Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Introduction to Financial Statements Chapter 1 Prepared by Carol A. Hartley Providence College.

Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.

Introduction to Financial Introduction to Financial StatementsStatements

Chapter 1Chapter 1

Prepared by Carol A. HartleyPrepared by Carol A. Hartley

Providence CollegeProvidence College

Principles of AccountingPrinciples of AccountingKimmel • Weygandt • KiesoKimmel • Weygandt • Kieso


Study ObjectivesStudy Objectives

1.1. Describe the primary forms of business Describe the primary forms of business organization.organization.

2.2. Identify the users and uses of accounting Identify the users and uses of accounting information.information.

3.3. Explain the three principal types of Explain the three principal types of business activity.business activity.

4.4. Describe the content and purpose of each Describe the content and purpose of each of the financial statements.of the financial statements.


Study ObjectivesStudy Objectives

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

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


##11 Forms of Business Forms of Business

OrganizationOrganization

• Sole proprietorshipSole proprietorship

• PartnershipPartnership

• CorporationCorporation


Sole ProprietorshipSole Proprietorship

• Business owned by Business owned by one personone person

• Simple to establishSimple to establish• Owner controlledOwner controlled• Tax advantagesTax advantages• Owner personally Owner personally

liableliable• Financing difficultFinancing difficult


PartnershipPartnership

• Two or more ownersTwo or more owners• Simple to establishSimple to establish• Shared controlledShared controlled• Broader skills & Broader skills &

resourcesresources• Tax advantagesTax advantages• Personal liabilityPersonal liability


CorporationCorporation

• Separate legal entity Separate legal entity owned by stockholdersowned by stockholders

• Easy to transfer Easy to transfer ownershipownership

• Greater capital raising Greater capital raising potentialpotential

• Lower legal liabilityLower legal liability• Unfavorable tax Unfavorable tax

treatmenttreatment


##22 Users of Financial Information Users of Financial Information

InternalInternal• Managers who plan, Managers who plan,

organize and run a organize and run a businessbusiness– Marketing managersMarketing managers

– Production supervisorsProduction supervisors

– Finance directorsFinance directors

– Company officersCompany officers

© PhotoDisc/Getty Images© PhotoDisc/Getty Images


Users of Financial InformationUsers of Financial InformationInternal Users Ask?Internal Users Ask?

Cash to pay bills?Cash to pay bills? Cost per unit?Cost per unit?

Give raises?Give raises? Which product is profitable?Which product is profitable?


Users of Financial InformationUsers of Financial InformationExternalExternal

• InvestorsInvestors

• OthersOthers– Regulatory agenciesRegulatory agencies

– Tax authoritiesTax authorities

– CustomersCustomers

– Labor UnionsLabor Unions

– Economic plannersEconomic planners

• CreditorsCreditors


Users of Financial InformationUsers of Financial InformationExternal Users Ask?External Users Ask?

Earning enough?Earning enough? Compare to competition?Compare to competition?

Will the company be able to pay bills when due?Will the company be able to pay bills when due?


##33 Types of Business Activity Types of Business Activity

• FinancingFinancing

• InvestingInvesting

• OperatingOperating


Financing ActivitiesFinancing Activities

• Borrowing createsBorrowing creates liabilitiesliabilities– Bank loansBank loans

– Debt securitiesDebt securities

– Goods on credit or Goods on credit or payablespayables

• Selling stockSelling stock creates creates stockholders’ equitystockholders’ equity


Investing ActivitiesInvesting Activities

• Obtaining resources or Obtaining resources or assets assets to operate the to operate the businessbusiness– LandLand

– BuildingsBuildings

– VehiclesVehicles

– ComputersComputers

– FurnitureFurniture

Digital VisionDigital Vision


Operating ActivitiesOperating Activities

• Primary activity of Primary activity of businessbusiness– Selling goodsSelling goods

– Providing servicesProviding services

– ManufacturingManufacturing

– Cost of SalesCost of Sales

– AdvertisingAdvertising

– Paying employeesPaying employees

– Paying utilitiesPaying utilities© PhotoDisc/Getty Images© PhotoDisc/Getty Images


Operating ActivitiesOperating Activities

• RevenueRevenue is generated from sales or services is generated from sales or services

• ExpensesExpenses are the cost of doing business are the cost of doing business

• If revenue If revenue >> expense expense == Net IncomeNet Income

• If revenue If revenue << expense expense == Net Loss!Net Loss!


