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Week 1 - PowersNeedles

The document outlines the fundamental concepts of accounting, including its role in decision-making, the importance of financial statements, and the ethical considerations in financial reporting. It discusses various business goals, activities, and the types of users of accounting information, as well as the four basic financial statements: income statement, statement of retained earnings, balance sheet, and statement of cash flows. Additionally, it highlights the significance of Generally Accepted Accounting Principles (GAAP) and the Sarbanes-Oxley Act in regulating financial reporting.

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0% found this document useful (0 votes)
5 views56 pages

Week 1 - PowersNeedles

The document outlines the fundamental concepts of accounting, including its role in decision-making, the importance of financial statements, and the ethical considerations in financial reporting. It discusses various business goals, activities, and the types of users of accounting information, as well as the four basic financial statements: income statement, statement of retained earnings, balance sheet, and statement of cash flows. Additionally, it highlights the significance of Generally Accepted Accounting Principles (GAAP) and the Sarbanes-Oxley Act in regulating financial reporting.

Uploaded by

Sakura Cn
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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You are on page 1/ 56

Chapter 1

Uses of Accounting
Information and the
Financial Statements

CFGM 6102 Accounting and Financial Decision Making


Learning Objectives
Define accounting and describe its role in making
informed decisions, identify business goals and activities,
and explain the importance of ethics in accounting.
Identify the users of accounting information.
Explain the importance of business transactions, money
measure, and separate entity.
Describe the characteristics of a corporation.
Identify the four basic financial statements and define
their elements.
Explain how generally accepted accounting principles
(GAAP) relate to financial statements and the
independent CPA’s report, and identify the organizations
that influence GAAP.
Accounting as an
Information System
 Accounting is an information system that
measures, processes, and communicates
financial information about an economic
entity.
 As shown in the Exhibit in the next slide,
accounting is a link between business
activities and decision makers.
Accounting as an
Information System
Business Goals
 A business is an economic unit that
aims to sell goods and services to
customers at prices that will provide an
adequate return to its owners.
 The two major goals of all businesses
are:
 Profitability—earning a sufficient return to
maintain owner interest
 Liquidity—having enough cash to pay
debts as they come due
Business Activities
 All companies pursue their business goals
by engaging in the following activities:
 Operating activities—selling goods and
services to customers; employing managers
and workers; buying and producing goods and
services; and paying taxes
 Investing activities—spending the capital a
company receives in productive ways that help
it achieve its objectives
 Financing activities—obtaining funds to
begin operations and to continue operating
Business Goals and
Activities
Financial Performance
Analysis
 Financial analysis is the use of
financial statements to determine that
a business is well managed and is
achieving its goals.
 Performance measures must be well
aligned with the two major goals of the
firm: profitability and liquidity.
 Financial ratios show how the
elements of financial statements relate
to each other.
Management Accounting
 Management accounting—accounting
information for internal decision makers
 This is an operating report providing the
details such as:
 how much was sold
 what costs were incurred
 a budget for sales and costs for the next
year
Financial Accounting
 Financial accounting—accounting
information for external decision makers;
reports are called financial statements.
 It is important to distinguish accounting from
the ways in which accounting information is
processed by bookkeeping and management
information systems.
 Bookkeeping is the mechanical and repetitive
recordkeeping aspect of accounting.
 Management information systems (MIS) consists
of the interconnected subsystems that provide the
information needed to run a business.
Ethical Financial Reporting
 Ethics is a code of conduct that
addresses whether actions are right or
wrong.
 Ethics is especially important in
preparing financial reports because
users of these reports must depend on
the good faith of the people involved in
their preparation.
 Fraudulent financial reporting can
result from the distortion of records,
falsified transactions, or the misapplication
Sarbanes-Oxley Act
 The Sarbanes-Oxley Act was passed in
2002 in response to Enron Corporation
and WorldCom scandals and regulates
financial reporting and the accounting
profession.
Match each term with one of the four definitions that follow:

