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Financial Accounting:Tools for Business Decision Making

ELS

Chapter 1`

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After studying Chapter 1, you should be able to: Describe the primary forms of business organization.

Identify the users and uses of accounting.

Explain the three principal types of business activity.

Describe the content and purpose of each of the financial

statements.

Chapter 1Introduction to Financial Statements

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Chapter 1Introduction to Financial Statements

After studying Chapter 1, you should be able to: Explain the meaning of assets, liabilities, and stockholders’ equity

and state the basic accounting equation.

Describe the components that supplement the financial statements

in an annual report.

Explain the basic assumptions and principles underlying financial

statements.

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Forms of Business Organizations

Sole Proprietorship - owned by one person

Partnership - owned by more than one person

Corporation - organized as a separate legal entity and owned by

stockholders

Forms of Business Organizations

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Users of Financial Information

Internal Users - managers plan, organize and run a business.

External Users - Investors Creditors Others

Taxing authoritiesRegulatory agenciesCustomersLabor unionsEconomic planners

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Questions Asked by Internal Users

Is cash sufficient to pay bills?What is the cost of manufacturing each unit

of product?Can we afford to give employee pay raises

this year?What product line is most profitable?

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Is the company earning satisfactory income?

How does the company compare in size and profitability with competitors?

Will the company be able to pay its debts when they become do?

Questions Asked by Internal Users

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Basic Terms

Assets - resources owned by a businessLiabilities - debts and obligations of

the businessCommon stock - stock representing

the primary ownership interest in a corporation

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Statement of Cash Flows

The primary purpose of a statement of cash flows is to provide financial information about the cash receipts and cash payments for a period of time.

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3 Types of Business Activity

FinancingInvestingOperating

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Financing Activities

It

Takes

MONEY

to

Make

MONEY!

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2 Ways of Outside Financing of a Corporation

Borrowing Money(liabilities)

Selling Shares ofStock

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Investing ActivitiesObtaining the

Resources or Assets needed to operate the

businessExamples of assets...

CashAccounts ReceivablePrepaid RentBuildings, Equipment, Furniture

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Investing Activities - Examples

Purchase or Sale of computers, delivery trucks, furniture, buildings

Purchase or Sale of investments

17Investing

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Operating activities are the main activities for which the organization is in business.

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What Are Revenues?

Revenues are the assets that result from sale of a product or service.

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Examples of Revenues

Taxi Company - sells services

Theatre - sells services & products

Retail Store - sells products

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Expenses are the costs of assets consumed or services used to

generate revenues. Examples...

What Are Expenses?

Cost of salesStore operating expensesGeneral and administrative expensesInterest expense

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Examples of Expenses

Taxi Company - gasoline, maintenance, insurance

Theatre - salaries, supplies, film rental, concessions to resale

Retail Store - utilities, taxes, rent, supplies, salaries

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Net Income

Net Income is the excess of revenues over expenses.

Revenue $10,000Expenses 3,000Net income $ 7,000

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Financial Accounting Statements

Income Statement - reports the results of operations for a specific period of time

Retained Earnings Statement - reports the changes in retained earnings for a specific period of time

Balance Sheet - reports the assets, liabilities, and stockholders’ equity at a specific date

Statement of Cash Flows - reports the cash receipts and payments for a specific period of time

Accounting Equation

Assets = Liabilities + Stockholders’ Equity

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Remember...

Remaining Liquid and Solvent is as important as

making a profit because...

A Company Can Survive a Long Time Without Profits...

but It Can’tSurvive

Very Long Without

CASH!

Financial Statements Income Statement Statement of Retained Earnings Balance Sheet Statement of Cash Flows

Management Discussion and AnalysisNotes to Financial StatementsAuditor's Report

Elements of an

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Management Discussionand Analysis

Covers three aspects of a company: liquidity - ability to pay near term

obligations capital resources - fund operations and

expansions results of operation

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Notes to Financial Statements

Provide additional information not

included in body of statements

Describe accounting policies or explain

uncertainties and contingencies

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Auditor's Report

Auditor, a professional accountant who

conducts an independent examination of the

financial accounting data presented by a

company.

Auditor gives an unqualified opinion if the

financial statements present the financial

position, results of operations, and cash flows

in accordance with GAAP.

