1. Needles Powers Crosson Financial and Managerial Accounting 10e Uses of Accounting Information and the Financial Statements 1 C H A P T E R © human/iStockphoto ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

2. LEARNING OBJECTIVES ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  LO1: Define accounting, explain the concepts underlying accounting measurement, explain the three forms of business entities, and describe the characteristics of a corporation.  LO2: Define financial position, and state the accounting equation.  LO3: Identify the four basic financial statements and their interrelationships.  LO4: Explain how generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS) relate to financial statements and the independent CPA’s report, and identify the organizations that influence GAAP.  LO5: Identify the users of accounting information, and identify business goals, activities, and performance measures.  LO6: Explain the importance of ethics in financial reporting.

3. SECTION 1: CONCEPTS ©2014 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 measurement: measuring business activities by recording data about them for future use  Business transactions: economic events that affect a business’s financial position  Money measure: the concept that all business transactions are recorded in terms of money  Separate entity: the concept that a business organization is distinct from its owners, creditors, and customers  Assets: economic resources that are expected to benefit the company’s future operations  Liabilities: a business’s obligations to pay cash, transfer assets, or provide services to other entities in the future  Stockholders’ equity: the claims by the owners of a corporation (the stockholders) to the assets of the business

4. Concepts Underlying Accounting Measurement  Accounting is an information system that measures, processes, and communicates financial information about a business or other economic entity. –An economic entity is a unit that exists independently, such as a business, hospital, or governmental body. –As shown on the next slide, accounting is a link between business activities and decision makers. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

5. Accounting as an Information System ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

6. Financial and Managerial Accounting (slide 1 of 2) - External decision makers use financial accounting to evaluate how well a business has achieved its goals.  These reports, called financial statements, are a central feature of accounting. They report on a business’s financial performance. - Internal decision makers use information provided by managerial accounting about operating, investing, and financing activities.  It provides managers and employees with information about how they have done in the past and what they can expect in the future. ©2014 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 is usually divided into financial accounting and managerial accounting.

7. Financial and Managerial Accounting (slide 2 of 2)  It is important to distinguish accounting from bookkeeping and management information systems. –Bookkeeping is the process of recording financial transactions and keeping financial records. It is mechanical and repetitive and is usually handled by computers. –Management information systems (MIS) consist of the interconnected business subsystems, including accounting, that provide the information needed to run a business. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

8. Accounting Measurement  To make an accounting measurement, the accountant must answer four basic questions: –What is measured? –When should the measurement be made? –What value should be placed on what is measured? –How should what is measured be classified? ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

9. Business Transactions  Business transactions are economic events that affect a business’s financial position. –A transaction can be an exchange of value (a purchase, sale, payment, collection, or loan) between two or more parties. –A transaction also can be an economic event that does not involve an exchange, such as losses from fire, flood, explosion, and theft; physical wear and tear on machinery and equipment; and the day-by-day accumulation of interest. –To be recorded, a transaction must relate directly to a business entity. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

10. Money Measure  All business transactions are recorded in terms of money. This concept is called money measure. –The monetary unit a business uses depends on the country in which the business resides. In the United States, the basic unit of money is the dollar. –In international transactions, exchange rates must be used to translate from one currency to another. An exchange rate is the value of one currency in terms of another. –The next slide illustrates the exchange rates of several currencies in dollars. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

11. Examples of Foreign Exchange Rates ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

12. Separate Entity  For accounting purposes, a business organization is a separate entity, distinct not only from its creditors and customers but also from its owners. –It should have its own set of financial records, and its records and reports should refer only to its own affairs. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

13. Forms of Business Organization (slide 1 of 2)  Three basic forms of business organization are recognized as separate entities. –Sole proprietorship—a business owned by 1 person  The owner takes all the profits or losses of the business and is liable for all its obligations. –Partnership—a business with 2 or more owners  The partners share the profits or losses according to a prearranged formula.  A partnership must be dissolved if a partner leaves or dies.  The partners have unlimited liability, which can be avoided by organizing as a limited liability partnership (LLP). ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

14. Forms of Business Organization (slide 2 of 2) –Corporation—a business unit chartered by the state and legally separate from its owners  The owners are called stockholders because their ownership is represented by shares of stock.  The stockholders do not directly control the corporation’s operations but elect a board of directors to run the corporation for their benefit.  Stockholders enjoy limited liability, which means that their risk of loss is limited to the amount they paid for their shares.  Stockholders can sell their shares without dissolving the corporation, so the life of a corporation is unlimited. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