Let’s ReviewLet’s Review

Which is Which is notnot one of the three forms of one of the three forms of business organization?business organization?

a.a. Sole proprietorship.Sole proprietorship.

d.d. Corporation.Corporation.

c.c. Partnership.

b.b. Creditorship.Creditorship.



Which is Which is notnot one of the three forms of one of the three forms of business organization?business organization?

a.a. Sole proprietorship.Sole proprietorship.

d.d. Corporation.Corporation.

c.c. Partnership.

b.b. Creditorship.Creditorship.


Let’s ReviewLet’s ReviewWhich is an advantage of corporations Which is an advantage of corporations

relative to partnerships and sole relative to partnerships and sole proprietorships?proprietorships?

a.a. Lower taxes.Lower taxes.

d.d. Most common form of business organization.Most common form of business organization.

c.c. Reduced legal liability for investors.Reduced legal liability for investors.

b.b. Harder to transfer ownership.Harder to transfer ownership.


Let’s ReviewLet’s ReviewWhich is an advantage of corporations Which is an advantage of corporations

relative to partnerships and sole relative to partnerships and sole proprietorships?proprietorships?

a.a. Lower taxes.Lower taxes.

d.d. Most common form of business organization.Most common form of business organization.

c.c. Reduced legal liability for investors.Reduced legal liability for investors.

b.b. Harder to transfer ownership.Harder to transfer ownership.



Which is Which is notnot one of the three primary one of the three primary business activities?business activities?

a.a. Financing.Financing.

d.d. Investing.Investing.

c.c. Advertising.Advertising.

b.b. Operating.Operating.



Which is Which is notnot one of the three primary one of the three primary business activities?business activities?

a.a. Financing.Financing.

d.d. Investing.Investing.

c.c. Advertising.Advertising.

b.b. Operating.Operating.


##44 Describe Content and Purpose Describe Content and Purpose

of Financial Statementsof Financial Statements

• Accountants communicate with users through four financial statements


##44 Describe Content and Purpose Describe Content and Purpose

of Financial Statementsof Financial Statements

• Income StatementIncome Statement

• Retained Earnings StatementRetained Earnings Statement

• Balance SheetBalance Sheet

• Statement of Cash FlowsStatement of Cash Flows


Income StatementIncome Statement

• Reports operating success or failure for a Reports operating success or failure for a

period.period.

• Summarizes revenues and expenses for Summarizes revenues and expenses for

period: period: month, quarter, or year.month, quarter, or year.

• If revenue If revenue >> expense expense == Net Income.Net Income.


Income StatementIncome Statement

Do this statement first!Do this statement first!


Retained Earnings StatementRetained Earnings Statement

• Shows changes in retained earnings for Shows changes in retained earnings for

period: period: month, quarter, or yearmonth, quarter, or year

• Beginning balanceBeginning balance

• AddAdd Net Income from income statement!Net Income from income statement!

• Deduct DividendsDeduct Dividends

• Ending balanceEnding balance


Retained Earnings StatementRetained Earnings Statement

Do this statement second!Do this statement second!


Balance SheetBalance Sheet

• Reports Reports assetsassets and claims to assets. and claims to assets.

• Claims of creditors, Claims of creditors, liabilitiesliabilities..

• Claims of owners, Claims of owners, stockholders’ equitystockholders’ equity..

• AssetsAssets = Liabilities + Stockholders’ Equity= Liabilities + Stockholders’ Equity

• Specific date – Specific date – one point in time!one point in time!


Balance SheetBalance Sheet

From From Retained Retained Earnings Earnings StatementStatement


Statement of Cash FlowsStatement of Cash Flows

• Provides information about cash Provides information about cash

receipts and cash paymentsreceipts and cash payments

• Summarizes for period: Summarizes for period: month, quarter, month, quarter,

or year.or year.

