Chapter 1 Notes

Created Sep 7, 2019 155 PM

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Updated Sep 7, 2019 256 PM

Accounting in Action

Accounting Activities and Users

Accounting- identifies, records and communicates economic events of an

organization to interested users

Three Activities

Identifying the economic events relevant to its business

Recording those events in order to provide a history of its financial

activities

Keeping a systematic, chronological diary of events

Communicates the collected information to interested users by means of

accounting reports

Financial statements- presenting data in a standardized way; most

common report

Reporting data- in aggregate- simplifies transactions and makes a

series of activities understandable and meaningful

Analyzing and interpreting the reported information

Using ratios, percentages, graphs and charts to highlight financial

trends and relationships

Interpreting involves explaining the uses, meaning and limitations

of reported data

Accounting process includes the bookkeeping function

Bookkeeping- only the recording of economic events

Accounting involves the entire process of identifying, recording and

communicating economic events

Chapter 1 Notes 1
 Who Uses Accounting Data

Internal users- managers who plan, organize and run the business

Marketing managers, production supervisors, finance directors and

company officers

Managerial accounting- provides internal reports to help users make

decisions about their companies

External Users- individuals and organizations outside a company who want

financial information about the company

Investors (owners)- use information to decide whether to buy, hold , or

sell ownership shares of a company

Creditors (suppliers and bankers)- use information to evaluate the risks

of granting credit or lending money

Financial Accounting- provides economic and financial information for

investors, creditors and other external users

The Building Blocks of Accounting

Ethics in Financial Reporting

Ethics- standards of conduct by which actions are judged as right or

wrong

Effective financial reporting depends on sound ethical behavior

Accounting Standard

To ensure high-quality financial reporting, accountants present financial

statements in conformity with accounting standards that are issued by
standard-setting bodies

International Accounting Standards Board IASB

International Financial Reporting Standards ISFR followed by 130

countries

Headquartered in London

Financial Accounting Standards Board FASB

Most companies in the US follow generally accepted accounting

principles GAAP issued by the FASB

Chapter 1 Notes 2
 Convergence- process of reducing the differences between ISFR and
GAAP to increase comparability

Measurement Principles

ISFR generally uses one of two measurement principles that have trade-
offs between Relevance and Faithful Representation

Relevance- financial information is capable of making a difference in a

decision

Faithful Representation- numbers and descriptions match what

happened/ existed

Historical Cost Principle- companies record assets at the cost

Recorded values don't change according to appreciation or

depreciation

Fair Value Principle- assets and liabilities should be reported at fair balue

More useful than historical cost for certain types of assets and
liabilities

Usually only used in situations where assets are actively traded

Assumptions

Monetary Unit Assumption- companies only include transaction data that

can be expressed in money terms

Enables accounting to quantify economic events, vital to historical

cost

Prevents inclusion of some relevant information

Economic Entity Assumption- activities of an entity is kept separate from

the activities of the owner and all other economic entities

Economic Entity- can be any organization or unit in society

Proprietorship- business owned by one person

Only a relatively small amount of money is necessary to start in

business

Owner/Proprietor receives any profits, suffers any losses, and is

personally liable for all debts

No legal distinction, but economic activities are distinct

Chapter 1 Notes 3
 Partnership- business owned by two or more people associated as
partners

Partnership agreement sets forth terms of share

Corporation- organized as a separate legal entity under jurisidiction

corporation law and having ownership divided into transferable shares

Holders of shares enjoy limited liability

Shareholders may transfer all or part of their shares to other

investors at any time

Unlimited life

Accounting Equation

Basic Accounting Equation: Assets = Liabilities + Equity

Applies to all economic entities

Underlying framework for recording and summarizing economic events

Assets- resources a business owns

Have the capacity to provide future services or benefits

Liabilities and equity- rights or claims against these resources

Liabilities- claims of those to whom the company owes money

Creditors- all people to whom an entity owes money

May legally force the liquidation of a business that doesn't pay

its debts, law requires creditor claims be paid before ownership
claims

Equity- claims of owners

Share Capital-ordinary- term used to describe amounts paid in by

shareholders for ordinary shares they purchase

Retained Earnings

Revenues- gross increases in equity resulting from business

activities entered into for the purposes of earning income

Usually result in an increase in an asset

Expenses- cost of assets consumed or services used in the

process of earning revenue

Chapter 1 Notes 4
 Decreases in equity that result from operating the business

Dividends- distribution of cash or other assets to shareholders

NOT EXPENSES!!!

Analyzing Business Transactions

Accounting Information System- system of collecting and processing

transaction data and communicating financial information to decision-
makers

Rely on accounting cycle

Accounting Transactions

Transactions- business's economic events recorded by accountants

External Transactions- involve economic events between the company

and some outside enterpirse

Internal Transactions- economic events that occur entirely within one

company

Each transaction must have a dual effect on the accounting equation

Financial Statements

Income Statement- presents the revenues and expenses and resulting net
income or net loss for a specific period of time

reports the success or profitability of company's operations over a

specific period of time

Lists revenues first, then expenses before showing net income or loss

Doesn't include investment and dividend transactions

Retained Earning Statement- summarizes the changes in retained earnings

for a specific period of time

Covers same time period as income statement

Beginning retained earnings, then net income and dividends

Retained earnings end balance is the final amount

Indicates the reasons why retained earnings increased or decreased

during the period

Chapter 1 Notes 5
 Statement of Financial Position (aka balance sheet)- reports the assets,
liabilities and equity of a company at a specific date

Lists assets at the top, followed by equity then liabilities

Snapshot of the company's financial condition at a specific moment in

time

Statement of Cash Flows- summarizes information about cash inflows

(receipts) and outflows (payments) for a specific period of time

Reports cash effects of a company's operations during a period,

investing activities, financing activities, net increase or decrease in
cash, and cash amount at the end of the period

Useful because external users want to know what is happening to a

comapny's most liquid resource

Comprehensive Income Statement- presents other comprehensive income

items not included in the determination of net income

Chapter 1 Notes 6