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The Role of Accounting in Business Chapter 1 and Chapter 9  (pp. 260-267 only) A200 - Survey of Accounting University of T...
Objectives <ul><li>Chapter 1 : </li></ul><ul><li>Describe the  types and forms  of businesses, how businesses make money, ...
Obj. 3:  Define Accounting and its role in Business <ul><li>Accounting  is an information system, also called “The languag...
Obj. 1:  Types of Business <ul><li>Manufacturer :  Buys basic inputs (Materials, Labor,  </li></ul><ul><li>and Overhead) f...
Obj. 1:  Forms of Businesses <ul><li>Proprietorship :   Owned by one individual; Not a separate legal entity from owner.  ...
Obj. 1:  Forms of Businesses <ul><li>Corporation :   Legal entity separate from its owners (stockholders.)  </li></ul><ul>...
Obj. 1:  How do businesses make money? <ul><li>Business Strategy:   How a business gains an advantage  </li></ul><ul><li>o...
Obj. 1:  Business Stakeholders <ul><li>External Stakeholders </li></ul><ul><li>Capital Market stakeholders :  Provide fina...
Obj. 2:  Describe the three business activities  <ul><li>Financing:   Acquiring cash or other assets to (1) start a busine...
Obj. 2:  Financing Activities  <ul><li>Financing:   Acquiring cash or other assets to (1) start a business,  </li></ul><ul...
Obj. 2:  Financing Activities  <ul><li>Debt Financing:   Acquiring cash or other assets by borrowing.  </li></ul><ul><li>(...
Obj. 2:  Debt Financing   <ul><li>Common Liabilities   (more on liabilities in Chapter 8) </li></ul><ul><li>Accounts Payab...
Obj. 2:  Financing Activities  <ul><li>Equity Financing:   Acquiring cash or other assets by either selling ownership </li...
Obj. 2:  Financing Activities  <ul><li>Equity Financing:  Dividends   </li></ul><ul><li>When a business finances asset pur...
Obj. 2:  Investing Activities <ul><li>After obtaining financing, the business uses the funds to acquire the </li></ul><ul>...
Obj. 2:  Investing Activities <ul><li>Businesses acquire  Assets  in one of four ways: </li></ul><ul><li>Trade another ass...
Obj. 2:  Operating Activities <ul><li>After acquiring resources (assets), the business can begin operations  </li></ul><ul...
Obj. 2:  Operating Activities <ul><li>Expenses:  Costs incurred during the period to help earn Revenue.   </li></ul><ul><l...
Obj. 3:  Define Accounting and its role in Business <ul><li>Accounting  is an information system, also called “The languag...
Obj. 4:  Describe and illustrate the  Basic Financial Statements . <ul><li>Reporting changes in financial condition over a...
Obj. 4:  Income Statement <ul><li>Starter Corporation  </li></ul><ul><li>Income Statement </li></ul><ul><li>For the month ...
Obj. 4:  Retained Earnings Statement <ul><li>Starter Corporation </li></ul><ul><li>Statement of Retained Earnings </li></u...
Obj. 4:  Balance Sheet <ul><li>Starter Corporation </li></ul><ul><li>Balance Sheet </li></ul><ul><li>as of January 31, 201...
Obj. 4:  Statement of Cash Flows <ul><li>Reports cash inflows (increases) and cash outflows (decreases) in  </li></ul><ul>...
Obj. 4:  Statement of Cash Flows <ul><li>Starter Corporation </li></ul><ul><li>Statement of Cash Flows </li></ul><ul><li>F...
Obj. 5:  Describe eight  basic accounting concepts   underlying financial reporting <ul><li>Generally Accepted Accounting ...
Obj. 5:  Basic Accounting Concepts <ul><li>Business Entity Concept:  We account for the activities of each entity </li></u...
Obj. 5:  Basic Accounting Concepts <ul><li>Cost Concept:  We record assets at their historical cost (the </li></ul><ul><li...
Obj. 5:  Basic Accounting Concepts <ul><li>Objectivity Concept:  We base entries in the accounting records  </li></ul><ul>...
Obj. 5:  Basic Accounting Concepts <ul><li>Adequate Disclosure Concept:  We report in the financial statements  </li></ul>...
