Chapter 1 Flashcards
Who uses financial accounting? (5)
1) shareholders
2) creditors
3) managers and directors
4) financial analysts
5) other users
Shareholder
owners of a corporation that own stock; rely on financial statements to evaluate performance
Sole proprietorship company
Single owner who manages daily operations (small family business)
Partnership company
Two or more owners of a company (lawyer, CPA)
Limited liability company (LLC)
New business; similar to a corporation but more flexibility
New York Stock Exchange (NYSE) and NASDAQ
Issue stock via organized exchanges
Separation of ownership
Sell stock to raise capital, CEO owns less
Accounting
Process of recording, summarizing, and analyzing financial transactions
Creditors- how do they use financial statements
Companies borrow from banks/lenders; interested in borrower’s ability to repay; determine loan terms, loan amount, interest rate, collateral
Suppliers- how do they use financial statements
Financial information establishes credit terms and commitment to relationships
Managers and directors- - how do they use financial statements
Often have incentives tied to financial reports; board of directors- publicly traded companies are required to have them, elected by shareholders; leverage other company reports to make decisions
Financial analysts- how do they use financial statements
Decision makers rely on analysts; dissemination of financial information to identify/assess risk, forecast performance, establish price, make investor decisions
Others- how do they use financial statements
Prospective employees- learn about companies; labor unions- assess health prior to negotiating; customers- ability to deliver products/services
Costs of disclosure
Costs of accountants, costs imposed by competitors- learn about products/strategies to reduce competitive advantage; raise investor expectations; political cost of regulation/taxation
Benefits of disclosure
Lowers financing and operating costs, bank uses info to determine interest
What are the 4 business activities as part of accounting?
1) planning activities
2) investing activities
2) financing activities
3) operating activities
How are planning activities influenced by accounting?
Company goal/strategy creates value for owners; strategic plan reviews market conditions, competition, opportunities, and threats
How are investing activities influenced by accounting?
Acquiring/disposing resources needed to sell; companies have a different mix of assets depending on business model (online only vs brick/mortar); also will vary if assets are short term or long term
How are financing activities influenced by accounting?
Methods company uses to fund investments
Financial management
Planning of resource needs/financing resources
What are the sources of financing activities?
1) equity (owner) financing
2) liability- creditor (or debt) financing
Equity (owner) financing
Funds contributed by owners with income retained in the company; does not impose repayment obligation
Liability- creditor (debt) financing
Funds by non-owners; company must pay in future- legal obligation to pay back
What is the accounting equation?
Investing=financing
investing assets= liabilities (financing)+equity (owner financing)
How are operating activities influenced by accounting?
Promotion, selling product/service; input market generates operating expenses (inventory, salary, material, logistics); output market generates operating revenue (sales) but also generate expenses- marketing, distributing
Operating income
If operating revenue > operating expense; if expense is more than revenue, operating loss
Revenue
Increase in equity from sale of goods or service to customer before deducting expenses
Expense
Costs incurred to generate revenue- cost of goods sold and other business activities
Income equation
income= revenues-expenses
What are the 4 financial statements?
1) balance sheet
2) income statement
3) statement of stockholders equity
4) statement of cash flows
Define balance sheet
Investments and sources of financing using accounting equation; summarizes company’s investing/financing activities by listing assets, liabilities, and equity; amounts carry over from the end of one fiscal year to the beginning of the next
Point in time
Define income statement
Results of operations; company’s operating activities over time, details revenues and expenses- difference is net income
Period of time
Define statement of stockholder equity
Change in owner financing; change in equity accounts over time; includes contributed capital, retained earnings, other stockholders equity
Period of time
Define statement of cash flows
Sources/uses of cash; reports net cash flow from operating, investing, and financing activities over a period of time
Period of time
What equation is applicable for the balance sheet?
Assets= liabilities + equity
What equation is applicable for the balance sheet?
Net income= revenue- expense
Gross profit
Revenue- cost of goods sold (COGs)
Contributed capital
Common stock; net amount received from issuing stock to shareholders (owners)
Retained earnings
Income the company has earned since inception minus shareholders dividends; aka income retained in company
Operating cash flow
Cash generated from operating activities; differs from net income due to difference when revenue and expenses recorded
Generally accepted accounting principles (GAAP)
Set of standards and procedures, not set laws, guide prep of financial statements; companies use discretion to balance between constraints and flexibility
Securities Act
After stock crash in 1929, required to disclose financials on securities for public sale and prohibit deceit/misrepresentation/fraud of security sale
Security and Exchange Commission (SEC)
Regulate issuance and security trading- companies with more than $10m in assets and securities held by more than 500 owners must file annual/periodic reports, including set of financial statements
American Institute of Certified Public Accountants (AICPA)
Professional body that sets accounting standards; resulted in 3 standard setting organizations
3 standard setting organizations of AICPA
1) financial accounting standards board (FASB)
2) Sarbanes-Oxley Act (SOX)
3) public accounting oversight board (PCAOB)
Financial Accounting Standards Board (FASB)
Part of AICPA- American Institute of Certified Public Accountants
7 member board responsible for setting financial accounting in the US; single source of authoritative, nongov US GAAP; developed framework of proposed future standards and for accountants to report info not governed by specific standards
Sarbanes-Oxley Act (SOX)
Part of AICPA- American Institute of Certified Public Accountants
Post scandal, paused in 2002 to ensure reporting quality to increase confidence to improve internal controls
Public accounting oversight board (PCAOB)
Part of AICPA- American Institute of Certified Public Accountants
Approve auditing standards and monitor quality of financial statements and audits
How SOX increases internal controls
Increase management responsibility, increase auditor independence, increase accountability of board of directors, establish internal controls to prevent fraud
requires that CEO and CFO of publicly traded corporations sign off personally on statements or penalized
SOX impact
3x company restatement of reports; costs of reporting and auditing; have relaxed requirements for some companies, high penalties on management might make companies less forthcoming with estimates
Audit
Auditor audits statements; independent firm to provide opinion of statements if they are fairly presented and respects company’s financial condition/result of operations
Not a guarantee, reasonable assurance that the statements aren’t misrepresented, required for public corporations
International accounting standards board (IASB)
Oversees development of standards outside of US
International financial reporting standards (IFRS)
Developed by IASB- 100+ countries including the EU; not use in the US (GAAP is); goal is to become compatible but there are some differences
Profitability
Whether a company is able to bring its product or service to the market in an efficient manner and if market values the product or service
What equation shows profitability?
Return on equity
ROE= net income/average stockholders equity
Return on equity equation
ROE= net income/average stockholders equity
ROE 10% and up: reasonable returns; higher risk company could have higher ROE while less risky could have lower ROE
Credit risk
Risks associated with investing or lending; increase risk, increase return demanded by investors
Solvency
Ability to remain in business and avoid bankruptcy or financial distress
What equation shows credit risk/solvency?
Debt to equity
D/E= total liabilities/total stockholders equity
Debt to equity equation
Total liabilities/total stockholders equity
DE of 1 means equal parts debt/equity; DE depends on business and long term commitments
Blockchain
Digital ledger that provides secure means for approved parties to view recorded transactions
