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financial accounting book part 1
Terms in this set (98)
an information system that measures, processes, and communicates financial information about an economic entity. it focus on the needs of decision makers who use financial information, whether those decision makers are inside or outside a business or other economic entity. it provide a vital service by supplying the information decision makers need to make "reasoned choices among alternative uses of scarce resources in the conduct of business and economic activities. 1. they measures business activities by recording data about them for future use. 2. the data are stored until needed and then processed to become useful information. 3. the information is communicated through reports to decision makers.
a unit that exists independently, such as a business, a hospital, or a governmental body.
A economic unit that aims to sell goods and services to customers at prices that will provide an adequate return to its owners. like Wal-Mart Corp. comprehensive discount store, Reebok international Ltd. Athletic footwear and clothing, Best Buy Co. Consumer electronics, personal computers; Wendy's International Inc. Food service, Starbucks Corp. Coffee, and Southwest Airlines Co. Passenger airline. For example Toyota may meet the goal of profitability by selling many cars at a price that earns a profit, but if its customers do not pay for their cars quickly enough to enable Toyota to pay its suppliers and employees, the company may fail to meet the goal of liquidity. If a company is to survive and be successful, it must meet both goals.
The ability to earn enough income to attract and hold investment capital.
The ability to have enough cash to pay debts when they are due.
Selling goods and services to customers, employing managers and workers, buying and producing goods and services, and paying taxes through more than 3,500 Drugstores and Pharmacies.
Spending the capital a company receives in productive ways that will help it achieve its objectives. These activities include buying land, buildings, equipment, and other resources that are needed to operate the business and selling them when they are no longer needed. Invests Funds in Furniture, fixtures and equipment; Improvements to buildings, and computer equipment.
Obtaining adequate funds, or capital, to begin operations and to continue operating. There activities include obtaining capital/Funds from creditors, such as banks and suppliers, and from owners. They also include repaying creditors and paying a return to the owners.
It indicate whether managers are achieving their business goals and whether the business activities are well manged. These performance measures must align with the goals of the business. For example, CVS, like all other companies, considers earned income to be a measure of profitability and cash flow to be a measure of liquidity. it measure for operating activities might be the ratio of expenses to the revenue of the business. it measure for financing activities might be the ratio money owed by the company to the total resources that it controls.
it provides internal decision makers who are charged with achieving the goals of profitability and liquidity with information about financing, investing, and operating activities. Mabagers and employees who conduct the activities of the business need information that tells them how they have done in the past and what they can expect in the future. For example, The Gap, a retail clothing business, needs an operating report on each outlet that tells how much was sold at that outlet and what costs were incurred, and it needs a budget for each outlet that projects the sales and costs for the next year.
it generates reports and communicates them to external decision makers so they can evaluate how well the business has achieved its goals. These reports are called financial statements. CVS, whose stock is traded on the New York Stock Exchange, send its financial statements to its owners (called stockholders), its banks and other creditors, and government regulators.
it report directly on the goals of profitability and liquidity and are used extensively both inside and outside a business to evaluate the business's success. it important for every person involved with a business to understand it. they are a central feature of accounting and a primary focus of this book.
mechanical and repetitive; it is the process of recording financial transactions and keeping financial records. it is a small---but important---part of accounting.
an electronic tool used to collect, organize, and communicate vast amounts of information with great speed. they can perform both routine bookkeeping chores and complex calculations. Accountants were among the earliest and most enthusiastic users of computers, and today they use computers in all aspects of their work. they make it possible to create a management information system to organize a business's many information needs.
Management information system (MIS)
it consists of the interconnected subsystems that provide the information needed to run a business. it is the most important subsystem because it plays the key role of managing the flow of economic data to all parts of a business and to interested parties outside the business.
A code of conduct that applies to everyday life. it addresses the question of whether actions are right or wrong. Actions---whether ethical or unethical, right or wrong---are the product of individual decisions. Thus, when an organization acts unethically by using false advertising, cheating customers, polluting the environment or treating employees unfairly, it is not the organization that is responsible--- it is the members of management and other employees who have made a conscious decision to act in this manner. it especially important in preparing financial reports because users of these reports must depend on the good faith of the people involved in their preparation. Users have no other assurance that the reports are accurate and fully disclose all relevant facts. To meet the high ethical standards of the accounting profession, they must apply accounting concepts in such a way as to present a fair view of a company's operations and financial position and to avoid misleading readers of their reports.
