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Summary Financial management
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chapter 1,2,3,6,7,9,10
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Summary Financial management Accounting principlesChapter 1 Accounting principles and the financial statements
Concepts underlying accounting measurement
Accounting is an information system that measures, processes, and communicates financial information
about a business.
Accountants focus on the needs for financial information.
An economic entity is a unit that exist independently, such as business, hospital, or a government body.
Accountants supply the information decision makers need to make reasoned choices. Data about business
activities are the input to the accounting system; useful information for decision makers is the output.
Financial and managerial accounting
Accounting’s role of measuring, processing, and communicating financial information is usually divided
into financial accounting and managerial accounting.
Financial accounting
External decision makers use this to evaluate how well the business had achieved its goals. These reports
called financial statements are a central feature of accounting. Financial statements report on a
business's financial performance and are used extensively to evaluate its financial success. It's important
to distinguish accounting from:
- Bookkeeping: is the process of recording financial transactions and keeping financial records. It is
mechanical and repetitive, yet an important part of accounting.
- Management information system (MIS) consists of the interconnected subsystems, including
accounting that provides the information needed to run a business.
Management accounting
Internal decision makers use information provided this about operation, investing, and financing
activities. Managers and employees need information about how they have done in the past and what they
expect in the future.
Accounting measurement
Business transactions
Are economic events that affect a business’s financial position. These transactions are raw material of
accounting reports. A transaction can be an exchanges, values or between two parties. To be recorded, a
transaction must relate directly to a business entity.
Money measure
All business transactions are recorded in terms of money. Money is the only factor common to all
businesses transactions, and thus the only unit of measure capable of producing financial data that can be
compared.
Exchange rate: the value of one currency in terms of another.
Separate entity
A business organization is a separate entity, it should have its own set of final records, and its records and
reports should refer only to its own affairs.
Forms of business organizations
Sole proprietorship: owned by one person who takes all the profits, losses of the business and is
liable for all its obligations.
Partnership: two or more owners. The partners share the profits and losses according to the
prearranged formula. If the partnership must be dissolved, a new partnership has to be formed.
Corporation: separate the personal activities from the commercial activities. A business
chartered by the state and legally separates from its owners. The stockholders, whose
ownership is represented by shares of stock, do not directly control the corporation’s operations.
They elect a board of directors to run the corporation for their benefit. In exchange for their
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, limited involvement they enjoy limited liability, which is their risk to loss is limited to the
amount they paid. Stockholders can sell their shares without dissolving the corporation
Concepts underlying financial position
Financial position: refers to a company’s economic resources. Another terms for claims are equities.
Every company has two types of equities: creditors’ equities and owner’s equities. Sum of these equities
equals a company’s resources:
Economic resources = creditors’ equities + owners equity
In accounting terminology, economic resources are called assets and creditors’ equities are called
liabilities so it can be written like: Assets= liabilities + owner’s equity (A=L+OE) the 2 sides must always
be equal.
Assets
Economic resources that are expected to benefit the company’s future operations.
Liabilities
Business’s present obligations to pay cash, transfer assets, or provide services to other entities in the
future. Claims recognized by law, the law gives creditors the right to force the sale of a company’s assets if
the company fails to pay its debts.
Owner’s equity
Represents the claims by the owner of a business to the assets of the business. Technically what would be
left if all liabilities were paid.
Owner’s equity = assets – liabilities
Owner’s equity is affected by:
- Owner’s investments: are assets that the owner puts into the business. In this case the assets of the
business and the owner’s equity in those assets increases.
- Withdrawals: are assets that owner takes out of the business. In this case, the assets and the
owner’s equity decrease.
Section 2 accounting applications
Financial statements
The primary means of communicating accounting information about a business to those who have an
interest in the business.
Income statement
Summarizes the revenues earned and expenses incurred by a business over an accounting period. It
shows whether a business achieve its profitability goal.
Statement of owner’s equity
Shows the changes in owner’s equity over an accounting period.
Balance sheet
Show the financial position of a business on a certain date. Presents a view of the business as the holder of
recourses, or assets, that are equal to the claims against those assets. The claims consist the company’s
liability and the owner’s equity.
Statement cash flows
Where the income statement focuses on a company’s profitability, the statement of cash flows focuses on
liquidity that is, balancing the inflows and outflows of cash to enable it to operate and pay its bills when
they are due. Net cash flow is the difference between inflows and outflows. They are organized according
to 3 major business activities:
- Cash flows from operating activities: cash produced by business operations
- Cash flows from investing activities
- Cash flows from financing activities
Relationships among the financial statements
Each heading identifies the company and the kind of statement.
(Look at page 11 exhibit 10 chapter 1 accounting principles)
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, Generally accepted accounting principles (GAAP)
Arises from wide agreement on the theory and practice of accounting at a particular time. These
“principles” evolve to meet the needs of decisions makers, and they change as circumstances change or as
better methods are developed.
GAAP and the independent CPA’s report
Many companies of all sizes have their financial statements audited by an independent certified public
accountant (CPA) independent means that the CPA is not an employee of the company. CPAs are licensed
by all states to protect the public by ensuring the quality of professional service. An audit is an
examination of a company’s financial statements and the accounting systems, controls, and records that
produced them. The purpose of the audit is to ascertain that the financial statements have been prepared
in accordance with generally accepted accounting principles. The audit lends credibility to a set of
financial statements.
0rganizations that issue accounting standards
- The financial accounting issue accounting standards (FASB): has been designated by the
securities and exchange communion(SEC). the FASB organizes these statements including any
amendments, interpretations, or other references to them into topical U.S GAAP compendium called
an American Standard Codification (ASC). This codification makes it easy to find all references to a
particular topic.
- The international accounting standards board(IASB) which issues international financing
reporting standards (IFRS) is becoming increasing important because of the acceptance of its
standards in may financial markets throughout the world.
Other organizations that influence GAAP
The public company accounting oversight board (PCAOB): a governmental body has wide
powers to determine the standards that auditors must follow. They regulates audits of public
companies registered with the SEC
The American institute of certified public accountants (AICPA): a professional association,
influences accounting practice through the activities of its senior committees. They are the
primary professional organization of certified public accountants
The securities and exchange commission (SEC): a governmental agency, has the legal power to
set and enforce accounting practices for companies whose securities are offered for sale to the
general public.
The governmental accounting standards board (GASB): a separate but related body to the
FASB, issues accounting standards for state and local governments
The internal revenue service (IRS): interprets and enforces the tax laws that specify the rules
for determining taxable income.
Professional conduct
The code of professional ethics of the American institute of certified public accountants governs the
conduct of CPAs. The code requires CPAs to act with:
- Integrity: be honest and candid and subordinate person gain to service and the public trust
- Objectivity: be impartial and intellectually honest
- Independence: avoid all relationships that impair or appear to impair objectivity.
the institute of management accountants (IMA), the primary professional association of managerial
accountants, also has a code of professional conduct. It emphasizes that managerial accountants have the
responsibility:
To be competent with their jobs
To keep information confidential except when authorized of legally required to disclose it
To maintain integrity and avoid conflicts of interest
To communicate information objectively and without bias
Section 3 business applications
Decision makers: the users of accounting information
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