Ch_01The Language of Business

8/3/2019 Ch_01The Language of Business

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2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick

ACCOUNTING:

The Languageof Business

CHAPTER

1


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2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e 2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 3 of 43

Learning Objectives

After studying this chapter, you should be able to

5. Identify how the owners equity section in acorporate balance sheet differs from that in a sole

proprietorship or partnership6. Describe auditing and how it enhances the value of

financial information

7. Explain the regulation of financial reporting

8. Evaluate the role of ethics in the accountingprofession


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The Nature of Accounting

Accounting is the process of identifying,recording, summarizing, and reporting economicinformation for decision makers

Accountants present this information in reportscalled financial statements

AccountantsAnalysis and

Recording

FinancialStatements

UsersEvent


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Accounting as an Aid

to Decision Making

Accounting information is useful to anyonemaking decisions that have economicconsequences

These decision makers include

Managers

Owners

Investors Politicians


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Financial Accounting

Financial accounting serves externaldecision makers:

Stockholders Suppliers

Banks

Government agencies


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Management Accounting

Management accounting serves internaldecision makers:

Top executives Department heads

College deans

Hospital administrators

Other managers within the organizations


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The Annual Report

The annual report is prepared by managementand informs investors about the companys pastperformance and future prospects


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The Annual Report

The annual report includes

A letter from corporate management

Management discussion and analysis

Footnotes explaining many elements of the financialstatements in more detail

The report of the independent auditors

A statement of managements responsibility forpreparation of the financial statements

Other corporate information


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The Annual Report

A companys financial statements can also befound in Form 10-K, which it files annually withthe Securities and Exchange Commission

The three major financial statements are the

Balance sheet

Income statement

Statement of cash flows


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The Annual Report

The balance sheet focuses on the financialposition of a company on a particular day

The income statement and cash flow statementfocus on the companys performance over time


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The Balance Sheet

The balance sheet (also called the statement offinancial position) shows the financial status of acompany at a particular instant in time

The left side lists the resources of the firm

The right side lists the claims against thoseresources

Assets= Liabilities + Owners equity


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The Balance Sheet

Assets are economic resources that thecompany expects to help generate future cashinflows or reduce or prevent future cash outflows

Examples: Cash, inventories, equipment Liabilities are economic obligations of the

organization to outsiders (creditors)

Example: A debt to a bank in the form of a note

payable Owners equity is the owners claim on the

organizations assets


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The Balance Sheet

Open account the practice of making mostpurchases on a credit basis instead of cashbasis

Accounts receivable are assets that result fromthe sale of goods or services on open account

Accounts payable are liabilities that result from a

purchase of goods or services on open account Inventories are assets held by the company for

the purpose of sale to customers


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Balance Sheet Transactions

Every transaction of a company or entity affectsthe balance sheet equation

An entity is an organization that stands apart from

other organizations and individuals as a separateeconomic unit

A transaction is any event that affects the financialposition of an entity and that can reliably recorded in

money terms


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An account is a summary record of the changesin a particular asset, liability, or owners equityitem

The double-entry accounting system recordseach transaction in at least two accounts

A compound entry affects more than two

balance sheet accounts


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Assets = Liabilities + Owners Equity

Cash Lopez, Capital

(1) + $400,000 = +$400,000

Transaction 1: Initial Investment of $400,000

(Owner Investment)


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Transaction 2: Loan of $100,000 from Bank


Cash Note payable Lopez, Capital

(1) + $400,000 = +$400,000

(2) + $100,000 = + $100,000

Bal. $500,000 = $100,000 $400,000

$500,000 $500,000


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Transaction 3: Acquire Store Equipmentfor Cash, $15,000


Cash Store Equipment Note payable Lopez, Capital

Bal. $500,000 = $100,000 $400,000

(3) -15,000 +15,000 =

Bal. 485,000 15,000 = 100,000 400,000

$500,000 $500,000



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Biwheels Company

Balance Sheet January 3, 20X2

Cash $485,000 Liabilities (note payable) $100,000

Store equipment 15,000 Lopez, capital 400,000

Total assets $500,000 Total liabilitiesand owners equity $500,000

Assets Liabilities and Owners Equity

Preparing the Balance Sheet


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Types of Ownership

Sole proprietorship a business with a singleowner

Partnership an organization that joins two ormore individuals who act as co-owners

Corporation a business organization createdunder state laws in the Unites States


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Corporation

Publicly owned corporation A corporation owned bythe public through the sale of shares; it may havethousands of owners

P

rivately owned corporation A corporation ownedby families or a small group of shareholders; sharesare not publicly sold

Corporation stockholders have limited liability

Creditors have claims against the corporationassets only, not the personal assets of the owners


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Advantages and Disadvantages

of the Corporate Form

Advantages

Limited liability

Easy transfer of

ownership

Ability to raise capitalfrom hundreds orthousands of potential

stockholders Continuity of existence

Prestige

Disadvantages

Unfavorable tax laws

Regulation


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Accounting Differences Among

