Midterm 1 Flashcards
Three types of businesses
-an organization which seeks to provide goods and services to customers
- Manufacturing - builds tangible parts/products
- Merchandising - retail and wholesale (sells directly)
- Service
- some are all three (Restaurants)
To start a business you need: (3)
- Idea - can be sold at a profit
- Capital - $/resources that bring product/service to life
- Management skill - ability to employ those resources and produce a profit
Some business are on non-profit basis (purpose) but still need those three things (like a hospital)
2 Ways to access capital - “Financing of a business” (how capital is obtained for a business)
- Debt financing - borrow from creditors/lenders
- Equity financing - contributing from investors in exchange for part ownership in the company (or your own $ as an owner)
Debt Financing
(temporary financing) -borrowed capital must be repaid in future with interest -harsh consequences in failure to repay -difficult to qualify for KEY ADVANTAGE -no sacrificing ownership rights -interest (but it is upfront)
Equity financing
-Capital for ownership (in corporation it is in shares of stock)
—right to vote and say in business affairs
—right to share in profits (Marriott lost $ bc of this)
—right to share in remaining resources if business terminates
KEY ADVANTAGE
-permanent financing (don’t have to repay and no interest)
2 ways owners/investors make a profit/loss on an investment
- Sharing in the business operating profits
- —dividend - one way an owner/investor gets a return on their stocks - Capital gains/losses on the sale of stock or distributions if the business terminates
Who requires information for investment decisions?
Creditors - evaluate company’s credit worthiness
-capable of repaying debt?
Investors - want to evaluate profit potential of an investment in company’s stock
Financial accounting
Primary Purpose is to provide info to assist investors/creditors in these evaluations (External users)
- Provide info to current/future providers of capital and other interested parties (gov. regulatory)
- financial statements: summarized historical information of financial position
Managerial accounting
-provide information to internal users - managers in operation
-customized, detailed reports of current, future, and historical data
Purpose: to improve managerial performance
General Purpose Financial Statements
- Balance Sheet (Statement of financial position)
- –to show assets and how business obtained them - Income Statement (statement of operations)
- –shows result of operations (profit) - Statement of cash flows (use of cash at given times)
- these are all found in company’s annual report available to the public
Two conditions for financial statements to be useful
Comparability and credibility
Comparability
Need for company’s to prepare statements in same methods as other companies
-standard form when investors look at info from other companies - comparative analysis (consistency)
GAAP
Generally accepted accounting principles
- rules and standards of acc used to create comparable info
- need became obvious in 1929 stock market crash - (no standardized information requirements)
In response, Congress created SEC (Securities and exchange commission) - to regulate capital transactions of publicly-held companies (large companies with stocks/bonds
- SEC determines GAAP, originally delegated to AICPA (Am institute of certified public accountants
- not successful bc CPAs were really conservative - business wanted to show more optimistic/promising info to investors
- private organization FASB (Financial acc standards board) formed and took over responsibility of GAAP
Credibility
Provide accurate and reliable info
- company’s management is responsible - may have conflicts of interest
- inaccurate financial statements are worthless and deceiving
- SEC requires all fin stmts of publicly held companies be subject to outside AUDIT for accuracy by a certified public accounting firm (CPA) - to test and verify material accuracy
- CPA issues auditor’s report which must accompany the company’s fin stmts
Publicly held companies…
FEDERAL AGENCIES
-SEC regulates publicly held companies
-IRS - collects income taxes
*Publicly held companies provide annual report for investors and creditors
PRIVATE ORGANIZATIONS
-AICPA license and certify CPAs who audit the annual reports
-FASB creates GAAP
Accounting is often referred to as…
the “language of business”
-bc it involves organizing and analyzing information to evaluate and make business decisions
Why is financial accounting information applicable to investors?
They are questioning the long-term profitability of the company
-look at past for clues to the future
Why is GAAP important?
Important for consistency in comparative analysis and credibility
- rules and standards by which accounting info is prepared and presented to external users
- MANAGERIAL ACCOUNTING is not governed by standardized rules
SEC, FASB, AICPA, IRS
SEC - regulate capital transactions of business and public in stocks and bonds
FASB - Financial accounting standards board - currently determines GAAP (independent, private institution - not gov. regulated)
AICPA - used to be responsible for GAAP, now licenses and certifies CPAs - establish procedures of auditing
IRS - (internal revenue service) - collect income taxes (An. institute of CPAs)
Do only large publicly held companies have audits performed?
They must have external audits to ensure their financial stmts are accurate
- businesses that seek to acquire capital from the public
- any business bc it adds credibility to their business
3 Basic legal forms of business
Proprietorship, partnership, corporation
Proprietorship
- one owner
- no legal red tape except if you hire employees (legal hire standards, safety issues, license, sales tax if you are selling products)
- no separation of business and personal liability
- –can sue and take your business and personal resources - exposes personal life to risk
- –no separate income taxation - any income or loss are taken to you directly - no separate tax for business
Partnership
- same as proprietorship except more than 1 owner
- a formal partnership is recommended, but not required (anticipate how to split profits and losses)
- no separate income taxation (if a partner is sued it affects the others assets as well)
- —tax return is to each individual personally
Corporation
Separate legal entity apart from its owners
- legal red tape in formation and operation imposed by state
- one or more owners
- separation of business and personal liability of owners
- —sue claims only business assets - no personal risk
- DOUBLE TAXATION!!
- —Corporate tax + state + personal = (less left to owners)
- —Can avoid by salaries and bonuses (decrease net income)
- —or use LLC (limited liability corp.) - treated like a partnership in taxing - no double taxation but any business decisions must be approved by all owners