Ch 1 Pp Slides 2001

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Chapter 1

Uses of

AccountingInformation and

the Financial

Statements

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12Copyright Houghton Mifflin Company. All rights reserved.

What Is Accounting?

An information system that measures, processes,and communicates financial information about an

economic entity

Focuses on the needs of decision makers who use

financial information

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Economic Entity

A unit that exists independently, such as a business,hospital, or government body

In this text, the focus is primarily on the business

entity

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Business Activities and

Decision Makers

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Business Goals

Profitability

The ability to earn enough income to attract and

hold investment capital

Liquidity

Having enough cash available to pay debts when

they are due

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Financial and Management

Accounting Accountings role is divided into two categories:

Management accounting

Financial accounting

The functions of both categories overlap

Primary difference between the two is the principal

users of the information

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Financial Accounting

Generates reports and communicates them to

external decision makers so they can evaluate how

well the business has achieved its goals

Financial information of company is reported in the

financial statements Used to report directly on goals of profitability and

liquidity

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Bookkeeping versus Accounting

Bookkeeping

Repetitive, mechanical

process of recording

financial transactions andkeeping financial records

A small part of accounting

Accounting

Includes design of an

information system to meet

users needs

Goals include the analysis,

interpretation, and use of

information

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Ethical Financial Reporting

Ethics is a code of conduct that applies to everyday

life

Addresses the question of whether actions are right

or wrong

Financial reports must be prepared in good faith, beaccurate, and disclose all relevant facts

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Fraudulent Financial Reporting

Intentional preparation of misleading financial

statements

Can result from the distortion of records (e.g., the

manipulation of inventory records), falsified

transactions (e.g., fictitious sales), or themisapplication of various accounting principles

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Sarbanes-Oxley Act of 2002

Legislation impacting the accounting profession and

corporate governance

Chief executives and chief financial officers of all

publicly traded U.S. companies must attest to the

accuracy of their quarterly statements and annualreports

Violation can result in criminal penalties

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Stop & Review

Q. What is the difference between profitabilityand

liquidity?

A. Profitability

Earning enough income (revenues minus

expenses) to attract and hold investors

Liquidity

Having enough funds available (cash) to paydebts when they are due

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Who Are the Decision Makers?

Management

Those outside a business enterprise who have a

direct financial interest in the business

People, organizations, and agencies that have an

indirect financial interest in a business

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Management

People who are responsible for operating a business and

meeting its goals of profitability and liquidity

Make key decisions using accounting information

Basic management functions require accounting

information for decision making

Financing the business

Investing resources

Producing goods and services

Marketing goods and services Managing employees

Providing information to decision makers

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Users With a Direct

Financial Interest External users who depend on accounting to

measure and report information about how a

business has performed

Two most important outside groups are investors

and creditors

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Investors and Creditors

Investors

Put money into a business to make money (by purchasing

and selling stocks and receiving dividends)

Use financial statements to judge the prospects for

profitable investments

Creditors

Loan money to a business to make money (by charging

interest)

Use financial statements to judge whether a company will

have enough cash to pay interest charges and repay debt

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Users With an Indirect

Financial Interest Society as a whole has become one of the largest

and most important users of accounting information

Tax authorities

Use accounting information to determine the

amount of tax dueProcedures for tax reporting mandated by law

Government regulatory agencies

Federal, state, and local levels

Securities and Exchange Commission (SEC)

Regulates the issuing, buying, and selling ofstocks in the U.S.

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Government and Not-For-Profit

Organizations Need accounting information just as for-profit

entities do

Must raise money, secure loans, pay taxes, and plan

for operations

Obligated to report their financial performance tolegislators, boards, and donors, as well as to deal

with tax authorities, regulators, and labor unions

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Stop & Review

Q. Why are investors and creditors interested in

reviewing a companys financial statements?

A. Investors review statements to determine the prospects of a

profitable investment. They review their commitment eachyear after investing. Creditors are interested in whether

the company can repay the debt and make the interest

payment obligations.

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Accounting Measurement

To make an accounting measurement, the accountant

must answer four basic questions:

What is measured?

When should the measurement be made?

What value should be placed on what is

measured?

How should what is measured be classified?

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Business Transactions

Economic events that affect the financial position of a

business An exchange of value

Purchase

Sale

Payment Collection

Events that have the same effect as an exchange of value(nonexchange transactions)

Loss from fire, flood, theft Physical wear and tear on equipment

Accumulation of interest

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Money Measure

Recording of all business transactions in terms of

money

Money is only factor common to all business

transactions

Basic unit of money determined by country inwhich business resides

Exchange rates used to translate transactions from

one currency to the other

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Separate Entity

A business is considered distinct from its

Owner(s)

Creditors

Customers

Its financial records and reports should refer only to

its own financial affairs

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Forms of Business Enterprises

Three basic forms of business enterprises

Sole proprietorshipbusiness owned by one

person. Owner takes all profits/losses and is

liable for all obligations.

Partnershiphas two or more owners. Partnersshare profits/losses. Personal resources of

partners can be used to settle obligations.

Corporationchartered by the state and legally

separate from its stockholders. Efficient in

raising capital.

