PRE-PARED BY: AZHAR AHMED 1-1 CHAPTER 4 The Financial Statements

PRE-PARED BY: AZHAR AHMED 1-2 ACCOUNTING - THE BASIS OF DECISION MAKING Accounting is the “language of business” Accounting is the information system that –Measures business activities –Processes that information into reports –Communicates the results to decision makers

PRE-PARED BY: AZHAR AHMED 1-3 THE ACCOUNTING SYSTEM: THE FLOW OF INFORMATION 1. People make decisions 2. Business transactions occur 3. Businesses prepare reports to show the results of their operations

PRE-PARED BY: AZHAR AHMED 1-4 ACCOUNTING VS. BOOKKEEPING Bookkeeping is the procedural element of accounting that processes the accounting data

PRE-PARED BY: AZHAR AHMED 1-5 Individuals Businesses Investors and Creditors Government Regulatory Agencies Taxing Authorities Nonprofit Organizations DECISION MAKERS WHO USE ACCOUNTING INFORMATION

PRE-PARED BY: AZHAR AHMED 1-6 Financial accounting provides information to managers and people outside the firm –Financial accounting information must meet certain standards of relevance and reliability Management accounting generates confidential information for internal decision makers, e.g., –Top executives –Department heads FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING

PRE-PARED BY: AZHAR AHMED 1-7 ETHICAL CONSIDERATIONS Ethical standards in accounting are designed to produce accurate information for decision making The result of ethical behavior by accountants is information that people can rely on for decision making

PRE-PARED BY: AZHAR AHMED 1-8 TYPES OF BUSINESS ORGANIZATIONS Proprietorships –Have a single owner who is generally the manager –Are business entities, but not legal entities –Have debt for which the proprietor is personally liable

PRE-PARED BY: AZHAR AHMED 1-9 TYPES OF BUSINESS ORGANIZATIONS Partnerships –Join two or more persons together as co- owners –Are business entities, but not legal entities –Have debt for which each partner is personally liable

PRE-PARED BY: AZHAR AHMED 1-10 TYPES OF BUSINESS ORGANIZATIONS Corporations –Are owned by stockholders or shareholders –Are business entities and legal entities –Are liable for all debts Stockholders have no personal obligation for corporation debts

PRE-PARED BY: AZHAR AHMED 1-11 ACCOUNTING PRINCIPLES AND CONCEPTS Generally accepted accounting principles (GAAP) are –The rules that govern how accountants operate –Based upon a conceptual framework written by the Financial Accounting Standards Board (FASB)

PRE-PARED BY: AZHAR AHMED 1-12 ACCOUNTING PRINCIPLES AND CONCEPTS The FASB works with the SEC (Securities and Exchange Commission) and the AICPA (American Institute of Certified Public Accountants)

PRE-PARED BY: AZHAR AHMED 1-13 KEY ACCOUNTING ORGANIZATIONS Private Sector The FASB determines generally accepted accounting principles Public Sector Law creates the SEC to regulate the stock and bond market in the U.S. GAAP governs accounting information Private Sector Accountants apply GAAP through the AICPA

PRE-PARED BY: AZHAR AHMED 1-14 ACCOUNTING PRINCIPLES AND CONCEPTS The entity concept –States that an organization is an economic entity that keeps its affairs separate from those of the owner(s) The reliability (objective) principle –States that accounting records and statements are based on the most reliable data available and documented by objective evidence

PRE-PARED BY: AZHAR AHMED 1-15 ACCOUNTING PRINCIPLES AND CONCEPTS The cost principle –States that acquired assets and services should be recorded at their actual (historical) cost and should maintain that historical cost for as long as they are owned The going-concern concept –States that the entity will remain in operation for the foreseeable future

PRE-PARED BY: AZHAR AHMED 1-16 ACCOUNTING PRINCIPLES AND CONCEPTS The stable-monetary-unit concept –States that each dollar has the same purchasing power as any other dollar at any other time

PRE-PARED BY: AZHAR AHMED 1-17 THE ACCOUNTING EQUATION The accounting equation presents the resources of the business and the claims to those resources Economic Resources = Claims to Economic Resources Assets = Liabilities + Owners’ Equity or

PRE-PARED BY: AZHAR AHMED 1-18 Assets are the economic resources of a business that are expected to be of benefit in the future Claims to assets come from –Liabilities Economic obligations - debts payable to outsiders, called creditors –Owners’ equity (capital) Assets held by the owners of the business THE ACCOUNTING EQUATION

PRE-PARED BY: AZHAR AHMED 1-19 For a corporation, stockholders’ (owners’) equity consists of two main categories –Paid-in capital –Retained earnings THE ACCOUNTING EQUATION Assets = Liabilities + Stockholders’ Equity Assets = Liabilities + Paid-in Capital + Retained Earnings or

PRE-PARED BY: AZHAR AHMED 1-20 Paid-in (contributed) capital is –The amount invested in the corporation by its owners –Comprised basically of common stock THE ACCOUNTING EQUATION

PRE-PARED BY: AZHAR AHMED 1-21 Retained earnings –Is the amount earned by income-producing activities and kept for use in the business –Is affected by Revenues - increases in retained earnings from delivering goods or services Expenses - decreases in retained earnings that result from operations THE ACCOUNTING EQUATION

