receipts and cash payments do businesses report on the statement of cash flows? Explain the types of cash flows reported in each category.

(1) Operating activities - explain the cash generated from revenue and the cash paid for expenses. (2) Investing activities - include cash received or spent by the business on productive assets used in the business, and investments in debt or equity of other companies. (3) Financing activities - include cash inflows and outflows from the company's transactions with its owners and inflows and outflows from its borrowing activities.

Distinguish between elements of financial statements and accounts.

1. Assets 2. Liabilities 3. Equity (Stockholders' Equity) 4. Investments by Owners (Contributed Capital) 5. Revenue 6. Expenses 7. Distributions (Dividends) 8. Net Income 9. Gains 10. Losses Items reported on the financial statements are organized into classes or categories called elements. Accounts are specific items or subclassifications of the elements. Examples of accounts include cash, land and common stock.

What does a double-entry bookkeeping system mean?

A double-entry bookkeeping system is one in which every transaction affects at least two accounts. A transaction can affect both assets and claims (liabilities and equity) or only assets or only claims. In order to "balance" the accounting equation, every transaction requires a "double entry."

In a business context, what does the term market mean?

A market is a group of people or organizations that come together for the purpose of exchanging items of value.

What causes a net loss?

A net loss occurs when expenses exceed revenues in a given accounting period.

Why is accounting called the language of business?

Accounting provides information that is useful in making decisions by all participants in the market for resource goods and services, both profit-oriented and nonprofit oriented. Because accounting's role is so important, it is often called the language of business.

Identify the three types of accounting transactions discussed in this chapter. Provide an example of each type of transaction, and explain how it affects the accounting equation.

An asset source transaction results in an increase in an asset account and an increase in one of the claims accounts; i.e., investments by owners (equity), borrowing funds from creditors (liabilities), or earnings activities (revenue). An asset use transaction results in a decrease in an asset account and a decrease in either liabilities or equity; i.e., the payment of a liability, the payment of an expense, or a dividend. An asset exchange transaction is a transaction in which one asset is exchanged for another; i.e., purchase of land with cash.

Discuss the term articulation as it relates to financial statements.

Articulation refers to the interrelationships among the various elements of the financial statements.

How are asset accounts usually arranged in the balance sheet?

Asset accounts are arranged on the balance sheet in accordance with their level of liquidity (those that can be most quickly converted to cash are listed first).

What is the difference between assets that are acquired by issuing common stock and those that are acquired using retained earnings?

Assets that are acquired by issuing common stock are the result of investments by owners. Assets that are acquired by using retained earnings are assets the business acquires through its earnings activities.

What role do assets play in business profitability?

Assets, the economic resources of a business, are used to produce earnings.

How does acquiring capital from owners affect the accounting equation?

Capital is acquired from owners by issuing stock to them. When stock is issued, the assets of the business increase and the stockholders' equity increases.

Explain how a career in public accounting differs from a career in private accounting.

Careers in public accounting consist of providing services to the general public from a public accounting firm. These services include auditing, tax and consulting services. Careers in private accounting usually consist of working for a specific company (which would be a client of the public accounting firm) providing a wide variety of services to the company including recording transactions, preparing financial statements, internal auditing and others.

What is the primary mechanism used to allocate resources in the United States?

Competition for resources in the open market

Describe the differences between creditors and investors.

Creditors are individuals and/or institutions that have provided goods or services to the business which are not yet paid for, or loaned money to the business. These parties have first claim to the assets of the business, and the owners have a residual interest in the assets.

How does distributing assets (paying dividends) to owners affect the accounting equation?

Distributions to owners, called dividends, decrease the asset side of the accounting equation and also decrease the retained earnings account in the stockholders' equity section of the equation.

What are the similarities and differences between dividends and expenses?

Dividends and expenses are similar in that they both decrease assets and affect the accounting equation in the same way (i.e. reduction of retained earnings). However, dividends differ from expenses because of the nature of the decline in assets. Expenses reduce assets as the result of a firm's efforts to earn revenue. Dividends reduce assets because of a transfer of wealth to the owners.

Give an example of a financial resource, a physical resource, and a labor resource.