Obj. 5:  Basic Accounting Concepts <ul><li>Accounting practice is overseen by the: </li></ul><ul><li>SEC  (Securities and ...
Ch. 9:  Financial Statement Analysis  <ul><li>Comparative analysis of financial statement data:  </li></ul><ul><li>Vertica...
Vertical Analysis Ratios for Chapter 1  <ul><li>COGS %  =  Cost of Sales  ÷ Net Sales Revenue </li></ul><ul><li>Measures h...
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Ch1 & 9 (Rev. 1 10)

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Transcript of "Ch1 & 9 (Rev. 1 10)"

  1. 1. The Role of Accounting in Business Chapter 1 and Chapter 9 (pp. 260-267 only) A200 - Survey of Accounting University of Tennessee Spring 2010
  2. 2. Objectives <ul><li>Chapter 1 : </li></ul><ul><li>Describe the types and forms of businesses, how businesses make money, </li></ul><ul><li>and business stakeholders . </li></ul><ul><li>2. Describe the three business activities: financing, investing, and operating . </li></ul><ul><li>3. Define accounting and explain its role in business. </li></ul><ul><li>4. Describe and illustrate the basic financial statements and how they </li></ul><ul><li>interrelate. </li></ul><ul><li>5. Describe eight basic accounting concepts underlying financial </li></ul><ul><li>reporting. </li></ul><ul><li>Chapter 9 : </li></ul><ul><li>1. Describe basic financial statement analytical procedures. </li></ul>
  3. 3. Obj. 3: Define Accounting and its role in Business <ul><li>Accounting is an information system, also called “The language of </li></ul><ul><li>business”. Accounting provides data to stakeholders so they can evaluate </li></ul><ul><li>the health and future prospects of the business. </li></ul><ul><li>Financial Accounting provides information to external stakeholders. </li></ul><ul><li>We will study financial accounting in Chapters 1-8. </li></ul><ul><li>Managerial Accounting provides information to internal stakeholders. </li></ul><ul><li>We will study managerial accounting in Chapters 10-14. </li></ul><ul><li>Purposes of a Financial Accounting system: </li></ul><ul><li>To report changes in the business’ financial condition over a period </li></ul><ul><li>of time. </li></ul><ul><li>To report the business’ financial condition at a single point in time </li></ul><ul><li>(end of period). </li></ul>
  4. 4. Obj. 1: Types of Business <ul><li>Manufacturer : Buys basic inputs (Materials, Labor, </li></ul><ul><li>and Overhead) from suppliers. Converts them into </li></ul><ul><li>a finished product (“goods”) for sale to merchandisers. </li></ul><ul><li>Merchandiser : Also called “middlemen”. </li></ul><ul><li>Buys finished goods from manufacturers </li></ul><ul><li>and sells them to customers. </li></ul><ul><li>Service : Does not sell goods. Provides services </li></ul><ul><li>to customers (human knowledge, talent, or strength). </li></ul>
  5. 5. Obj. 1: Forms of Businesses <ul><li>Proprietorship : Owned by one individual; Not a separate legal entity from owner. </li></ul><ul><li>Advantages : Easy and inexpensive to organize. </li></ul><ul><li>Disadvantages : Financial resources are limited to what the owner has </li></ul><ul><li>or can individually raise. Owner is 100% liable for all business debt. </li></ul><ul><li>Business income is taxed 100% to the owner. Proprietorship terminates </li></ul><ul><li>when owner dies. </li></ul><ul><li>Partnership : Owned by two or more individuals or other entities. </li></ul><ul><li>Advantages : Easy and can be inexpensive to organize. Generally, more </li></ul><ul><li>financial resources are available to partnerships than to proprietorships. </li></ul><ul><li>Disadvantages : Each partner is legally liable for the actions of other partners. </li></ul><ul><li>Partnership income is taxed to the partners. Partnership terminates when </li></ul><ul><li>partner dies. </li></ul>
