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ACC 203 Chapter 1
id entifies, records, records, and I. Accounting is the information system that identifies, communicates the economic events of an organization to intereste int erested d users. The
purpose of financial information is to provide inputs for decision making. The
users of financial information fall into two groups--internal users and external users. j
Internal users - users within the organization. y Internal users and questions they may ask:
Marketing Human Resources Finance Management
j
What price will maximize the company¶s net income? Can we afford to give employees pay raises this year? Is
cash sufficient to pay dividends to stockholders? Which product line is most profitable? What should be eliminated?
External users - users who are outside the organization. y External users and questions they may ask:
Investors (current
and potential) Creditors (suppliers and bankers) IRS, SEC, FTC, labor unions, customers
Is
the company earning satisfactory satisfactory income? How does the company compare in size and profitability with competitors? Will the company be able to pay its debts as they come due? Is the company complying with rules and regulations? Is the company properly paying its taxes?
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Accounting helps users assess and manage risk. 1.
Risk is the uncertainty about outcomes.
2.
More risk = More uncertainty = greater potential for higher returns (and expectations of higher returns by investors and creditors).
Ethics in financial reporting y In 2002, Congress passed the Sarbanes-Oxley Act (SOX) to try to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals. See page A-22 in Appendix A for required Management¶s Report
II. j
y
Effective
financial reporting depends on sound ethical behavior.
y
Steps for solving ethical dilemmas: 1. Recognize an ethical situation and the ethical issues involved. 2. Identify and analyze the principal elements in the situation. 3. Identify the alternatives, and weigh the impact of each alternative on various stakeholders.
Forms of Business Organizations Sole proprietorship - a business owned by one person Advantages y simple to establish y owner controlled y tax advantages
Disadvantages y y y
proprietor personally liable for all business debts financing may be difficult transfer of ownership may be difficult
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j
Partnership - a business owned by two or more people Advantages y simple to establish y shared control y broader skills and resources y tax advantages
Disadvantages y y
j
partners personally liable for all business debts transfer of ownership may be difficult
Corporation - a separate legal entity owned by stockholders Advantages y easier to transfer ownership y easier to raise capital y lower legal liability ± no personal liability for stockholders
Disadvantages y
unfavorable tax treatment
Note: ALL of the above are separate accounting entities ! The
emphasis of this text is the corporate form of business.
The
primary purpose of business owners is to earn a profit (Net Income) Revenues ± Expenses = Net Income 1. Accounting is necessary to measure revenues and expenses (& therefore a profit or loss) and the owner¶s return on investment.
2. Accounting is also used to record and report assets (what we own), liabilities (what we owe; the creditors claims to the assets) and owner¶s equity (the owner¶s claim to the assets).
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III. There are 3 main activities of a business: The accounting information system keeps track of the results of each of these activities.
1.
F inancing: borrowing
& paying back loans, owner¶s investments into the business, distributing profits to owners.
2. Investing: acquiring and disposing of long-term assets (e.g. equipment, buildings, etc.) used by the business. 3. Operating: use of assets to carry out an organization's plans (all revenues and expenses are operating activities).
IV. Accounting Equation Basic Accounting Equation:
Assets = Liabilities + Equity Alternative: Assets ± Liabilities = Equity Assets: Resources owned by the business that provide probable future economic benefits to the business. What we own.
Examples:
Obligations of a business or organization or creditor¶s claims against assets. What we owe.
Liabili ti es:
Examples:
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owner¶s claim to the assets or the residual interest in the assets of an entity after deducting liabilities; also called net assets. (Assets ± Liabilities = Equity)
Equi ty:
The
Corporation¶s equity is divided into 2 parts: 1. Contributed Capital: the amount the shareholders have paid for the stock (ownership) of the corporation. 2. Retained Earnings: net income minus net losses minus dividends (distributions to owners) since the inception of the corporation.
Expanded Accounting Equation:
Assets = Liabilities + Equity + Revenues - Expenses (Balance Sheet)
(Income Statement)
Revenues: What we earn in exchange for goods or services provided to
customers as part of the company's operations. Examples:
Expenses:
The
costs of providing products and service to customers.
Examples:
minus expenses equals net income (if R ev > Exp) or net loss (if Exp > R ev)
R evenues
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V. Financial Statements (examples on pg. 18)
Income Statement Reports revenues and expenses over a period of time ; net income is computed as revenues less all costs and expenses. Statement of Retained Earnings Reports changes in Retained Earnings over a period of time . Changes result from net income (increase); and net loss, dividends (decreases). Balance Sheet Reports amounts for assets, liabilities, and equity at a point in time. Statement of Cash F lows Reports on cash flows for operating, investing, and financing activities over a period of time.
Question: Which financial statement does not cover a period of time?
y
Note the headings (Co. name, statement name, dateline)
y
Note the format ($ signs, double underline for totals)
y
Note the order of preparation, and the relationship of the statements.
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Components that Supplement the Financial Statements in an Annual A ppend i x A) R eport (
Companies traded on an organized exchange like the New York Stock Exchange or the American Stock Exchange are required to provide shareholders with an annual report which always includes financial statements. In addition, the annual report includes the following information: Discussion and Analysis ± pg. A-6 ± covers three aspects of a company: 1. Its ability to pay near-term obligations (liquidity) 2. Its ability to fund operations and expansion (capital resources) 3. It results of operations
j Management
to Financial Statements ± pg. A-15. Clarify information presented in the financial statements Describe accounting policies or explain uncertainties and contingencies
j Notes
j
Auditor's R eport ± pg. A-23. An auditor, a CPA, conducts an independent examination of the company¶s financial statements. An auditor gives an unqualified opinion if the financial statements present the financial position, results of operations, and cash flows in accordance with generally accepted accounting principles (GAAP).
GAAP = Generally Accepted Accounting Principles FASB (Financial Accounting Standards Board) - A nonprofit board that sets accounting rules for Financial Accounting
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a.
Financial Accounting: The preparation , reporting, and interpretation of accounting information for external users.
b.
Primary external users: Investors and creditors.
Managerial Accounting is for internal users (BA 257).
Accounting information is prepared using Generally Accepted Accounting Principles (GAAP), in order for the information to be comparable, reliable, and relevant to the external users (investors and creditors primarily).
VI. Accounting careers.
1. Public accounting Auditing y y Tax Consulting y
2. Private sector Corporate accounting y Cost accountant, internal auditor 3. Government and nonprofit y IRS FBI y y y
Hospitals Universities and colleges, etc.
