Introduction to Financial Statements Chapter One Introduction to Financial Statements Zining Li ACCT 2301 FALL 2009 Cox School of Business, SMU

What do we hope to learn? What are the characteristics of a corporation? What are the four basic financial statements? What information does each statement convey? What categories of items are reported in each financial statement? How are elements within a statement related? Acct 2301 Li Fall 09 Chapter 1

How is Business Formed Sole proprietorship Partnership Corporation Single owner Not separate entity for liability & responsibility Partnership Two or more owners, but not a separate entity Corporation Typically multiple owners separate legal entity This course is about Corporations. Acct 2301 Li Fall 09 Chapter 1

Corporations Popular form of business because… It’s simple for individuals to purchase small amounts of stock Allows easy transfer of ownership through established exchanges Provides limited liability – the most you can lose is your initial investment Easier to raise capital Acct 2301 Li Fall 09 Chapter 1

Separate Legal Entity Since a corporation is a separate legal entity it can: Own assets Incur liabilities Sue and be sued Enter into contracts independent of the stockholders (owners) Acct 2301 Li Fall 09 Chapter 1

Accounting System and its Users Accounting system records and summarizes financial information. Users Internal decision makers (managers) get reports. External decision makers (investors, creditors, suppliers, and customers) get financial statements prepared in accordance with rules. Acct 2301 Li Fall 09 Chapter 1

Four Basic Financial Statements Balance Sheet Report the financial condition about a firm Income Statement Performance measure of a business Statement of Shareholders’ Equity Statement of Retained Earnings is part of it Statement of Cash Flows Acct 2301 Li Fall 09 Chapter 1

Balance Sheet: Basic Accounting Equation Assets = Liabilities + Owners’ Equity Economic resources Sources of financing for the economic resources Acct 2301 Li Fall 09 Chapter 1

Balance Sheet: Elements Assets: economic resources controlled by the company Liabilities: debts or obligation Owners’ Equity Also called Shareholders’ Equity, Stockholders’ Equity Contributed Capital Retained Earnings Acct 2301 Li Fall 09 Chapter 1

Income Statement The income statement equation is: Revenues – Expenses = Net Income Net Income is also called net earnings, profits, or the bottom line number. It is just a subtotal! net profit net loss result Acct 2301 Li Fall 09 Chapter 1

Income Statement: Elements Revenues are inflows of net assets Expenses are dollar amount of resources used to earn the revenues Acct 2301 Li Fall 09 Chapter 1

Statement of Shareholders’ Equity Beginning Contributed Capital + Issuance of capital - Purchase of capital = Ending Contributed Capital Beginning Retained Earnings + Net Income for the period - Dividends Declared for the period = Ending Retained Earnings Total Shareholders’ Equity: $$ (sum of ending Contributed Capital and ending Retained Earnings) Acct 2301 Li Fall 09 Chapter 1

The Statement of Cash Flows Reports cash inflows (receipts) and cash outflows (payments). Three categories Operating activities Investing activities Financing activities Net change in cash usually NOT equal to net income The statement ends with a reconciliation of cash Acct 2301 Li Fall 09 Chapter 1

Four Financial Statements All Contains a Heading that Includes Company name Statement title Specific date or a period of time that a statement relates to Unit of measure Acct 2301 Li Fall 09 Chapter 1

Dates of Financial Statements are Important! Balance sheet is “AS OF…” or “AT” a particular date Income statement, Statement of changes in owner’s equity and Statement of cash flows cover a period of time, and thus are “FOR THE PERIOD ENDING” Acct 2301 Li Fall 09 Chapter 1

Is There Some Relationship Among the Statements? Net Income from the Income Statement is shown as an increase to the beginning Retained Earnings on the Statement of S/E The ending balances of Retained Earnings and Contributed Capital from the Statement of S/E appear in the Balance Sheet (the owners equity section) The Statement of Cash Flows reflects the change in the CASH account on the Balance Sheet Acct 2301 Li Fall 09 Chapter 1

Structure of Financial Statements Statement of Owners’ Equity Beginning balance of Contributed Capital + Issuance (sale) of (own) stocks - Purchase of (own) stocks = Ending balance of C.C. Beginning balance of Retained Earnings + Net Income - Dividends = Ending balance of R/E Ending balance of Shareholders’ Equity Income Statement Revenues - Expenses = Net Income Statement of Cash Flows Beginning cash balance + Cash Inflows - Cash outflows = Ending cash balance Balance Sheets Assets = Liabilities + S/E (C.C. +R/E)

Notes to Financial Statements Notes provide supplemental information about the financial condition of a company. Three basic types of notes: Description of accounting rules applied. Presentation of additional detail about an item on the financial statements. Provides additional information about an item not on the financial statements. Acct 2301 Li Fall 09 Chapter 1

Who Prepares and is Responsible for the Financial Statements? The management of a business is responsible for accounting for transactions and preparing financial statements. Maintain a system of controls over both records and assets. Engage independent auditors Establish an audit committee The auditors attest to whether the management prepared the report in accordance with the ‘rules’. Acct 2301 Li Fall 09 Chapter 1

To Take Away… What are the four financial statements? What information is provided by each statement? How is the information different? What categories of items are reported in each financial statements? Can you give some examples of those elements? How are elements within a statement related? Acct 2301 Li Fall 09 Chapter 1