Financial accounting is the communication of information about a business or other type of organization (such as a charity or government) so that individuals can access its financial health
How does financial accounting differ from managerial accounting?
Financial accounting relates to profiding information to those outside of the organization so that they can make decisions about the organization as a whole. Managerial accounting provides information for those inside of the organization so that they can make decisions on behalf of the organziation
list the potential users of the information provided by financial accounting
potential users include potential and current stockholders, potential investors and current creditors, potential and current employees of the organization, governments, customers and suppliers
What is a corporation?
A corporation is an organization that has been formally recognized by a government as a legal entity. It has certain rights such as the right to sell stock in itself and the right to form contracts
How does a business become a corporation?
In order to become a corporation, a business must apply to its state government for recognition. It files Articles of Incorporation with the state which includes information about such things as its stock and its line of business.
Why would a business want to become a corporation?
A business would want to become a business for several reasons, including raising capital and liability issues. This chapter discussed the advantage that corporations have in being able to sell stock to raise money
What is the Board of Directors of a corporation?
The Board of Directors of a corporation is a representative group elected by its shareholders to oversee the company for them
Why do individuals or entities choose to invest in the capital stock of corporations?
Investing in the capital stock of corporations gives owners two potential ways to increase their wealth: 1) if the stock price increases 2) if the corporation pays dividends.
How does an investor differ from a creditor?
An investor is an individual or entity who purchases stock in a business and becomes an owner of that business. A creditor is an individual or entity who loans money to a business. The creditor is not an owner, but does have the right to be repaid.
What is financial information?
Financial information is data that can be measured in monetary terms.
True or False
Financial accounting helps with decisions made inside of an organization.
False:
Financial accounting provides information to those outside of an organization to help them make decisions about the organization. Managerial accounting helps with decisions made inside an organization.
True or False:
Typically, a sole proprietor will be able to raise money easier than a corporation.
False:
One of the advantages of incorporating is increasing the ease of raising money.
True or False:
Employees are not users of the information provided by financial accounting
False:
Employees are one of the stakeholder groups who are interested in the financial health of a company.
True or False:
The Board of Directors of a corporation is elected by its shareholders.
True:
Shareholders elect the Board of Directors to set policy for the corporation.
True or False:
Investors who hold investments in a stock longer than a year may enjoy a tax benefit.
True:
An investment in stock held longer than a year may be subject to lower capital gains tax rates.
True or False:
Corporations are required by law to pay dividends to their shareholders.
False:
Corporations choose whether or not to pay dividends to shareholders. There is no requirement that they do so.
True or False:
Purchasing stock is typically a riskier investment than opening a savings account.
True:
While no investment is completely free of risk, opening a savings account involves little risk of loss to the account holder. Investments in stock are considered much riskier as the stock price could decrease just as easily as increase.
True or False:
Financial information is communicated in monetary terms but may be explained verbally
True
Financial information by definition has to be measured in monetary terms; however, verbal clarification is often included.
True or False:
Accountants are the only users of the information provided by financial accounting.
False:
Financial information is used by many different individuals and entities including potential and current creditors, potential and current stockholders, potential and current employees, and governments.
True or False:
An entity that loans a company money is referred to as a “shareholder.”
False:
An entity which loans a company money is a creditor.
Ramon Sanchez is a loan officer at Washington Bank. He must decide whether or not to loan money to Medlock Corporation. Which of the following would Ramon most likely consider when making this decision?
a) Medlock had a positive cash flow last year
b) Medlock paid dividends last year
c) Medlock's stock price increased last year
d) The number of stockholders in Medlock increased last year
a. Medlock had positive cash flows last year.
Creditors are primarily concerned with a client’s ability to repay the loan and accompanying interest. Ramon would most likely look at Medlock’s cash flows for an indication of future positive cash flows for repayment.
Which of the following is not a reason an investor would purchase stock in a corporation?
a) to receive dividend payments
b) to sell the stock for a gain if the share price increases
c) to earn a return on their investments
d) to participate in the day to day operations of the business
d. To participate in the day-to-day operations of the business.
The vast majority of stockholders do not participate in the day-to-day operations of a business. The corporation’s Board of Directors and management team have this responsibility.