____ 1. Management Accounting a. An unethical


practice
____ 2. Liquidity b. A business goal
____ 3. Financial Accounting c. Engaged in by all
businesses
____ 4. Investing Activities d. A major branch of
Accounting
____ 5. Operating Activities
____ 6. Financing Activities
SOLUTION
____
1. d;7.2. b;
Profitability
3. d; 4. c; 5. c; 6. c; 7. b; 8. a
____ 8. Fraudulent financial reporting
Decision Makers: The Users
of Accounting Information
 Management refers to the people who
are responsible for ensuring that a
company meet its goals of profitability and
liquidity
 Users with a Direct financial interest
 Investors: have invested capital in a company
and thus acquired part ownership in it
 Creditors: those who lend money or deliver
goods and services before being paid
 Users with an Indirect financial interest
 Tax Authorities: Companies and individuals
pay many kinds of taxes.
The Users of Accounting
Information
 Regulatory Agencies include Securities and
Exchange Commission (SEC) to which all
publically traded corporations must report
periodically.
 Other groups include the following:
 Labor Unions
 Advisors of Investors and Creditors
 Consumer Groups, Customers, and the General
Public
 Economic Planners

 Governmental and Not-for-Profit


Organizations include functions raising funds
and deploying scarce resources.
The Users of Accounting
Information
Match each term with one of the three types of users of
accounting information that follow:

____ 1. Tax authorities a. Internal user


____ 2. Investors b. Direct external
user
____ 3. Management c. Indirect user
____ 4. Creditors
____ 5. Regulatory agencies
____ 6. Labor unions and consumer groups

SOLUTION
1. c; 2. b; 3. a; 4. b; 5. c; 6. c
Accounting Measurement
 Four questions must be answered to
make an accounting measurement.
 What is measured?
 When should the measurement be made?
 What value should be placed on what is
measured?
 How should what is measured be classified?
Business Transactions
 A business transaction is an economic
event that affects a business’s financial
position.
 A transaction can be an exchange of value (a
purchase, sale, payment, collection, or loan)
between two or more parties.
 A transaction that does not involve an
exchange is a “nonexchange transaction.” For
example, losses from fire, flood, explosion, and
theft; physical wear and tear on machinery and
equipment; and the day-by-day accumulation
of interest.
Money Measure
 The money measure concept states
that a business transaction should be
recorded in terms of money.
 Transactions between countries must
involve the translation of amounts of
money using the appropriate exchange
rate.
Examples of Foreign
Exchange Rates
Separate Entity
 In accounting, a business is a separate
entity, distinct not only from its
creditors and customers but also from its
owners.
Match each description with one of the terms that follow:

____ 1. An exchange of value between a. Business


transaction
two or more parties
____ 2. Requires a separate set of records b. Money
measure
for a business
____ 3. An amount associated with a business c. Separate
entity
transaction
SOLUTION
1. a; 2. c; 3. b
Forms of Business
(slide 1 of 2)

 Forms of Business
 Sole proprietorship—one owner
 Theowner takes all of the profits or losses of
the business
 The owner has unlimited liability
 Partnership—two or more owners
 In a partnership two or more owners share
profits or losses based on a predetermined
arrangement
 Owners have unlimited liability which can be
avoided by forming a limited liability
partnership
Forms of Business
(slide 1 of 2)