Fraudulent financial reporting
The intentional preparation of misleading financial statements. it can result from the distortion of records (e.g., themanipulation of inventory records), falsified transactions (e.g., fictionious sales), or the misapplication of various accounting principles. There are a number of motives for fraudulent reporting---For instance, to cover up financial weakness in order to obtain a higher price when a company is sold, to meet the expectations of stockholders and financial analysts, or to obtain a loan. The incentive can also be personal gain, such as additional compensation, promotion, or avoidance of penalties for poor performance. Whatever the motive for FFR, it can have dire consequences, as the account scandals that erupted at Enron Corporation and WorldCom in 2001 and 2002 attest. Unethical financial reporting and accounting practices at those two major corporations caused thousands of people to lose their jobs, their investment incomes, and their pensions. they also resulted in prison sentences and fines for the corporate executives who were involved.
it regulate financial reporting and the accounting profession among other things. Thsi legislation order the Securities and Exchange Commission (SEC) to draw up rules requiring the chief executives and chief financial officers of all publicly traded U.S. companies to swear that, based on their knowledge, the quarterly statements and annual reports that their companies file with the SEC are accurate and complete. Violation can result in criminal penalties.
A company's management
it expresses its duty to ensure that financial reports are not false or misleading in the management report that appears in the company's annual report. For example, in it management report, Target Corporation makes the following statement: Management is responsible for the consistency, integrity, and presentation of the information in the Annual Report.
it refers to the people who are responsible for operating a business and meeting its goals of profitability and liquidity. In a small business, management may consist solely of the owners. In a large business, management usually consists of people who have been hired to do the job. They must decide what to do, how to do it, and whether the results match their original plans. Successful managers consistently make the right decisions based on timely and valid information. To make good decisions, they at CVS and other companies need answers to such questions as: What were the company's earnings during the past quarter? Is the rate of return to the owners adequate? Does the company have enough cash? Which products or services are most profitable? what is the cost of manufacturing each product or providing each service? this is one of the most important users of accounting information.
based on accounting data
The basic management function
they performs function that are essential to the operation of a business. The same basic functions must be performed, and each requires accounting information on which to base decisions.
Financing the business
obtaining funds so that a company can begin and continue operating. One of the basic management functions
Investing assets in productive ways that support a company's goals. One of the basic management functions
Producing goods and services
Managing the production of goods and services. One of the basic management functions
Marketing goods and services
Overseeing how goods or services are advertised, sold, and distributed. One of the basic management functions
Overseeing the hiring, evaluation, and compensation of employees. One of the basic management functions
Providing information to decision makers
Gathering data about all aspects of a company's operations, organizing the data into usable information, and providing reports to managers and appropriate outside parties. accounting plays a key role in this function. One of the basic management functions
Users with a direct financial interest
They depend on accounting to measure and report information about how a business has performed. Most businesses periodically publish a set of general-purpose financial statements that report their success in meeting the goals of profitability and liquidity. These statements show what has happened in the past, and they are important indicators of what will happen in the future. many people outside the company carefully study these financial reports.
Those, such as CVS's stockholders, who invest or may invest in a business and acquire a part ownership in it are interested in its past success and its potential earnings. A thorough study of a company's financial statements help potential investors judge the prospects for a profitable investment. after investors, they must continually review their commitment, again by examining the company's financial statements. One of users with a direct financial interest
Most companies, including CVS, borrow money for both long- and short-term operating needs. creditors, those who lend money or deliver goods and services before being paid, are interested mainly in whether a company will have the cash to pay interest charges and to repay the debt at the appropriate time. they study a company's liquidity and cash flow as well as its profitability. Banks, finance companies, mortgage companies, securities firms, insurance firms, suppliers, and other lenders must analyze a company's financial position before they make a loan. One of users with a direct financial interest.
Users with an indirect financial interest
One of the largest and most important users of accounting information. Users who need accounting information to make decisions on public issues.
Government at every level is financed through the collection of taxes. companies and individuals pay many kinds and taxes, including federal, state, and city income taxes; social security and other payroll taxes; excise taxes; and sales taxes. each tax requires special tax returns and often a complex set of records as well. Proper reporting is generally a matter of law and can be very complicated. The Internal Revenue Code, for instance, contains thousands of rules governing the preparation of the accounting information used in computing federal income taxes.
