1. 1 Chapter 2 Chapter 2 Preparing financial statements and analyzing business transactions

2. 2  Primary objective - provide information to help people make decisions  Assumptions  Separate entity - do not include any financial information about owners  Time period - life of a business can be divided into meaningful time periods  Historical cost - measuring assets at the time of their purchase  Going concern - company will continue operating in the future Objectives, assumptions, and qualities of financial reporting

3. 3 Qualities - information  Relevant - useful to decision makers  Reliable - accurate, verifiable, and unbiased and therefore a faithful representation  Comparability - can be compared across firms - same accounting principles  Consistency - same accounting principles and methods from period to period  Materiality and conservatism in financial reporting  Materiality - size or significance  Conservatism - select the treatment that is least likely to overstate income or overstate assets

4. 4 Balance sheet  Classified balance sheet - shows a subtotal for many items  Assets  Current asset - plan to turn into cash or use to earn revenue in the next fiscal year.  Non-current asset - not be used up within 12 months.  Liabilities  Current - obligations that can be settled with current assets  Non-current - be aid off in a period longer than one year  Interest - cost of using someone else’s money

5. 5  Shareholder’s equity  Contributed capital - owners make capital contributions  Retained earnings - owner’s claims to earnings  Revenue recognition principle - revenue should be recognized when it is earned and its collection is reasonably assured  Matching principle - expenses are recognized in the same period as the revenue they helped generate Balance sheet

6. 6 Stone Company had $1,000 of supplies at the beginning of 2006. Stone Company purchased $10,000 supplies on account in 2006 and paid $8,000 for those supplies by year-end. Stone had $1,500 of supplies left at the end of 2006. What amount of supplies expense should be recorded for 2006?

7. 7 The amount of supplies used $9,500, should be deducted from revenue in 2006. The amount purchased or aid is not considered an expense under the accrual basis.  Accrual basis accounting - means that accountants recognize revenue when it is earned and expenses when they are incurred to earn that revenue - no matter when the cash is received or aid.

8. 8  Earnings per share - EPS - net income divided by the average number of outstanding shares of (common) stock  Statement of shareholders’ equity  Statement of retained earnings - bb retained earnings + net income - dividends +/- other adjustments = eb retained earnings  Statement of cash flows - explain in detail the change in the cash balance during the accounting period  Operating, investing, financing

9. 9 Notes to financial statements  Provide information about any circumstances or events that would make a difference to the users of the statements - called full disclosure principle.  Materiality - importance of the item or transaction on the company’s financial performance or financial position.  Conservatism

10. 10 Analyzing transactions Analyzing transactions  Steps - record a transaction  Determine which are affected by the transaction - asset, liability, equity, revenue, expense;  Identify the specific account, and whether it increases or decreases  Determine the amount; and  Record the transaction in the accounting equation

11. 11 Order of presentation of statements Income statement always reared first Second - statement of changes in shareholders’ equity Third - balance sheet Final statement - statement of cash flows

12. 12 Financial statement equations Income statement - revenues - expenses = net income Income statement - revenues - expenses = net income Statement of retained earnings - bb retained earnings + net income - dividends = eb retained earnings Statement of retained earnings - bb retained earnings + net income - dividends = eb retained earnings Balance sheet - assets = liabilities + stockholder’s equity Balance sheet - assets = liabilities + stockholder’s equity

13. 13 Financial statement analysis Current ratio - divide current assets by current liabilities Used to determine a firm’s ability to fund its current operations Internal controls - designed to protect the accounting system from both intentional errors and fraud. Preventive controls - help prevent errors in an accounting system Detective controls - help a company find errors. Corrective controls - correct any errors that have been discovered.

14. 14 Assign #3: pg. 79-81, E2-1A, E2-gA, E2-10A (due 2/17) Assign #4: pg. 86-88, P2-3A, P2-8A (due 2/22)