Accounting as a Form of Communication Chapter 1 Accounting as a Form of Communication

Learning Objectives LO1 Explain what business is about. LO2 Distinguish among the forms of organization. LO3 Describe the various types of business activities. LO4 Define accounting and identify the primary users of accounting information and their needs. LO5 Explain the purpose of each of the financial statements and the relationships among them and prepare a set of simple statements. LO6 Identify and explain the primary assumptions made in preparing financial statements.

Learning Objectives (continued) LO7 Identify the various groups involved in setting accounting standards and the role of auditors in determining whether the standards are followed. LO8 Explain the critical role that ethics plays in providing useful financial information.

Module 1 The Nature of Business Business consists of all activities necessary to provide members of an economic system with goods and services Module 1

Types of Businesses Certain business activities focus on providing goods or products Companies can: produce or manufacture the products distribute the products sell directly to the consumer Suppliers, manufacturers, wholesalers, and retailers are examples of product companies Module 1: LO 1

Exhibit 1-1—Types of Businesses Module 1: LO 1

Business Entities Business Entity: 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 is established by acquiring shares of stock Module 1: LO 2

Exhibit 1-2—Forms of Organization Module 1: LO 2

Nonbusiness Entities Organizations operated for some purpose other than to earn a profit Do not have an identifiable owner Fund accounting is used by nonbusiness entities Module 1: LO 2

Organizations and Social Responsibility U.S. business entities recognize the societal aspects of their overall mission and have established programs to meet these responsibilities Module 1: LO 2

The Nature of Business Activity All business activities can be categorized as operating, investing, or financing activities Financing activities: raising money from owners’ contributions as well as obtaining loans from outsiders Investing activities: investing the amounts raised from financing activities in various types of assets Operating activities: providing goods and services to customers Module 1: LO 3

Exhibit 1-3—A Model of Business Activities Module 1: LO 3

Module 2 Accounting and Financial Statements The primary users of financial statements depend on the economic information conveyed in those statements to make decisions Accounting: the process of identifying, measuring, and communicating economic information to various users to permit informed judgments and decisions Module 2

Users of Accounting Information Primary users may be broadly classified as internal and external users Internal users are usually managers of a company External users include stockholders, investors, creditors, and government agencies Module 2: LO 4

Management and Financial Accounting Management accounting: the branch of accounting concerned with providing internal users with information to facilitate planning and control Financial accounting: the branch of accounting concerned with the preparation of financial statements for external users Module 2: LO 4

Exhibit 1-4—Users of Accounting Information Module 2: LO 4

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 Module 2: LO 4

The Accounting Equation Assets = Liabilities + Owners’ Equity Left side: valuable economic resources 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 Module 2: LO 5

Stockholders’ Equity Created when a company issues stock to an investor Retained earnings: earnings accumulated or retained by the company Module 2: LO 5

The Balance Sheet Financial statement that summarizes the assets, liabilities, and owners’ equity of a company Sometimes called the statement of financial position At any point in time, assets must equal liabilities and owners’ equity Module 2: LO 5

Example 1-4—Preparing a Balance Sheet Module 2: LO 5

Exhibit 1-5—The Accounting Equation and the Balance Sheet Module 2: LO 5

The Income Statement Summarizes the revenues and expenses of a company for a period of time Module 2: LO 5

Example 1-5—Preparing an Income Statement Module 2: LO 5

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 Module 2: LO 5

The Statement of Cash Flows Summarizes a company’s cash receipts and cash payments during the period from operating, investing, and financing activities Module 2: LO 5

Exhibit 1-6—Relationships Among the Financial Statements Module 2: LO 5

Module 3 Conceptual Framework of Accounting The usefulness of accounting information is enhanced through the various assumptions set forth in the conceptual framework developed by the accounting profession This conceptual framework is the foundation for the methods, rules, and practices that make up generally accepted accounting principles (GAAP) Module 3

Conceptual Framework for Accounting Important assumptions in the conceptual framework are as follows: Economic entity concept Cost principle Going concern Monetary unit Time period Module 3: LO 6

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 Module 3: LO 6

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 Module 3: LO 6

Going Concern Assume entity will continue indefinitely into the future Justifies use of historical cost Module 3: LO 6