Financial Resource: money Physical Resource: natural resources, buildings, machinery and equipment, furniture and fixtures. Labor Resource: includes both intellectual and physical labor; i.e. employees

How do financial and managerial accounting differ?

Financial accounting provides information that is useful to external resource providers. Managerial accounting provides information that is useful to managers in operating an organization (i.e., internal users).

What type of income or profit does an investor expect to receive in exchange for providing financial resources to a business? What type of income does a creditor expect from providing financial resources to an organization or business?

Investors expect a distribution of the business's profits as a return on their financial investment (capital allocation). Creditors lend financial resources to businesses and receive interest as a return or profit on the loan.

Describe a not-for-profit or nonprofit enterprise. What is the motivation for this type of entity?

Not-for-profit or nonprofit entities provide goods or services to consumers for humanitarian or special reasons rather than to earn a profit for owners.

What is the source of retained earnings?

Retained earnings are a result of a business retaining its earned assets, rather than distributing those earnings to its owners.

How does earning revenue affect the accounting equation?

Revenue increases the asset side of the accounting equation and also increases the retained earnings account in the stockholders' equity section of the equation.

Explain the term stakeholder. Distinguish between stakeholders with a direct versus an indirect interest in the companies that issue financial reports.

Stakeholders are the parties that use accounting information. Stakeholders with a direct interest include owners, managers, creditors, suppliers, and employees. These individuals are directly affected by what happens to the business. Stakeholders with an indirect interest include financial analysts, brokers, attorneys, government regulators, and news reporters. These individuals use information in the financial reports to advise and influence their clients.

How do temporary accounts differ from permanent accounts? Name three temporary accounts. Is retained earnings a temporary or a permanent account?

Temporary accounts are used to capture information for a single accounting period. The balances in temporary accounts are transferred out of the accounts at the end of the accounting period. Temporary accounts have zero balances at the beginning of an accounting period. Temporary accounts include revenue accounts, expense accounts and dividends. Permanent accounts carry over from one accounting period to the next. Retained Earnings is a permanent account.

What is the accounting equation? Describe each of its three components.

The accounting equation is: ASSETS = LIABILITIES + STOCKHOLDERS' EQUITY Assets are the economic resources used by a business for the production of revenue. Liabilities are obligations of a business to relinquish assets, provide services, or accept other obligations. Equity, also called "residual interest" or "net assets", is the portion of the assets remaining after the creditors' claims have been satisfied (i.e., Assets - Liabilities).

To whom do the assets of a business belong?

The assets of a business belong to that business entity and there may be claims on the assets. Claims on the assets belong to resource providers.

Which of the general-purpose financial statements provides information about the enterprise at a specific designated date?

The balance sheet provides information about the enterprise at a particular point in time.

What is the historical cost concept and how does it relate to verifiability?

The historical cost concept requires that most assets be reported at the amount paid for them regardless of their increase or decrease in value. It is related to the qualitative characteristic of verifiability in that information can be independently verified. The historical cost is verified, while a change in value is subjective.

What market trilogy components are involved in the process of transforming resources into finished products?

The market for business resources involves three distinct participants: consumers, conversion agents, and resource owners.

Who ultimately bears the risk and collects the rewards associated with operating a business?

The owners ultimately bear the risk and collect the rewards associated with operating a business.

Name the accounting term used to describe a business's obligations to creditors.

The term "liabilities" is used to describe creditors' claims on the assets of a business.

What are the three primary sources of assets?

The three primary sources of assets are (1) investments by owners (issue of stock), (2) borrowing from creditors, and (3) earnings activities.

What is U.S. GAAP? What is IFRS?

U.S. GAAP, generally accepted accounting principles in the United States, are the measurement rules established by the (FASB) Financial Accounting Standards Board. The FASB is a privately funded organization with the primary authority for establishing accounting standards in the United States. International Financial Reporting Standards (IFRS) are issued by the International Accounting Standards Board and are an attempt to set a common standard to be used in different countries. IFRS is used by global companies and there is a move underway to merge GAAP and IFRS.

What type of information does a business typically include in its annual report?

While the contents of annual reports vary from company to company, all annual reports contain: Management's discussion and analysis (MD&A) Financial statements Notes to the financial statements Auditor's report

What are the U.S. rules of accounting information measurement called?

generally accepted accounting principles (GAAP)