Intermediate Accounting Chapter 1 Notes

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Chapter 1 Environment and Theoretical Structure of Financial Accounting
Part A Financial Accounting Environment
Accounting provides useful information about economic activity to help produce good decisions and
foster a prosperous society
Financial accounting financial information provided to external users
The primary focus of financial accounting is on the financial information provided by profit-oriented
companies to their present and potential investors and creditors
Financial statements: balance sheet, income statement, statement of cash flows, statement of
shareholders’ equity
Financial reporting process of providing information to external users
The Economic Environment and Financial Reporting
Capital markets provide a mechanism to help the economy allocate resources efficiently
Three primary forms of organizations: sole proprietorship, partnerships, and corporation
Corporation acquire capital from investors in exchange for ownership interest and from creditors by
borrowing
o Dominant form of business organization
Initial market transactions issuance of stocks and bonds by the corporation
Secondary market transactions transfers of stocks and bonds between individuals and institutions
Corporations receive no new cash from secondary market transactions
The Investment-Credit Decision A Cash Flow Perspective
Investors and creditors are willing to provide capital to a corporation (buy stocks or bonds) only if they
expect to receive more cash in return at some time in the future
Shareholders will receive cash from their investment through ultimate sale of the ownership shares of
stock and periodic dividends
Rate of return - dividends+share price appreciation
initial investment
o Investor provides $10,000 cash through stock at the end of 2017, receive $400 dividend during
2018, and sells ownership interest at the end of 2018 for $10,600
$400 +$600
$10,000 =10%
Investors and creditors would like to invest in stocks or bonds that provide highest rate of return
The expected rate of return and the uncertainty, or risk, of that return are key variables in the
investment decision
Cash versus Accrual Accounting
Accrual accounting measurement of the entity’s accomplishments and resource sacrifices during the
period regardless of when cash is received or paid
Cash basis accounting difference between cash receipts and cash disbursements during a reporting
period from transactions related to providing goods and services to customers
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Cash Basis Accounting
Net operating cash flow difference between cash receipts and cash disbursements during a reporting
period from transactions related to providing goods and services to customers
Net operating cash flow is a measure of concern in the long-run, but not necessarily in the short-run
o Companies may receive or pay cash for prior period sales or make advance payments
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