Chapter 1

Financial Accounting
and Business
Decisions

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Forms of Business Organization

Sole Proprietorship
A business owned by one person
The most common form of business
Partnership
A business owned by two or more people
Can have many partner owners
Corporation
A separate legal entity
The owners of the corporation are the stockholders
Most business activity is conducted by corporations

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Sole Proprietorship

Advantages
Easiest to form
Tax advantages
Sole owner controls the business

Disadvantage
Unlimited liability

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Partnership

Advantages
Relatively easy to form
Tax advantages
Broader skill set

Disadvantage
Unlimited liability

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Corporation

Advantages
Easiest to raise capital
Easiest to transfer ownership
Limited liability

Disadvantages
Harder to form
Double taxation

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Select the Correct Answer…

Each of the following is an attribute of a corporation

except:

A. The owners are the stockholders

B. The dominant organizational type
C. The most common form of business
D. A separate legal entity

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Business Activities—Financing

Financing Activities
A company needs to acquire financing to support its
operations.
1. Debt financing

Borrowing money from creditors

2. Equity financing

Selling stock to investors

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Business Activities—Investing

Investing Activities
A company needs to have long-term resources to
run its day-to-day operations.
Sometimes referred to as capital investments
Investing activities involve the acquisition or
disposition of items such as land, buildings, and
equipment.

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Business Activities—Operating

Operating Activities
The day-to-day activities of producing and selling a
product or providing a service.
Necessary for the ultimate success of the business.

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Business Activities

Investing Activities Financing Activities

Operating Activities

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Select the Correct Answer…

Which of the following is an example of a financing

activity?

A. Acquisition of land
B. Borrowing money from a bank
C. Producing and selling a product
D. Disposition of old equipment

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Accounting Information and Its Use

External Users
Investors
Need to know how profitable the company is compared to its
competitors.
Creditors
Need to know if the company has the ability to repay its
loans.
Regulators
Need to know if rate increases are justified.

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Accounting Information and Its Use

Internal Users
Management
Need to know the profitability of each division.
The Finance Department
Need to if there is enough cash to pay its short-term
expenses.
Human Resources
Need to know the effect of a four percent raise for all
employees.

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Ethics and Accounting

Ethics deals with the values, rules, and

justifications that govern one’s way of life.
Many business have a written code of ethics to help guide
the behavior of employees.
Accounting organizations such as the American Institute of
Certified Public Accountants have a professional code of
ethics.
Unethical behavior can result in misleading
financial statements.
Sarbanes-Oxley Act of 2002 was written to help deter
unethical behavior.

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The Accounting Process

Accounting is the process of measuring economic

activity of an entity in monetary terms and
communicating the results to users.
1.

2. Identify the relevant economic activity

3. Measure the impact of those activities
4. Record the results

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Generally Accepted Accounting
Principles

GAAP
Changes over time with changes in the business
environment
Organized by topic in the Accounting Standards Codification
(ASC)

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Financial Accounting Oversight

Securities and Exchange Commission (SEC)

A federal agency whose primary focus is to regulate the
interstate sale of stocks and bonds
Financial Accounting Standards Board (FASB)
Reports to the Security and Exchange Commission (SEC)
A nongovernmental entity whose pronouncements establish
U.S. GAAP
Public Company Accounting Oversight Board
(PCAOB)
Approves auditing standards, known as generally accepted
auditing standards (GAAS)

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International Financial Reporting
Standards

International
Accounting Taken the lead role in
formulating international
Standards Board accounting principles.
(IASB)

International
Financial Approximately 120 nations or
reporting jurisdictions require
Reporting or permit its use.
Standards Reduce information-
generating costs of
(IFRS) multinational companies.
Not currently allowed for U.S.
companies.

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The Accounting Equation

Company resources Claims on resources

Liabilities
Creditor claims
Assets

Stockholders’
Equity
Owner claims

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Balance Sheet
Reports the company’s financial position as of a
point in time
Assets = Liabilities + Stockholders’ Equity

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Income Statement

Reports the results of operations for a given period of time

Reports revenues and expenses
Revenues―increases in resources from providing goods or services
Expenses―decreases in resources from providing goods or services
Net income results when revenues exceed expenses

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Statement of Stockholders’ Equity

Reports events causing an increase or decrease in a

company’s stockholders’ equity during a given period
of time
Capital contributed by stockholders
Earned capital
Some companies have
a separate statement of
retained earnings, but most
include retained earnings
as part of the statement
of stockholders’
equity.

