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INTRODUCTION TOFINANCIAL STATEMENTS
Accounting, Fourth Edition
1
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1. Describe the primary forms of business organization.
2. Identify the users and uses of accounting information.
3. Explain the three principal types of business activity.
4. Describe the content and purpose of each of the financial
statements.
5. Explain the meaning of assets, liabilities, and stockholders
equity, and state the basic accounting equation.
6. Describe the components that supplement the financial
statements in an annual report.
Study ObjectivesStudy Objectives
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Internal usersExternal users
Ethics in financial
reporting
Forms ofForms of
BusinessBusiness
OrganizationOrganization
Forms ofForms of
BusinessBusiness
OrganizationOrganization
Users and UsesUsers and Uses
of Financialof Financial
InformationInformation
Users and UsesUsers and Uses
of Financialof Financial
InformationInformation
BusinessBusiness
ActivitiesActivities
BusinessBusiness
ActivitiesActivities
CommunicatingCommunicating
with Userswith Users
CommunicatingCommunicating
with Userswith Users
Soleproprietorship
Partnership
Corporation
FinancingInvesting
Operating
Income statementRetained earnings
statement
Balance sheet
Statement of cash
flows
Interrelationshipsof statements
Other elements of
an annual report
Introduction to Financial StatementsIntroduction to Financial Statements
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Proprietorship Partnership Corporation
Simple to
establish
Shared control
Broader skills
and resources
Tax advantages
Easier to transfer
ownership
Easier to raise
funds
No personal
liability
Forms of Business OrganizationForms of Business Organization
Generally owned
by one person
Simple to
establish
Owner
controlled
Tax advantages
SO 1 Describe the primary forms of business organization.SO 1 Describe the primary forms of business organization.
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Questions Asked byInternal Users User
1. Can we afford to give our
employees a pay raise?Human Resources
2. What price for our product
will maximize net income?
3. Which product line is most
profitable?4. Is cash sufficient to pay
dividends to the stockholders?
Marketing
Management
Finance
Users and Uses of Financial InformationUsers and Uses of Financial Information
SO 2 Identify the users and uses of accounting information.SO 2 Identify the users and uses of accounting information.
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Questions Asked byExternal Users User
1. Is the company earning
satisfactory income?Investors
2. How does Disney compare in
size and profitability with Time
Warner?
3. Will United Airlines be able to
pay its debts as they come
due?
Investors
Creditors
Users and Uses of Financial InformationUsers and Uses of Financial Information
SO 2 Identify the users and uses of accounting information.SO 2 Identify the users and uses of accounting information.
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Ethics In Financial Reporting
United States regulators and lawmakers were very concerned
that the economy would suffer if investors lost confidence in
corporate accounting because of unethical financial reporting.
Recent financial scandals include: Enron, WorldCom,
HealthSouth, AIG, and others.
Congress passed Sarbanes-Oxley Act of 2002.
Effective financial reporting depends on sound ethical
behavior.
Users and Uses of Financial InformationUsers and Uses of Financial Information
SO 2 Identify the users and uses of accounting information.SO 2 Identify the users and uses of accounting information.
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Which of the following did notresult from the Sarbanes-
Oxley Act?
a. Top management must now certify the accuracy of
financial information.
b. Penalties for fraudulent activity increased.
c. Independence of auditors increased.
d. Tax rates on corporations increased.
Question
Users and Uses of Financial InformationUsers and Uses of Financial Information
SO 2 Identify the users and uses of accounting information.SO 2 Identify the users and uses of accounting information.
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Two primary sources of outside funds are:
1. Borrowing money
Amounts owed are called liabilities.
Party to whom amounts are owed are creditors.
Notes payable and bonds payable are different
type of liabilities.
2. Issuing shares of stock for cash.
Payments to stockholders are called dividends.
Business ActivitiesBusiness Activities
SO 3 Explain the three principal types of business activity.SO 3 Explain the three principal types of business activity.
Financing Activities
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Operating Activities
Once a business has the assets it needs,
it can begin its operations.
Revenues - Amounts earned from the sale of products
(sales revenue, service revenue, and interest revenue).
Inventory - Goods available for sale to customers.
Accounts receivable - Right to receive money from a
customer,in the future, as the result of a sale.
Business ActivitiesBusiness Activities
SO 3 Explain the three principal types of business activity.SO 3 Explain the three principal types of business activity.
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Operating Activities
Expenses - cost of assets consumed or services used.
(cost of goods sold, selling, marketing, administrative,
interest, and income taxes expense).
Liabilities arising from expenses include accounts
payable, interest payable, wages payable, sales taxes
payable, and income taxes payable.
Net income when revenues exceed expenses.
Net loss when expenses exceed revenues.
Business ActivitiesBusiness Activities
SO 3 Explain the three principal types of business activity.SO 3 Explain the three principal types of business activity.
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Companies prepare four financial statements from the
summarized accounting data:
Income
Statement
Balance
Sheet
Statement
of Cash
Flows
Retained
Earnings
Statement
Communicating with UsersCommunicating with Users
SO 4 Describe the content and purpose of each of the financial statements.SO 4 Describe the content and purpose of each of the financial statements.
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Net income will result during a time period when:
a. assets exceed liabilities.
b. assets exceed revenues.
c. expenses exceed revenues.
d. revenues exceed expenses.
