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The purpose of accounting is to provide decision makers with relevant and reliable information to help them make better decisions. Examples include information for people making investments, loans, and business plans.
External users and their uses of accounting information include: (a) lenders, to measure the risk and return of loans; (b) shareholders, to assess whether to buy, sell, or hold their shares; (c) directors, to oversee their interests in the organization; (d) employees and labor unions, to judge the fairness of wages and assess future employment opportunities; and (e) regulators, to determine whether the organization is complying with regulations. Other users are voters, legislators, government officials, contributors to nonprofits, suppliers, and customers.
The objectivity concept means that financial statement information is supported by independent, unbiased evidence other than someone’s opinion or imagination. This concept increases the reliability and verifiability of financial statement information.
The revenue recognition principle provides guidance for managers and auditors so they know when to recognize revenue. If revenue is recognized too early, the business looks more profitable than it is. On the other hand, if revenue is recognized too late the business looks less profitable than it is. This principle demands that revenue be recognized when it is both earned (when service or product provided) and can be measured reliably. The amount of revenue should equal the value of the assets received or expected to be received from the business’s operating activities covering a specific time period.
Assets are resources owned or controlled by a company that are expected to yield future benefits. (b) Liabilities are creditors’ claims on assets that reflect obligations to provide assets, products, or services to others. (c) Equity is the owner’s claim on assets and is equal to assets minus liabilities. (d) Net assets refer to equity.
Equity is increased by investments from the owner and by net income (which is the excess of revenues over expenses). It is decreased by withdrawals by the owner and by a net loss (which is the excess of expenses over revenues).
Accounting principles consist of (a) general and (b) specific principles. General principles are the basic assumptions, concepts, and guidelines for preparing financial statements. They stem from long-used accounting practices. Specific principles are detailed rules used in reporting on business transactions and events. They usually arise from the rulings of authoritative and regulatory groups such as the Financial Accounting Standards Board or the Securities and Exchange Commission.
Revenue (or sales) is the amount received from selling products and services.
Net income (also called income, profit, or earnings) equals revenues minus expenses (if revenues exceed expenses). Net income increases equity. If expenses exceed revenues, the company has a net loss. Net loss decreases equity.
The four basic financial statements are: income statement, statement of owner’s equity, balance sheet, and statement of cash flows.