1-1 Electronic Presentation by Douglas Cloud Pepperdine University FINANCIAL ACCOUNTING WARREN REEVE FOR FUTURE BUSINESS LEADERS

1-2 Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.

1-3 The Role of Accounting in Business Chapter 1

1-4 1.Describe the types and forms of businesses, business strategies, value chains, and stakeholders. 2.Describe the three business activities of financing, investing, and operating. 3.Define accounting and its role in business. 4.Describe and illustrate the basic financial statements and how they interrelate. 5.Describe eight basic accounting concepts underlying financial reporting. 6.Describe and illustrate how horizontal analysis can be used to evaluate a company’s performance. Learning Goals After studying this chapter, you should be able to:

1-5 1 Learning Goal Describe the types and forms of businesses, business strategies, value chains, and stakeholders.

1-6 Product Product General MotorsAutomobiles, trucks, vans General MillsBreakfast cereals BoeingJet aircraft NikeAthletic shoes Coca-ColaBeverages SonyStereos, televisions, radios General MotorsAutomobiles, trucks, vans General MillsBreakfast cereals BoeingJet aircraft NikeAthletic shoes Coca-ColaBeverages SonyStereos, televisions, radios Manufacturing Business` Types of Businesses

1-7 Merchandising Business Product Product Wal-MartGeneral merchandise Toys”R”UsToys Barnes & NobleBooks Best BuyConsumer electronics Amazon. ComBooks Types of Businesses

1-8 Product Product DisneyEntertainment Delta Air LinesTransportation Marriott HotelsHospitality and lodging Merrill LynchFinancial advice SprintTelecommunication DisneyEntertainment Delta Air LinesTransportation Marriott HotelsHospitality and lodging Merrill LynchFinancial advice SprintTelecommunication Service Business Types of Businesses

1-9 There are three forms of business organizations Proprietorship Partnership Corporation

1-10 A proprietorship is owned by one individual. Advantages Ease in organizing Low cost of organizing Disadvantage Limited source of financial resources Unlimited liability Doug’s

1-11 A partnership is owned two or more individuals. Advantages More financial resources than a proprietorship. Additional management skills. Disadvantage Unlimited liability. Doug and Max’s

1-12 A corporation is organized under state or federal statutes as a separate legal entity. Advantage The ability to obtain large amounts of resources issuing stocks. Disadvantage Double taxation. D & M Inc.

1-13 Total Companies Business Ownership in America

1-14 Business Strategy A business strategy is an integrated set of plans and actions designed to enable the business to gain an advantage over its competitors, and to maximize profits.

1-15 Differential Strategy Under a differential strategy, a business designs and produces a product or service that possess unique attributes or characteristics for which customers are willing to pay a premium price.

1-16 Business Stakeholders A business stakeholder is a person or entity that has an interest in the economic performance and well- being of a business.

1-17 STAKEHOLDERS Internal: Stockholders Managers Employees External: Suppliers Customers Stockholders Business Stakeholders

1-18 Business Stakeholders Interest in the Business Examples Capital market Providers of majorBanks, owners, stakeholderfinancing for the stockholders business Product or service Buyers of products Customers and market stakeholdersor services and vendorssuppliers to the business Government Collect taxes and feesFederal, state, and stakeholderfrom the business andcity governments its employees Initial stakeholders Individuals employed Employees and by the businessmanagers

Learning Goal Describe the three business activities of financing, investing, and operating.

1-20 Financing Activities Financing activities involve obtaining funds to begin and operate a business.

1-21 Financing Activities Businesses seek financing by: borrowing issuing shares of ownership

1-22 Financing Activities A liability is a legal obligation to repay the amount borrowed according to the terms of the borrowing agreement.

1-23 Financing Activities Samples of Liabilities Accounts payable: When a business buys a service or product on service. Bonds payable: When a business borrows money by issuing bonds. Interest payable: Any interest that is due on a note or a bond. Note payable: When a business issues commercial paper or borrows on a line of credit.

1-24 Financing Activities A business may also finance its operations by issuing shares of stock. The basic type of stock is called common stock.

1-25 Investing Activities Investing activities involve the selection and management of long-term resources that will be used to develop, produce, and sell goods and services.

1-26 Investing Activities Assets are resources that the business owns or otherwise under its legal control and available for use in the future. What are assets?

1-27 Investing Activities When the business sells merchandise or services to a customer, the right to collect is an accounts receivable.

1-28 Operating Activities Revenue is the increase in assets from selling products or services. Revenue is often identified according to their source, such as Rent Revenue. What is revenue?

1-29 Operating Activities An expense is a decrease in assets or an increase in liabilities from producing and delivering goods or providing services that constitute the primary operating activities of an organization. What is an expense?

1-30 Revenues - Expenses = Net Income Revenues - Expenses = Net Income Operating Activities = Net Loss

1-31 Define accounting and its role in business. 3 Learning Goal

1-32 What is accounting? Accounting is an information system that provides reports to stakeholders about the economic activities and condition of a business.

1-33 Major objectives of financial accounting 1.To report the financial condition of a business at a point in time. 2.To report changes in the financial condition of a business over a period of time.

1-34 Describe and illustrate the basic financial statements and how they interrelate. 4 Learning Goal

1-35 Income Statement An income statement is a summary of the revenue and the expenses for a specific period of time. Objective:Objective: Reports change in financial condition

1-36 Income Statement Hershey Foods Corporation Income Statement For the Year Ended December 31, 2001 (in thousands) Revenues: Sales$4,557,241 Expenses: Cost of sales$2,665,566 Selling and administrative1,269,964 Other expenses209,077 Interest69,093 Income taxes 136,385 4,350,085 Net income$ 207,156 Note that the time period for the statement is in the heading.