Which of the following would not be considered an example of a decision made using financial accounting information?
a) an investor decided to invest in the stock of rayburn corporation
b) a credit analyst at mayfield corporation rejected a request for credit from rayburn corporation
c) a rayburn corporation manager decided to increase production of widgets
d) a loan officer at fairburn bank chose to grant a loan request made by rayburn corporation
c. A Rayburn Corporation manager decided to increase production of widgets.
Production decisions are made inside of the company. Managerial accounting provides the information for these decisions.
Which of the following is most likely to have a say in the policy decision of a large corporation?
a) a stockholder
b) a member of the board of directors
c) an employee
d) a creditor
b. A member of the Board of Directors
The Board of Directors is elected by the stockholders of a corporation to set policy for a corporation.
1) Leon Williams is an investor in Springfield Corporation. On September 1, Year One, he purchased 150 shares of stock at a price of $45 per share. On October 15, Year One, Springfield distributed dividends of $1.50 per share. On December 31, Year One, Springfield’s stock is selling for $47 per share. Which of the following is the value of Leon’s investment on December 31, Year One?
a) 6,750
b) 6,975
c) 7,050
d) 7,275
d. $7,275
Leon’s investment gains value in two ways: 1) the stock price increases and 2) the company pays dividends on its stock. Leon’s initial investment had a value of $6,750 (150 shares × $45 per share). On December 31, the stock price had risen, and dividends had been paid. Thus, the value of December 31 is $7,275.
(150 shares × $47 price per share) + (150 shares × $1.50 dividend per share)
Explain how each of the following might use the information provided by the financial accounting of Nguyen Company:
Bank loan officer considering loaning money to Nguyen Company.
A loan officer is primarily concerned with Nguyen Company’s ability to pay back the loan with interest. Thus, the loan officer is going to look at Nguyen’s past cash flows to help determine future cash flows.
Explain how each of the following might use the information provided by the financial accounting of Nguyen Company.
Current employee of Nguyen Company.
A current employee will be interested in the financial health of Nguyen. The employee will want to know the likelihood of bonuses because the company is doing well or the risk that company will have to layoff workers due to poor financial performance.
Explain how each of the following might use the information provided by the financial accounting of Nguyen Company.
Potential employee of Nguyen Company.
A potential employee is interested in the same thing as a current employee, but from a different perspective. He or she will want to gauge the financial health of Nguyen against other companies to which he or she is applying.
Explain how each of the following might use the information provided by the financial accounting of Nguyen Company.
Current investor in Nguyen Company
A current investor is interested in how the financial status of Nguyen is likely to affect its stock price. He or she will also be interested in whether Nguyen has sufficient cash flows to pay dividends.
Explain how each of the following might use the information provided by the financial accounting of Nguyen Company.
Potential investor in Nguyen Company
Like the current investor, the potential investor is also interested in how the financial health of Nguyen might impact the stock price and its ability to pay dividends. He or she is more likely to use this information to compare Nguyen to other potential investments.
Explain how each of the following might use the information provided by the financial accounting of Nguyen Company.
A credit analyst of company wanting to sell inventory to Nguyen Company.
A credit analyst of a potential supplier will be interested in Nguyen Company’s ability to pay for any inventory it purchases on credit. The credit analyst will look at Nguyen’s liquidity or in other words, its ability to pay off short-term debts.
Mark each of the following with an (F) to indicate if it is financial information or an (N) to indicate if it is non-financial information
Metro Corporation has Cash of $4,000,000
financial
Mark each of the following with an (F) to indicate if it is financial information or an (N) to indicate if it is non-financial information.
Metro Corporation has a building that cost $50,000,000
financial
Mark each of the following with an (F) to indicate if it is financial information or an (N) to indicate if it is non-financial information.
Metro Corporation has 2,000 employees
non-financial
Mark each of the following with an (F) to indicate if it is financial information or an (N) to indicate if it is non-financial information.
Metro Corporation has inventory worth $16,000,000
financial
Mark each of the following with an (F) to indicate if it is financial information or an (N) to indicate if it is non-financial information.
