Company Outsiders: potential investors, potential lenders
The Information Gap
Company Insiders
There are two types of information problems…
1. current owners have more information about the company’s value than
prospective owners and creditors
2. Agency problems: because capital providers are often not involved in day to
day management of the company, managers have an incentive to benefit
themselves at the capital provider’s expense
Financial Reporting’s Primary Objective:
- “The objective of general purpose financial reporting is to provide financial
information about the reporting entity that is useful to existing and potential
investors, lenders, and other creditors in making decisions about providing
resources to the entity” (a fancy way to say that we need to close the
information gap)
Relevance: capable of making a difference in the decisions made by its users
Faithful Representation: must faithfully represent the phenomena it reports to
represent
Enhancing Qualitative Characteristics
Comparibility: accounting information is comparable with information from other
companies, and is consistent with similar information from previous periods
Verifiability: it is possible to check the information for accuracy
Timeliness: information is available to users early enough to help them make
decisions
Understandability: information is transparent enough so that it makes sense to
reasonably informed users of the information
ACC 231 Uses of Accounting Info 1 (01/12/22)
Ch. 1 Financial Statements
Assumptions
Entity Assumptions: business transactions are separate from owner’s transactions
Going Concern Assumption: business will continue to operate into the foreseeable
future
Stable Monetary Unit Assumption: the dollar’s purchasing power is stable over time
Mixed-Attribute Measurement Model
historical cost principle: most elements are recorded at their historical cost
“a mixed attribute measurement model”
Forms of Business Organization
Proprietorship: proprietor- one owner, personally liable
Partnership: two or more partners, general partners are personally liable, limited
partners are not
LLC: members, members are not personally liable
Corporation: stockholders, generally many owners, stockholders are not personally
liable (when the corporation generates earnings, those earnings will be taxed first
then the stockholder also gets taxed; double taxing)
The Accounting Equation
- addition/inflows, stock is how much there is, subtraction/outflows
How Does Accounting Represent Stocks?
(How much stuff do we have? = Who has claims to that stuff?)
A (Assets)
- probable future economic benefits
- obtained and controlled by a particular entity
- resulting from past transactions or events
L (Liabilities)
- probable future sacrifices of economic benefits
- arising from present obligations of a particular entity to transfer assets or
provide services to other entities in the future
- resulting from the past transactions
SE (Stockholders Equity)
- the residual interest in the assets of the entity after subtracting liabilities
A (Assets) = L (Liabilities) + SE (Stockholders Equity)
Income Statement Elements
NI (Net Income)= R (Revenue) - E (Expenses)
Revenue:
- increases in assets
- or decreases in liabilities
- from activities that constitute the entity’s ongoing major or central
operations
Expenses:
- decreases in assets
- or increases in liabilities
- from activities that constitute the entity’s ongoing major or central
operations
What can companies do with their net income?
- distribute them to company owners: this is called a “dividend”
- retain them in the company: this is called “retained earnings”
SE (Stockholders Equity) = CC (Contributed Capital) + RE (Retained Earnings)
RE (Retained Earnings)= BRE (Beginning Retained Earnings) + NI (Net Income) - D (Dividends)
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