  6. 6. Obj. 1: Forms of Businesses <ul><li>Corporation : Legal entity separate from its owners (stockholders.) </li></ul><ul><li>Advantage s: Can generate large amounts of capital through sale of stock </li></ul><ul><li>(ownership shares). Stockholders are at risk for only the amount they invested </li></ul><ul><li>(limited liability). Corporation continues even if stockholders die. </li></ul><ul><li>Disadvantages : Stockholders may not have the control they desire over </li></ul><ul><li>the affairs of the corporation. </li></ul><ul><li>Limited Liability Company (LLC) : Legal entity separate from its owners </li></ul><ul><li>(owners are called members.) </li></ul><ul><li>Advantage s: Members are at risk for only the amount they invested (limited </li></ul><ul><li>liability.) LLCs can generally raise more financial resources than proprietorships </li></ul><ul><li>and partnerships. </li></ul><ul><li>Disadvantages : Business income is taxed to members. LLC terminates when </li></ul><ul><li>members die. </li></ul>
  7. 7. Obj. 1: How do businesses make money? <ul><li>Business Strategy: How a business gains an advantage </li></ul><ul><li>over competitors. How the business increases revenues </li></ul><ul><li>and/or lowers costs to maximize profit. </li></ul><ul><li>Generally, businesses choose one of the following overall strategies: </li></ul><ul><li>Low-cost emphasis : Design and produce products or services of </li></ul><ul><li>acceptable quality at a cost lower than its competitors. </li></ul><ul><li>Premium-price emphasis : Design and produce products or services </li></ul><ul><li>that have perceived unique qualities for which a customer is willing </li></ul><ul><li>to pay a premium price. </li></ul>
  8. 8. Obj. 1: Business Stakeholders <ul><li>External Stakeholders </li></ul><ul><li>Capital Market stakeholders : Provide financial resources to business. </li></ul><ul><li>Lenders: Want the business to succeed so they can be paid back with interest. </li></ul><ul><ul><li>Owners/Stockholders: Want the business to succeed so they can earn a return on their investment. </li></ul></ul><ul><li>Product/Service Market stakeholders : Sell goods or services to the business </li></ul><ul><li>(suppliers) or buy goods or services from the business (customers). They </li></ul><ul><li>want the business to succeed to they can continue dealing with it. </li></ul><ul><li>Government stakeholders : Collect taxes from the business and regulate business </li></ul><ul><li>activities. Want the business to succeed so government revenues increase. </li></ul><ul><li>Internal Stakeholders </li></ul><ul><li>Business managers and employees : Want the business to succeed so they will </li></ul><ul><li>continue to have jobs. </li></ul>
  9. 9. Obj. 2: Describe the three business activities <ul><li>Financing: Acquiring cash or other assets to (1) start a business, </li></ul><ul><li> (2) acquire more assets, and (3) operate the business. </li></ul><ul><li>Investing: After obtaining financing, the business uses the funds to </li></ul><ul><li>acquire the resources it needs to start operating. </li></ul><ul><li>The resources a business invests in are called Assets. </li></ul><ul><li>Operating: After acquiring resources (assets), the business can begin </li></ul><ul><li>operations (the day-to-day business activities that generate </li></ul><ul><li>Revenue and Expenses .) </li></ul><ul><li>The Business Cycle: </li></ul>
  10. 10. Obj. 2: Financing Activities <ul><li>Financing: Acquiring cash or other assets to (1) start a business, </li></ul><ul><li> (2) acquire more assets, and (3) operate the business. </li></ul><ul><li>The basic Accounting equation is: </li></ul><ul><li> Assets = Liabilities + Equity </li></ul><ul><ul><li>Resources owned Creditors’ claims Owners’ claims </li></ul></ul><ul><ul><li>by the business = on the assets of + on the assets of </li></ul></ul><ul><ul><li> the business the business </li></ul></ul><ul><ul><ul><li>The accounting equation reflects the two kinds of financing: </li></ul></ul></ul><ul><ul><ul><li> Debt Financing and Equity Financing </li></ul></ul></ul>
