Accounting
is an information system that measures, processes, and communicates financial information about an economic entity. Accounting is a link between business activities and decision makers
Business
an economic unit that aims to sell goods and services to customers at prices that will provide an adequate return to its owners. The two major goals of all businesses are profitability and liquidity.
Profitability
is the ability to earn enough income to attract and hold investment capital.
Liquidity
is the ability to have sufficient cash to pay debts as they fall due.
operating activities
which include selling goods and services to customers, employing managers and workers, and buying and producing goods and services;
investing activities
which involve spending the capital a company receives in productive ways to help it achieve its objectives; and
financing activities
which include obtaining funds to sustain operations.
performance measures
which indicate whether managers are achieving their business goals and whether the business activities are well managed.
Management accounting
provides information to internal decision makers, such as managers
financial accounting
communicates financial information via financial statements to external decision makers. Most businesses publish financial statements that report their profitability and financial position.
Bookkeeping
a small but important aspect of accounting, deals with the mechanical, repetitive recordkeeping process.
computer
is an electronic device that rapidly collects, organizes, and communicates vast amounts of information. A computer does not take the place of the accountant but rather is a tool used by the accountant to perform both routine bookkeeping chores and complex accounting calculations.
management information system (MIS)
consists of the interconnected subsystems that provide the information needed to run a business. The accounting information system is an integral part of the management information system.
Ethics
is the code of conduct that helps individuals in their everyday life distinguish right from wrong. Ethics is especially important in preparing financial reports because users of these reports must depend on the good faith of the people involved in their preparation.
fraudulent financial reporting
The intentional preparation of misleading financial statements is called. It can result from the distortion of records, falsified transactions, or the misapplication of various accounting principles.
Sarbanes-Oxley Act
regulates financial reporting in public corporations. This legislation requires the chief executives and chief financial officers of all publicly traded U.S. companies to attest to the accuracy and completeness of the quarterly statements and annual reports that their companies file with the SEC.
three groups use accounting information
management, outsiders with a direct financial interest, and outsiders with an indirect financial interest.
To make an accounting measurement, the accountant must answer what questions?
1. What is measured?
2. When should the measurement be made?
3. What value should be placed on what is measured?
4. How should what is measured be classified?
Accounting
concerned with measuring specific transactions of specific business entities in terms of money.
Business transactions
are economic events that affect the financial position of the business. Business transactions may involve exchanges of value (e.g., sales, borrowings, and purchases) or nonexchanges (the physical wear and tear on machinery and losses resulting from fire or theft).
exchange rate
translating of currency from one currency to another.
The three basic forms of business organization
sole proprietorships, partnerships, and corporations. Accountants recognize each form as an economic unit separate from its owners.
sole proprietorship
is an unincorporated business owned by one person.
partnership
is much like a sole proprietorship, except that it has two or more owners.
corporation
a business unit chartered by the state and legally separate from its owners (the stockholders).
articles of incorporation
a contract between the state and the incorporators.
A share of stock
represents a unit of ownership in a corporation.
Common stock
is the most universal form of stock. A corporation is considered a separate legal entity from its owners. The owners are the firm’s stockholders.
board of directors
determines major business policies and selects top management who run the business.
Financial position
refers to the relationship between economic resources and equities at a given time, which is shown on the balance sheet.
Assets
the economic resources of a business. Examples of assets are cash, accounts receivable, inventory, buildings, equipment, patents, and copyrights.
Stockholders’ equity
represents the claims of the owners of a corporation to the assets of the business. It is equal to the net assets, or the assets that would be left after all liabilities are paid. Stockholders’ equity has two parts, contributed capital and retained earnings.
Contributed capital
the amount that stockholders invest in the business. Typically, contributed capital is made up of par value and additional paid-in capital.
Par value
an amount per share that is entered in the corporation’s capital stock account; it is the minimum amount that can be reported as contributed capital.
additional paid-in capital
the amount over par value when the value received is greater than par value
Retained earnings
represent stockholders’ equity that has been generated by the business’s income-producing activities and kept for use in the business. Retained earnings are affected by three kinds of transactions: revenues, expenses, and dividends. Revenues are the increases in stockholders’ equity resulting from the operation of the business.
Expenses
decreases in stockholders’ equity that result from operating a business.
net income
the difference when revenues exceed expenses
net loss
the difference when expenses exceed revenues
Dividends
are distributions to stockholders of assets generated by past earnings.