Metro Corporation has 500 shares of capital stock
non-financial
Mark each of the following with an (F) to indicate if it is financial information or an (N) to indicate if it is non-financial information.
Metro Corporation has 1,000 trucks
non-financial
Mark each of the following with an (F) to indicate if it is financial information or an (N) to indicate if it is non-financial information.
Metro Corporation has sales of $45,000,000
financial
Sole Proprietorship
Sole Proprietorship: A sole proprietorship is defined as an unincorporated business with one owner, who is also likely to be the manager. It is very easy to start as the only filing requirements include obtaining proper licenses and permits. It is also easy to get out of business—the owner may just decide to close up shop. The business also ends upon the death of the owner. The owner is liable for all debts incurred by the business. Sole proprietorships are not taxed as a separate entity. They are considered a pass-through entity for tax purposes. The profits or losses of the business are reported on the owner’s personal tax return, and any taxes are paid by the owner based on that return. The sole proprietorship can be the most limiting form when it comes to funding sources. The owner typically invests him- or herself and may persuade family and friends to invest. A loan is also possible if the owner has personal or business collateral.
Partnership
Partnership: A partnership is similar in many ways to a sole proprietorship. The most significant difference is that there are at least two owners. These owners should develop a written agreement to start the partnership which details investments by the partners as well as how profits and losses will be divided, but an agreement is not required. The partnership will be dissolved if a partner leaves or dies unless the partnership agreement states otherwise. The partners are liable for the debts of the business and the actions of the other partners. The partnership is a pass-through tax entity, with the partners reporting profits and losses on their personal tax returns as described in the partnership agreement. Like a sole proprietorship, funding sources include the partners, their friends and family, and bank loans.
Limited Partnership
Limited Partnership: A partnership in which some of the partners have limited liability. At least one partner must be a general partner whose liability is not limited
C Corporation
C Corporation: A C Corporation (so called because of a section of the tax code) is formed when Articles of Incorporation are filed with its state. A C Corporation typically has many owners. Entities and individuals become owners when they purchase stock in the corporation. Because a C Corporation is a separate entity from its owners, it does not cease to exist upon the death or departure of an owner. This separation between corporation and owners also greatly limits the liability of the owners. The owners are not typically involved in the day-to-day management of the corporation. This is left to management and the Board of Directors elected by the stockholders. The corporation is considered an entity for tax purposes. It files its own tax return and pays taxes on its profits. If it chooses to distribute those profits to its owners in the form of dividends, the owners are taxed on those distributions. This is known as “double taxation.” The corporation has the easiest time raising needed money because it can sell stock in itself as well as obtain loans and lines of credit.
S Corporation
S Corporation: Like a C Corporation, an S Corporation (so called because of a section of the tax code) is formed when Articles of Incorporation are filed with its state. Unlike a C Corporation, an S Corporation has a limited number of owners. Currently, this limit is 100 owners. Because of this limit, it is easier for owners to have some say in the day-to-day operations of the corporation, but it is not necessary. Because an S Corporation is a separate entity from its owners, it does not cease to exist upon the death or departure of an owner. This separation between corporation and owners also greatly limits the liability of the owners. The main difference between an S Corporation and a C Corporation is taxation. An S Corporation is a pass-through tax entity like a partnership. The owners pay taxes on their share of profits or losses on their personal tax returns. An S Corporation is more limited in funding than a C Corporation because it cannot sell stock to more than 100 individuals or entities.
Limited Liability Corporation (LLC
Limited Liability Corporation (LLC): A limited liability corporation is a combination of a corporation and a partnership. Like a corporation, Articles of Organization must be filed with its state to setup the LLC. The LLC must have at least one owner (called a member), but can have more. Often the owners will sign an agreement similar to a partnership. Unlike a partnership, though, the LLC can continue to exist even upon the death or departure of an owner. Some of the owners will most likely be involved in the day-to-day operations of the LLC, but not all have to be. An LLC has the freedom to choose how it is taxed. It can be taxed as a pass-through entity like a partnership or S Corporation where the owners will pay taxes on their share of profits or losses on their personal return. It can also choose to file a corporate tax return like a C Corporation.
