1. 1 Uses of Accounting Information and the Financial Statements
C H A P T E R
Financial and Managerial Accounting
10e
Needles
Powers
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2. Concepts Underlying Accounting Measurement
Accounting is an information system that measures, processes, and communicates financial information about a business or other economic entity.
An economic entity is a unit that exists independently, such as a business, hospital, or governmental body.
Bookkeeping is the process of recording financial transactions and keeping financial records. It is mechanical and repetitive and is usually handled by computers.
Management information systems (MIS) consist of the interconnected business subsystems, including accounting, that provide the information needed to run a business.
For accounting purposes, a business organization is a separate entity, distinct not only from its creditors and customers but also from its owners.
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3. Financial and Managerial Accounting
Accounting is usually divided into financial accounting and managerial accounting.
Internal decision makers use information provided by managerial accounting about operating, investing, and financing activities.
It provides managers and employees with information about how they have done in the past and what they can expect in the future.
External decision makers use financial accounting to evaluate how well a business has achieved its goals.
These reports, called financial statements, are a central feature of accounting. They report on a business’s financial performance.
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4. Business Transactions
Business transactions are economic events that affect a business’s financial position.
All business transactions are recorded in terms of money. This concept is called money measure.
In international transactions, exchange rates must be used to translate from one currency to another. An exchange rate is the value of one currency in terms of another.
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5. Forms of Business Organization
There are three basic forms of business organization that are recognized as separate entities.
Sole proprietorship—a business owned by 1 person
The owner takes all the profits or losses of the business and is liable for all its obligations.
Partnership—a business that has 2 or more owners
The partners share the profits or losses according to a prearranged formula.
Corporation—a business unit chartered by the state and legally separate from its owners
The owners, called stockholders, have limited liability—their risk of loss is limited to the amount they paid for their shares.
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6. Formation and Organization of a Corporation
To form a corporation, most states require incorporators to sign an application and file it with the proper state official.
This application contains the articles of incorporation, which form the company charter.
The authority to manage a corporation is delegated by its stockholders to a board of directors and by the board of directors to the corporation’s officers, as shown below.
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7. A unit of ownership in a corporation is called a share of stock.
Stockholders
A unit of ownership in a corporation is called a share of stock.
The articles of incorporation state the maximum number of shares that a corporation is authorized to issue.
The number of shares held by stockholders is the outstanding stock.
To invest in a corporation, a stockholder transfers cash or other resources to the corporation and receives shares of stock in return.
Corporations may have more than one kind of stock, but here we refer only to common stock.
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8. Board of Directors
A corporation’s board of directors decides on major business policies, authorizes contracts, sets executive salaries, and arranges major loans with banks.
The oversight of a corporation’s management and ethics by its board of directors is known as corporate governance.
To strengthen corporate governance, the Sarbanes-Oxley Act requires boards of directors to establish an audit committee made up of the independent directors (those directors who do not directly participate in managing the business) who have financial expertise.
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9. Concepts Underlying Financial Position
Financial position refers to a company’s economic resources, such as cash, inventory, and buildings, and the claims against those resources at a particular time. Another term for claims is equities.
Every corporation has two types of equities: creditors’ equities, such as bank loans, and stockholders’ equity. The sum of these equities equals a company’s resources:
Economic Resources = Creditors’ Equities +
Stockholders’ Equity
OR Assets = Liabilities + Stockholders’ Equity
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10. The Accounting Equation
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11. Assets
Assets are the economic resources that are expected to benefit the company’s future operations. They include:
monetary items (cash and money owed to the company by customers)
nonmonetary, physical items (inventories, land, buildings, equipment)
nonphysical items (rights granted by patents, trademarks, and copyrights)
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12. Liabilities
Liabilities are a business’s present obligations to pay cash, transfer assets, or provide services to other entities in the future. They include:
amounts to suppliers for goods or services bought on credit
borrowed money such as bank loans
salaries and wages owed to employees
taxes owed to the government
services to be performed
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13. Stockholders’ Equity (slide 1 of 3)
Stockholders’ equity represents the claims by the owners of a corporation (the stockholders) to the assets of the business.
Theoretically, stockholders’ equity is what would be left if all liabilities were paid.
It is sometimes said to equal net assets.
We can define stockholders’ equity this way:
Stockholders’ Equity = Assets − Liabilities
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14. Stockholders’ Equity (slide 2 of 3)
Stockholders’ equity has two parts:
Contributed capital—the amount that stockholders invest in the business. It is typically divided between:
Par value—an amount per share that when multiplied by the number of common shares becomes the corporation’s common stock amount
Additional paid-in capital—the amount over par value, when the value received is greater than par value
Retained earnings—earnings of the corporation since its inception, less any losses, dividends, or transfers to contributed capital
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15. Stockholders’ Equity (slide 3 of 3)
Revenues and expenses are the increases and decreases in stockholders’ equity that result from operating a business.
When revenues exceed expenses, the difference is called net income.
