Chapter 1 Accounting In Action 1 What Is Accounting organizations a The financial information system that provides insight into what is happening financially in i Consists of three basic activities Identifying Recording and Communicating 1 Identifying Company selects the economic events relevant to its business 2 Recording Write down events in order to provide a history of financial activities a Keep a systematic chronological diary of events measured in dollars and cents b Bookkeeping Usually involves only the recording of economic events 3 Communicating Relay the communicated information to interested users by developing an accounting report standardized way a One type of accounting report is a financial statement Report the data in a b In the aggregate Accumulating all sales transactions over a certain period of time and reporting the data as one amount in the company s financial statement ii Important to be able to analyze interpret data in order to perform the basic activities 2 Who Uses Accounting Data a Internal Users Those inside a company who plan organize and run the business i Include marketing managers production supervisors finance directors and company officers ii Answer questions such as 1 Is cash sufficient to pay dividends to stockholders 2 What price will maximize the company s net income 3 Can we afford to give employees a raise this year 4 Which product line is most profitable Should any lines be eliminated iii Managerial Accounting Provides internal reports to help users make decisions about their b External Users Individuals and organizations outside a company who want financial information about companies the company i Investors Owners who use accounting information to make decisions to buy hold or sell ownership shares of a company 1 Is the company earning a satisfactory income 2 How does one company compare in size and profitability with another company ii Creditors Suppliers bankers evaluate the risks of granting credit or lending money 1 Will company be able to pay it s debts when they arrive iii Financial Accounting Provides economic and financial information for investors creditors and other external users 1 Taxing Authorities IRS Is the company complying with tax laws 2 Regulatory Agencies SEC FTC is company operating with the rules 3 Labor Unions Can owners pay increased wages benefits 3 Ethics in Financial Reporting a Sarbanes Oxley Act of 2002 Intent is to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals i As a result top management must certify the accuracy of financial information b Ethics Standards of conduct by which one s actions are judged as right or wrong honest or dishonest fair or not fair 4 Generally Accepted Accounting Principles GAAP Common set of standards that indicate how to report economic events these are generally accepted and universally practiced a Who determines GAAP guidelines i Securities Exchange Commission SEC Agency of the U S government that oversees U S financial markets and accounting standard setting bodies ii Public Company Accounting Oversight Board PCAOB Determines auditing standards and reviews auditing firms the U S iii Financial Accounting Standards Board FASB Primary accounting standard setting body in iv International Accounting Standards Board IASB Issues international financial reporting standards that have been adopted by many countries outside of the U S b Measurement Principles i Cost Principle Companies record assets at their cost 1 Example If Best Buy purchases land for 30 000 the company needs to report it as 30 000 even if the fair value of land increases within a year 2 Most assets must follow this principle b c market values are not representationally ii Fair Value Principle Assets and liabilities should be reported at fair value or the price received faithful to sell an asset or settle a liability 1 Use in situations where assets are actively traded such as investment securities iii In order to determine which principle to follow check for 1 Relevance Is financial information capable of making a difference 2 Faithful Representation Do the numbers and descriptions match what really existed or 5 Assumptions happened a Monetary Unit Assumption Requires that companies include in the accounting records only transaction data that can be expressed in money terms b Economic Entity Assumption Requires that the activities of the entity be kept separate from the activities of its owner all other economic entities i Keep personal living costs separate from costs of company 6 Forms of Business Types of Ownership a Proprietorship A business owned by one person i Usually only a relatively small amount of capital is necessary to start the business ii Owner receives any profits suffers any losses and is personally liable for all debts of the b Partnership Business owned by two or more persons associated as partners i Maintains unlimited liability for debts of the partnership ii Partnership transactions must be kept separate from the personal activities of the partners c Corporation A business organized as a separate legal entity under state corporation law and having ownership divided into transferable shares of stock i Stockholders enjoy limited liability may transfer their shares to other investors at any time ii Enjoys an unlimited life business 7 Basic Accounting Equation Assets Liability Stockholder s Equity a Assets The resources a business owns and uses to carry out production and sales events i Have the capacity to provide future services or benefits b Liabilities Claims against assets existing debts and obligations All people and entities that companies owe money to are called creditors i Businesses usually borrow money and purchase merchandise on credit resulting in payables 1 Accounts Payable Purchasing items on credit from supplier 2 Notes Payable Loans and money borrowed from the bank 3 Wages Payable To employees 4 Sales and Real Estate Taxes Payable To the government ii Creditors can legally force the liquidation of a business that does not pay its debts c Stockholder s Equity Total claim on assets total assets total liabilities Common Stock Retained Earnings equity i Common Stock Total amount paid by stockholders for the shares they purchase increases ii Retained Earnings Determined by revenues expenses and dividends 1 Revenues Increases in stockholder s equity resulting from business activities entered into for the purpose of earning income Result from
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