Several types of entities provide financial information to a variety of external users. Our primary focus in this book is on the financial information that profit-oriented companies provide to present and potential investors and to creditors. These profit-oriented companies also provide financial information that is used by financial intermediaries such as financial analysts, stockbrokers, mutual fund managers, and credit rating agencies.
Not-for-profit organizations also provide financial information to external users such as citizen groups and donors. As an individual, you provide financial information to the internal revenue service and to creditors when you seek a loan.
Accounting is often thought of as the “language” used to communicate financial information about a business. The primary method that profit-oriented companies use to provide financial information to investors, creditors, and other external parties is through financial statements and their accompanying disclosure notes. The financial statements used most frequently for this purpose are the: Balance Sheet, also called the Statement of Financial Position. Income Statement, also called the Statement of Operations. Statement of Cash Flows.
Statement of Shareholders’ Equity.
Starting in 2012, companies must either provide a statement of other comprehensive income immediately following the income statement, or present a combined statement of comprehensive income that includes the information normally contained in both the income statement and the statement of other comprehensive income.
The three primary forms of business organization are the sole proprietorship, the partnership, and the corporation. A sole proprietorship is owned by a single individual. A partnership is owned by two or more individuals. A corporation is owned by shareholders, frequently numbering in the tens of thousands in large corporations. Although sole proprietorships and partnerships outnumber corporations, corporations are the dominant form of business in terms of size and ownership of productive resources.
Investors and creditors provide massive amounts of financial resources to corporations. A highly developed system of financial reporting is necessary to communicate financial information from a corporation to its many shareholders and creditors concerning how the corporation uses these resources.
Investors and creditors are willing to provide capital to a corporation only if they expect to receive more cash in return at some future time. Investors may receive future cash returns in the form of periodic dividends and from the sale of their ownership shares. Creditors may receive future cash returns in the form of interest and repayment of principal. Part II.
The primary objective of financial accounting is to provide investors and creditors with financial information that will help them make investment and credit decisions. The information should help investors and creditors evaluate the amounts, timing, and uncertainty of the company’s future cash receipts and payments. With better financial information, investors and creditors will be able to make better resource allocation decisions.
Using cash basis accounting, revenue is recognized when cash is received, and expenses are recognized when cash is paid. This net cash flow measure of income is easily understood, and all information to measure cash flows is factual. However, there is a major shortcoming to using current net cash flow to predict future periods’ cash flows.
Using accrual accounting, revenue is recognized when it is earned, and expenses are recognized when they are incurred.
Carter Company has sales on account totaling $100,000 per year for three years. Carter collected $50,000 in the first year and $125,000 in the second and third years. The company prepaid $60,000 for three years’ rent in the first year. Utilities are $10,000 per...
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