Chapter 1 H S Notes Financial accounting is the communication of information about a business or other type of organization such as a charity or government so that individuals can assess its financial health and future prospects The information reported by financial accounting is similar to a giant complex portrait painted of the organization Managerial accounting is the communication of financial information within an organization so internal decisions can be made in an appropriate manner In the United States as well as in many other countries owners of a business can apply to the state government to become identified as an entity legally set apart from its owners This process is referred to as incorporation A corporation is an organization that has been formally recognized by the state government as a separate legal entity that can act independently of its owners Ex Walt Disney Co or GE A business that has not been incorporated is either a sole proprietorship one owner or a partnership more than one owner A corporation has the ability to obtain monetary resources by selling also known as issuing capital shares that allow investors to become owners They are then known as stockholders or shareholders Equity ownership shares or capital stock In a vast number of such organizations stockholders vote to elect a representative group to oversee operations This body called the board of directors is made up of approximately ten to twenty five knowledgeable individuals A dividend is a reward for being an owner of a business that is prospering It is not a required payment it is a sharing of profits with the stockholders Unless an owner has the chance to influence or control the operations of a business only these two potential benefits can accrue from the ownership of capital shares appreciation in the value of the stock price and cash dividends Ultimately in connection with the buying and selling of capital stock all investors are trying to arrive at the same two insights They are attempting to use the provided financial accounting data to estimate the following 1 The price of the corporation s capital stock in the future 2 The amount of cash dividends that will be paid over time by the business Millions of individuals and groups use reported financial information to assess business organizations in order to make three predictions 3 Future stock market prices for the capital shares issued by the business 4 Future cash dividend distributions 5 Future ability to generate sufficient cash to meet debts as they mature Financial information reported by and about an organization consists of data that can be measured in monetary terms Although financial accounting starts by reporting balances as monetary amounts the communication process does not stop there Extensive verbal explanations as well as additional numerical data are also provided to clarify or expand the monetary information where necessary Thus accounting actually communicates to decision makers in two distinct steps 1 Financial information is provided in monetary terms 2 Further explanation is given to clarify and expand on those monetary balances 5 MOST IMPORTANT THINGS 1 Financial accountants paint a picture of an organization 2 Financial accounting information is primarily for the benefit of external parties 3 Investors decide whether to buy or sell ownership shares creditors decide whether to loan money or give credit 4 Outsiders want to predict stock prices dividend payments and cash flows for debt 5 Financial Accounting is the conveyance of financial information for decision payments making purposes TAKEAWAYS 1 Financial accounting encompasses the rules and procedures covering the 2 conveyance of monetary information to describe a business or other organization Individuals who attain a sufficient level of knowledge of financial accounting can then utilize this information to make decisions based on the organization s perceived financial health and future prospects Such decisions might include assessing employment potential lending money granting credit and buying or selling ownership shares However financial accounting does not address issues that are purely of an internal nature such as whether an organization should buy or lease equipment or the level of pay raises Information to guide such internal decisions is generated according to managerial accounting rules and procedures that are introduced in other books and courses Although financial accounting is not directed toward the inner workings of an organization most employees are interested in the resulting information because it helps them assess the future of their employer Incorporation allows an organization to be viewed legally as a separate entity apart from its ownership In most large corporations few owners are able to be involved in the operational decision making Instead stockholders elect a board of directors to oversee the business and direct the work of management Corporations can issue shares of capital stock that give the holder an ownership right and enables the business to raise monetary funds If the organization is financially healthy and prospering these shares can increase in value over time possibly by a significant amount In addition a profitable organization may well share its good fortune with its ownership through the distribution of cash dividends Investors often attempt to estimate the annual rate of return that can be expected from an investment as a way of comparing it to other investment alternatives This computation takes the profit for the year stock appreciation and dividends and divides it by the amount of the investment at the start of the period 3 Throughout the world each day investors buy and sell the capital stock shares of thousands of businesses Other individuals choose to loan money or grant credit to these same organizations Such decisions are based on assessing potential risks and rewards Financial accounting provides information to these decision makers to help them evaluate the possibility of capital stock price appreciation cash dividend distributions and the business s ability to generate cash to meet obligations as they come due This information is financial in nature meaning that it is stated in monetary terms However numerical data alone is of limited value Thus financial accounting provides monetary balances as well as clarifying verbal explanations to assist users in assessing the financial health and future prospects of