1-37 Retained Earnings Statement The retained earnings statement reports changes in financial condition due to changes in retained earnings. Objective:Objective: Reports change in financial condition

1-38 Retained Earnings Statement Hershey Foods Corporation Retained Earnings Statement For the Year Ended December 31, 2001 (in thousands) Retained earnings, January 1, 2001$2,702,927 Add net income$207,156 Less dividends 154,750 Increase in retained earnings 52,406 Retained earnings, December 31, 2001$2,755,333 From the income statement Again, note the time period

1-39 Balance Sheet The balance sheet reports the financial condition as of a point in time. Objective:Objective: Reports financial condition

1-40 Balance Sheet Assets = (Claims) Rights to the Assets

1-41 Balance Sheet Assets = Liabilities Stock- holders’ Equity + The rights of creditors The rights of the stockholders The Accounting Equation

1-42 Balance Sheet Hershey Foods Corporation Balance Sheet December 31, 2001 (in thousands) Assets Cash$ 134,147 Accounts receivable361,726 Inventories512,134 Prepaid expenses62,595 Property, plant, and equipment1,534,901 Intangibles429,128 Other assets 212,799 Total assets$3,247,430 ContinuedContinued Note that the date is a specific point in time

1-43 Liabilities Accounts payable$ 133,049 Accrued liabilities462,901 Notes and other debt1,245,939 Income taxes 258,337 Total liabilities$2,100,226 Stockholders’ Equity Capital stock$ 183,213 Retained earnings2,755,333 Repurchased stock and other equity items (1,791,342) Total stockholders’ equity$1,147,204 Total liabilities and stockholders’ equity$3,247,430 Matches total assets

1-44 Statement of Cash Flows The statement of cash flows reports the changes in financial condition due to the changes in cash during a period. Objective:Objective: Reports change in financial condition

1-45 Statement of Cash Flows Three categories on the statement of cash flow are: 1.Operating activities 2.Investing activities 3.Financing activities

1-46 Hershey Foods Corporation Statement of Cash Flows For the Year Ended December 31, 2001 (in thousands) Net cash flows from operating activities$ 706,405 Cash flows from investing activities: Investments in property, plant, and equipment$(187,029) Proceeds from sale of property, plant, and equipment 63,042 Net cash flows used in investing activities$(123,987) Cash flows from financing activities: Cash receipts from financing activities, including debt$ 30,589 Dividends paid to stockholders(154,750) Repurchase of stock(40,322) Other, including repayment of debt (315,757) Net cash flows used in financing activities$(480,240) Net increase in cash during 2001$ 102,178 Cash as of January 1, ,969 Cash as of December 31, 2001$ 134,147 Note the time period 1-46

1-47 Describe eight basic accounting concepts underlying financial reporting. 5 Learning Goal

1-48 The business entity concept limits the economic data in the accounting system to data related directly to the activities of the business. The cost concept determines the amount initially entered into the accounting records for purchases. Accounting Concepts

1-49 Accounting Concepts A business normally expects to continue operating for an indefinite period of time. This is known as the going concern concept. Under the matching concept, revenues for a period are matched with the expenses incurred in generating the revenue. The objectivity concept requires that entries in the accounting records and the data reported on financial statements be based on objective evidence.

1-50 Accounting Concepts The unit of measure concept requires that all economic data be recorded in dollars. Financial statements should contain all relevant data a reader needs to understand the financial condition and performance of a business. This is the adequate disclosure concept. The accounting period concept is the process in which accounting data are recorded and summarized in financial statements.

1-51 Financial History of a Business DEC Balance Sheet Dec. 31, 2003 Income statement for the year ended December 31, 2003 Next slide

1-52 Financial History of a Business DEC Balance Sheet Dec. 31, 2004 Income statement for the year ended December 31, 2004 Next slide

1-53 Financial History of a Business DEC Balance Sheet Dec. 31, 2005 Income statement for the year ended December 31, 2005

1-54 Describe and illustrate how horizontal analysis can be used to analyze and evaluate a company’s performance. 6 Learning Goal

1-55 Horizontal Analysis Hershey Foods Corporation Income Statement For the Year Ended December 31, 2001 and 2000 (in thousands) Sales$4,557,241$4,220,976$336,265 Cost of sales 2,665,566 2,471, ,415 Gross profit$1,891,675$1,749,825$141,850 Selling and admin. expenses 1,269,964 1,127, ,789 Operating income before taxes$ 621,711$ 622,650$ (939) Amount Percent $336,265 $4,220, %

1-56 Horizontal Analysis Hershey Foods Corporation Income Statement For the Year Ended December 31, 2001 and 2000 (in thousands) Sales$4,557,241$4,220,976$336,265 Cost of sales 2,665,566 2,471, ,415 Gross profit$1,891,675$1,749,825$141,850 Selling and admin. expenses 1,269,964 1,127, ,789 Operating income before taxes$ 621,711$ 622,650$ (939) Amount Percent $194,415 $2,471, % 7.9%

1-57 Horizontal Analysis Hershey Foods Corporation Income Statement For the Year Ended December 31, 2001 and 2000 (in thousands) Sales$4,557,241$4,220,976$336,265 Cost of sales 2,665,566 2,471, ,415 Gross profit$1,891,675$1,749,825$141,850 Selling and admin. expenses 1,269,964 1,127, ,789 Operating income before taxes$ 621,711$ 622,650$ (939) Amount Percent 8.0% 7.9% 8.1% 12.7% (0.2)%

1-58 The End Chapter 1

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