of Financial Accounting, 3e CORNERSTONES

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. CHAPTER 1: ACCOUNTING AND THE FINANCIAL STATEMENTS Cornerstones of Financial Accounting, 3e

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Demand for Accounting Information and Typical Questions LO-1

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Businesses: Forms and Activities LO-2  Sole Proprietorship  Easily formed  Tax advantages  Controlled by owner  Unlimited liability (personal liability)  Limited Life

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Businesses: Forms and Activities  Partnership  Access to the resources and skills of partners  Tax advantages  Shared control  Can be unlimited liability  Limited life LO-2

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Businesses: Forms and Activities  Corporation  Easier to raise money  Easier to transfer ownership  Limited Liability  Complex to organize  Higher Taxes LO-2

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Business Activities  Investing Activities  Buying assets used to generate revenue  Financing Activities  Obtaining funds to start the business  Operating Activities  Operating the business for profit LO-2

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Communication of Accounting Information ►To communicate a company’s activities to decision-makers, detailed transactions are summarized and reported in reports called financial statements. LO-3

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Financial Statements  Companies prepare four basic financial statements:  The balance sheet reports the sources (assets) owned by a company and the claims against those resources (liabilities and stockholders’ equity) at a specific point in time.  The income statement reports how well a company has performed its operations (revenues, expenses, and net income) over a period of time. LO-3

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Financial Statements (cont.)  The retained earnings statement reports how much of the company’s income was retained in the business and how much was distributed to owners over a period of time.  The statement of cash flows reports the sources and uses of a company’s cash over a period of time. LO-3

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Timing of Financial Statements LO-3

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Fundamental Accounting Equation  The fundamental accounting equation captures two basic features of any company.  It shows what a company owns (its assets) must always be equal to what it owes (its liabilities and stockholders’ equity). Assets = Liabilities + Owner’s Equity LO-3

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Fundamental Accounting Equation LO-3 The left side shows the assets, or economic resources of a company. The right side of the accounting equation indicates who has a claim on the company’s assets. Creditor claims are liabilities. Owner claims in the form of stockholders’ equity.

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Classified Balance Sheet  The purpose of the balance sheet is to report the financial position of a company (its assets, liabilities, and stockholders’ equity) at a specific point in time.  The balance sheet is organized, or classified, to help users identify the economic similarities and differences between the various items within the balance sheet. LO-4

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Classified Balance Sheet (cont.) LO-4

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Working Capital  Working capital is a measure of liquidity, computed as: Working capital = Current Assets – Current Liabilities  Working capital signals that a company has adequate funds pay its current obligations LO-4

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Current Ratio  The current ratio is a measure of liquidity that allows comparisons to be made between different companies and is computed as: Current Ratio = Current Assets ÷ Current Liabilities LO-4

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Elements of the Income Statement  The income statement consists of two major elements: revenues and expenses.  Revenues are the increase in assets that result from the sale of products or services.  They include:  Sales/Fees revenue  Interest revenue from investments LO-5

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Elements of the Income Statement (cont.)  Expenses are the cost of resources used to earn revenues during a period. They include:  Cost of goods sold or cost of sales - the cost to the seller of all goods sold  Selling and general administrative expenses – expenses to manage the company that are not direct product or service costs  Research and development expense—the cost of developing new products LO-5

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Income Statement Formats  Companies prepare their income statements in one of two different formats:  Single-step income statements  Multiple-step income statements. LO-5

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Single-Step Income Statement  Two categories: 1. Total revenues 2. Total expenses LO-5

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Income Statement Formats (cont.)  The multiple-step income statement provides classifications of revenues and expenses that financial statement users find useful, with three important subtotals: Gross margin (gross profit)= Net sales – Cost of Goods Sold Income from operations = Gross Margin – Operating Expenses Net income = Income from Operations – (Nonoperating Revenues – Expenses) LO-5

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Using Income Statement Information  A company’s ability to generate current income is useful in predicting its ability to generate future income. LO-5

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Using Income Statement Information (cont.)  Sometimes called return on sales, net profit margin shows the percentage of profit in each dollar of sales computed as: Net profit Margin = Net income ÷ Sales Revenue LO-5

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Retained Earnings Statement  The owners of a company contribute capital in one of two ways: 1. Directly, though purchases of common stock from the company, and 2. Indirectly, by the company retaining some or all of the net income earned each year rather than paying it out in dividends. LO-6

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Retained Earnings Statement (cont.)  The income earned by the company but not paid out as dividends is called retained earnings.  The retained earnings statement summarizes and explains the changes in retained earnings. LO-6

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Use of the Retained Earnings Statement  The retained earnings statement is used to monitor and evaluate a company’s dividend payouts to its shareholders.  Creditors are interested in a company’s dividend payouts. LO-6

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Statement of Cash Flows and Its Elements  The statement of cash flows describes the company’s cash receipts (cash inflows) and cash payments (cash outflows) for a period of time. LO-7

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Statement of Cash Flows and Its Elements (cont.) 1. Cash flows from operating activities—Cash flows from operating activities—any cash flows directly related to earning income. 2. Cash flows from investing activities—any cash flow related to the acquisition or sale of investments and long-term assets such as property, plant, and equipment. 3. Cash flows from financing activities—any cash flow related to obtaining capital of the company. LO-7

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Use of the Statement of Cash Flows (cont.)  A company with healthy cash flow—particularly if it comes from operating activities—is in a good position to repay debts as they come due and is usually a low-risk borrower.  Stockholders are also interested in the adequacy of cash flows as an indicator of the company’s ability to pay dividends and to expand its business. LO-7

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Relationship Among the Statements LO-8

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Guidelines in Ethical Decision Making LO-9