Introduction to Financial Statements CHAPTER 1. Proprietorship: simple to establish, owner- controlledProprietorship: simple to establish, owner- controlled.

Introduction to Financial Statements

CHAPTER

1

• Proprietorship:Proprietorship: simple to establish, owner-simple to establish, owner-controlledcontrolled

• Partnership:Partnership: simple to establish, shared simple to establish, shared control, broader skills and resourcescontrol, broader skills and resources

• Corporation:Corporation: easier to transfer ownership, easier to transfer ownership, easier to attract investors, no personal easier to attract investors, no personal liability, tax advantages possibleliability, tax advantages possible

Forms of Business OrganizationsForms of Business Organizations

• Internal UsersInternal Users– Managers plan, organize and run a businessManagers plan, organize and run a business

Users of Financial InformationUsers of Financial Information

• External UsersExternal Users

– InvestorsInvestors

– CreditorsCreditors

– OthersOthers• Tax authoritiesTax authorities• Regulatory agenciesRegulatory agencies• CustomersCustomers• Labour unionsLabour unions• Economic plannersEconomic planners

Primary users

Users of Financial InformationUsers of Financial Information

• Ethical dilemmas in financial reportingEthical dilemmas in financial reporting– e.g., Enrone.g., Enron

• To solve an ethical dilemmaTo solve an ethical dilemma– Recognize situation and ethical issuesRecognize situation and ethical issues– Identify and analyse principal elementsIdentify and analyse principal elements– Identify alternatives and determine impact Identify alternatives and determine impact

on stakeholderson stakeholders

Ethics in Financial ReportingEthics in Financial Reporting

3 Types of Business Activities3 Types of Business Activities

• FinancingFinancing• InvestingInvesting• OperatingOperating

• Borrowing money Borrowing money (debt)(debt)

• Selling shares Selling shares (equity)(equity)

Financing ActivitieFinancing Activitiess

• Obtaining the resources or assets needed to Obtaining the resources or assets needed to operate the business for the long termoperate the business for the long term

• ExamplesExamples– Purchase or sale of investmentsPurchase or sale of investments

– Purchase or sale of long-lived assets such as Purchase or sale of long-lived assets such as property, plant and equipment and intangible property, plant and equipment and intangible assetsassets

Investing ActivitiesInvesting Activities

Operating ActivitiesOperating Activities

• Operating activities are the main Operating activities are the main activities for which the organization activities for which the organization is in businessis in business

Accounting EquationAccounting Equation

AssetsAssets = Liabilities + Shareholders’ Equity= Liabilities + Shareholders’ Equity

Basic TermsBasic Terms

• Assets Assets - resources owned by a business- resources owned by a business

• Liabilities Liabilities - obligations of the business- obligations of the business

• Shareholders’ equityShareholders’ equity– Share capitalShare capital - represents the primary ownership - represents the primary ownership

interest in a corporationinterest in a corporation– Retained earningsRetained earnings – accumulated earnings of the – accumulated earnings of the

corporation that have not been distributed to corporation that have not been distributed to shareholdersshareholders

• RevenuesRevenues arise from arise from the sale of a product the sale of a product or serviceor service

• Revenues result in Revenues result in an inflow of assetsan inflow of assets

RevenuesRevenues

• Expenses are the costs of assets Expenses are the costs of assets consumed or the costs of services used to consumed or the costs of services used to generate revenuesgenerate revenues

• ExamplesExamples– Cost of goods soldCost of goods sold

– Operating expensesOperating expenses

– Interest expenseInterest expense

ExpensesExpenses

Net EarningsNet Earnings

• Net earnings (or net income) is the amount by Net earnings (or net income) is the amount by which revenues exceed expenseswhich revenues exceed expenses

(Net loss is the amount by which expenses (Net loss is the amount by which expenses exceed revenues)exceed revenues)

RevenueRevenue $10,000$10,000

Less: ExpensesLess: Expenses 3,0003,000

Net earningsNet earnings $ 7,000$ 7,000

Financial Accounting StatementsFinancial Accounting Statements

• Statement of Earnings (also called Income Statement of Earnings (also called Income Statement)Statement)– Reports the results of operations for a specific Reports the results of operations for a specific

period of timeperiod of time

• Statement of Retained EarningsStatement of Retained Earnings– Reports the changes in retained earnings for a Reports the changes in retained earnings for a

specific period of timespecific period of time


• Balance SheetBalance Sheet– Reports the assets, liabilities, and shareholders’ Reports the assets, liabilities, and shareholders’

equity as at a specific point in timeequity as at a specific point in time

• Cash Flow StatementCash Flow Statement – Reports the cash receipts and payments for a Reports the cash receipts and payments for a

specific period of timespecific period of time

CSU CORPORATIONStatement of Earnings

Year Ended December 31, 2004

First:First:Statement of EarningsStatement of Earnings

Name of companyName of companyName of statementName of statementPeriod of time coveredPeriod of time covered

List revenuesList revenues



RevenuesRevenues

Service revenueService revenue $22,200$22,200

List and total the expenses. Note that income tax List and total the expenses. Note that income tax is shown separately from other expenses.is shown separately from other expenses.