15. Number and Receipts (Revenues) of U.S. Proprietorships, Partnerships, and Corporations ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

16. Formation and Organization of a Corporation  To form a corporation, most states require incorporators to sign an application and file it with the proper state official. –This application contains the articles of incorporation, which form the company charter. –The authority to manage a corporation is delegated by its stockholders to a board of directors and by the board of directors to the corporation’s officers, as shown below. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

17. Stockholders  A unit of ownership in a corporation is called a share of stock. –The articles of incorporation state the maximum number of shares that a corporation is authorized to issue. –The number of shares held by stockholders is the outstanding stock. –To invest in a corporation, a stockholder transfers cash or other resources to the corporation and receives shares of stock in return. –Corporations may have more than one kind of stock, but here we refer only to common stock. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

18. Board of Directors  A corporation’s board of directors decides on major business policies, authorizes contracts, sets executive salaries, and arranges major loans with banks. –The oversight of a corporation’s management and ethics by its board of directors is known as corporate governance.  To strengthen corporate governance, the Sarbanes-Oxley Act requires boards of directors to establish an audit committee made up of the independent directors (those directors who do not directly participate in managing the business) who have financial expertise. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

19. Management  Management consists of the operating officers— generally the president or chief executive officer; vice presidents; chief financial officer; and chief operating officer. –It is appointed by the board of directors to carry out corporate policies and run day-to-day operations. –It also has the duty of reporting the financial results of its administration to the board of directors and the stockholders. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

21. Concepts Underlying Financial Position (slide 1 of 2)  Financial position refers to a company’s economic resources, such as cash, inventory, and buildings, and the claims against those resources at a particular time. Another term for claims is equities.  Every corporation has two types of equities: creditors’ equities, such as bank loans, and stockholders’ equity. The sum of these equities equals a company’s resources: Economic Resources = Creditors’ Equities + Stockholders’ Equity ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

22. Concepts Underlying Financial Position (slide 2 of 2)  In accounting terminology, economic resources are called assets and creditors’ equities are called liabilities, so the equation can be written: Assets = Liabilities + Stockholders’ Equity – This equation is known as the accounting equation (A = L + SE). – The two sides of the equation must always be equal, or “in balance,” as shown on the next slide. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

23. The Accounting Equation ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

24. Assets  Assets are the economic resources that are expected to benefit the company’s future operations. They include: –monetary items (cash and money owed to the company by customers) –nonmonetary, physical items (inventories, land, buildings, equipment) –nonphysical items (rights granted by patents, trademarks, and copyrights) ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

25. Liabilities  Liabilities are a business’s present obligations to pay cash, transfer assets, or provide services to other entities in the future. They include: –amounts owed to suppliers for goods or services bought on credit (called accounts payable) –borrowed money such as bank loans –salaries and wages owed to employees –taxes owed to the government –services to be performed ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

26. Stockholder’s Equity (slide 1 of 3)  Stockholders’ equity (or shareholders’ equity) represents the claims by the owners of a corporation (the stockholders) to the assets of the business. –Theoretically, stockholders’ equity is what would be left if all liabilities were paid. –It is sometimes said to equal net assets (or net worth). –We can define stockholders’ equity this way: Stockholders’ Equity = Assets − Liabilities ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

27. Stockholders’ Equity (slide 2 of 3)  Stockholders’ equity has two parts: - Contributed capital—the amount that stockholders invest in the business. It is typically divided between:  Par value—an amount per share that when multiplied by the number of common shares becomes the corporation’s common stock amount  Additional paid-in capital—the amount over par value, when the value received is greater than par value - Retained earnings—earnings of the corporation since its inception, less any losses, dividends, or transfers to contributed capital ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

28. Stockholders’ Equity (slide 3 of 3)  Revenues and expenses are the increases and decreases in stockholders’ equity that result from operating a business. – When revenues exceed expenses, the difference is called net income. – When expenses exceed revenues, the difference is called net loss. – Retained earnings is the accumulated net income minus dividends over the life of a business.  Dividends are distributions of resources, generally in the form of cash, to stockholders. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

30. SECTION 2: ACCOUNTING APPLICATIONS  Describe the income statement  Describe the statement of retained earnings  Describe the balance sheet  Describe the statement of cash flows ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

31. Financial Statements ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.  Four major financial statements are used to communicate accounting information: the income statement, the statement of retained earnings, the balance sheet, and the statement of cash flows.