Retained earnings
the accumulated net income (revenues – expenses) less dividends over the life of the business.
income statement
components are revenues and expenses, is perhaps the most important financial statement. Its purpose is to measure a business’s profitability during a given period of time. The net income or net loss is used to update retained earnings on the statement of retained earnings. Net income (loss) also appears on the statement of cash flows.
statement of retained earnings
a calculation of the changes in retained earnings during the accounting period. Retained earnings at the beginning of the period is the first item on the statement, followed by an addition for net income and a deduction for dividends. The ending figure is transferred to the retained earnings section of the balance sheet.
balance sheet
shows the financial position of a business on a specific date.
assets
the resources used in the business
liabilities
debts of the business
stockholders’ equity
the owner’s financial interest in the business
statement of cash flows
provides users with information about the business’s liquidity by disclosing all important financing, investing, and operating activities that affect its cash balance during the accounting period.
Cash flows
the inflows and outflows of cash into and out of a business.
Financing activities
may include issuing or repaying debt.
Investing activities
may include selling a building or investing in stock.
Operating activities
include receipts from customers and payments to suppliers and others in the ordinary course of business.
Generally accepted accounting principles (GAAP)
the conventions, rules, and procedures that define acceptable accounting practice at a particular time. They arise from wide agreement on the theory and practice of accounting at a given time. These principles change continually as business conditions change and practices improve.
Public Company Accounting Oversight Board (PCAOB)
is a governmental body created by the Sarbanes-Oxley Act to regulate the accounting profession.
Financial Accounting Standards Board (FASB)
an independent body, is the authoritative body in the development of GAAP. The FASB issues Statements of Financial Accounting Standards.
American Institute of Certified Public Accountants (AICPA)
the professional association of CPAs, influences accounting practice through the activities of its senior technical committees.
Securities and Exchange Commission (SEC)
an agency of the federal government that has the legal power to set and enforce accounting practices for companies whose securities are traded by the general public.
International Accounting Standards Board (IASB)
develops international accounting standards.
The Internal Revenue Service (IRS)
has its own set of rules that govern the assessment and collection of taxes. These rules, while sometimes contrary to GAAP, are an important influence on accounting practice.
Professional ethics
the application of a code of conduct to the practice of a profession. The accounting profession has developed a code that is intended to guide the accountant in carrying out his or her responsibilities to the public.
AICPA’s code for CPAs
the accountant must act with integrity, objectivity, independence, and due care. Integrity means the accountant is honest, regardless of consequences. Objectivity means the accountant is impartial and intellectually honest in performing his or her job. Independence means the accountant avoids all relationships that could impair, or even appear to impair, his or her objectivity, such as owning stock in a company being audited.
accounting equation
Assets = Liabilities + Stockholders’ Equity
Other forms of the equation are:
Assets – Liabilities = Stockholders’ Equity
Assets – Stockholders’ Equity = Liabilities
payables turnover
number of times, on average, that accounts payable are paid in an accounting period and shows the relative size of a company’s accounts payable.
days’ payable
the average length of time a company takes to pay its accounts payable.
Current liabilities
are present obligations that are expected to be satisfied within one year or within the normal operating cycle, whichever is longer. Payment is expected to be out of current assets or through the incurrence of another current liability.
Definitely determinable liabilities
are obligations that can be measured exactly. They include accounts payable, bank loans and commercial paper, notes payable, accrued liabilities, dividends payable, sales and excise taxes payable, current portions of long-term debt, payroll liabilities, and unearned revenues.
Accounts payable
are short-term obligations to suppliers for goods and services.
Short-term notes payable
are current obligations evidenced by promissory notes. Usually, interest is stated separately on the face of the note.
accrued liability
is an actual or estimated liability that exists at the balance sheet date but is unrecorded. An end-of-period adjustment is needed to record both expenses and accrued liabilities.
Dividends payable
represent an obligation to distribute a corporation’s earnings to its stockholders. This arises only when the board of directors declares a dividend.
Payroll liabilities
consist of the labor-related obligations incurred by a business. Not only is the business responsible for wages, paid at an hourly rate, and salaries, paid at a monthly or yearly rate, earned by its employees, but also it is obligated for items such as social security (FICA) taxes, Medicare tax, and unemployment taxes. The business is likewise liable for amounts withheld from its employees’ gross earnings that must be remitted to governmental and other agencies.
contingent liability
a potential liability that may or may not become an actual liability. The uncertainty regarding its outcome is resolved by the occurrence or nonoccurrence of a future event. Contingent liabilities arise from pending lawsuits, tax disputes, and failure to follow government regulations. Contingent liabilities are recorded if the occurrence is probable and the amount can be reasonably estimated. A commitment is a legal obligation that does not meet the technical requirements for recognition as a liability. The most common examples are purchase agreements and leases.
