econ 262, chap. 1 notes
econ 262, chap. 1 notes Econ 262
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This 12 page Class Notes was uploaded by Kaleigh Stalker Alves on Sunday September 25, 2016. The Class Notes belongs to Econ 262 at University of Nevada Reno taught by Debra Stiver in Fall 2016. Since its upload, it has received 3 views. For similar materials see Principles of Statistics II in Statistics at University of Nevada Reno.
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Ch. 1 Class notes for Fundamentals of Financial Accounting, 5e by Phillips/Libby/Libby UT San Antonio edited by Linda Vaello, CPA Chapter 1 Business Decisions and Financial Accounting Chapter 1 Learning Objectives LO 1-‐ 1 Describe various organizational forms and business decision makers. LO 1-‐ 2 Describe the purpose, structure, and content of the four basic financial statements. LO 1-‐ 3 Explain how financial statements are used by decision makers. LO 1-‐ 4 Describe factors that contribute to useful financial information. LO 1-‐ Organizational Forms: Three main types of business organizations: 1. _____________________ – a business organization owned by one person. The owner is personally liable for all debts of the business. 2. _______________ – a business organization owned by two or more people. Each partner is personally liable for all debts of the business. 3. _________________ – a separate entity from both a legal and accounting perspective. Owners of corporations (stockholders) are not personally responsible for debts of the corporation. Note a corporation’s stock can be publicly traded (over a stock exchange) or privately traded. Although sole proprietorships make up the majority of businesses in terms of quantity, the majority of business wealth is held in corporations due to the limited liability a corporation provides. The Accounting System (Exhibit 1.1) 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 decision makers, both inside and outside the organization Operating, Investing and Financing Activities Accounting System External users Accounting Reports (creditors, investors, etc.) Internal users Financial Managerial (managers, etc.) Acc 2013 Chapter 1 Notes, 5e Ch. 1 -‐ p. 1 The accounting system produces two kinds of reports. 1) Managerial accounting reports (For internal use) include detailed financial plans and continually updated reports about the operating performance of the company. These reports are made available only to the company’s employees (internal users) so that they can make business decisions related to production, marketing, human resources, and finance. For example, managerial accounting reports are needed when determining whether to build, buy, or rent a building; whether to continue or discontinue making particular products; how much to pay employees; and how much to borrow. 2) Financial accounting reports (called financial statements) are prepared periodically to provide information to people not employed by the business (external users). These external financial statement users are not given access to the detailed internal records of the company, so they rely extensively on the financial statements. The four main groups of external users are (1) creditors, (2) investors, (3) directors, and (4) government. LO 1-‐2 The 4 Basic Financial Statements The Basic Accounting Equation One of the central concepts to understanding financial reports is that what a company owns must equal what a company owes to its creditors and stockholders. In accounting, there are special names for the items a company owns ( assets) and the claims on these items by creditors ( liabilities) and stockholders ( equity), as shown below. Resources Owned … Resources Owed … by the company to creditors to stockholders Assets = Liabilities + Stockholders’ Equity Abbreviated: = L + SE Separate entity assumption: Requires that a business’s financial reports include only the activities of the business and not those of its stockholders. Assets are _____________ controlled by the company that have measurable value and are expected to provide future benefits to the company. Some examples of account names for Assets include 1.__________________________________________________ 2.__________________________________________________ 3.__________________________________________________ 4.__________________________________________________ Accounting 2013 Class Notes , 5E Ch. 1 -‐ p. 2 Liabilities are ____________ ________ by the business to creditors. . Some examples of account names for Liabilities include 1. _______________________________ 2._______________________________ Note the common ending ___________________. Stockholders’ Equity represents owners’ claims to the business resources. Stockholders’ equity These claims arise for two reasons. 1. First, the owners have a claim on amounts they contributed directly to the company in exchange for its stock (__________________ __________________________). 