• Cash effects of operating, investing, Cash effects of operating, investing,

and financing activities.and financing activities.



• Where did the cash come from?Where did the cash come from?

• How was cash used during the period?How was cash used during the period?

• What was the change in the cash What was the change in the cash

balance during the period?balance during the period?

• You can’t survive without cash!You can’t survive without cash!



Agrees Agrees

withwith Balance Balance SheetSheet


#5#5 Explain the Meaning of Explain the Meaning of Assets, Liabilities, and Assets, Liabilities, and Stockholders’ Equity. Stockholders’ Equity.

State the Basic Accounting State the Basic Accounting EquationEquation


AssetsAssets• Resources owned by the Resources owned by the

businessbusiness

– CashCash

– Accounts receivableAccounts receivable

– InventoriesInventories

– Furniture and fixturesFurniture and fixtures

– EquipmentEquipment

– SuppliesSupplies



LiabilitiesLiabilities

• Obligations or debts of businessObligations or debts of business– Notes payableNotes payable– Accounts payableAccounts payable– Interest payableInterest payable– Salaries payableSalaries payable– Unearned revenueUnearned revenue


Stockholders’ EquityStockholders’ Equity

• Ownership claims on assetsOwnership claims on assets

• Paid-in capitalPaid-in capital– Common stockCommon stock

• Retained earningsRetained earnings



Basic Accounting EquationBasic Accounting Equation

Assets = Assets =

Liabilities + Stockholders’ EquityLiabilities + Stockholders’ Equity


Classic Accounting JokeClassic Accounting Joke

The job interview question,The job interview question,

““What is 2 What is 2 ++ 2?” 2?”


Let’s ReviewLet’s ReviewWhat questions might each of the following What questions might each of the following decision makers ask that could be answered decision makers ask that could be answered by the financial statements …by the financial statements …

Bank loan officer?Bank loan officer?

Federal bank regulator?Federal bank regulator?

Labor union president?Labor union president?

Stock investor?Stock investor?


Let’s ReviewLet’s ReviewWhich of the following is Which of the following is notnot a correct a correct

representation of the accounting equation?representation of the accounting equation?

a.a. Assets Assets == Liabilities Liabilities ++ Stockholders’ Equity Stockholders’ Equity

d.d. Assets Assets – – Stockholders’ Equity Stockholders’ Equity = = Liabilities Liabilities

c.c. Assets Assets + + Stockholders’ Equity Stockholders’ Equity = = Liabilities Liabilities

b.b. Assets Assets –– Liabilities Liabilities = = Stockholders’ Equity Stockholders’ Equity


Let’s ReviewLet’s ReviewWhich of the following is Which of the following is notnot a correct a correct

representation of the accounting equation?representation of the accounting equation?

a.a. Assets Assets == Liabilities Liabilities ++ Stockholders’ Equity Stockholders’ Equity

d.d. Assets Assets – – Stockholders’ Equity Stockholders’ Equity = = Liabilities Liabilities

c.c. Assets Assets + + Stockholders’ Equity Stockholders’ Equity = = LiabilitiesLiabilities

b.b. Assets Assets –– Liabilities Liabilities = = Stockholders’ Equity Stockholders’ Equity


Let’s ReviewLet’s ReviewUsing the accounting equation, answer the Using the accounting equation, answer the following questions …following questions …

If Liabilities If Liabilities == $10,000 $10,000

Then Assets Then Assets == ? ?

And Stockholders’ Equity And Stockholders’ Equity == $20,000 $20,000



If Liabilities If Liabilities == $10,000 $10,000

Then Assets Then Assets == $30,000 $30,000

And Stockholders’ Equity And Stockholders’ Equity == $20,000 $20,000

$30,000 $30,000 == $10,000 $10,000 ++ $20,000 $20,000



If Assets If Assets == $75,000 $75,000

Then Stockholders’ Equity Then Stockholders’ Equity == ? ?

