ACCT 2010 Chapter 1 Book Notes
ACCT 2010 Chapter 1 Book Notes ACCT 2010
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This 9 page Class Notes was uploaded by Gabrielle Blados on Monday January 18, 2016. The Class Notes belongs to ACCT 2010 at Clemson University taught by Dr. Smalls in Winter 2016. Since its upload, it has received 25 views.
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Date Created: 01/18/16
Accounting Chapter 1 Notes Learning Objectives: 1. Describe various organizational forms and business decision makers 2. Describe the purpose, structure, and content of the four basic financial statements 3. Explain how financial statements are used by decision makers 4. Describe factors that contribute to useful financial information 1. Organizational Forms Sole Proprietorship - Owned and operated by one individual - The owner is personally liable for all debts of the business Partnership - Two or more owners share responsibilities for: taxes, profits, and liabilities - More resources are usually available to it • Resources are used to fuel the business’s growth Corporation - Is a separate entity from both legal and accounting perspectives - Owners cannot lose more than their investment in the corporation • Major advantage for owners - Can raise large amounts of money for growth - Two types of corporations 1. Private corporations 2. Public corporations Accounting for Business Decisions - Most companies exist to earn profits for their stockholders - Accounting: • Is an information system designed by an organization to capture (analyze, record, and summarize) the activities affecting its financial condition and performance and then report the results to internal and external decision makers • The language of business - Private Accountants work as employee to a business - Public Accountants are hired when needed for basic services - The main goal of an accounting system is to capture information about the operating, investing and financing activities of a company - Managerial accounting reports: • Include detailed financial plans and continually updated reports about the operating performance if the company - Financial accounting reports: Managerial Report= Internal Financial Report= External • Aka financial statements • Prepared periodically to provide information to people not employed by the business - Four main types of External Users 1. Creditors: suppliers, banks, and anyone to whom money is owed. • Suppliers—want to be sure they will be paid for goods and services they deliver • Banks—use financial statements to evaluate the risk they will not be repaid the money they’ve loaned the company 2. Investors: existing and potential stockholders to assess the financial strength of a business, and ultimately, to estimate its value 3. Directors: short title for the members of a company’s board of directors, they use financial statements to ensure the company’s managers make decisions that are in the best financial interest of its stockholders 4. Government: agencies look closely at companies’ financial statements. • Securities and Exchange Commission (SEC) is responsible for the functioning of the stock market • Internal Revenue Service (IRS) is responsible to ensure taxes are completed correctly 2. The Basic Accounting Equation - What a company owns must equal what a company owes - A=L+SE (assets= liabilities + stockholder’s equity) - Separate Entity Assumption • Requires the a business’s financial reports include only the activities of the business and not the personal dealings of its stockholders Assets - Things you own - Is an economic resource controlled by the company - Is expected to benefit the company by producing cash inflows or by reducing cash outflows in the future - Cash, supplies, equipment and software - Inventory is also considered an asset Liabilities - Things you owe - What the company owes to creditors - Note Payable: • Banks require borrowers to sign a legal document (note) that describes details about how the company must repay them. Long term loans - Account payable • Purchases made using credit are said to be “on account” and are expected to be paid back quicker • Smaller loans - From a legal perspective creditors have priority over stockholders—liabilities are paid before any amounts are paid to stockholders Stockholders Equity - SE represents the owner’s claim on the business - Owners have a claim on amounts they contributed directly to the company in exchange for stock (common stock) - Owners have a claim on amounts the company has earned through profitable business operations (Retained earnings) • Important because a business can only survive if it’s profitable - Accounting systems separately keep track of two profit components • Revenue: earned by selling goods or services to customers Profit Components • Expenses: are all costs of doing business that are necessary to earn revenue - Running an ad, using electricity, etc. • Net income: the correct term for profit Revenue-Expenses= Net Income - By generating net income, a company increases its stockholder’s equity - Or it can be paid out to the company’s stockholders for their own personal use (Dividends) • Dividends: profits accumulated in Retained Earnings until a decision is made to distribute them to stockholders - Paid in cash - Are not an expense incurred to generate earnings - Are reported as a reduction in retained earnings Financial Statements - Refers to four accounting reports prepared in the following order: 1. Income Statements 2. Statement of Retained Earnings 3. Balance Sheet 4. Statement of Cash Flows - Most commonly prepared monthly, quarterly, and yearly st - Fiscal year ends on day other than Decstber 31 - Financial year ends on December 31 The Income Statement - Also called the statement of operations - Larger businesses use a fourth line in the