Chapter 1 Introduction to Financial Statements Forms of a Business Organization 3 choices sole proprietorship partnership or corporation Sole proprietorship a business owned by one person o Simple to set up o Gives you control over the business o Ex small owner operated businesses such as barber ships law offices farms small retail stores and auto repair shops Partnership a business owned by two or more persons associated as partners o Usually formed because one individual doesn t have enough economic resources to initiate or expand the business o Sometimes partners bring unique skills or resources to the partnership o Ex retail and service type businesses including professional practices lawyers doctors cpas architects Corporation a business organized as a separate legal entity owned by stockholders o As an investor in a corporation you receive shares of stock to indicate your ownership claim o Buying a stock in a corporation is often more attractive than investing in a partnership because shares of stock are easy to sell transfer ownership Selling a proprietorship or partnership is much more involved Individuals can become stockholders by investing relatively small amounts of Therefore it s easier for corporations to raise funds Other factors to consider in deciding which organizational form to choose are taxes and legal liability If you choose a sole proprietorship or partnership you generally receive more o favorable tax treatment than a corporation However proprietors and partners are personally liable for all debts of the o money In other words corporate stock holders generally pay higher taxes buy business corporate stockholders are not have no personal liability Sole Proprietorship Partnership Simple to establish Owner controlled Tax advantages Simple to establish Shared control Broader skills and resources Tax advantages Corporation Easier to transfer ownership Easier to raise funds No personal liability Users and Uses of Financial Information The purpose of financial accounting is to provide inputs for decision making Accounting the information system that identifies records and communicates the economic events of an organization to interested users o Users of accounting information can be divided broadly into 2 groups internal users and external users INTERNAL USERS Internal users of accounting information are managers who plan organize and run a business o These include marketing managers production supervisors finance directors and company officers For internal users accounting provides internal reports such as financial comparisons of operating alternatives projections of income from new sales campaigns and forecasts of cash needs for the next year In addition companies present summarized financial information in the form of o financial statements EXTERNAL USERS Investors owners use accounting information to make decisions to buy hold or sell stock Creditors such as suppliers and bankers use accounting information to evaluate the risks of selling on credit or lending money Taxing authorities such as the IRS want to know whether the company complies with the tax laws Customers are interested in whether a company will continue to honor product warranties and otherwise support to its product lines Labor unions want to know whether the owners have the ability to pay increased wages and benefits Regulatory agencies such as the SEC or the FTC want to know whether the company is operating within prescribed rules ETHICS IN FINANCIAL REPORTING In 2002 Congress passed the Sarbanes Oxley Act SOX to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals o Now top management must certify the accuracy of financial information In addition penalties for fraudulent financial activity is more severe Also SOX increased the independence of the outside auditors who review the accuracy of corporate financial statements and increased the oversight role of boards of directors Business Activities All businesses are involved in 3 types of activity financing investing and operating o Financing can come from personal savings and outside sources like banks o You invest the cash in equipment to run the business such as mixing equipment and delivery vehicles o Once the equipment Is in place you can begin the operating activities FINANCING ACTIVITES The 2 primary sources of outside funds for corporations are borrowing money and issuing selling shares of stock in exchange for cash Persons or entities to whom Tootsie Roll owes money are called creditors Amounts owed to creditors in the form of debt and other obligations are called liabilities o There are 2 types of liabilities depending on their source A note payable to a bank for the money borrowed to purchase delivery trucks for ex Debt securities sold to investors that much be repaid at a particular date some years in the future are bonds payable A corporation may also obtain funds by selling shares of stock to investors o Common stock is the term used to describe the total amount paid in by stockholders for the shares they purchase The claims of creditors differ from those of stockholders If you loan money to a company you are one of its creditors In lending money you specify a payment schedule You have a legal right to be paid at the agreed time In the even of non payment you may legally force the company to sell property to pay its debts In the case of financial difficulty creditor claims must be paid before stockholders claims Stockholders have no claim to corporate cash until the claims of creditors are satisfied Many corporations make payments to stockholders on a regular basis as long as there is sufficient cash to cover required payments called dividends INVESTING ACTIVITIES Once the company has reased cash through financing activities it will then use that cash in investing activities Investing activities involve the purchase of the resources a company needs in o order to operate Resources owned by a business are called assets o Different types of assets are given different names property plant and equipment Cash is one of the more important assets owned by a business If a company has excess cash that it doesn t need for a while it might choose to invest in securities stock or bonds of other corporations Investments are another example of an investing activity OPERATING ACTIVITIES Once a company has the assets needed it can begin its operations Amounts earned on the sale of products is called
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