Principles of Accounting Ch 1
Terms in this set (110)
Identify the forms of business organization and the uses of accounting information.
3 forms of business organization:
1) Sole proprietorship - a business owned by one person
2) Partnership - a business owned by 2 or more persons
- Partnerships often are formed because one individual does not have enough economic resources to initiate or expand the business
- Sometimes partners bring unique skills or resources to the partnership
3) Corporation - a business organized as a separate legal entity owned by stockholders
Users and uses of financial information
How should you and your partners formalize your duties and contributions?
In a written partnership agreement
Ethics in financial reporting
3 principal types of business activity
1) Financing activities
2) Investing activities
3) Operating activities
Describe the 4 financial statements and how they are prepared
- Income statement
- Retained earnings statement
- Balance sheet
- Statement of cash flows
- Interrelationships of statements
- Other annual report elements
What types of business often form partnerships?
Retail and service-type businesses, including professional practices (lawyers, doctors, architects, and certified public accountants)
How do investors in a corporation indicate their ownership claim?
Investors in a corporation receive shares of stock to indicate their ownership claim
Which is a more attractive way of indicating ownership claim?
Buying stock in a corporation is often more attractive than investing in a partnership bc shares of stock are easy to sell (transfer ownership).
What is another way that individuals can become stockholders?
- By investing relatively small amounts of money; therefore, it is easier for corporations to raise funds.
- Successful corporations often have thousands of stockholders, and their stock is traded on organized stock exchanges like the New York Stock Exchange.
T or F: Selling a proprietorship or partnership interest is much more involved
T or F: Many businesses start as sole proprietorships or partnerships and eventually incorporate.
Other factors to consider in deciding which organizational form to choose:
Taxes and legal liability
Costs & benefits of having sole proprietorship
If you choose a sole proprietorship or partnership, you generally receive more favorable tax treatment than a corporation.
However, proprietors and partners are personally liable for all debts and legal obligations of the business; corporate stockholders are not.
T or F: Corporate stockholders generally pay higher taxes but have no personal legal liability.
T or F: Hybrid forms of business organizations are now allowed in all states; they combine the tax advantages of partnerships w/ the limited liability of corporations
Most common hybrid businesses are what?
Limited liability companies and subchapter S corporations
T or F: There are more proprietorships & partnerships in the US more than corporations
T or F: The majority of U.S. business is done by corporations
What 2 business forms are simple to establish and have tax advantages?
Sole proprietorship & partnership
Difference in control b/w partnership & sole proprietorship
Partnership - broader skills & resources
Sole proprietorship - owner controlled
Stockholders are sometimes aka???
What is the purpose of financial information?
To provide inputs for decision making
What is accounting?
is the info system that identifies, records, and communicates the economic events of an organization to interested users.
What 2 groups can users of accounting information can be divided broadly into?
internal users or external users
What are internal users of accounting info?
managers who plan, organize, and run a business
E.g. These include:
1) marketing managers
2) production supervisors
3) finance directors
4) company officers
What are external users of accounting info?
1) Investors (owners) use accounting information to make decisions to buy, hold, or sell stock
2) Creditors such as suppliers and bankers use accounting information to evaluate the risks of selling on credit or lending money.
Questions asked by ea. internal user:
Finance: Is cash sufficient to pay dividends to Microsoft stockholders?
Marketing: What price should Apple charge for an iPad to maximize the company's net income?
Human Resources: Can General Motors afford to give its employees pay raises this year?
Management: Which PepsiCo product line is the most profitable? Should any product lines be eliminated?
Questions asked by ea. external user:
Investors: Is GE earning satisfactory income?
How does Disney compare in size and profitability with Time Warner?
Creditors: Will U.S Airlines be able to pay its debts as they come due?
such as the Internal Revenue Service, want to know whether the company complies with the tax laws.
are interested in whether a company like General Motors will continue to honor product warranties and otherwise support its product lines
such as the Major League Baseball Players Association, want to know whether the owners have the ability to pay increased wages and benefits.
such as the Securities and Exchange Commission or the Federal Trade Commission, want to know whether the company is operating within prescribed rules
What business careers is accounting used for?
