Chapter1: Accounting in Business
Terms in this set (95)
- Identifying (Select transactions and events)
- Recording (Input, measure, and classify)
- Communicating (Prepare, analyze, and interpret)
Point: Technology is only as useful as the accounting data available, and users' decisions are only as good as their understanding of accounting. The best software and recordkeeping cannot make up for lack of accounting knowledge.
Users of Accounting Information
- Consumer Groups
- External Auditors
- Should we make a five-year loan to that business?
- Do income levels justify the current stock price?
- Which firm reports the highest sales and income?
- Internal Auditors
- Sales Staff
- Budget Officers
- Research and Development Director
- Purchasing Manager
- Human Resources Director
- Production Supervisors
- Distribution Managers
- Should we spend further research on our product?
- What are the costs of our service to customers?
- What are reasonable payroll benefits and wages?
- What are the costs of our product's ingredients?
- Nonexecutive employee
Opportunities in Accounting
- Criminal Investigation
- General Accounting
- Cost Accounting
- Internal Auditing
- Legal Services
- Estate Plans
- FBI Investigators
- Market Researchers
- Systems Designers
- Merger Services
- Business Valuation
- Forensic Accounting
- Litigation Support
Accounting Jobs by Area
Government, not-for-profit and education 16%
Public Accounting 24%
Private Accounting 60%
The largest accounting firms are Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers.
Census Bureau (2009) reports that for workers 18 and over, higher education yields higher average pay:
Advanced Degree: $80,977
Bachelors Degree: $57,181
HS Degree: $31,286
No HS Degree: $21,484
Information and measurement system that identifies, records, and communicates relevant information about a company's business activities.
Recordkeeping or Bookkeeping
Part of accounting that involves recording transactions and events, either manually or electronically; also called bookkeeping.
Persons using accounting information who are not directly involved in running the organization.
Area of accounting aimed mainly at serving external users.
Persons using accounting information who are directly involved in managing the organization.
Area of accounting aimed mainly at serving the decision-making needs of internal users; also called management accounting.
Virtue is not always its own reward. Compare the S&P 500 with the Domini Social Index (DSI), which covers 400 companies that have especially good records of social responsibility. We see that returns for companies with socially responsible behavior are at least as high as those of the S&P 500.
Fundamentals of Accounting
Accounting is guided by principles, standards, concepts, and assumptions. This section describes several of these key fundamentals of accounting.
Codes of conduct by which actions are judged as right or wrong, fair or unfair, honest or dishonest.
requires each issuer of securities to disclose whether it has adopted a code of ethics for its senior financial officers and the contents of that code.
Guidelines for Ethical Decision Making
Identify Ethical Concerns
- Use personal ethics to recognize an ethical concern.
- Consider all good and bad consequences.
Make Ethical Decision
- Choose best option after weighing all consequences.
Point: The American Institute of Certified Public Accountants' Code of Professional Conduct is available at www.AICPA.org.
They Fought the Law
Our economic and social welfare depends on reliable accounting. Some individuals forgot that and are now paying their dues. They include Bernard Madoff (in photo) of Madoff Investment Securities, convicted of falsifying securities records; Bernard Ebbers of WorldCom, convicted of an $11 billion accounting scandal; Andrew Fastow of Enron, guilty of hiding debt and inflating income; and Ramalinga Raju of Satyam Computers, accused of overstating assets by $1.5 billion.
generally accepted accounting principles (GAAP)
Point: State ethics codes require CPAs who audit financial statements to disclose areas where those statements fail to comply with GAAP. If CPAs fail to report noncompliance, they can lose their licenses and be subject to criminal and civil actions and fines.
Securities and Exchange Commission (SEC)
Federal agency Congress has charged to set reporting rules for organizations that sell ownership shares to the public.
Federal agency Congress has charged to set reporting rules for organizations that sell ownership shares to the public.
Financial Accounting Standards Board (FASB)
Independent group of full-time members responsible for setting accounting rules.
