Accounting Chapter 1

Define Financial Accounting

Financial accounting provides relevant and timely information for the decision making needs of users outside of the business, such as investors, creditors, customers, and the government.

What is owner's equity?

For a proprietorship, partnership, or limited liability company, equity is called owner's equity.

Define Managerial Accounting

Managerial accounting or management accounting provides timely information to internal users such as managers and employees to meet their decision-making needs.

What is fees earned?

Revenue from providing services is recorded as fees earned.

What is sales?

Revenue from the sale of merchandise is recorded as sales.

What are arm's length transactions?

Transactions between 2 independent parties that provide objective and verifiable amounts.

Verifiability

Verifiability allows users to agree on the meaning of reported items.

Understandability

requires clear and concise financial reports that facilitate user interpretation and analysis.

Timeliness

requires distribution of the financial reports in time to influence a user's decision.

What is an income statement?

• The income statement reports the revenues and expenses for a period of time, based on the revenue and expense recognition principles. - These principles match revenues and their related expenses so that they are reported in the same period. • The excess of the revenue over the expenses is called net income, net profit, or earnings. • If expenses exceed revenue, the excess is a net loss.

What is the statement of stockholder's equity?

• The statement of stockholders' equity reports the changes in the retained earnings and common stock for a period of time. • It is prepared after the income statement because the net income or net loss for the period must be reported in this statement. • Similarly, it is prepared before the balance sheet, since the amounts of common stock and retained earnings at the end of the period must be reported on the balance sheet

What is the ratio of liabilities to stockholder's equity?

• Useful in analyzing the ability of a company to pay its creditors. • Computed as total liabilities / total stockholder's equity

Define accounting

Accounting can be defined as an information system that provides reports to users about the economic activities and condition of a business.

What are accounting principles and assumptions?

Accounting principles and assumptions provide the framework upon which accounting standards are constructed.

What are accounting standards?

Accounting standards are the rules that determine the accounting for individual business transactions.

Define Ethics in Accounting and Business

- Ethics are moral principles that guide the conduct of individuals. - The objective of accounting is to provide relevant, timely information for user decision making. - Accountants must behave in an ethical manner so that the information they provide users will be trustworthy and, thus, useful for decision making. - Managers and employees must also behave in an ethical manner in managing and operating a business.

What are the Generally Accepted Accounting Principles (GAAP)?

- Financial information in the United States is based on generally accepted accounting principles (GAAP). - GAAP is a collection of accounting standards, principles, and assumptions that define how financial information will be reported.

What is the business entity assumption?

- It limits the economic data in financial reports to that directly related to the activities of the business. - The business is viewed as an entity separate from its owners, creditors, or other businesses.

Define business

A business is an organization in which basic resources (inputs), such as materials and labor, are assembled and processed to provide goods or services (outputs) to customers.

What is common stock?

A corporation issues common stock to investors as proof of their ownership rights.

What are expenses?

Amounts used to generate revenue.

What is an account receivable?

An account receivable is a claim against the customer, which is an asset.

What is an expense?

Assets used in this process of earning revenue are called expenses.

Why are liabilities listed before stockholder's equity in the accounting equation?

Because creditors have first rights to assets.

What is the revenue recognition principle?

Determines when revenue is recorded in the accounting records. - Normally, revenue is recorded when the services have been performed or goods are delivered to the customer.

What are dividends?

Dividends are distributions of earnings to stockholders.

What are general-purpose financial statements?

General-purpose financial statements are one type of financial accounting report that is distributed to external users.

What is stockholder's equity?

If stockholders own a corporation, equity is called stockholder's equity.

What is the time period assumption?

It allows a company to report its economic activities on a regular basis for a specific period of time. - Financial condition is reported periodically on a consistent basis. - Calendar year is the commonly used fiscal year, beginning on January 1, 20Y1, and ending on December 31, 20Y1. - Natural business year is a 12-month period beginning on a date chosen by the company.

What is the Financial Accounting Standards Board?

It has the primary responsibility for developing accounting standards.

What is the International Accounting Standards Board?

Outside the US, most countries use accounting standards and principles adopted by the International Accounting Standards Board (IASB).

Define profit

Profit is the difference between the amounts received from customers for goods or services and the amounts paid for the inputs used to provide the goods or services.

What is revenue?

The amount earned (received) from providing services or selling goods to customers.

What is account payable?

The liability created by a purchase on account is called an account payable.

What are assets?

The resources owned by a company.

What are liabilities?

The rights of creditors are the debts of the business and called liabilities.

What is equity?

The rights of owners.

Comparability

allows users to identify similarities and differences among reported items.

What is a balance sheet?

• A balance sheet reports the amounts of assets, liabilities, and stockholders' equity as of a specific date. • The report form presents a balance sheet in a vertical format.

What is the monetary unit assumption?

- It requires that financial reports be expressed in a single money unit. - This provides a common measurement of the effects of economic events and transactions on an entity. - The monetary unit used is normally determined by the country in which the company operates.

Relevance and Faithful Representation in Financial Information

- Relevant information has the potential to impact decision making. - Faithful representation means that the information accurately reflects an entity's economic activity or condition.

What is the Sarbanes-Oxley Act (SOX)?

- SOX established a new oversight body for the accounting profession called the Public Company Accounting Oversight Board (PCAOB). - SOX established standards for independence, corporate responsibility, and disclosure.

What is the expense recognition principle?

- The expense recognition principle, sometimes called the matching principle, requires expenses to be recorded in the same period as the related revenue. - Doing so allows the reporting of a profit or loss for the period

What are the four primary financial statements for a corporation?

- income statement - statement of stockholders' equity - balance sheet - statement of cash flows

What is the measurement principle?

It determines the amount that will be recorded and reported. - requires that amounts be objective and verifiable. ▪ objective if it is based upon independent, unbiased evidence. ▪ verifiable if it can be confirmed by a third party.

What is the Securities and Exchange Commission?

It has authority over the accounting & financial disclosures for companies whose shares of ownership (stock) are traded and sold to the public.

What is the going concern assumption?

It requires that financial reports be prepared assuming that the entity will continue operating into the future.

What is a prepaid expense?

Items such as supplies that will be used in the business in the future are called prepaid expenses, which are assets.

What is the historical cost principle or the cost principle?

Recording an item at its initial transaction price.

What is the statement of cash flows?

consists of the following three sections: • Operating activities: •reports a summary of cash receipts and cash payments from operations. • The net cash flow from operating activities normally differs from the amount of net income for the period. • This difference occurs because revenues and expenses may not be recorded at the same time that cash is received from customers or paid to creditors. • Investing activities: • The cash flows from investing activities section reports the cash transactions for the acquisition and sale of relatively permanent assets. • Financing activities: • The cash flows from financing activities section reports the cash transactions related to cash investments by stockholders, borrowings, and dividends.

What are the classifications of stockholder's equity?

• Common stock is shares of ownership distributed to investors of a corporation. - It represents the portion of stockholders' equity contributed by investors • Retained earnings is the stockholders' equity created from business operations through revenue and expense transactions.