2. Second, the owners have a claim on amounts the company has earned through profitable business operations (______________________ _____________________). The second part of Stockholders’ Equity (Retained Earnings) can be further broken down into net income (and its components) and Dividends Revenues – Expenses = Net Income o ___________________ arise from sales of goods or services to customers. They are measured at the amount the business charges the customer. o ____________________ are the costs of business necessary to earn revenues. They include wages to employees, advertising, insurance, and utilities. Dividends are distributions of a company’s earnings to its stockholders as a return on their investment. Assets = Liabilities + Stockholders’ Equity Revenues Common Stock – Expenses NOTE: Dividends are not an expense. = Net Income (profit generated) Retained Earnings Dividends (profit distributed) The Financial Statements The term financial statements refers to four accounting reports, typically prepared in the following order: 1. Income Statement 2. Statement of Retained Earnings 3. Balance Sheet 4. Statement of Cash Flows Accounting 2013 Class Notes , 5E Ch. 1 -‐ p. 3 Income Statement The purpose of the income statement is to report the amount of revenues less expenses for a period of time Income Statement: Net Income = _________________ -‐ _________________ Account Titles on the Income Statement Students refer to Exhibit 1.3 and write down the names of the accounts that match the descript ions below: ____________________________ Revenue earned from selling apps to customers in September ____________________________ Revenue earned from providing promotional services to other app developers ____________________________ Total amount earned durin g September ____________________________ Cost of salaries and employee wages for work done in September ____________________________ Cost of rent for the month of September ____________________________ Cost of utilities used in September ____________________________ Cost of insurance coverage for September ____________________________ Cost of advertising done in September ____________________________ Cost of taxes on September’s income ____________________________ Total expenses incurred in September to generat e revenues ____________________________ Difference between total revenues and total expenses Note expenses are for charges used, expired, performed in a particular period. This type of format is known as a SINGLE STEP Income statement Statement of Retained Earnings The 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. For SonicGateway, most changes in stockholders’ equity relate to generating and distributing earnings, so a statement of retained earnings is just as informative as a detailed statement of stockholders’ equity. . Students refer to Exhibit 1.4 and write down the items that match the descriptions below for the statement of retained earnings _____________________________ Last period’s ending Retained Earn ings balance ____________________________ _Reported on the income statement ( Exhibit 1.3 ) _____________________________ Distributions to stockholders in the current period _____________________________ This period’s ending Retained Earnings balance (Reported on Balance Sheet) Accounting 2013 Class Notes , 5E Ch. 1 -‐ p. 4 The formula for the Statement of Retained Earnings: Beginning Retained Earnings + _____________ -‐ ________________ = Ending Retained Earnings Which retained earnings is reported on the Balance Sheet?_______________________ Balance Sheet The balance sheet’s purpose is to report the amount of a business’s assets, liabilities, and stockholders’ equity at a specific point in time. Think of the balance sheet as a picture or screen capture of SonicGateway’s resources and claims to resources at the end of a particular day (in this case, September 30, 2015). Assets are listed in order of liquidity, that is, how quickly they are used up or converted into cash. Likewise, liabilities are listed in order of how soon each is to be paid or settled. The balance sheet “balances” because the resources (assets) equal the claims to the resources (liabilities and stockholders’ equity). Formula for the Balance Sheet: _____________________ = ___________________ + ____________________ Students refer to Exhibit 1.5 and write down the items that match the descriptions below for the Balance Sheet _____________________________ Resources controlled by the company _____________________________Amount of cash on hand and in the business’s bank account _____________________________Amount due from the business ’s customers (Amounts they have a right to collect from their credit customers ______________________ _______ Cost of paper and other supplies on hand _____________________________ Cost of computers, desks, etc. _____________________________ Cost of software and programming code purchased from others _____________________________ Total amount of the company’s resources _____________________________ Claims on the company’s resources _____________________________ Creditors’ claims on the company’s resources _____________________________ Amount owed to suppliers for prior credit purchases ( on account) (Generally no interest is charged) ____________________________ Amount of loan owed to the bank ( for promissory note) Interest will be charged on the amount owed ___________________________ Total claims on the resources by creditors ___________________________ Stockholders’ claims on the company’s resources ____________________________Amount stockholders contributed for company common stock ____________________________ Total earnings retained in the business ( Exhibit 1.4 ) ____________________________ Total claims on the company’s resources by stockholders ____________________________ Total claims on the company’s resources Accounting 2013 Class Notes , 5E Ch. 1 -‐ p. 5 Statement of Cash flows The fourth financial report of interest to external users is the statement of cash flows. It includes only those activities that result in cash changing hands. The statement of cash flows is divided into three types of activities. Operating activities are directly related to running the business to earn profit. They include selling apps and services, paying employee wages, buying advertising, renting a building, obtaining insurance coverage, and so on. Investing activities