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Weekly Overview

Week One

Overview

All organizations are required to produce financial statements using accounting methods. Different types of organizations have different requirements. For example, public corporations must adhere to the Sarbanes-Oxley Act of 2002 requirements. Private companies, sole proprietorships, and partnerships do not have as stringent requirements in terms of accounting reporting requirements. However, accounting requirements are just one of many reasons why these various types of businesses are established. Thus, the introductory week will cover the advantages and disadvantages of each of these types of organizations. Regardless of the organization type, there are several individuals who have an interest in the accounting and financial reporting results. In some cases, the various individuals who are internal and external to the organization have different reasons or needs to review this information. These individuals include stockholders, bondholders, creditors, employees, managers, and customers as well as owners or business partners of privately owned businesses.

There are ongoing financial statements and results that are produced monthly and quarterly, such as the income statement, balance sheet, statement of retained earnings, and statement of cash flows. In addition, public companies are required to produce an annual report each year to highlight the financial and operational performance of the organization. Included in the annual report are detailed schedules of the financial statements mentioned above along with many other supplementary schedules that make up the most comprehensive information found on a company.

It is also important to understand the double-entry process applied in the reporting of accounting results. This ensures that the debit and credit entries are equal in the accounting system. The basic accounting equation that formulates a balance sheet is an initial accounting concept that helps you understand how this statement is generated. In addition, this provides insight into how financial systems are used to maintain accounting processes and generate financial statements.

What you will cover

1. Accounting Environment

a. Explain the forms of business organizations and the key users of financial information.

1) Types of business organizations:

a) Sole proprietorship – a business with one owner

1) Simple to establish that it is owner controlled and taxed as personal income to the owner

b) Partnership – a business with two or more owners

1) The business is simple to establish with shared control for all of the owners

2) Multiple owners create broader skills and resources

3) Has tax advantage similar to that of a sole proprietorship

c) Corporation – an organization that is formed with a charter

1) Ownership is based on shareholders in which the transfer of ownership is easy to facilitate

2) Advantages of a corporation include: the ability to raise capital/funding vs. sole proprietorship and partnerships, no personal liability to shareholders

3) Disadvantages: double taxation at the corporate and shareholder level.

2) Key users of financial information:

a) Internal users: need information to manage on-going operations

1) Company officers

2) Department managers

3) Executive and key leadership

b) External users: information is used to assess the creditworthiness of the company for investing, making loans, or meeting compliance requirements.

1) Investors

2) Creditors

3) Regulatory agencies

4) Taxing authorities

5) Customers

b. Describe the relationship between financial statements and the supplemental components comprised in an annual report.

1) The annual report consists of a narrative that highlights the year’s events, the organization’s actions, the financial statements, and the accompanying auditor’s notes and audit opinion.

a) This includes a detailed analysis of the following financial statements (at a minimum):

1) Income statement

2) Balance sheet

3) Statement of retained earnings and cash flow

b) In some cases, organizations will also provide other financial results that may be applicable, such as:

1) Detailed sales results by products/services or geographical markets

2) Break-down of cash vs. credit sales, etc.

2) The annual report is an opportunity to show the organization at its best, whatever the performance of the past year was.

3) The components of the annual report are vital in determining a company’s ability to pay near-term obligations as well as the ability to fund operations and expansion, and assess overall operational performance.

4) Just as financial statements can be used to identify trends in performance, the annual report will highlight key financial and strategic changes that impact the business.

c. Explain how the accounting equation affects financial statement components.

1) Most companies have computerized financial systems to track and monitor all accounting activity. These systems are called electronic data processing (EDP) systems. EDPs are essential in producing accounting results and financial statements on a timely basis.

2) Any economic event that affects a company’s assets, liabilities, or stockholder’s equity requires an accounting entry.

d. Determine the effects of transactions on the accounting equation.

1) The basic accounting equation is: Assets = Liabilities + Stockholder’s Equity

a) This equation must always balance after each accounting transaction has been posted.

b) All accounting transactions are completed with a dual entry of a debit and credit in which each the total amount of debits and credits must match.

Discussion starters

1. WHAT ARE THE ELEMENTS OF THE ACCOUNTING ENVIRONMENT? HOW DO THESE ELEMENTS AFFECT FINANCIAL STATEMENTS? WHY ARE THESE IMPORTANT? HOW DO THESE ELEMENTS AFFECT COMPARABILITY BETWEEN COMPANIES? PROVIDE EXAMPLES.

2. Share an example of an external user of financial statements and describe how financial statements are important to this user.

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