Accounting Fundamentals - 1

Great ideas and passions often lead to the formation of businesses, which, in turn may lead to great rewards for those involved; not only for those who originate the ideas, but also for those who help them become realized. Bill Gates had a great idea: making computers user-friendly. His business – Microsoft is the realization of that great idea and passion.

These great ideas can take the form of making something (we call this type of business manufacturing), selling something (this would be considered retailing), or doing something (which is known as service). Ford’s great idea was manufacturing cars, Sam Walton’s great idea was selling lots of items for less, and Henry and Richard Block came up with a great idea to help people file their income taxes. None of these individuals would have been able to build the successful businesses that exist today without help.

Business Operations Resources
Business resources include creditors (who make loans to the business) and investors (who provide financial support to the business and in turn receive partial ownership in that business). There are risks and rewards associated with providing these resources. Creditors risk non-repayment of the loans, whereas investors risk losing their entire investment. Creditors are rewarded by interest they receive; investors are rewarded by sharing in the company’s earnings or by seeing the value of their investment increase. These two groups of resources (creditors and investors) must evaluate the risk that they will be incurring and will need useful information on which to base their economic decisions. The ultimate purpose of financial accounting is to provide that information.

Financial Statements
This information takes the form of specialized reports, which communicate specific information about the business. The income statement provides information on how effectively the company used resources to generate income. The balance sheet presents how company resources are financed (by either creditors or investors). Finally, the cash flow statement describes how cash is provided by and used by operating, financing, and investing activities. These specialized reports are collectively known as the financial statements, which must be prepared based on what is known as ‘generally accepted accounting principles’ (or GAAP). These principles originated as unregulated best practices used by accountants with open interpretations. It was not until the 1929 market crash that the government intervened, issuing acts creating and empowering the Securities Exchange Commission, (the SEC) to regulate publicly traded companies (including the financial statements these companies issue).

Accounting Regulation
The Financial Accounting Standards Board (the FASB), is the current organization empowered to create financial accounting standards. Formed in 1975, the FASB began its mission, by evaluating the objectives of financial reporting. They determined that the most critical objective is to provide ‘useful’ information on which economic decisions may be based. Since the term ‘useful’ is not clear-cut, the FASB then determined what characteristics of information would make that information ‘useful’ and described those characteristics in their Statements of Financial Accounting Concepts. All of the financial accounting rules that you will be learning in this course are based on those concepts. The SEC mandates that the financial reports are audited to provide some assurance to creditors and investors that their risk assessments are valid. Obviously, both the preparers and auditors of these statements must uphold the highest ethical standards so that those who rely upon them may make viable economic decisions.