Financial Accounting: Chapter 1

proprietorship

A business owned by one person. Only a relatively small amount of capital is needed to start this type of business. The owner receives all profits, suffers all losses, and is personally liable for all of the business' debts.

partnership

A business owned by two or more persons and includes an agreement, written or oral. Often retail and service businesses are partnerships. Partners must agree upon initial investment, partner duties, division of income, and settlement.

corporation

A business that is a separate legal entity. Ownership is divided into transferable shares of stock. Unlimited life.

transactions

A business's economic events recorded by accountants.

bookkeeping

A function that only records economic events. It is part of the accounting process.

GAAP (Generally Accepted Accounting Principles)

A standard set of principles practiced in America.

identifying

A starting point to the accounting process: a company must _______ the economic events relevant to its business.

investors

A type of external user that uses accounting information to decide on buying, holding, or selling company shares.

creditors

A type of external user that uses accounting information to evaluate the risks of granting credit or lending money. Ex. banks and suppliers.

notes payable

A written note or agreement between a company and a creditor. A borrower obtains money from a lender and agrees to pay it back with interest over a specific time period.

financial accounting

Accounting that provides information for investors, creditors, and other external users.

monetary unit assumption

An assumption that companies only report transaction data that can be expressed in monetary terms. Relevant information like health, employee satisfaction, and customer satisfaction cannot be included because they cannot be translated into money terms.

IASB (International Accounting Standards Board)

An international board that sets financial standards which many countries have adopted.

basic accounting equation

Assets = Liabilities + Owner Equity.

expanded accounting equation

Assets = Liabilities + [Common Stock] + [Revenues-Expenses-Dividends]

liabilities

Claims by those to whom the company owes money. Existing debts and obligations.

stockholder's equity

Claims of owners. Sometimes stockholders. In a proprietorship, this would simply be the owner's claim. Often referred to as "residual equity" because it's the equity left over after creditor claims.

recording

Creating a systematic, chronological diary of economic events. Measured in monetary terms. Includes classifying and summarizing.

external transactions

Economic events between the company and some outside enterprise. Ex. sales to customers.

internal transactions

Economic events that occur entirely in the company.

taxing authorities

Ex. USA's Internal Revenue Service (IRS), an external user that wants to know whether the company complies with tax laws.

regulatory agencies

Ex. USA's Securities and Exchanges Commission (SEC), an external user that wants to know whether the company complies with given rules.

labor unions

External users that want to know whether a company can provide wages, pay raises, and benefits.

customers

External users that want to know whether a company will honor product warranties and support product lines, etc.

questions that internal users ask

Finance: Is cash sufficient to pay dividends? Marketing: What price for this item will maximize income? HR: Can we afford to give pay raises? Management: Which product line is most profitable? Should we discontinue a product line?

external users

Individuals and organizations outside a company who want financial information about the company.

questions that external users ask

Investors: Is this company profitable when compared to another company? Creditors: Will this company be able to pay debts when they are due?

economic entity assumption

Keep parts separate from the whole. The activities of the entity must be kept separate and distinct from the activities of its owner and other economic entities.

communicating

Making financial information available through accounting reports. Ex. financial statements. Reports are standardized.

internal users

Managers who plan, organize, and run the business are examples of _________. Includes: marketing managers, production supervisors, finance directors, and company officers.

accounts payable

Money owed by a company to its creditors.

stockholder benefits

Not personally liable for the corporation's debts. They may transfer all or part of their ownership shares to other investors at any time.

assets

Resources a business owns that can carry out activities such as production and sales. Includes cash and equipment. Has the capacity to provide future services or benefits.

Sarbanes-Oxley Act

SOX. Congress passed this act, effectively forcing management to certify the accuracy of financial information, increased penalties for fraudulent financial activity, and increased the independence of auditors, and increased the BOD oversight.

IFRS (International Financial Reporting Standards)

Standards issued by the IASB.

SEC (Securities and Exchanges Commission)

The agency that oversees financial markets and accounting standard-setting bodies, which public companies must follow. USA.

expenses

The cost of assets consumer or services used in the process of earning revenue. Decreases in OE that result from operating the business. Ex. cost of materials, telephone expense, delivery expense, tax expenses.

dividends

The distribution of cash or other assets to stockholders. These are NOT expenses.

convergence

The effort by the IASB and the FASB to reduce differences in their accounting standards.

accounting

The entire process of identifying, recording, and communicating economics events.

revenue

The gross increases in OE resulting from business activities that are entered into for the purpose of earning income. Ex. selling merchandise, performing services, renting property, and lending money.

FASB (Financial Accounting Standards Board)

The primary standard-setting body for accounting in the USA.

(historical) cost principle

The principle that companies must record assets at their cost. If a company buys equipment at $7,000, this principle dictates that the equipment's value must always be reported as $7,000. Most common.

fair value principle

The principle that companies report assets at the value in the market at that present moment. If a company buys equipment at $7,000, but a year later its value has depreciated to $3,500, the company must report the equipment's value as $3,500. Used in situations where assets are actively traded.

ethics

The standards of conduct by which one's actions are judges ars right or wrong, honest or dishonest, fair or not fair. A fundamental business concept.

managerial accounting

This provides internal financial reports, which helps internal users make decisions about their companies. It is reported in pursuit of an organization's goals.

analyzing and interpreting financial data

To communicate economic events, an accountant must be able to use ratios, percentages, graphs, and charts and explain or highlight significant trends. He must also explain the uses, meaning, and limitations of the reported data.

in the aggregate

When a company compiles all sales transactions over time into one number, a company reports this data _______.