Chapter 1 Readings.docx

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Department
Management and Organizational Studies
Course
Management and Organizational Studies 2181A/B
Professor
Prof
Semester
Fall

Description
Chapter 1 Notes Users and Uses of Accounting - Accounting is the information system that identifies and records the economic events of an organization and then communicates them to wide variety of interested users - The world’s economic systems depend on highly transparent, reliable and accurate financial reporting - Users of accounting information can be divided broadly into two types: internal and external users Internal Users - Plan, organize and run companies; they work for the company - Many different departments use accounting, but they ask different questions o Finance—is there enough cash to pay the bills? o Marketing—what price should we sell our product for to maximize profits? o HR—how many employees can we afford to hire this year? o Production—which line is the most profitable? - Accounting provides a variety of internal reports - Companies also present summarized financial information in the form of financial statements for both internal and external use External Users - Several types o Investors use accounting info to make decisions (buy, hold, sell) o Lenders use it to evaluate risks of lending money o Other creditors use it to decide whether or not to grant credit - These are the primary (key) external users - There are other external users (ie. employees and labour unions, customers, taxing authorities and regulatory agencies) Ethical behaviour by users - For financial information to have value, it must be prepared by individuals with high standards of ethical behaviour - Many companies today have codes of conduct to enforce ethical business decisions - When analyzing an ethical situation: o Recognize an ethical situation and the ethical issues involved o Identify and analyze the main elements in the situation  Identify the stakeholders (persons or groups who may be harmed or benefited) o Identify the alternatives and weigh the impact of each alternative on various stakeholders Forms of Business Organization - Businesses can be organized in different ways - 3 common forms: proprietorships, partnerships and corporations Proprietorships - A proprietorship is a business owned by one person (aka “sole” proprietorship) - Simple to set up and gives the owner control of the business - Usually only a small amount of capital is needed - Owner receives any profits, suffers any losses, and is personally liable for all debts (unlimited liability) - No legal distinction between the business as an economic unit and the owner - Business records of the proprietorship must be kept separate from those related to the owner’s personal activities, known as the reporting entity concept which requires that the economic activity that can be identified with a particular company be kept separate and distinct from the activities of the owner(s) and of all other economic entities o Applies to all forms of business organization Partnership - A partnership is a business owned by more than one person - Often formed because one person does not have enough economic resources to initiate or expand business - Normally formalized in a written partnership agreement - Usually each partner has unlimited liability for all debts of the partnership independent of who created the debt - Profits of a partnership are reported as self-employment income and taxed on each partner’s personal income tax return - Reporting entity concept requires that partnership records be kept separate from each partner’s personal activities - Typically used to organize professional service businesses (ie. lawyer, doctor and engineering practices) Corporations - A corporation is a business organized as a separate legal entity owned by shareholders - Have an indefinite life – continue on regardless of who owns its shares - Corporate shareholders are not responsible for corporate debts unless they have personally guaranteed them (ie. most shareholders enjoy limited liability since they only risk losing the amount they have invested in the company’s shares) - Easier to raise capital - Pay income tax as separate legal entities on any corporate profits - Publicly traded - Public corporations distribute their financial statements to investors, lenders, other creditors, other interested parties and the general public (you can usually view them online) - Some corporations own other companies and their financial statements will be consolidated meaning that all financial results for the corporation and all the companies they own will be on the same statements (ie. they have one income statement, one balance sheet, etc.) - Private corporations issue shares, but they are not available to the general public and they are not traded on stock exchanges o This makes it difficult to raise capital o Rarely distribute financial statements publicly Generally Accepted Accounting Principles (GAAP) for Corporations - GAAP includes broad policies and practices as well as rules and procedures that have substantive authoritative support and agreement about how to report economic events - GAAPs are different for publicly traded and private corporations - Publicly traded corporations must use International Financial Reporting Standards (IFRS) - Private corporations can use IFRS or Accounting Standards for Private Enterprises (ASPE) o Most private corporations use ASPE, but there are a few exceptions - Proprietorships and partnerships do not need to choose between IFRS and ASPE because generally their statements are prepared for internal use of the owners only Business Activities - There are three types of business activities o Financing o Investing o Operating Financing Activities - Activities that result in raising outside funds for corporations - Two primary ways of doing this: o Borrowing money (debt financing) o Issuing (selling) shares (equity financing) in exchange for cash - Money can be borrowed in a variety of ways (ie. bank loan, borrowing money from other lenders) - Lenders or creditors are the persons or companies that a corporation owes money to (a primary user of accounting information) - Liabilities are the amounts owed to lenders and creditors in the form of debt and/or other obligations - Liabilities have specific names depending on their source o Most companies have an operating line of credit with their bank  When the company uses its operating LOC to cover cash shortfalls and overdraws its bank account it is called bank indebtedness o Loan (note) payable is a short-term money loan o Long-term debt can include mortgages payable, bonds payable, finance lease obligations and other types of debt securities that are borrowed for longer periods of time - A corporation can also obtain financing by selling shares of ownership to investors o Common shares is the amount paid by investors for shares of ownership in the company - Companies can also use cash for financing activities (ie. repaying debt) - Claims of lenders and creditors are different from shareholders o Lenders loan money to a company with a set repayment schedule (usually with added interest) o Creditors have a legal right to be paid at an agreed time and in the event of nonpayment they may force the company to sell assets to pay its debts o Shareholders have no claim to corporate resources until the claims of lenders and creditors are satisfied (ie. if you buy shares you have no legal right to expect any payments until all of a company`s lenders and creditors are paid) o Additionally, a company is not obligated to buy shares back, whereas debt obligations MUST be repaid o Many companies pay shareholders a return on their investment called dividends on a regular basis, provided that there is enough cash to cover required payments to lenders and creditors Investing Activities - Once a company raises money through financing activities, they use that money for investing activities - Investing activities involve the purchase (or sale) of long-lived assets that a company needs in order to operate - Assets are resources that a company owns or controls o Capable of providing future economic benefits that can be short or long lived - Investing activities generally involve long lived assets (ie. buildings, vehicles, equipment) which are collectively referred to as property, plant and equipment - Cash is one of the more important assets owned by a business o If a company has excess cash it doesn`t need for a while it may choose to invest it in debt securities (ie. bonds) or equity securities (ie. shares) of other corporations or organizations which are called investments  Investments can be short or long term  Short term investments are generally considered operating activities  Long term investments are generally classified as investing activities Operating Activities - Once a business has the finances and has made the investments it needs to get started, it can begin its operations - The amounts earned from the sale of goods is revenue o Revenues are increases in economic benefits—usually an increase in an asset but sometimes a decrease in a liability—that result from the sale of a product or service in the normal course of business - Revenues come from different sources and are identified by various names o Common sources of revenue include sales revenue (sales), service revenue, interest revenue and rent revenue - Sometimes companies sell goods on credit which means that they do not immediately receive all the cash for the sale o The right to receive money in the future is called an account receivable o They are assets because they will result in a future benefit (cash) when the amounts owed are eventually collected - Assets with shorter lives result from ope
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