This OpenStax ancillary resource is © Rice University under a CC BY 4.0 International license; it may be reproduced or modified but
must be attributed to OpenStax, Rice University and any changes must be noted.
CHAPTER FOURTEEN
Using Financial Information and Accounting
CHAPTER SUMMARY
Financial information is central to every organization. To operate effectively, businesses
must have a way to track income, expenses, assets, and liabilities in an organized
manner. Accounting involves collecting, recording, classifying, summarizing, reporting,
and analyzing a firm’s financial activities according to a standard set of procedures. The
financial reports resulting from the accounting process give managers, employees,
investors, customers, suppliers, creditors, and government agencies a way to analyze a
company’s past, current, and future performance.
Public accountants work for independent firms that provide accounting services – such
as financial repot preparation and auditing, tax return preparation, and management
consulting – to other organizations on a fee basis. Private accountants are employed to
serve one organization and may prepare financial statements, tax returns, and
management reports. To ensure accuracy and consistency in the way financial
information is reported, accountants in the United States follow generally accepted
accounting principles (GAAP)when preparing financial statements. The Financial
Accounting Standards Board (FASB)is a private organization that is responsible for
establishing financial accounting standards used in the United States.
In 2002, the Sarbanes-Oxley Act(commonly referred to as SOX) went into effect. This law
was designed to address the investing public’s lack of trust in corporate America. It
redefines the public corporation–auditor relationship and restricts the types of services
auditors can provide to clients.
The accounting cycle refers to the process of generating financial statements. It begins
with analyzing business transactions, recording them in journals, and posting them to
ledgers. Ledger totals are then summarized in a trial balance that confirms the accuracy
of the figures. Next the accountant prepares the financial statements and reports. The
final step involves analyzing these reports and making decisions. Computers have
simplified many of these labor-intensive tasks.
The balance sheet represents the financial condition of a firm at one moment in time, in
terms of assets, liabilities, and owners’ equity. Assets are resources of the company.
Liabilities are the amounts a firm owes to creditors. Owners’ equity is the owners’ total
investment in the business after all liabilities have been paid.
September 17, 2018 1
,This OpenStax ancillary resource is © Rice University under a CC BY 4.0 International license; it may be reproduced or modified but
must be attributed to OpenStax, Rice University and any changes must be noted.
The income statement summarizes the firm’s revenues and expenses and shows its total
profit or loss over time. Revenues are the dollar amount of sales plus any other income
received from sources such as interest, dividends, and rents. Expenses are the costs of
generating revenues. The amount a company earns after paying to produce or buy its
products but before deducting operating expenses is the gross profit. The final figure on
an income statement is the net profit or net loss. It is calculated by subtracting all
expenses from revenues.
In addition to net profit or net loss, creditors and investors are interested in how much
cash a business generates and how it is used. The statement of cash flows, a summary of
the money flowing into and out of a firm, is the financial statement used to assess the
sources and uses of cash during a certain period, typically one year.
By studying the relationships among the balance sheet, the income statement, and the
statement of cash flows, an individual can gain even more insight into a firm’s financial
condition and performance. Ratio analysis involves calculating and interpreting financial
ratios using data taken from the firm’s financial statements in order to assess its
condition and performance.
Several important trends may affect the accounting industry over the next several years;
including cloud computing services, automation, and staffing challenges.
LEARNING OUTCOMES
1. Why are financial reports and accounting information important, and who uses
them?
Accounting involves collecting, recording, classifying, summarizing, reporting,
and analyzing a firm’s financial activities according to a standard set of
procedures. The financial reports resulting from the accounting process give
managers, employees, investors, customers, suppliers, creditors, and
government agencies a way to analyze a company’s past, current, and future
performance. Financial accounting is concerned with the preparation of financial
reports using generally accepted accounting principles. Managerial accounting
provides financial information that management can use to make decisions
about the firm’s operations.
2. What are the differences between public and private accountants, and are
public accounts subject to new regulations?