PRE-PARED BY: AZHAR AHMED 1-22 Net income (net earnings) –Total revenues exceed total expenses Net loss –Total expenses exceed total revenues Dividends –Distributions to stockholders (usually cash) generated by net income THE ACCOUNTING EQUATION

PRE-PARED BY: AZHAR AHMED 1-23 Beginning Balance of Retained Earnings Beginning Balance of Retained Earnings = = Net Income (Loss) for the Period Net Income (Loss) for the Period Dividends for the Period Dividends for the Period Ending Balance of Retained Earnings Ending Balance of Retained Earnings Revenues for the Period Revenues for the Period Expenses for the Period Expenses for the Period - - = = COMPONENTS OF RETAINED EARNINGS Start of the Period End of the Period

PRE-PARED BY: AZHAR AHMED 1-24 The owners’ equity of proprietorships and partnerships – Makes no distinction between paid-in capital and retained earnings –Accounts for the equity of each owner under the single heading of Capital THE ACCOUNTING EQUATION

PRE-PARED BY: AZHAR AHMED 1-25 INFORMATION REPORTED ON THE FINANCIAL STATEMENTS

PRE-PARED BY: AZHAR AHMED 1-26 Question Answer Financial Statement

PRE-PARED BY: AZHAR AHMED 1-27 INCOME STATEMENT The income statement (statement of earnings) reports the company’s revenues, expenses, and net income or net loss for the period

PRE-PARED BY: AZHAR AHMED 1-28 INCOME STATEMENT

PRE-PARED BY: AZHAR AHMED 1-29 Revenues are –Increases in retained earnings from delivering goods or services to customers or clients Expenses are –Decreases in retained earnings that result from operations INCOME STATEMENT

PRE-PARED BY: AZHAR AHMED 1-30 Expenses include –Cost of goods sold (cost of sales) The cost of the goods that a company sold to its customers –Operating expenses The costs of operating the business INCOME STATEMENT

PRE-PARED BY: AZHAR AHMED 1-31 Operating expenses –Advertising The cost to promote the company’s products –Depreciation The expense of using company-owned buildings, equipment, and furniture –Other operating expenses The costs of salaries, utilities, rent, and supplies –Interest expense The cost of borrowed money INCOME STATEMENT

PRE-PARED BY: AZHAR AHMED 1-32 STATEMENT OF RETAINED EARNINGS The statement of retained earnings reports that portion of net income the company has retained, or kept for use in the business –Net income increases retained earnings –Dividends paid to stockholders decrease retained earnings

PRE-PARED BY: AZHAR AHMED 1-33 STATEMENT OF RETAINED EARNINGS

PRE-PARED BY: AZHAR AHMED 1-34 BALANCE SHEET The balance sheet (statement of financial position) reports the company’s assets, liabilities, and owners’ equity

PRE-PARED BY: AZHAR AHMED 1-35 BALANCE SHEET

PRE-PARED BY: AZHAR AHMED 1-36 ASSETS Current assets are –Those assets which the company expects to convert to cash, sell, or consume during the next 12 months or within the business's normal operating cycle if longer than a year Current assets include –Cash –Accounts receivable –Merchandise inventory –Prepaid expenses

PRE-PARED BY: AZHAR AHMED 1-37 ASSETS Long-term assets are –Those assets which the company expects to hold longer then the next 12 months or the business’s normal operating cycle if longer than one year Long-term assets include –Property –Equipment

PRE-PARED BY: AZHAR AHMED 1-38 ASSETS Intangible assets are –Those with no physical form Trademarks Patents Other assets are –Those with small values which do not fall within any other standard asset category

PRE-PARED BY: AZHAR AHMED 1-39 LIABILITIES Current liabilities are –Debts payable within one year or within the business’s normal operating cycle if longer than a year Current liabilities include –Notes payable, short term –Accounts payable –Accrued expenses payable –Income taxes payable

PRE-PARED BY: AZHAR AHMED 1-40 LIABILITIES Long-term liabilities are –Debts not payable within one year or within the business’s normal operating cycle if longer than a year Long-term liabilities include –Notes payable, long term –Bonds payable

PRE-PARED BY: AZHAR AHMED 1-41 OWNERS’ EQUITY Owners’ equity –Represents the shareholders’ ownership of the assets of the business Owners’ equity of a corporation consists of –Common stock –Retained earnings

PRE-PARED BY: AZHAR AHMED 1-42 STATEMENT OF CASH FLOWS The statement of cash flows reports the company’s cash inflows and outflows from operating, investing, and financing activities

PRE-PARED BY: AZHAR AHMED 1-43

PRE-PARED BY: AZHAR AHMED 1-44 Operating activities –Companies operate by buying goods and services, which are sold to customers Investing Activities –Companies invest in long-term assets that are used to run the business Financing Activities –Companies finance themselves by issuing stock and borrowing money STATEMENT OF CASH FLOWS

PRE-PARED BY: AZHAR AHMED 1-45 RELATIONSHIPS AMONG THE FINANCIAL STATEMENTS

PRE-PARED BY: AZHAR AHMED 1-46

PRE-PARED BY: AZHAR AHMED 1-47 END OF CHAPTER 3