Chapter 1 Notes
Created Sep 7, 2019 155 PM
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Updated Sep 7, 2019 256 PM
Accounting in Action
Accounting Activities and Users
Accounting- identifies, records and communicates economic events of an
organization to interested users
Three Activities
Identifying the economic events relevant to its business
Recording those events in order to provide a history of its financial
activities
Keeping a systematic, chronological diary of events
Communicates the collected information to interested users by means of
accounting reports
Financial statements- presenting data in a standardized way; most
common report
Reporting data- in aggregate- simplifies transactions and makes a
series of activities understandable and meaningful
Analyzing and interpreting the reported information
Using ratios, percentages, graphs and charts to highlight financial
trends and relationships
Interpreting involves explaining the uses, meaning and limitations
of reported data
Accounting process includes the bookkeeping function
Bookkeeping- only the recording of economic events
Accounting involves the entire process of identifying, recording and
communicating economic events
Chapter 1 Notes 1
Who Uses Accounting Data
Internal users- managers who plan, organize and run the business
Marketing managers, production supervisors, finance directors and
company officers
Managerial accounting- provides internal reports to help users make
decisions about their companies
External Users- individuals and organizations outside a company who want
financial information about the company
Investors (owners)- use information to decide whether to buy, hold , or
sell ownership shares of a company
Creditors (suppliers and bankers)- use information to evaluate the risks
of granting credit or lending money
Financial Accounting- provides economic and financial information for
investors, creditors and other external users
The Building Blocks of Accounting
Ethics in Financial Reporting
Ethics- standards of conduct by which actions are judged as right or
wrong
Effective financial reporting depends on sound ethical behavior
Accounting Standard
To ensure high-quality financial reporting, accountants present financial
statements in conformity with accounting standards that are issued by
standard-setting bodies
International Accounting Standards Board IASB
International Financial Reporting Standards ISFR followed by 130
countries
Headquartered in London
Financial Accounting Standards Board FASB
Most companies in the US follow generally accepted accounting
principles GAAP issued by the FASB
Chapter 1 Notes 2
Convergence- process of reducing the differences between ISFR and
GAAP to increase comparability
Measurement Principles
ISFR generally uses one of two measurement principles that have trade-
offs between Relevance and Faithful Representation
Relevance- financial information is capable of making a difference in a
decision
Faithful Representation- numbers and descriptions match what
happened/ existed
Historical Cost Principle- companies record assets at the cost
Recorded values don't change according to appreciation or
depreciation
Fair Value Principle- assets and liabilities should be reported at fair balue
More useful than historical cost for certain types of assets and
liabilities
Usually only used in situations where assets are actively traded
Assumptions
Monetary Unit Assumption- companies only include transaction data that
can be expressed in money terms
Enables accounting to quantify economic events, vital to historical
cost
Prevents inclusion of some relevant information
Economic Entity Assumption- activities of an entity is kept separate from
the activities of the owner and all other economic entities
Economic Entity- can be any organization or unit in society
Proprietorship- business owned by one person
Only a relatively small amount of money is necessary to start in
business
Owner/Proprietor receives any profits, suffers any losses, and is
personally liable for all debts
No legal distinction, but economic activities are distinct
Chapter 1 Notes 3
Partnership- business owned by two or more people associated as
partners
Partnership agreement sets forth terms of share
Corporation- organized as a separate legal entity under jurisidiction
corporation law and having ownership divided into transferable shares
Holders of shares enjoy limited liability
Shareholders may transfer all or part of their shares to other
investors at any time
Unlimited life
Accounting Equation
Basic Accounting Equation: Assets = Liabilities + Equity
Applies to all economic entities
Underlying framework for recording and summarizing economic events
Assets- resources a business owns
Have the capacity to provide future services or benefits
Liabilities and equity- rights or claims against these resources
Liabilities- claims of those to whom the company owes money
Creditors- all people to whom an entity owes money
May legally force the liquidation of a business that doesn't pay
its debts, law requires creditor claims be paid before ownership
claims
Equity- claims of owners
Share Capital-ordinary- term used to describe amounts paid in by
shareholders for ordinary shares they purchase
Retained Earnings
Revenues- gross increases in equity resulting from business
activities entered into for the purposes of earning income
Usually result in an increase in an asset
Expenses- cost of assets consumed or services used in the
process of earning revenue
Chapter 1 Notes 4
Decreases in equity that result from operating the business
Dividends- distribution of cash or other assets to shareholders
NOT EXPENSES!!!
Analyzing Business Transactions
Accounting Information System- system of collecting and processing
transaction data and communicating financial information to decision-
makers
Rely on accounting cycle
Accounting Transactions
Transactions- business's economic events recorded by accountants
External Transactions- involve economic events between the company
and some outside enterpirse
Internal Transactions- economic events that occur entirely within one
company
Each transaction must have a dual effect on the accounting equation
Financial Statements
Income Statement- presents the revenues and expenses and resulting net
income or net loss for a specific period of time
reports the success or profitability of company's operations over a
specific period of time
Lists revenues first, then expenses before showing net income or loss
Doesn't include investment and dividend transactions
Retained Earning Statement- summarizes the changes in retained earnings
for a specific period of time
Covers same time period as income statement
Beginning retained earnings, then net income and dividends
Retained earnings end balance is the final amount
Indicates the reasons why retained earnings increased or decreased
during the period
Chapter 1 Notes 5
Statement of Financial Position (aka balance sheet)- reports the assets,
liabilities and equity of a company at a specific date
Lists assets at the top, followed by equity then liabilities
Snapshot of the company's financial condition at a specific moment in
time
Statement of Cash Flows- summarizes information about cash inflows
(receipts) and outflows (payments) for a specific period of time
Reports cash effects of a company's operations during a period,
investing activities, financing activities, net increase or decrease in
cash, and cash amount at the end of the period
Useful because external users want to know what is happening to a
comapny's most liquid resource
Comprehensive Income Statement- presents other comprehensive income
items not included in the determination of net income
Chapter 1 Notes 6
