1-1 INTRODUCTION TO FINANCIAL STATEMENTS Financial Accounting, Sixth Edition 1

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INTRODUCTION TO FINANCIAL STATEMENTS

Financial Accounting, Sixth Edition

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1. Describe the primary forms of business organization.

2. Identify the users and uses of accounting information.

3. Explain the three principal types of business activity.

4. Describe the content and purpose of each of the financial

statements.

5. Explain the meaning of assets, liabilities, and stockholders’

equity, and state the basic accounting equation.

6. Describe the components that supplement the financial

statements in an annual report.

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

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Proprietorship Partnership Corporation

Simple to

establish

Shared control

Broader skills

and resources

Tax advantages

Easier to transfer

ownership

Easier to raise

funds

No personal

liability

Forms of Business OrganizationForms of Business OrganizationForms of Business OrganizationForms of Business Organization

Generally owned

by one person

Simple to

establish

Owner

controlled

Tax advantages

SO 1 Describe the primary forms of business organization. SO 1 Describe the primary forms of business organization.

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Management

Human Resources

Taxing Authorities

Labor Unions

Regulatory Agencies

Marketing

Finance

Investors

Creditors

Customers

Internal Users

External Users

Who Uses Accounting Data

Users and Uses of Financial InformationUsers and Uses of Financial InformationUsers and Uses of Financial InformationUsers and Uses of Financial Information

SO 2 Identify the users and uses of accounting information. SO 2 Identify the users and uses of accounting information.

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Questions Asked by Internal Users User

1. Can we afford to give our employees a pay raise?

Human Resources

2. What price for our product will maximize net income?

3. Which product line is most profitable?

4. Is cash sufficient to pay dividends to the stockholders?

Marketing

Management

Finance



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Questions Asked by External Users User

1. Is the company earning satisfactory income?

Investors

2. How does Disney compare in size and profitability with Time Warner?

3. Will United Airlines be able to pay its debts as they come due?

Investors

Creditors



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Ethics In Financial Reporting

Effective financial reporting depends on sound ethical

behavior.

Recent financial scandals: Enron, WorldCom,

HealthSouth, AIG, and others.

United States regulators and lawmakers were very

concerned that the economy would suffer if investors lost

confidence in corporate accounting because of unethical

financial reporting.

Congress passed Sarbanes-Oxley Act of 2002.



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All businesses are involved in three types of activity —

financing,

investing,

and operating.

Business ActivitiesBusiness ActivitiesBusiness ActivitiesBusiness Activities

SO 3 Explain the three principal types of business activity. SO 3 Explain the three principal types of business activity.

The accounting information system keeps track of the results of each of these business activities.

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Two primary sources of outside funds are:

1. Borrowing money

Amounts owed are called liabilities.

Party to whom amounts are owed are creditors.

Notes payable and bonds payable are different type of liabilities.

2. Issuing shares of stock for cash.

Payments to stockholders are called dividends.



Financing Activities

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Investing Activities

Purchase of resources a company needs to

operate.

Computers, delivery trucks, furniture, buildings, etc.

Resources owned by a business are called assets.



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Operating Activities

Once a business has the assets it needs,

it can begin its operations.

Revenues - Amounts earned from the sale of products

(sales revenue, service revenue, and interest revenue).

Inventory - Goods available for sale to customers.

Accounts receivable - Right to receive money from a

customer,in the future, as the result of a sale.



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Operating Activities

Expenses - cost of assets consumed or services used.

(cost of goods sold, selling, marketing, administrative,

interest, and income taxes expense).

Liabilities arising from expenses include accounts

payable, interest payable, wages payable, sales taxes

payable, and income taxes payable.

Net income – when revenues exceed expenses.

Net loss – when expenses exceed revenues.



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Companies prepare four financial statements from the summarized accounting data:

Companies prepare four financial statements from the summarized accounting data:

Income Statement

Balance Sheet

Statement of Cash Flows

Retained Earnings

Statement

Communicating with UsersCommunicating with UsersCommunicating with UsersCommunicating with Users

SO 4 Describe the content and purpose of each of the financial statements.SO 4 Describe the content and purpose of each of the financial statements.

