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CHAPTER 1: INTRODUCING FINANCIAL ACCOUNTINGI. IMPORTANCE OF ACCOUNTING Accounting is the language of business and iscalled this because all organizations set up anaccounting information system to communicatedata to help people make better decisions. Accounting is a systemthat Indentifies Records Communicatesrelevant, reliable, and comparable information about an organization’s business activities. Identifying means selecting transactions andevents relevant to an organization. Example: sale of iPods by Apple, receipt ofticket money by TicketMaster. Recording means keeping a chronological logof transactions and events measured indollars and classified and summarized in auseful format. Communicating means preparing accountingreports such as financial statements, and analyzing and interpreting these reports. Management Accounting provides information for decision-making activities ofmanagement WITHIN the business. Financial Accounting is concerned with providing useful information to those partiesOUTSIDE of the business. Financial accountants are concerned with the preparation of Financial Statements, which aredistributed to outside parties in an annual report. Most common experience with accounting is through: credit approvals, checking accounts,tax forms, and payroll.Financial Accounting Fundamentals, Ch. 1, Wild, 2009.Page 1

These common experiences are limited and tend to focus on the recordkeeping parts ofaccounting. Recordkeeping/Bookkeeping—is recording of transactions and events, either manually orelectronically of an organization’s day-to-day activities. Recordkeeping is only ONE part ofaccounting. Accounting—is the process of analyzing and drawing conclusions from this information. Example: bookkeeper of a shoe store keeps the day-to-day records as to how many shoes aresold and what bills need to be paid; accountant analyzes this data to evaluate the profitabilityand health of the business.A. Users of Accounting Information1. External Information Users External Users—are NOT directly involved in running the organization. Examples: shareholders (investors), lenders,directors, customers, suppliers, regulators, lawyers,brokers, and the press. External users have limited access to anorganization’s information.Financial Accounting Fundamentals, Ch. 1, Wild, 2009.Page 2

External users business decisions depend on information that is reliable, relevant, andcomparable. These financial statements are called general-purpose financial statements.a. Lenders (creditors) Loan money or other resources to an organization. They look for information to help them assess whether anorganization is likely to repay its loans with interest. Examples: banks, savings and loans, co-ops, andmortgage and finance companies.b. Shareholders (investors) Owners of a corporation. Use accounting reports in deciding whether to buy, hold, orsell stock.c. Board of Directors oversees stockholders interests in an organization.d. External (Independent) Auditors Examine financial statements to verify that they are prepared according togenerally accepted accounting principles (GAAP).e. Employees and Labor Unions Use financial statements to judge the fairness of wages, assessjob prospects, and bargain for better wages.f. Regulators Often have legal authority over certain activities of organizations.Financial Accounting Fundamentals, Ch. 1, Wild, 2009.Page 3

IRS who requires organizations to file accounting reports in computing taxes. Utility boards use accounting information to set utility rates.g. Voters, Legislators, and Government Officials Use accounting information to monitor and evaluategovernment receipts and expenses.h. Contributors Use accounting information to evaluate the use and impact of their donations.i. Suppliers Use accounting information to judge the soundness of a customer beforemaking sales on credit.j. Customers Use financial reports to assess the staying power of potential suppliers.2. Internal Information Users Internal Users—are those directly involved in managing and operating anorganization. Managerial Accounting—area of accountingthat serves the needs of internal users. Internal Controls—are procedures set up toprotect company property and equipment,ensure reliable accounting reports, promoteefficiency, and encourage adherence tocompany policies. Examples: good records, physical controls (locks, passwords, guards), andindependent reviewsFinancial Accounting Fundamentals, Ch. 1, Wild, 2009.Page 4

a. Research and Development Managers Need information about projected costs and revenues of any proposed changesin products and services.b. Purchasing Managers Need to know what, when, and how much to purchase.c. Human Resource Managers Need information about employees’ payroll, benefits, performance, andcompensation.d. Production Managers Depend on information to monitor costs and ensure quality.e. Distribution Managers Need reports for timely, accurate, and efficient delivery of products andservices.f. Marketing Managers Use reports about sales and costs to target consumers, set prices, and monitorconsumer needs, tastes, and price concerns.g. Service Managers Require information on the costsand benefits of looking afterproducts and services.B. Opportunities in Accounting We are influenced by accounting when weearn money, pay taxes, invest savings,budget earnings, and plan for the future.Financial Accounting Fundamentals, Ch. 1, Wild, 2009.Page 5

