Chapter 1

Chapter 1 Financial Accounting and Its Environment

What is Accounting? Why Does it Exist?

Bookkeeping • The preservation of a systematic, quantitative record of an entity • Mechanical in nature

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Accounting System Step 1: Bookkeeping (keep track of information)

Step 2: Analysis (organize and evaluate accounting information) Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson

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Accounting A system providing quantitative information... Numbers are easily tabulated and summarized. Does not capture qualitative information.

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Accounting Accounting A system providing quantitative information, primarily financial in nature... Accounting does not capture non-financial information.

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Accounting Accounting A system providing quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions. Although historical in nature, it is useful only if future decisions are impacted by it. Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson

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Financial Statement Users Internal Users

External Users

Managerial/Tax accounting

Financial accounting

• Managers

• Lenders

• Executives

• Investors

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Financial Statements

Types of Financial Statements • Balance sheet • Income statement • Statement of cash flows

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Balance Sheet

Assets = Liabilities + Equity

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Income Statement Revenue

- Expenses Net Income Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson

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Statement of Cash Flows • Cash from operating activities • Cash from investing activities • Cash from financing activities

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Who Uses Financial Accounting Information

Who Uses Financial Accounting Information? • Lenders • Investors • Management • Suppliers and customers • Employees

• Competitors • Government agencies • Politicians • The press

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The Need for Financial Accounting Standards

Financial Accounting Standards Board (FASB) • Sets accounting standards in the United States – Generally Accepted Accounting Principles – GAAP

• Established in 1973 • Is a private sector regulatory authority Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson

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Other AccountingRelated Organizations

Other Accounting-Related Organizations • Securities and Exchange Commission • American Institute of Certified Public Accountants (AICPA) • Public Company Accounting Oversight Board (PCAOB) • Internal Revenue Service • International Accounting Standards Board Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson

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The External Audit

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The External Audit • Provides an independent outside opinion from a CPA firm that – The statements are prepared in accordance with GAAP – The audit was conducted using generally accepted auditing standards

• Not a guarantee! • The SEC requires all publicly traded companies to provide potential investors with audited financial statements Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson

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Economic consequences of accounting principles • Accounting principles have economic consequences because of implementation costs, compensation plans, debt contracts, and political costs. • Care must be taken in interpreting both financial statements and managers’ recommendations about accounting standards.

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Importance of ethics in accounting • Accountants have an important responsibility to the public that arises because financial statements are used by large numbers of people for a variety of purposes. • It is essential that accountants adhere to the highest levels of ethical conduct. Financial Accounting, 6e Stice/Stice/Diamond, 2001 © Thomson

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In Summary ... •

Three primary financial statements – – –

• • • •

Income Statement Balance Sheet Statement of Cash Flows

Users of financial data United States GAAP from the FASB Other accounting-related organizations: AICPA, SEC, PCAOB, IRS, IASB Factors impacting changes in accounting

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