Accounting as a Form of Communication in Business

1. Chapter 1 Accounting as a Form of Communication

2. What is Business? Consists of activities necessary to provide members of society with goods and services LO 1

3. Exhibit 1.1—Types of Businesses

4. Exhibit 1.2—Forms of Organization LO 2

5. Business Entities • An organization operated to earn a profit • Sole Proprietorships: organization with a single owner • Partnerships: business owned by two or more individuals • Often used by accounting firms and law firms • Corporations: entity organized under the laws of a particular state • Ownership evidenced by shares of stock

6. Nonbusiness Entities Organization operated for some purpose other than to earn a profit Do not have an identifiable owner

7. Organizations and Social Responsibility U.S. business entities recognize the societal aspects of their overall mission and have established programs to meet these responsibilities

8. Nature of Business Activity Financing Activities Investing Activities Operating Activities • Borrowing • Sale of stock • Purchase and sale of assets • Sale of products/services • Costs incurred to operate business • Businesses engage in three types of activities: LO 3

9. Exhibit 1.3—A Model of Business Activities

10. What is Accounting? • Various Users • Management • Stockholders • Creditors • Financial analysts • Government Economic Information Identifying Measuring Communicating LO 4

11. Users of Accounting Information and Their Needs • Internal Users: • Primarily the managers of a company • Involved in the daily affairs of the business • External Users: • Not directly involved in the operations of a business • Need information that differs from that needed by internal users • Outsiders must rely on the information presented by the company’s management

12. Management Accounting and Financial Accounting • Management accounting • Branch of accounting concerned with providing management with information to facilitate planning and control • Financial accounting • Branch of accounting concerned with the preparation of financial statements for outsider use

13. Exhibit 1.4—Users of Accounting Information

14. Financial Decision Framework Formulate the question Gather information from the financial statements and other sources Analyze the information gathered Make the decision Monitor your decision

15. The Accounting Equation Assets = Liabilities + Owners’ Equity Left side: valuable economic resources and that will provide future benefit to the company Right side: indicates who provided, or has a claim to, the assets Stockholders’ equity or shareholders’ equity: used to refer to the owners’ equity of a corporation LO 5

16. Source of Stockholders’ Equity • Created when a company issues stock to an investor • Retained earnings • Earnings accumulated or retained by the company • Part of owners’ equity that represents the income earned less dividends paid over the life of an entity

17. The Balance Sheet Financial statement that summarizes the assets, liabilities, and owners’ equity at a specific point in time At any point in time, assets must equal liabilities and owners’ equity

18. Example 1.4—Preparing a Balance Sheet

19. The Income Statement Summarizes the revenues and expenses of a company for a period of time

20. EXHIBIT 1.5—The Relationship Between the Accounting Equation and the Balance Sheet

21. Example 1.5—Preparing an Income Statement

22. The Statement of Retained Earnings Summarizes the income earned and dividends paid over the life of a business Dividends: Distribution of the net income of a business to its owners

23. Example 1.6—Preparing a Statement of Retained Earnings

24. The Statement of Cash Flows Summarizes a company’s cash receipts and cash payments during the period from operating, investing, and financing activities

25. Example 1.7—Preparing a Statement of Cash Flows

26. Exhibit 1.6—Relationships Among the Financial Statements

27. Financial Statement Assumptions Economic Entity Concept Cost Principle Time Period Assumption Going Concern Monetary Unit LO 6

28. Economic Entity Concept Single, identifiable unit must be accounted for in all situations Specific entity be the subject of a set of financial statements Does not intermingle the personal assets and liabilities of the employees or any of the other stockholders

29. Cost Principle • Assets are recorded at the cost to acquire them • Original cost or historical cost—until the company disposes them • More objective than market value

30. Going Concern Assume an entity is not in the process of liquidation and that it will continue indefinitely Justifies use of historical cost

31. Monetary Unit • Yardstick used to measure amounts in financial statements • Example: U.S. dollar, Japanese yen, Mexican peso, etc. • Assumes monetary unit is relatively stable; no adjustment for inflation made in financial statements

32. Time Period Assumption Artificial segment on the calendar used as the basis for preparing financial statements Accountants assume that it is possible to prepare an income statement that accurately reflects net income or earnings for a specific time period

33. Setting Accounting Standards • Generally accepted accounting principles (GAAP) • Various methods, rules, practices, and other procedures—preparing financial statements • Securities and Exchange Commission (SEC) • Federal agency with ultimate authority to determine the rules for preparing statements • Financial Accounting Standards Board (FASB) • Authority to set accounting standards LO 7

34. Setting Accounting Standards (continued) • American Institute of Certified Public Accountants (AICPA) • Professional organization of Certified Public Accountants (CPA) • Public Company Accounting Oversight Board (PCAOB) • Five-member body created by an act of Congress in 2002 to set auditing standards • International Accounting Standards Board (IASB) • Develop worldwide accounting standards

35. Audit of Financial Statements • Most stockholders are not actively involved in the daily affairs of the business • Auditing: examining whether financial statements are fairly presented • External auditor performs various tests and procedures and render his opinion • Auditors’ report is an opinion, not a statement of fact

36. Ethics in Accounting Ethics plays a critical role in providing useful financial information Investors and other users must have confidence in a company, its accountants, and its outside auditors that the information presented in financial statements is relevant, complete, neutral, and free from error Moral and social ethical behavior must be considered while decision making LO 8

37. Exhibit 1.9—Ethics and Accounting: A Decision-Making Model

38. Sarbanes-Oxley Act • An attempt to bring about major reforms in corporate accountability and stewardship • Most important provisions in the act: • Establishment of the Public Company Accounting Oversight Board • Requirement that the external auditors report directly to the company’s audit committee • Clause to prohibit public accounting firms from providing any other services that could impair their ability to act independently in the course of their audit

39. End of Chapter 1