AN INTRODUCTION TO FINANCIAL STATMENTS Chapter 1 AN INTRODUCTION TO FINANCIAL STATMENTS

Study Objectives Describe the primary forms of business organization. Identify the users and uses of accounting information. Explain the three principal types of business activity. Describe the content and purpose of each of the financial statements.

Study Objectives Explain the meaning of assets, liabilities, and stockholders’ equity, and state the basic accounting equation. Describe the components that supplement the financial statements in an annual report.

Forms of Business Organization 11 1 Forms of Business Organization Sole proprietorship Partnership Corporation

Sole Proprietorship Business owned by one person Simple to establish Owner controlled Tax advantages Owner personally liable Financing difficult

Partnership Two or more owners Simple to establish Shared control Broader skills & resources Tax advantages Personal liability

Corporation Separate legal entity owned by stockholders Easy to transfer ownership Greater capital raising potential Lower legal liability Unfavorable tax treatment

Users of Financial Information Internal 11 2 Users of Financial Information Internal Managers who plan, organize and run a business Marketing managers Production supervisors Finance directors Company officers

Users of Financial Information Internal Users Ask?

Users of Financial Information External Investors Creditors Others Regulatory agencies Tax authorities Customers Labor Unions Economic planners

Users of Financial Information External Users Ask?

Types of Business Activity 11 3 Types of Business Activity Financing Investing Operating

Financing Activities Borrowing creates liabilities Bank loans Debt securities Goods on credit or payables Selling stock creates stockholders’ equity

Investing Activities Obtaining resources or assets to operate the business Land Buildings Vehicles Computers Furniture Equipment

Operating Activities Primary activity of business Selling goods Providing services Manufacturing Cost of Sales Advertising Paying employees Paying utilities

Operating Activities Revenues are the increases in assets resulting from the sale of a product or service Expenses are the cost of assets consumed or services used in generating revenue. If revenue > expense = Net Income If revenue < expense = Net Loss!

Review Which is not one of the three forms of business organization? a. Sole proprietorship. b. Creditorship. c. Partnership. d. Corporation.

Review Which is not one of the three forms of business organization? a. Sole proprietorship. b. Creditorship. c. Partnership. d. Corporation.

Review Which is an advantage of corporations relative to partnerships and sole proprietorships? a. Lower taxes. b. Harder to transfer ownership c. Reduced legal liability for investors. d. Most common form of business organization.

Review Which is an advantage of corporations relative to partnerships and sole proprietorships? a. Lower taxes. b. Harder to transfer ownership c. Reduced legal liability for investors. d. Most common form of business organization.

Which is not one of the three primary business activities? Review Which is not one of the three primary business activities? a. Financing. b. Operating. c. Advertising. d. Investing.

Which is not one of the three primary business activities? Review Which is not one of the three primary business activities? a. Financing. b. Operating. c. Advertising. d. Investing.

Content and Purpose of Financial Statements 11 4 Content and Purpose of Financial Statements Accountants communicate with users through four financial statements

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

Income Statement Reports operating success or failure for a period. Summarizes revenues and expenses for period: month, quarter, year. If revenue > expense = Net Income.

Do this statement first! Income Statement Do this statement first!

Retained Earnings Statement Shows changes in retained earnings for period: month, quarter, year Beginning balance Add Net Income from income statement. Deduct Dividends Ending balance

Retained Earnings Statement Do this statement second!

Balance Sheet Reports assets and claims to assets. Claims of creditors, liabilities. Claims of owners, stockholders’ equity. Assets = Liabilities + Stockholders’ Equity Specific date – one point in time!

From Retained Earnings Statement Balance Sheet From Retained Earnings Statement

Statement of Cash Flows Provides information about cash receipts and cash payments Summarizes for period: month, quarter, year. Cash effects of operating, investing, and financing activities.

Statement of Cash Flows Where did the cash come from? How was cash used during the period? What was the change in the cash balance during the period? A company cannot survive without cash!

