CHAPTER 1

The Financial Statements

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ACCOUNTING - THE BASIS OF DECISION MAKING

Accounting is the language of business Accounting is the information system that
Measures business activities Processes that information into reports Communicates the results to decision makers
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THE ACCOUNTING SYSTEM: THE FLOW OF INFORMATION

1. People make decisions

2. Business transactions occur

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

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DECISION MAKERS WHO USE ACCOUNTING INFORMATION

Individuals Businesses Investors and Creditors Government Regulatory Agencies Taxing Authorities Nonprofit Organizations
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FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING

Financial accounting provides information to managers and people outside the firm
Financial accounting information must meet certain standards of relevance and reliability

Management accounting generates confidential information for internal decision makers, e.g.,
Top executives Department heads
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TYPES OF BUSINESS ORGANIZATIONS

Proprietorships
Have a single owner who is generally the manager Are business entities, but not legal entities Have debt for which the proprietor is personally liable

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TYPES OF BUSINESS ORGANIZATIONS

Partnerships
Join two or more persons together as coowners Are business entities, but not legal entities Have debt for which each partner is personally liable

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TYPES OF BUSINESS ORGANIZATIONS

Corporations
Are owned by stockholders or shareholders Are business entities and legal entities Are liable for all debts
Stockholders have no personal obligation for corporation debts

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ACCOUNTING PRINCIPLES AND CONCEPTS

Generally accepted accounting principles (GAAP) are
The rules that govern how accountants operate Based upon a conceptual framework written by the Financial Accounting Standards Board (FASB)

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ACCOUNTING PRINCIPLES AND CONCEPTS

The entity concept States that an organization is an economic entity that keeps its affairs separate from those of the owner(s) The reliability (objective) principle
States that accounting records and statements are based on the most reliable data available and documented by objective evidence
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ACCOUNTING PRINCIPLES AND CONCEPTS

The cost principle
States that acquired assets and services should be recorded at their actual (historical) cost and should maintain that historical cost for as long as they are owned

The going-concern concept

States that the entity will remain in operation for the foreseeable future
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THE ACCOUNTING EQUATION

The accounting equation presents the resources of the business and the claims to those resources
Economic Resources = Claims to Economic Resources or Assets = Liabilities + Owners Equity
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THE ACCOUNTING EQUATION

Assets are the economic resources of a business that are expected to be of benefit in the future Claims to assets come from
Liabilities
Economic obligations - debts payable to outsiders, called creditors

Owners equity (capital)

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Assets held by the owners of the business

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THE ACCOUNTING EQUATION

For a corporation, stockholders (owners) equity consists of two main categories
Paid-in capital Retained earnings
Assets = Liabilities + Stockholders Equity or Assets = Liabilities + Paid-in Capital + Retained Earnings
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THE ACCOUNTING EQUATION

Paid-in (contributed) capital is
The amount invested in the corporation by its owners Comprised basically of common stock

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THE ACCOUNTING EQUATION

Retained earnings
Is the amount earned by income-producing activities and kept for use in the business Is affected by
Revenues - increases in retained earnings from delivering goods or services Expenses - decreases in retained earnings that result from operations

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THE ACCOUNTING EQUATION

Net income (net earnings)
Total revenues exceed total expenses

Net loss
Total expenses exceed total revenues

Dividends
Distributions to stockholders (usually cash) generated by net income
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THE ACCOUNTING EQUATION

The owners equity of proprietorships and partnerships
Makes no distinction between paid-in capital and retained earnings Accounts for the equity of each owner under the single heading of Capital

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INFORMATION REPORTED ON THE FINANCIAL STATEMENTS

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INCOME STATEMENT
The income statement (statement of earnings) reports the companys revenues, expenses, and net income or net loss for the period

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INCOME STATEMENT
AIR & SEA TRAVEL, INC. Income Statement Month Ended April 30, 2001

Revenue: Service revenue Expenses: Salary expense Rent expense Utilities Total expenses Net Income

$8,500

$1,200 1,100 400 2,700 $5,800

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INCOME STATEMENT
Revenues are
Increases in retained earnings from delivering goods or services to customers or clients

Expenses are
Decreases in retained earnings that result from operations

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INCOME STATEMENT
Expenses include
Cost of goods sold (cost of sales)
The cost of the goods that a company sold to its customers

Operating expenses
The costs of operating the business

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INCOME STATEMENT
Operating expenses
Advertising
The cost to promote the companys products

Depreciation
The expense of using company-owned buildings, equipment, and furniture

Other operating expenses

The costs of salaries, utilities, rent, and supplies

Interest expense
The cost of borrowed money
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STATEMENT OF RETAINED EARNINGS

The statement of retained earnings reports that portion of net income the company has retained, or kept for use in the business
Net income increases retained earnings Dividends paid to stockholders decrease retained earnings

