Chapter 1: Study Notes

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Chapter 1: Study Notes

1.1 The business environment:

Companies must perform five critical tasks to be successful:

Create strategic goals

Secure financial resources

Deploy capital to make investments

Carry out day-to-day business operations

Continuously improve or refine the strategic goals and business operations

The key points of the five critical tasks are the following:

Create Strategic Goals: Strategic goals are goals which the company will work towards achieving, such as: maximizing profit potential, customer satisfaction, expanding to new markets, and achieving sustainable business operations. The achievement of strategic goals are heavily influenced by government regulations, barriers to entry, competition, and market forces.

Secure Financial Resources: The company must raise capital (money) at economical rates to implement business processes that achieve the desired strategic goals.

Deploy Capital to Make Investments: The capital that is raised is invested in equipment, land, investments, employing research staff and other resources needed to carry out business processes designed to achieve the strategic goals.

Carry Out Day-to-Day Business Operations: After the capital is deployed to develop business processes those business processes will need to be managed on a daily basis to ensure they are being used to achieve the strategic goals.

Continuously Improve or Refine the Strategic Goals and Business Operations: Business strategies must be review periodically and business processes refined to make sure the business is working at optimal efficiency towards achieving the strategic goals.

1.2 Purpose of Accounting

The purpose of accounting is to measure, record and communicate relevant business information to users of accounting information.

Measure: To assign a monetary value to relevant business transactions.

Record: Relevant transactions are written down, summarized and recorded in ledgers or other accounting documents.

Communicate: The summarized accounting information is communicated to accounting information users through the use of documents, such as financial statements.

1.3 Brief History of Accounting

The Mesopotamian era (3100 BC – 539 BC) is when the first known use of accounting was known to exist.

During the Venetian Era, a man named Luca Pacioli wrote a book called Summa de arithmetica, geometria, proportioni et proportionalita (Summary of arithmetic, geometry, proportions and proportionality) which summarized accounting methods during the Venetian era.

Pacioli’s summa recorded the use of double-entry bookkeeping methods which are the standard basis of accounting today.

In the 1880s professional trade organizations began to form and standardization of accounting methods became more prominent.

1.4 – Users of Accounting Information

A user of accounting information is an individual or organization that relies upon accounting information to make decisions.

There are two types of information users: internal and external.

Internal users are individuals, such as managers within the business entity, that need accounting information to make operational decisions.

External users are individuals or organizations that are outside of the company. Financial accounting is focused on meeting the informational needs of external users.

1.5 – Financial Accounting Courses

There are three general levels of financial accounting courses: financial accounting, intermediate financial accounting and advanced financial accounting. Financial accounting teaches the basic theories of financial accounting while intermediate teaches financial accounting based on commonly used standards, such as, generally accepted accounting principals. Advanced financial accounting focuses on advanced topics that would normally be taught in intermediate financial accounting.

The courses of auditing, financial accounting research and industry specific financial accounting are courses which compliment the standard financial accounting courses.

1.6 – The Role of Ethics in Financial Accounting

Ethical decision making is essential to ensuring quality accounting reports are created.

An accounting fraud occurs when business management or the internal accounting staff purposefully decides to create misleading financial statements with the intent of deceiving internal or external users. The impacts of an accounting fraud can have huge consequences.

Companies and accounting professionals must take adequate steps to make sure they are always following strong ethical principles and guidelines.

1.7 – Basics of How A Business is Operated

Understanding the basics of how a business is operated is essential to understanding how to perform accounting processes.

The basic premise of a business is that the founders of the business will raise capital and then use the capital to invest in equipment or other resources to begin operating the business. All businesses must have revenues that exceed their expense in order to be able to operate the business long-term.

Revenues in excess of expenses are profits which can be used to reinvest into the business or reward investors/owners through distributions.

1.8 – Characteristics of Business Entities

There are a total of three key attributes of business entities that differentiate them:

  • Liability: Liability refers to how much financial responsibility will be held by a business or individual in the event of business losses.
  • Double Taxation: When the profits of a business are ultimately taxed two times: once at the corporate level and second when it is distributed to owners in the form of dividends. Only impacts C-corporations.
  • Flow-Through Entities: A flow-through entity is an important tax concept which means that income and expenses of the business “flow-through” the entity and on to the investors of the entity.

There are six major types of business entities:

  • Sole Proprietorship: A business owned and operated by one person.
  • General Partnership: Similar to a sole proprietorship except two or more owners control the business.
  • Limited Partnership: A limited partnership is where at least one of the partners has unlimited liability (a general partner) while the remaining partners can be either limited partners or general partners.
  • C-Corporation:  A corporation is considered to be completely separate from the owners and is often chartered or incorporated by a government agency. 
  • S-Corporations: An S-corporation is similar to a C-corporation except for some significant differences related to amount of owners and flow through taxation status.
  • Limited Liability Companies (LLC): Allows for unlimited owners and limited liability for the owners.

1.9 – Accounting As a Profession

There are four major sectors that accountants are employed in:

  • Public Accounting: Accounting firms will employ accountants to sell services as auditors or tax professionals.
  • Private Accounting: Private companies will employ accountants to perform a variety of tasks, these tasks are often related to: general accounting, cost accounting, internal control functions, internal auditors and tax accounting.
  • Government or Fund Accounting: Local governments need accounting information to be created.
  • Not-For-Profit Accounting: Not-for-profit organizations also must create accounting information to ensure that their financial affairs are in order.

Accountants can obtain the following certificates to advance their career:

  • Certified Public Accountant (CPA) – Often considered the “highest level” of accounting certification. The certification process is comprehensive and includes areas of financial reporting, regulation, auditing and business concepts.
  • Certified Management Accountant (CMA) – The CMA is oriented towards a managerial or an internal focus of accounting.
  • Certified Internal Auditor (CIA) – The CIA designation is for individuals who practice internal auditing.
  • Certified Fraud Examiner (CFE) – The CFE designation is for individuals who work in industries that require the detection and prevention of fraud.
  • Enrolled Agent (EA) –  An EA is an individual who is authorized by the US Department of Treasury to represent taxpayers before the Internal Revenue Service (IRS).

1.10 – Financial Accounting’s Role in Financial Reporting

Financial reporting is the process of a company reporting their financial results to owners or investors. Financial statements, created by accountants, is a subprocess of the financial reporting process.

General purpose financial statements must be audited by accounting professional to ensure accuracy. Various government agencies, such as the securities and exchange commission (SEC) work to ensure that companies are not engaging in financial fraud.

1.11 – Overview of Financial Accounting

 The end goal of financial accounting is to create financial information for investors, lenders and other individuals who are external to the entity. To accomplish this goal four primary general purpose financial statements are used, which are the following:

  • Balance Sheet: Reports the entity’s financial position at a specific date.
  • Income Statement: Reports the entity’s financial performance over a specific period of time.
  • Statement of Retained earnings: Reports the changes in retained earnings for a specific period.
  • Statement of Cash Flows: Reports the changes in cash during a specific period of time.

The financial statements must be prepared according to a standard set of rules and supplemental information must be properly disclosed to give a true and clear representation of the business and its financial results.

 

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