heading to indicate rounding in numbers i.e. thousands, or millions - It is crucial to have the unit of measure • Unit of measure assumption: assuming everything is done in US dollars - Has three major captions: Revenues, Expenses, and Net Income - Accounts: accumulate and report the effects of each different business activity - Each major caption has an underlined subtotal and the “bottom line” amount for net income has a double underline to highlight it Income Statement Example Revenues don’t necessarily equal cash coming in during the month, and expense don’t always equal cash going out during the month Net income is a measure of how much better off your business is, not how much cash you made Statement of Retained Earnings - Reports the way that net income and the distribution of dividends affected the financial position of the company during the period - Starts with the retained earnings balance at the beginning of the period • The profits that have accumulated in the company over time - The statement adds net income and subtracts any dividends for the current period - The goal is to see what the retained earnings are for the end of the period Statement of Retained Earnings Example Balance Sheet - Reports the amount of assets, liabilities, and stockholder’s equity of a business at a point in time - Aka Statement of Financial Position - Assets are listed in order of how soon they are to be used or turned into cash (liquidity) - Liabilities are listed in order of how soon each is to be paid or settled (accounts first then notes) - Assets come first, then liabilities and stockholder’s equity balances - Cash is first reported because it is the most liquid - Balance sheets follow the Cost Principle • Assets are initially reported on the balance sheet based on their original cost to the company - All liabilities are financial obligations of the business arising from past business activities - Common stock reflects the dollar amount of the company’s stock given when contributions are made to the company Balance Sheet Example The basic accounting equation is also called the balance sheet equation Any account name containing receivable is an asset and any containing payable is a liability Statement of Cash Flows - Reports the operating, investing, and financing activities that caused increases and decreases in cash during the period - Net income is not necessarily equal to cash • Revenues are reported when earned and expenses when incurred regardless of when cash is received or paid - Records activities that result in cash changing hands - Divided into three different types of activities: 1. Operating: - Directly related to running the business to earn profit - Selling apps and services, paying employee wages, buying advertisements, renting a building, etc. 2. Investing: - Involve buying and selling productive resources with long lives (buildings, land and equipment) purchasing investments and lending to others 3. Financing: - Any borrowing from a bank, repaying bank loans, receiving cash from stockholders for company stock or paying dividends Statement of Cash Flows Example Parentheses are used on the statement of cash flows to indicate negative cash flows (outflows) Relationship among Financial Statements Order of producing these forms is necessary for these relationships to work Notes to the Financial Statements - Financial statements are not complete without notes to help users understand how the amounts were derived and what other information may affect their decisions 3. Using Financial Statements - Creditors are mainly interested in assessing: 1. Is the company generating enough cash to make payments on its loans? 2. Does the company have enough assets to cover its liabilities? 3. Investors expect a return on their contributions to a company 4. Useful Financial Information Generally Accepted Accounting Principles - GAAP for short - Enforced by Securities and Exchange Commission (SEC) • Government agency that oversees stock exchanges and financial reporting by public companies in the US - Rules of financial accounting created by the Financial Accounting Standards Board for the use in the US - IFRS: International Financial Reporting Standards • Rules of accounting created by the International Accounting Standards board for international use - The main goal for GAAP and the IFRS is to ensure companies produce financial information that is useful in making decisions about providing resources to the company - For financial statements to be useful they must possess two fundamental characteristics • Relevance: if it makes a difference in decision making • Faithful Representation: if it fully depicts the economic substance of business activities - Useful information is enhanced when it is: 1. Timely—available in time to influence decision makers 2. Verifiable—if others such as external auditors reach similar values using similar methods 3. Comparable—if the same accounting principles are used over time and across companies 4. Understandable—if reasonable informed users can comprehend and interpret it Ethical Conduct - Ethics refers to the standards of conduct for judging right from wrong, honest from dishonest, and fair from unfair - Many situations require accountants, auditors, and managers to weigh in - AICPA requires that all its members follow the Code of Professional Conduct - Sarbanes-Oxley Act • Set of laws established to strengthen corporate reporting in the united states - Ethical conduct is just as important for small private business as it is for large public companies - When faced with an ethical dilemma you should follow a three-step process: 1. Identify who will be affected by the situation 2. Identify and evaluate the alternative courses of action 3. Choose the alternative that is the most ethical
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