  11. 11. Obj. 2: Financing Activities <ul><li>Debt Financing: Acquiring cash or other assets by borrowing. </li></ul><ul><li>(more on debt financing in Chapter 8) </li></ul><ul><li>Business increases cash or other assets and also increases liabilities, because the amount borrowed must be paid back. See slide #12 for common liabilities. </li></ul><ul><li>Transaction 1 : Starter Corporation began business in January 2010 by </li></ul><ul><li>Issuing (signing) a note payable for $20,000 to First National Bank. How </li></ul><ul><li>does Starter’s accounting equation appear after this transaction? </li></ul><ul><li> Assets = Liabilities + Equity </li></ul><ul><li> 20,000 = 20,000 + 0 </li></ul>
  12. 12. Obj. 2: Debt Financing <ul><li>Common Liabilities (more on liabilities in Chapter 8) </li></ul><ul><li>Accounts Payable: </li></ul><ul><ul><li>Recorded when business buys supplies/goods or uses services (such as </li></ul></ul><ul><ul><li> employees’ labor) without paying cash in the current period. </li></ul></ul><ul><ul><li>Often called “open” accounts payable – no formal contract, no interest. </li></ul></ul><ul><ul><li>Usually short-term (due in less than one year.) </li></ul></ul><ul><li>Notes Payable: </li></ul><ul><ul><li>Recorded when business borrows money (as from a bank) or buys goods </li></ul></ul><ul><ul><li> without paying cash in the current period. </li></ul></ul><ul><ul><li>Formal written contract stipulating specific term and interest due. </li></ul></ul><ul><ul><li>Sometimes short-term, sometimes long-term. </li></ul></ul><ul><ul><li>Seller chooses whether a payable is an open account or a note. </li></ul></ul><ul><li>Bonds Payable: </li></ul><ul><ul><li>Recorded when business borrows money from investors (bondholders). </li></ul></ul><ul><ul><li>Issuing bonds payable typically raises much more cash than issuing a note payable. </li></ul></ul><ul><ul><li>Formal written contract stipulating specific term and interest due. </li></ul></ul><ul><ul><li>Always long-term (due in more than one year.) </li></ul></ul>
  13. 13. Obj. 2: Financing Activities <ul><li>Equity Financing: Acquiring cash or other assets by either selling ownership </li></ul><ul><li>shares (capital stock) in the business, or by operating the business, earning </li></ul><ul><li>and then retaining its earnings (retained earnings). Equity financing increases equity </li></ul><ul><li>and also increases cash or other assets. </li></ul><ul><li>Transaction 2 : Starter Corporation raises another $200,000 in January by issuing </li></ul><ul><li> (selling) capital stock to new owners in exchange for cash. </li></ul><ul><li> Assets = Liabilities + Equity </li></ul><ul><li> 200,000 = 0 + 200,000 </li></ul><ul><li>Transaction 3 : Starter Corporation earns $8,000 in January by operating the </li></ul><ul><li> business (selling goods or services.) </li></ul><ul><li> Assets = Liabilities + Equity </li></ul><ul><li> 8,000 = 0 + 8,000 </li></ul>
  14. 14. Obj. 2: Financing Activities <ul><li>Equity Financing: Dividends </li></ul><ul><li>When a business finances asset purchases with capital stock equity, the </li></ul><ul><li>owners (stockholders) want a return on their investments. One way the </li></ul><ul><li>business gives stockholders a return is by distributing part of its earnings. </li></ul><ul><li>This distribution is called a Dividend. Dividends can be distributed in cash </li></ul><ul><li>or other property, or in new shares of stock (more on dividends in Chapter 8.) </li></ul><ul><li>Transaction 4 : Starter Corporation distributes $200 of its January </li></ul><ul><li>earnings to the stockholders in cash. </li></ul><ul><li> Assets = Liabilities + Equity </li></ul><ul><li> (200) = 0 + (200) </li></ul>