Legal Forms

Proprietorships and partnerships

Owners equities are labeled capital

Owners equities are recorded in the capital account

Corporations Owners equities are labeled stockholders equity or

shareholders equity. Total capital investment iscalled paid-in capital

Owners equity is recorded in two parts: Common stock at par value

Paid-in capital in excess of par value


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The Meaning of Par Value

Par value (or stated value) the dollar amountprinted on the stock certificate

Paid-in capital in excess of par value (or

additional paid-in capital) the differencebetween the total amount the company receivesfor the stock and the par value

Common stock is recorded at the par value

Common shareholders are owners who have aresidual ownership in the corporation throughthe purchase of common stock


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Stockholders and the

Board of Directors

Shareholders elect a board of directors to lookout for their interests

Members of a board often include CEOs andpresidents of other corporations; universitypresidents and professors; attorneys; andcommunity representatives

The chairman of the board may also be the topmanager, the chief executive officer (CEO)


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Stockholders and the

Board of Directors

The boards duty is to ensure that managers actin the interest of shareholders

When boards do their duty in monitoringmanagement, the corporate form of organizationis effective

Board of Directors ManagersStockholders


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Credibility and the Role of Auditing

The separation of owners and managers createspotential problems in getting truthful informationabout the performance of a company

Shareholders must rely on managers to tell thetruth

The auditor examines the information that

managers use to prepare the financialstatements and provides assurances about thecredibility of those statements


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The Certified Public Accountant and

the Auditors Opinion

Third party assurance about the credibility offinancial statements is provided by auditprofessionals called Certified Public

Accountants (CPAs) CPAs are public accountants who offer services

including auditing, preparing income taxes, andmanagement consulting to the general public on

a fee basis Each state has a Board of Accountancy that sets

standards of both knowledge and integrity


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The Certified Public Accountant and

the Auditors Opinion

An audit is an examination of a companystransactions and the resulting financialstatements

The auditors opinion describes the scope andresults of the audit and a judgment that thefinancial statements prepared by managementare accurate


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The Accounting Profession

Public accountants offer services to the generalpublic for a fee

Private accountants work for businesses,government agencies, and other nonprofitorganizations


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Public Accounting Firms

The four largest public accounting firms are

Deloitte Touche Tohmatsu

Ernst & Young

KPMG International

PricewaterhouseCoopers

97% of the firms listed on the NYSE are clients

of these four firms


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Public Accounting Firms

Each firm has annual billings in excess of $1billion

All firms must follow generally acceptedaccounting principles (GAAP)

The broad concepts and detailed practices ofpreparing and distributing financial statements


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Standard-Setting Bodies

The Financial Accounting Standards Board(FASB) is responsible for establishing GAAP inthe United States by issuing FASB Statements

The Securities and Exchange Commission(SEC) is responsible for authorizing the GAAPfor companies whose stock is held by thegeneral investing public

The FASB and SEC work closely together andseldom have public disagreements


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The International Accounting Board (IASB)

Is responsible for developing high quality,understandable and enforceable global accounting

standards Has 12 full-time and 2 part-time members

Standards will be adopted by the European Union forfinancial statements prepared after 2005


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The American Institute of Certified PublicAccountants (AICPA) is the principalprofessional association in the private sector that

regulates the quality of the public accountingprofession


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Sarbanes-Oxley Act

Established the Public Company AccountingOversight Board to regulate public accountingand to set standards for audit procedures

through the issuance of generally acceptedauditing standards (GAAS)

Prohibits public accounting firms from providingaudit clients with certain non-audit services

Requires rotation every 5 years of the lead auditor coordinating partner and the reviewingpartner on an audit


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Sarbanes-Oxley Act

Provides regulation of corporate governance

Requiring boards to appoint an audit committeecomposed only of independent directors

Requiring CEOs and chief financial officers (CFOs) topersonally sign a statement certifying theappropriateness and fairness of their companiesfinancial statements

Increasing criminal penalties for knowinglymisreporting financial information


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Professional Ethics

Members of the AICPA must abide by a code ofprofessional conduct

The Institute of Management Accountants has acode of ethics for management accounts

Auditors and management accountants haveprofessional responsibilities concerning

competence, confidentiality, integrity, andobjectivity


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Professional Ethics

Ethical standards are personal and depend onthe values of the individual

A successful manager must recognize theethical dimensions of a situation and act withabsolute integrity


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Professional Ethics

Despite the criticism of accounting ethics,accountants were responsible for revealing theproblems in many of the recent corporate

scandals Companies often rely on accountants to

safeguard the ethics of the company

WorldCom and Enron whistle-blowers becametwo of the three 2002 Persons of the Year inTime magazine


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Career Opportunities

for Accountants

Accounting provides an excellent training groundfor future managers and executives

More CEOs started out in finance or accountingthan any other area


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2006 Prentice Hall Business Publishing Introduction to Financial Accounting 9/e 2006 Prentice Hall Business Publishing Introduction to Financial Accounting 9/e Horngren/Sundem/Elliott/Philbrick 43 of 43

Nonprofit Organizations

Fundamental accounting principles also apply tononprofit organizations

The Governmental Accounting StandardsBoard (GASB) regulates disclosures forgovernmental organizations

The FASB regulates financial reporting for other

nonprofit organizations

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Ch_01The Language of Business