Chapter One Textbook Outline
Chapter One Textbook Outline ACG2021
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This 4 page Class Notes was uploaded by Nicholas D'Ambrosio on Wednesday August 17, 2016. The Class Notes belongs to ACG2021 at University of Florida taught by Jill Kristen Goslinga in Fall 2016. Since its upload, it has received 132 views. For similar materials see Introduction to Financial Accounting in Finance at University of Florida.
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Date Created: 08/17/16
Chapter One: The Financial Statements I. The Financial Statements The core of financial accounting revolves around these 4 basic financial statements: - Income Statement (statement of operations) - Statement of Retained Earnings - Balance Sheet - Statement of Cash Flows A. Explain Why Accounting is the Language of Business 1. Two Kinds of Accounting: Financial and Management Financial accounting: provides information for decision makers outside an entity. Management Accounting: provides information for managers of an entity. 2. Organizing a Business A business generally takes one of the following 4 forms: proprietorship, partnership, LLC, or Corporation a. Proprietorship Has a single owner called a proprietor. Tend to be small retail stores or solo providers of professional services. The proprietor is personally liable for all the business’ debts. b. Partnership Two or more parties as co-owners, each is referred to as a partner. Incomes and losses flow through the partners and theyrecognize them based on their agreed upon percentage of interest in the business. Each partner takes a proportionate share of the entity’s taxable income and pays tax according to that partner’s individual or corporate rate. Partnerships are governed by agreement, usually spelled out in writing in the form of a contract between thepartners.Partnerships canberisky,forthedecisions ofonepartnercould put all partners in debt. c. LLC (Limited Liability Corporation The business, not the owner, is liable for the company’s debts. An LLC may have one or manyowners known as members. Members of an LLC do NOT have unlimited liabilityfor the LLC’s debts. An LLC does not pay business income tax. Instead, the members pay income tax at their own tax rates. d. Corporation A corporation is owned bythe stockholders or shareholders who own stock. An advantage of a corporation is the ability to raise large sums of capital from the issuance of stock to the public Formed under state law, a corporation is legally distinct from its owners. Stockholders have no personal obligation to the business’ debt. Corporations paybusiness income tax. Also, shareholders are taxed twice on distributions received from the corporation (known as dividends). Major disadvantage: double taxation of distributed profits. Shareholders elect a board of directors. Board of directors elect officers (CEO, COO, CFO). B. Explain and Apply Underlying Accounting Concepts Accountants follow professional frameworks. The most common is called the Generally Accepted Accounting Principles (GAAP). In the USA, the Financial Accounting Standards Board (FASB) formulates GAAP. The International Accounting Standards Board (IASB) sets global or International Financial Reporting Standards (IFRS). Accounting information must have the following characteristics: comparability, verifiability, timeliness, and understandability. 1. Continuity (going concern) Assumption Definition: We assume that the entity will continue to operate long enough to sell its inventories, convert anyreceivables to cash, use other existing assets for their intended purposes, and settle its obligations in the normal course of business. 2. Historical Cost Principle Definition: assets should be recorded at their actual cost, measured on the date of purchase as the amount of cash paid plus the fair market value of all noncash consideration also given in exchange. Also used is a measurement called fair value, where assets are measured at what they currently could be worth based on market value. 3. Stable Monetary Unit Assumption Accountants assume that the value of currency will remain the same, removes the effect of inflation. This allows for comparison over time. C. Apply the Accounting Equation to Business Organizations 1. Assets and Liabilities Assets: Economic resources that are expected to produce a benefit in the future. Claims on assets come from 2 sources: - Liabilities: “outsider claims”, debts that are payable to outsiders, called “creditors”. - Owner’s Equity: represent the “insider claims” of a business. Assets = Liabilities + Owner’s Equity Long term debt is a liability that is payable beyond one year from the date of the financial statements. The Current Portion of long term debt is the amount due within the next year. 2. Owner’s Equity Owner’s Equity = Assets - Liabilities Stockholder’s equity has 2 main subparts: Paid-in Capital and Retained Earnings: a. Paid-in Capital Paid-in Capital: the amount stockholder’s have invested in the corporation. The basic component of paid-in capital is common stock, which the corporation issues to stockholders as evidence of ownership. b. Retained Earnings Retained Earnings: the amount earned by income-producing activities and kept for use in the business. There are 3 types: - Revenues: Inflows of resources that increase retained earnings. - Expenses: Resource outflows that decrease retained earnings. - Dividends: Decrease retained earnings for they are distributions of assets to stockholders. Dividends are recorded as direct reductions of retained earnings. D. Evaluate Business Operations through Financial Statements Income Statement Statement of Retained Earnings Balance Sheet Statement of Cash flows 1. The Income Statement Measures Operating Performance Income Statement: reports revenues and expenses. The bottom line is the net income or net loss for the period. If a company owns 20-50% of another company, GAAP requires theuseof theequitymethodof accounting. Ifthepercentage owned >50%,itissaidthatthecompanyownsacontrollinginterest.Theproperaccounting for controlling interests is consolidation of the financial statements of all entities under common control. In this, they must subtract the portion of net income of all consolidated subsidiaries that is NOT owned, known as net income attributed to non-controlling interests. 2. The Statement of Retained Earnings The statement of retained earnings shows what a company did with its net income. A positive balance in retained earnings indicates that a corporation has been able to accumulate earnings over its lifetime in order to expand, as well as to return a portion of its assets in the form of dividends to its shareholders. Dividends decrease retained earnings because they represent a distribution of a company’s assets to its stockholders. 3. The Balance Sheet Measures Financial Position The balance sheet reports 3 things: a. Assets - Current Assets: Assets that are expected to be converted to cash, sold, or consumed within the next 12 months. Include: cash, cash equivalents, receivables, inventories, and other current assets. - Long Term Assets: Assets that are expected to benefit the company for long periods of time. Include: investments, intangible assets, etc. b. Liabilities Current AND long term liabilities. Includes: accounts payable and accrued liabilities, current portion of long term borrowings, unearned royalties and other advances. c. Equity Includes: common stock and additional paid-in capital, retained earnings. 4. The Statement of Cash Flows Measures Cash Receipts + Payment Companies engage in 3 basic types of activities: Operating activities, investing activities, and financial activities. The statement of cash flows reports cash receipts and cash payments from each of these three activities: companies operate by selling goods and services to customers, companies invest in long term assets, companies need money for financing. E. Evaluate Business Decisions Ethically 3 factors affect business and accounting decisions: Economic, Legal, and Ethical. Ethics are at the basis of all decisions and ethical decision making plays a large role in accounting. “Do or do not - there is no try” – Yoda