  15. 15. Obj. 2: Investing Activities <ul><li>After obtaining financing, the business uses the funds to acquire the </li></ul><ul><li>resources it needs to start operating the business. The resources a </li></ul><ul><li>business invests in are called Assets. </li></ul><ul><li>Common Assets (more on Assets in Chapters 5-7) </li></ul><ul><li> Tangible Intangible </li></ul><ul><li>(physical substance) (no physical substance) </li></ul><ul><li>Cash Patents </li></ul><ul><li>Accounts receivable Trade names </li></ul><ul><li>Prepaid expenses Copyrights </li></ul><ul><li>Supplies Trademarks </li></ul><ul><li>Land Intellectual property </li></ul><ul><li>Equipment Goodwill </li></ul><ul><li>Building </li></ul><ul><li>Automobiles </li></ul>
  16. 16. Obj. 2: Investing Activities <ul><li>Businesses acquire Assets in one of four ways: </li></ul><ul><li>Trade another asset for the new asset. Transaction 5 : Starter Corporation </li></ul><ul><li>purchases equipment in January for $125,000 cash. </li></ul><ul><li> Assets = Liabilities + Equity </li></ul><ul><li>125,000 </li></ul><ul><li>(125,000) = 0 + 0 </li></ul><ul><li>Borrow. Transaction 6 : Starter purchases a building in January for $100,000, </li></ul><ul><li>giving a note payable. </li></ul><ul><li> Assets = Liabilities + Equity </li></ul><ul><li> 100,000 = 100,000 + 0 </li></ul><ul><li>3. Issue stock to new owners (stockholders). See Transaction 2 on slide #13. </li></ul><ul><li>4. Earn (sell goods or services). See Transaction 3 on slide #13. </li></ul>
  17. 17. Obj. 2: Operating Activities <ul><li>After acquiring resources (assets), the business can begin operations </li></ul><ul><li>(the day-to-day business activities that generate Revenue and Expenses .) </li></ul><ul><li>Revenue: Amounts earned during the period from either selling products </li></ul><ul><li>or providing services. A transaction that increases Revenue increases </li></ul><ul><li>equity (via net income) and either increases assets or decreases liabilities. </li></ul><ul><li>See Transaction 3 on slide #13 </li></ul><ul><li>Expenses: Amounts used during the period to help generate revenue. </li></ul><ul><li>A transaction that increases Expense decreases equity (via net income) </li></ul><ul><li>and either decreases assets or increases liabilities. </li></ul><ul><li>See Transaction 7 on the following slide </li></ul>
  18. 18. Obj. 2: Operating Activities <ul><li>Expenses: Costs incurred during the period to help earn Revenue. </li></ul><ul><li> Cash may be paid in the same transaction, but often is not. </li></ul><ul><li>Transaction 7 : Starter Corporation incurs the following expenses in </li></ul><ul><li>January: </li></ul><ul><li>Wages expense $3,000 </li></ul><ul><li>Rent expense 2,600 </li></ul><ul><li>Miscellaneous expense 750 </li></ul><ul><li>Starter did not pay cash for any of these (it will in the future). </li></ul><ul><li>Assets = Liabilities + Equity </li></ul><ul><li>0 = 6,350 + (6,350) </li></ul><ul><li> </li></ul>
  19. 19. Obj. 3: Define Accounting and its role in Business <ul><li>Accounting is an information system, also called “The language of </li></ul><ul><li>business”. Accounting provides data to stakeholders so they can evaluate </li></ul><ul><li>the health and future prospects of the business. </li></ul><ul><li>Financial Accounting provides information to external stakeholders. </li></ul><ul><li>We will study financial accounting in Chapters 1-8. </li></ul><ul><li>Managerial Accounting provides information to internal stakeholders. </li></ul><ul><li>We will study managerial accounting in Chapters 10-14. </li></ul><ul><li>Purposes of a Financial Accounting system: </li></ul><ul><li>To report changes in the business’ financial condition over a period </li></ul><ul><li>of time. </li></ul><ul><li>To report the business’ financial condition at a single point in time </li></ul><ul><li>(end of period). </li></ul>
  20. 20. Obj. 4: Describe and illustrate the Basic Financial Statements . <ul><li>Reporting changes in financial condition over a period of time : </li></ul><ul><ul><li>Income Statement: [ Revenues – Expenses = Net Income ] </li></ul></ul><ul><ul><li>Statement of Retained Earnings: [ Beginning RE + Net Income </li></ul></ul><ul><ul><li> - Dividends = Ending RE ] </li></ul></ul><ul><ul><li>Statement of Cash Flows: [ Beginning Cash +/- Net Cash Flows </li></ul></ul><ul><ul><li> from Operating, Investing, and Financing = Ending Cash ] </li></ul></ul><ul><li>Reporting financial condition at a single point in time (end of the period) : </li></ul><ul><ul><li>Balance Sheet: [ Assets = Liabilities + Equity ] </li></ul></ul>
