CHAPTER 1 – BA 99.

1 o Financial accounting answers these

Accounting Activities and Users questions
Three Activities of the Accounting  Provides economic and financial
Process information
- Identify o Needs of external users
o Economic events related to business  Taxing authorities: to know
o Select economic events whether the company complies
- Record with tax laws
o Records events in order  Regulatory agencies: to know
o Systematic, chronological diary of whether the company is operating
events within prescribed rules
o Record, classify, and summarize  Customers: to know whether a
company will continue to honor
- Communicate
product warranties and support its
o Through accounting reports: financial
product lines
statements
 Labor unions: to know whether a
o An accountant’s ability to analyze and
company has the ability to pay
interpret is vital
increased wages and benefits
 Analysis involves ratios,
Building Blocks of Accounting
percentages, graphs, and charts
Ethics in Financial Reporting
 Interpretation involves explaining
- Effective financial reporting depends on
the uses, meaning, and limitations
sound ethical behavior
of the reported data
- Steps in analyzing ethics cases in
- The accounting process includes the
situations
bookkeeping function but it usually
1. Recognize an ethical situation and the
involves only the recording
ethical issues involved
Users of Accounting Data
2. Identify and analyze the principal
- Internal Users
elements in the situation
o Managers who plan, organize, and run
3. Identify the alternatives, and weigh
a business the impact of each alternative on
o Questions asked: various stakeholders
 Finance: Is cash sufficient to pay Generally Accepted Accounting
stockholders? Principles
 Marketing: What price should be - Standards that indicate how to report
charged for a product to maximize economic events
the company’s net income? - Set by the Financial Accounting
 Human Resources: Can the Standards Board
company afford to give its - International Financial Reporting
employees pay raises this year? Standards: standards issued by the
 Management: Which product line International Accounting Standards Board:
is most profitable? Should any for countries other than US
product lines be eliminated? Measurement Principles
o Detailed info on a timely basis is - Selection of which principle to follow
needed for internal users to answer relates to trade-offs between relevance
these questions and faithful representation
o Managerial Accounting: provides o Relevance: financial info is capable of
internal reports to help make decisions making a difference in a decision:
about their companies predictive
- External Users o Faithful representation: numbers
o Individuals and organizations outside a and descriptions match what really
company who want financial existed or happened: they are factual
information about the company - Historical Cost Principle
o Investors: to decide whether to buy, o Dictates that companies record assets
hold, or sell ownership shares at their cost
o Creditors: to evaluate risks of o True at the time the asset is purchased
granting credit or lending money and over the time the asset is held
o Questions asked: - Fair Value Principle
 Investors o Assets and liabilities should be
 Is the company earning reported at fair value: price received
satisfactory income to sell an asset or settle a liability
 How does the company o May be more useful for certain types of
compare in size and profitability assets and liabilities
with other companies? Assumptions
 Creditors - Provide a foundation for the accounting
 Will the company be able to process
pay its debts as they come - Monetary Unit Assumption
due?
oCompanies should include in the - Ownership claim on total assets
accounting records only transactions - Total assets – liabilities
that can be expressed in money - Often referred to as residual equity
terms o Increases in Owner’s Equity
o Quantify economic events  Investments by owner
o Vital to apply the historical cost  Revenue
principle o Decreases in Owner’s Equity
- Economic Entity Assumption  Drawings
o Economic entity: can be any  Expenses
organization or unit in society Analyzing Business Transactions
o Activities of the entity must be kept - Accounting information system:
separate and distinct from the system of collecting and processing
activities of its owner and all other transaction data and communicating
economic entities financial information to decision-makers
Proprietors - Owned by one person - Factors that shape a company’s
hip - Owner is often the accounting information system:
manager/operator o Nature of the company’s business
- Often small service-type o Type of transactions
businesses o Size of company
- Usually only a relatively o Volume of data
small amount of capital o Information demands of management
is needed and others
- No legal distinction - Most businesses use computerized
between the business accounting systems: electronic data
and the owner as processing systems
economic units: o Handles all the steps involved in the
accounting records recording process
are separate - Accounting information systems rely on
Partnership - Owned by two or more the accounting cycle
persons Analyze
Adjusted Financial
- Partnership agreement business
transactions
Trial Balance Statements
sets forth terms
(investments, duties,
Adjusting Closing
division of income, Journalize
Entries Entries
settlement)
Corporation - Organized as a separate
Unadjusted Post-closing
legal entity under state Post
Trial Balance Trial Balance
corporation law
- Limited liability for
stockholders Accounting Transactions
- May transfer their - Transactions: business’ economic
shares to other investors events recorded by accountants
The Accounting Equation o External: between the company and
some outside enterprise
Basic Accounting Equation o Internal: occur entirely within one
Assets = Liabilities + Owner’s Equity company
- There are activities that do not represent
- Liabilities appear before the owner’s business transactions that may lead to
equity because it is paid first if the business transactions
business is liquidated - Transaction Identification Process
- Applies to all economic entities o Is the financial position (assets,
- Provides the underlying framework for liabilities, or owner’s equity) of
recording and summarizing economic the company changed?
events - Each transaction must have a dual effect
Assets on the accounting equation
- Resources a business owns Transaction Analysis
- Used to carry out production and sales - Each transaction is analyzed in terms of
- Has the capacity to provide future its effect on:
services or benefits o The three components of the basic
Liabilities accounting equation (assets, liabilities,
- Claims against assets: existing debts owner’s equity)
and obligations o Specific types of items within each
- Payable through: component
o Accounts payable o The two sides of the equation must
o Note payable always be equal
o Loan payable o Owner’s capital, owner’s drawings,
Owner’s Equity revenues, and expenses columns
indicate the causes of each change in
the owner’s claim on assets
The Four Financial Statements
- Income Statement: presents revenues
and expenses and resulting net income or
net loss for a specific period
- Owner’s Equity Statement:
summarizes the changes in owner’s
equity for a specific period
- Balance Sheet: reports the assets,
liabilities, and owner’s equity at a specific
date
- Statement of Cash Flows: summarizes
information about the cash inflows
(receipts) and outflows (payments) for a
specific period
- The heading of each statement identifies:
o Company
o Type of statement
o Specific date or time period covered by
the statement
- Final sums are double-underlined
- Negative amounts are presented in
parentheses
- Interrelationships of the four financial
statements:
o Net income is computed first and is
needed to determine the ending
balance in owner’s equity
o The ending balance in owner’s equity is
needed in the balance sheet
o The cash shown on the balance sheet
is needed for the statement of cash
flows
Income Statement
- Lists revenues > expenses > net
income/loss
Owner’s Equity Statement
- Same time period that is covered in the
income statement
Balance Sheet
- Total assets > liabilities > owner’s equity
Statement of Cash Flows
- Provides answers to the following
questions:
1. Where did cash come from during the
period?
2. What was cash used for during the
period?
3. What was the change in the cash
balance during the period?