 Corporation—a business unit chartered by


the state
 Many owners but managed by a board of
directors
 Legally separate from its owners (the
stockholders)
 Stockholders enjoy limited liability
Number and Receipts of U.S.
Proprietorships, Partnerships, and
Corporations
The Corporate Form of
Business (slide 1 of 5)
 Formation and Organization of a
Corporation
 A corporation is a business unit chartered
by the state (when articles of
incorporation are filed) and considered a
separate legal entity from its owners.
 The liability of corporate stockholders is
limited to their investment.
The Corporate Form of
Business (slide 2 of 5)
 Stockholders
 A share of stock is a unit of ownership in
a corporation.
 Common stock is the most universal form of
stock.
 Board of Directors
 The board of directors sets corporate policy
and declares dividends.
The Corporate Form of
Business (slide 3 of 5)
 The authority to manage a corporation is
given by the owners and board of directors
to the corporate management. Corporate
governance is the oversight of a
corporation’s management and ethics by
its board of directors.
 A provision of the Sarbanes-Oxley Act
requires boards of directors to establish an
audit committee to ensure that the board
is objective in evaluating management
performance.
The Corporate Form of
Business (slide 4 of 5)
 Management
 Appointed by the board of directors to carry
out corporate policies and run day-to-day
operations
 Also have the duty of reporting the financial
results
The Corporate Form of
Business
(slide 5 of 5)
Match each of the descriptions with the terms that follow:

____ 1.
Issues stock a. Sole proprietorship
____ 2.
Owned by only one person b. Partnership
____ 3.
Multiple co-owners c. Corporation
____ 4.
Management appointed by
board of directors
____ 5. Most numerous but usually
small in size
____ 6. Biggest segment of the economy
SOLUTION
1. c; 2. a; 3. b; 4. c; 5. a; 6. c.
The Financial Statements
and their Elements
 Income statement (also referred to as the
statement of operations) the most
important financial report because it shows
whether a business achieved its profitability
goal through its operating activities
 Revenues are the increases in stockholders’
equity that result from operating a business.
 Expenses are the decreases in stockholders’
equity that result from operating a business.
 Net Income When revenues exceed expenses,
the difference is called net income. When
expenses exceed revenues, the difference is
called net loss.
Income Statement for Inglot
Consultancy, Inc.
Statement of Retained
Earnings
 Retained earnings represent the
accumulated earnings generated by a
business’s income-producing activities
less amounts that have been paid out to
the stockholders.
 The statement of retained earnings shows
the changes in retained earnings over an
accounting period.
 Dividends are distributions of resources,
generally in the form of cash, to
stockholders, and only the board of
directors has the authority to declare
them.
Statement of Retained
Earnings for Inglot
Consultancy, Inc.
The Accounting Equation
Balance Sheet
 Balance sheet (also called the statement
of financial position) shows the financial
position of a business on a certain date,
usually the end of the month or year
 The assets equal the sum of the liabilities and
stockholders’ equities, under the accounting
equation
 Assets are the economic resources of a
company that are expected to benefit the
company’s future operations.
 Liabilities are a business’s present obligations
to pay cash, transfer assets, or provide
services to other entities in the future.
Balance Sheet for Inglot
Consultancy
Balance Sheet

 Stockholders’ equity (also called


shareholders’ equity) represents the claims of
the owners of a corporation (the stockholders)
to the assets of the business.
 Net assets are what would be left over if all liabilities
were paid
 Contributed capital is the amount that stockholders
invest in the business.
 Par value is an amount per share that when
multiplied by the number of common shares becomes
the corporation’s common stock amount; it is the
minimum amount that can be reported as contributed
capital.
 When the value received is greater than par value, the
amount over par value is called additional paid-in
capital.
Statement of Cash Flows
 Statement of cash flows focuses on
company’s liquidity.
 Cash flows are the inflows and outflows
of cash into and out of a business. The
statement is organized according to the
three major business activities:
 Cash Flows from Operating Activities
 Cash Flows from Investing Activities
 Cash Flows from Financing Activities
Statement of Cash Flows for
Inglot Consultancy, Inc.
Income Statement, Statement of Retained
Earnings, Balance Sheet, and Statement of
Cash Flows
Financial Ratios
 Financial ratios show important
relationships among the elements of the
financial statements.
 The following financial ratios have been
shown to be most predictive of company
performance:
 Profitmargin
 Asset turnover
 Cash flow yield
 Debt to equity ratio
Focus on Financial
Statement Elements

The six elements (top row) on the financial


statements are used to compute the four ratios
(bottom row) that allow you to analyze financial
statements and determine how well or poorly a
company is performing, which, in turn, is the basis
for making good business decisions.
Financial Ratio: Profit
Margin
By using the net income and revenues
that appear on Inglot Consultancy’s
income statement, we can calculate
Inglot’s profit margin as follows:
Net Income
Profit Margin 
Revenues
$3, 200
Profit Margin =
$10, 000
= 0.320, or 32.0%
Complete the financial statements that appear below by determining the amounts that correspond to
the letters. (Assume no new investments by stockholders.)

