Chapter One
Accounting and the Business
Environment

What is Financial
Accounting?
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Financial Accounting: The process of identifying, measuring and communicating economic
(financial) information about a company, primarily to investors and creditors (existing or potential). Content of Financial Reports
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The Management Letter
The Financial Statements:
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Balance Sheet
Income Statement
Statement of Shareholders’ Equity
Statement of Cash Flows

The Footnotes
The Auditor’s Report
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The Management Letter
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The management letter is the statement of management to the investors.
It indicates:
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management is responsible for the preparation and content of the financial report. the statements were prepared in accordance with generally accepted accounting principles
(GAAP).
the company maintains a system of internal controls to safeguard assets.
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The Financial Statements
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Include a balance sheet, income statement, statement of shareholders’ equity, and a statement of cash flows (discussed in a later chapter). The footnotes to the financials are considered an integral part of the financials, and explain many of the policies and assumptions used to prepare the financials.
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The Auditors’ Report
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The auditor indicates:
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That the financial statements are the responsibility of the management. That the auditor has performed the audit in accordance with the standards of the Public Company Accounting Oversight
Board (PCAOB). whether the financial statements are prepared in accordance with Generally Accepted Accounting Principles (GAAP) and whether they represent the financial position of the company fairly.

The auditor has access to all financial records of the company. The Auditor
(Continued)

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Most audits result in clean opinion which indicates that based on their assessment the financial statements are prepared according to GAAP.
Some other possibilities are:
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Qualified opinion: These arise if one auditor does not perform the complete audit, or if there are some uncertainties regarding the valuation or realization of certain assets or liabilities.
Adverse opinion or disclaimer of opinion: The auditor is unable to express an opinion about the overall fairness of the financial statements. Accounting Principles

Accounting Principles

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Accounting Principles
(continued)

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Information in Financial
Statements
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Financial statements comprise of the following: 
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Balance sheet.
Income statement
Statement of cash flows.
Statement of Shareholders’ Equity.
Notes to the financial statements.

The Balance Sheet
How much is the company worth?

The balance sheet reports the financial position at a point in time (end of the quarter or year).
The components of the Balance Sheet are:
 Assets
 Liabilities
 Shareholders’ (Owners’) Equity
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The Balance Sheet
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Assets and liabilities are listed in order of liquidity.
Current vs. Non-current items
The balance sheet is represented by the fundamental accounting equation:

Assets
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Current assets: Cash and other assets a company expects to convert into cash, sell, or consume either in one year or in the operating cycle, whichever is longer.
 Cash and cash equivalents
 Short-term investments
 Accounts receivable: Claims held against customers and others for money, goods, or services.
 Inventory: items or products for sale
 Prepaid expenses: Payment of cash, that is recorded as an asset because service or benefit will be received in the future. 15

Assets
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Non-current assets
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Long-term investments: acquired by companies to provide benefits for periods of time usually extending beyond one year (e.g. land held for speculation) Property, plant, and equipment: assets acquired for use in the day-to-day operations of the business
(e.g., land used in the operations)
Intangible assets: Lack physical substance
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Balance Sheet

Liabilities
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Current liabilities: Obligations that a company reasonably