ACCT 201 Chapter 1 Summary: Introduction to Financial Statements
ACCT 201 Chapter 1 Summary: Introduction to Financial Statements ACCT 201
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This 6 page Study Guide was uploaded by Amend on Tuesday August 23, 2016. The Study Guide belongs to ACCT 201 at Towson University taught by Raymond Kitson Walters in Fall 2016. Since its upload, it has received 19 views. For similar materials see Principles of Financial Accounting in Accounting (ACCT) at Towson University.
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Date Created: 08/23/16
ACCT 201 Chapter 1 Summary: Introduction to Financial Statements Primary Forms of Business Organization. A business may be organized as a sole proprietorship, partnership, or corporation. Sole proprietorship a business owned by one person (Examples include hair salons, auto repair shops, and freelance editors) Advantages o simple to establish o owner controlled o tax advantages that are more favorable than a corporation Disadvantages o proprietor personally liable for all business debts o financing may be difficult o transfer of ownership may be difficult Partnership a business owned by two or more people (Examples include retail and service type businesses including professional practices (lawyers, doctors, etc.) Advantages o simple to establish o shared control o broader skills and resources o tax advantages that are more favorable than a corporation Disadvantages o partners personally liable for all business debts o transfer of ownership may be difficult Corporation a separate legal entity owned by stockholders (Examples include CocaCola, ExxonMobil, General Motors, Citigroup, and Microsoft) Advantages o easier to transfer ownership o easier to raise funds o no personal liability for stockholders Disadvantages o unfavorable tax treatment resulting in higher taxes paid by stockholders 1 ACCT 201 Chapter 1 Summary: Introduction to Financial Statements The emphasis of this text is the corporate form of business. Users and Uses of Accounting Information. The purpose of financial information is to provide inputs for decision making. Accounting is the information system that identifies, records, and communicates the economic events of an organization to interested users. The users of accounting information fall into two groups—internal users and external users. Internal users users within the organization. Internal users and questions they may ask: Marketing What price will maximize the company’s net income? Human Resources Can we afford to give employees pay raises this year? Finance Is cash sufficient to pay dividends to stockholders? Management Which product line is most profitable? What should be eliminated? External users users who are outside the organization. External users and questions they may ask: Investors (current and Is the company earning satisfactory income? potential) How does the company compare in size and profitability with competitors? Should I buy, sell, or hold this stock? Creditors (suppliers and Will the company be able to pay its debts as they come due? How risky is this company? bankers) IRS, SEC, FTC, labor Is the company complying with rules and regulations? unions, customers Is the company properly paying its taxes? Can the company afford to pay increased wage and salaries? Will the company be able to stand behind its warranties? 2 ACCT 201 Chapter 1 Summary: Introduction to Financial Statements Ethics in financial reporting (How would you like to do business or invest in a business if you couldn’t trust their financial statements?) In 2002, Congress passed the SarbanesOxley Act (SOX) to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals. As a result of SOX: o Top management must now certify the accuracy of financial information o The penalties for fraudulent financial activity are much more severe o There is now increased independence of the outside auditor who review the accuracy of corporate financial statements o Increased the oversight role of boards of directors Effective financial reporting depends on sound ethical behavior. 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. The Three Principal Types of Business Activity. All businesses are involved in three types of activity. The accounting information system keeps track of the results of each of these activities. Financing activities – Cash is often obtained from outside sources to start or expand a business. The two primary sources are: Borrowing from creditors which creates liabilities o bank loan (note payable) o debt securities (bonds payable) o goods on credit from suppliers (accounts payable) Issuing ownership interests in the corporation to investors (selling common stock to shareholders) In addition, financing activities include using cash to pay dividends to stockholders Investing activities – Cash raised through financing activities is used for investing in resources (assets) needed to operate the business (i.e., land, buildings, delivery trucks, equipment, computers, furniture, etc.). 3 ACCT 201 Chapter 1 Summary: Introduction to Financial Statements Operating activities – Once a business has the assets it needs to get started, it begins its operations. Operating activities involve revenue and expenses. Revenue is the increase in assets resulting from the sale of goods or the performance of services – Sources of revenue common to many businesses are sales revenue, service revenue, and interest revenue. Assets that result from operating activities include supplies, inventory, and accounts receivable. Expenses are the cost of assets consumed or services used in generating revenues – Expenses take their name from the type of asset consumed or service used. Cost of goods sold, selling expenses, marketing expenses, administrative expenses, interest expense, and income taxes are common types of expenses. The related liabilities created include accounts payable, wages payable, interest payable, sales taxes payable, and income taxes payable. The Content and Purpose of Each of the Financial Statements. Accounting information is communicated through four different financial statements: Income Statement Reports the success or failure of the company’s operations for a period of time. Summarizes all revenue and expenses for period—month, quarter, or year. If revenues exceed expenses, the result is a net income. If expenses exceed revenue, the result is a (net loss). o Dividends are payments to the stockholders and are not expenses. o Amounts received from issuing stock or obtaining loans are not revenues. Retained Earnings Statement Reports the amount paid out in dividends and the amount of net income or net loss for a specific period of time. Shows changes in the retained earnings balance during period covered by statement. Ending retained earnings represents net income since the inception of the business that has not been paid out as dividends. The Meaning of Assets, Liabilities, and Stockholders’ Equity; The Basic Accounting Equation Balance Sheet Shows the relationship between assets and claims on assets which include liabilities (claims of the creditors) and stockholders’ equity (claims of the owners) at a specific point in time.. 4 ACCT 201 Chapter 1 Summary: Introduction to Financial Statements Assets and claims (liabilities and stockholders’ equity) must balance. The basic accounting equation; Assets = Liabilities + Stockholders’ Equity. The accounting equation is just that. It is an equation. The components can be moved in the same way the components of an algebraic equation can be moved. Assets resources owned by the business (things of value) Liabilities creditors’ claims on total assets (obligations or debts of the business) Stockholders’ Equity ownership claim on total assets Statement of Cash Flows Provides information about cash receipts and cash payments for a specific period of time. Reports the cash effects of a company’s operations for a period of time. Shows cash increases and decreases from investing and financing activities. Indicates the increase or decrease in cash as well as the ending cash balance. Provides answers to three important questions: o Where did the cash come from during the period? o How was cash used during the period? o What was the change in the cash balance during the period? Interrelationship of Statements Retained earnings statement uses the results of the income statement. Balance sheet and retained earnings statement are also interrelated. The retained earnings amount on the balance sheet is the ending amount on the retained earnings statement. Statement of cash flows relates to balance sheet information. It shows how the Cash account changed during the period. The Components that Suppleme..nt the Financial Statements in an Annual Report. Publicly traded U.S. Companies that are must provide shareholders with an annual report which always includes financial statements. In addition, the annual report includes the following information: Management Discussion and Analysis covers three aspects of a company: Its ability to pay nearterm obligations Its ability to fund operations and expansion 5 ACCT 201 Chapter 1 Summary: Introduction to Financial Statements Its results of operations Notes to the Financial Statements Clarify information presented in the financial statements Provide additional detail (i.e. Describe accounting policies or explain uncertainties and contingencies) Auditor’s Report An auditor, a CPA, conducts an independent examination of the company’s financial statements. The auditor gives an opinion if the financial statements provide a fair representation of the firm’s financial position and results of operations in accordance with generally accepted accounting principles. If they do, the auditor expresses an unqualified opinion. If the auditor doesn’t express an unqualified opinion, users of the financial statements are skeptical that the statements give an accurate picture of the firm’s financial health. 6
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