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Ch 1: Introducing Accounting in Business (Study Sheet, Accounting Competency)

A. Importance of Accounting
a. Accounting – information and measurement system that identifies, records and
communicates relevant information about a company’s business activities
b. Most common contact with accounting is through credit approvals, checking
accounts, tax forms, and payroll
i. These experiences focus on recordkeeping/bookkeeping
1. Recordkeeping/bookkeeping – part of accounting that involves
recording transactions and events, either manually or electronically
ii. technology is only as useful as the accounting data available, and users’
decisions are only as good as their understanding of accounting
B. Users of Accounting Information
a. Accounting is called the language of business because all organizations set up an
accounting system to communicate data that help people make better decisions
b. External users – persons using accounting information who are not directly
involved in running the organization
i. Financial accounting – area of accounting aimed mainly at serving
external users by providing them with general purpose financial
c. Internal users – persons using accounting information who are directly involved
in managing the organization
i. Managerial accounting – area of accounting aimed mainly at serving the
decision-making needs of internal users; also called management
1. Internal reports are not subject to the same rules as external reports
and are designed for the unique needs of internal users
C. Opportunities in Accounting
a. Accounting has four broad areas of opportunities:
i. Financial
ii. Managerial
iii. Taxation
iv. Accounting-related
b. Majority of opportunities are in
private accounting
c. Public accounting offers the
next largest number of
opportunities, which offers
services such as such as auditing
and taxation
i. Opportunities also exist in
government and no-for-profit agencies, including business regulation and
investigation of law violations
d. Accounting specialist are highly regarded and their professional standing is often
denoted by a certificate
i. Certification examples:
1. CPA – certified public accountant
2. CMA – certificate in management accounting
3. CIA – certified internal auditor
4. CB – certified bookkeeper
5. CPP – Certified payroll professional
6. CFE- certified fraud examiner
7. CrFA – certified forensic accountant
ii. Demand for accounting specialist is strong, and they earn good money
D. Fundamentals of Accounting
a. Ethics–A Key Concept
i. For information to be useful, it must be trusted
1. Ethics – codes of conduct by which actions are judged as right or
wrong, fair or unfair, honest or dishonest
a. Beliefs that distinguish right from wrong
ii. Fraud
1. There three factors why a person commits
a. Opportunity – a person must be able to
commit fraud with a low risk of getting
b. Pressure (incentive) – a person must
feel pressure or have incentive to commit fraud
c. Rationalization (attitude) – a person justifies the fraud and
fails to see its criminal nature
2. The key to dealing with fraud is to focus on prevention. It is less
expensive and more effective to prevent fraud from happening than
it is to detect it.
a. By the time a fraud is discovered, the money is often gone
and chances for recovery is slim
iii. Both internal and external users rely on internal controls to reduce the
likelihood of fraud
1. Internal controls – procedure set up to protect company property
and equipment, ensure reliable accounting, promote efficiency, and
encourage adherence to policies
a. Examples:
i. Good records, physical controls (locks, password,
guards), and independent reviews
b. Enforcing Ethics
i. Sarbanes-Oxley Act (SOX) – created the Public Company Accounting
Oversight Board, regulates analyst conflicts, imposes corporate
governance requirements, enhances accounting and control disclosures,
impacts insider transactions and executive loans, and expands penalties for
violations of federal securities laws
1. Passed in response to major accounting scandals, such as Enron
and WorldCom
2. Compliance with SOX requires documentation and verification of
internal controls and increased emphasis on internal control
3. Failure to comply can yield financial penalties, stock market
delisting, and criminal prosecution of executives
4. Management must issue a report stating that internal controls are
5. Auditors – individuals hired to review financial reports
a. Internal auditor – employed to assess and evaluate a
company’s system of internal controls, including the
resulting reports
b. External auditors – independent of a company; hired to
assess and evaluate the “fairness: of financial statements (or
to perform other contracted financial services)
c. Auditors also must verify the effectiveness of internal
ii. Dodd-Frank Wall Street Reform and Consumer Protection Act
1. Three functions:
a. Promotes accountability and transparency
b. Puts an end to the notion of “too big to fail”
c. Protects consumers from abusive financial services
2. Two of its notable provisions are:
a. Clawback – Mandates recovery (clawback) of excess
incentive compensation
b. Whistleblower – requires the SEC to pay whistleblowers
between 10% and 30% of any sanction exceeding $1
c. Generally Accepted Accounting Principles
i. Financial accounting is governed by concepts and rules known as
generally accepted accounting principles
1. GAAP – rules that specify accounting principles
a. Aims to make information relevant, reliable, and
2. Securities and Exchange Commission (SEC)
a. Federal agency Congress has charged to set reporting rules
for organizations that sell ownership and shares to the
i. Has the legal authority to set GAAP
1. Oversees proper use of GAAP by companies
that raise money from the public through
issuance of stock and debt
b. Financial Accounting Standards Group (FASB)
i. Independent group of full-time members
responsible for setting accounting rules that the
SEC has largely delegated the task of setting U.S.