September 17, 2018 2
, This OpenStax ancillary resource is © Rice University under a CC BY 4.0 International license; it may be reproduced or modified but
must be attributed to OpenStax, Rice University and any changes must be noted.
Public accountants work for independent firms that provide accounting services
– such as financial repot preparation and auditing, tax return preparation, and
management consulting – to other organizations on a fee basis. Private
accountants are employed to serve one organization and may prepare financial
statements, tax returns, and management reports.
The bankruptcies of companies like Enron and WorldCom, plus widespread
abuses of accounting practices, raised critical issues of auditor independence and
integrity and reliability of financial reports. To set better standards for
accounting, auditing, and financial reporting and prevent future accounting
irregularities, Congress passed the Sarbanes-Oxley Act in 2002. This Act
establishes an independent board to oversee the accounting profession, sets
stricter auditing and financial disclosure standards, and places increased
accountability on a company’s senior executives and management. It restricts
auditors from providing certain types of consulting services to clients. Other
organizations such as the Securities and Exchange Commission (SEC), the New
York Stack Exchange (NYSE), and accounting industry professional associations
issued new regulations and guidelines related to compliance with the Act.
3. What are the six steps in the accounting cycle?
The accounting cycle refers to the process of generating financial statements. It
begins with analyzing business transactions, recording them in journals, and
posting them to ledgers. Ledger totals are then summarized in a trial balance
that confirms the accuracy of the figures. Next the accountant prepares the
financial statements and reports. The final step involves analyzing these reports
and making decisions. Computers have simplified many of these labor-intensive
tasks.
4. In what terms does the balance sheet describe the financial condition of an
organization?
The balance sheet represents the financial condition of a firm at one moment in
time, in terms of assets, liabilities, and owners’ equity. The key categories of
assets are current assets, fixed assets, and intangible assets. Liabilities are
divided into current and long-term liabilities. Owners’ equity, the amount of the
owners’ investment into the firm after all the liabilities have been paid, is the
third major category.
5. How does the income statement report a firm’s profitability?
The income statement is a summary of the firm’s operations over a period. The
main parts of the statement are revenues (gross and net sales), cost of goods
September 17, 2018 3
must be attributed to OpenStax, Rice University and any changes must be noted.
CHAPTER FOURTEEN
Using Financial Information and Accounting
CHAPTER SUMMARY
Financial information is central to every organization. To operate effectively, businesses
must have a way to track income, expenses, assets, and liabilities in an organized
manner. Accounting involves collecting, recording, classifying, summarizing, reporting,
and analyzing a firm’s financial activities according to a standard set of procedures. The
financial reports resulting from the accounting process give managers, employees,
investors, customers, suppliers, creditors, and government agencies a way to analyze a
company’s past, current, and future performance.
Public accountants work for independent firms that provide accounting services – such
as financial repot preparation and auditing, tax return preparation, and management
consulting – to other organizations on a fee basis. Private accountants are employed to
serve one organization and may prepare financial statements, tax returns, and
management reports. To ensure accuracy and consistency in the way financial
information is reported, accountants in the United States follow generally accepted
accounting principles (GAAP)when preparing financial statements. The Financial
Accounting Standards Board (FASB)is a private organization that is responsible for
establishing financial accounting standards used in the United States.
In 2002, the Sarbanes-Oxley Act(commonly referred to as SOX) went into effect. This law
was designed to address the investing public’s lack of trust in corporate America. It
redefines the public corporation–auditor relationship and restricts the types of services
auditors can provide to clients.
The accounting cycle refers to the process of generating financial statements. It begins
with analyzing business transactions, recording them in journals, and posting them to
ledgers. Ledger totals are then summarized in a trial balance that confirms the accuracy
of the figures. Next the accountant prepares the financial statements and reports. The
final step involves analyzing these reports and making decisions. Computers have
simplified many of these labor-intensive tasks.
The balance sheet represents the financial condition of a firm at one moment in time, in
terms of assets, liabilities, and owners’ equity. Assets are resources of the company.
Liabilities are the amounts a firm owes to creditors. Owners’ equity is the owners’ total
investment in the business after all liabilities have been paid.
