Financial%20Accounting%20and%20Its%20Environment

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Financial Accounting and Its Environment

• Chapter 1

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Major Types of Accounting

• Financial accounting provides information to
  decision makers who are external to the business.
• Examples include present and future shareholders,
  present and future creditors, and government
  regulators.

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Major Types of Accounting

• Managerial accounting provides information to
  decision makers who are internal to the business.
• This information is not published to people
  outside of the business.

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Major Types of Accounting

• Tax accounting involves tax compliance and tax
  planning.
• Tax compliance involves the calculation of the
  company's tax liability after the transactions
  for a year have been completed.

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Major Types of Accounting

• Tax accounting involves tax compliance and tax
  planning.
• Tax planning involves the consideration of a
  transaction before it has taken place in order to
  determine tax consequences.

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Major Types of Accounting

• Accounting Information Systems
• The processes and procedures required to generate
  accounting information.

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Major Types of Accounting

• Nonbusiness Organization Accounting
• Deals with the accounting needs of organizations
  which do not attempt to earn a profit, such as
  hospitals, colleges, and churches.

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Overview of Financial Accounting
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The Financial Accounting Process

• Categorize past transactions and events.
• Measure attributes of those transactions and
  events.
• Record and summarize the measurements.

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The Financial Accounting Process

• The initial valuation of a transaction is
  generally not changed in the future.
• This original measurement is called the
  historical cost.

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Primary Financial Statements

• The end result of the accounting process is the
  preparation of the following
• Balance sheet
• Income statement
• Statement of cash flows

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The Balance Sheet

• The balance sheet shows a firm's assets,
  liabilities, and owners' equity at one point in
  time.

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The Balance Sheet

• Assets are valuable resources that a firm owns.
• Liabilities are obligations to convey something
  of value in the future.

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The Balance Sheet

• Owners' equity is a residual amount, calculated
  by subtracting liabilities from assets.
• If assets are 300 and liabilities are 50, then
  owner's equity must equal 250.

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The Balance Sheet
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The Income Statement

• The income statement summarizes a firm's revenues
  and expenses for a period of time.

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The Income Statement

• Revenues are inflows of assets from providing
  goods and services to customers.
• Expenses are the costs incurred to generate
  revenues.

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The Income Statement

• If revenues exceed expenses, then the result is
  net income.
• If expenses exceed revenues, then the result is a
  net loss.
• If expenses are 500 and revenues are 400, then
  there is a net loss of 100.

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The Income Statement
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The Statement of Cash Flows

• The statement of cash flows summarizes a firm's
  inflows and outflows of cash over a period of
  time.

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The Statement of Cash Flows

• The statement has three sections.
• Operating activitiesdeal with a company's
  operations.
• Investing activitiesdeal with a company's
  long-term asset transactions.
• Financing activitiesdeal with a company's
  long-term debt activities and activities
  involving shareholders.

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The Statement of Cash Flows
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Distinguishing Between Financial Statements

• The balance sheet reports its components as of
  one moment in time.
• The income statement and the statement of cash
  flows cover a period of time.

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Notes to the Financial Statements

• Clarify and expand upon the material presented in
  the body of the statements.

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Notes to the Financial Statements

• They are an integral part of a set of financial
  statements.
• An example is a note which explains a company's
  inventory pricing policies or the methods used to
  depreciate fixed assets.

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Annual Reports

• Annual reports include the following
• Descriptions of significant events that occurred
  during the year.
• Commentary on future plans and strategies.
• A discussion and analysis by management of the
  years results.

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Users of Financial Statements and the Decisions
They Make

• Present and potential owners (investors) assess
  and compare the prospects of alternative
  investments.

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Present and Potential Owners Evaluate Two
Variables

• Expected returnthe increase in the investor's
  wealth that is expected over the investment's
  time horizon.
• Riskthe uncertainty surrounding estimates of
  expected return.

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Users of Financial Statements and the Decisions
They Make

• Shareholders must decide whether to buy, hold, or
  sell shares in the firm.
• Creditors must decide whether to extend credit
  and on what terms.

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Other Users of Financial Statements

• Financial analysts and advisors
• Customers
• Employees and labor unions
• Regulatory authorities

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Generally Accepted Accounting Principles

• The most widely used set of accounting principles
  is called generally accepted accounting
  principles (GAAP).
• GAAP is currently set by the Financial Accounting
  Standards Board (FASB).

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Generally Accepted Accounting Principles

• The FASB uses a due-process procedure in setting
  standards.
• Ensures that all interested parties are given an
  opportunity to have input into the
  standard-setting process.

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FASBs Due Process Procedures
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Two sources of FASB's authority

• The acceptance of its rulings by the business
  community and the accounting profession
• The delegation by the Securities and Exchange
  Commission of its legislative authority to
  determine GAAP for large, publicly held
  corporations

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Groups Involved in Setting Accounting Standards
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The Role of Auditing

• Independent certified public accountants (CPAs)
  often perform audits in order to enhance the
  credibility of the statements.
• Only a CPA may perform an audit.

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The Role of Auditing

• The wording of the audit report is very specific
  about what the audit does and does not do.

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The Role of Auditing

• Auditors follow generally accepted auditing
  standards (GAAS) in the conduct of the audit.

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The Role of Auditing

• GAAS are standards developed by the accounting
  profession to provide guidance in the performance
  of an audit.

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The Role of Auditing

• An audit is not a guarantee of the correctness of
  the financial statements.

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The Role of Auditing

• Auditors do not certify the financial statements.
• The audit report notes in the second paragraph
  that an audit provides reasonable, but not
  absolute, assurance that financial statements are
  free of material error.

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The Role of Auditing

• The most desirable audit opinion is the
  unqualified opinion.

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Auditing Relationships
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Consequences of the Choice of Accounting
Principles

• The FASB's primary objective is to select
  accounting principles that provide useful
  information to financial statement readers.

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Consequences of the Choice of Accounting
Principles

• Accounting principles have implementation costs.
• They can affect the wealth of managers and firms
  via compensation plans, debt contracts, and
  political costs.
• Managers consider these economic consequences
  when selecting accounting principles.

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Compensation Plans

• A compensation plan may tie managers'
  compensation to earnings, and therefore, the
  managers might choose principles which will
  enhance earnings.

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Debt Contracts

• The use of accounting principles which increase
  reported net income can reduce the chances of
  contract violation.

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Political Costs

• A firm might choose accounting principles which
  will minimize reported income in order to keep
  government regulation and taxation to a minimum.

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Two Roles of Financial Accounting

• The primary objective of accounting is to provide
  useful information to those who make business and
  economic decisions.
• A secondary objective of accounting is to help
  develop and enforce contracts.

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Ethics in Accounting

• Accountants have a significant responsibility to
  the public because the public relies upon
  financial statements in order to make business
  decisions.

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Ethics in Accounting

• It is imperative that accountants follow the
  highest ethical principles in order to keep that
  public trust in the profession.

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Ethics in Accounting

• The American Institute of Certified Public
  Accountants (AICPA) has a Code of Professional
  Conduct which emphasizes CPAs' obligation to
  serve the public interest.

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Financial Accounting and Its Environment

• End of Chapter 1