There are accounting jobs in private accounting, public accounting, and government (andnon-for-profit) agencies. Majority of the jobs are in private accounting, followed by public accounting. Accounting specialists are highly regarded. People with accounting knowledge are always in demand as they can help with financialanalysis, strategic planning, e -commerce, product feasibility analysis, informationtechnology, and financial management. Demand for accounting specialists is boosting salaries, and can vary because of location,company size, professional designation, experience, etc. Accountants can possibly have great benefit packages that can include: flexible workschedules, telecommuting options, career path alternatives, casual work environments,extended vacation time, and child and elder care. Examples of Accounting Specialists: Certified public accountant (CPA), certifiedbookkeeper(CB),certifiFinancial Accounting Fundamentals, Ch. 1, Wild, 2009.Page 6

ed payroll professional (CPP),personal financial specialist (PFS), certified fraud examiner(CFE), certified forensic accountant (CrFA)II. FUNDAMENTALS OF ACCOUNTINGA. Ethics—A Key Concept Ethics—are beliefs that distinguish rightfrom wrong; they are accepted standards ofgood and bad behavior. Goal of accounting is to provide usefulinformation for decisions. So there must be ethics in accounting. Old saying: “Good ethics are goodbusiness” Providers of accounting information oftenface ethical choices as they prepare financialreports. For example, these choices can affect theprice a buyer pays and the wages paid toworkersB. Generally Accepted Accounting Principles(GAAP) GAAP—are rules that specify acceptableaccounting practices. GAAP aims to make information in financialstatements relevant, reliable, andcomparable.1. Setting Accounting Principles Two main groups establish GAAP in theUS:a. Financial Accounting Standards Board (FASB) Private group that sets both broad and specific principles.Financial Accounting Fundamentals, Ch. 1, Wild, 2009.Page 7

b. Securities and Exchange Commission (SEC) Government group that establishes reporting requirements for companies thatissue stock to the public. International Accounting Standards Board (IASB)—issues International FinancialReporting Standards (IFRS) that identify preferred accounting practices, for example,when companies wish to raise money from lenders and investors in different countries.2. Principles and Assumptions of Accounting Two types:(1) General Principles—the basic assumptions, concepts, and guidelines forpreparing financial statements.(2) Specific Principles—detailed rules used in reporting business transactions andevents.a. Accounting Principlesi. Cost Principle Means that accounting information is based onactual cost. Cost is measure on a cash or equal-to-cashbasis. Cash Example: cash is given for a service, its cost is measured as the amount ofcash paid. Equal to Cash Example : if something besides cash is exchanged (i.e. truck), costis measured as the cash value of what is given up or received. It emphasizes reliability and verifiability, and information based on cost isconsidered objective. Objectivity—information is supported byindependent, unbiased evidence; it demands morethan a person’s opinion.Financial Accounting Fundamentals, Ch. 1, Wild, 2009.Page 8

ii. Revenue Recognition Principle Revenue (sales)—is the amount received fromselling products and services. Revenue Recognition Principle—providesguidance on when a company must recognizerevenue. Recognize—means to record it. If revenue is recorded too early, then a companywould look more profitable than it is. If revenue is recorded too late, acompany would look less profitablethan it is. Three important concepts:1. Revenue is recognized whenearned.2. Proceeds from selling productsand services need not be in cash(can be credit sale).3. Revenue is measured by the cashreceived plus the cash value ofany other items received.iii. Matching Principle A company must record its expenses incurred to generate the revenue reported.iv. Full Disclosure Principle Requires a company to report the detailsbehind financial statements that would impactusers’ decisions.b. Accounting Assumptionsi. Going-Concern Assumption Accounting information reflects a presumption that the business will continueoperating instead of being closed or sold.Financial Accounting Fundamentals, Ch. 1, Wild, 2009.Page 9

Think Energizer Bunny, it keeps going and going.ii. Monetary Unit Assumption We can express transactions and events inmonetary, or money units. Money is the most common denominator inbusiness.iii. Time Period Assumption Presumes that the life of a company can bedivided into time periods, such as months and years, and that useful reportscan be prepared for those periods.iv. Business Entity Assumption A business is accounted for separately fromother business entities, including its owner. Separate information about each business isnecessary for good decisions.v. Conservatism By being conservative with the numbers.C. Sarbanes-Oxley (SOX) Congress passed this act to help curb financial abuses at companies that issue theirstock to the public. It requires that the public companies apply other accounting oversight and stringentinternal controls. Failure to comply can lead to financial penalties, stock market delisting, and criminalprosecution of executives. Management and Auditors must verify the effectiveness of internal controls.Financial Accounting Fundamentals, Ch. 1, Wild, 2009.Page 10

Financial Accounting Fundamentals, Ch. 1, Wild, 2009. Page 1 CHAPTER 1: INTRODUCING FINANCIAL ACCOUNTING I. IMPORTANCE OF ACCOUNTING Accounting is the language of business and is called this because all organizations set up an accounting information system to communicate data to help people make better decisions. Accounting is a system that Indentifies