CHAPTER 1
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Investors and creditors look at the balance sheet to see whether the company:
Owns enough assets to pay what it owes to creditors
The Income Statement reports:
The amount of revenues earned and expenses incurred during the period
What would affect stockholders' equity?
A company receives $100 million from an investor in exchange for stock
The WC Company borrowed $26,500 from a bank during 2012:
This would be listed as $26,500 under financing activities on the statement of cash flows
Investors are often interested in the amount of net income distributed as dividends. In which section of the financial statements would investors look to find this amount?
Statement of retained earnings
What is Accounting?
A system of analyzing, recording, and summarizing the results of a business's activities and then reporting the results to decision makers
The 3 Organizational Forms:
1) Sole Proprietorship
2) Partnership
3) Corporation
Sole Proprietorship
Form of business owned (and usually operated) by one individual. Easiest form of business to start b/c it doesn't require any special legal maneuvers
Partnership
Similar to sole proprietorship; except that profits, taxes, and legal liability are the responsibility of two or more owners instead of just one. Slightly more expensive to form (than sole pro.) b/c a lawyer is usually needed to draw up a partnership agre
Corporation
Unlike the first two, this is a separate entity from both a legal and accounting perspective. This means that the ___ is legally responsible, not its owners, for its own taxes and debts.
Corporation Cont.
Can raise large amounts of money for growth because they divide ownership of the corporation into shares that can be sold to new owners.
Advantage of A Corporation Over First 2:
B/c owners aren't legally responsible, they cannot lose more than their investment in the corporation.
Disadvantages of A Corporation:
1) The legal fees for creating a corporation can be high
2) Income taxes must be paid by both the corporation and its owners
Key advantage of partnership over sole proprietorship=
Is that it typically has more resources available to it, which can fuel the business's growth
Financial Statements (also known as financial accounting reports):
Accounting reports that summarize the financial results of business and financing activities
The two primary external user groups of Financial Statements:
Creditors and Investors
Creditors:
Anyone to whom money is owed
Types of Creditors:
Banks & Suppliers
Types of Investors:
Stockholders:
Which are a major external user group. Both existing and future stockholders rely on financial statements to evaluate whether the company is financially secure and likely to be a profitable investment
Other External Users of Financial Statements:
-Customers: use it to judge the company's ability to provide service on its products and honor warranties
-Various Local, State, and Federal Governments: also collect taxes based on information used to prepare the financial statements
THE BASIC ACCOUNTING EQUATION:
Resources Owned
by the company
= Resources Owed
to creditors to stockholders
Assets= Liabilities + Stockholders' Equity
What a company owns must equal:
What a company owes to its creditors and stockholders
Separate Entity Assumption:
The financial reports of a business are assumed to include the results of only that business's activities
Assets:
An economic resource presently controlled by the company; it has measurable value and is expected to benefit the company by producing cash inflows or reducing cash outflows in the future
Assets represent:
The resources owned or controlled by a company
Liabilities:
Measurable amounts that the company owes to creditors
Liabilities on the balance sheet would include:
Accounts payable, notes payable, and wages payable
Stockholders' Equity:
Represents the owners' claims on the business. Profits belong to the company's owners, so they increase Stockholders' Equity
Stockholders' Equity claims arise for two reasons:
1.) Contributed Capital (paid in by stockholders)
2.) Retained Earnings (earned by the company)
Two components of profit:
Revenues and Expenses
Revenues:
Are earned by selling goods or services to customers
Expenses:
Are all costs of doing business that are necessary to earn revenues
Net Income (the preferred term in accounting for "profit"):
Calculated as revenues minus expenses. If revenues are less than expenses, the company would have a net loss. To be profitable, its revenues must be greater than its expenses
Net Income Equation:
Revenues - Expenses = Net Income
(Profit generated)
By generating net income, a company increases its stockholders' equity
Dividends:
A company's profits are accumulated in Retained Earnings until a decision is made to distribute them to stockholders in what is called a "dividend
Is the simplest type of Dividend:
A dividend paid in cash; Dividends are not an expense incurred to generate earnings, rather they are a distribution of earnings
FINANCIAL STATEMENTS:
1.) Income Statement
2.) Statement of Retained Earnings
3.) Balance Sheet
4.) Statement of Cash Flows
1.) Income Statement:
Reports the amount of revenues less expenses for a period of time
2.) Statement of Retained Earnings:
Reports the way that net income and the distribution of dividends affected the financial position of the company during the period
3.) Balance Sheet:
Reports the amount of assets, liabilities, and stockholders' equity of a business at a point in time
4.) Statement of Cash Flows:
Reports the operating, investing, and financing activities that caused increases and decreases in cash during the period
Statement of Cash Flows is Divided Into Three Types of Activities:
1.) Operating
2.) Investing
3.) Financing
1.) Operating:
These activities are directly related to running the business to earn profit
2.) Investing
These activities involve buying and selling productive resources with long lives (buildings, land, equiptment, and tools), purchasing investments, and lending to others
3.) Financing
Any borrowing from banks, repaying bank loans, receiving contributions from stockholders, or paying dividends to stockholders are considered financing activities
Unit of Measure Assumption:
Results of business activities should be reported in an appropriate monetary unit, which in the US is the US dollar
Accounts:
Accumulate and report the effects of each different business activity
Ending Retained Earnings from the statement of retained earnings is:
Then reported on the balance sheet
The Cash on the Balance Sheet is equal to:
The ending Cash reported on the statement of cash flows