Chapter 2 Introduction to Financial Statements and Other Financial Reporting Topics © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Forms of Business Entities © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Financial Statements Income statement Statement of stockholders’ equity Balance sheet Statement of cash flows Support for the financial statements is provided by notes © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Income Statement Dated for a specific period Summarizes revenues and expenses Reports net income Excess of revenues over expense Net income increases retained earnings Income Statement For the Year Ended Dec. 31, 2011 Revenue $ 120,000 Expenses (100,000) Net Income $ 20,000 © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Statement of Stockholders’ Equity Dated for a specific period Reconciles beginning and ending balances of the stockholders’ equity accounts Capital Stock Retained Earnings Etc. Links the income statement and the balance sheet Income Statement For Year Ending December 31, 2011 Revenue $ 120,000 Expenses (100,000) Net Income $ 20,000 Statement of Stockholders’ Equity Capt. Stk. Ret. Earn. Beginning Balance $40,000 $ 25,000 Issue stock 10,000 Net income 20,000 Dividends (10,000) Ending Balance $50,000 $ 35,000 © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Statement of Stockholders’ Equity Income Statement Revenue $ 120,000 Expenses (100,000) Net Income $ 20,000 Statement of Stockholders’ Equity Capt. Stk. Ret. Earn. Beginning Balance $40,000 $ 25,000 Issue stock 10,000 Net income 20,000 Dividends (10,000) Ending Balance $50,000 $ 35,000 Shows the financial condition of an entity as of a particular date Assets: the resources of the business Liabilities: the debts of the business Equity: the owners’ interest in the business The Accounting Equation: Balance Sheet Assets $110,000 Liabilities 25,000 Stockholders’ Equity Capital Stock 50,000 Retained Earnings 35,000 Tot Liab. & Equity $110,000 Assets = Liabilities + Stockholders’ Equity Assets = Liabilities + Capital Stock + Retained Earnings © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Statement of Cash Flows Covers the same period as the income statement Three sections Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Notes An integral part of the financial statements Required presentation Summary of significant accounting policies Contingent liabilities Subsequent events relating to conditions that existed at the balance sheet date Disclose and adjustment of the financial statements Subsequent events relating to conditions that did not exist at the balance sheet date Disclosure but no adjustment of the financial statements © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Accounting Cycle Recording transactions Recording adjusting entries Preparing the financial statement © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Recording Transactions Internal or external event that causes a change in a company’s assets, liabilities, or stockholders’ equity Recorded in a journal (journal entry) Posted to general ledger accounts Double-entry system Debit: left side of an account Credit: right side of an account Debits = Credits Account Title Debit Credit © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Accounting System Components Permanent Temporary Account types Assets Liabilities Equity Revenues, Gains Expenses, Losses Dividends Balances Carry forward to the next fiscal period Closed to retained earnings at year-end Represent the accounting equation © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Accounting System Components Required by the accrual basis of accounting Prepared at the end of the fiscal period Records (recognizes) for the current period Expenses incurred Revenues earned Recorded in the general journal Posted to the general ledger © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Preparing the Financial Statements The output of the accounting system Based on the adjusted general ledger account balances Directly from the general ledger Income statement Balance sheet From analysis of general ledger accounts Statement of cash flows © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Treadway Commission Voluntary private sector organization (Treadway) Committee of Sponsoring Organizations (COSO) Internal control reports Standard framework for evaluating internal control Need for internal control emphasized by Sarbanes-Oxley Act §404 Management's Report on Internal Control Independent auditor’s opinion on management’s assessment of internal control © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Auditor’s Opinion Audit is conducted by CPAs The audit report is the formal statement of audit opinion Unqualified opinion Qualified opinion Adverse opinion Disclaimer of opinion © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Unqualified Opinion The financial statements present fairly The financial position Results of operations Cash flows In conformity with generally accepted accounting principles For the user: the highest degree of reliability © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Qualified Opinion Except for the matter to which the exception relates The financial statements present fairly The financial position Results of operations Cash flows In conformity with generally accepted accounting principles For the user: determine the significance of the exception © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Adverse Opinion The financial statements do not present fairly The financial position Results of operations Cash flows In conformity with generally accepted accounting principles For the user: reliability of financial statements need to be seriously questioned © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Disclaimer of Opinion The auditor does not express an opinion Auditor Has not preformed an audit sufficient in scope to form an opinion or Is not independent For the user: auditor’s statement conveys no indication of financial statement reliability © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Unqualified Auditor’s Report Paragraph #1: Financial statements have been audited Financial statements are responsibility of management Auditors have responsibility to express or disclaim an opinion © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Unqualified Auditor’s Report (cont’d) Paragraph #2 Audit conducted in accordance with the standards of the (U.S.) Public Accounting Oversight Board Auditor is required to plan and perform the audit Obtain reasonable assurance Financial statements are free from material misstatement Audit provides a reasonable basis for opinion Examining evidence Assessing accounting principles and estimates © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Unqualified Auditor’s Report (cont’d) Paragraph #3 Opinion: in conformity with generally accepted (U.S.) accounting principles Also: for public companies, reference to the audit of internal control effectiveness In accordance with the (U.S.) Public Accounting Oversight Board Based on criteria established by COSO © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Auditor’s Report on Internal Control Required by Sarbanes-Oxley May be combined with audit opinion report Paragraphs Scope Responsibility and procedures Opinion Reference to financial statement audit © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Other Types of Engagements Review Less in scope than an audit An opinion is not expressed Provides negative assurance “Not aware of any material misstatements or required modifications” Compilation Presents only financial information provided by management No opinion or any other assurance is given © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Management’s Responsibility Management is responsible for The preparation of the financial statements The integrity of the financial statements Management’s Statement of Responsibility May be included in the annual report © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The SEC’s Integrated Disclosure System Required filings 10-K: annual filing (audited) Includes financial statements plus Information on the business entity Market information Management discussion and analysis Directors, executive officers, and their compensation Related party transactions 10-Q: quarterly filing (unaudited) 8-K: “current report” To report the occurrence of any material events or corporate changes © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Additional Reporting Venues Proxy Notice and authorization of shareholder voting rights on corporate actions Content and form governed by the SEC Summary Annual Report Highly condensed financial information Must be accompanied by a proxy containing full financial information Not adequate for financial analysis © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