Most companies must report periodically to one or more regulatory agencies at the federal, state, and local levels. For example, all publicly traded corporations must report periodically to the Securities and Exchange Commission SEC. This body, set up by Congress to protect the public, regulates the issuing, buying, and selling of stock in the US. Companies listed on a stock exchange also must meet the special reporting requirements of their exchange.
Labor unions study the financial statements of corporations as part of preparing for contract negotiation; a company's income and costs often play an important role in these negotiations. Those who advise investors and creditors---financial analysts, brokers, underwriters, lawyers, economists, and the financial press---also have an indirect interest in the financial performance and prospects of a business. Consumer groups, customers, and the general public have become more concerned about the financing and earnings of corporations as well as the effects that corporations have on inflation, the environment, social issues, and the quality of life. and economic planners, among them the president's Council of Economic Advisers and the Federal Reserve Board, use aggregated accounting information to set and evaluate economic policies and programs.
Chief financial officer CFO
New business partner of the chief executive officer (CEO) Increasingly required to take on responsibilities for strategic planning, mergers and acquisition, and task involving international operations, and many of them are becoming CEOs of their companies. Those who do become CEOs are finding that "a financial background is invaluable when they're saddled with the responsibility of making big calls."
what is measured?- Every system must deWhen should the measurement be made? What value should be placed on what is measured? How should what is measured be classified? accountants in industry, professional associations, public accounting, government, and academic circles debate the answers to these questions constantly, and the answers change as new knowledge and practice require.
Economic events that affect a business's financial position. Businesses can have hundreds or even thousands of transactions every day. These transactions are the raw material of accounting reports. A transaction can be an exchange of value (a purchase, sale, payment, collection, or loan) between two or more parties. a transaction also can be economic event that has the same effect as an exchange transaction but that does not involve an exchange. Some examples of "nonexchange" transactions are losses from fire, flood, explosion, and theft; physical wear and tear on mashinery and equipment; and the day-by-day accumulation of interest. To be recorded, a transaction must relate directly to a business entity. Suppose a customer but toothpaste from CVS is out of shampoo. The transaction in which the toothpaste was sold is entered in CVS's records. However, the purchase of the shampoo from the competitor is not entered in CVS's records because even though it indirectly affects CVS economically, it does not involve a direct Exchange of value between CVS and the customer.
All business transactions are recorded in terms of money. Non-financial information may also be recorded, but it is through the recording of monetary amounts that a business's transactions and activities are measured. Money is the only factor common to all business transactions, and thus it is the only unit of measure capable of producing financial data that can be compared.
The monetary unit
a business uses depends on the country in which the business resides. For example, in the US, the basic unit of money is the dollar. In Japan, it is the yen; In Europe, the euro; and in the United Kingdom, the pound. In international transaction, exchange rates must be used to translate from one currency to another.
the value of one currency in terms of another. For example, a British person purchasing goods from a U.S. company like CVS and paying in U.S. dollars must exchange British pounds for U.S. dollars before making payment. In effect, currencies are goods that can be bought and sold. the example of foreign exchange rates at the price in $ U.S: Australia (dollar) 0.769, Brazil (real) 0.38, Britain (pound) 1.88, Canada (dollar) 0.82, Europe (euro) 1.29, Hong Kong (dollar) 0.13, Japan (yen) 0.009, Mexico (peso) 0.09, Russia (ruble) 0.036, and Singapore (dollar) 0.602
a business distinct not only from its creditors and customers but also from its owners. It should have its own set of financial records, and its records and reports should refer only to its own affairs. For example, Just Because Flowers Company should have a bank account separate from the account of Holly Sapp, the owner. Holly Sapp may own a home, a car, and other property, and she may have personal debts, but these are not the resources or debts of jest because flowers. Holly sapp may own another business, say a stationery shop. If shoe does, she should have a completely separate set of records for each business.
