Chapter 1 Intermediate Account I
Financial Accounting Environment
This chapter discusses different aspects of financial accounting and its importance in
providing useful information to investors and creditors. Financial reporting is the term used to
describe the process of providing financial information to those who may have an interest in the
company such as investors.
The Economic Environment and Financial Reporting
This section discusses capital markets and their importance in the economy. The capital
markets is responsible for allocating important resources to the companies that will use them to
provide the goods and services that will most benefit the economy. It is their job to make sure
that these resources are given to companies that will use them appropriately and not waste them.
Corporations that go through these markets usually give up ownership interest in the form of
stocks or bonds in exchange for the cash they need to help their company grow. These investors
are only willing to provide the companies with funds if they believe they will make more money
from the investment in the future. An investor that invests into a corporation and makes back
more money than they put in would have a positive rate of return. Financial accounting is
important because it provides important information to the investors so they can make an
educated decision on whether to invest in a company.
Two methods used to predict future cash flows are the accrual accounting model and the
cash basis accounting model. The cash basis model examines the difference between cash
receipts and cash payments. This is known as net operating cash flow. In this method, cash
received for a specific purpose would be registered in the month it is receieved even though the
service they provided for that cash may not take place immediately. Same for cash that the
company may use for expenses suh as rent. If they pay for five years of rent at once, they would
register that expense all at once instead of registering it as the resource cost is accrued. However,
accrual accounting is the opposite. In this method, the focus is on the net income which is the
difference between revenues and expenses. For this method, the payment made on the five years
of rent would be registered as the resource is used instead of when the payment was made. The
accrual method is the primary model used by for-profit companies.
Development of Financial Accounting
Generally accepted accounting principles is the set of broad and specific procedures that
companies should follow when handling financial information. After the stock market crash of
1929, there was pressure to establish a uniform set of accounting standards. This led to the