1. A private-sector group that sets both board
and specific principles
d. International Standards
i. Our global economy creates demand by external users for comparability in
accounting reports
ii. The International Accounting Board (IASB), an independent group
(consisting of individuals from many countries), issues International
Financial Reporting Standards (IFRS) that identify preferred
accounting practices
1. IASB – group that identifies preferred accounting practices and
encourages global acceptance; issues IFRS
2. IFRS – set of international accounting standards explaining how
types of transactions and events are reported in financial
statements; IFRS are issued by the International Accounting
Standards Board
iii. Differences between U.S. GAAP and IFRS have been decreasing in recent
years as the FASB and IASB pursued a process aimed at reducing
e. Conceptual Framework
i. Conceptual framework – basic concepts that underlie the preparation and
presentation of financial statements for external users; can serve as a guide
in developing future standards and to resolve accounting issues that are
not addressed directly in current standards using the definitions,
recognition criteria, and measurement concepts for assets, liabilities,
revenues, and expenses
ii. The FASB conceptual framework consist broadly of the following:
1. Objectives – to
provide information
useful to investors,
creditors, and others
2. Qualitative
characteristics – to
require relevant,
reliable, and
3. Elements – to define
items that financial
statements can contain
4. Recognition and Measurement – to set criteria for an item to be
recognized as an element; and how to measure it
f. Principles and Assumptions of Accounting
i. Tow types of accounting principles and assumptions:
1. General principles – assumptions, concepts, and guidelines for
preparing financial statements
2. Specific principles – detailed rules used in reporting business
transactions and events; they often arise from rulings of
authoritative groups and are described as we encounter them
3. General principles consist of at least four basic principles, four
assumptions, and two constraints
4. Four principles:
a. Measurement/cost principle
i. Principle that prescribes financial statement
information, and its underlying transactions and
events, be based on relevant ,measures of valuation
ii. Accounting information is based on actual costs
(with possible later adjustments to market)
iii. Cost is measured on a cash or equal-to-cash basis
1. If cash is given for service. Its cost is
measured by the cash paid
2. If something besides cash is exchanged
(such as a car traded for a truck), cost is
measured as the cash value of what is given
up or received
iv. The cost principle emphasized reliability and
verifiability, and information based on cost is
considered objective
1. Objectivity means that information is
supported by independent, unbiased
evidence (opinionated)
b. Revenue recognition principle
i. Revenue is recognized
1. When goods or services are provided to
2. At the moment expected to be received from
the customer
ii. The amount received is usually in cash, but it is also
common to receive a customer’s promise to pay at a
future date, called credit sales
1. To recognize = to record it
c. Expense recognition principle (matching principle)
i. Expenses are to be reported in the same period as
(matched with) the revenues that were earned as a
result of the expenses
ii. A company must record the expenses it incurred to
generate the revenue reported
d. Full disclosure principle
i. Financial statements (including notes) are to report
all relevant information about an entity’s operations
and financial condition
ii. A company report the details behind financial
statements that would impact users’ decisions
1. Those disclosures are often in footnotes to
the statements
5. Four Accounting Assumptions:
a. The going-concern assumption
i. Financial statements are to reflect the assumption
that the business will continue operating instead of
being closed or soled
b. Monetary unit assumptions
i. Transactions and events can be expressed in