September 17, 2018 1
,This OpenStax ancillary resource is © Rice University under a CC BY 4.0 International license; it may be reproduced or modified but
must be attributed to OpenStax, Rice University and any changes must be noted.
The income statement summarizes the firm’s revenues and expenses and shows its total
profit or loss over time. Revenues are the dollar amount of sales plus any other income
received from sources such as interest, dividends, and rents. Expenses are the costs of
generating revenues. The amount a company earns after paying to produce or buy its
products but before deducting operating expenses is the gross profit. The final figure on
an income statement is the net profit or net loss. It is calculated by subtracting all
expenses from revenues.
In addition to net profit or net loss, creditors and investors are interested in how much
cash a business generates and how it is used. The statement of cash flows, a summary of
the money flowing into and out of a firm, is the financial statement used to assess the
sources and uses of cash during a certain period, typically one year.
By studying the relationships among the balance sheet, the income statement, and the
statement of cash flows, an individual can gain even more insight into a firm’s financial
condition and performance. Ratio analysis involves calculating and interpreting financial
ratios using data taken from the firm’s financial statements in order to assess its
condition and performance.
Several important trends may affect the accounting industry over the next several years;
including cloud computing services, automation, and staffing challenges.
LEARNING OUTCOMES
1. Why are financial reports and accounting information important, and who uses
them?
Accounting involves collecting, recording, classifying, summarizing, reporting,
and analyzing a firm’s financial activities according to a standard set of
procedures. The financial reports resulting from the accounting process give
managers, employees, investors, customers, suppliers, creditors, and
government agencies a way to analyze a company’s past, current, and future
performance. Financial accounting is concerned with the preparation of financial
reports using generally accepted accounting principles. Managerial accounting
provides financial information that management can use to make decisions
about the firm’s operations.
2. What are the differences between public and private accountants, and are
public accounts subject to new regulations?
September 17, 2018 2
, This OpenStax ancillary resource is © Rice University under a CC BY 4.0 International license; it may be reproduced or modified but
must be attributed to OpenStax, Rice University and any changes must be noted.
Public accountants work for independent firms that provide accounting services
– such as financial repot preparation and auditing, tax return preparation, and
management consulting – to other organizations on a fee basis. Private
accountants are employed to serve one organization and may prepare financial
statements, tax returns, and management reports.
The bankruptcies of companies like Enron and WorldCom, plus widespread
abuses of accounting practices, raised critical issues of auditor independence and
integrity and reliability of financial reports. To set better standards for
accounting, auditing, and financial reporting and prevent future accounting
irregularities, Congress passed the Sarbanes-Oxley Act in 2002. This Act
establishes an independent board to oversee the accounting profession, sets
stricter auditing and financial disclosure standards, and places increased
accountability on a company’s senior executives and management. It restricts
auditors from providing certain types of consulting services to clients. Other
organizations such as the Securities and Exchange Commission (SEC), the New
York Stack Exchange (NYSE), and accounting industry professional associations
issued new regulations and guidelines related to compliance with the Act.
3. What are the six steps in the accounting cycle?
The accounting cycle refers to the process of generating financial statements. It
begins with analyzing business transactions, recording them in journals, and
posting them to ledgers. Ledger totals are then summarized in a trial balance
that confirms the accuracy of the figures. Next the accountant prepares the
financial statements and reports. The final step involves analyzing these reports
and making decisions. Computers have simplified many of these labor-intensive
tasks.
4. In what terms does the balance sheet describe the financial condition of an
organization?
The balance sheet represents the financial condition of a firm at one moment in
time, in terms of assets, liabilities, and owners’ equity. The key categories of
assets are current assets, fixed assets, and intangible assets. Liabilities are
divided into current and long-term liabilities. Owners’ equity, the amount of the
owners’ investment into the firm after all the liabilities have been paid, is the
third major category.
5. How does the income statement report a firm’s profitability?
The income statement is a summary of the firm’s operations over a period. The
main parts of the statement are revenues (gross and net sales), cost of goods
September 17, 2018 3
