Chapter 1 The Financial Statements Financial statements business documents that companies use to report the results of their activities to groups like managers investors creditors and regulatory agencies o Measures business activities processes data into reports and communicates results to Financial statements measure performance and shows where a business is financially Accounting is the Language of Business Accounting an information system decision makers Produces financial statements o o Bookkeeping is the mechanical part of accounting Who uses accounting information Individuals to make decisions on renting buying budgeting etc Investors creditors to decide how much income to invest and how when a company will pay them back Regulatory bodies businesses are required to pay taxes to the body SEC requires companies whose stock is traded publicly to release statements periodically Nonprofit organizations base operating decisions on statements Financial vs Managerial Financial accounting provides info for decision makers outside of the company Managerial accounting provides info for decision makers inside the company managers o Kept separate for confidentiality reasons Organizing a business Proprietorship 1 owner o Accepts all liability personally o In accounting a proprietorship is separate from owner Partnership 2 owners o General partnership all general partners are personally liable risky o Limited liability partnership only the general partner is liable Limited partners are only liable up to his her investment plus their proportionate share of liabilities o Partnership doesn t pay taxes it flows through each owner Limited liability Company LLC members o Members are not liable the LLC is o Members pay tax at their rate for income LLC not taxed Corporation stockholders shareholders o o o o Stockholders not liable Corporation is separate entity with many rights Formed under state law Corp pays taxes shareholders pay taxes double taxation of distributed profits Shareholders are taxed on their dividends o Stockholders elect board of directors CEO COO CFO Underlying Accounting Concepts Generally accepted accounting principals GAAP guidelines for measurement and disclosure of financial information o Formulated by the financial accounting standards board FASB International accounting standards board sets International financial reporting standards IFRS Fundamental qualitative characteristics o Relevance Must be capable of making a difference to decision maker Must be material important enough to user so that if it were omitted it would make a difference to users decisions Only info that is material needs to be separately disclosed discussed in statements Faithful representation o Info must be complete free from bias and without material error Must focus on economic substance of transaction event etc Makes info reliable Enhancing qualitative characteristics o Comparability Must be capable of being compared with info from another company in the same Must be consistent with similar info for that company from previous periods Info is capable of being checked for accuracy completeness and reliability Verifying info is done by auditors Enhances reliability period o Verifiability o Timeliness Must be made available to users early enough to make decisions o Understandability Transparent so it makes sense and can reasonably inform users o Constrains Cost Management must weigh costs Cost of disclosure should not exceed expected benefit to users The Entity Assumption Entity any organization that stands apart as a separate economic unit Most basic accounting assumption Managers need accounting information for each entity division in the company The Continuity Going Concern Assumption Going concern assumption Assume the entity will exist long enough to use all existing assets for its intended purposes o Should stay in long enough to recover the cost of assets by allocation that cost through depreciation to business operations over the assets economic lives o Most relevant measure of the value of assets is their current fair market value amount the Opposite quitting concern company would receive is assets were sold The Historic Cost Principal Historic cost principal assets should be recorded at their actual cost measured on the date of the purchase o amount of cash paid plus the dollar value of all non cash consideration given in exchange privileges rights etc Holds value of assets at measured price for as long as the business holds asset same with continuity Historic cost is most relevant verifiable faithful representation of its carrying value Is asset is later sold at different price the new value is established Fair value amount the business could sell the asset for or amount business could pay to settle liability IFRS are more liberal with fair values than GAAP The Stable Monetary Unit Assumption Stable Monetary Unit Assumption assume the dollars purchasing power will be stable over time o Done so that each years statements will not have to be converted to new dollar amount Inflation rise in general price level SEC has announced plan to adopt some version of IFRS in 2015 GAAP will probably be used where IFRS is vague IFRS Most common accounting principals are same for both IFRS allows for more flexibility and professional judgment o Allows fair value approach The Accounting Equation Assets Liability Assets Liability Owners Equity Liability Assets Owners equity Owners equity Assets Liability o o Ex inventory Assets economic resources that are expected to produce a benefit in the future Cash liquid assets that are the medium of exchange Fixed assets long lived assets the company uses to do business Ex property plant equipment Liability outside claim debts payable to outsiders creditors o Payables always liability Ex accounts payable taxes payable Accounts payable are typically paid within year or operating cycle o Long term debt liability payable beyond a year Current portion of long term debt is amount due within next year and must be disclosed separately Owners Equity capital stockholders equity Insider claims ownership interest in the assets of corp o Paid in capital amount stockholders have invested Basic component common stock corp gives to stockholders for prof of ownership Every corp has common stock o Retained earnings amount earned by income producing activities and kept for business Major types to affect earnings revenues expenses dividends Revenue inflows of resources that increase