Monetary Unit Yardstick used to measure amounts in financial statements The dollar is used because it is the recognized medium of exchange in the United States Assumes monetary unit is relatively stable; no adjustment for inflation made in financial statements Module 3: LO 6

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 Module 3: LO 6

Setting Accounting Standards Financial statements are the responsibility of management. Various groups are involved in setting the standards that are used in preparing the statements Although the SEC has the ultimate authority to determine the rules, the FASB currently sets the standards in the United States Module 3: LO 7

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 Module 3: LO 7

Setting Accounting Standards (continued) American Institute of Certified Public Accountants (AICPA) Professional organization of Certified Public Accountants (CPAs) 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 Module 3: LO 7

The 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 to render an opinion as to whether the financial statements of a company are fairly presented Auditors’ report is an opinion, not a statement of fact Module 3: LO 7

Introduction to 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 Module 3: LO 8

Why Should Accountants Be Concerned with Ethics? Moral and social ethical behavior must be considered while decision making Recent news of questionable accounting practices has placed increased scrutiny on the accounting profession Professional judgment is often needed to arrive at appropriate decisions when some question arises about the application of GAAP Module 3: LO 8

Exhibit 1-9—Ethics and Accounting: A Decision-Making Model Module 3: LO 8

Review LO1 Explain what business is about. Business consists of all activities necessary to provide members of an economic system with goods and services. Suppliers, manufacturers, wholesalers, and retailers are examples of product companies. LO2 Distinguish among the forms of organization. Some entities are organized to earn a profit, while others are organized to serve various segments of society. The three forms of business entities are sole proprietorships, partnerships, and corporations.

Review LO3 Describe the various types of business activities. All business activities can be categorized as operating, investing, or financing activities. Financing activities involve raising money from contributions made by the owners of a business as well as obtaining loans from outsiders. Companies invest the amounts raised from financing activities in various types of assets, such as inventories, buildings, and equipment. Once funds are obtained and investments are made in productive assets, a business can begin operations. Operating activities involve providing goods and services to customers.

Review LO4 Define accounting and identify the primary users of accounting information and their needs. The primary users of financial statements depend on the economic information conveyed in those statements to make decisions. Primary users may be broadly classified as internal and external users. Internal users are usually managers of a company. External users include stockholders, investors, creditors, and government agencies.

Review LO5 Explain the purpose of each of the financial statements and the relationships among them and prepare a set of simple statements. Four major financial statements are covered in this chapter: balance sheet, income statement, statement of retained earnings, and statement of cash flows. The balance sheet is a snapshot of a company’s financial position at the end of the period. It reflects the assets, liabilities, and stockholders’ equity accounts. The income statement summarizes the financial activity for a period of time. Items of revenues, expenses, gains, and losses are reflected on the income statement. Ultimately, all net income (loss) and dividends are reflected in retained earnings on the balance sheet. The statement of retained earnings links the income statement to the balance sheet by showing how net income (loss) and dividends affect the Retained Earnings account. The statement of cash flows summarizes the cash flow effects of a company’s operating, investing, and financing activities.

Review LO6 Identify and explain the primary assumptions made in preparing financial statements. The usefulness of accounting information is enhanced through the various assumptions set forth in the conceptual framework developed by the accounting profession. This conceptual framework is the foundation for the methods, rules, and practices that make up generally accepted accounting principles (GAAP). Important assumptions in the conceptual framework are as follows: Economic entity concept Cost principle Going concern Monetary unit Time period

Review LO7 Identify the various groups involved in setting accounting standards and the role of auditors in determining whether the standards are followed. Financial statements are the responsibility of management. Various groups are involved in setting the standards that are used in preparing the statements. Although the SEC has the ultimate authority to determine the rules, the FASB currently sets the standards in the United States. The role of the external auditor is to perform various tests and procedures to render an opinion as to whether the financial statements of a company are fairly presented. LO8 Explain the critical role that ethics plays in providing useful financial information. All decision makers must consider the moral and social implications of their decisions. Recent news of questionable accounting practices has placed increased scrutiny on the accounting profession. Professional judgment is often needed to arrive at appropriate decisions when some question arises about the application of GAAP.

End of Chapter 1