Accounting: Recording Transactions, Financial Statements, and

Chapter 1 NotesAccounting: The recording of financial transaction, preparation of summarized reports of the financial transaction, and analy zing the transactions themselves. •Financial Statements: Are made from the accounting system but can be visible to people within the company andthe public. •Classificationof BusinessOperations Financing Activities: Transactions that raise funds for the company to operate and expand. ○Investing Activities: Transactions for the company to invest in assets that it will use in its business operations.○Operating Activities: All other transactions that the business has that cannot be defined as financing or investing such as payments of rent, salary, and insurance expenses. ○Financing Activities There are two basic ways for a company to raise money to finance operations: Equity "Equity" refers to ownership. When a company sells equity, they are selling ownership of the company and owners are stockholders. Therefore people who have equity ofthe company are considered "equity investors" (or stockholders/shareholders). Money investors pay for stock can be used to finance business operations. □There are two ways stockholders can make money from this. By receiving dividends from the company Dividends are payments made from a corporation to its stockholders. ◊Selling the stock at a higher price in the future. □▪○Debt- Borrowing money from investors or banks. The company will have to sign agreeing to pay back the money + interest. Creditorsare the ones who loan money to the business. Creditors and different than stockholdersbecause they have the legal right to receive back the money loaned, called the "principal", as well as interest payments on this money for the period of time the loan is outstanding. Interestis the amount of money the creditor is charging for the money loaned. ◊□▪Loan contract- Specific requirements of a loan spelled out in a contract. Maturity date:Date which the loan has to be repaid by. □Interest that will accrue □Collateral:Assets (or like monetarily valued things) that are given to the creditor if the borrower cannot pay back the loan. In the loan contract they were already given up as collateral. □Terms:The specific terms of a contract may vary. □▪○ •Investing Activities Fixed Assets:Things that companies purchase like buildings, land, and equipment that they need to operate a business are fixed assets. Usu ally these things are: Likely to last a number of years ○Expected to be used as part of business operations rather than sold as the company's general operations. Things in the fixed asset category are generally expensive and companies may event set a minimum amount purchase for them. ▪○•Operating Activities Anything that is not a financing activity or an investing activity is generally considered to be an operating activity. Anything related to running a business or marketing a company product. Ex. Salaries, wages, rent, utilities, insurance, or anything bought with the intention of being resold. ▪○•Setting of Financial Accounting Securities and Exchange Commission (SEC) -Maintain fair and truthful markets. However this only extends to "publicly held corporations", which means it would be on theNew York Stock exchange or NASDAQ.SEC requires: Form 10K(annually) an audited financial report. ○Form 10Q(quarterly) unaudited financial report covering the current quarter. These publicly available forms help analysts analyze and compare various companies. ▪○Annual Report:Afinancial statementrequired by the SEC that must be audited by an outside, independent auditor. Required to have four standard financial statements: Balance sheet ▪Income statement ▪Statement of Stockholder's equity (or statement of retained earnings) ▪Statement of Cash flows ▪Notes to Financial Statements:Give additional information supporting the data in the financial statements ▪CEO's Letter:Discusses a company's management performance to date and what company hopes to accomplish in the future. ▪○Independent Auditor:also called anExternal Auditoris an accounting firm that specializes inPublic Accounting,basically a company that provides accounting services to other companies. They need to be "independent from the company their auditing" which means: They are not employees of the company they are auditing. ▪ Don't own substantial investment in the company they are auditing. ▪○Certified Public Accountants (CPA's)most common service is providing andaudit. ○Audit:is a thorough assessment of bookkeeping records, financial accounts, and the policies and procedures of an "entity" (business, trust, or governmental unit). Just because an auditor approved something doesn't mean it's absolutely correct, but it has not material errors. ▪○ Preparation of the financial statements are the responsibility of the company that is being audited whereas it is the auditors job to state an opinion regarding the statements management has prepared. ○•The Big Four:These are the biggest public accounting firms in the world. They are international and are responsible for a lot of the accou nting work done in the world. Deloitte ○ Ernst & Young (EY) ○KPMG ○PricewaterhouseCoopers (PwC) ○•Internal Auditors:Auditors that are employed by the company and are responsible for finding problems that external auditors may come across andcorrect them ahead of time. They do this by creating and managing internal controls which are rules and procedures to ensure employees not only follow co mpany rules but also those of outside regulators like SEC, IRS, FASB, etc... •Corporate Governance:Mechanisms in place to ensure managers to report the truth in their financial statements. Reputations of managers and business (reputation always matters) ○Threat of legal liability ○Maintaining ethics. Most successful companies know the ethical way is the best way. ○•Generally Accepted Accounting Principles (GAAP):Accounting standards that have been formally used since the formation of SEC in early 1930's. GAAP is a "rule based system" that gives direction on how to account for common and uncommon transactions by companies. Some examples of their guidance includes: How quickly purchases are to be expensed ▪When expenses on their balance sheet should be recorded at their cost and when at their fair value ▪When revenue can be considered earned "GAAP is the responsibility of an organization called the "Financial Accounting Standards Board" ("FASB"). When the Board makes a change to the standards, it does so only after receiving input from anyone who might be interested, which includes the SEC, Congress, the While House, other government agencies, public hearings, and letters from individuals." - Tophat textbook □Conceptual Framework is: "To provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity." - Tophat textbook Useful financial information has relevance and faithful representation. □▪○•International Financial Reporting Standards (IFRS):IFRS is the responsibility ofInternational Accounting Standards Board (IASB)and these international standards are relatively new but are gaining momentum in countries around the world, now used in 100+ countries. IFRS is different than GAAP, because it is "principle based" rather than "rule based" IFRS gives substantially less guidance and relies on interpretation to be handled by the preparers of the statements and their external auditors. FASB AND IASB has been working to merge the two under IFRS so that there can be an international set of accounting rules for the whole world. □▪○•Types of Reporting Entities: Organizations that prepare financial statements. One type is a profit -seeking business, usually large but segmented. There are also non -profit like charities or government. Profit seeking entities can be categorized in three different ways: Service: Sell knowledge or skill not good. ▪Retail: Buy from manufacturer and sell at higher price. ▪Manufacturing: Buy raw materials and turn them into a product. ▪○•Taxes: There are many types of taxes but we will be focusing on the Federal Income Taxes that are required to be paid by businesse s. ONLY TAXES THAT BUSINESSES PAY BASED ON THEIR INCOME. Five Business Types (we only care about 2) : Sole proprietorship -Partnership -C corporation -S corporation -Limited Liability Company - Corporation:A corporation is a business that hasincorporated, which means it is established as a separate legal entity. A corporation can own assets and experience liabilities. -Objectives Discuss the different classifications of financial transactions •Define an equity investor and a debt investor and understand the difference •Discuss the role of the Securities and Exchange Commission •Understand the basic terms surrounding auditing •Define corporate governance •Discuss GAAP and IFRS and the concept of rules-based versus principles-based •Discuss the roles of the board of directors and the audit committee •Discuss the basics of Sarbanes-Oxley •Discuss how legal liability and corporate ethics work to help strengthen corporate governance •Understand the tax implications of a corporation •Define the words in bold in this chapter •