Week 1 - Class Notes Flashcards
- What is the informational role for financial accounting in securities markets?
Accounting records inform creditors and investors, ensuring securities/stocks/bonds are bought and sold at appropriate prices.
U.S. GAAP.
US GAAP = “Generally Accepted Accounting Principles.” A set of standards based on some underlying principles that guides the preparation of financial statements. Uses accrual accounting
Accrual accounting
Transactions are recorded in the books when business activities occur regardless of when the cash effect takes place. (Ex: a company might sell some products to a customer and the customer takes the product and promises to pay at a later day. Well, that company can go ahead and record the sales as revenues in its books. Even it hasn’t received the cash from the customer. As long as the customer is expected to pay.)
- What is accounting?
Accounting is a system of recording, categorizing, summarizing, and communicating financial information about an organization to those who might be curious.
Why is accounting called the language of business?
Well, because it communicates information to help decision-makers make really good economic decisions. And then it communicates the results or the financial consequences of those decisions to others that need to understand them.
The financial books
(Ex: annual report) Audience: external parties, like investors or creditors Obj: communicate economic performance and financial position of the org Rules: US GAAP, IFRS, Specific country GAAP Authority: SEC -> FASB, IASB, specific country authority
The management books
(Ex: budget reports or product profitability reports) Audience: internal, management itself Obj: to facilitate management decision making in the org Rules: None Authority: Management
The tax books
(Ex: tax return) Audience: tax authorities Obj: to facilitate the collection of tax revenue by the gov Rules: Tax code Authority: Tax authority (IRS)
Accounting Standards
promote consistency/comparability across companies BUT allow managers some discretion
- Which of the following are correct about U.S. GAAP? (Select all that apply)
1) Accounting Standards promote consistency/comparability across companies, but allow managers some discretion 2) GAAP stands for “Generally Accepted Accounting Principles” 3) U.S. GAAP uses accrual accounting 4) U.S. GAAP is a set of standards that guide the preparation of financial statements
Who set the GAAP standards?
Securities & Exchange Commission (SEC)
SEC established
created by US Congress with Securities Exchange Act of 1934 b/c of stock market crash of 1929
SEC does
regulates the issuance and trading of securities
SEC delegated
SEC delegated the preparation of accounting standards to the Financial Accounting Standards Board. A private organization, not-for-profit. 7-member board that has five year renewable terms, and they have an extensive staff support.
10 K
annual filing, end of the year (After Q4 - 10 K)
10 Q
Quarterly filing (Q1, Q2, Q3)
8 K
must be filed with the SEC when a company encounters or undergoes a material event.
Who makes sure the “rules” are followed?
Generally speaking, four parties: 1) management, 2) the independent auditor, 3) the audit committee of the board of directors and the board itself, 4) and then regulators, the legal systems and the securities market.
Role of management
prepares the financial statements, SOX
Sarbanes-Oxley Act (SOX) of 2002
Implemented in response to extensive financial reporting fraud in late 90’s (Ex: Enron, Worldcom)
Impact of Sarbanes-Oxley Act (SOX) of 2002
1) Communicated and clarified reporting responsibilities. 2) Stiffened or enhanced the penalties associated with misreporting. 3) Explicitly placed the responsibility on the CFO and CEO. Now, both have to personally sign off on the financial statements and are subject to criminal penalties if misreporting is found to have occurred.
Role of the Independent Audit Firm
express an opinion, reasonable assurance, nut not fool-proof
Role of the Audit Committee of the board
1) Appoint and hire the external audit firm to conduct the audit. 2) They make sure the results of that audit is adequately made available and the appropriate details are made available to the board of directors and to shareholders. So that the appropriate parties know the results of the audit and what the controversies were, if any.
Role of the regulators, legal system, and the securities markets
1) Regulators, such as the SEC, will investigate if there is some suspicion of fraudulent or misreporting. 2) Shareholders might band together and file a lawsuit against a company if they suspect that there’s some misreporting. 3) Security prices (stock) will move up and down in response to investors’ concerns about integrity in financial reporting.
- Who make sure the rules of financial reporting are followed? (Select all that apply)
Management, Independent auditor, Audit committee of the board of directors, Regulators, legal system, and securities market
IFRS
IFRS = “International Financial Reporting Standards”
IASB
IASB = “International Accounting Standards Boards”
LIFO
last in, first out
- Although Luann just briefly discussed accounting standards outside the U.S., which accounting standards are important for this course?
Accounting standards inside the U.S., called the Generally Accepted Accounting Principles (GAAP).