32. Income Statement  The income statement summarizes the revenues earned and expenses incurred by a business over an accounting period. –Many people consider it the most important financial report because it shows whether a business achieved its profitability goal—that is, whether it earned an acceptable income. –To show the period to which the statement applies, it is dated “For the [Month/Year] Ended [Date]” ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

33. Income Statement for Roland Consultancy ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

34. Statement of Retained Earnings  The statement of retained earnings shows the changes in retained earnings over an accounting period. –As shown on the next slide, beginning retained earnings for Roland Consultancy is zero because the company began operations in this period. –Dividends are deducted from the net income for the month to arrive at the ending balance. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

35. Statement of Retained Earnings for Roland Consultancy ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

36. Balance Sheet  The purpose of a balance sheet is to show the financial position of a business on a certain date, usually the end of a month or year. –For this reason, it is often called the statement of financial position. –The date on the balance sheet is a single date, whereas the dates on the other three statements cover a period of time. –The amount of the retained earnings account on the balance sheet comes from the ending balance on the statement of retained earnings. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

37. Balance Sheet for Roland Consultancy ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

38. Statement of Cash Flows  The statement of cash flows focuses on liquidity, that is, balancing the inflows and outflows of cash to enable the business to operate and pay its bills when they are due. –Cash flows are the inflows and outflows of cash into and out of a business. –The statement of cash flows is organized according to three major business activities:  Cash flows from operating activities  Cash flows from investing activities  Cash flows from financing activities ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

39. Statement of Cash Flows for Roland Consultancy ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

40. Relationships Among the Financial Statements  As shown on the next slide, the statement of cash flows is related directly to the other three financial statements. –Net income comes from the income statement. –Dividends come from the statement of retained earnings. –The other items in the statement represent changes in the balance sheet accounts.  The heading at the top of each statement identifies the company and the kind of statement. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

41. Income Statement, Statement of Retained Earnings, Balance Sheet, and Statement of Cash Flows for Roland Consultancy ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

43. Generally Accepted Accounting Principles  To ensure that financial statements are understandable to their users, a set of generally accepted accounting principles (GAAP) has been developed to provide guidelines for financial accounting. –They encompass the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time. –They evolve to meet the needs of decision makers, and they change as circumstances change or as better methods are developed. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

44. GAAP and the Independent CPA’s Report  Many companies of all sizes have their financial statements audited by an independent certified public accountant (CPA). –Independent means that the CPA is not an employee of the company being audited and has no financial or other compromising ties to it. –An audit is an examination of a company’s financial statements and the accounting systems, controls, and records that produced them. It ascertains that the statements were prepared in accordance with GAAP. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

45. Large International Certified Public Accounting Firms ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

46. Organizations That Issue Accounting Standards  Two organizations issue accounting standards that are used in the United States: –The Financial Accounting Standards Board (FASB) has been designated by the Securities and Exchange Commission (SEC) to issue Statements of Financial Accounting Standards. –The International Accounting Standards Board (IASB) issues international financial reporting standards (IFRS). The SEC allows foreign companies to use these standards in the United States. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

47. Other Organizations That Influence GAAP (slide 1 of 2)  The Public Company Accounting Oversight Board (PCAOB) is a governmental body that has wide powers to determine the standards that auditors must follow.  The American Institute of Certified Public Accountants (AICPA) is the primary professional organization of certified public accountants.  The Securities and Exchange Commission (SEC) is a governmental agency that has the legal power to set and enforce accounting practices for companies whose securities are offered for sale to the general public. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

48. Other Organizations That Influence GAAP (slide 2 of 2)  The Governmental Accounting Standards Board (GASB) is a separate but related body to the FASB that issues accounting standards for state and local governments.  The Internal Revenue Service (IRS) interprets and enforces the tax laws that specify the rules for determining taxable income. In some cases the rules conflict with good accounting practice, but they are important nonetheless. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