A business owned by one person. The owner takes all the profits or losses of the business and is liable for all its obligations. it represent the largest number of businesses in the U.S., but typically they are the smallest in size.
a sole proprietorship in most ways, but it has two or more owners. The partners share the profits and losses of the business according to a prearranged formula. Generally, any partner can obligate the business to another party, and the personal resources of each partner can be called on to pay the obligations. they must be dissolved if the ownership changes as when a partner leaves or dies. If the business is to continue as a partnership after this occurs, a new partnership are convenient ways of separating the owners' commercial activities from their personal activities. Legally, however, there is no economic separation between the owners and the businesses.
a business unit chartered by the state and legally separate from its owners (the stockholders). The stockholders, whose ownership is represented by shares of stock, do not directly control the corporation's operations. Instead, they elect a board of directors to run the corporation for their benefit. In exchange for their limited involvement in the corporation's operation, stockholders enjoy limited liability; that is, their risk of loss is limited to the amount they paid for their shares. Thus, stockholders are often willing to invest in risky, but potentially profitable, activities. also, because stockholders can sell their shares without dissolving the corporation, the life of a corporation is unlimited and not subject to the whims or health of a proprietor or a partner.
Formation of a Corporation
To form a corporation, most states require individuals, called incorporators, to sign an application and file it with the proper state official. This application contains the articles of incorporation. If approved by the state, these articles, which form the company charter, become a contract between the state and the incorporators. The company is then authorized to do business as a corporation.
Organization of a Corporation
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. the stockholders elect a board of directors, which sets corporate policies and chooses the corporation's officers, who in turn carry out the corporate policies in their management of the business.
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; this may be less than the number authorized in the articles of incorporation. To invest in a corporation, a stockholder receives shares of stock representing a proportionate share of ownership in the corporation. Afterward the stockholder may transfer the share at will. Corporations may have more than one kind of stock, but in the first part of this book, we refer only to common stock---the most universal form of stock.
Board of Directors
they decides on major business policies. Among the board's specific duties are authorizing contracts, setting executive salaries, and arranging major loans with banks. The declaration of dividends is also an important function of the board of directors. The composition of the board of directors varies from company to company, but generally it includes several officers of the corporation and several outsiders. The outsiders are called independent directors because they do not directly participate in managing the business.
distributions of resources, generally in the form of cash, to stockholders, and only the board of directors has the authority to declare them. paying dividends is one way of rewarding stockholders for their investment when the corporation has been successful in earning a profit. (the other way is through a rise in the market value of the stock.) Although there is usually a delay of two or three weeks between the time the board declares a dividend and the date of the actual payment, we assume that declaration and payment are made on the same day.
they appointed by the board of directors to carry out corporate policies and run day-to-day operations, consists of the operating officers---generally the president, or chief executive officer; vice presidents; chief financial officer; and chief operating officer. Besides being responsible for running the business, management has the duty of reporting the financial results of its administration to the board of directors and the stockholders. Though management must, at a minimum, make a comprehensive annual report, it generally reports more often. The annual reports of large public corporations are available to the public.
the oversight of a corporation's management and ethics by its board of directors. it's growing and is clearly in the best interests of a business. A recent survey of 124 corporations in 22 countries found that 78% of boards of directors had established ethical standards, a fourfold increase over a 10-year period. In addition, research has shown that, over time, companies with codes of ethics tend to have higher stock prices than those that have not adopted such codes. To strengthen corporate governance, a provision of the Sarbanes-Oxley Act required boards of directors to eastblish an audit committee made up of independent directors who have financial expertise. This provision was aimed at ensuring that boards of directors would be objective in evaluating management's performance.
The audit committee
This provision was aimed at ensuring that boards of directors would be objective in evaluating management's performance. they are responsible for engaging the corporation's independent auditors and reviewing their work. they need to ensure that adequate systems exist to safeguard the corporation's resources and that accounting records are reliable. In short, they are in the front line of defense against fraudulent financial reporting
a company's economic resources, such as cash, inventory, and buildings, and the claims against those resources at a particular time.
Every corporation has two types of equities: Creditors' equities, such as bank loans, and stockholders' equity. (In the case of sole proprietorship and partnerships, which do not have stockholders, stockholders' equity is called owners' equity.) The sum of these equals a corporation's resources: Economic Resources = Creditors' Equities + Stockholders' Equity.