Monetary Unit Assumption

Economic Entity Assumption

Time Period Assumption

Going Concern Assumption

Cost Principle

Full Disclosure Principle

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COPYRIGHT

Copyright © 1998 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that named in Section 117 of the United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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CSU CORPORATIONIncome Statement

For the Year Ended December 31, 1998

1st- head up the statement•name of company•name of statement•period of time covered

Revenues Service revenue

$17,000

CSU CORPORATIONIncome Statement

For the Year Ended December 31, 1998

2nd - List the revenues

Revenues Service revenue

$17,000 Expenses

Rent expense $9,000 Insurance expense 1,000 Supplies expense 200Total expenses 10,200

CSU CORPORATIONIncome Statement

For the Year Ended December 31, 1998

3rd - List and total the expenses

Revenues Service revenue

$17,000 Expenses

Rent expense $9,000 Insurance expense 1,000 Supplies expense 200Total expenses 10,200

Net Income $ 6,800

CSU CORPORATIONIncome Statement

For the Year Ended December 31, 1998

4th - Subtract expenses from revenues to obtain net income.

CSU CORPORATIONRetained Earnings Statement

For the Year Ended December 31, 1998

1st- head up the statement•name of company•name of statement•period of time covered

CSU CORPORATIONRetained Earnings Statement

For the Year Ended December 31, 1998

Retained earnings, January 1 $ 0

2nd - Start with beginning retained earnings

CSU CORPORATIONRetained Earnings Statement

For the Year Ended December 31, 1998

Retained earnings, January 1 $ 0Add: Net Income 6,800 6,800

3rd - Add net income from the current year - subtotal

CSU CORPORATION Retained Earnings Statement

For the Year Ended December 31, 1998

Retained earnings, January 1 $ 0Add: Net Income 6,800 6,800Less: Dividends 0Retained earnings, December 31 $ 6,800

4th - Subtract current year’s dividends and total

CSU CORPORATION Balance Sheet

December 31, 1998

1st- head up the statement•name of company•name of statement•date

CSU CORPORATION Balance Sheet

December 31, 1998

AssetsCash $ 2,000Accounts receivable 4,000Supplies 1,800Equipment 16,000Total assets $23,800

2nd - list the assets and total

CSU CORPORATION Balance Sheet

December 31, 1998

AssetsCash $ 2,000Accounts receivable 4,000Supplies 1,800Equipment 16,000Total assets $23,800

Liabilities and Stockholders’ EquityLiabilities Accounts payable $ 2,000

Notes payable 5,000 Total liabilities 7,000

3rd - list the liabilities and sub-total

CSU CORPORATION Balance Sheet

December 31, 1998

4th - list stockholders’ equitysubtotal. Add to liabilities,Total

CSU CORPORATION Balance Sheet

December 31, 1998

AssetsCash $ 2,000Accounts receivable 4,000Supplies 1,800Equipment 16,000Total assets $23,800

Liabilities and Stockholders’ EquityLiabilities Accounts payable $ 2,000

Notes payable 5,000 Total liabilities 7,000Stockholders’ equity

Common stock 10,000Retained earnings 6,800

Total Stockholders’ equity 16,800Total liabilities and stockholders’ equity $23,800

If total assets and total liabilities and stockholders’

equity equal…

double underline.

CSU CORPORATION Balance Sheet

December 31, 1998

AssetsCash $ 2,000Accounts receivable 4,000Supplies 1,800Equipment 16,000Total assets $23,800

Liabilities and Stockholders’ EquityLiabilities Accounts payable $ 2,000

Notes payable 5,000 Total liabilities 7,000Stockholders’ equity

Common stock 10,000Retained earnings 6,800

Total Stockholders’ equity 16,800Total liabilities and stockholders’ equity $23,800

In what order are financial statements prepared?

WHY?

Revenues Service revenue

$17,000 Expenses

Rent expense $9,000 Insurance expense 1,000 Supplies expense 200Total expenses 10,200

Net Income $ 6,800

CSU CORPORATION Income Statement

For the Year Ended December 31, 1998

Net Income is needed for theStatement of Retained Earnings.

CSU CORPORATION Retained Earnings Statement

For the Year Ended December 31, 1998

Retained earnings, January 1 $ 0Add: Net Income 6,800 6,800Less: Dividends 0Retained earnings, December 31 $ 6,800

Ending Retained Earnings is neededfor the balance sheet.

CSU CORPORATION Balance Sheet

December 31, 1998

AssetsCash $ 2,000Accounts receivable 4,000Supplies 1,800Equipment 16,000Total assets $23,800

Liabilities and Stockholders’ EquityLiabilities Accounts payable $ 2,000

Notes payable 5,000 Total liabilities 7,000Stockholders’ equity

Common stock 10,000Retained earnings 6,800

Total Stockholders’ equity 16,800Total liabilities and stockholders’ equity $23,800