Chapter 16

Understanding Accounting and Financial Statements ls
Goa g rnin Lea
5 Explain the three principal
financial statements.

1

Explain the functions and importance of accounting. involving accounting.

6 Discuss how financial ratios are

2 Identify the three basic activities
Describe the roles played by 3 public, management, government and not-for-profit accountants.

used to analyze a firm’s financial strengths and weaknesses. business.

7 Describe the role of budgets in a 8 Explain uniform financial
statements and how exchange rates influence international accounting practices.

4 Outline the steps in the accounting
process.

Accounting Process of measuring, interpreting, and communicating financial  information to support internal and external business decision making.

USERS OF ACCOUNTING INFORMATION

• Open book management Sharing sensitive financial information with  employees and teaching them how to understand and use financial statements.  • Viewing financial information may help them better understand how their  work contributes to the company’s success. • Outsiders use financial data to evaluate investment opportunities. • Accountants serve public good. • Example: Volunteer programs that provide free help for low­ and middle­ income senior citizens file their taxes.  AARP’s Tax Aide

BUSINESS ACTIVITIES INVOLVING ACCOUNTING
• Accounting plays a key role in each of a businesses three key areas: • Financing activities Provide necessary funds to start and expand a business. • Investing activities Provide valuable assets required to run a business.  • Operating activities Focus on selling goods and services, but they also  consider expenses as important elements of sound financial management.

ACCOUNTING PROFESSIONALS
Public Accountants
Public accountant Accountant who works for an independent accounting firm. Certified public accountant (CPA) Accountant who meets specified  educational and experiential requirements and has passed a  comprehensive examination on accounting theory and practice.

Management Accountants
• Management accountant Accountant employed by a business other than a  public accounting firm.

Government and Not-for-Profit Accountants
• Perform professional services similar to those of management  accountants.

THE ACCOUNTING PROCESS
Accounting process Set of activities involved in converting  information about transactions into financial statements.

The Impact of Computers and the Internet on the Accounting Process
• Simplifies the accounting process by automating data entry and calculations. • Software that handles accounting information for international businesses is also  available.

The Foundation of the Accounting System
• Generally accepted accounting principles (GAAP) Principles that encompass  the conventions, rules, and procedures for determining acceptable accounting  practices at a particular time.  • Financial Accounting Standards Board (FASB) Organization primarily  responsible for evaluating, setting, or modifying GAAP in the U.S. Sarbanes­Oxley Act A response to cases of accounting fraud. • Created the Public Accounting Oversight Board.  • Added to the reporting requirements for publicly traded companies. 

The Accounting Equation
Assets Anything of value owned or leased by a business. • Tangible: Equipment, buildings, inventory. • Intangible: Patents, trademarks Liability Claim against a firm’s assets by a creditor. Owner’s equity All claims of the proprietor, partners, or stockholders against the  assets of a firm, equal to the excess of assets over liabilities. Basic accounting equation Relationship that states that assets equal liabilities  plus owners’ equity.

Double-entry bookkeeping Process by which accounting transactions are  entered; each individual transaction always has an offsetting  transaction.

FINANCIAL STATEMENTS
• Provide managers with information for evaluating organization’s ability to meet  current obligations and needs, its profitability, and its overall financial health.

The Balance Sheet
Balance sheet Statement of a firm’s financial position—what it owns and the  claims against its assets—at a particular point in time.

The Income Statement
Income statement Financial record of a company’s revenues, expenses, and  profits over a period of time. • Helps decision makers focus on overall revenues and the costs involved in  generating these revenues. • Sometimes called a profit­and­loss, or P&L, statement.

The Statement of Cash Flows
Statement of cash flows Statement of a firm’s cash receipts and cash payments  that presents information on its sources and uses of cash.  Accrual accounting Accounting method that records revenue and expenses when  they occur, not necessarily when cash actually changes hands.  • Inadequate cash flow is a reason for many business failures.

FINANCIAL RATIO ANALYSIS
• Ratio analysis Tool for measuring a firm’s liquidity, profitability, and reliance  on debt financing, as well as the effectiveness of management’s resource  utilization.

BUDGETS
Budget Planning and control tool that reflects a firm’s  expected sales revenues, operating expenses, and cash  receipts and outlays. • Cash budget Tracks the firm’s cash inflows and outflows.

INTERNATIONAL ACCOUNTING
• Global firms must translate financial statements of the firm’s international  affiliates, branches, and subsidiaries and convert data about foreign currency  transactions to dollars.

Exchange Rates
• Ratio at which a country’s currency can be exchanged for other currencies. • Consolidated financial statements must reflect gains and losses due to changes in  exchange rates.

International Accounting Standards
• International Accounting Standards Committee (IASC) promotes worldwide  consistency in financial reporting practices.

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