And Liabilities And Liabilities == $35,000 $35,000



If Assets If Assets == $75,000 $75,000

Then Stockholders’ Equity Then Stockholders’ Equity == $40,000 $40,000

And Liabilities And Liabilities == $35,000 $35,000

$75,000 $75,000 == $35,000 $35,000 ++ $40,000 $40,000


##66 Components that Supplement Components that Supplement the Financial Statements in an the Financial Statements in an

Annual ReportAnnual Report

• Managements Discussion and AnalysisManagements Discussion and Analysis

• Notes to Financial StatementsNotes to Financial Statements

• Auditor’s reportAuditor’s report


Management’s Discussion and Management’s Discussion and Analysis covers three items:Analysis covers three items:

1.1. LiquidityLiquidity

2.2. Capital resourcesCapital resources

3.3. Results of operationsResults of operations


Management’s Discussion and Management’s Discussion and AnalysisAnalysis


Notes to Financial StatementsNotes to Financial Statements

• Explanatory notes and supplementary Explanatory notes and supplementary schedulesschedules

• Clarifies information in financial statementsClarifies information in financial statements

• Expands with additional detailExpands with additional detail

• Describes accounting policiesDescribes accounting policies

• Explains uncertainties and contingenciesExplains uncertainties and contingencies


Notes to Financial StatementsNotes to Financial Statements


Auditor’s ReportAuditor’s Report

• Certified Public Accountant – CPACertified Public Accountant – CPA

• Auditor (CPA) conducts independent Auditor (CPA) conducts independent examination of financial statementsexamination of financial statements

• Fair representation?Fair representation?

• Follow Follow generally accepted accounting generally accepted accounting principlesprinciples (GAAP)?(GAAP)?

• Unqualified opinionUnqualified opinion


Auditor’s ReportAuditor’s Report


Monetary Unit AssumptionMonetary Unit Assumption

• Only what can be expressed in moneyOnly what can be expressed in money

• Assumes unit of measure stays constantAssumes unit of measure stays constant



Economic Entity AssumptionEconomic Entity Assumption

• Economic events identified with unitEconomic events identified with unit

• Separately identified apart from ownerSeparately identified apart from owner


Time Period AssumptionTime Period Assumption

• Divide life of business into artificial time Divide life of business into artificial time periodsperiods

• Monthly, quarterly, yearlyMonthly, quarterly, yearly


Going Concern AssumptionGoing Concern Assumption

• Divide life of business into artificial time Divide life of business into artificial time periodsperiods

• Monthly, quarterly, yearlyMonthly, quarterly, yearly


Cost PrincipleCost Principle

• Assets must be recorded at costAssets must be recorded at cost

• Verifiable vs. subjectiveVerifiable vs. subjective


Full Disclosure PrincipleFull Disclosure Principle

• All circumstances and events that would All circumstances and events that would make a difference to users must be make a difference to users must be discloseddisclosed


Do It Problem: CSU CorporationDo It Problem: CSU CorporationService revenue $17,000Accounts receivable $4,000Accounts payable $2,000Building rental expense $9,000Notes payable $5,000Common stock $10,000Retained earnings ?Equipment $16,000Insurance expense $1,000Supplies $1,800Supplies expense $200Cash $2,000Dividends $600

• CSU begins on CSU begins on Jan. 1, 2005Jan. 1, 2005

• For year ended For year ended Dec. 31, 2005Dec. 31, 2005, , prepareprepare– Income statementIncome statement

– Retained earnings Retained earnings statementstatement

– Balance sheetBalance sheet



• Action step 1Action step 1: : Report the Report the revenues & revenues & expenses for a expenses for a period of time, period of time, Income StatementIncome Statement



• Action step 1Action step 1: : Report the Report the revenues & revenues & expenses for a expenses for a period of time, period of time, Income StatementIncome Statement