General management: Managers all need to understand accounting data in order to make wise business decisions.
Marketing: Marketing specialists must be sensitive to costs and benefits, which accounting helps them quantify and understand.
Finance: These fields rely heavily on accounting knowledge to analyze financial statements. In fact, it is difficult to get a good job in a finance function without two or three courses in accounting.
Real estate: brokers must understand the numbers involved: Can the buyer afford to make the payments to the bank? Does the cash flow from an industrial property justify the purchase price? What are the tax benefits of the purchase?
Sarbanes-Oxley Act (SOX)
Regulations passed by Congress to reduce unethical corporate behavior.
As a result of SOX, top management must now certify the accuracy of financial information
Penalties for fraudulent financial activity are much more severe.
SOX increased both the independence of the outside auditors who review the accuracy of corporate financial statements and the oversight role of boards of directors
Solving an ethical dilemma
1. Recognize an ethical situation and ethical issues involved
- Use your personal ethics/written code of ethics to identify ethical issues/situations
2. Identify and analyze the principal elements in the situation
- Identify the stakeholders - persons or groups who may be harmed or benefited - what are the responsibilities/obligations of the parties involved?
3. Identify the alternatives and weigh the impact of each alternative on various stakeholders
- Consider most ethical alternative
What 3 Types of Activity are all businesses involved in?
financing, investing, and operating
What does accounting information system keep track of?
the results of each of the various business activities—financing, investing, and operating
What are the two primary sources of outside funds?
1) borrowing money (debt financing)
2) issuing (selling) shares of stock in exchange for cash (equity financing
How do companies borrow money?
1) Take out loan at a bank
2) Bonds - borrow directly from investors by issuing debt securities
- Ppl or entities that others owe money to
- They loan money to a company, you are one of its creditors.
- Specifying a payment schedule (e.g., payment at the end of three months).
- Have a legal right to be paid at the agreed time.
- In the event of nonpayment, you may legally force the company to sell property to pay its debts.
- Creditor claims must be paid before stockholders' claims
amts owed to creditors - in the form of debt and other obligations
Examples of liabilities
Note payable to the bank for borrowed money
Bonds payable - debt securities sold to investors that must be repaid at a particular date some years in the future
is the term used to describe the total amt paid in by stockholders for the shares they purchase.
Have no claim to corporate cash until the claims of creditors are satisfied
cash payments to stockholders
is the increase in assets or decrease in liabilities resulting from the sale of goods or the performance of services in the normal course of business
Arise from different sources & identified by various names depending on the nature of the business.
What are sources of revenue common to many businesses?
Sales revenue, service revenue, and interest revenue
assets used in day-to-day operations.
Goods available for future sales to customers are assets
This right to receive money from customers in the future
the cost of assets consumed or services used in the process of generating revenues
Cost of goods sold
such as the cost of materials
such as the cost of salespersons' salaries
such as the cost of advertising
such as the salaries of administrative staff, and telephone and heating costs incurred at the corporate office
amounts of interest paid on various debts
corporate taxes paid to the government
obligations to pay for liabilities from expenses
on the outstanding amounts owed to the bank
current liability account that records the amount of wages that are owed to employees for work that was performed by the employees in prior periods
sales taxes payable, property taxes payable, and income taxes
payable to the government
The amount by which revenues exceed expenses.
The amount by which expenses exceed revenues.
How are assets, liabilities, expenses, and revenues are of interest to users of accounting information
into financial statements
What are the 4 financial statements?
1) Income statement - reports revenues & expenses to show how successfully your business performed during a period of time
2) Retained earnings statement - to indicate how much of previous income was distributed to you and the other owners of your business in the form of dividends, and how much was retained in the business to allow for future growth
3) Balance Sheet - to present a picture at a point in time of what your business owns (its assets) and what it owes (its liabilities)
4) Statement of cash flows - to show where your business obtained cash during a period of time and how that cash was used
provides financial information about the cash receipts and cash payments of a business for a specific period of time
highlight differences between U.S. and international accounting standards.
