Introduction 3 Forms of Business 1 Sole proprietorship o Owned by one person o Simple to establish o Owner controlled o Ex Barber shop 2 Partnership o Business owned by two or more people o One individual lacks economic resources o Broader skills and resources o Professional practices Ex Lawyers doctors CPA s 3 Corporation o Owned by stockholders o Separate legal entity from owners o Easier to transfer ownership o Easier to raise funds o No personal liability How will I raise funds 1 Debt Financing o Consists of borrowing funs from individuals or entities called creditors o Need to repay with interest o Rigid payment schedule o Interest paid is tax deductible 2 Equity Financing ownership stock dividends o Consists of raising funds through owner investment and selling shares of o No repayment is legally required though investors often receive o Dividends paid to investors are not tax deductible Regardless of what system you choose you need a system to capture results Accounting Accounting activities of a business and communicate these results to interested users the means by which we measure and describe the economic o Links decision makers with economic activities and with the results of decisions their Types of Accounting Information Managerial Accounting Financial accounting Examples of internal users o Management evaluating yourself Examples of external users used by people inside the company to make decisions used by outsiders to make decisions o Investors owners stockholders o Creditors lenders bankers o Other taxing authorities regulatory agencies customers competitors set of accounting reports that convey information to the evaluating other companies How Do We Get Information to the Outside Users Financial Statements outside users such as creditors and investors 4 Major Financial Statements o 1 Balance Sheet statement of Financial Positions o 2 Income Sheet statement of earnings o 3 Statement of Owner s Equity o 4 Statement of Cash Flows o FASB rules o SEC GAAP How Do You Decide to Invest Between Company A and B Compare the financial statements of both companies In order for comparison to be meaningful the statements must be prepared using the same methods concepts terminology etc Generally Accepted Accounting Principles GAAP concepts standards guidelines and conventions companies are supposed to follow when preparing financial statements Organizations Responsible for GAAP private sector organization that develop most of the accounting Doesn t have express authority to develop GAAP public sector organization that has express authority to develop SEC has allowed professionals FASB to form GAAP How Do Creditors Investors and Other Users Know That Companies Make Truthful Statements Independent auditors audit the statements every year Independent audits are required to safe guard investors and creditors from misleading statements Auditors must issue an audit report that will state if the statements are fair and comply with GAAP The independent audit report must accompany the financial statements Why are audits necessary Managers have incentive flexible methods to manipulate financial statements Reasons for this o To deceive investors and creditors o Management bonuses and compensation are tied to performance o Avoid violating debt covenants o Avoid higher tax liability Companies that are publicly traded are required to give an annual report Report includes o Financial statements and notes to these o Independent auditor s report o Management discussion and analysis management s report Notes to financial statements clarify financial statements and provide additional detail Auditor s report expresses auditor s opinion as to if the statements are true Management s report companies ability to pay debt and fund operation o Indicate positives and negatives Two sets of accounting standards that are in use o U S A GAAP o International Financial Reporting Standards IFRS issued by International Accounting Standards Board IASB IFRS is used in over 100 countries and here are some differences between GAAP and IFRS that currently exist o Want to remove all differences so they can merge IFRS and GAAP o Driven by the need to protect outside users o IFRS is a little bit more simple o Both IFRS and GAAP have a framework that underlies these principles making same principles shouldn t be hard Financial Statements Financial Statements financial information to outside users such as creditors and investors a set of accounting reports that convey economic and Types Balance Sheet statement of financial positions Income Statement Statement of Owner s Equity Statement of Cash Flows Balance Sheet shows o 1 The economic resources owned by a business assets o 2 The debts owed by a business liabilities o 3 The amount of owner s investment in the business equity o Snapshot specific point in time o These 3 things form Fundamental Accounting Equation Assets Liabilities Equity Assets 1 Current Assets assets that are expected to be either converted into cash or expire be used up in a year Ex o Cash represents the amounts owed to the company by the product the company sells to its customers items used in the normal course of business not the same as o Accounts Receivable its customers inventory Identify Current Assets o Inventory o Supplies 2 Long Term Assets assets that are expected to be used in business operations for longer than one year o Types Property Plant Equipment P P E Long term assets that have a physical substance touch feel see Ex Land buildings equipment o PPE is a decrease to long term assets Intangible Assets lack a physical substance Ex Trademark patent copyright Historical Cost Concept assets are shown on balance sheet at their cost not current value Liabilities debts owed by business Represents creditors claims against company s assets Current Liabilities expected to be paid within one year o Ex Accounts payable short term notes payable salaries payable income taxes payable utilities payable accrued liability debts paid in longer than one year Long term Liabilities o Ex Long term notes payable mortgage payable bonds payable Equity represents amount of owner investment For a corporation there are two types o 1 Contributed Capital investments made by owners into the business through the purchase of the organization s stock common stock o 2 Retained Earnings net income that is earned by the corporation that is kept within the company for growth and expansion rather than given to stockholders in