49. Professional Conduct (slide 1 of 2)  The code of professional ethics of the American Institute of Certified Public Accountants governs the conduct of CPAs. The code requires CPAs to act with: –Integrity—be honest and candid and subordinate personal gain to service and the public trust. –Objectivity—be impartial and intellectually honest. –Independence—avoid all relationships that impair or appear to impair objectivity. –Due care—carry out professional responsibilities with competence and diligence. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

50. Professional Conduct (slide 2 of 2)  The Institute of Management Accountants (IMA), the primary professional association of managerial accountants, has a code of professional conduct that emphasizes that these accountants have a responsibility: –To be competent in their jobs –To keep information confidential unless authorized or legally required to disclose it –To maintain integrity and avoid conflicts of interest –To communicate information objectively, without bias ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

52. SECTION 3: BUSINESS APPLICATIONS  Profitability: the ability to earn enough income to attract and hold investment capital  Liquidity: the ability to have enough cash to pay debts when they are due  Ethics: a code of conduct that addresses the question of whether actions are right or wrong ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

53. Decision Makers: The Users of Accounting Information  The people who use accounting information to make decisions fall into three categories: managers (internal users), outsiders who have a direct financial interest in the business, and outsiders who have an indirect financial interest. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

54. Management  Management is responsible for ensuring that a company meets its goals of profitability and liquidity.  To make good decisions, managers need to answer such questions as: –What were the company’s earnings during the past quarter? –Is the rate of return to the owners adequate? –Does the company have enough cash? –Which products or services are most profitable? ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

55. Users with a Direct Financial Interest  Investors—stockholders who have invested in the company—have a direct financial interest in the success of their companies.  Creditors—those who lend money or deliver goods or services before being paid—are interested mainly in whether a company will have the cash to pay interest charges and to repay the debt on time. They study a company’s cash flow to determine its liquidity. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

56. Users with an Indirect Financial Interest  Tax authorities—federal, state, and local  Regulatory agencies—such as the SEC for publicly traded corporations  Labor unions  Advisors of investors and creditors  Consumer groups, customers, the general public  Economic planners—such as the President’s Council of Economic Advisers ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

57. Governmental and Not-for-Profit Organizations  These include hospitals, universities, professional organizations, and charities.  Their functions include: –raising funds from investors, creditors, taxpayers, and donors –deploying scarce resources –planning how to pay for operations and to repay creditors on a timely basis –reporting their financial performance to legislators, boards, and donors ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

58. Business Goals and Activities (slide 1 of 2)  A business is an economic unit that aims to sell goods and services at prices that will provide an adequate return to its owners.  The two major goals of all businesses are: –Profitability—the ability to earn enough income to attract and hold investment capital –Liquidity—the ability to have enough cash to pay debts when they are due ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

59. Business Goals and Activities (slide 2 of 2)  All businesses pursue their goals by engaging in the following activities: –Operating activities—buying, producing, and selling goods and services; hiring managers and other employees; paying taxes –Investing activities—buying resources for operating the business, such as land, buildings, and equipment; selling those resources when no longer needed –Financing activities—obtaining capital from creditors and from the company’s stockholders; repaying creditors; paying a return to stockholders ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

60. Business Goals and Activities ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

61. Financial Analysis  Financial analysis is the use of financial statements to determine that a business is well managed and is achieving its goals.  The effectiveness of financial analysis depends on: –Performance measures: Profitability is commonly measured in net income, and liquidity is commonly measured by cash flows. –Financial ratios: The ratio of earnings to total assets can be used to assess profitability, and the ratio of cash flows to total assets can be used to assess liquidity. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

63. Ethical Financial Reporting (slide 1 of 2)  Ethics is a code of conduct that addresses the question of whether actions are right or wrong. –Ethics is especially important in preparing financial reports because users must be able to trust that the reports are accurate and disclose all relevant facts. –The intentional preparation of misleading financial statements is called fraudulent financial reporting and can result from distortion of records, falsified transactions, and misapplication of various accounting principles. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

64. Ethical Financial Reporting (slide 2 of 2)  In response to the accounting scandals at Enron Corporation and WorldCom, the Sarbanes-Oxley Act of 2002 was passed. –It regulates the financial reporting of public companies and their auditors. –It requires chief executives and chief financial officers of all publicly traded U.S. companies to swear that, based on their knowledge, their quarterly statements and annual reports filed with the SEC are accurate and complete. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.