International Accounting Standards Board (IASB)
Group that identifies preferred accounting practices and encourages global acceptance; issues International Financial Reporting Standards (IFRS).
International Financial Reporting Standards (IFRS)
International Financial Reporting Standards (IFRS) are required or allowed by over 100 countries; IFRS is set by the International Accounting Standards Board (IASB), which aims to develop a single set of global standards, to promote those standards, and to converge national and international standards globally.
Like the FASB, the IASB uses a conceptual framework to aid in revising or drafting new standards. However, unlike the FASB, the IASB's conceptual framework is used as a reference when specific guidance is lacking. The IASB also requires that transactions be accounted for according to their substance (not only their legal form), and that financial statements give a fair presentation, whereas the FASB narrows that scope to fair presentation in accordance with U.S. GAAP.
A written framework to guide the development, preparation, and interpretation of financial accounting information.
Objectives—to provide information useful to investors, creditors, and others.
Qualitative Characteristics—to require information that is relevant, reliable, and comparable.
Elements—to define items that financial statements can contain.
Recognition and Measurement—to set criteria that an item must meet for it to be recognized as an element; and how to measure that element.
Principles and Scruples
Auditors, directors, and lawyers are using principles to improve accounting reports. Examples include accounting restatements at Navistar, financial restatements at Nortel, accounting reviews at Echostar, and expense adjustments at Electronic Data Systems. Principles-based accounting has led accounting firms to drop clients deemed too risky. Examples include Grant Thorton's resignation as auditor of Fremont General due to alleged failures in providing information when promised, and Ernst and Young's resignation as auditor of Catalina Marketing due to alleged accounting errors.
Principles and Assumptions of Accounting
Accounting principles (and assumptions) are of two types. General principles are the basic assumptions, concepts, and guidelines for preparing financial statements. Specific principles are detailed rules used in reporting business transactions and events. General principles stem from long-used accounting practices. Specific principles arise more often from the rulings of authoritative groups.
General principles consist of at least four basic principles, four assumptions, and two constraints.
Point: The cost principle is also called the historical cost principle.
Accounting information is based on cost with potential subsequent adjustments to fair value; see also cost principle.
Accounting principle that prescribes financial statement information to be based on actual costs incurred in business transactions.
revenue recognition principle
The principle prescribing that revenue is recognized when earned.
expense recognition principle or matching principle
Prescribes expenses to be reported in the same period as the revenues that were earned as a result of the expenses.
full disclosure principle
Principle that prescribes financial statements (including notes) to report all relevant information about an entity's operations and financial condition.
Revenues for the Green Bay Packers and Dallas Cowboys football teams include ticket sales, television and cable broadcasts, radio rights, concessions, and advertising. Revenues from ticket sales are earned when the NFL team plays each game. Advance ticket sales are not revenues; instead, they represent a liability until the NFL team plays the game for which the ticket was sold. At that point, the liability is removed and revenues are reported.
There are four accounting assumptions: the going concern assumption, the monetary unit assumption, the time period assumption, and the business entity assumption.
Principle that prescribes financial statements to reflect the assumption that the business will continue operating.
monetary unit assumption
Principle that assumes transactions and events can be expressed in money units.
time period assumption
Assumption that an organization's activities can be divided into specific time periods such as months, quarters, or years.
business entity assumption
Point: Abuse of the entity assumption was a main culprit in Enron's collapse.
Point: Proprietorships and partnerships are usually managed by their owners. In a corporation, the owners (shareholders) elect a board of directors who appoint managers to run the business.
Business owned by one person that is not organized as a corporation; also called proprietorship.
Unincorporated association of two or more persons to pursue a business for profit as co-owners.
Most proprietorships and partnerships are now organized as LLCs.
Business that is a separate legal entity under state or federal laws with owners called shareholders or stockholders.
Owners of a corporation; also called stockholders.
Owners of a corporation; also called stockholders.
Corporation's basic ownership share; also generically called capital stock.
Transaction Analysis and the Accounting Equation
To understand accounting information, we need to know how an accounting system captures relevant data about transactions, and then classifies, records, and reports data.