Long-term liabilities
obligations that are not expected to be satisfied within the longer of one year or the normal operating cycle.
The three chief management considerations related to issuing long-term debt
are (1) whether to take on long-term debt, (2) how much long-term debt to carry, and (3) what type(s) will be most practicable. Among the advantages of long-term debt financing are (1) common stockholders do not relinquish any control, (2) interest on debt is tax-deductible, and (3) financial leverage may increase earnings.
Financial leverage
is the ability to earn more on assets than is paid in interest on the debt incurred to finance the assets. Financial leverage is measured by the debt to equity ratio and a company’s ability to pay its interest is measured by its interest coverage ratio.
Disadvantages of long-term financing
(1) interest and principal must be repaid on schedule, (financial risk) and (2) financial leverage can work against a company if the earnings from its investments do not exceed its interest payments (negative financial leverage).
off-balance-sheet financing
company can structure long-term debts in such a way that they do not appear on the balance sheet, which is known as
Mortgage
a long-term debt, usually payable in equal monthly installments, that is secured by real property. When a mortgage payment is made, both Mortgage Payable and Mortgage Interest Expense are debited, and Cash is credited. Each month, the interest portion of the payment decreases, and the principal portion of the payment increases.
Lease
a contract that allows a business or an individual to use an asset for a specific length of time in return for periodic payments.
capital lease
(as determined by certain criteria) is in substance a sale and should be recorded as an asset (to be depreciated) and a related liability by the lessee.
pension plan
a program whereby a company agrees to pay benefits to its employees after they retire. Pension plans are classified as either defined contribution plans or defined benefit plans. Other postretirement benefits, such as for health care, should be estimated and accrued while the employee is still working (in accordance with the matching rule).
Bond
is a security, usually long-term, that represents money that a corporation or some other entity borrows from the investing public. Bondholders are considered creditors (not owners) of the issuing corporation, who are entitled to periodic interest plus the principal of the debt on some specified date. As is true for all corporate creditors, their claims for interest and principal take priority over stockholders’ claims.
bond certificate
as evidence of its indebtedness.
bond issue
is made up of the total value of bonds issued at one time. Bonds are usually issued in denominations of $1,000 or some multiple of $1,000 and have a variety of features.
Interest for a period is computed
with the following formula: Interest = Principal × Rate × Time
discount
When the face interest rate is less than the market interest rate for similar bonds on the issue date, (less than face value).
Unamortized Bond Discount
is a contra-liability account to Bonds Payable in the balance sheet. The difference between the two is called the carrying value, an amount that increases as the discount is amortized, and that equals the face value of the bonds at maturity.
premium
When the face interest rate is greater than the market interest rate for similar bonds on the issue date, the bonds usually sell at a (greater than face value). Unamortized Bond Premium is added to Bonds Payable on the balance sheet to produce the carrying value.
Unsecured bonds
(also called debenture bonds) are issued on a corporation's general credit,
secured bonds
give the bondholders a claim to certain assets of the organization on default.
serial bonds
When the bonds in an issue have several maturity dates.
early extinguishment of debt
Some bonds may be bought back and retired by the company prior to their maturity date
Callable bonds
give the issuer the right to buy back and retire bonds before maturity at a call price, which is a specified price usually above face value.
Convertible bonds
can be exchanged for common stock or other securities at the option of the bondholder.
registered bonds
the organization maintains a record of all bondholders and pays interest by check to the bondholders of record.
Coupon bonds
entitle the bearer to interest when the detachable coupons are deposited at a bank.
A corporation might issue convertible bonds
(1) because investors will accept a lower rate of interest, (2) to avoid a shift in control, since bondholders do not have voting rights, (3) to benefit from the tax-deductibility of the bond interest, (4) in the hopes that the resultant earnings will exceed the interest cost, and/or (5) to achieve a certain financial flexibility.
Bond prices are expressed
as a percentage of face value. For example, when bonds with a face value of $100,000 are issued at 97, the company receives $97,000.
When bonds are issued at a discount or premium, the interest payments will
not equal the (true) total interest cost. Instead, total interest cost equals (1) interest payments over the life of the bond, plus (2) the original discount amount or minus (3) the original premium amount.
zero coupon bond
is a promise to pay a fixed amount at maturity, with no periodic interest payments. Investor earnings consist of the large discount on issue, which in turn is amortized by the issuing corporation over the life of the bond.
discount on bonds payable
is considered an interest charge that must be amortized (spread out) over the life of the bond. Amortization is generally recorded on the interest payment dates, using either the straight-line or the effective interest method.
straight-line method of amortization,
the amount to be amortized each interest period equals the bond discount divided by the number of interest payments during the life of the bond.