RevenuesRevenues


ExpensesExpenses

Rent expenseRent expense $9,000$9,000

Insurance expenseInsurance expense 1,0001,000

Supplies expenseSupplies expense 200200

Total expensesTotal expenses 10,20010,200

Earnings before income taxEarnings before income tax 12,00012,000

Income tax expenseIncome tax expense 5,2005,200

Subtract expenses from revenues to obtain net Subtract expenses from revenues to obtain net earnings (loss)earnings (loss)



RevenuesRevenues


ExpensesExpenses

Rent expenseRent expense $9,000$9,000

Insurance expenseInsurance expense 1,0001,000

Supplies expenseSupplies expense 200200

Total expensesTotal expenses 10,20010,200

Earnings before income taxEarnings before income tax 12,00012,000

Income tax expenseIncome tax expense 5,2005,200

Net earningsNet earnings $ 6,800$ 6,800

CSU CORPORATIONStatement of Retained EarningsYear Ended December 31, 2004

Second:Second:Statement of Retained EarningsStatement of Retained Earnings

Name of companyName of companyName of statementName of statementPeriod of time covered (same Period of time covered (same period as period as statement of earnings)statement of earnings)


Start with beginning retained earnings Start with beginning retained earnings (same as ending retained earnings of prior (same as ending retained earnings of prior period)period)

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

Add net earnings (subtract loss) from the current Add net earnings (subtract loss) from the current year (see Statement of Earnings)year (see Statement of Earnings)

SubtotalSubtotal


Retained earnings, Retained earnings, January 1January 1

$ 0$ 0

Add: Net earningsAdd: Net earnings 6,8006,800

6,8006,800

Subtract current year’s dividends (if any) and Subtract current year’s dividends (if any) and totaltotal


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

Add: Net earningsAdd: Net earnings 6,8006,800

6,8006,800

Less: DividendsLess: Dividends 00

Retained earnings, December 31Retained earnings, December 31 $6,800$6,800

CSU CORPORATION Balance Sheet

December 31, 2004

Third:Third:Balance SheetBalance Sheet

Name of companyName of companyName of statementName of statementDate (as at a specific point in time)Date (as at a specific point in time)

List the assets and totalList the assets and total


December 31, 2004

AssetsAssets

CashCash $ 2,000$ 2,000

Accounts receivableAccounts receivable 4,0004,000

SuppliesSupplies 1,8001,800

EquipmentEquipment 16,00016,000

Total assetsTotal assets $23,800$23,800

List the liabilities and subtotalList the liabilities and subtotal


December 31, 2004

AssetsAssets

CashCash $ 2,000$ 2,000

Accounts receivableAccounts receivable 4,0004,000

SuppliesSupplies 1,8001,800

EquipmentEquipment 16,00016,000

Total assetsTotal assets $23,800$23,800

Liabilities and Shareholders’ EquityLiabilities and Shareholders’ Equity

LiabilitiesLiabilities

Accounts payableAccounts payable $ 2,000$ 2,000

Notes payableNotes payable 5,0005,000

Total liabilitiesTotal liabilities 7,0007,000

List shareholders’ equity; subtotalList shareholders’ equity; subtotal

Add Add shareholders’ equity shareholders’ equity to liabilities; totalto liabilities; total


December 31, 2004


December 31, 2004

AssetsAssetsCashCashAccounts receivableAccounts receivableSuppliesSuppliesEquipmentEquipment Total assetsTotal assets

$ 2,000$ 2,0004,0004,0001,8001,800

16,00016,000$23,800$23,800

Liabilities and Shareholders’ EquityLiabilities and Shareholders’ EquityLiabilitiesLiabilities Accounts payableAccounts payable Notes payableNotes payable Total liabilitiesTotal liabilitiesShareholders’ equityShareholders’ equity Common sharesCommon shares Retained earningsRetained earnings Total shareholders’ equityTotal shareholders’ equityTotal liabilities and shareholders’ equityTotal liabilities and shareholders’ equity

$10,000$10,000 6,8006,800

$ 2,000$ 2,000 5,0005,000

7,0007,000

16,80016,800$23,800$23,800

Stop and CheckStop and Check

Total assets must equal total liabilities and Total assets must equal total liabilities and shareholders’ equityshareholders’ equity

In what order are financial statements In what order are financial statements prepared? Presented?prepared? Presented?

