Accounting in Business

Accounting in BusinessChapter 1Accounting in BusinessC1Importance of AccountingC1For example, the sale by Apple of an iPhone.Keep a chronological log of transactions.Prepare reports such as financial statements.Users of Financial InformationC1Accounting is called the language of business because all organizations set up an accounting information system to communicate data to help people make better decisions. Accounting serves many users who can be divided into two groups: external users and internal users.Opportunities in AccountingAccounting information is in all aspects of our lives. When we earn money, pay taxes, invest savings, budget earnings, and plan for the future, we use accounting.Ethics – A Key ConceptC3The goal of accounting is to provide useful information for decisions. For information to be useful, it must be trusted. This demands ethics in accounting. Ethics are beliefs that distinguish right from wrong. They are accepted standards of good and bad behavior.Generally Accepted Accounting Principles (GAAP)C4Financial accounting is governed by concepts and rules known as generally accepted accounting principles (GAAP). GAAP aims to make information relevant, reliable, and comparable. Relevant information affects decisionsof users. Reliable information is trusted by users. Comparable information is helpful in contrasting organizations.Fraud TriangleC3Three factors must exist for a person to commit fraud: opportunity, pressure, and rationalization.Envision a way to commit fraud with a low perceived risk of getting caughtFails to see the criminal nature of the fraud or justifies the actionMust have some pressure to commit fraud, like unpaid billsInternational StandardsC4In today’s global economy, there is increased demand by external users for comparability in accounting reports. This demand often arises when companies wish to raise money from lenders and investors in different countries. Differences between U.S. GAAP and IFRS are decreasing as theFASB and IASB pursue a convergence process aimed to achieve a single set of accounting standards for global use.International Accounting Standards Board (IASB) An independent group (consisting of individuals from many countries), issues International Financial Reporting Standards (IFRS)International Financial Reporting Standards (IFRS) Identify preferred accounting practices Conceptual Framework and ConvergenceC4Principles and Assumptions of AccountingC4General principles are the basic assumptions, concepts, and guidelines for preparing financial statements. General principles stem from long-used accounting practices. Specific principles are detailed rules used in reporting business transactions and events. Specific principles arise more often from the rulings of authoritative groups.Accounting PrinciplesC4Cost PrincipleAccounting information is based on actual cost. Actual cost is considered objective.Matching PrincipleA company must record its expenses incurred to generate the revenue reported.Full Disclosure PrincipleA company is required to report the details behind financial statements that would impact users’ decisions.Accounting AssumptionsTime Period AssumptionPresumes that the life of a company can be divided into time periods, such as months and years.C4Proprietorship, Partnership, and CorporationHere are some of the major attributes of proprietorships, partnerships, and corporations:C4Sarbanes–Oxley (SOX)Congress passed the Sarbanes–Oxley Act to help curb financial abuses atcompanies that issue their stock to the public. SOX requires that these public companies apply both accounting oversight and stringent internal controls. The desired results include more transparency, accountability, and truthfulness in reporting transactions.C4Dodd-Frank Wall Street Reform and Consumer Protection ActThe Act was designed to:promote accountability and transparency in the financial system,put an end to the notion of “too big to fail,” protect the taxpayer by ending bailouts, andprotect consumers from abusive financial services.Transaction Analysis and the Accounting Equation The Accounting EquationExpanded Accounting Equation:A1Net IncomeP1Transaction AnalysisTransaction 1On December 1, Chas Taylor personally invests $30,000 cash in FastForward and deposits the cash in a bank account opened under the name of FastForward.The accounts involved are: (1) Cash (asset) (2) Owner Capital (equity)P1Transaction AnalysisTransaction 2FastForward uses $2,500 of its cash to buy supplies of brand name footwear for performance testing over the next few months.The accounts involved are: (1) Cash (asset) (2) Supplies (asset)P1Transaction AnalysisTransaction 3FastForward spends $26,000 to acquire equipment for testing footwear. This is an exchange of one asset, cash, for another asset, equipment. The equipment is an asset because of its expected future benefits from testing footwear.The accounts involved are: (1) Cash (asset) (2) Equipment (asset)P1Transaction AnalysisTransaction 4Taylor decides more supplies of footwear and accessories are needed. These additional supplies total $7,100, but as we see from