Equality involving a company's assets, liabilities, and equity; Assets 5 Liabilities 1 Equity; also called balance sheet equation.
Assets = Liabilities + Equity
Creditors' claims on an organization's assets; involves a probable future payment of assets, products, or services that a company is obligated to make due to past transactions or events.
Owner's claim on the assets of a business; equals the residual interest in an entity's assets after deducting liabilities; also called net assets.
Assets put into the business by the owner.
owner investments and revenues increase equity, whereas owner withdrawals and expenses decrease equity
Account showing the owner's claim on company assets; equals owner investments plus net income (or less net losses) minus owner withdrawals since the company's inception; also referred to as equity.
Account used to record asset distributions to the owner. (See also withdrawals.)
Outflows or using up of assets as part of operations of a business to generate sales.
expanded accounting equation
Assets 5 Liabilities 1 Equity; Equity equals [Owner capital 2 Owner withdrawals 1 Revenues 2 Expenses] for a noncorporation; Equity equals [Contributed capital 1 Retained earnings 1 Revenues 2 Expenses] for a corporation where dividends are subtracted from retained earnings.
Assets = Liabilities + Owner, Capital - Owner, Withdrawals + Revenues - Expenses
Amount earned after subtracting all expenses necessary for and matched with sales for a period; also called income, profit, or earnings.
Excess of expenses over revenues for a period.
Most organizations maintain Websites that include accounting data—see Research in Motion (RIM.com) as an example. The SEC keeps an online database called EDGAR (www.SEC.gov/edgar.shtml), which has accounting information for thousands of companies that issue stock to the public (EDGAR is being upgraded and renamed IDEA). Information services such as Finance.Google.com and Finance.Yahoo.com offer additional online data and analysis.
Exchanges of economic value between one entity and another entity.
Activities within an organization that can affect the accounting equation.
Happenings that both affect an organization's financial position and can be reliably measured.
There are 3 basic types of company operations: (1) Services—providing customer services for profit, (2) Merchandisers—buying products and re-selling them for profit, and (3) Manufacturers—creating products and selling them for profit.
If FastForward pays $500 cash in transaction 4, how does this partial payment affect the liability to CalTech? What would be FastForward's cash balance?
Answers: The liability to CalTech would be reduced to $6,600 and the cash balance would be reduced to $1,000.
Receipt of cash is not always a revenue
This section introduces us to how financial statements are prepared from the analysis of business transactions. The four financial statements and their purposes are:
1. Income statement
Financial statement that subtracts expenses from revenues to yield a net income or loss over a specified period of time; also includes any gains or losses.
—describes a company's revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities.
2. Statement of owner's equity
Report of changes in equity over a period; adjusted for increases (owner investment and net income) and for decreases (withdrawals and net loss).
—explains changes in equity from net income (or loss) and from any owner investments and withdrawals over a period of time.
3. Balance sheet
Financial statement that lists types and dollar amounts of assets, liabilities, and equity at a specific date.
—describes a company's financial position (types and amounts of assets, liabilities, and equity) at a point in time.
4. Statement of cash flows
A financial statement that lists cash inflows (receipts) and cash outflows (payments) during a period; arranged by operating, investing, and financing.
—identifies cash inflows (receipts) and cash outflows (payments) over a period of time.
Net income is sometimes called earnings or profit.
A statement's heading identifies the company, the statement title, and the date or time period.
Arrow lines show how the statements are linked. Net income is used to compute equity. Owner capital is used to prepare the balance sheet. Cash from the balance sheet is used to reconcile the statement of cash flows.
The income statement, the statement of owner's equity, and the statement of cash flows are prepared for a period of time. The balance sheet is prepared as of a point in time.
A single ruled line denotes an addition or subtraction. Final totals are double underlined. Negative amounts are often in parentheses.
Statement of Owner's Equity
The statement of owner's equity is also called the statement of changes in owner's equity. Note: Beg. Capital + Net Income − Withdrawals = Ending Capital
Statement of Cash Flows
Statement of cash flows has three main sections: operating, investing, and financing.