What does IFRS stand for?
International Financial Reporting Standards
What does GAAP stand for?
generally accepted accounting principles
A financial statement that reports a company's revenues and expenses and resulting net income or net loss for a specific period of time.
Why are investors interested in a company's past net income?
Bc it provides useful information for predicting future net income
What determines whether investor will buy and sell stock?
Based on their beliefs about a company's future performance
T or F: Amounts received from issuing stock are not revenues
True; therefore not reported on income statement
T or F: Amounts paid out as dividends are not expenses
True; therefore not reported on income statement
The amount of net income retained in the corporation
Retained earnings statement
A financial statement that summarizes the amounts and causes of changes in retained earnings for a specific time period
- The beginning retained earnings amount appears on the first line of the statement.
- Then, the company adds net income and deducts dividends to determine the retained earnings at the end of the period.
- If a company has a net loss, it deducts (rather than adds) that amount in the retained earnings statement
A financial statement that reports the assets and claims to those assets at a specific point in time
The owners' claim to assets = common stock + retained earnings
Basic accounting equation
Assets = Liabilities + Stockholders' Equity
What 2 parts are stockholders' equity is comprised of?
(1) common stock
(2) retained earnings
When does common stock occur?
when company sells new shares of stocks
How does statement of cash flows help investors, creditors, and others in their analysis of a company's cash position?
- The statement of cash flows reports the cash effects of a company's operating, investing, and financing activities
- Shows the net increase or decrease in cash during the period, and the amount of cash at the end of the period.
What questions do statement of cash flows answers?
•Where did cash come from during the period?
•How was cash used during the period?
•What was the change in the cash balance during the period?
T or F: Some believe we should take into account ecological and social performance
What is an example of a socially responsible business?
- Allows fair trade practices
- Provides safe environments for workers
- Bears responsibility for environmental damage
INTERRELATIONSHIPS OF STATEMENTS
- Bc the results on some financial statements become inputs to other statements, the statements are interrelated
1. The retained earnings statement uses the results of the income statement.
- Sierra reported net income of $2,860 for the period.
- Net income is added to the beginning amount of retained earnings to determine ending retained earnings.
2. The balance sheet and retained earnings statement are also interrelated.
- Sierra reports the ending amount of $2,360 on the retained earnings statement as the retained earnings amount on the balance sheet
3.Finally, the statement of cash flows relates to information on the balance sheet.
- The statement of cash flows shows how the cash account changed during the period.
- It shows the amount of cash at the beginning of the period, the sources and uses of cash during the period, and the $15,200 of cash at the end of the period.
- The ending amount of cash shown on the statement of cash flows must agree with the amount of cash on the balance sheet.
Management discussion and analysis (MD&A)
A section of the annual report that presents management's views on the company's ability to pay:
- Near ear-term obligations,
- To fund operations and expansion
- It's results of operations
is an accounting professional who conducts an independent examination of a company's financial statements
Notes to the financial statements
Notes clarify information presented in the financial statements and provide additional detail
A report prepared by an independent outside auditor stating the auditor's opinion as to the fairness of the presentation of the financial position and results of operations and their conformance with generally accepted accounting principles.
Certified public accountant (CPA)
An individual who has met certain criteria and is thus allowed to perform audits of corporations.
If the auditor is satisfied that the financial statements provide a fair representation of the company's financial position and results of operations in accordance with generally accepted accounting principles
One of the most important assets owned by a company is
stock sold by company
Kim's Flowers decided to borrow $26,000 from the bank to purchase a new delivery vehicle. How should they categorize this business activity?
as both a financing activity and an investing activity
What does a balance sheet include?
assets, liabilities, and stockholders' equity
Simon Properties began the year with retained earnings of $420,000. During the year, the company issued $400,000 of common stock, recorded expenses of $2,200,000, and paid dividends of $100,000. If Simon's ending retained earnings was $520,000, what was the company's revenue for the year?
$520,000 + $100,000 + $2,200,000 - $420,000 = $2,400,000
Which of the following external users of a company's financial documents will be MOST concerned about the company's financial ability to honor an extended warranty?