Statement of Cash Flows.. Agrees with Balance Sheet

Assets 5 Resources owned by the business Cash Accounts receivable 11 5 Assets Resources owned by the business Cash Accounts receivable Inventories Furniture and fixtures Equipment Supplies

Liabilities Obligations or debts of business Notes payable Accounts payable Interest payable Salaries payable Unearned revenue

Stockholders’ Equity Ownership claims on assets Paid-in capital Common stock Retained earnings

Basic Accounting Equation Assets = Liabilities + Stockholders’ Equity

Review What questions might each of the following decision makers ask that could be answered by the financial statements … Bank loan officer? Stock investor? Labor union president? Federal bank regulator?

Review Which of the following is not a correct representation of the accounting equation? a. Assets = Liabilities + Stockholders’ Equity b. Assets - Liabilities = Stockholders’ Equity c. Assets + Stockholders’ Equity = Liabilities d. Assets - Stockholders’ Equity = Liabilities

Review Which of the following is not a correct representation of the accounting equation? a. Assets = Liabilities + Stockholders’ Equity b. Assets - Liabilities = Stockholders’ Equity c. Assets + Stockholders’ Equity = Liabilities d. Assets - Stockholders’ Equity = Liabilities

Review Using the accounting equation, answer the following question. If Liabilities = $10,000 and Stockholders’ Equity = $20,000 Then Assets = $30,000 $30,000 = $10,000 + $20,000

Review Using the accounting equation, answer the following question. If Assets = $75,000 And Liabilities = $35,000 Then Stockholders’ Equity = $40,000 $75,000 = $35,000 + $40,000

Supplements to the Financial Statements in an Annual Report 11 6 Supplements to the Financial Statements in an Annual Report Management Discussion and Analysis Notes to Financial Statements Auditor’s report

Management’s Discussion and Analysis covers three items: Liquidity Capital resources Results of operations

Management’s Discussion and Analysis

Notes to Financial Statements Explanatory notes and supplementary schedules Clarifies information in financial statements Expands with additional detail Describes accounting policies Explains uncertainties and contingencies

Notes to Financial Statements

Auditor’s Report Certified Public Accountant – CPA Auditor (CPA) conducts independent examination of financial statements Fair representation? Follow generally accepted accounting principles (GAAP)? Unqualified opinion

Auditor’s Report

Do It Problem: CSU Corporation CSU begins on Jan. 1, 2007 For year ended Dec. 31, 2007, prepare Income statement Retained earnings statement Balance sheet

Do It Problem: CSU Corporation Action step 1: Report the revenues & expenses for a period of time, Income Statement

Do It Problem: CSU Corporation Action step 1: Report the revenues & expenses for a period of time, Income Statement

Do It Problem: CSU Corporation Create the heading Name of the company CSU Corporation Income Statement For the Year Ended December 31, 2007 Name of the statement Period of time

Do It Problem: CSU Corporation Income Statement For the Year Ended December 31, 2007 Revenues Service revenue $17,000 List the revenues Use dollar signs to denote U.S. currency

Do It Problem: CSU Corporation Income Statement For the Year Ended December 31, 2007 Revenues Service revenue $17,000 Expenses Rent expense $9,000 Insurance expense 1,000 Supplies expense 200 Total expenses 10,200 ________ List the expenses & underline sub-totals

Do It Problem: CSU Corporation Income Statement For the Year Ended December 31, 2007 Revenues Service revenue $17,000 Expenses Rent expense $9,000 Insurance expense 1,000 Supplies expense 200 Total expenses 10,200 Net Income $ 6,800 Calculate net income: revenues - expenses ________ ________ ________ ________

Do It Problem: CSU Corporation Action step 2: Show amounts and causes of changes in retained earnings Use Net Income from Income Statement Dividends

Do It Problem: CSU Corporation Retained Earnings Statement For the Year Ended December 31, 2007 Retained earnings, January 1 $ 0 Add: Net income 6,800 6,800 Less: Dividends 600 Retained earnings, Dec. 31 $ 6,200 ________

Do It Problem: CSU Corporation Action step 3: Present assets and claims to those assets at a specific point in time on the Balance Sheet Use $6,200 Retained earnings from previous statement!

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