The Financial Statements

Chapter 1

The Language of Business

Accounting is an information
system
Measures business activities
pertinent to an entity
Processes data into reports
Communicates results to financial
statement users

Types of Accounting
FINANCIAL

Provides
information for
external users:
Investors
Creditors
Government
agencies
The public

MANAGEMENT

Provides information
for internal users managers of the
company
Budgets
Product cost data

Proprietorship
Single owner

Legally, business is
not separate from its
owner
Owner is personally
liable for business
debts

Business records are

kept
separate from
personal records of
the owner

Partnership
Two or more owners
Each partner is
personally liable
for all of the
debts of the
business

Limited Liability Company (LLC)

Owners are called
members
Members are not
personally liable
for business debts
No income taxes
on profits

Reduces members risk

to amount of each
members investment

Corporations

Owners are called stockholders

because of their ownership through
stock

Stockholders elect Board of Directors

Board sets policy and appoints officers

Corporations
Legally distinct entity from its owners
Stockholders not personally liable for
corporate debts

Formed under state law

Pays income taxes
Stockholders pay taxes on dividends

GAAP
GAAP is an acronym for
Generally Accepted Accounting
Principles
GAAP is:
rule based
17,000 pages long

FASB
U.S. GAAP is
formulated by the Financial
Accounting Standards Board (FASB)
created in 1973
7 members, 60+ staf
Norwalk, Connecticut

International Financial
Accounting Standards
The IASB (founded in 2001, 15 members,
London) developed IFRS (International
Financial Reporting Standards)
principle based
2,500 pages

International Financial
Accounting Standards

Best guess is that the SEC will require

U.S. public companies to adopt IFRS by
2015

GAAP Assumptions & Principles

Entity assumption

A business is a separate economic unit

Continuity (going-concern) assumption

Entity will continue to exist indefinitely

Historical cost principle

Assets recorded at purchase price

Stable monetary unit assumption

No hyperinflation

Move towards Fair Value

Fair value is the price received if
something were sold in an orderly
transaction between independent
market participants

The Accounting Equation

Assets = Liabilities + Owners Equity
Liabilities
Assets
Owners
Equity

Assets
Economic resources that provide
future benefits

Liabilities
Outsiders claims to assets
Accounts payable liability for goods or
services purchased on credit
Notes payable written promise to pay on a
certain date (bank loan)

Owners Equity
Owners claim on the assets
Assets minus liabilities
- whats left after debts are paid
A corporations equity is called
stockholders equity

Stockholders Equity
Paid-in capital
Amounts invested
by stockholders
Common stock

Retained
Earnings

Amounts earned
and kept for use in
the company
Increased by
Revenues
Decreased by
Expenses

Net Income
Revenues
Earned by selling goods or services

Expenses
Costs of doing business (e.g., rent, utilities)

Revenues minus expenses equal

net income

Dividends
Distributions of assets
(usually cash) to shareholders
Decrease Retained Earnings
Do NOT impact net income

The Financial Statements

A vehicle to report the

results of a business to
the public

The Income Statement

Measures operating
performance for a period
Reports revenue and
expenses
and the net income (or
loss)
Answers the question: How
well did the company do
this year

Statement of Retained Earnings

Shows increases and
decreases to retained
earnings for a period
Increase: net
income
Decrease:
dividends paid

Answers the question:

Why did a companys
retained earnings
change during a
period

Balance Sheet

Answers the question: What

is the companys financial
position as of a certain
date

Reports assets, liabilities and

shareholders equity
Assets and liabilities are
categorized as current and
long-term

Balance Sheet Categories

Current
assets

Converted to
cash or used
within one year
Cash, Accounts
Receivable,
Inventory

Balance Sheet Categories

Long-term
assets
Property,
Plant and
Equipment;
Goodwill

Balance Sheet Categories

Current
liabilities
Obligations
due within
one year of
balance
sheet date

Accounts
Payable,
Salaries
Payable, Taxes
Payable

Balance Sheet Categories

Long-term
liabilities
Bonds
Payable

Balance Sheet Categories

Stockholders Equity
Paid-in Capital: Common Stock
Retained Earnings

Statement of Cash
Flows
Shows inflows and outflows
of cash for a period
Answers the question: How
much cash did the
company generate and
spend during the year

Cash Flow Categories

Operating
Cash generated from day-to-day
business activities
Related to selling goods and services to
Investing
customers
Related to acquiring and disposing of
long-term assets

Cash Flow Categories

Financing
How a company obtains resources to
finance its business
Related to long-term debt and equity
(issuing stock)

Relationships of Financial Statements