  21. 21. Obj. 4: Income Statement <ul><li>Starter Corporation </li></ul><ul><li>Income Statement </li></ul><ul><li>For the month ended January 31, 2010 </li></ul><ul><li>Revenues: </li></ul><ul><li> Fees Earned $8,000 (slide 11) </li></ul><ul><li>Expenses: </li></ul><ul><li>Wages expense $ 3,000 </li></ul><ul><li> Rent expense 2,600 (slide 16) </li></ul><ul><li> Miscellaneous expense 750 </li></ul><ul><li> (6,350) </li></ul><ul><li>Net Income: $1,650 </li></ul><ul><li>Net Income (Revenue-Expenses) increases Equity (Retained Earnings) </li></ul><ul><li>Revenue increases Equity (RE) and Expenses decrease Equity (RE). </li></ul>
  22. 22. Obj. 4: Retained Earnings Statement <ul><li>Starter Corporation </li></ul><ul><li>Statement of Retained Earnings </li></ul><ul><li>For the month ended January 31, 2010 </li></ul><ul><li>Retained Earnings, January 1, 2010: $ 0 </li></ul><ul><li>+ Net Income 1,650 </li></ul><ul><li>- Dividends (200) (slide 12) </li></ul><ul><li>Retained Earnings, January 31, 2010: $1,450 </li></ul>
  23. 23. Obj. 4: Balance Sheet <ul><li>Starter Corporation </li></ul><ul><li>Balance Sheet </li></ul><ul><li>as of January 31, 2010 </li></ul><ul><li>Assets Liabilities </li></ul><ul><li>Cash $102,800 Accounts Payable $ 6,350 </li></ul><ul><li>Building 100,000 Notes Payable 120,000 </li></ul><ul><li>Equipment 125,000 </li></ul><ul><li> Stockholders’ Equity </li></ul><ul><li> Capital Stock 200,000 </li></ul><ul><li> Retained Earnings 1,450 </li></ul><ul><li> </li></ul><ul><li> Total Liabilities & </li></ul><ul><li>Total Assets: $ 327,800 = Stockholders Equity: $327,800 </li></ul>
  24. 24. Obj. 4: Statement of Cash Flows <ul><li>Reports cash inflows (increases) and cash outflows (decreases) in </li></ul><ul><li>three categories: </li></ul><ul><li>Operating Activities: </li></ul><ul><ul><li>Cash received from customers (inflow) </li></ul></ul><ul><ul><li>Cash paid for expenses (outflow) </li></ul></ul><ul><li>Investing Activities: </li></ul><ul><ul><li>Cash received from sales of long-term assets (inflow) </li></ul></ul><ul><ul><li>Cash paid for purchases of long-term assets (outflow) </li></ul></ul><ul><li>Financing Activities: </li></ul><ul><ul><li>Cash received from the sale of capital stock or bonds (inflow) </li></ul></ul><ul><ul><li>Cash paid for dividends, bond redemptions, and treasury stock (outflow) </li></ul></ul>
  25. 25. Obj. 4: Statement of Cash Flows <ul><li>Starter Corporation </li></ul><ul><li>Statement of Cash Flows </li></ul><ul><li>For the month ended January 31, 2010 </li></ul><ul><li>Cash flows from Operating Activities: </li></ul><ul><li>Cash inflow from customers $ 8,000 </li></ul><ul><li>Cash outflow for expenses ( 0) </li></ul><ul><li>Net Cash Flows from Operating Activities: $ 8,000 </li></ul><ul><li>Cash flows from Investing Activities: </li></ul><ul><li>Cash inflow from sale of Property, Plant & Equipment 0 </li></ul><ul><li>Cash outflow for Property, Plant & Equipment (125,000) </li></ul><ul><li>Net Cash Flows from Investing Activities: (125,000) </li></ul><ul><li>Cash flows from Financing Activities: </li></ul><ul><li>Cash inflow from issuing stock 200,000 </li></ul><ul><li>Cash inflow from issuing notes payable 20,000 </li></ul><ul><li>Cash outflow for dividends to stockholders (200) </li></ul><ul><li>Net Cash Flows from Financing Activities: 219,800 </li></ul><ul><li>Net Increase (Decrease) in Cash: 102,800 </li></ul><ul><li>+ Cash at January 1, 2010 (beginning balance) 0 </li></ul><ul><li>= Cash at January 31, 2010 (ending balance) $102,800 </li></ul>