When expenses exceed revenues, the difference is called net loss.
Retained earnings is the accumulated net income minus dividends over the life of a business.
Dividends are distributions of resources, generally in the form of cash, to stockholders.
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16. Financial Statements
Four major financial statements are used to communicate accounting information: the income statement, the statement of retained earnings, the balance sheet, and the statement of cash flows.
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17. Income Statement
The income statement summarizes the revenues earned and expenses incurred by a business over an accounting period.
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18. Statement of Retained Earnings
The statement of retained earnings shows the changes in retained earnings over an accounting period.
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19. Balance Sheet
The purpose of a balance sheet is to show the financial position of a business on a certain date, usually the end of a month or year.
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20. Statement of Cash Flows
The statement of cash flows focuses on liquidity, that is, balancing the inflows and outflows of cash to enable the business to operate and pay its bills when they are due.
Cash flows are the inflows and outflows of cash into and out of a business.
The statement of cash flows is organized according to three major business activities:
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
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21. GAAP and the Independent CPA’s Report
To ensure that financial statements are understandable to their users, a set of generally accepted accounting principles (GAAP) has been developed to provide guidelines for financial accounting.
Many companies of all sizes have their financial statements audited by an independent certified public accountant (CPA).
An audit is an examination of a company’s financial statements and the accounting systems, controls, and records that produced them. It ascertains that the statements were prepared in accordance with GAAP.
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22. Organizations That Issue Accounting Standards
Two organizations issue accounting standards that are used in the United States:
The Financial Accounting Standards Board (FASB) has been designated by the Securities and Exchange Commission (SEC) to issue Statements of Financial Accounting Standards.
The International Accounting Standards Board (IASB) issues international financial reporting standards (IFRS). The SEC allows foreign companies to use these standards in the United States.
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23. Other Organizations That Influence GAAP
The Public Company Accounting Oversight Board (PCAOB) has wide powers to determine the standards that auditors must follow.
The American Institute of Certified Public Accountants (AICPA) is the primary professional organization of CPAs.
The Securities and Exchange Commission (SEC) is a governmental agency that has the legal power to set and enforce accounting practices for companies whose securities are offered for sale to the general public.
The Governmental Accounting Standards Board (GASB) issues accounting standards for state and local governments.
The Internal Revenue Service (IRS) interprets and enforces the tax laws that specify the rules for determining taxable income.
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24. Professional Conduct
The code of professional ethics of the American Institute of Certified Public Accountants governs the conduct of CPAs. The code requires CPAs to act with:
Integrity—be honest and candid and subordinate personal gain to service and the public trust.
Objectivity—be impartial and intellectually honest.
Independence—avoid all relationships that impair or appear to impair objectivity.
Due care—carry out professional responsibilities with competence and diligence.
The Institute of Management Accountants (IMA), the primary professional association of managerial accountants, also has a code of professional conduct.
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25. Decision Makers: The Users of Accounting Information
The people who use accounting information to make decisions fall into three categories: managers (internal users), outsiders who have a direct financial interest in the business, and outsiders who have an indirect financial interest.
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26. Management, Investors, and Creditors
Management is responsible for ensuring that a company meets its goals of profitability and liquidity.
Investors—stockholders who have invested in a company—have a direct financial interest in the success of their companies.
Creditors—those who lend money or deliver goods or services before being paid—are interested mainly in whether a company will have the cash to pay interest charges and to repay the debt on time.
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27. Business Goals and Activities (slide 1 of 2)
A business is an economic unit that aims to sell goods and services at prices that will provide an adequate return to its owners.
The two major goals of all businesses are:
Profitability—the ability to earn enough income to attract and hold investment capital
Liquidity—the ability to have enough cash to pay debts when they are due
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28. Business Goals and Activities (slide 2 of 2)
All businesses pursue their goals by engaging in the following activities:
Operating activities—buying, producing, and selling goods and services; hiring managers and other employees; paying taxes
Investing activities—buying resources for operating the business, such as land, buildings, and equipment; selling those resources when no longer needed
Financing activities—obtaining capital from creditors and from the company’s stockholders; repaying creditors; paying a return to stockholders
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29. The effectiveness of financial analysis depends on:
Financial analysis is the use of financial statements to determine that a business is well managed and is achieving its goals.
The effectiveness of financial analysis depends on:
Performance measures: Profitability is commonly measured in net income, and liquidity is commonly measured by cash flows.
Financial ratios: The ratio of earnings to total assets can be used to assess profitability, and the ratio of cash flows to total assets can be used to assess liquidity.
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30. Ethical Financial Reporting
Ethics is a code of conduct that addresses the question of whether actions are right or wrong.
The intentional preparation of misleading financial statements is called fraudulent reporting and can result from distortion of records, falsified transactions, and misapplication of various accounting principles.
In response to the accounting scandals at Enron Corporation and WorldCom, the Sarbanes-Oxley Act of 2002 was passed.
It regulates the financial reporting of public companies and their auditors.
©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.