Payment for supplies is an operating activity because supplies are expected to be used up in short-term operations (typically less than one year).
Investing activities refer to long-term asset investments by the company, not to owner investments.
Return on Assets
Return on Assets = Net Income / Average Total Assets
Monies received from an investment; often in percent form.
Uncertainty about an expected return.
Average Returns for Bonds with Different Risks
U.S. Treasury - 3.6%
Low-Risk Corporate - 4.8%
Medium-Risk Corporate - 6.3%
High-Risk Corporate - 8.0%
Appendix 1A Return and Risk Analysis
This appendix explains return and risk analysis and its role in business and accounting.
Appendix 1B Business Activities and the Accounting Equation
This appendix explains how the accounting equation is derived from business activities.
There are three major types of business activities: financing, investing, and operating. Each of these requires planning. Planning involves defining an organization's ideas, goals, and actions. Most public corporations use the Management Discussion and Analysis section in their annual reports to communicate plans. However, planning is not cast in stone. This adds risk to both setting plans and analyzing them
Management must understand accounting data to set financial goals, make financing and investing decisions, and evaluate operating performance.
Investing (assets) and financing (liabilities plus equity) totals are always equal.
A-1 pays its own income taxes and has two owners.
Ownership of Zeller Company is divided into 1,000 shares of stock.
Waldron is owned by Mary Malone, who is personally liable for the company's debts.
Micah Douglas and Nathan Logan own Financial Services, a financial services provider. Neither Douglas nor Logan has personal responsibility for the debts of Financial Services.
Bailey and Kay own Squeaky Clean, a cleaning service. Both are personally liable for the debts of the business.
Plasto Products does not pay income taxes and has one owner.
Ian LLC does not have separate legal existence apart from the one person who owns it.
Office Mart has assets equal to $123,000 and liabilities equal to $53,000 at year-end. What is the total equity for Office Mart at year-end?
At the beginning of the year, Logan Company's assets are $200,000 and its equity is $150,000. During the year, assets increase $70,000 and liabilities increase $30,000. What is the equity at the end of the year?
At the beginning of the year, Keller Company's liabilities equal $60,000. During the year, assets increase by $80,000, and at year-end assets equal $180,000. Liabilities decrease $10,000 during the year. What are the beginning and ending amounts of equity?
Beginning Equity: $40,000
Ending Equity: $130,000
An owner contributes resources to the business.
An organization purchases equipment.
An organization advertises a new product.
The organization borrows money from a bank.
An organization sells some of its land.
A business has assets of $154,000 and liabilities of $67,000. How much is its equity?
Assets = Liabilities + Equity
$154,000 = $67,000 + Equity
$154,000 - $67,000 = Equity = $87,000
Brian Company had net income of $16,700 in 2010. Total assets were $134,000 at the beginning of the year and $174,000 at the end of the year. Calculate return on assets.
Return on Assets = Net Income ÷ Average Total Assets
Return on Assets = $16,700 ÷ (($134,000 + $174,000) ÷ 2) = 10.84%
The performance of service for a customer or client and immediate receipt of cash will
Increase an asset and increase equity
The report of assets, liabilities and equity is called the
The financial statements that are dated for a time period (rather than a specific time) are the
Income statement and statement of owner's equity
Colby Company had assets of $280,000 and liabilities of $120,000 at the beginning of the year, and assets of $400,000 and liabilities of $140,000 at the end of the year. During the year, there was an investment of $40,000 in the business and the owner withdrew $48,000 from the business. What amount of net income dud the company earn during the year?
Beginning of the year—Accounting Equation: $280,000 = $120,000 + Equity
Equity = $280,000 - $120,000 = $160,000
End of the year—Accounting Equation: $400,000 = $140,000 + Equity
Equity = $400,000 - $140,000 = $260,000
Statement of Owner's Equity:
Beginning of the Year Equity
End of the Year Equity
**Just need to work backwards to calculate net income. For example, $260,000 + $48,000 - $40,000 - $160,000 = $108,000
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