involve buying and selling productive resources with long lives (such as buildings, land, equipment, and software), purchasing investments, and lending to others. Financing activities include any borrowing from banks, repaying bank loans, receiving cash from stockholders for company stock, and paying dividends to stockholders. The statement of cash flows will be covered more indepth at the end of the semester when we cover Chapter 12. Notes to the Financial Statements Notes help financial statement users understand how the amounts were derived and what other information may affect their decisions. Relationships among the Financial Statements Here is how the four statements fit together. Review Exhibit 1.7 in your book. 1) The income statement reports the results of business operations for the accounting period. The net income from the income statement is a component in determining ending Retained Earnings on the statement of retained earnings. 2) The ending retained earnings balance for the period is also reported on the balance sheet. If we did not report the ending retained earnings balance on the balance sheet, our balance sheet would not balance. So the statement of retained earnings must be prepared before the balance sheet may be completed. The Cash on the balance sheet is equal to the ending Cash reported on the statement of cash flows. LO 1-‐3 Using Financial Statements Creditors are primarily interested in answers to the following questions: List the financial statement the user can examine to answer that question 1. Is the company generating enough cash to make payments on its loans? What financial statement can they examine to answer that question?____________________ 2. Does the company have enough assets to cover its liabilities? Financial statement?________________ Investors are primarily interested in answers to the following questions: List the financial statement the user can examine to answer that question 1. What is the immediate return (through dividends) on my contributions? Financial statement?________________ Accounting 2013 Class Notes , 5E Ch. 1 -‐ p. 6 2. What is the long-‐term return (through stock price increases resulting from the company’s profits)? Financial statement?________________ LO 1-‐4 Factors that contribute to useful financial information. External Financial Reporting The main goal is to provide useful financial information to external users for decision making. The factors that affect whether information is useful are: Useful Faithful Relevant Representation For financial information to be judged useful, it must be relevant and a faithful representation. Information is relevant if it makes a difference in decision making and it is a faithful representation if it fully depicts the economic substance of business activities. The usefulness of financial information is enhanced when it is comparable (to prior periods and other companies), verifiable, timely, and understandable . Comparable Verifiable Timely Understandable Accounting Standards The system of financial statement reporting in use today has a long history—all the way back to a publication in 1494 by an Italian monk and mathematician, Luca Pacioli. Currently, in the United States, the Financial Accounting Standards Board (FASB) has the primary responsibility for setting the underlying rules of accounting. As a group, these rules are called Generally Accepted Accounting Principles, or GAAP for short (pronounced like the name of the clothing store). The accounting rules in the United States are similar, for the most part, to those used elsewhere in the world, but some important differences exist. The FASB is working alongside the International Accounting Standards Board (IASB) to eliminate these differences. The accounting rules developed by the IASB are called International Financial Reporting Standards, or IFRS for short. United States Where? World FASB Name of IASB (Financial Accounting organization? (International Accounting Standards Board) Standards Board) GAAP Abbreviation IFRS (Generally Accepted for (International Financial Accounting 2013 Class Notes , 5E Ch. 1 -‐ p. 7 Accounting Principles) Reporting Standards) standards? Ethical Conduct Ethics refers to the standards of conduct for judging right from wrong, honest from dishonest, and fair from unfair. Intentional financial misreporting is both unethical and illegal. As you will see throughout this course, some accounting and business issues have clear answers that are either right or wrong. However, many situations require accountants, auditors, and managers to weigh the pros and cons of alternatives before making final decisions. To help ensure these decisions are made in a professional and ethical manner, the American Institute of Certified Public Accountants (AICPA) requires all its members to adhere to a Code of Professional Conduct. Not all ethical dilemmas are clear-‐cut. Some situations will require you to weigh one moral principle (e.g., honesty) against another (e.g., loyalty). When faced with an ethical dilemma, follow these three steps: 1. Identify who will benefit from the situation and how others will be harmed. 2. Identify the alternative courses of action. 3. Choose the alternative that is the most ethical. Demonstration of a few Solved Exercises . You will get more practice in your Connect Assignments M1-‐12 Preparing a Statement of Retained Earnings Stone Culture Corporation was organized on January 1, 2014. For its first two years of operations, it reported the following: Net income for 2014 $ 40,000 Net Income for 2015 45,000 On the basis of the data given, prepare a statement of retained earnings for 2014 (its first Dividends for 2014 15,000 year of operations) and 2015. Show computations. Dividends for 2015 20,000 Total assets at the end of 2014 125,000 Total assets at the end of 2015 242,000 2014 2015 Accounting 2013 Class Notes , 5E Ch. 1 -‐ p. 8 Alternate: Let’s go one step further. Let’s Total Liabilities at the end of 2014 50,000 assume the liabilities are as follows: Total liabilities at the end of 2015 100,000 1. What is the total stockholders’ equity at the end of 2014?