Review Question
Communicating with UsersCommunicating with Users
SO 4 Describe the content and purpose of each of the financial statements.SO 4 Describe the content and purpose of each of the financial statements.
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Reports revenues and
expenses for a specific
period of time.
Net income
revenuesexceed expenses.
Net loss expenses
exceed revenues.
Past net incomeprovides information for
predicting future net
income.
Communicating with UsersCommunicating with Users
SO 4 Describe the content and purpose of each of the financial statements.SO 4 Describe the content and purpose of each of the financial statements.
Income StatementIllustration 1-4
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Illustration 1-4
Communicating with UsersCommunicating with Users
SO 4 Describe the content and purpose of each of the financial statements.SO 4 Describe the content and purpose of each of the financial statements.
Retained EarningsStatement
Net income is needed to
determine the ending balance in
retained earnings.
Illustration 1-5
Income Statement
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Communicating with UsersCommunicating with Users
SO 4 Describe the content and purpose of each of the financial statements.SO 4 Describe the content and purpose of each of the financial statements.
Retained EarningsStatement
Illustration 1-5
Ending balance in retained
earnings is needed in preparing
the balance sheet.
Balance Sheet Illustration 1-7
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Communicating with UsersCommunicating with Users
Balance Sheet Reports assets and
claims to assets at a
specific point in time.
Assets = Liabilities +
Stockholders Equity.
Lists assets first,
followed by liabilities and
stockholders equity.
SO 5 Explain the meaning of assets, liabilities, and stockholdersSO 5 Explain the meaning of assets, liabilities, and stockholdersequity, and state the basic accounting equation.equity, and state the basic accounting equation.
Illustration 1-7
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Answers:
Where did cash
come from during
the period?
How was cash used
during the period?
What was the
change in the cash
balance during the
period?
Communicating with UsersCommunicating with Users
Statement of Cash FlowsIllustration 1-8
SO 5 Explain the meaning of assets, liabilities, and stockholdersSO 5 Explain the meaning of assets, liabilities, and stockholdersequity, and state the basic accounting equation.equity, and state the basic accounting equation.
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Managements Report
Management discussion and analysis (MD&A) covers the
companies ability to pay near-term obligations, its ability to
fund operations and expansion, and its results of operations.
Management must highlight favorable or unfavorable trends
and identify significant events and uncertainties that affect
these three factors.
Other Elements of an Annual ReportOther Elements of an Annual Report
SO 6 Describe the components that supplement theSO 6 Describe the components that supplement thefinancial statements in an annual report.financial statements in an annual report.
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Other Elements of an Annual ReportOther Elements of an Annual Report
Illustration 1-10
Managements Report
SO 6 Describe the components that supplement theSO 6 Describe the components that supplement thefinancial statements in an annual report.financial statements in an annual report.
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Other Elements of an Annual ReportOther Elements of an Annual Report
SO 6 Describe the components that supplement theSO 6 Describe the components that supplement thefinancial statements in an annual report.financial statements in an annual report.
Notes to the Financial Statements
Illustration 1-11
Clarify the financial statements.
Provide additional detail.
Notes are essential to understanding a companys operating
performance and financial position.
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Auditors Report
Other Elements of an Annual ReportOther Elements of an Annual Report
SO 6SO 6
Illustration 1-12
Auditors opinion as to the fairness of the presentation of the
financial position and results of operations and their conformance
with generally accepted accounting standards.
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1. Descriptions of significant accounting policies: Notes2. Unqualified opinion: Auditors report
3. Explanations of uncertainties and contingencies: Notes
4. Description of ability to fund operations and expansion: MD&A
5. Description of results of operations: MD&A
6. Certified Public Accountant (CPA): Auditors report
SO 6 Describe the components that supplement theSO 6 Describe the components that supplement thefinancial statements in an annual report.financial statements in an annual report.
Other Elements of an Annual ReportOther Elements of an Annual Report
State whether each of the following items is mostclosely associated with the management discussion
and analysis (MD&A), the notes to the financial statements, or the
auditors report.
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Key Points
International standards referred to as International Financial
Reporting Standards (IFRS), are developed by the International
Accounting Standards Board (IASB). The United States and the international standard-setting
environment are primarily driven by meeting the needs of
investors and creditors.
The internal control standards applicable to Sarbanes-Oxley
(SOX) apply only to large public companies listed on U.S.exchanges.
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Looking into the Future
Both the IASB and the FASB are hard at work developing
standards that will lead to the elimination of major differences in
the way certain transactions are accounted for and reported. In
fact, at one time the IASB stated that no new major standards
would become effective until 2009. The major reason for this
policy was to provide companies the time to translate and
implement IFRS into practice, as much has happened in a veryshort period of time.
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Which of the following is nota reason why a single set of high-
quality international accounting standards would be
beneficial?
a) Mergers and acquisition activity.
b) Financial markets.
c) Multinational corporations.
d) GAAP is widely considered to be a superior reporting
system.
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The Sarbanes-Oxley Act determines:
a) international tax regulations.
b) internal control standards as enforced by the IASB.
c) internal control standards of U.S. publicly traded
companies.
d) U.S. tax regulations.
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IFRS is considered to be more:
a) principles-based and less rules-based than GAAP.
b) rules-based and less principles-based than GAAP.
c) detailed than GAAP.
d) None of the above.
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Copyright 2011 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission 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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