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Overview of the Financial Statements
Chapter 2 Overview of the Financial Statements
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The Need for Financial Statements
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Financial Disclosure Benefits
Enhances decision-making Reduces risk Reduces risk lowers cost Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Three Primary Financial Statements
Balance Sheet Income Statement Statement of Cash Flows Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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The Balance Sheet
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The Balance Sheet Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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The Balance Sheet Presents the financial position of a company at a particular point in time. Three categories: Assets Liabilities Owners’ Equity Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Assets Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. likely to occur Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Assets Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. assets have implications for the future Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Assets Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. substance rules over legal form Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Assets Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Liabilities Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. includes legal and implied commitments Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Liabilities Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. the obligation can involve either type of future event Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Liabilities Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. have already happened Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Liabilities Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Owners’ Equity The residual interest in the assets of an entity that remains after deducting liabilities Also known as net assets Creditors legally have first claim to assets The owners’ equity of a corporation is referred to as stockholders’ equity Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Owners’ Equity Factors Impacting the Amount of Owners’ Equity
DECREASE Owners’ Equity INCREASE Owners’ Equity Owners Withdraw Assets Company Suffers a Loss Owners Invest Assets Company Generates a Profit Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Owners’ Equity: Two Primary Components
Paid-in Capital The value of assets contributed by investors in exchange for shares of stock Retained Earnings The cumulative earnings of the company not paid to owners as dividends Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Owners’ Equity: Two Additional Components
Treasury Stock Repurchased shares of the company’s stock Accumulated Other Comprehensive Income Increases and decreases to equity due to changes in the market prices of investments changes in exchange rates Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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The Balance Sheet Format
A classified balance sheet distinguishes between current and noncurrent categories for assets and liabilities Current assets are more liquid than other assets Current liabilities are repaid usually within one year Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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The Accounting Equation
The balance sheet is a detailed version of the accounting equation ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Balance Sheet Concepts and Conventions
The entity concept requires that the records of the business must be kept separate from the personal finances of the owner. Under the historical cost convention, assets and liabilities are recorded at their original costs and are not adjusted for changes in value. Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Balance Sheet Concepts and Conventions
The going concern assumption presumes that the business will continue for the foreseeable future Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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The Income Statement
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The Income Statement Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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The Income Statement Describes a company’s financial performance for a specified period of time Reports Revenues Expenses Net Income Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Elements of the Income Statement
Revenue is the amount of assets created through the performance of business operations Retailers generate revenue by selling goods Service businesses generate revenue by providing a valuable service Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Elements of the Income Statement
Expenses are the amount of assets consumed from the performance of business operations Gains and losses refer to money made or lost on activities outside the normal business operations Net income (loss) is the difference between revenues and expenses Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Elements of the Income Statement
Earnings per share represents how much income belongs to the owner of one share of stock Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Income Statement Concepts and Conventions
Time Period The life of a business is divided into time periods to measure performance Revenue recognition occurs when The goods have been delivered or the service has been provided and Cash has been collected or collection is reasonably assured Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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The Statement of Cash Flows
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The Statement of Cash Flows
Describes a company’s cash flows for a specified period of time Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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The Statement of Cash Flows
Classifies individual cash flows according to three main activities: Operating activities Investing activities Financing activities Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Producing and Selling Goods and Services Day-to-Day Activities
Operating Activities Producing and Selling Goods and Services Day-to-Day Activities Inflows/Receipts: Selling products Providing services Outflows/Payments: Inventory Wages Utilities Rent Interest Taxes, etc. Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Buying and Selling Long-Term Assets
Investing Activities Buying and Selling Long-Term Assets Inflows/Sale of: Land Buildings Equipment Stocks of other companies Outflows/Purchase of: Land Buildings Equipment Stocks of other companies Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Cash to/from Creditors and Investors
Financing Activities Cash to/from Creditors and Investors Inflows/Receipts: Sell stock shares Loan proceeds Outflows/Payments: Repay loans Acquire treasury stock Pay cash dividends Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Cash Flow Process Raw Cash Flow Data Accounting Adjustments Net Income
Undo Accounting Adjustments Statement of Cash Flows Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Notes to the Financial Statements
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Four Types of Notes A summary of significant accounting policies
Additional information about the summary totals found in the statements Disclosure of important information not recognized in the statements Supplementary information required by the FASB or the SEC Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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The External Audit
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The External Audit Provides an independent outside opinion from a CPA firm that The statements are prepared in accordance with GAAP The audit was conducted using generally accepted auditing standards Not a guarantee! The SEC requires all publicly traded companies to provide potential investors with audited financial statements Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Other Concepts and Conventions
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Other Concepts and Conventions
Relevance and reliability are the two primary qualities that make information useful Relevant information must be timely, useful for evaluating past decisions, and useful for evaluating future decisions Reliable information must be reliable, unbiased, and represent the economic conditions that it purports to represent Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Other Concepts and Conventions
Comparability Information is more useful when it can be compared to that of other companies or to that of the same company over time Consistency Financial statements should be prepared using the same accounting methods consistently to be comparable Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Other Concepts and Conventions
Conservatism When in doubt, recognize all losses but do not anticipate gains Materiality An item is material if misstatement of that item could impact a decision Materiality is largely a matter of professional judgement Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Other Concepts and Conventions
Articulation The three primary financial statements are an integrated set of reports on a company’s financial health For example, net income (income statement) increases retained earnings (balance sheet) in order for net assets to equal stockholders’ equity Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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Articulation Accrual Adjustments $ $ Net Income - Dividends
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In Summary ... Financial information reduces uncertainty for creditors and investors The balance sheet reports assets, liabilities, and equity The income statement reports revenues and expenses The statement of cash flows reports changes in cash Notes to financial statements provide important detail and supplemental explanations Audits do not provide guarantees Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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