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Separate Entities

All three forms of businesses are economically

separate from their owners

Financial records and reports refer to the

financial affairs of the business only

Only the corporation is a legally separate entityfrom its owners

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Formation of a Corporation

Most states require individuals, called incorporators,

to sign an application and file it with the proper

state official

Articles of incorporation form the company charter

and become a contract between the state and theincorporators

Th C ti

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The Corporation as a

Separate Entity Legally and economically separate from its owners

Owners (stockholders) do not directly control

operations

Elected board of directors run the corporation

Owners risk of loss limited to amount paid for

shares of stockowners are not liable for the

obligations of the business

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Organization of a Corporation

Stockholders

Invest in shares of stock

Elect board of directors

Board of Directors

Decide major business policies Declare dividends

Appoint managers

Management

Carry out corporations policies

Run day-to-day operations

Prepare financial reports (used by stockholders)

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Stop & Review

Q.How do a sole proprietorship, partnership,and corporation differ?

A. Sole proprietorship

B. Partnership

C. Corporation

One ownerOwner legally obligated to pay company liabilities

Multiple ownersOwners legally obligated to pay company liabilities

Owned by stockholdersStockholders notlegally obligated to pay company liabilities

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Financial Position

A companys economic resources, such as

cash, inventory, and buildings

and the claims against those resourcesat a particular time

Economic Resources = Equities

D l i th

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Developing the

Accounting Equation

Economic

Resources =

Creditors

Equities + Stockholders Equity

In accounting terminologyEconomic resources are called Assets

Creditors equities are called Liabilities

Assets = Liabilities + Stockholders Equity

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Accounting Equation

Assets = Liabilities + Stockholders Equity

Two sides of equation must always stay in balance

Assets

Economic resources owned by a company that are

expected to benefit future operations

Liabilities

Present obligations of a business to pay cash, transfer

assets, or provide services to other entities in the future

Represent claims of creditors to the assets of the business Stockholders Equity

Represents the claims of the owners of a corporation to

the assets of the business

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Stockholders Equity

Stockholders Equity =

Contributed Capital + Retained Earnings

Contributed capitalAmount invested in the business by the stockholders

Retained earnings

Stockholders equity that has been generated by operationsand kept for use in the business

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Stop & Review

Q. What does the accounting equation represent?

A. The economic resources owned by a company and

the claims against those resources at a particular

timeAssets = Liabilities + Stockholders Equity

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Four Major Financial Statements

Income Statement

Statement of Retained Earnings

Balance Sheet

Statement of Cash Flows

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Income Statement

Summarizes revenues earned and expenses incurred

over an accounting period

Dated For the Month Ended or For the Year

Ended

Shows whether a company achieved its profitabilitygoal

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Ramirez Agency, Inc.

Income Statement

For the Month Ended December 31, 20xx

Revenues

Commissions earned $7,000

Expenses

Equipment rental expense $2,000

Wages expense 800Utilities expense 600

Total expenses 3,400Net income $3,600

Income Statement

Net income figure used to prepare

statement of retained earnings

Date reflects revenues

and expenses incurred

over a period of time

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Shows changes in retained earnings over an

accounting period

Dated For the Month Ended or For the Year

Ended

Uses net income figure from income statement Retained Earnings end of period balance used to

prepare balance sheet

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The Ramirez Agency, Inc.


For the Month Ended December 31, 20xx

Retained earnings, December 1, 20xx $ 0

Net income for the month 3,600Subtotal $3,600Less dividends 1,200

Retained earnings, December 31, 20xx $2,400


Net income figure comes

from income statement

Ending balance of retained

earnings used to prepare the

balance sheet

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Balance Sheet

Shows the financial position of a business on a

certain date

Often called the statement of financial position

Presents view of business as holder of assets that are

equal to the claims against those assets Claims consist of the companys liabilities and the

stockholders equity

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The Ramirez Agency, Inc.

Balance SheetDecember 31, 20xx

Assets Liabilities

Cash $30,600 Accounts payable $ 1,200Accounts receivable 2,000

Supplies 1,000 Stockholders EquityLand 20,000

Building 50,000 Common stock $100,000

Retained earnings 2,400

Total stockholders equity 102,400

Total assets $103,600Total liabilities andstockholders equity $ 103,600

Balance Sheet Date reflects accountbalances as of a

certain date

Ending balance of Retained Earnings comes

from statement of retained earnings

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Statement of Cash Flows

Shows cash flows into and out of a business during

an accounting period

Shows important investing and financing

transactions of the period

Focuses on liquidity Explains how the cash account changed during the

period

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Stop & Review

Q. The balance sheet is often referred to as the

statement of financial position. What does

financial position mean?

A. Financial position is the resources, or assets,owned by a business as of a certain date. These

resources are offset by claims against them and

stockholders equity, as shown on the balance

sheet.

Generally Accepted Accounting

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Generally Accepted Accounting

Principles (GAAP) The conventions, rules, and procedures necessary to

define accounting practice at a particular time

Developed to provide guidelines for financial

accounting

Evolve as better methods emerge or ascircumstances change

GAAP and the Independent

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GAAP and the Independent

CPAs Report Public companies must have their financial

statements audited by a Certified Public Accountant

Audit determines whether the financial statements

have been prepared in accordance with GAAP

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Professional Ethics

Accountants have a responsibility to their

employers, clients, and society to uphold highest

ethical standards

AICPA and each state have adopted codes of

professional conduct for certified public accountants Key to the accountants reputation for independence

and competence

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Chapter Review

1. Define accounting, identify business goals and

activities, and describe the role of accounting in

making informed decisions.

2. Identify the users of accounting information.

3. Explain the importance of business transactions,money measure, and separate entity.

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Chapter Review (contd)

4. Describe the characteristics of a corporation.

5. Define financial position, state the accounting

equation.

6. Identify the four financial statements.

7. Explain how generally accepted accountingprinciples (GAAP) relate to financial statements

and the independent CPAs report, and identify the

organizations that influence GAAP.

Ch 1 Pp Slides 2001

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