Do It Problem: CSU CorporationDo It Problem: CSU Corporation

CSU CorporationCSU CorporationIncome StatementIncome Statement

For the Year Ended December 31, 2005For the Year Ended December 31, 2005

Create the headingCreate the heading

Name of the Name of the statementstatement

Name of the Name of the companycompany

Period Period of timeof time


Do It Problem: CSU CorporationDo It Problem: CSU Corporation

CSU CorporationCSU CorporationIncome StatementIncome Statement

For the Year Ended December 31, 2005For the Year Ended December 31, 2005RevenuesRevenues

Service revenueService revenue $17,000$17,000

List the revenuesList the revenues

Use dollar signs to denote U.S. currencyUse dollar signs to denote U.S. currency


Do It Problem: CSU CorporationDo It Problem: CSU CorporationCSU CorporationCSU CorporationIncome StatementIncome Statement


Service revenueService revenue $17,000$17,000ExpensesExpenses

Rent expenseRent expense $9,000$9,000Insurance expenseInsurance expense 1,000 1,000Supplies expenseSupplies expense 200 200

Total expensesTotal expenses 10,200 10,200

________________

List the expenses & underline sub-totalsList the expenses & underline sub-totals________________


Do It Problem: CSU CorporationDo It Problem: CSU CorporationCSU CorporationCSU CorporationIncome StatementIncome Statement


Service revenueService revenue $17,000$17,000ExpensesExpenses

Rent expenseRent expense $9,000$9,000Insurance expenseInsurance expense 1,000 1,000Supplies expenseSupplies expense 200 200

Total expensesTotal expenses 10,200 10,200Net IncomeNet Income $ 6,800$ 6,800

Calculate net income: revenues - expensesCalculate net income: revenues - expenses

________________________________

________________________________



• Action step 2Action step 2: : Show amounts Show amounts and causes of and causes of changes in changes in retained earningsretained earnings

• Use Net Income Use Net Income from Income from Income StatementStatement

• DividendsDividends


Do It Problem: CSU CorporationDo It Problem: CSU CorporationCSU CorporationCSU Corporation

Retained Earnings StatementRetained Earnings StatementFor the Year Ended December 31, 2005For the Year Ended December 31, 2005

Retained earnings, January 1Retained earnings, January 1 $ 0$ 0

Add: Net incomeAdd: Net income 6,800 6,800 6,8006,800

Less: DividendsLess: Dividends 600 600Retained earnings, Dec. 31 Retained earnings, Dec. 31 $ 6,800$ 6,800________________________________

________________

________________


Do It Problem: CSU CorporationDo It Problem: CSU CorporationService revenue $17,000Accounts receivable $4,000Accounts payable $2,000Building rental expense $9,000Notes payable $5,000Common stock $10,000Retained earnings $6,800Equipment $16,000Insurance expense $1,000Supplies $1,800Supplies expense $200Cash $2,000Dividends $600

• Action step 3Action step 3: : Present assets and Present assets and claims to those claims to those assets at a specific assets at a specific point in time on point in time on the the Balance Balance SheetSheet

• Use $6,800 Use $6,800 Retained earnings Retained earnings from previous from previous statement!statement!


CSU CORPORATION CSU CORPORATION Balance SheetBalance Sheet

December 31, 2005 December 31, 2005

AssetsAssetsCashCash $ 2,000$ 2,000Accounts receivableAccounts receivable 4,000 4,000SuppliesSupplies 1,800 1,800EquipmentEquipment 16,000 16,000Total assets Total assets $23,800$23,800

Liabilities and Stockholders’ EquityLiabilities and Stockholders’ EquityLiabilitiesLiabilities

Accounts payableAccounts payable $ 2,000$ 2,000Notes payableNotes payable 5,0005,000

Total liabilitiesTotal liabilities 7,000 7,000Stockholders’ equityStockholders’ equity

Common stockCommon stock $10,000$10,000Retained earningsRetained earnings 6,8006,800

Total Stockholders’ equityTotal Stockholders’ equity 16,80016,800Total liabilities and stockholders’ equityTotal liabilities and stockholders’ equity $23,800$23,800


Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that named in Section 117 of the United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Introduction to Financial Statements Chapter 1 Prepared by Carol A. Hartley Providence College.

Documents

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