Accounting for Lawyers
Professor Pilato Fall 2012
2 hour final
Chapter 1
Study Objectives
1. Describe the primary forms of business organizations
a. Sole Proprietorship – a business owned by one person
i. Simple to establish
ii. Owner controlled (owner operated)
iii. Tax advantages
b. Partnership – a business owned by 2 or more persons associated as partners
i. Formalize duties in a partnership agreement
ii. Simple to establish
iii. Shared control
iv. Broader skills and resources – one individual may not have the unique skills or economic resources
v. Tax advantages
c. Corporation – a business organized as a separate legal entity owned by stockholders
i. Investors in a corporation receive shares of stock to indicate their ownership claim
ii. Easier to transfer ownership – Buying stock in a corporation is often more attractive than investing in a partnership because shares of stock are easy to sell.
iii. Easier to raise funds – an investor can invest a very small amount of money to become a stockholder
iv. No personal liability
d. Sole Proprietorship and Partnerships generally receive more favorable tax treatment than a corporation.
e. Sole Proprietorship and Partnerships are personably liable for all debts of the business; corporate stockholders are not.
2. Identify the users and uses of accounting information
· Internal Usersà managers who plan organize, and run a business
o In running a business, managers must answer important questions
§ To answer these questions, you need detailed info on a timely basis.
§ Accounting provides internal reports to answer these questions
o Human resources: ask “Can we afford to give our employees pay raises this year?”
o Finance: ask “Is cash sufficient to pay dividends to our stockholders?”
o Management: ask “Which product line of ours is the most profitable?”
o Marketing: ask “What price for a product will maximize our net income?”
· External Userà
o Investors (owners)à use accounting info to make decisions to buy, hold, or sell stock.
o Creditors (suppliers and bankers)àuse accounting info to evaluate the risks of selling on credit or lending money
o Taxing Authorities (IRS) àwant to know whether the company complies with the tax laws.
o Customersàwant to know whether a company will continue to honor product warranties and otherwise support its product lines
o Labor Unionsà want to know whether the owners have the ability to pay increased wages and benefits.
o Regulatory agenciesà want to know whether the company is operating within prescribed rules.
3. Explain the 3 principle types of business activity
a. All businesses are involved in 3 types of activity
i. Financing
ii. Investing
iii. Operating
b. The Accounting Information System keeps track of the results of each of these business activities
· Financing Activities
o Two Primary Sources of outside funds for corporations are:
§ Borrowing Money
· May take out a loan or borrow directly from investors by issuing debt securities called bonds.
· Amounts owed are liabilitiesà the debts and obligations of a business.
o Name changes depending on the source
§ Note Payableà owed to a bank for money borrowed
§ Bonds Payableà debt securities sold to investors that must be repair at a particular date in the future.
· Parties to whom amounts are owed are creditors.
§ Issuing (selling) shares of stock for cash
· Common Stockà term used to describe the total amount paid in by stockholders for the shares they purchase
· Dividendsàpayments of cash from a corporation to its stockholders
o Difference Between a Creditor and Stockholder See page 9
· Investing Activities
o Involve the purchase of the resources a company needs in order to operate.
o Assetsà Resources owned by a business.
· Operating Activities
o Revenueàthe increase in assets that result from the sale of a product or service in the normal course of business
o Expensesàthe cost of assets consumed or services used in the process of generating revenues
o Net Incomeàthe amount by which revenues exceed expenses.
o Net Lossà the amount by which expenses exceed revenues.
o Inventoryàgoods available for sale to customers
o Accounts Receivableà
4. Describe the content and purpose of each of the financial statements
· Balance Sheet
o Presents a picture at a point in times of what your business owns (assets) and what its owes (liabilities)
o A financial statement that reports the assets and claims to those assets at a specific point in time.
o Assets must balance with the claims to assets
o Purpose
§ Creditors analyze a company’s balance sheet to determine the likelihood that they will be repaid.
§ For operating purposes, the balance sheet will be used to determine whether cash on hand is sufficient for immediate cash needs.
§ Used to evaluate the relationship between debt and stockholders’ equity to determine whether the company has a satisfactory proportion of debt and common stock financing.
· Income Statementà answers: Are the company’s operations profitable?
o Shows how successfully your business performed during a period of time
o A financial statement that presents the revenues and expenses and resulting net income or net loss of a company for a specific period of time
o The income statement reports the success of failure of the company’s operations for a period of time.
o Lists revenues followed by expenses; Expenses listed from largest to smallest
o Purpose
§ Investors are interested in a company’s past net income because it provides useful information for predicting future net income.
· Investors buy and sell stock base on their beliefs about a company’s future performance.
§ Creditors use the income statement to predict future earnings
· Prior to making the loan a bank officer uses the income statement as a source of information to predict whether the company will be profitable enough to repay its loan
· Retained Earnings Statementà answers: What is the company’s policy towards dividends and growth?
o Indicates how much of previous income was distributed to
tic of the forms of business organizations
o See SO 1.
· What is Sarbanes Oxley?
o
· Question on the Users of Financial Statements
o See SO 2
Summaries
1. A sole proprietorship is a business owned by one person. A partnership is a business owned by two or more people associated as partners. A corporation is a separate legal entity for which evidence of ownership is provided by shares of stock.
2. Internal users are managers who need accounting information to plan, organize, and run business operations. The primary external users are investors and creditors. Investors (stockholders) use accounting information to help them decide whether to buy, hold, or sell shares of a company’s stock. Creditors (suppliers and banks) use accounting information to assess the risk of granting credit or loaning money to a business. Other groups who have an indirect interest in a business are taxing authorities, customers, labor unions, and regulatory agencies.
3. Financing activities involve collecting the necessary funds to support the business. Investing activities involve acquiring the resources necessary to run the business. Operating activities involve putting the resources of the business into action to generate a profit.
4. An income statement presents the revenues and expenses of a company for a specific period of time. A retained earnings statement summarizes the changes in retained earnings that have occurred for a specific period of time. A balance sheet reports the assets, liabilities, and stockholders’ equity of a business at a specific date. A statement of cash flows summarizes information concerning the cash inflows (receipt) and outflows (payments) for a specific period of time.
5. Assets are resources owned by a business. Liabilities are the debts and obligations of the business. Liabilities represent claims of creditors on the assets of the business. Stockholders’ equity represents the claims of owners on the assets of the business. Stockholders’ equity is subdivided into two parts: common stock and retained earnings. The basic accounting equation is: Assets = Liabilities + Stockholder’s Equity.
6. The management discussion and analysis provides management’s interpretation of the company’s results and financial position as well as a discussion of plans for the future. Notes to the financial statements provide additional explanation or detail to make the financial statements more informative. The auditor’s report expresses an opinion as to whether the financial statements present fairly the company’s results of operations and financial position.
