SM 131: What is Accounting?

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Liabilities

External Claims Against the Assets

Who uses accounting information? (F.A)

External parties: Investors, Creditors, Potential Employees, Government Agencies

Statement of Cash Flows

Financial statement that reports cash receipts and disbursements related to a firm's three major activities: operations, investments, and financing.

Assets

Future economic benefits

What is the focus of accounting? (M.A)

Planning, Directing and Controlling

Net Income

Profit

Setting Prices

Sales Data (quantity, region, competitor) Cost Data (to ensure making profit)

External Controls (who to minimize measurement error/bias)

auditors exchanges regulators institutional investors

Internal Controls (who to minimize measurement error/bias)

board of directors information systems internal auditors

Bonus

directly driven by accounting

Types of Accounting

financial and managerial

Measurement Error

some economic events are hard to measure (but not systematic)

Bias

systematically too low or too high

Steps for the accounting cycle

1. analyze source documents 2. record transactions in journals 3. transfer journal entries to ledger 4. take a trial balance 5. prepare financial statements 6. analyze financial statements

Three key questions in allocating capital (how do investors decide where put $)

1. what does the company have? 2. How has the company performed? 3. How risky is this investment?

balance sheet

A financial statement that reports assets, liabilities, and owner's equity on a specific date.

The Accounting Cycle

A six-step procedure that results in the preparation and analysis of the major financial statements.

ledger

A specialized accounting book/program where all information is in one place

Formula for Accounting

Accounting = Economic Truth + Measurement Error + Bias

balace sheet

Assets = Liabilities + Equity

Incentivizing People and Measuring their Performance

Compensation contracts (Bonus & Stock options)

How minimize measurement error / bias?

Governance (Internal Controls & External Controls)

Economic Truth

Is the center The economic event we wish to capture

Who uses accounting information? (M.A)

Internal parties: CEO's, Operations Managers, Marketing, HR Departments

Why does Accounting matter? (F.A)

Investors face an information asymmetry problem

Use of Resources - what managers do (internal perspective)

Make investments Manage costs Set pricing Incentivize employees

Why does Accounting matter? (M.A)

Managers need to make decisions

Equity

Residual Interest

Formula for income statement

Revenue - Expenses = Net Income

income statement

The financial statement that shows a firm's profit after costs, expenses, and taxes.

Accounting

The language of business A system for recording business transactions A set of rules to standardize investor information A source of data managers use to make decisions Applied information economics

What is the focus of accounting? (F.A)

Transaction Analysis, Financial Reporting, Audit, Tax

URACSI

Use of Resources Allocating Capital Safeguarding Information

Trial Balance

a summary of all the information in the account ledgers

annual report

a yearly statement of the financial condition, progress, and expectations of an organization

Stock options

indirectly driven by accounting

The Accounting System

inputs, processing, outputs

Key things to watch for and read in an annual report

management's discussion and analysis of operations balance sheet income statement statement of cash flows auditor's opinion

Manage costs

o Direct Materials o Direct Labor o Overhead *key components of managerial accounting

Make investments

o Where/how big to make factory o Choice of machine vs labor o Strategic additional investments o Incentivize people

double-entry bookkeeping

record all transactions in two places so they can check one list of transactions against the other for accuracy


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