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Chapter 1 – Accounting in Action ● What is Accounting ○ Three Activities ■ An info system that identifies, records, and communicates economic events to interested users ● Identify ­ events related to business ● Record ­ systematic, chronological diary of events ● Communicate ­ accounting reports ■ Bookkeeping Definition ● The recording of economic events ○ Who Uses Accounting Data ■ Internal Users ● Managers who plan, organize, run business ● Managerial Accounting ○ Provides internal reports to help users make decisions about companies ■ External Users ● Individuals/Organizations outside company who want financial info ● Investors (owners) ○ Make decisions to buy, hold, sell ownership shares of company ● Creditors​ (suppliers/bankers) ○ Evaluate risks of granting credit/lending money ● Taxing authorities (IRS) ○ Does company comply w/tax rules ● Regulatory agencies ​(SEC/FTC) ○ Is company operating within prescribed rules ● Customers ○ Will company honor warranties/support product lines ● Labor Unions ○ Do owners have ability to pay increased wages/benefits ● Financial Accounting ○ Providing economic/financial info to external users ● The Building Blocks of Accounting ○ Ethics In Financial Reporting ■ Sarbanes­Oxley Act (SOX) ● Passed in 2002 by Congress to reduce unethical corporate behaviour/decrease likelihood of future corporate scandals ● Top mgmt has to sign financial reports ■ Ethics Definition ● Standards of conduct judged as right/wrong, honest/dishonest, fair/unfair ○ Generally Accepted Accounting Principles (GAAP) ■ GAAP Definition ● Common standards that indicate how to report economic events ■ IFRS​ = International Financial Reporting Standards ■ FASB ​= Financial Accounting Standards Boards ● Private organization that establishes GAAP in the US ■ SEC​ = Securities and Exchange Commission ● Agency of US gvmt that oversees US financial markets/accounting standard­setting bodies ● Relies on FASB ■ IASB​ = International Accounting Standards Boards ■ Convergence ● Effort to reduce differences between US GAAP and IFRS to enhance comparability ○ Measurement Principles ■ Cost principle (Historical Cost Principle) ● Companies record assets at their cost ■ Fair Value principle ● Assets/Liabilities should be reported at price received to sell asset/settle liability ● Can be more useful than Cost Principle for certain assets/liabilities ■ Which principle = weigh factual nature of cost figures vs. relevance of fair value ■ Relevance ● Financial information is capable of making a difference in a decision ■ Faithful Representation ● Numbers/Descriptions match what really existed/happened ○ Assumptions ■ Monetary Unit Assumption ● Companies include in the accounting records only transaction data that can be expressed in terms of money ● Enables accounting to measure economic events ● Prevents inclusion of relevant info in accounting records ■ Economic Entity Assumptions ● Economic Entity Definition ○ Any organization or unit in society ○ Company, governmental unit, municipality, school district, church ● Define ○ Activities of entity be kept separate and distinct from activities of owner and all other entities ● Proprietorship ○ Business owned by one person ○ Small amount of capital used to start business ○ Owner receives profits, suffers losses, personally liable for all business debts ● Partnership ○ Business owned by two+ persons ○ Written/Oral agreement ○ Partnership transactions must be kept separate from personal activities of partners ● Corporation ○ Ownership is divided into transferrable shares of stock ○ Limited Liability ■ Holders of shares ■ Not personally liable for the debts of entity ■ Can transfer all or part of ownership to other investors at any time ○ Enjoy unlimited life ● The Basic Accounting Equation ○ Assets = Liabilities + Stockholders’ Equity ■ Assets ● Resources a business owns ● Carry out production/sales ● Capacity to provide future services or benefits ■ Liabilities ● Claims against assets (existing debt/obligations) ● Credit = accounts payable ● Borrowed money = note payable ● Employee's = salary/wages payable ● Local gvmt = sales/real estate taxes payable ■ Stockholder’s Equity ● Ownership claim on total assets ● Residual equity = equity left over after creditor’s claims are satisfied ○ Applies to all economic entities ○ Provides underlying framework for recording/summarizing economic events ○ Common Stock ■ Total amount paid in by stockholders for the shares they purchase ○ Retained Earnings ■ Determined by revenues, expenses, dividends ■ Revenues ● Gross increases in stockholder’s equity resulting from business activities entered into for the purpose of earning income ● Increase in asset ● Sales, fees, services, commissions, interest, dividends, royalties, rent ■ Expenses ● Cost of assets consumed/services used in process of earning revenue ● Decreases in equity resulting from operating business ■ Dividends ● Distribution of cash or other assets to stockholder ● Reduce retained earnings ● Using the Accounting Equation ○ Transactions ■ Business’s economic events recorded by accountants ■ External or internal ■ Money is exchanged ○ Transaction Analysis ○ Summary of Transactions ■ Each transaction must be analyzed in term of effect on: ● Three components of basic accounting equation ● Specific kinds of items within each component ■ Two sides of equation must always be equal ■ Common Stock/Retained Earnings columns indicate causes of each change in stockholders’ claim on assets ● Financial Statements ○ Income Statement Definition ■ Presets revenues/expenses/resulting net income/loss for specific period of time ■ Statement of operations, earnings statement, profit/loss statement ■ Net Income ● Revenues exceed expenses ■ Net Loss ● Expenses exceed revenues ○ Retained Earnings Statement Definition ■ Summarizes changes in retained earnings for specific period of time ○ Balance Sheet Definition ■ Reports assets, liabilities, equity of company at specific date ■ Snapshot of company’s financial condition @ specific moment in time ○ Statement of Cash Flows Definition ■ Summarizes info about cash inflows/outflows for specific period ■ Cash effects of company’s operations during a period ■ Investing transactions ■ Financing transactions ■ Net increase/decrease in cash during period ■ Cash amount at end of period ■ Where did cash come from What was it used for What was change in cash balance ○ Net income → Retained Earnings → Balance Sheet → Statement of Cash Flows