Introduction

Business consists of all the activities necessary to provide the members of an economic system with goods and services.

 

Forms of organization:

ü      Sole Proprietorships

ü      Partnerships

ü      Corporations

 

3 categories of business activity

I.                Operating Activities

Ø     The actual operation of the business.

Ø     Revenues - the value of assets a business receives from the sale of merchandise or the performance of services.

Ø     Expenses - the cost of assets consumed or services used in the process of generating revenue.

 

II.            Investing Activities

Ø     Acquiring the resources needed to operate--equipment, buildings, etc.

Ø     Disposing of these resources when they are obsolete or no longer needed

 

III.       Financing Activities

Ø     Acquiring the money necessary to acquire resources for a business and operate a business. Also paying back the money.

Ø     Borrowing

Ø     Repaying borrowings

Ø     Selling ownership interests in a business

Ø     Repurchasing ownership interests

 

Chapter 1 – Accounting Information: Users and Uses

 

What is Accounting?

ü      Accounting is a service activity designed to assist individuals and organizations in deciding how to allocate scarce resources and reach their financial objectives.

v     Purpose is to provide financial information to decision makers.

 

 

 

 

 

 

 

ü      Accounting is used to

v     identify,

v     measure, and

v     communicate information about organizations and to assist in the decision-making process.

 

 

Who Uses Accounting Information?

1.    Internal Users

•      Internal users - planning and controlling the business - also uses financial information to answer the following questions:

ü      Is cash sufficient to pay our debts?

ü      Are customers paying their bills promptly?

ü      What is the cost of each unit of product?

ü      What costs exceed budget?

ü      Can we afford to give employees pay raises this year?

ü      Which product line is the most profitable?

ü      How much money must be borrowed to expand?

 

2.    External Users

•      External users – make-- buy--hold--sell decisions - Investors, lenders, and other external users use financial information to answer the following questions:

o       Is the company earning satisfactory income?

o       How does the company compare in size and profitability with competitors?

o       Will the company be able to pay its debt as they come due?

o       Are interest payments and dividends protected by an adequate inflow of cash from operations?

ü      Other external lenders include:

o       Suppliers and customers

o       Employees (or potential employees)

o       Competitors

o       Governmental agencies

o       The press

External Reports

1.    Accountants communicate through financial statements

2.    Included in the firm’s annual report and quarterly reports

3.    Report financial information to external parties who have an economic interest in the business.

4.    Information is provided in the form of general-purpose financial statements

1.      Balance sheet – reports the company’s :

a.       Assets (resources)

b.      Liabilities (debts; creditors’ claims on the assets)

c.       Owners’ Equity (the owners’ claims on the assets)

 

 

 

 

Owners’ Equity has 2 components:

1. Contributed Capital (Capital Stock in a corporation)
2. Earned Capital (Retained Earnings – the cumulative earnings of a corporation that have not been paid out in dividends)

 

 

2.      Income statement – reports the company’s net income or net loss during a period

a.       Revenues

b.      Expenses

 

 

 

3.      Statement of Owners’Equity– explains the changes in retained

earnings during an accounting period

 

 

4.      Statement of cash flows – reports cash provided by or used by the 3 categories of business activities:

a.       Operating

b.      Investing

c.       Financing

 

 

 

Financial Statement Assumptions

1.    Economic Entity Concept

ü      Each entity has its own books, records and financial statements that are separate from owners

ü      No intermingling of personal and business assets and liabilities or income and expenses

 

2.    Cost Principle

ü      Record assets at cost paid to acquire them

ü      Continue to value assets at historical cost until sold

ü      More objective than market value

 

3.    Going Concern

ü      Assume business will continue indefinitely into the foreseeable future

ü      Justifies use of historical cost

 

 

4.    Monetary Unit

ü      How we measure (e.g. U.S. dollar, Japanese yen, Mexican peso, etc.)

ü      Assumes economic measure is relatively stable; no adjustment for inflation made in financial statements

 

5.    Time Period Assumption

ü      Assumes it is possible to break up an entity’s earnings in discrete time periods (a month, quarter, year)

ü      Necessary to provide users with financial results on a timely basis

ü      Requires use of estimates

 

 

The Rules of the Game

 

The Rules--------> GAAP

The rule makers---------->FASB

The rule enforcers-------------------->SEC

                    The CPA -------------------->regulators