  26. 26. Obj. 5: Describe eight basic accounting concepts underlying financial reporting <ul><li>Generally Accepted Accounting Principles (GAAP) </li></ul><ul><li>rule the preparation of financial statements </li></ul><ul><ul><li>GAAP are written by the Financial Accounting Standards Board (FASB). </li></ul></ul><ul><ul><li>GAAP are based on eight accounting concepts. </li></ul></ul><ul><li>Business Entity Concept: We record transactions of different entities </li></ul><ul><li>separately. Owners are separate from their businesses, and each business </li></ul><ul><li>is separate from all other businesses. </li></ul><ul><li>Real-life Fraud Transaction : Adelphia Communications (6 th largest cable </li></ul><ul><li>provider in the U.S.) was owned by the Rigas family. In 2002, several </li></ul><ul><li>members of the family were convicted of fraud for treating company assets </li></ul><ul><li>as their own, to the tune of about $2.3 billion. The business concealed the </li></ul><ul><li>Rigases’ use of company funds for stock purchases, real estate procurement, </li></ul><ul><li>and other deals. Adelphia went bankrupt and the convicted family members </li></ul><ul><li>face up to 30 years in prison. </li></ul>
  27. 27. Obj. 5: Basic Accounting Concepts <ul><li>Business Entity Concept: We account for the activities of each entity </li></ul><ul><li>separate from all other entities. </li></ul><ul><li>Mark Stone owns and operates Stone Landscaping as a sole proprietorship. Mark’s </li></ul><ul><li>wife, Lisa, owns and operates Custom Food, a catering business, as a sole </li></ul><ul><li>proprietorship. Mark and Lisa have one child, Joe, age 12. The Stones have </li></ul><ul><li>established a trust fund to finance Joe’s college education. The trust fund is </li></ul><ul><li>maintained by First Tennessee Bank, Inc. in Joe’s name. </li></ul><ul><li>How many different entities exist for Accounting purposes? </li></ul><ul><li>Answer: Six. </li></ul><ul><li>Mark and Lisa (married individuals are a single individual entity) </li></ul><ul><li>Joe (individual entity) </li></ul><ul><li>Stone Landscaping (business entity – sole proprietorship) </li></ul><ul><li>Custom Foods (business entity – sole proprietorship) </li></ul><ul><li>First Tennessee Bank, Inc. (business entity - corporation) </li></ul><ul><li>Joe Stone Trust Fund (fiduciary entity) </li></ul><ul><li>In A200, we will account for business entities only. </li></ul>
  28. 28. Obj. 5: Basic Accounting Concepts <ul><li>Cost Concept: We record assets at their historical cost (the </li></ul><ul><li>amount actually incurred when the asset was acquired). </li></ul><ul><li>Market value, asking price, replacement cost are irrelevant </li></ul><ul><li>and are not recorded. </li></ul><ul><li>Going Concern Concept: We assume that a business is going </li></ul><ul><li>to continue indefinitely unless otherwise indicated. </li></ul><ul><li>Matching Concept: We record a period’s Revenues on the </li></ul><ul><li>periodic Income Statement with the Expenses (costs) that helped </li></ul><ul><li>to generate those revenues. </li></ul><ul><li>Real-life Fraud Transaction : World Com (2 nd largest long-distance </li></ul><ul><li>telecom operator in U.S.) inflated net income by recording $3.8 </li></ul><ul><li>billion of expenses as assets. Result: bankruptcy and criminal </li></ul><ul><li>conviction of CEO and CFO. Over $100 billion in stock market </li></ul><ul><li>losses. Board of Directors fined $18 million. </li></ul>
  29. 29. Obj. 5: Basic Accounting Concepts <ul><li>Objectivity Concept: We base entries in the accounting records </li></ul><ul><li>and data reported on the financial statements on objective evidence. </li></ul><ul><li>(Transaction: purchase invoice or receipt is objective evidence of an </li></ul><ul><li>asset purchase.) </li></ul><ul><li>Unit of Measure Concept: We report all financial statement numbers </li></ul><ul><li>in dollars (in the U.S.) </li></ul><ul><li>Accounting Period Concept: We report data on financial </li></ul><ul><li>statements in separate time compartments. (Transaction: April is not </li></ul><ul><li>the same month as May, and 2009 is not the same year as 2010.) </li></ul><ul><li>Real-life Fraud Transaction : Fannie Mae (the Federal National </li></ul><ul><li>Mortgage Association), illegally shifted expenses between periods, </li></ul><ul><li>pushing $107 million of earnings into future years. Result: CEO </li></ul><ul><li>and CFO fired, and the company was forced to restate earnings. </li></ul>
