The Financial Statements Chapter 1

Learning Objective 1 Learn that financial statements are the product of accounting

Accounting The Language of Business

Accounting Accounting is is the the information information system system that... that... measures measures business business activities, activities, processes processes data data into into reports, reports, and and communicates communicates results results to to decision decision makers. makers.

Accounting Language
Financial Statements:
companies use to report the results of their activities to various user groups. The system of accounting produces the following statements:

Financial Statements are the business documents that

Income Statement

Statement of changes in equity

Balance Sheet

Statement of Cash Flow

The Flow of Accounting Information

1. People make decisions.

2. Business transactions occur.

3. Businesses prepare reports to show the results of their operations.

Who Uses Accounting Information?

Individuals Government regulatory agencies Taxing authorities Non-profit organizations

Businesses Investors and creditors

Financial and Management Accounting

External Users

Internal Users

Financial Accounting
Summarize business transactions of business entity for a specified period
Users Users

Internal Internal External Externaldecision decisionmakers makers

Information Informationmust: must: Be Bepresented presentedin insystematic systematicreports reports Meet MeetGAAP GAAPstandards standardsfor forrelevance relevanceand andreliability reliability

Management Accounting
Financial and operating data about an organizations activities, processes, operating units products services and customers
Users Users -- Internal Internaldecision decisionmakers makers

Information Information --Can Canbe begenerated generatedusing usingassumptions assumptions --Future Futureoriented oriented --Not Notgoverned governedby byGAAP GAAP

How to Organize a Business

Proprietorships Proprietorships Partnerships Partnerships Corporations Corporations

Corporations
Canadian Business Corporation Act

Stocks Stocks Shareholders Shareholders

Chief Chief Operating Operating officers, officers, Presidents, Presidents, Managers Managers

Board of Directors

Learning Objective 2

Apply the accounting equation to business organizations

The Accounting Equation

Assets = Liabilities and Shareholders Equity

Assets = Liabilities and Owners Equity

What I own = Who supplied the resources: Creditors and Owners

The Accounting Equation

Assets = Liabilities and Shareholders Equity Assets are economic resources of a business that are expected to produce future benefits Examples include

The Accounting Equation

Assets = Liabilities and Shareholders Equity Liabilities are economic claims or debts payable to outsiders called creditors Examples include

The Accounting Equation

Assets = Liabilities and Shareholders Equity Shareholders equity owners interests in the assets of a corporation. Two main categories are:
Contributed capital Retained earnings amounts earned by profitable operations and kept in the business. Components include revenue, expenses and dividends

The Accounting Equation: Net income

Revenues are increases in retained earnings from delivering goods or services to customers. Expenses are decreases in retained earnings that result from operations.

Components of Retained Earnings

Revenues for the period

Start of = the period Beginning Net income + balance of (or Net loss) or retained for the earnings period Expenses for the period End of the period Ending balance of retained earnings

Dividends for the period

Question #1
Retained earnings include: a. Amounts earned and kept by profitable operations b. Economic claims to the resources c. Amounts invested by the owners d. Economic resources of a business

Learning Objective 3 Understanding financial statements and how to use them

Financial Statements
They represent the company in financial terms. Each one relates to a specific date or covers a particular period. They include: The Income Statement The Statement of Changes in Equity The Balance Sheet The Cash Flow Statement

Falk Consulting Inc. Income Statement For the Month Ended May 31, 2010 Revenue: Service revenue Expenses: Rent expense Salary expense Utilities expense Total expenses Net income

$10,950 $1,500 1,400 500 3,400 $7,550

Falk Consulting Inc. Statement of Retained Earnings (was used for a public co.; still used for a private co.) for the month ending May 31, 2010 Retained earnings, May 1, 2010 Add: Net income for the month Less: Dividends Retained earnings, May 31, 2010 $ 0 7,550 7,550 (2,500) $5,050

Falk Consulting Inc. Statement of Changes in Equity (now required for a public enterprise) for the month ending May 31, 2010
Common shares Balance, May 1 0 Issued shares $70,000 Profit Dividends Balance, May 31 $70,000 Retained Earnings 0 $7,550 (2,500) $5,050 Total Equity 0 $70,000 7,550 (2,500) $75,050

Copyright 2004 Pearson Education Canada Inc.

