Chapter 1 Accounting in Action Pgs 2 16 To be good at business you have to know the numbers cold What is accounting Accounting consists of three basic activities it identifies records and communicates the economic events of an Bookkeeping Involves only the recording of economic events Just one part of the accounting process organization to interested users Who uses accounting data Internal users Managers who plan organize and run the business They use managerial accounting to make important decisions to help run a business It provides internal reports to help users make decisions about their companies Ex Financial comparisons of operating alternatives projections of income from new sales campaigns and forecasts of cash needs for the next year External users individuals and organizations outside a company who want financial information about the company Two most common types of external users are investors and creditors They use financial accounting to make important decisions as to how to invest credit Generally Accepted Accounting Principles GAPP GAPP is a common set of standards used to indicate how to report economic events Many countries outside of US use the International Accounting Standards Board IASB as a reference They developed standards called International Financial Reporting Standards Measurement Principles Convergence the attempt to increase comparability reduce the differences between the U S GAAP and IFRS Typically use two measurement principles cost principle or the fair value principle Cost Principle dictates that companies record assets at their cost what you paid for it is how much of an Fair Value Principle states that assets and liabilities should be reported at fair value the price received to asset it is sell an asset or settle a liability Assumptions economic entity assumption Provide a foundation for accounting process Two main assumptions are the monetary unit assumption and the Monetary unit assumption Requires that companies include in the accounting records only transaction data that can be expressed in money terms Allows accounting to quantify economic events Downside is it leaves out lots of important non monetary information like health of CEO morale of employees etc Economic Entity Assumption Requires that the activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities In other words you cannot combine the information of entities and other personal activities or companies An economic entity can be any organization or unit in society Business Formations Proprietorship A business owned by one person Usually small business and the owner is the owner operator Usually only a small amount of money is necessary to have a proprietorship The owner proprietor receives any profits suffers any losses and is personally liable for all debts of the business No legal distinction between teh business as an economic unit and the owner Accounting records are separate Partnership A business owned by two or more persons associated as partners Like a proprietorship but with more people Like a proprietorship for accounting purposes the partnership transactions must be kept separate from the personal activities of the partners Corporation A business organized as a separate legal entity under state corporation law and having ownership divided into transferable shares of stock Stockholders enjoy limited liability and can transfer ownership of shares to other investors at any time Revenue produced is 8x greater than a proprietorship and partnerships Basic Accounting Equation Assets Resources a business owns The common characteristic possessed by all assets is the capacity to provide future services or benefits Includes trucks tables etc Can also be the right for someone to owe you Liabilities Claims of those to whom the company owes money Claims against assets existing debts and obligations Accounts payable note payable salaries and wages payable sales and real estate taxes payable 1 Stockholders equity total assets total liabilities Stockholders Equity Claims of owners The ownership claim on total assets Residual Equity The equity left over after creditors claims have been satisfied Assets Liabilities Stockholders equity Applies to all economic entities regardless of size Stockholders equity section of a corporation s balance sheet generally consists of Common Stock term used to describe the total amount paid in by stockholders for the shares they Retained Earnings determined by 3 items revenues expenses and retained earnings purchase Corporation can obtain funds by selling shares of stock to investors Revenues the gross increases in stockholders equity resulting from business activities entered into for the purpose of earning income Usually result from selling merchandise performing services renting property and lending income They are decreases in stockholders equity that result from operating the business Expenses the cost of the assets consumed or services used in the process of earning revenue Dividends The distribution for cash or other assets to stockholders Dividends reduce retained earnings but are not an expense If a corporation realizes that they have a net income and has no better use for it they can distribute a dividend to its stockholders Using the Accounting Equation Transactions a businesses economic events recorded by accountants Can be internal or external External Transactions economic events between the company and some outside enterprise Internal Transactions economic events that occur entirely within one company Some activities that do not represent business transactions include hiring employees answering the telephone and How to determine if the transaction will be recorded If the financial position assets liabilities or stockholders equity Each transaction must have a dual effect on the accounting equation if an asset is increased there must be a corresponding 1 decrease in another asset 2 increase in a specific liability or 3 increase in stockholders equity placing merchandise orders is changed you must record it Transaction Analysis Expanded accounting equation Investments made by stockholders do not represent revenues and they are excluded in determining net income Must indicate if it is an increase is an investment rather than revenue from operations Accounts Receivable Willingness to pay a company in the future Dividends are not expenses They are excluded in determining net income