_______________________ 2. Of the SE, how much is common stock at the end of 2014?________________________ 3. What is the total stockholders’ equity at the end of 2015?_______________________ 4. Of the SE, how much is common stock at the end of 2015?_______________________ E1-‐3 Preparing a Balance Sheet DSW is a designer shoe warehouse, selling some of the most luxurious and fashionable shoes at prices that people can actually afford. Its balance sheet, at February 2, 2013, contained the following items (listed alphabetically in thousands of dollars). Required: 1. Prepare the balance sheet as of February 2, 2013, solving for the missing amount. Assets Liabilities Stockholders ‘ Equity Accounting 2013 Class Notes , 5E Ch. 1 -‐ p. 9 As of Feb 2, did most of the financing for assets come from creditors or stockholders?________________ E1-‐ 5 Labeling and Classifying Business Transactions The following items relate to business transactions involving K ·∙ Swiss Inc. Required: 1. Identify an appropriate label ( account name) for each item as it would be reported in the company’s financial statements. Choose from the following: Accounts Payable, Accounts Receivable, Cash, Common Stock, Dividends, Land, Notes Payable, Sales Revenue, Supplies, and Supplies Expense. 2. Classify each item as an asset ( A), liability ( L), stockholders’ equity ( SE), revenue ( R), or expense ( E). Account Name Classification a. Coins and currency ______________________ __________ b. Amounts K ·∙ Swiss owes to suppliers of watches ______________________ __________ c. Amounts K ·∙ Swiss can collect from customers ______________________ __________ d. Amounts owed to bank for loan to buy building ______________________ __________ e. Property on which buildings will be built ______________________ __________ f. Amounts distributed from profits to stockholders ______________________ __________ g. Amounts earned by K ·∙ Swiss by selling watches ______________________ __________ h. Unused paper in K ·∙ Swiss head office ______________________ __________ i. Cost of paper used up during month ______________________ __________ j. Amounts contributed by stockholders for K ·∙ Swiss stock ____________________ __________ E1-‐6 Preparing an Income Statement and Inferring Missing Values Cinemark Holdings operates movie theaters and food concession counters throughout the United States. Its income statement for the quarter ended September 30, 2013, reported the following amounts (in thousands): 1. Solve for the missing amounts and prepare an Income Statement for the quarter ended September 30, 2013. TIP: First put the items in the order they would appear on the Income Statement and then solve for the missing values. 2. What is Cinemark’s main source of revenue and two biggest expenses?___________________Revenue_______________________________Expenses Accounting 2013 Class Notes , 5E Ch. 1 -‐ p. 10 Exercise 1-‐6 (Continued) E1-‐8 Inferring Values Using the Income Statement and Balance Sheet Equations Review the chapter explanations of the income statement and the balance sheet equations. Apply these equations in each of the following independent cases to compute the two missing amounts for each case. Assume that it is the end of the first full year of operations for the company. TIP: First identify the numerical relations among the columns using the balance sheet and income statement equations. Then compute the missing amounts. Accounting 2013 Class Notes , 5E Ch. 1 -‐ p. 11 S1-‐6 (Req. 1) Critical Thinking: Developing a Balance Sheet On September 30, Ashley and Jason started arguing about who is better off. Jason said he was better off because he owned a PlayStation console that he bought last year for $250. He figures that, if needed, he could sell it to a friend for $180. Ashley argued that she was better off because she had $1,000 cash in her bank account and a piece of art that she bought two years ago for $800 but could now sell for $1,400. Jason countered that Ashley still owed $250 on her car loan and that Jason’s dad promised to buy him a Porsche if he does really well in his accounting class. Jason said he had $6,000 cash in his bank account right now because he just received a $4,800 student loan. Ashley knows that Jason also owes a tuition installment of $800 for this term. Required: 1. Prepare a financial report that compares what Ashley and Jason each own and owe on September 30. Make a list of any decisions you had to make when preparing your report. Assets Ashley Jason Total Assets Liabilities Total Liabilities Equity Total Liabilities & Equity Test your knowledge on the use of the accounting equation 1. If cash is $35,000, accounts payable is $15,000, how much is owner's equity?_____________ 2. If assets decreased $20,000 and liabilities increased $5,000, how much did owner's equity change (include increase or decrease) ______________________ ____________________ 3. During May, ABC Company reported sales of $70,000, accounts receivable of $10,000, cost of goods sold of $15,000, wages expense of $10,000 and wages payable of $2,000. What is net income for May?_____________________________ Accounting 2013 Class Notes , 5E Ch. 1 -‐ p. 12
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