chapter one notes Flashcards
sole proprietorship
one owner
(separate entity for accounting)
(not a separate entity for tax)
partnership
two or more owners
(separate entity for accounting)
(not a separate entity for tax)
corporation
many stockholders/shareholders
separate entity for accounting and tax
what are the advantages of a sole proprietorship?
easy to form
what are the disadvantages of a sole proprietorship?
“unlimited liability”
what are the disadvantages of a partnership?
“unlimited liability”
what are the advantages of a corporation?
limited liability
continuity of life
ease in transfer of ownership
opportunity to raise large capital through stock
what are the disadvantages of a corporation?
double taxation
double taxation
dividends are taxed on personal returns as well as on the corporation’s return
what are the three business activities?
financing
investing
operating
financing
how a company pays for growth/expansion
what are the two ways to finance?
borrowing (liabilities) selling ownership (stock)
borrowing
temporary form of financing
you have to pay it back
selling ownership
permanent form of financing
you don’t have to pay it back
investing
purchasing resources (assets) to be used in day-to-day operations LONG TERM ASSETS
operating
activities that earn revenue and generate expenses (day-to-day activities)
what is the purpose of accounting?
to identify, measure, and communicate information about a company that is useful in making economic decisions
information system of accounting
decision maker->(analyze)
transaction occurs->
accounting records->(recording or book keeping)
4 standardized financial statements->(summarize)
decision maker (again)
internal users
management of a company
ex: payroll is needed
management accounting
limited only by the extent of data available and the cost involved in generating the information
external users
those not directly involved in the operations of a business
ex: financial statements are needed
financial accounting
limited by the presentation of information by the company’s management
balance sheet
shows the financial position of the company AT A SINGLE POINT IN TIME
“snapshot”
accounting equation
assets=liabilities+stockholder’s equity
assets
resources that will produce a future economic benefit
liabilities
debts owed to creditors, suppliers, employees, customers
“payable”
equity
financing provided by owners and operations of the company
common stock
investments made by owners
retained earnings
cumulative earnings of the company that have been retained (reinvested in the company)
statement of retained earnings
shows how net income and dividends cause change in.a company’s financial position during a period of time
retained earnings equation
beginning retained earnings
+net income
-dividends
net income equation
revenues-expenses
statement of cash flows
shows the actual change in cash of a company for a period of time
equation for cash flows
cash flows from operating, investing, and financing activities+cash at the beginning of the period
what is the order in which you prepare financial statements?
income statement
statement of retained earnings
balance sheet
statement of cash flows
footnotes
give added details necessary to under financial conditions a company
what is the basic objective of financial reporting?
to provide economic information about a company that is useful in making an “informed decision”
“informed decision”
the investor/creditor/supplier wants to be able to analyze the financial statements to determine the amounts, timing and uncertainty of future cash flows
what are the underlying assumptions of accounting help the decision maker to understand what accounting information reports as well as inherent limitations?
economic entity going concern monetary unit time period assumption cost principle
economic entity
business transactions are separate from the personal transactions of the owners
going concern
company will continue to operate into the foreseeable future without forced liquidation
monetary unit
all information will be measured in its national currency
done in monetary unit of the country it is traded in
time period assumption
the long life of a company can be reported over a series of shorter time periods
cost principle
assets are recorded at original cost (what we paid for them)
do we record costs as historical or current?
we keep assets recorded at historical costs until we get rid of them (otherwise its subjective)
what are the measurement rules?
general accepted accounting principles (GAAP)
generally accepted accounting principles (GAAP)
a common set of “rules” used to report US financial statements
financial accounting standards board (FASB)
private sector body given responsibility to develop GAAP
securities and exchange commission (SEC)
a federal (government) agency that has broad powers to prescribe accounting practices and standards to public companies that trade securities on the major exchanges (NYSE and NASDAQ)
what special privileges does the SEC have?
the SEC can influence or override any FASB ruling “checks and balances”
american institute of certified public accountants (AICPA)
professional organization go certified public accounts
not considered “direct” influence
international accounting standards board (IASB)
working towards a convergence of international reporting standards (IFRS) and GAAP
global differences in accounting standards
some IFRS principles differ from GAAP
ex: accounting for inventories, accounting for losses on income statement, accounting for PPE (property, plant, and equipment), accounting for research and development
public company accounting oversight board
five member body that sets auditing standards (set responsibility)
what is management’s responsibility?
accuracy
what are the auditor’s responsibility?
to attest to the fairness
what makes information useful?
if it is relevant and reliable
relevance
information makes a difference in decision making
reliability/accurate
verifiable
representational faithfulness
neutral
verifiable
free from error
have “backup”
representational faithfulness
numbers represent what really happened in the business; factual
neutral
free from bias
decision makers should:
- be aware of ethical conflicts
- ask questions, do research
- be aware of pressures to make choices that are not in best interest
decision making model:
- recognize an ethical dilemma
- analyze key elements in a situation
- list alternatives and evaluate impact of each
- select best alternative
when was the sarbanes-oxley act passed?
2002
why was the sarbanes-oxley act passed?
to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals
what was the result of the sarbanes-oxley act?
- management must now certify the accuracy
- severe penalties for fraudulent activity
- auditors must be independent
- increased responsibility of board of directors
what were some of the accounting scandals uncovered in the early 2000s?
Enron, Tyco, Worldcom, Athur Anderson
who sponsored the sarbanes-oxley act?
senator Paul Sarbanes of Maryland and congressman Michael Oxley of Ohio
what are the management provisions of the sarbanes-oxley act?
- report effectiveness of internal control
- code of ethics
- CEO and CFO must certify (penalties if inaccurate)
- whistle-blower protection
whistle-blower protection
firms must provide a mechanism for anonymous reporting of fraudulent activities in the company
what are the board of directors provisions of the sarbanes-oxley act?
- some directors are required to be independent of management
- audit committee must be independent of management
what are the external auditors provisions of the sarbanes-oxley act?
- you cannot consult AND audit
2. report to audit committee not management
what are the enforcement provisions of the sarbanes-oxley act?
- Public Company Accounting Oversight Board can regulate auditing firms
- all accounting firms must register with the PCAOB
