Chapter Summary
A business provides goods or services (outputs) to customers with the objective of earning a profit. Three types of businesses include service, retail, and manufacturing businesses. Accounting is an information system that provides reports to users about the economic activities and condition of a business. Ethics are moral principles that guide the conduct of individuals. Good ethical conduct depends on individual character and company culture. Accountants are engaged in private accounting or public accounting.
Generally accepted accounting principles (GAAP) are used in preparing financial statements. To be useful, financial reports should provide information that is relevant and a faithful representation of the economic activity or condition, which are enhanced by comparability, verifiability, timeliness, and understandability. GAAP is based upon the assumptions of monetary unit, time period, business entity, and going concern. The principles of measurement, historical cost, revenue recognition, and expense recognition are an integral part of GAAP. The Financial Standards Board (FASB), Securities and Exchange Commission (SEC), and International Accounting Standards Board (IASB) develop standards that are incorporated into GAAP.
The resources owned by a business and the rights or claims to these resources may be stated in the form of an equation, as follows:
All business transactions can be stated in terms of the change in one or more of the three elements of the accounting equation.
The primary financial statements of a corporation are the income statement, the statement of stockholders equity, the balance sheet, and the statement of cash flows. The income statement reports a periods net income or net loss, which is also reported on the statement of stockholders equity. The ending common stock and retained earnings reported on the statement of stockholders equity are also reported on the balance sheet. The ending cash balance is reported on the balance sheet and the statement of cash flows.
The relationship between liabilities and stockholders equity can be expressed as a ratio of liabilities to stockholders equity, which is computed as total liabilities ÷ total stockholders equity. Since the rights of creditors to a businesss assets come before the rights of stockholders, the lower the ratio the better able the company is to withstand poor business conditions and to pay its obligations to creditors.
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