Assets = Liabilities + Stockholders' Equity. Economic resources are called assets and Creditors' Equities are called liabilities.
the economic resources of a company that are expected to benefit the company's future operations. Certain kinds of assets--For example---Cash and money that customers owe to the company (called accounts receivable)---are monetary items. Other assets---inventories (goods held for sale), land, buildings, and equipment---are nonmonetary, physical items. Still other assets---the rights granted by parents, trademarks, and copyrights---are nonphysical.
a business's present obligations to pay cash, transfer assets, or provide services to other entities in the future. Among these obligations are amounts owed to suppliers for goods or services bought on credit (called accounts payable), borrowed money (e.g., money owed on bank loans), salaries and wages owed to employees, taxes owed to the government, and services to be performed. as debts, liabilities are claims recognized by law. That is, the law gives creditors the right to force the sale of a company's assets if the company's assets if the company fails to pay its debts. Creditors have rights over stockholders and must be paid in full before the stockholders receive anything, even if payment of the debt uses up all the assets of the business.
Stockholders' equity / shareholders' equity
the claims of the owners of a corporation (the shareholders) to the assets of the business. Theoretically, it is what would be left over if all liabilities were paid, and it is sometimes said to equal net assets. By rearranging the account equation, we can define this equation this way: ? = assets - liabilities. there are two parts: contributed Capital and retain earnings. ? = Contributed capital + Retained Earnings
the amount that stockholders invest in the business. their ownership in the business is represented by shares of capital stock. Stock certificate, which represents such ownership. it's divided between par value and additional paid-in capital.
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.
Additional paid-in capital
When the value received is greater than par value.
it represent stockholders' equity that has been generated by the business' income-producing activities and kept for use in the business. they are affected by three kinds of transactions: revenues, expenses, and dividends.
the increases in stockholders' equity that result from operating a business. For example, the amount a customer pays (or agrees to pay in the future) to CVS in return for a product or service is a revenue to CVS. CVS's assets increase, as does its stockholders' equity in those assets.
the decreases in stockholders' equity that result from operating a business. For example, the amount CVS must pay out (or agree to pay out) so that it can provide a product or service. In this case, the assets decrease or the liabilities increase, and the stockholders' equity decreases.
When revenues exceed expenses
When expenses exceed revenues
it summarizes the revenues earned and expense incurred by a business over an accounting period. many people consider it the most important financial report because it shows whether a business achieved its profitability goal--that is, whether it earned an acceptable income. The steps for multistep form of the income statement are gross margin, operating profit, earnings before income tax provision, and net earnings.
statement of retained earnings
it the changes in retained earnings over an accounting period. Beginning retained earnings + net income minus less dividends equal ending retained earnings
to show the financial position of a business on a certain date, usually the end of the month or year. assets equal liability minus equity/capital. it often is called the statement of financial position and is dated as of a specific date. In the assets and liabilities sections, the company separates out the current assets and the current liabilities. Current assets will become available as cash or will be used up in the next year; Current liabilities will have to be paid or satisfied in the next year. These groupings are useful in assessing a company's liquidity.
Statement of cash flows
it focuses on its liquidity. operating activities + Investing activities + Financing activities = ? if they reflects profitability, the statement of cash flows reflect its liquidity.
the inflows and outflows of cash into and out of a business. Net cash flows are the difference between the inflows and outflows.
Generally accepted accounting principles (GAAP)
to ensure that financial statements are understandable to their users, a set of practices. it developed to provide guidelines for financial accounting. it encompass the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.
Certified public accountant (CPA)
they are licensed by all states for the same reason that lawyers and doctors are---to protect the public by ensuring the quality of professional service. Independent means that they are not an employee of the company being audited and has no financial or other compromising ties with it.
an examination of a company's financial statements and the accounting systems, controls, and records that produced them. the purpose of this is to ascertain that the financial statements have been prepared in accordance with generally accepted accounting principles.
Public Company Accounting Oversight Board (PCAOB)
A governmental body created by the Sarbanes-Oxley Act, regulates the accounting profession and has wide powers to determine the standards that auditors must follow and to discipline them if they do not
Financial Accounting Standards Board (FASB)
The most important body for developing rules on accounting practice. This independent body has been designated by the Securities and Exchange Commission (SEC) to issue the Statements of Financial Accounting Standards
American Institute of Certified Public Accountants (AICPA)
The professional association of certified public accountants, influences accounting practice through the activities of its senior technical committees.
Securities and Exchange Commission (SEC)
an agency of the federal government that has the legal power to set and enforce accounting practices for companies whose securities are offered for sale to the general public. As such, it has enormous influence on accounting practice.
Governmental Accounting Standards Board (GASB)
Which was established in 1984 under the same governing body as the FASB, is responsible for issuing accounting standards for state and local governments.
