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ACC 203
Chapter 1

I. Accounting is the information system that identifies, records, and

communicates the economic events of an organization to interested users.

The purpose of financial information is to provide inputs for decision

making.

The users of financial information fall into two groups--internal users

and external users.

 Internal users - users within the organization.

 Internal users and questions they may ask:

Marketing What price will maximize the company’s net income?

Human Can we afford to give employees pay raises this year?
Resources
Finance Is cash sufficient to pay dividends to stockholders?
Management Which product line is most profitable? What should be
eliminated?

 External users - users who are outside the organization.

 External users and questions they may ask:

Investors (current Is the company earning satisfactory income? How

and potential) does the company compare in size and profitability
with competitors?
Creditors (suppliers Will the company be able to pay its debts as they
and bankers) come due?
IRS, SEC, FTC, Is the company complying with rules and
labor unions, regulations? Is the company properly paying its
customers taxes?
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Accounting helps users assess and manage risk.

1. Risk is the uncertainty about outcomes.

2. More risk = More uncertainty = greater potential for higher

returns (and expectations of higher returns by investors and
creditors).

Ethics in financial reporting

 In 2002, Congress passed the Sarbanes-Oxley Act (SOX) to try to
reduce unethical corporate behavior and decrease the likelihood of
future corporate scandals. See page A-22 in Appendix A for
required Management’s Report

 Effective financial reporting depends on sound ethical behavior.

 Steps for solving ethical dilemmas:

1. Recognize an ethical situation and the ethical issues involved.
2. Identify and analyze the principal elements in the situation.
3. Identify the alternatives, and weigh the impact of each alternative
on various stakeholders.

II. Forms of Business Organizations

 Sole proprietorship - a business owned by one person

 Advantages
 simple to establish
 owner controlled
 tax advantages

 Disadvantages
 proprietor personally liable for all business debts
 financing may be difficult
 transfer of ownership may be difficult
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 Partnership - a business owned by two or more people

 Advantages
 simple to establish
 shared control
 broader skills and resources
 tax advantages

 Disadvantages
 partners personally liable for all business debts
 transfer of ownership may be difficult

 Corporation - a separate legal entity owned by stockholders

 Advantages
 easier to transfer ownership
 easier to raise capital
 lower legal liability – no personal liability for stockholders

 Disadvantages
 unfavorable tax treatment

Note: ALL of the above are separate accounting entities!

The emphasis of this text is the corporate form of business.

The primary purpose of business owners is to earn a profit (Net Income)

Revenues – Expenses = Net Income

1. Accounting is necessary to measure revenues and expenses (&
therefore a profit or loss) and the owner’s return on investment.

2. Accounting is also used to record and report assets (what we

own), liabilities (what we owe; the creditors claims to the assets)
and owner’s equity (the owner’s claim to the assets).
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III. There are 3 main activities of a business:

The accounting information system keeps track of the results of each of
these activities.

1. Financing: borrowing & paying back loans, owner’s

investments into the business, distributing profits to owners.

2. Investing: acquiring and disposing of long-term assets (e.g.

equipment, buildings, etc.) used by the business.

3. Operating: use of assets to carry out an organization's plans

(all revenues and expenses are operating activities).

IV. Accounting Equation

Basic Accounting Equation:
Assets = Liabilities + Equity
Alternative: Assets – Liabilities = Equity
Assets: Resources owned by the business that provide probable future
economic benefits to the business. What we own.
Examples:

Liabilities: Obligations of a business or organization or creditor’s claims

against assets. What we owe.
Examples:
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Equity: The owner’s claim to the assets or the residual interest in the
assets of an entity after deducting liabilities; also called net assets.
(Assets – Liabilities = Equity)
Corporation’s equity is divided into 2 parts:
1. Contributed Capital: the amount the shareholders have paid for
the stock (ownership) of the corporation.
2. Retained Earnings: net income minus net losses minus dividends
(distributions to owners) since the inception of the corporation.

Expanded Accounting Equation:

Assets = Liabilities + Equity + Revenues - Expenses
(Balance Sheet) (Income Statement)

Revenues: What we earn in exchange for goods or services provided to

customers as part of the company's operations.
Examples:

Expenses: The costs of providing products and service to customers.

Examples:

Revenues minus expenses equals net income (if Rev > Exp)
or net loss (if Exp > Rev)
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V. Financial Statements (examples on pg. 18)

Income Statement
Reports revenues and expenses over a period of time; net income
is computed as revenues less all costs and expenses.

Statement of Retained Earnings

Reports changes in Retained Earnings over a period of time.
Changes result from net income (increase); and net loss,
dividends (decreases).

Balance Sheet
Reports amounts for assets, liabilities, and equity at a point in
time.

Statement of Cash Flows

Reports on cash flows for operating, investing, and financing
activities over a period of time.

Question: Which financial statement does not cover a period of time?

 Note the headings (Co. name, statement name, dateline)

 Note the format ($ signs, double underline for totals)

 Note the order of preparation, and the relationship of the

statements.
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Components that Supplement the Financial Statements in an Annual
Report (Appendix A)

Companies traded on an organized exchange like the New York Stock

Exchange or the American Stock Exchange are required to provide
shareholders with an annual report which always includes financial
statements. In addition, the annual report includes the following
information:

 Management Discussion and Analysis – pg. A-6 – covers three

aspects of a company:
1. Its ability to pay near-term obligations (liquidity)
2. Its ability to fund operations and expansion (capital resources)
3. It results of operations

 Notes to Financial Statements – pg. A-15.

 Clarify information presented in the financial statements
 Describe accounting policies or explain uncertainties and
contingencies

 Auditor's Report – pg. A-23.

 An auditor, a CPA, conducts an independent examination of the
company’s financial statements.
 An auditor gives an unqualified opinion if the financial statements
present the financial position, results of operations, and cash flows
in accordance with generally accepted accounting principles
(GAAP).

GAAP = Generally Accepted Accounting Principles

FASB (Financial Accounting Standards Board) - A nonprofit board that

sets accounting rules for Financial Accounting
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a. Financial Accounting: The preparation , reporting, and interpretation
of accounting information for external users.

 Primary external users: Investors and creditors.

b. Managerial Accounting is for internal users (BA 257).

Accounting information is prepared using Generally Accepted
Accounting Principles (GAAP), in order for the information to be
comparable, reliable, and relevant to the external users (investors and
creditors primarily).

VI. Accounting careers.

1. Public accounting
 Auditing
 Tax
 Consulting

2. Private sector
 Corporate accounting
Cost accountant, internal auditor

3. Government and nonprofit

 IRS
 FBI
 Hospitals
 Universities and colleges, etc.