The 4 financial statements that companies are required to prepare
1) the balance sheet, 2) the income statement 3) the statement of cash flows 4) the statement of stockholders’ equity. So, we have one financial statement, the balance sheet, that captures something at a specific point in time. The other three statements capture something over apot
The balance sheet
shows the company’s financial position at a specific pit
The income statement
shows the results of operations over apot
The statement of cash flows
shows the sources and uses of cash over apot
The statement of stockholders’ equity
shows the changes in stockholders’ equity over apot
The Accounting Cycle
occurs every fiscal period; Analyze events and transactions -> Rec transactions (j&p) -> Rec adjusting entries (j&p) -> Prep financial statements -> Close temporary acounts (r&ea) -> The cycle starts over
j&p
journalize &post
r&ea
revenue & expense accounts
- Which of the following are examples of fiscal periods during which we might go through the accounting cycle?
30 days/1 month, quarter, year
The balance sheet will have:
a section that lists assets, lists liabilities, and lists owner’s equity items
What are assets?
Resources that are expected to provide future economic benefit. In layman’s terms, it’s stuff. It’s stuff that the company owns that’s going to be beneficial to it at some point in time. (Ex: Some examples of assets are cash, inventory, buildings, etc)
The liabilities and owner’s equity section tell
where the company got the funds to invest in those resources that are sitting on the asset side of the balance sheet
Liabilities Ex’s
amount owed to suppliers, loans from bank
Owner’s Equity Ex’s
capital stock, retained earnings
capital stocks
the owners give it some funds, The equity obtained directly from owners
retained earnings
the company generates some earnings, retains the equity in its own business instead of paying it out to shareholders in dividends.
Total Assets $$ =
Total L + OE $$
Investments decisions
What resources has the company invested in? (assets)
Financing decisions
How has the company invested in those resources? (liabilities, owner’s equity)
- The Balance Sheet Equation
Assets (A) = Liabilities (L) + Owners’ Equity (OE) The funds the company has obtained through liabilities and equity must equal the amount of resources in which the company chooses to invest (assets).
Common examples of assets
cash, accounts receivable, inventory, prepaid expenses, investments, property plant & equipment, intangible assets
Accounts receivable
the amount that a company is owed by its customers that has not yet been paid.
Prepaid expenses
the amount that a company has paid to a supplier in advance of receiving a service. (Ex: it might pay rent in advance, a year’s worth of rent in advance before occupying a building )
Property, plant and equipment
Term for land, buildings, machinery, things of that nature
Intangible assets
Don’t have that much physical substance in nature, can’t really touch them but they’re very important resources to the firm. (Ex: patents, brand names)
Inventory
The product that a company has that it expects to sell to customers in the future
When can assets be recorded in the books? (2 criteria)
1) Owned or controlled by the company as a result of a past exchange 2) Expected to provide future benefits that can be reliably measured
Asset classification
Current or non-current
Current asset
Would turn into cash within a year, or use in the operations of the company within a year.
Non-current asset
Would expect to use in the business’s operations, or not turn into cash for substantially longer than a years’ time.
Historical cost
The original cost, preferred by US GAAP
Liabilities
Obligations that the company must repay in the future
When are liabilities recorded in the books? (3 criteria)
1) A future payment is probable 2) Amount of the obligations can be reasonably estimated 3) The event that caused the obligation has occurred
Common examples of liabilities
accounts payable, accrued expenses, deferred revenue, notes payable, loans payable, bonds payable
Accounts payable
that’s the amount a company owes its suppliers for things that it’s purchased in the past but hasn’t yet paid for
Accrued expenses
expenses that have been incurred by the company that have not yet been paid
Deferred revenue
a liability that is incurred because a customer has paid cash to the organization but the organization has not yet provided the product or the service that the customer was paying for.
Notes payable, or loans payable
these are amounts that we owe other parties
Bonds payable
that would be if we had issued bonds to investors in an effort to raise some funds, then that would be a liability that we would have to repay in the future
Owner’s Equity
AKA shareholders equity, net assets, net book value
2 sources of owner’s equity
contributed capital, retained earnings
Contributed capital
capital that owners have invested in the company (Ex: capital stock, treasury stock)
Retained earnings
earnings that the company has generated and retained
- What is the balance sheet equation we need to remember throughout this course?
Assets (A) = Liabilities (L) + Owners’ Equity (OE)
The funds the company has obtained through liabilities and equity must equal the amount of resources in which the company chooses to invest (assets).