the accounting equation, FastForward has only $1,500 in cash. Taylor arranges to purchase them on credit from CalTech Supply Company. The accounts involved are: (1) Supplies (asset) (2) Accounts Payable (liability)P1Transaction AnalysisTransaction 5In one of its first jobs, FastForward provides consulting services to a powerwalking club and immediately collects $4,200 cash.The accounts involved are: (1) Cash (asset) (2) Revenues (equity)P1Transaction AnalysisTransaction 6 and 7FastForward pays $1,000 rent and the biweekly $700 salary of the company’s only employee.The accounts involved are: (1) Cash (asset) (2) Expenses (equity)P1Transaction AnalysisTransaction 8FastForward provides consulting services of $1,600 and rents its test facilities for $300 to a podiatric services center. The center is billed for the $1,900 total. This transaction results in a new asset, called accounts receivable, from this client.The accounts involved are: (1) Accounts Receivable (asset) (2) Revenues (equity)P1Transaction AnalysisTransaction 9The podiatric center pays $1,900 to FastForward 10 days after it is billed for consulting services.The accounts involved are: (1) Cash (asset) (2) Accounts Receivable (asset)P1Transaction AnalysisTransaction 10FastForward pays CalTech Supply $900 cash as partial payment for its earlier $7,100 purchase of supplies, leaving $6,200 unpaid.The accounts involved are: (1) Cash (asset) (2) Accounts Payable (liability)P1Transaction AnalysisTransaction 11The owner of FastForward withdraws $200 cash for personal use.The accounts involved are: (1) Cash (asset) (2) Withdrawals (equity)Summary of TransactionsP1Financial StatementsThe four financial statements and their purposes are: Income statement — describes a company’s revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities. Statement of owner’s equity— explains changes in equity from net income (or loss) and from any owner investments and withdrawals over a period of time. Balance sheet — describes a company’s financial position (types and amounts of assets, liabilities, and equity) at a point in time. Statement of cash flows — identifies cash inflows (receipts) and cash outflows (payments) over a period of time.P2Income StatementThe income statement describes a company’s revenues and expenses along with the resulting net income or loss over a period of time due to earnings activities.P2Statement of Owner’s EquityNet income from the income statement.The statement of owner’s equity reports information about how equity changes over the reporting period. P2Balance SheetThe balance sheet describes a company’s financial position at a point in time.P2Statement of Cash FlowsP2Global ViewBasic PrinciplesNeither U.S. GAAP nor IFRS specifies particular account names nor the detail required. IFRS does require certain minimum line items be reported in the balance sheet along with other minimum disclosures that U.S. GAAP does not. On the other hand, U.S. GAAP requires disclosures for the current and prior two years for the income statement, statement of cash flows, and statement of retained earnings (equity), while IFRS requires disclosures for the current and prior year. Still, the basic principles behind these two systems are similar.Global ViewTransaction AnalysisBoth U.S. GAAP and IFRS apply transaction analysis identically as shown in this chapter. Although some variations exist in revenue and expense recognition and other principles, all of the transactions in this chapter are accounted for identically under these two systems. It is often said that U.S. GAAP is more rules-based whereas IFRS is more principles-based. The main difference on the rules versus principles focus is with the approach in deciding how to account for certain transactions. Under U.S. GAAP, the approach is more focused on strictly following the accounting rules; under IFRS, the approach is more focused on a review of the situation and how accounting can best reflect it.Global ViewFinancial StatementsBoth U.S. GAAP and IFRS prepare the same four basic financial statements. To illustrate, a condensed version of Piaggio’s income statement follows (numbers are in Euros thousands).Global ViewStatus of IFRS AdoptionReturn on AssetsA2Return on assets (ROA) is stated in ratio form as income divided by assets invested.Net incomeAverage total assetsReturn on assets =DellAppendix 1A Return and Risk AnalysisA3Many different returns may be reported.ROAInterest return on savings accounts.Interest return on corporate bonds.Risk is the uncertainty about the return we will earn.The lower the risk, the lower our expected return.Appendix 1B Business Activities and the Accounting EquationA3Three major types of business activities:Financing activities provide the means organizations use to pay for resources such as land, buildings, and equipment to carry out plans.Investing activities are the acquiring and disposing of resources (assets) that an organization uses to acquire and sell its products or services.Operating activities involve using resources to research, develop, purchase, produce, distribute, and market products and services.End of Chapter 1