1 Financial Accounting: Tools for Business Decision Making, 4th Ed. Kimmel, Weygandt, Kieso CHAPTER 1 Prepared by Dr. Joseph Otto CSLA

2 Chapter 1 AN INTRODUCTION TO FINANCIAL STATEMENTS

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

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

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

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

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

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

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

10 Users of Financial Information Internal Users Ask?

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

12 Users of Financial Information External Users Ask?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

27 Income Statement Do this statement first!

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

29 Retained Earnings Statement Do this statement second!

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

31 Balance Sheet From Retained Earnings Statement

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

33 Statement of Cash Flows Statement of Cash Flows 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 balance during the period? What was the change in the cash balance during the period? A company cannot survive without cash! A company cannot survive without cash!

34 Statement of Cash Flows.. Agrees with Balance Sheet

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

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

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

38 Basic Accounting Equation Basic Accounting Equation Assets = Liabilities + Stockholders’ Equity

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

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

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

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

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

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

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

46 Management’s Discussion and Analysis

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

48 Notes to Financial Statements

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

50 Auditor’s Report

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

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

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

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

55 Do It Problem: CSU Corporation 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 Do It Problem: CSU Corporation 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 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 ________ ________ ________ ________

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

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

60 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 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! Use $6,200 Retained earnings from previous statement!

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62 Assign #1 – E1-3, 5, 8, 11, 14 (due 4/7) Assign #1 E- 3, 5, 8, 11, 14 (due 4/12)