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Reports revenues and expenses for a specific period of time.

Net income – revenues exceed expenses.

Net loss – expenses exceed revenues.

Past net income provides information for predicting future net income.



Income StatementIllustration 1-4

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Illustration 1-4



Retained Earnings Statement

Net income is needed to determine the ending balance in

retained earnings.

Illustration 1-5

Income Statement

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Statement shows amounts and

causes of changes in retained

earnings during the period.

Time period is the same as

that covered by the income

statement.

Users can evaluate dividend

payment practices.


Illustration 1-5

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Illustration 1-5

Ending balance in retained earnings is needed in preparing

the balance sheet.

Balance SheetIllustration 1-7

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Balance Sheet

Reports assets and

claims to assets at a

specific point in time.

Assets = Liabilities +

Stockholders’ Equity.

Lists assets first,

followed by liabilities and

stockholders’ equity.

SO 5 Explain the meaning of assets, liabilities, and stockholders’ SO 5 Explain the meaning of assets, liabilities, and stockholders’ equity, and state the basic accounting equation.equity, and state the basic accounting equation.

Illustration 1-7

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Answers:

Where did cash

come from during

the period?

How was cash used

during the period?

What was the

change in the cash

balance during the

period?


Statement of Cash FlowsIllustration 1-8

SO 5 Explain the meaning of assets, liabilities, and stockholders’ SO 5 Explain the meaning of assets, liabilities, and stockholders’ equity, and state the basic accounting equation.equity, and state the basic accounting equation.

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Resources owned by the business Resources owned by the business (examples)(examples) CashCash Accounts receivableAccounts receivable InventoriesInventories Furniture and fixturesFurniture and fixtures EquipmentEquipment SuppliesSupplies

Elements of the Financial StatementsElements of the Financial Statements

AssetsAssets

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Obligations or debts of the businessObligations or debts of the business Notes payableNotes payable Accounts payableAccounts payable Salaries payableSalaries payable Unearned revenueUnearned revenue

LiabilitiesLiabilities

Elements of Financial StatementsElements of Financial Statements

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EElleemmeennttss ooff tthhee FFiinnaanncciiaall SSttaatteemmeennttss

Stockholders’ EquityStockholders’ Equity

Owners’ claims on assetsOwners’ claims on assets Paid-in capitalPaid-in capital

Capital stockCapital stock

Retained earningsRetained earnings Amount earned by a company that has not yet been paid Amount earned by a company that has not yet been paid

out in dividends to stockholdersout in dividends to stockholders

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U.S. companies that are publicly traded must provide

shareholders with an annual report.

The annual report always includes:

Financial statements.

Management discussion and analysis.

Notes to the financial statements.

Independent auditor's report.

Other Elements of an Annual ReportOther Elements of an Annual ReportOther Elements of an Annual ReportOther Elements of an Annual Report

SO 6 Describe the components that supplement the SO 6 Describe the components that supplement the financial statements in an annual report.financial statements in an annual report.

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Management’s Report

Management discussion and analysis (MD&A) covers the

companies ability to pay near-term obligations, its ability to

fund operations and expansion, and its results of operations.

Management must highlight favorable or unfavorable trends

and identify significant events and uncertainties that affect

these three factors.

Other Components of an Annual ReportOther Components of an Annual ReportOther Components of an Annual ReportOther Components of an Annual Report


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Notes to the Financial Statements

Illustration 1-11

Clarify the financial statements.

Provide additional detail.

Notes are essential to understanding a company’s operating

performance and financial position.

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Auditor’s Report


SO 6SO 6

Illustration 1-12

Auditor’s opinion as to the fairness of the presentation of the

financial position and results of operations and their conformance

with generally accepted accounting standards.

Documents

1-1 INTRODUCTION TO FINANCIAL STATEMENTS Financial Accounting, Sixth Edition 1