After studying Chapter 1, you should be able to
* Discuss the different classifications of financial transactions * Define an equity investor and a debt investor and understand the difference * Discuss the role of the Securities and Exchange Commission * Name the Big Four accounting firms and define the term “independent auditor” * Define corporate governance
* Discuss GAAP and IFRS and the concept of rules-based versus principles-based * Discuss the roles of the board of directors and the audit committee * Discuss the basics of Sarbanes-Oxley
Discuss how legal liability and corporate ethics work to help strengthen corporate governance * -------------------------------------------------
Define the words in bold in this chapter
“Accounting” is the recording of business transactions and the preparation of reports summarizing these transactions. These reports are called “financial statements”, and they are available to be read by anyone who might be interested, either inside or outside the company. Because the information in the financial statements is often the basis for decisions by analysts outside the company, it is important that the statements be prepared impartially, objectively, and in accordance with established standards. The term “financial accounting” refers specifically to the records and related reports that are available to be read by people outside of the company. We will take an overview approach to financial accounting in this course. Accounting is based on debits and credits, but we will not have time to cover these in this course. You will learn about debits and credits and the basics of an accounting system when you take the first Principles of Accounting course. Instead, the approach used in this course is an overview called “impact on the financial statements”. It is a top-down approach of looking at financial accounting and how various transactions impact the financial statements. Classifications of Business Operations:
Every business transaction can be classified into one of three types: financing activity, investing activity, or operating activity. “Financing activities” are those transactions that raise funds for the company to operate. “Investing activities” are the transactions in which the company is investing in assets that it will keep in the business to use in its operations. “Operating activities” are all of the other transactions that a business engages in which cannot specifically be classified as financing or investing. Examples of operating transactions are the payment of rent, salaries, and insurance expenses. Financing Activities:
Imagine a company which is just going into business. The first thing it needs to do is raise money to begin operations. There are two basic ways a company can raise money to help finance its operations: (1) equity and (2) debt. The term “equity” refers to ownership. When a company sells equity, it is selling ownership in the company. The usual way this is done is for the company to form a corporation and sell shares of stock. Purchasers of the stock are called “equity investors” (or “stockholders” or “shareholders”). When equity investors buy stock in the company, they are buying ownership of the company. The typical reason that an investor would want to do this is because they believe in the concept of the company and believe the corporation will be profitable and either pay dividends or the value of the stock will rise or both. Buying stock in the company entitles the holders to two rights, the first of which is to vote for the “directors” of the company. All the directors together form the corporation’s “board of directors”. The job of the directors is to represent the stockholders’ interest to management and protect the stockholders’ investment. Many stockholders are not located near the...