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Statement of Cash Flows

Reports cash inflows and outflows during a given

period of time
Cash flows from operations includes cash received from the sale
of goods and services and cash spent on operating the business.
Cash flows from investing includes the cash paid to purchase
long-term assets used in operating the business and the cash
received when those resources are sold.
Cash flows from financing includes the issuance and repurchase
of company stock and the cash borrowed from and repaid to
creditors.
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Relations Among the Statements

A. Net income from

the income statement is
used to compute
ending retained earnings
on the statement of
retained earnings.

B. Ending common
stock, retained earnings,
and total equity from the
statement of
stockholders’ equity is
shown on the balance
sheet.

C. The ending cash

balance on the
statement of cash flows
is shown on the balance
sheet.
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Relations Among the Statements

The beginning-of-period balance sheet shows the company’s

financial position at the start of the accounting period.
The income statement, statement of stockholders’ equity, and
statement of cash flows report activity for a period of time.
The end-of-period balance sheet shows the company’s
financial position at the end of the accounting period.

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Select the Correct Answer…

Which of the following financial statements displays a

company’s revenues and expenses?

A. Balance Sheet
B. Statement of Cash Flows
C. Statement of Stockholders’ Equity
D. Income Statement

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Additional Information

Notes to Financial Statements

Contains information about assumptions, estimates,
accounting methods, and details behind the summary
numbers.
Auditor’s Report
The report of the independent auditor containing an opinion
regarding the financial statements.
Management’s Discussion and Analysis (MD&A)
Management’s interpretation of the company’s recent
performance and financial condition.
Management’s “forward-looking” view.

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Additional Information

Environmental, social, and governance report

Voluntary but rapidly growing practice
Quantitative and qualitative measures on how the company
addresses ESG issues
Important to various parties wanting to understand the
influence of these issues on business strategy and future
outlook
Accountants need to consider ESG issues when applying
accounting standards.

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Careers in Accounting

Private Accounting
Analyst, Internal Audit, Tax, Budgeting, Cost Accounting, etc.
Public Accounting
Auditor, Tax, Consulting
Government
Auditor, Tax, Budgeting,
Criminal Investigation, etc.

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Evolving Accounting Skills

Data analytics
The process of examining sets of data to discover useful
information from patterns in the data.
Blockchain technology
A distributed ledger that provides a secure means to view
recorded transactions.
These technologies will likely have a major
impact on how accountants work in the future.

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Conceptual Framework

Interrelated objectives and fundamentals for

external financial reporting.
Financial reporting objectives
Financial statement elements
Qualitative characteristics of accounting information
Recognition and measurement criteria for financial
statement items

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Financial Reporting Objectives

Useful in making financial decisions

Helpful in assessing the ability of a company to
generate future cash flows
Provide information about a company’s economic
resources and the claims on those resources

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Financial Statement Elements

The components of the financial statements

1. Assets
2. Liabilities
3. Stockholders’ equity
4. Investments by owners
5. Distributions to owners
6. Revenues
7. Expenses
8. Gains
9. Losses
10. Comprehensive income

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Qualitative Characteristics

Contribute to decision usefulness

Relevance
Accounting information helps users to predict and evaluate
Faithful representation
Complete, neutral, free from error, verifiable
Comparability and consistency
Aids users to understand similarities and
differences across companies and over time
Understandability
Accounting information is presented
clearly and concisely

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Recognition and Measurement

Specify the conditions under which a particular

asset, liability, revenue, or expense can be
recorded in the financial records.

Principles
Concepts

1. Accounting entity 1. Cost principle

2. Accounting period 2. Revenue recognition
3. Monetary unit 3. Expense recognition
4. Going Concern 4. Full disclosure

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Constraints

Materiality

Cost-Benefit

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Select the Correct Answer…

Each of the following is a qualitative characteristic of

accounting information except:

A. Comprehensive income
B. Verifiability
C. Faithful representation
D. Relevance

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