Johnson Mechanics started the year with total assets of $250,000 and total liabilities of $180,000. During the year, the business recorded $410,000 in revenues, $250,000 in expenses, and dividends of $45,000. The net income reported by Johnson Mechanics for the year was
$410,000 - $250,000 = $160,000.
Jane and Sarah are both investors. Jane has invested thousands of dollars into one small company. Sarah has invested hundreds of dollars into several large companies. What is the difference between these two investors?
Jane has invested in a sole proprietorship, whereas Sarah has invested in corporations.
You are an analyst for a consulting firm and are working on several projects. Which project would MOST effectively use accounting information?
Project 1: profitability of the firm's client engagements over the last year
Ethics is so important in financial accounting and reporting that the government has passed a law regulating ethical actions of businesses related to their financial reporting practices. Why is ethics in financial reporting so important for the country's economy?
Investors and creditors will no longer provide financial backing to companies if they believe their financial reporting practices are unethical.
Watson Energy decided to borrow cash from the bank in order to build a new office building. The board of directors was arguing about which type of business activity this was. Diane stated that it was a financing activity, but Paul stated that it was an investing activity. Who was correct?
Both. Borrowing the cash is a financing activity, but building the new office building is an investing activity.
A CFO is looking at the end-of-year financial statements. His goal is to identify the store that performed the best over the past year so he can give them an award. Which step in the accounting process is most important for helping him make this decision? Why?
Identification; as the first step, transactions must be identified correctly in order to record them correctly.
Recording; correct categorization, recording, and summarizing of financial data is vital to accurate financial reports.
You got it correct :
All are equally important; an error in any step would affect each subsequent step.
Communication; as the final step, preparation and analysis of financial reports provides the most useful form of the data for making decision.
Mark and Sally both decided to invest in the same company. Mark does not like risk, so he purchased bonds from the company. Sally does not mind a little bit of risk, so she purchased stocks from the company. What is the difference between Mark's and Sally's expectations of the company?
Mark expects to be paid back for his investment with interest, whereas Sally only expects to receive dividends from her investment unless she decides to sell her stocks
At the end of the accounting period on December 31, 2016, Rose Industries records wages payable of $42,500. For the same accounting period, Romero Industries does not need to record wages payable. Why?
The end of the accounting period fell on a payday for Romero Industries but not for Rose Industries.
Wages payable is used to record the accumulation of wages that are owed to employees that they will receive on the next payday. Because they recorded wages payable for this accounting period, the accounting period for Rose Industries must have landed between pay days. However, Romero Industries must have had their payday coincide with the end of their accounting period, so they do not record wages payable because all wages have been paid to date.
Brooks Flooring is a national supplier of all types of flooring. Their biggest customer is Jenkins Construction Company. On July 8, 2016, Brooks Flooring purchased 100 shares of Jenkins stock. Later that year, on November 14, 2016, Brooks decided to sell 1,000 shares of Brooks stock to investors. What is the difference between these two transactions involving stock?
The first transaction is an investing activity, whereas the second transaction is a financing activity.
Transactions involving stock are recorded differently depending on who is selling and who is buying the stock. If a company sells stock, it is a financing activity in which they gain cash to use in other activities. If a company purchases stock of another company, it is an investing activity in which they hope to increase their return on investment compared to having the money sitting in a bank. Therefore, in this case, the first transaction is an investing activity, and the second transaction is a financing activity.
On May 31, 2016, Hughes Construction recorded $50,000 in bonds payable, $30,000 in notes payable, $9,000 in wages payable, $3,000 in accounts payable, and $1,450 in taxes payable. How are all of these accounts similar?
All of them represent liabilities that must be paid back at some specified point in the future.
What should you consider when purchasing stock?
- One of them should be your careful analysis of a company's financial statements.
- The reason: Financial statements offer relevant and reliable information, which will help you in your decision-making.
Identify the sections of a classified balance sheet
- Current assets
- Long term investments
- Property, plant, equipment
- Intangible assets
- Current liabilities
- Long term liabilities
- Stockholders' equity
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