©2004 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 1 The Financial Statements Chapter 1

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 2 Learning Objective 1 Use accounting vocabulary for decision making.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 3 Accounting – The Language of Business An information system that...  measures business activities  processes data into reports  communicates results to decision makers

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 4 Individuals Who Uses Accounting Information? Businesses Investors and creditors Government regulatory agencies Taxing authorities Nonprofit organizations

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 5 Financial and Management Accounting  External Users  Internal Users

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 6 Ethics in Accounting and Business  Standards of professional conduct for accountants  AICPA’s Code of Professional Conduct

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 7 Business Organizations  Proprietorships  Partnerships  Corporations

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 8 Learning Objective 2 Apply accounting concepts and principles

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 9 Accounting Principles and Concepts  GAAP –Generally Accepted Accounting Principles –Rules that govern accounting:  Some accounting rules have generally acceptance due to the test of time, e.g. accounting for depreciation of fixed assets  The Financial Accounting Standards Board establishes accounting principles for morecomplex issues

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 10 The Entity Concept  An accounting entity is an organization that stands apart as a separate economic unit.  That is, the financial affairs of a business owner should be accounted for separately from the owner’s personal financial activities

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 11 The Reliability Principle  Data is reliable if: –It is verifiable –It can be confirmed by an independent observer

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 12 The Cost Principle  Assets and services acquired should be recorded at their actual (historical) cost.  This can result in some “Alice in Wonderland” disclosures on the balance sheet  An example: a square block of land purchased in downtown Dallas for $10,000 in 1930 would still be reported on the balance sheet at $10,000, even though its fair value today is $10 million!

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 13 The Going-Concern Concept  The entity will continue remain in operation for the foreseeable future.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 14 The Stable-Monetary-Unit Concept  The dollar’s purchasing power is stable

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 15 Learning Objective 3 Use the accounting equation to describe an organization.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 16 The Accounting Equation Assets = Liabilities + Owner’s Equity Economic Resources Claims to Economic Resources

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 17 Assets Economic resources that are expected to produce a benefit in the future

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 18 Liabilities Economic obligations (debt) of a business

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 19 Owner’s Equity The owner’s claim on the entity’s assets Capital (for a partnership or sole proprietorship) Capital (for a partnership or sole proprietorship) Stockholders’ equity (for a corporation) Stockholders’ equity (for a corporation) Assets – liabilities = owner’s equity

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 20 Stockholders’ Equity  For a corporation, stockholders’ equity is divided into two main categories: –Paid in capital –Retained earnings.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 21 The Accounting Equation  Paid-in capital: amount invested by its owners, i.e. common stock.  Retained earnings: amount earned by income-producing activities and kept for use in the business Assets = Liabilities + Paid-in capital + Retained earnings

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 22 The Accounting Equation  Revenues (sales) are increases in retained earnings from delivering goods or services to customers  Expenses are decreases in retained earnings that result from operations

Components of Retained Earnings Revenues for the period – Expenses for the period = Net income (or Net loss) for the period Dividends for the period Ending balance of retained earnings End of the period Start of the period Beginning balance of retained earnings + or – –=

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 24 Learning Objective 4 Evaluate operating performance, financial position, and cash flows.

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 25 Income Statement How well did the company perform during the month? Revenues Revenues – Expenses Net Income (Loss)

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 26 Statement of Retained Earnings Why did the company's retained earnings change during the year? Beginning retained earnings +Net income (-Net loss) -Dividends Ending retained earnings

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 27 Balance Sheet What is the company’s financial position at the end of a period? Assets = Liabilities + Owner’s Equity

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 28 Statement of Cash Flows How much cash did the company generate and spend during the year? Operating cash flows + Investing cash flows + Financing cash flows Increase (decrease) in cash Which of these three cash flow components is most crucial to a business’s success?

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 29 Learning Objective 5 Explain the relationships among the financial statements.

Relationships Among the Financial Statements ABC Company Income Statement – Year Ended December 31, 2006 Revenues $700,000 Expenses 670,000 Net income$ 30,000

Relationships Among the Financial Statements ABC Company Statement of Retained Earnings Year Ended December 31, 2006 Beginning retained earnings$180,000 Net income 30,000 Cash dividends (10,000) Ending retained earnings$200,000

Relationships Among the Financial Statements ABC Company Balance Sheet December 31, 2006 Assets Cash$ 25,000 All other assets 275,000 Total assets$300,000 Liabilities Total liabilities$120,000 Stockholders’ equity Common stock 40,000 Retained earnings 200,000 Other equity (60,000) Total liabilities and stockholders’ equity$300,000

Relationships Among the Financial Statements ABC Company Statement of Cash Flows Year Ended December 31, 2006 Net cash provided by operating activities$ 90,000 Net cash used for investing activities(110,000) Net cash provided by financing activities 40,000 Net increase in cash 20,000 Beginning cash balance 5,000 Ending cash balance$ 25,000

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 34 Be Sure to Study the Yum! Brands, Inc. discussion Chapter 1 to Better Understand the Financial Statement Relationships

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 35 A Few final Words about Homework Assignments  Homework solutions are readily available to students  Used correctly, these can be helpful  Used incorrectly, they can be even more harmful!

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 36 How to Make an A or B in this Course  This is a homework problem-based course, but you don’t have to be a math wizard!  Make a good effort to do the exercises and problems WITHOUT ANY REFERENCE TO AVAILABLE SOLUTIONS MATERIALS  When I cover the problems in class, make notes of what you did wrong in your solutions  Within 24 hours, reconcile what you did wrong with reference to my in class solutions, and, if necessary, the solutions manual materials

©2006 Prentice Hall Business Publishing Financial Accounting, 6/e Harrison/Horngren 37 How to Make a C or Worse  Miss classes and don’t study properly  Get behind in the class  Listen to people who got bad grades in ACCT in previous semesters because they missed classes and didn’t study well  Go directly to the solutions materials for exercises and problems without having made a good attempt  If you do the latter, “You won’t know what you didn’t know!” and will not learn effectively