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STATEMENT OF RETAINED EARNINGS

AIR & SEA TRAVEL, INC. Statement of Retained Earnings Month Ended April 30, 2001 Retained earnings, April 1, 2001 Add: Net income for the month Less: Dividends Retained Earnings, April 30, 2001 $ 0 5,800 $5,800 (2,100) $3,700

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BALANCE SHEET
The balance sheet (statement of financial position) reports the companys assets, liabilities, and owners equity

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BALANCE SHEET
AIR & SEA TRAVEL, INC. Balance Sheet As at NOV 30, 2007 Assets Current Assets Cash $33,300 Accounts receivable 2,000 Office supplies 500 Long term Assets 50,000 Land 18,000 Liabilities Accounts payable $ 100

Stockholders Equity Common stock Retained earnings 3,700 Total stockholders equity 53,700 Total liabilities and stockholders equity $53,800
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Total assets

$53,800

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ASSETS
Current assets are
Those assets which the company expects to convert to cash, sell, or consume during the next 12 months or within the business's normal operating cycle if longer than a year

Current assets include

Cash Accounts receivable Merchandise inventory Prepaid expenses
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ASSETS
Long-term assets are
Those assets which the company expects to hold longer then the next 12 months or the businesss normal operating cycle if longer than one year

Long-term assets include

Property Equipment
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ASSETS
Intangible assets are
Those with no physical form
Trademarks Patents

Other assets are

Those with small values which do not fall within any other standard asset category

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LIABILITIES
Current liabilities are
Debts payable within one year or within the businesss normal operating cycle if longer than a year

Current liabilities include

Notes payable, short term Accounts payable Accrued expenses payable Income taxes payable
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LIABILITIES
Long-term liabilities are
Debts not payable within one year or within the businesss normal operating cycle if longer than a year

Long-term liabilities include

Notes payable, long term Bonds payable
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OWNERS EQUITY
Owners equity
Represents the shareholders ownership of the assets of the business

Owners equity of a corporation consists of

Common stock Retained earnings
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STATEMENT OF CASH FLOWS

The statement of cash flows reports the companys cash inflows and outflows from operating, investing, and financing activities

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AIR & SEA TRAVEL, INC. Statement of Cash Flows Month Ended Nov 30, 2007 Cash flows from operating activities: Collections from customers Payments to suppliers and employees Net cash inflow from operating activities Cash flows from investing activities: Acquisition of land $(40,000) Sale of land 22,000 Net cash outflow from investing activities Cash flows from financing activities: Issuance (sale) of stock $ 50,000 Payment of dividends (2,100) Net cash inflow from financing activities Net increase in cash Cash balance, Nov 1, 2007 Cash balance, Nov 30, 2007
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$ 6,500 (3,100) 3,400

(18,000)

47,900 $ 33,300 0 $ 33,300

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STATEMENT OF CASH FLOWS

Operating activities
Companies operate by buying goods and services, which are sold to customers

Investing Activities
Companies invest in long-term assets that are used to run the business

Financing Activities
Companies finance themselves by issuing stock and borrowing money
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RELATIONSHIPS AMONG THE FINANCIAL STATEMENTS

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AIR & SEA TRAVEL, INC. Statement of Cash Flows Month Ended April 30, 2001 Cash flows from operating activities: Collections from customers Payments to suppliers and employees Net cash inflow from operating activities Cash flows from investing activities: Acquisition of land $(40,000) Sale of land 22,000 Net cash outflow from investing activities Cash flows from financing activities: Issuance (sale) of stock $ 50,000 Payment of dividends (2,100) Net cash inflow from financing activities Net increase in cash Cash balance, April 1, 2001 Cash balance, April 30, 2001

AIR & SEA TRAVEL, INC. Income Statement Month Ended April 30, 2001
$ 6,500 (3,100) 3,400

Revenue: Service revenue Expenses: Salary expense Rent expense Utilities Total expenses Net Income

$8,500

(18,000)

$1,200 1,100 400 2,700 $5,800

47,900 $ 33,300 0 $ 33,300

AIR & SEA TRAVEL, INC. Statement of Retained Earnings Month Ended April 30, 2001

AIR & SEA TRAVEL, INC. Balance Sheet April 30, 2001 Assets Cash $33,300 Accounts receivable 2,000 Office supplies 500 Land 18,000 Liabilities Accounts payable $ 100

Retained earnings, April 1, 2001 Add: Net income for the month

$ 0 5,800 $5,800 Less: Dividends (2,100) Retained Earnings, April 30, 2001 $3,700

Total assets

_______ $53,800

Stockholders Equity Common stock 50,000 Retained earnings 3,700 Total stockholders equity 53,700 Total liabilities and _______ stockholders equity $53,800

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END OF CHAPTER 1

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