monetary/ money units
1. Money is the common denominator in
c. Time period assumption
i. An organization’s activities can be divided into
specific time period such as months, quarters, or
years, and that useful reports can be prepared for
those periods
d. Business entity assumptions
i. Required that a business is to be accounted for
separately from its owner(s) and from any other
ii. A business can take one of three legal forms:
iii. Sole proprietorship - Business owned by one
person that is not organized as a corporation and
accounted for separate
1. Disadvantage: it is not a separate legal entity
from its owner (unlimited liability)
2. Advantage: a proprietor’s income is not
subject to a business income tac but is
instead reported and taxed on the owner’s
personal income tax return
iv. Partnership – unincorporated association of two or
more persons to pursue a business for profit as coowners
1. Partners are jointly liable for tax and other
a. Unlimited liability
2. Three types of partnership limit liability:
a. Limited partnership (LP)
b. Limited Liability partnership (LLP)
c. Limited Liability company (LLC)
i. Most popular and offers
limited liability off a
corporation and the tax
treatment of a partnership
(and proprietorship)
ii. Most proprietorships and
partnerships are now
recognized as LLCs
v. Corporation (C Corporation) – business that is a
separate legal entity under state or federal laws,
meaning it is responsible for its own acts and its
own debts
1. Separate legal status means that a
corporation can conduct business with the
rights, duties, and responsibilities of a
2. Shareholders/stockholders – owners of a
a. Not personally liable for corporate
acts and debts
3. Disadvantage: subjected to double taxation
a. The corporation income is taxed
b. Any distribution of income to its
owners through dividends is taxed as
part of the owners’ personal income,
usually at the individual’s income
tax rate
4. S-corporation – a corporation with special
attributes; does not owe income tax
a. Owners of S corporations report their
share of corporate income with their
personal income
5. Shares/Stocks – equity of a corporation
divided into ownership
a. Common/Capital stock – basic
ownership share; when a corporation
issues only one class of stock
6. Accounting Constraints
a. Materiality constraint – only information that influences
decisions (such as through importance and dollar amount)
need to be disclosed
i. Accounting for items that significantly impact
financial statements and any inferences from there
adhere strictly to GAAP
b. Cost-benefit constraint – the benefit of a disclosure
exceeds cost of that disclosure
i. only information with benefits of disclosure greater
than the costs of providing it need to be disclosed
g. Accounting Equation
i. Accounting Equation (Balance sheet equation)
1. Equality involving a company’s assets, liabilities, and equity
𝑨𝒔𝒔𝒆𝒕𝒔 = π‘³π’Šπ’‚π’ƒπ’Šπ’π’Šπ’•π’Šπ’†π’” + π‘¬π’’π’–π’Šπ’•π’š
ii. Assets – resources a company owns or controls that are expected to
provide current and future benefits to the business
1. Examples
a. Web servers for an online services company
b. Musical instruments for a rock band
c. Land of a vegetable grower
2. Terms to know
a. Receivable – used to refer to an asset that promises a future
inflow of resources
i. A company that provides a service or product on
credit has an account receivable from that customer
b. On credit/on account – cash payment will occur at a future
iii. Liabilities – creditors’ claims on an organization’s assets; involves a
probable future payment of assets; products, or services that a company is
obligated to make due to past transactions or events
1. Payable – refers to a liability that promises a future outflow of
a. Ex:
i. Wage payable to workers
ii. Accounts payable to suppliers
iii. Notes payable to banks
iv. Taxes payable to the government
iv. Equity – owner’s claim on the assets of a business; equals the residual
interest in an entity’s assets after deducting liabilities; also called net
assets or residual equity
1. Increases from owner investments, called stock issuances, and
from revenue.
