© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin BASIC FINANCIAL STATEMENTS Chapter 2

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Previous Lecture Accounting information is for decision maker which enable them to make economic activities. Types of business Types of organizations & theirs plus & minus Business Stakeholders Internal : Owners, managers, employees External: Customers, creditors, government

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Types of Accounting Information Financial, Managerial, Tax Types of Business Activities Financing, Investing, Operating Types of Financial Statement Statement of earnings Statement of retained earnings Balance sheet Cash flow statement

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Conceptual Framework of Accounting Guides choices about – what to present in financial statements – decisions about alternative ways of reporting economic events – the selection of appropriate ways of communicating such information Chapter 2 4

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Conceptual Framework of Accounting Four main sections – Objective of financial reporting – Qualitative characteristics of accounting information – Elements of financial statements – Recognition and measurement criteria Chapter 2 5

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 6 Objective of Financial Reporting To provide information that is useful to individuals who are making investment and credit decisions

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 7 Qualitative Characteristics To be useful for decision-making, information should have these qualitative characteristics – Relevance – Faithful representation – Comparability – Understandability

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 8 Relevance – Information is relevant if it makes a difference in a decision. It is said to have predictive value, feedback value, and timeliness Faithful representation – Information should reflect economic reality. It must be verifiable, neutral, and complete Qualitative Characteristics of Accounting Information

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 9 Qualitative Characteristics of Accounting Information Comparability – Accounting information can be compared when companies with similar circumstances use the same accounting standards consistently from year to year Understandability – Average user is assumed to understand the accounting information

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Elements of Financial Statements Assets Liabilities Equity Revenues Expenses Chapter 2 10

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Recognition and Measurement Criteria Accountants need detailed criteria to help them decide when and where an item is included in the financial statements. Includes – Assumptions – Principles – Constraints Chapter 2 11

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Assumptions Monetary unit Economic entity Time period Going concern Chapter 2 12

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Monetary Unit Assumption Only those things that can be expressed in terms of money should be included in the accounting records Important presumption is that the monetary unit remains stable over time and the effects of inflation are nominal Chapter 2 13

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 14 Economic Entity Every economic entity can be separately identified and accounted for Personal items relating to shareholders are not accounted for by the business

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Chapter 2 15 Time Period Assumption The economic life of a business can be divided into artificial time periods

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Going Concern Assumption The business will continue operating in the foreseeable future Justifies the use of the cost principle Chapter 2 16

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Companies prepare interim financial statements and annual financial statements 2000 X

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Three primary financial statements. Income Statement Balance Sheet Statement of Cash Flows We will use a corporation to describe these statements.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Describes where the enterprise stands at a specific date. Income Statement Balance Sheet Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Depicts the revenue and expenses for a designated period of time. Income Statement Balance Sheet Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Revenues result in positive cash flow. Expenses result in negative cash flow. Either in the past, present, or future.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Net income (or net loss) is simply the difference between revenues and expenses. Income Statement Balance Sheet Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Introduction to Financial Statements Depicts the ways cash has changed during a designated period of time. Income Statement Balance Sheet Statement of Cash Flows

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin The Concept of the Business Entity Vagabond Travel Agency A business entity is separate from the personal affairs of its owner.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin A Starting Point: Statement of Financial Position

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Assets Assets are economic resources that are owned by the business and are expected to provide positive future cash flows.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Assets Cost Principle Going-Concern Assumption Objectivity Principle Stable-Dollar Assumption These accounting principles support cost as the basis for asset valuation.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Liabilities Liabilities are debts that represent negative future cash flows for the enterprise.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Owners’ Equity Owners’ equity represents the owner’s claim to the assets of the business.

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin Owners’ Equity Changes in Owners’ Equity Owners’ Investments Business Earnings Payments to Owners Business Losses

© The McGraw-Hill Companies, Inc., 2002 McGraw-Hill/Irwin End of Todays session