Financial Accounting Exam 1 ReviewChapter 1: Introduction to Financial Statements• Primary forms of business organizationo Sole proprietorship: a business owned by one person Simple to establish Owner controls Tax advantages, favorable tax treatmento Partnership: a business owned by two or more persons associated as partners Simple to establish Shared control Broader skills and resources, often formed because one person does not have enough economic resources Tax advantages, more favorable tax treatmento Corporation: a business organized as a separate legal entity having ownership divided into transferable shares of stock Easier to transfer ownership Easier to raise funds, rely on investors who share stock (they become stockholders) No personal liability• Users and uses of financial informationo Accounting: the information system that identifies, records, and communicates the economic events of an organization to interested users.o Users Internal users: managers who plan, organize, and run a business; examples are marketing managers, production supervisors, finance directors, and company officers• Finance: Is cash sufficient to pay dividends to stockholders?• Marketing: What price for a product will maximize the company’s net income?• Human resources: Can we afford to give employees pay raises this year?• Management: Which product line is the most profitable? Should any product lines be eliminated? External users• Investors: use accounting information to make decisions to buy, hold or sell stock• Creditors: suppliers and bankers use accounting information to evaluate the risks of selling on credit or lending money• Tax authorities: want to know whether the company complies with the tax law; example IRS• Customers: interested in whether the company will continue to honor product warranties and otherwise support its product lines• Labor Unions: want to know whether the owners have the ability to pay increased wages and benefits• Regulatory agencies: want to know whether the company is operating within prescribed rules; example SEC or Federal Trade Commissiono Ethics Sarbanes-Oxley Act: regulations passes by Congress in 2002 to try to reduce unethical corporation behavior• Top management must now certify the accuracy of financial information• Penalties for fraudulent financial activity are more severe• Increased independence of the outside auditors who review the accuracy of corporate financial statements• Increased oversight role of boards of directors Solving ethical dilemmasFinancial Accounting Exam 1 Review• Recognize an ethical situation and the ethical issues involved• Identify and analyze the principal elements in the situation: what are the responsibilities and obligations of the parties involved?• Identify the alternatives, and weigh the impact of each alternative on various stakeholders (who may be harmed or benefited)• Three principal types of business activityo Financing activities: it takes money to make money, sources are borrowing money and issuing shares of stock Creditors: persons or entities to who a company owes money Liabilities: the debts and obligations of a business, it represents the amounts owed to creditors• Note payable: given to the bank for money borrowed to purchase something• Bonds payable debt securities sold to investors that must be repaid at a particular date some years in the future Common stock: term used to describe the total paid in by stockholders for the shares they purchase• If you loan money to a company, you are one of its creditors, you specify a payment schedule and have the legal right to be paid at an agreeable time. In the case of financial difficulties, creditor claims must be paid before stockholders’ claims Dividends: payments of cash from a corporation to its stockholderso Investing activities: involve the purchase of the resources a company needs in order to operate Assets: resources owned by a business, like computers, delivery trucks, furniture, and buildings• Property, plant, and equipment; called fixed assets Cash, if a company has excess cash is may chose to invest in securities (stocks or bonds) of other corporations (this is an investment)o Operating activities Revenues: the increase in assets that results from the sale of a product or service in the normal course of business• Sales revenue• Service revenue• Interest revenue• Inventory: goods available for future sales to customers ARE ASSETS• Account receivable: if a good is sold to a customer and does not receive money immediately, then the company has the right to expect payment in the near future Expenses: necessary to produce and sell products, the cost of assets consumed or services used in the process of generating revenues• Cost of goods sold• Selling expenses: salaries of employees• Marketing expenses: advertising• Administrative expenses: salaries of administrative staff• Interest expense: amount of interest paid on various debts• Income taxes: corporate taxes paid to government Liabilities: accounts payable, interest payable, wages payable, sales taxes payable, property taxes payable, income taxes payable Net income: the amount by which revenues exceed expenses revenues− expenses=net income Net loss: the amount by with expenses exceed revenues• Financial statements (are used to communicate with users)o Comparative statement: financial statements of a company for more than one yearFinancial Accounting Exam 1 Review The percentage change from one year to the next is changeduring periodpreviousvalue The percentage change in income is change∈incomeprevious years incmeo Annual report: presents financial information including financial statements, notes, a management discussion, and analysis section, and an independent auditor’s report Management discussion and analysis: management’s views on the company’s ability to pay near-term obligations Notes to the financial statements: clarify and expand upon information Auditor’s reports: report by an independent outside auditor stating their opinion as to the fairness of the presentation• Certified Public Accountant: an individual who has met certain criteria and is thus allowed to perform audits of corporationso Balance sheets: reports assets and claims to those assets at a specific point in time, it is what your business owns and
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