Income Statement
Revenues $2,775
Expenses (a)
Net income $
(b)
Statement of Retained Earnings
Beginning balance $7,250
Net income (c)
Less dividends 500
Ending balance
$7,500
Balance Sheet
Total assets $ (d)
Liabilities $4,000
Stockholders’ equity
Common stock
5,000
Retained earnings (e)
Total liabilities and stockholders’ equity $ (f)
SOLUTION

Net income links the income statement and the statement


of retained earnings. The ending balance of retained
earnings links the statement of retained earnings and the
balance sheet.

Thus, start with (c), which must equal $750 ($7,250 + $750
- $500 + $7,500). Then, (b) equals (c), or $750. Thus, (a)
must equal $2,025 ($2,775 - $2,025 + $750). Because (e)
equals $7,500 (ending balance from the statement of
retained earnings), (f) must equal $16,500 ($4,000 +
$5,000 + $7,500 + $16,500). Now, (d) equals (f ), or
$16,500.
Generally Accepting
Accounting Principles
 GAAP are the conventions, rules, and
procedures that define acceptable
accounting practice at a particular time.
 GAAP and the Independent CPA’s Report
 Certified public accountant (CPA) performs
independent audits of businesses’ financial
statements.
 An audit is an examination of the financial
statements and the accounting systems,
controls, and records to ascertain that financial
statements are in accordance with GAAP.
Large International Certified
Public Accounting Firms
Organizations That Issue
Accounting Standards
 The Financial Accounting Standards
Board (FASB) is responsible for
developing GAAP.
 The International Accounting
Standards Board (IASB) sets
international accounting standards.
 Issues international financial reporting
standards (IFRS)
 IFRS is becoming increasingly important
because of the acceptance of its standards
in many financial markets throughout the
world.
Other Organizations That
Influence GAAP
 The Public Company Accounting Oversight Board (PCAOB) is a
governmental body created by the Sarbanes-Oxley Act to regulate
the accounting profession.
 The American Institute of Certified Public Accountants (AICPA)
influences GAAP through advisory committees.
 The Securities and Exchange Commission (SEC) sets its own
standards for companies whose securities are listed on the stock
exchanges.
 The Governmental Accounting Standards Board (GASB) was
established to issue accounting standards for state and local
governments.
 Internal Revenue Service (IRS) guidelines are established to
collect taxes but play an influential role in the establishment of
accounting practices.
Professional Conduct
(slide 1 of 2)

 Management accountants have a code


of professional ethics
 Integrity
 Objectivity
 Independence
 Due care
Professional Conduct
(slide 2 of 2)

 Institute of Management
Accountants (IMA)
 the primary professional association of
management accountants,
 Code of professional conduct emphasizes
that management accountants
 have a responsibility to be competent in their
jobs,
 must keep information confidential except when
authorized or legally required to disclose it,
 must maintain integrity and avoid conflicts of
interest,
 and communicate information objectively and
without bias.
Match the following acronyms with the descriptions that follow:
____ 1. GAAP a. Sets U.S. accounting standards
____ 2. IFRS b. Audits financial statements
____ 3. CPA c. Established by the Sarbanes-Oxley
Act
____ 4. FASB d. Sets international accounting
standards
____ 5. IASB e. Established by the FASB
____ 6. PCAOB f. Established by the IASB
____ 7. AICPA g. Influences accounting standards
through
SOLUTION member CPAs
1. e;8.2. f;SEC
____ 3. b; 4. a; 5. d; 6. c; 7. g; 8.
h.h.Receives audited financial
statements of public companies

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