© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin BASIC FINANCIAL STATEMENTS Chapter 2.

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

BASIC FINANCIAL STATEMENTS

Chapter

2

© The McGraw-Hill Companies, Inc., 2002McGraw-Hill/Irwin

Previous Lecture

• Accounting information is for decision maker which enable them to make economic activities.

• Types of business• Types of organizations & theirs plus & minus• Business Stakeholders

Internal : Owners, managers, employees External: Customers, creditors, government

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• Types of Accounting InformationFinancial, Managerial, Tax

• Types of Business ActivitiesFinancing, Investing, Operating

• Types of Financial Statement Statement of earnings Statement of retained earningsBalance sheetCash flow statement

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Conceptual Framework of Accounting

• Guides choices about– what to present in financial statements– decisions about alternative ways of reporting

economic events– the selection of appropriate ways of

communicating such information

Chapter 2 4

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Conceptual Framework of Accounting

• Four main sections– Objective of financial reporting– Qualitative characteristics of accounting

information– Elements of financial statements– Recognition and measurement criteria

Chapter 2 5

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Objective of Financial Reporting

• To provide information that is useful to individuals who are making investment and credit decisions

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Qualitative Characteristics

• To be useful for decision-making, information should have these qualitative characteristics– Relevance– Faithful representation – Comparability – Understandability

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• Relevance– Information is relevant if it makes a difference in a

decision. It is said to have predictive value, feedback value, and timeliness

• Faithful representation– Information should reflect economic reality. It

must be verifiable, neutral, and complete

Qualitative Characteristics of Accounting Information

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Qualitative Characteristics of Accounting Information

• Comparability– Accounting information can be compared when

companies with similar circumstances use the same accounting standards consistently from year to year

• Understandability– Average user is assumed to understand the

accounting information

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Elements of Financial Statements

• Assets• Liabilities• Equity• Revenues• Expenses

Chapter 2 10

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Recognition and Measurement Criteria

• Accountants need detailed criteria to help them decide when and where an item is included in the financial statements.

• Includes– Assumptions– Principles– Constraints

Chapter 2 11

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Assumptions

• Monetary unit• Economic entity• Time period• Going concern

Chapter 2 12

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Monetary Unit Assumption

• Only those things that can be expressed in terms of money should be included in the accounting records

• Important presumption is that the monetary unit remains stable over time and the effects of inflation are nominal

Chapter 2 13

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Economic Entity

• Every economic entity can be separately identified and accounted for

• Personal items relating to shareholders are not accounted for by the business

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Time Period Assumption

• The economic life of a business can be divided into artificial time periods

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Going Concern Assumption

• The business will continue operating in the foreseeable future

• Justifies the use of the cost principle

Chapter 2 16

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Introduction to Financial Statements

Companies prepare interim financial statements and annual

financial statements

2000

X

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Introduction to Financial Statements

Three primary financial

statements.Income Statement

Balance Sheet

Statement of Cash FlowsWe will use a corporation

to describe these statements.

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Introduction to Financial Statements

Describes where the enterprise stands at a

specific date.

Income Statement

Balance Sheet

Statement of Cash Flows

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Introduction to Financial Statements

Depicts the revenue and

expenses for a designated

period of time.

Income Statement

Balance Sheet

Statement of Cash Flows

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Introduction to Financial Statements

Revenues result in positive

cash flow.

Expenses result in negative

cash flow.

Either in the past, present, or future.

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Introduction to Financial Statements

Net income (or net loss) is simply the difference between

revenues and expenses.

Income Statement

Balance Sheet

Statement of Cash Flows

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Introduction to Financial Statements

Depicts the ways cash has changed during

a designated period of time.

Income Statement

Balance Sheet

Statement of Cash Flows

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The Concept of the Business Entity

Vagabond Travel

Agency

A business entity is

separate from the personal affairs of its

owner.

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Vagabond Travel AgencyBalance Sheet

December 31, 2002Assets Liabilities & Owners' Equity

Cash 22,500$ Liabilities:Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Office equipment 15,000 Capital stock 150,000

Retained earnings 70,000 Total 300,000$ Total 300,000$

A Starting Point: Statement of Financial Position

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Vagabond Travel AgencyBalance Sheet

December 31, 2002Assets Liabilities & Owners' Equity

Cash 22,500$ Liabilities:Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Office equipment 15,000 Capital stock 150,000

Retained earnings 70,000 Total 300,000$ Total 300,000$

Assets

Assets are economic resources

that are owned by the business and are expected to provide positive

future cash flows.

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Assets

Cost Principle

Going-ConcernAssumption

Objectivity Principle

Stable-DollarAssumption

These accounting principles support cost as the basis

for asset valuation.

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Vagabond Travel AgencyBalance Sheet

December 31, 2002Assets Liabilities & Owners' Equity

Cash 22,500$ Liabilities:Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Office equipment 15,000 Capital stock 150,000

Retained earnings 70,000 Total 300,000$ Total 300,000$

Liabilities

Liabilities are debts that

represent negative future cash flows

for the enterprise.

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Vagabond Travel AgencyBalance Sheet

December 31, 2002Assets Liabilities & Owners' Equity

Cash 22,500$ Liabilities:Notes receivable 10,000 Notes payable 41,000$ Accounts receivable 60,500 Accounts payable 36,000 Supplies 2,000 Salaries payable 3,000 Land 100,000 Total liabilities 80,000$ Building 90,000 Owners' Equity:Office equipment 15,000 Capital stock 150,000

Retained earnings 70,000 Total 300,000$ Total 300,000$

Owners’ Equity

Owners’ equity represents the

owner’s claim to the assets of the

business.

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Owners’ Equity

Changes in Owners’ Equity

•Owners’ Investments

•Business Earnings

•Payments to Owners

•Business Losses

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End of Todays session