ch04 - JWCL006_c04_106-165.qxd 3/18/08 11:40 PM Page 106...

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106 Part 1 An Overview of Financial Accounting The Mechanics of Financial Accounting CHAPTER 4 KEY POINTS The following key points are emphasized in this chapter: Two criteria necessary for economic events to be reFected in the ±nancial statements. The accounting equation and how it relates to the balance sheet, income statement, statement of shareholders’ equity, and statement of cash Fows. Journal entries (and T-accounts) and how they express the effect of economic events on the basic accounting equation and the ±nancial statements. Why managers need to understand how economic events affect the ±nancial statements. Why the ±nancial statements are adjusted periodically to reFect certain economic events. JWCL006_c04_106-165.qxd 3/18/08 11:40 PM Page 106 TEAM-B 204:JWCL006:ch04:
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Chapter 4 The Mechanics of Financial Accounting 107 The U.S. General Accounting OfFce (GAO) periodically reports to Congress on the performance and accountability of various U.S. government agencies. In its report on the Small Business Administration (SBA), established to help small U.S. businesses, the GAO concluded: The SBA continues to have difFculties producing complete, accurate, and timely Fnancial statements. It incorrectly calculated the accounting losses on loan sales and did not perform key analyses to determine the overall Fnancial impact of the sales. These errors and lack of key analyses also mean that congressional decision- makers are not receiving accurate Fnancial data to make informed decisions about the SBA’s budget and appropriations. This quote re±ects a problem confronting many large and well-known U.S. com- panies, not just governmental agencies—a lack of high-quality internal control de- signed to ensure that all transactions are recorded in a timely and accurate manner. As discussed in Chapter 1, the Sarbanes–Oxley Act recently placed greater emphasis on the need for internal control as many believe that costly corporate Fnancial frauds are in part due to internal control breakdowns. This chapter covers the mechanics underlying the preparation of Fnancial state- ments and how they help to ensure that a company’s transactions are accurately and completely accounted for. After completing it, you should be able to construct Fnan- cial statements from economic events. Understanding the mechanics underlying the preparation of Fnancial statements is crucial for effective management. Timely and accurate reporting is critical. Also, man- agers often choose among transactions, and such choices should not be made without considering the Fnancial statement effects and the associated economic consequences. Consequently, managers must understand the mechanics that link transactions to the Fnancial statements. Managers must also understand how to read, interpret, and analyze Fnancial statements. To do so effectively, it is useful to be able to infer from the Fnancial state- ments events and transactions that occurred during the accounting period. A mechan- ical process, called T-account analysis, can enable users to make such inferences.
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