a. Owner investments – assets out into the business by the
2. Decreases from dividends and from expenses
3. Contains four elements:
a. Common stock – corporation’s basic ownership share
i. Part of contributed capital; reflects inflows of
resources such as cash and other net assets from
stockholders in exchange for stock
b. Dividends – corporation’s distributions of assets to its
i. Outflow of resources such as cash and other assets
1. Reduces equity
c. Revenues – gross increase in equity from a company’s
business activities that earn income; also called sales
i. Increase equity via net income from sales of
products and services to customers
ii. Ex:
1. Sales of products, consulting services
provided, facilities rented to others,
commissions from services
d. Expenses – outflows or using up of assets as part of
operations of a business to generate sales
i. Decrease equity via net income from costs of
providing products
1. Costs of employee time, use of supplies,
advertising, utilities, and insurance fees
v. Expanded Accounting Equation:
1. For non-corporations:
πΈπ‘žπ‘’π‘–π‘‘π‘¦ = π‘‚π‘€π‘›π‘’π‘Ÿ ′ 𝑠 π‘π‘Žπ‘π‘–π‘‘π‘Žπ‘™ − π‘‚π‘€π‘›π‘’π‘Ÿ ′ 𝑠 π‘Šπ‘–π‘‘β„Žπ‘‘π‘Ÿπ‘Žπ‘€π‘Žπ‘™π‘  +
𝑅𝑒𝑣𝑒𝑛𝑒𝑒𝑠 − 𝑅π‘₯𝑝𝑒𝑛𝑠𝑒𝑠
2. For corporations:
πΈπ‘žπ‘’π‘–π‘‘π‘¦ = πΆπ‘œπ‘›π‘‘π‘Ÿπ‘–π‘π‘’π‘‘π‘’π‘‘ π‘π‘Žπ‘π‘–π‘‘π‘Žπ‘™ + π‘…π‘’π‘‘π‘Žπ‘–π‘›π‘’π‘‘ π‘’π‘Žπ‘Ÿπ‘›π‘–π‘›π‘”π‘ 
+ 𝑅𝑒𝑣𝑒𝑛𝑒𝑒𝑠 − 𝐸π‘₯𝑝𝑒𝑛𝑠𝑒𝑠 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
vi. Net income – amount earned after subtracting all expenses necessary for
and matched with sales for a period
1. When revenues exceed expenses
2. Increases equity
3. Also known as income, profit, or earnings
vii. Net loss – excess of expenses over revenues for a period
1. Decreases equity
h. Transaction Analysis
i. External transactions – Exchanges of economic value between one entity
and another entity
1. Yields changes in the accounting equation
ii. Internal transactions – activities within an organization that can affect
the accounting equation
1. May or may not affect the accounting equation
iii. Events – happenings that both affect an organization’s financial position
and can be reliably measured
1. Ex:
a. Changes in the market value of certain assets and liabilities
b. Natural events such as floods and fires that can destroy
assets and create losses
i. Communicating with users
i. Income statement – describes a company’s revenues and expenses along
with the resulting net oncome or loss over a period of time
1. Financial statement that subtracts expenses from revenues to yield
a net income or loss over a specified period of time; also includes
any gains or losses
ii. Statement of retained earnings – explains changes in retained earnings
from net income (or loss) and from any dividends over a period of time
1. Report of changes in retained earnings over a period; adjusted for
increases (net income), for decreases (dividends and net loss), and
for any prior period adjustment
iii. Balance sheet – describes a company’s financial position (types and
amounts of assets, liabilities, and equity) at a point in time
1. Financial statement that lists types of dollar amount of assets,
liabilities, and equity at a specific date
iv. Statement of cash flows – identifies inflows (receipts) and cash outflows
(payments) over a period of time
1. A financial statement that lists cash inflows (receipts) and cash
outflows (payments) during a period; arranged by operating,
investing, and financing
j. Sustainability and Accounting
i. Sustainability – the ability of an item or activity to continue indefinitely;
for a business, it usually refers to that company’s environmental, social,
and governance aspects
ii. Sustainability Accounting Standards Board (SASB) – a nonprofit entity
engaged in creating and disseminating sustainability accounting standards
for use by companies
1. Sustainability accounting standards are intended to complement
financial accounting standards
k. Decision Analysis
i. We recognize financial statement analysis into four areas:
1. Liquidity and efficiency
2. Solvency
3. Profitability
4. Market prospects
ii. When analyzing ratios, we need benchmarks to identify good, and, or
average levels
1. Common benchmarks include company’s prior levels and those of
its competitors
iii. Return on assets (ROA) – ratios reflecting operating efficiency; defined
as net income divided by average total assets of the periods; also called
return on total assets or return on investment (ROI)
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𝑁𝑒𝑑 πΌπ‘›π‘π‘œπ‘šπ‘’
π΄π‘£π‘’π‘Ÿπ‘Žπ‘”π‘’ π‘‡π‘œπ‘‘π‘Žπ‘™ 𝐴𝑠𝑠𝑒𝑑𝑠