1–1Copyright © Cengage Learning. All rights reserved.

Chapter 1

Uses of Accounting Information and the Financial Statements

1–2Copyright © Cengage Learning. All rights reserved.

Financial and Management Accounting

• Accounting’s role is divided into two categories: – Management accounting– Financial accounting

• The functions of both categories overlap.• The primary difference between the two is the

principal users of the information.

1–3Copyright © Cengage Learning. All rights reserved.

Management Accounting• Provides internal decision makers who are charged

with achieving the goals of profitability and liquidity with information about financing, investing, and operating activities.

• Used to report past performance and expected future performance.

1–4Copyright © Cengage Learning. All rights reserved.

Financial Accounting• Generates reports and communicates them to

external decision makers so they can evaluate how well the business has achieved its goals.

• Financial information of company is reported in the financial statements.

• Used to report directly on goals of profitability and liquidity.

1–5Copyright © Cengage Learning. All rights reserved.

Accounting Measurement• Objective 3

– Explain the importance of business transactions, money measure, and separate entity.

1–6Copyright © Cengage Learning. All rights reserved.

Accounting MeasurementTo make an accounting measurement, the accountant

must answer four basic questions: – What is measured?– When should the measurement be made?– What value should be placed on what is

measured?– How should what is measured be classified?

1–7Copyright © Cengage Learning. All rights reserved.

Business Transactions• Economic events that affect the financial position of a

business– An exchange of value

• Purchase• Sale• Payment• Collection• Loan

– Events that have the same effect as an exchange of value (nonexchange transactions)

• Loss from fire, flood, theft• Physical wear and tear on equipment• Accumulation of interest

1–8Copyright © Cengage Learning. All rights reserved.

Money Measure• Recording of all business transactions in terms of

money.• Money is only factor common to all business

transactions.• Basic unit of money determined by country in

which business resides.• Exchange rates used to translate transactions from

one currency to the other.

1–9Copyright © Cengage Learning. All rights reserved.

Separate Entity• A business is considered distinct from its

– Owner(s)– Creditors– Customers

• Its financial records and reports should refer only to its own financial affairs.

1–10Copyright © Cengage Learning. All rights reserved.

Financial Position and the Accounting Equation

• Objective 5– Define financial position, and state the

accounting equation.

1–11Copyright © Cengage Learning. All rights reserved.

Accounting Equation• Assets = Liabilities + Stockholders’ Equity

• The two sides of the equation must always stay in balance.

• Assets

– Economic resources owned by a company that are expected to benefit future operations

• Liabilities

– Present obligations of a business to pay cash, transfer assets, or provide services to other entities in the future

– Represent claims of creditors to the assets of the business

• Stockholder’s Equity

– Represents the claims of the owners of a corporation to the assets of the business

1–12Copyright © Cengage Learning. All rights reserved.

Stockholders’ Equity

Stockholders’ Equity = Contributed Capital + Retained Earnings

Contributed capitalAmount invested in the business by the stockholders

Retained earningsStockholders’ equity that has been generated by operations and kept for use in the business

1–13Copyright © Cengage Learning. All rights reserved.

Financial Statements• Objective 6

– Identify the four basic financial statements.

1–14Copyright © Cengage Learning. All rights reserved.

Four Major Financial Statements• Income Statement• Statement of Retained Earnings• Balance Sheet• Statement of Cash Flows

1–15Copyright © Cengage Learning. All rights reserved.

Income Statement• Summarizes revenues earned and expenses incurred

over an accounting period.• Dated “For the Month Ended …” or “For the Year

Ended …” • Shows whether a company achieved its profitability

goal.

1–16Copyright © Cengage Learning. All rights reserved.

Weiss Consultancy, Inc. Income Statement

For the Month Ended December 31, 2010 Revenues Commissions earned $14,000 Expenses Equipment rental expense $2,800 Wages expense 1,600 Utilities expense 1,200 Total expenses 5,600 Income before income taxes $8,400 Income taxes expense 1,200 Net income $7,200

Income Statement

Net income figure used to prepare statement of retained earnings

Date reflects revenues and expenses incurred over a period of time

1–17Copyright © Cengage Learning. All rights reserved.Copyright © Houghton Mifflin Company. All rights reserved.

Statement of Retained Earnings• Shows changes in retained earnings over an

accounting period• Dated “For the Month Ended …” or “For the Year

Ended…”• Uses net income figure from income statement• Retained Earnings end of period balance used to

prepare balance sheet

1–18Copyright © Cengage Learning. All rights reserved.

Weiss Consultancy, Inc. Statement of Retained Earnings

For the Month Ended December 31, 2010 Retained earnings, December 1, 2010 $ 0 Net income for the month 7,200 Subtotal $7,200 Less dividends 2,400 Retained earnings, December 31, 2010 $4,800

Statement of Retained Earnings

Net income figure comes from income statement

Ending balance of retained earnings used to prepare the balance sheet

1–19Copyright © Cengage Learning. All rights reserved.

Balance Sheet• Shows the financial position of a business on a

certain date.• Often called the statement of financial position.• Presents view of business as holder of assets that are

equal to the claims against those assets.• Claims consist of the company’s liabilities and the

stockholders’ equity.

1–20Copyright © Cengage Learning. All rights reserved.

Weiss Consultancy, Inc. Balance Sheet

December 31, 2010

Assets Liabilities Cash $61,200 Accounts payable $ 2,400 Accounts receivable 4,000 Supplies 2,000 Stockholders’ Equity Land 40,000 Building 100,000 Common stock $200,000 Retained earnings 4,800 Total stockholders’ equity 204,800

Total assets

$207,200 Total liabilities and

stockholders’ equity

$ 207,200

Balance Sheet Date reflects account balances as of a certain date

Ending balance of Retained Earnings comes from statement of retained earnings

1–21Copyright © Cengage Learning. All rights reserved.

Statement of Cash Flows• Shows cash flows into and out of a business during

an accounting period.• Shows important investing and financing

transactions of the period.• Focuses on liquidity. • Explains how the cash account changed during the

period.

1–22Copyright © Cengage Learning. All rights reserved.

Weiss Consultancy, Inc. Statement of Cash Flows

For the Month Ended December 31, 2010 Cash flows from operating activities Net income $ 7,200 Adjustments to reconcile net income to net cash

flows from operating activities

Increase in accounts receivable ($4,000) Increase in supplies (2.000) Increase in accounts payable 2,400 (3,600) Net cash flows from operating activities $ 3,600 Cash flows from investing activities Purchase of land ($40,000) Purchase of building (100,000) Net cash flows from investing activities (140,000) Cash Flows from financing activities Investments by stockholders $200,000 Dividends (2,400) Net cash flows from financing activities 197,600 Net increase (decrease) in cash $61,200 Cash at beginning of month 0 Cash at end of month $61,200

Statement of Cash Flows

Begins with net income from income statement

Cash at end of month should be the same as Cash account balance on balance sheet