  30. 30. Obj. 5: Basic Accounting Concepts <ul><li>Adequate Disclosure Concept: We report in the financial statements </li></ul><ul><li>and related footnotes all relevant data that readers need to understand the </li></ul><ul><li>financial condition and performance (results of operations) of a business. </li></ul><ul><li>We leave out irrelevant data. </li></ul><ul><li>Transaction: Reporting the total cash balance at the end of the year is </li></ul><ul><li>adequate disclosure. The financial statements do not need to include the </li></ul><ul><li>details of a $5.00 purchase of paper clips. Recall, though, that the </li></ul><ul><li>Objectivity Concept requires that we be able to prove that $5.00 </li></ul><ul><li>expenditure upon audit. </li></ul><ul><li>Real-life Fraud Transaction : Tyco International, one of the world’s largest </li></ul><ul><li>electronics companies, failed to disclose secret loans to executives that </li></ul><ul><li>were subsequently forgiven by the company (never paid back by the execs.) </li></ul><ul><li>Result: CEO and others were forced to resign and were convicted in criminal </li></ul><ul><li>proceedings; currently serving 8-25 year sentences. </li></ul>
  31. 31. Obj. 5: Basic Accounting Concepts <ul><li>Accounting practice is overseen by the: </li></ul><ul><li>SEC (Securities and Exchange Commission) </li></ul><ul><ul><li>Has authority to set accounting principles for publicly-held </li></ul></ul><ul><ul><li>corporations </li></ul></ul><ul><ul><li>Delegates this function to the Financial Accounting Standards </li></ul></ul><ul><ul><li>Board (FASB). </li></ul></ul><ul><ul><li>Currently working to align U.S. generally accepted accounting principles </li></ul></ul><ul><ul><li>(GAAP) with international financial reporting standards (IFRS) </li></ul></ul><ul><li>Financial Accounting Standards Board (FASB) </li></ul><ul><ul><li>Writes GAAP: the rules that determine the proper content and form </li></ul></ul><ul><ul><li>of financial statements. </li></ul></ul><ul><li>Public Company Accounting Oversight Board (PCAOB) </li></ul><ul><ul><li>Helps regulate publicly-held companies as well as the </li></ul></ul><ul><ul><li>accounting industry </li></ul></ul><ul><ul><li>Created by Congress in the wake of fraud scandals of the 1990s. </li></ul></ul>
  32. 32. Ch. 9: Financial Statement Analysis <ul><li>Comparative analysis of financial statement data: </li></ul><ul><li>Vertical analysis of the Balance Sheet: </li></ul><ul><ul><ul><li>Each asset item expressed as a % of total assets </li></ul></ul></ul><ul><ul><ul><li>Each liability and equity item expressed as a % of total liabilities and equities </li></ul></ul></ul><ul><li>Vertical analysis of the Income Statement: </li></ul><ul><ul><ul><li>Each item of revenue and expense expressed as a % of net sales revenue </li></ul></ul></ul><ul><li>Horizontal analysis: </li></ul><ul><ul><ul><li>Compare two statements (two balance sheets, two income statements, two statements of retained earnings, two cash flow statements). Find the dollar and % change of each item in the two statements. </li></ul></ul></ul>
  33. 33. Vertical Analysis Ratios for Chapter 1 <ul><li>COGS % = Cost of Sales ÷ Net Sales Revenue </li></ul><ul><li>Measures how much of each dollar of revenue earned was used </li></ul><ul><li>to buy the goods the company sold. </li></ul><ul><li>Net Income % = Net Income ÷ Net Sales Revenue </li></ul><ul><li>Measures how much of each dollar of revenue is available to the </li></ul><ul><li>company after all expenses for expansion (retained earnings) or for </li></ul><ul><li>distribution to owners (dividends). </li></ul>
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