Financial Accounting and Its Environment doc

Major Types of Accounting• Financial accounting provides information to decision makers who are external to the business.. Major Types of Accounting• Managerial accounting provides inf

Financial Accounting and Its Environment

Chapter 1

Major Types of Accounting

• Financial accounting provides

information to decision makers

who are external to the business

– Examples include present and future shareholders, present and future

creditors, and government regulators.

Major Types of Accounting

• Managerial accounting

provides information to decision makers who are internal to the business

– This information is not published to people outside of the business.

Major Types of Accounting

• Tax accounting involves tax

compliance and tax planning

– Tax compliance involves the

calculation of the company's tax liability after the transactions for a year have been completed.

Major Types of Accounting

• Tax accounting involves tax

compliance and tax planning

– Tax planning involves the

consideration of a transaction before

it has taken place in order to determine tax consequences.

Major Types of Accounting

• Accounting Information Systems

– The processes and procedures

required to generate accounting information.

Major Types of Accounting

Overview of Financial Accounting

Overview of Financial Accounting

Financial Statements

Decision Makers

Past Transactions and

Other Economic

Events

Financial Accounting Process

The Financial Accounting

• Measure attributes of those

transactions and events

• Record and summarize the

measurements

The Financial Accounting

Process

The Financial Accounting

Process

• The initial valuation of a

transaction is generally not

changed in the future

– This original measurement is called

the historical cost.

– Balance sheet

– Income statement

– Statement of cash flows

The Balance Sheet

• The balance sheet shows a firm's assets, liabilities, and owners'

equity at one point in time

The Balance Sheet

• Assets are valuable resources

that a firm owns

• Liabilities are obligations to

convey something of value in the future

The Balance Sheet

• Owners' equity is a residual

amount, calculated by

subtracting liabilities from assets

– If assets are $300 and liabilities are

$50, then owner's equity must equal

$250.

The Balance Sheet

Cash 5,000 Liabilities

Accounts receivable 7,000 Accounts payable 8,000 Inventory 10,000 Notes payable 2,000 Equipment 7,000 Total liabilities 10,000

Owners’ equity 19,000 Total assets 29,000 Total liabilities and

owners’ equity 29,000

The Income Statement

• The income statement

summarizes a firm's revenues and expenses for a period of time

The Income Statement

• Revenues are inflows of assets

from providing goods and

services to customers

• Expenses are the costs incurred

to generate revenues

The Income Statement

• If revenues exceed expenses,

then the result is net income.

• If expenses exceed revenues,

then the result is a net loss.

– If expenses are $500 and revenues are $400, then there is a net loss of

$100.

The Income Statement

Revenues

Expenses

The Statement of Cash

Flows

The Statement of Cash

Flows

• The statement of cash flows

summarizes a firm's inflows and outflows of cash over a period of time

The Statement of Cash

Flows

The Statement of Cash

Flows

• The statement has three sections.

– Operating activities—deal with a

company's operations.

– Investing activities—deal with a

company's long-term asset transactions

– Financing activities—deal with a

company's long-term debt activities and activities involving shareholders.

The Statement of Cash Flows

The Statement of Cash Flows

Distinguishing Between

Financial Statements

Distinguishing Between

Financial Statements

• The balance sheet reports its

components as of one moment in time

• The income statement and the

statement of cash flows cover a period of time

Notes to the Financial

Statements

Notes to the Financial

Statements

• Clarify and expand upon the

material presented in the body of the statements

Notes to the Financial

– An example is a note which explains

a company's inventory pricing policies or the methods used to depreciate fixed assets.

– A discussion and analysis by

management of the year’s results.

Users of Financial Statements and the Decisions They Make

Users of Financial Statements and the Decisions They Make

• Present and potential owners

(investors) assess and compare the prospects of alternative

investments

Present and Potential Owners Evaluate Two Variables

Present and Potential Owners Evaluate Two Variables

• Expected return—the increase

in the investor's wealth that is

expected over the investment's time horizon

• Risk—the uncertainty

surrounding estimates of

expected return

Users of Financial Statements and the Decisions They Make

Users of Financial Statements and the Decisions They Make

• Shareholders must decide

whether to buy, hold, or sell

shares in the firm

• Creditors must decide whether to extend credit and on what terms

Other Users of Financial Statements

Other Users of Financial Statements

• Financial analysts and advisors

• Customers

• Employees and labor unions

• Regulatory authorities

Generally Accepted

Accounting Principles

Generally Accepted

Accounting Principles

• The most widely used set of

accounting principles is called generally accepted accounting principles (GAAP)

• GAAP is currently set by the

Financial Accounting Standards Board (FASB)

Generally Accepted

Accounting Principles

Generally Accepted

Accounting Principles

• The FASB uses a due-process

procedure in setting standards

– Ensures that all interested parties are given an opportunity to have input into the standard-setting process.

FASB’s Due Process

Issuance of an

Exposure Draft

Public Hearings

Issuance of a Statement

of Financial Accounting

Standard

Two sources of FASB's

• The delegation by the Securities and Exchange Commission of its legislative authority to determine GAAP for large, publicly held

corporations

Groups Involved in Setting Accounting Standards

Groups Involved in Setting Accounting Standards

The Role of Auditing

The Role of Auditing

• Independent certified public

accountants (CPAs) often perform audits in order to enhance the

credibility of the statements

– Only a CPA may perform an audit.

The Role of Auditing

The Role of Auditing

• The wording of the audit report is very specific about what the audit does and does not do

The Role of Auditing

The Role of Auditing

• Auditors follow generally

accepted auditing standards (GAAS) in the conduct of the audit

The Role of Auditing

The Role of Auditing

• GAAS are standards developed by the accounting profession to

provide guidance in the

performance of an audit

The Role of Auditing

The Role of Auditing

• An audit is not a guarantee of the correctness of the financial

statements

The Role of Auditing

The Role of Auditing

• Auditors do not certify the

The Role of Auditing

The Role of Auditing

• The most desirable audit opinion

is the unqualified opinion

Consequences of the Choice of Accounting Principles

Consequences of the Choice of Accounting Principles

• The FASB's primary objective is to select accounting principles that provide useful information to

financial statement readers

Consequences of the Choice of Accounting Principles

Consequences of the Choice of Accounting Principles

• Accounting principles have

implementation costs.

– They can affect the wealth of

managers and firms via compensation plans, debt contracts, and political costs.

– Managers consider these economic

consequences when selecting accounting principles.

Compensation Plans

• A compensation plan may tie managers' compensation to earnings, and therefore, the managers might choose

principles which will enhance earnings

Two Roles of Financial

Accounting

Two Roles of Financial

Accounting

• The primary objective of

accounting is to provide useful

information to those who make

business and economic decisions

• A secondary objective of

accounting is to help develop and enforce contracts

Ethics in Accounting

• The American Institute of

Certified Public Accountants

(AICPA) has a Code of

Professional Conduct which

emphasizes CPAs' obligation to serve the public interest

Financial Accounting and Its Environment

End of Chapter 1