Principles of Financial Accounting
Principles of Financial Accounting
Principles of Financial Accounting
Class 1 Introduction
What is Accounting?
Accounting a process of identifying, analyzing, recording, summarizing, and reporting economic information to decision makers in the form of financial statements. Financial accounting focuses on the specific needs of decision makers external to the organization (e.g. stockholders, suppliers, banks, and government agencies).
Professor Lucile Faurel Principles of Financial Accounting Class 1: Introduction to Financial Accounting
Who Cares?
Accounting information is useful to anyone who needs to make a decision based upon the companys performance and potential.
For example:
Investors Owners Managers Creditors Legislators Etc.
Professor Lucile Faurel Principles of Financial Accounting Class 1: Introduction to Financial Accounting
Event
Financial statements
Users
Professor Lucile Faurel Principles of Financial Accounting Class 1: Introduction to Financial Accounting
Professor Lucile Faurel Principles of Financial Accounting Class 1: Introduction to Financial Accounting
Financial Accounting
What might we want to know about an organization as an external user of financial statements? Accountants answer many of these questions with three major financial statements.
Balance sheet shows financial picture on a given day. Income statement shows financial performance over a given period. Statement of cash flows shows cash inflows and outflows over a given period.
Professor Lucile Faurel Principles of Financial Accounting Class 1: Introduction to Financial Accounting
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Annual Report
Prepared by management and distributed to current and potential investors providing information about the companys past performance and future prospects.
Includes the three main financial statements (BS, IS, SCF). Includes footnotes explaining in more detail many elements of the financial statements. Includes the Managements Discussion and Analysis (MD&A):
Should cover three financial aspects: liquidity, capital structure, and results from operations. Should highlight favorable and unfavorable trends and identify significant event and uncertainties that affect these three factors.
Professor Lucile Faurel Principles of Financial Accounting Class 1: Introduction to Financial Accounting
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Annual Report
Prepared by management and distributed to current and potential investors providing information about the companys past performance and future prospects.
Usually ALSO includes:
Financial highlights Five-year financial data Letter from corporate management to stockholders Independent auditors report Managements responsibility for preparation of the financial statements Other information (description of company, business, products, etc.)
Professor Lucile Faurel Principles of Financial Accounting Class 1: Introduction to Financial Accounting
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Types of Firms
Three basic forms of ownership:
Sole proprietorships
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Corporations
Owners are called shareholders or stockholders. Publicly owned vs. privately owned corporations:
Private Shares in the ownership are owned by families, small groups of shareholders, or a single shareholder and are not sold to the public. Public Shares in the ownership are sold to the public on a stock exchange; the corporation may have many thousands of shareholders.
The shareholders elect a board of directors that essentially oversee the company.
Professor Lucile Faurel Principles of Financial Accounting Class 1: Introduction to Financial Accounting
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The board of directors is elected by the stockholders. Management is appointed by the board of directors. Often, top executives (president, vice presidents, etc.) are elected to the board of directors. Therefore, the interests of both the stockholders and management are usually represented on the board of directors. The separation between ownership and management creates demand for information from investors.
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Financial Reporting
Public firms are required to file financial reports with the SEC four times a year:
Each quarter (three 10-Qs) and each year (one 10-K). For a December 31 fiscal year-end company:
March 31: 10-Q June 30: 10-Q September 30: 10-Q December 31: 10-K
Professor Lucile Faurel Principles of Financial Accounting Class 1: Introduction to Financial Accounting
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Investors must be able to rely on the financial statements to show an accurate picture of the company. One way to ensure that the financial statements are credible is to introduce an independent, expert third party.
The auditor examines the information used by managers to prepare the financial statements and attests to the credibility of the statements.
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Auditing
Audit an examination of transactions and financial statements made in accordance with generally accepted auditing standards (GAAS) developed primarily by:
The American Institute of Certified Public Accountants (AICPA) prior to 2003. The Public Company Accounting Oversight Board (PCAOB) since 2003.
The PCAOB is a private-sector, non-profit corporation created by the Sarbanes-Oxley Act (a 2002 United States federal law) to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports.
An audit includes:
Tests of the accounting records. Tests of the internal control over the financial reporting system. Other audit procedures as deemed necessary.
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Professor Lucile Faurel Principles of Financial Accounting Class 1: Introduction to Financial Accounting
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Professor Lucile Faurel Principles of Financial Accounting Class 1: Introduction to Financial Accounting
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