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Falk Consulting Inc. Balance Sheet May 31, 2010

Assets Cash $ 21,600 Accounts receivable 2,950 Office supplies 750 Land 50,000 Total assets $ 75,300 Liabilities Accounts Payable $ 250 Shareholders Equity Common shares $70,000 Retained earnings 5,050 Total shareholders equity $75,050 Total liabilities and shareholdersequity $75,300

Falk Consulting Inc. Cash Flow Statement for the month ending May 31, 2010
Operating Activities: Cash received from customers Cash paid to suppliers, salaries, etc. Investing Activities: Bought land Financing Activities: Issued shares Paid dividends Cash at end of the month +8,000 - 3,900 4,100 -50,000

+70,000 - 2,500 21,600

Question #2
Which financial statement covers a period of time? a. Balance sheet b. Income statement c. Statement of Cash flow d. Both a and b e. Both b and c

Learning Objective 4

Explain the relationships among the financial statements

Relationships Among the Financial Statements

Income Statement Net Income Statement of Changes in Equity - changes in shares & retained earnings Balance Sheet - Report shares & retained earnings Cash Flow Statement - Report cash balance from balance sheet

Learning Objective 5

Understanding financial accounting standards

How Accounting Standards are Set

Accountants Accountants follow follow professional professional guidelines. guidelines. The The rules rules that that govern govern accounting accounting are are called called GAAP GAAP (generally (generally accepted accepted accounting accounting principles) principles)..

GAAP
CICA CICA Handbook Handbook:: official official source source of of GAAP; GAAP; sanctioned sanctioned by by federal federal and and provincial provincial governments governments and and the the Canadian Canadian Securities Securities Administrators Administrators Accounting Accounting Standards Standards Board Board Public Public Sector Sector Accounting Accounting Standards Standards Board Board Emerging Emerging Issues Issues Committee Committee

International Accounting Standards Board (IASB) IASB is charged with setting International Financial Reporting Standards (IFRS) Canadian GAAP will converge with IFRS 1st year for reporting under IFRS-based standards will be 2011

Conceptual Framework
Information must be useful for decision makers

Relevance Comparability Verifiability

Faithful Representation Timeliness Understandability

Materiality

Cost

Financial Reporting Standards

Accounting Assumptions
Entity assumption Going-concern assumption Cost assumption Stable monteary-unit assumption

Generally Accepted Accounting Principles

The Entity Assumption The Going-Concern Assumption The entity will continue to operate in the foreseeable future The Cost Assumption The Stable Monetary Unit Assumption

Ethics in Accounting and Business

Standards Standards of of professional professional conduct conduct for for accountants accountants

Self-regulating Self-regulating bodies bodies of of accountants accountants

CICA

CGAAC

SMAC

Question #3
The Cost Principle states that a. The dollars purchasing power is relatively stable b. Data is verifiable and can be confirmed c. Assets and services are recorded at their actual cost d. Assets and services are recorded at their market value

Analyzing Financial Statements

Investors which company to invest in? Creditors which customer will get a loan? Managers are they beating competitors?

Analyzing Financial Statements

1. Can the company sell its
products? 2. What are the main income measures to watch for trends 3. What % of sales revenue ends up as profit? 4. Can the company collect its receivables? 1. Look at revenue on the income statement 2. a) Gross margin b) Operating income c) Net income 3. Net income/Sales revenue Examine the trend 4. Compare the % increase in accounts receivable to the % increase in sales

Analyzing Financial Statements

5. Can the company pay its a) Current liabilities b) Current and long-term liabilities 5. From the balance sheet, compare a. Current assets to Current liabilities b. Total assets to total liabilities 6. Cash flow statement operating activities should provide the bulk of the companys cash

6. Where is the companys cash coming from? How is cash being used?

Question #4
Can the company pay its bills due within the next year? Look at: a. b. c. d. Cash and liabilities Current assets and liabilities Cash and current liabilities Current assets and current liabilities

End of Chapter 1