WHY?


CSU CORPORATION Statement of Earnings


Net earnings is needed for the Net earnings is needed for the Statement of Retained EarningsStatement of Retained Earnings

RevenuesRevenues Service revenueService revenueExpensesExpenses Rent expenseRent expense Insurance expenseInsurance expense Supplies expenseSupplies expenseTotal expensesTotal expensesEarnings before income taxEarnings before income taxIncome tax expenseIncome tax expenseNet earningsNet earnings

$9,000$9,0001,0001,000

200200

$22,200$22,200

10,20010,20012,00012,000

5,2005,200$ 6,800$ 6,800

CSU CORPORATION Statement of Retained EarningsYear Ended December 31, 2004

Ending retained earnings is needed Ending retained earnings is needed for the Balance Sheetfor the Balance Sheet

Retained earnings, January 1Retained earnings, January 1

Add: Net earningsAdd: Net earnings

Less: DividendsLess: Dividends

Retained earnings, December 3Retained earnings, December 3

$ 0$ 0

6,8006,800 6,800 6,800

00

$ 6,800$ 6,800


December 31, 2004

AssetsAssetsCashCashAccounts receivableAccounts receivableSuppliesSuppliesEquipmentEquipment Total assetsTotal assets

$ 2,000$ 2,0004,0004,0001,8001,800

16,00016,000$23,800$23,800

Liabilities and Shareholders’ EquityLiabilities and Shareholders’ EquityLiabilitiesLiabilities Accounts payableAccounts payable Notes payableNotes payable Total liabilitiesTotal liabilitiesShareholders’ equityShareholders’ equity Common sharesCommon shares Retained earningsRetained earnings Total shareholders’ equityTotal shareholders’ equityTotal liabilities and shareholders’ equityTotal liabilities and shareholders’ equity

$10,000$10,000 6,8006,800

$ 2,000$ 2,000 5,0005,000

7,0007,000

16,80016,800$23,800$23,800

CSU CORPORATION Cash Flow Statement


Operating activitiesOperating activitiesNet earningsNet earningsAdjustments to reconcile net earnings to net Adjustments to reconcile net earnings to net cash provided by operating activities:cash provided by operating activities:

Increase in accounts receivableIncrease in accounts receivableIncrease in suppliesIncrease in suppliesIncrease in accounts payableIncrease in accounts payable

Net cash provided by operating activitiesNet cash provided by operating activities

Investing activitiesInvesting activitiesPurchase of equipmentPurchase of equipment

Net cash used by investing activitiesNet cash used by investing activities

$(4,000)$(4,000)(1,800)(1,800) 2,0002,000

$(16,000)$(16,000)

$ 6,800$ 6,800

(3,800)(3,800)

3,0003,000

(16,000)(16,000)

CSU CORPORATION Cash Flow Statement

Year Ended December 31, 2004(Continued)

Financing activitiesFinancing activitiesIncrease in notes payableIncrease in notes payableIncrease in common sharesIncrease in common shares

Net cash provided by financing activitiesNet cash provided by financing activities

Net increase in cashNet increase in cash

Cash, January 1Cash, January 1

Cash, December 31Cash, December 31

$ 5,000$ 5,000 10,00010,000

15,00015,000

2,0002,000

00

$2,000$2,000

Assumptions and Principles in Assumptions and Principles in Financial ReportingFinancial Reporting

• AssumptionsAssumptions– Monetary unitMonetary unit

– Economic entityEconomic entity

– Time periodTime period

– Going concernGoing concern

• Generally accepted Generally accepted accounting principlesaccounting principles– CostCost

– Full disclosureFull disclosure

Monetary Unit AssumptionMonetary Unit Assumption

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

Economic EntityEconomic Entity

• Every economic entity can be separately Every economic entity can be separately identified and accounted foridentified and accounted for

Time Period AssumptionTime Period Assumption

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

Going Concern AssumptionGoing Concern Assumption

• The business will continue operating The business will continue operating long enough to carry out its existing long enough to carry out its existing objectivesobjectives

Cost PrincipleCost Principle

• Assets should be recorded at costAssets should be recorded at cost

Full Disclosure PrincipleFull Disclosure Principle

• Circumstances and events Circumstances and events that make a difference to that make a difference to financial statement users financial statement users should be disclosedshould be disclosed

Introduction to Financial Statements CHAPTER 1. Proprietorship: simple to establish, owner- controlledProprietorship: simple to establish, owner- controlled.

Documents

business slide

shareholders slide

financial reporting

costs of assets

inflow of assets revenues

intangible assets

net earnings net earnings

main activities