Chapter 1 Lecture 2 June 2nd Business organizations 1 Sole proprietorship 2 Partnership 3 Corporation Same as above Advantage easy to form Disadvantage unlimited liability Separate entity for accounting purposes economic entity NOT a separate entity for tax purposes a Sell shares of stocks to investors b Fully separate entity for both accounting and tax purposes i ii Advantage limited liability continuity of life can continue long past the death of operator ease of transfer of ownership opportunity to raise large capital through stock Disadvantage double taxation Types of business activities 1 Financing how a company pays for growth expansion a Borrowing liabilities b Selling ownership stocks 2 Investing purchasing resources assets to be used in day to day operations a Ex desks trucks other office supplies equipment 3 Operating activities that earn revenue and generate expenses a Profits retained earnings capital b NI net income Revenues Expenses 4 Accounting identify measure and communicate information about company useful in making informed business decisions Economic event used to create money portion of hiring Decision maker Standardized financial statements Transaction occurs event Accounting records I A Balance sheet shows financial position of the company A SINGLE POINT IN TIME Equation Assets Liabilities stockholders equity 1 Assets resources that will produce a future economic benefit held by a company 2 Liabilities debts owed to creditors suppliers employees customers a Ex supplies granted but not yet paid for borrowed money payments made by customer before product received employee paychecks 3 Equity financing provided by owners and operators of the company a Common stock investments made by owners b Retained earnings cumulative earnings of the company that have been retained reinvested not paid out by the company what has the company made since its beginning less what it has paid in dividend B Income statement shows result of the company s operations for a period of time Equation revenues Expenses Net income 1 Revenues inflow of assets cast accounts receivable as result of a Performing a service b Delivering a good product 2 Expenses resources used to generate revenue C Statement of retained earnings Shows how net income and dividends cause change in a company s financial position during a period of time Equation Beginning retained earnings net income dividends ending retained earnings Liabilities accounts payable balance sheet Assets accounts receivable cashm office equipment supplies balance sheet Expenses rent expenses insurance salary income statement Retained earnings beginning of year Income statement SRE D Statement of cash flows shows atual change in cash of a company for a period of time Equation Cash flows from operating activities Cash flows from operating activities Cash flows from financing activities Net increase decrease Cash at beginning of the period Cash at the end of the period Financial statements linked together in order Income statement Statement of retained earnings Balance sheet Statement of cash flows Chapter 2 Lecture 2 June 3rd The Conceptual Framework A Basic Objective of Financial Reporting To provide economic information about a company that is useful in making an informed decision Decision makers are expected to have a reasonable understanding of accounting concepts An Informed Decision means the investor creditor supplier wants to be able to analyze the financial statements to determine the amounts timing and uncertainty of future cash flows B Underlying assumptions of accounting help the decision maker to understand what accounting information reports as well as inherent limitations 1 Economic entity business transactions are separate from the personal transactions of the owners 2 Going Concern company will continue to operate into the foreseeable future without forced liquidation 3 Monetary Unit all information will be measured in its national currency 4 Time Period Assumption The long life of a company can be reported over a series of shorter time periods 5 Cost principle assets are recorded original cost what we paid for them C In order for the information to be useful relevant reliable it should have the following Qualitative Characteristics p 56 1 Understandability info should be comprehensible to those who are willing to spend the time to understand it 2 Relevance Information makes a difference in decision making 3 Faithful Representation complete neutral free from error 4 Comparability between companies similar methods have been applied apples to apples oranges to oranges disclosure of what methods have been used 5 Consistency between accounting periods within the same company 6 Materiality The size of the transaction makes a difference in how it gets recorded 7 Conservatism Never want to overstate Assets or Revenues or understate Liabilities or Expenses Expensing Not balance sheet note made Pg 56 Objectives and qualitative characteristics of financial reporting are not the same for ISAB and FASB Financial statement content the rules To understand financial statements users must understand the measurement rules used to report them Generally Accepted Accounting Principles GAAP a common set of Rules used to prepare and report financial information in U S financial statements Who makes these rules A For U S Companies 1 Financial Accounting Standards Board FASB private sector body given responsibility to develop GAAP responsible for creating rules 2 Securities Exchange Commission SEC federal government agency that has broad powers to prescribe accounting practices and standards to public companies that trade securities on the major exchanges NYSE NASDAQ The SEC can influence or override any FASB ruling Does NOT create rules Are tasked with regulating the rules Has the power to override influence rules procedures of FASB ruling Federal agency Powers to prescribe accounting standards practices Do not confuse who is in charge of making rules procedures and who is in charge of enforcing influencing and prescribing them 3 American Institute of Certified Public Accountants AICPA professional organization of certified public accountants professional organization for certified accountants B For Non U S Companies International Accounting Standards Board IASB working towards a convergence of International Financial Reporting Standards IFRS GAAP Global Differences in Accounting Standards some IFRS Principles differ from GAAP Examples 1