The Efficient Market Hypothesis Capital markets generate security prices that reflect worth Publicly available information is reflected in share prices Investors will be harmed if full disclosure is not made Method of disclosure does not impact value Body of the financial statements Notes to the financial statements Benefit of making disclosure outweighs the cost © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Ethics Essential values in interpersonal relationships Caring Honesty Accountability Promise keeping Pursuit of excellence Loyalty Fairness Integrity Respect for others Responsible citizenship © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

AAA Ethical Decision Framework Determine the facts Define the ethical issues Identify major principles, rules, and values Specify the alternatives Compare norms, principles, and values with alternatives Assess the consequences Make your decision © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

SEC Requirement: A Code of Ethics Enacted under Sarbanes-Oxley Act Applicable to chief financial officers Disclosure requirements Whether a code of ethics has been adopted If not, why not Code is published in the annual report or on the firm’s web site © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Harmonization of International Accounting Standards Accounting standards can vary by country Development is often in response to domestic needs International accounting standards set by IASC (1973 – 2000) IASB (2001 to present) has no enforcement power In the U.S. SEC requires registrants to report in U.S. GAAP FASB is participating in the harmonization project © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Harmonization of International Accounting Standards IASB issues (IFRS) International Financial Reporting Standards. 2002 Norwalk agreement – FASB and IASB commit to high-quality, compatible accounting standards. 2007 agreement between US and European Union to allow companies to drop US GAAP if financials were prepared by IFRS. © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Consolidated Financial Statements Parent consolidates with subsidiary Report results of operations separately Sum subsidiary and parent results of operations Legal control vs. effective control Consolidation occurs when parent has effective control over the subsidiary Holds a majority of risks, rewards, and decision-making ability © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Accounting for Business Combinations Effected through merger or acquisition Purchase method of accounting Record assets and liabilities acquired at their fair values Excess of purchase price over fair value of net assets acquired is reported as goodwill © 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.