International Accounting Standards Board (IASB)
the growth of financial markets throughout the world, global cooperation in the development of accounting principles has become a priority.
Internal Revenue Service (IRS)
it Interprets and enforces these rules. In some cases, the rules conflict with good accounting practice, but they are nonetheless an important influence on practice. Cases in which the tax laws affect accounting practice are noted throughout this book.
Key to the accountant's reputation for independence and competence. the code of this ethics of the American Institute of Certified Public Accountants governs the conduct of CPAs. Fundamental to this code is responsibility to clients, creditors, investors, and anyone else who relies on the work of a CPA. The code of CPAs to act with integrity, objectivity, and independence.
the accountant is honest and candid and subordinates personal gain to service and the public trust.
the accountant is impartial and intellectually honest.
the accountant avoids all relationships that impair or even appear to impair his or her objectivity.
they must exercise in all activities, carrying out professional responsibilities with competence and diligence. For example, an accountant must not accept a job for which he or she is not qualified, even at the risk of losing a client to another firm, and careless work is unacceptable. These board principles are supported by more specific rules that public accountants must follow; for instance, with certain exceptions, client information must be kept strictly confidential. Accountants who violate the rules can be disciplined or even suspended from practice.
Institute of Management Accountants (IMA)
a code of professional conduct. It emphasizes that management accountants have a responsibility to be competent in their jobs, to keep information confidential except when authorized or legally required to disclose it, to maintain integrity and avoid conflicts of interest, and to communicate information objectively and without bias.
Return on assets ratio
A ratio that show how efficiently a company is using its assets to produce income; Net income / average total assets = ?
The most common form of stock
Assets - liabilities; stockholders' equity or owners' equity.
share of stock
A unit of ownership in a corporation.
it occurs when it consists of more than one company and has combined the companies' data for reporting purposes.
Comparative financial statements.
CVS provides several years of data for each financial statement: two year for the balance sheet and three years for the others. such statements are in accordance with generally accepted accounting principles and help readers assess the company's performance over several years.
Summary of Significant Accounting Policies
GAAP require that the financial statements. In most case, this summary is presented in the first note to the financial statements or as a separate section just before the notes. In this summary, the company tells which GAAP it has followed in preparing the statements. For example, in CVS's report, the company states the principles followed for revenue recognition: "the company recongnizes revenue from the sale of merchandise at the time the merchandise is sold. Service revenue from the Company's pharmacy benefit management segment, which is recognized using the net method.
Interim financial statements
In recent years, the FASB and the SEC have ruled that certain supplemental information must be presented with financial statements. Examples are the quarterly reports that most companies present to their stockholders and to the SEC. These quarterly reports called this statements. In most case reviewed but not audited by a company's independent CPA firm. In its annual report, CVS presents unaudited quarterly financial datat from its 2004 quarterly statements. The quarterly data also includes the high and low price for the company's common stock during each quarter.
Registered independent auditor's report
it deals with the credibility of the financial statements. This report prepared by independent certified public accountants, gives the accountants' opinion about how fairly the statements have been presented. Because management is responsible for preparing the financial statements, issuing statements that have not been independently audited would be like having a judge hear a case in which he or she was personally involved. The CPA acting independently, add the necessary credibility to management's figures for interested third parties. They report to the board of directors and the stockholders rather than to the company's management.
In forma and language, Usually, such a report is shot, but its language is very important. it normally has four parts, but it can have a firth part if an explanation is needed. The first paragraph identifies the financial statements that have audited. it also identifies responsibilities. The company's management is responsible for the financial statements, and the auditor is responsible for expressing an opinion on the financial statements based on the audit. the second paragraph, or scope section, states that the examination was made in accordance with standard of the PCAOB. This paragraph also contains a brief description of the objectives and nature of the audit. The third paragraph, or opinion section, states the results of the auditors' examination. The use of the word opinion is very important because the auditor does certify or guarantee that the statements are absolutely correct. To do so would go beyond the truth, because many items, such as depreciation, are based on estimates. Instead, the auditors simply give an opinion about whether, overall, the financial position, results of operations, and cash flows. This means that the statements are prepared in accordance with GAAP. If, in the auditors' opinion, the statements do not meet accepted standards, the auditors must explain why and to what extent. The fourth paragraph says the company's internal controls are effective.
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