Financial accounting the impact on decision makers 9e chapter 1

Users of Accounting Information and Their Needs  Internal Users:  Primarily the managers of a company  Involved in the daily affairs of the business  External Users:  Not directly i

Chapter 1

Accounting as a Form of

Communication

What is Business?

 Consists of activities necessary to provide

members of society with goods and services

LO 1

Exhibit 1.1—Types of Businesses

Exhibit 1.2—Forms of Organization

LO 2

Business Entities

 An organization operated to earn a profit

 Sole Proprietorships: organization with a single

owner

 Partnerships: business owned by two or more

individuals

 Often used by accounting firms and law firms

 Corporations: entity organized under the laws of

a particular state

 Ownership evidenced by shares of stock

Organizations and Social Responsibility

 U.S business entities recognize the societal

aspects of their overall mission and have

established programs to meet these

responsibilities

Nature of Business Activity

 Businesses engage in three types of activities:

• Purchase and sale of assets

Operating Activities

• Sale of

products/services

• Costs incurred

to operate business

Exhibit 1.3—A Model of Business

Activities

Users of Accounting Information

and Their Needs

 Internal Users:

 Primarily the managers of a company

 Involved in the daily affairs of the business

 External Users:

 Not directly involved in the operations of a business

 Need information that differs from that needed by internal users

 Outsiders must rely on the information presented by the company’s management

Management Accounting and

Financial Accounting

 Management accounting

 Branch of accounting concerned with providing

management with information to facilitate planning and control

 Financial accounting

 Branch of accounting concerned with the

preparation of financial statements for outsider use

Exhibit 1.4—Users of Accounting

Information

Financial Decision Framework

1. Formulate the question

2. Gather information from the financial

statements and other sources

3. Analyze the information gathered

4. Make the decision

5. Monitor your decision

The Accounting Equation

 Assets = Liabilities + Owners’ Equity

 Left side: valuable economic resources and that

will provide future benefit to the company

 Right side: indicates who provided, or has a

claim to, the assets

 Stockholders’ equity or shareholders’ equity:

used to refer to the owners’ equity of a

corporation

LO 5

Source of Stockholders’ Equity

 Created when a company issues stock to an

investor

 Retained earnings

 Earnings accumulated or retained by the company

 Part of owners’ equity that represents the income earned less dividends paid over the life of an entity

The Balance Sheet

 Financial statement that summarizes the assets, liabilities, and owners’ equity at a specific point

in time

 At any point in time, assets must equal liabilities and owners’ equity

Example 1.4—Preparing a Balance

Sheet

The Income Statement

 Summarizes the revenues and expenses of a company for a period of time

EXHIBIT 1.5—The Relationship Between the Accounting Equation and the Balance Sheet

Example 1.5—Preparing an Income

Statement

The Statement of Retained Earnings

 Summarizes the income earned and dividends paid over the life of a business

 Dividends: Distribution of the net income of a

business to its owners

Example 1.6—Preparing a Statement of

Retained Earnings

The Statement of Cash Flows

 Summarizes a company’s cash receipts and cash payments during the period from operating,

investing, and financing activities

Example 1.7—Preparing a Statement of

Cash Flows

Exhibit 1.6—Relationships Among the

Financial Statements

Financial Statement Assumptions

Going

Concern Monetary Unit

Time Period Assumption

Economic Entity Concept

 Single, identifiable unit must be accounted for in all situations

 Specific entity be the subject of a set of financial statements

 Does not intermingle the personal assets and

liabilities of the employees or any of the other stockholders

Cost Principle

 Assets are recorded at the cost to acquire them

 Original cost or historical cost—until the company disposes them

 More objective than market value

Going Concern

 Assume an entity is not in the process of

liquidation and that it will continue indefinitely

 Justifies use of historical cost

Time Period Assumption

 Artificial segment on the calendar used as the basis for preparing financial statements

 Accountants assume that it is possible to

prepare an income statement that accurately reflects net income or earnings for a specific time period

Setting Accounting Standards

 Generally accepted accounting principles

(GAAP)

 Various methods, rules, practices, and other

procedures—preparing financial statements

 Securities and Exchange Commission (SEC)

 Federal agency with ultimate authority to determine the rules for preparing statements

 Financial Accounting Standards Board (FASB)

 Authority to set accounting standards

LO 7

Setting Accounting Standards

 Five-member body created by an act of Congress in

2002 to set auditing standards

 International Accounting Standards Board (IASB)

 Develop worldwide accounting standards

Audit of Financial Statements

 Most stockholders are not actively involved in the daily affairs of the business

 Auditing: examining whether financial

statements are fairly presented

 External auditor performs various tests and

procedures and render his opinion

• Auditors’ report is an opinion, not a statement of fact

Ethics in Accounting

 Ethics plays a critical role in providing useful

financial information

 Investors and other users must have confidence

in a company, its accountants, and its outside

auditors that the information presented in

financial statements is relevant, complete,

neutral, and free from error

 Moral and social ethical behavior must be

considered while decision making

LO 8

Exhibit 1.9—Ethics and Accounting: A

Decision-Making Model

Sarbanes-Oxley Act

 An attempt to bring about major reforms in

corporate accountability and stewardship

 Most important provisions in the act:

 Establishment of the Public Company Accounting

Oversight Board

 Requirement that the external auditors report directly

to the company’s audit committee

 Clause to prohibit public accounting firms from

providing any other services that could impair their ability to act independently in the course of their audit

End of Chapter 1