FINANCIAL ACCOUNTING Robert Libby Patricia A. Libby Daniel G. Short

Chapter 1 Financial Statements and Business Decisions

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-3 Understanding the Business Owner-Managers Founders of the business who also function as managers are called Owner- Managers. Creditors Creditors lend money for a specific period of time and gain by charging interest on the money they lend. Investors Investors buy ownership in the company in the form of stock.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-4 Understanding the Business Investors purchase stock (or ownership) in businesses hoping to gain in two ways: Sell ownership interest in the future for more than they paid. Receive a portion of the company’s earnings in cash (dividends).

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-5 The Accounting System Collects and processes financial information Reports information to decision makers Managers (internal) Investors and Creditors (external)

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-6 The Accounting System Accounting System Financial Accounting System Periodic financial statements and related disclosures Managerial Accounting System Detailed plans and continuous performance reports External Decision Makers Investors, creditors, suppliers, customers, etc. Internal Decision Makers Managers throughout the organization

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-7 The Four Basic Financial Statements Income StatementBalance Sheet Statement of Cash Flows Statement of Retained Earnings Financial statements summarize the financial activities of the business.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-8 Let’s look at MAXIDRIVE CORP.’s financial statements.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin Name of entity 2. Title of statement 3. Specific date 4. Unit of measure The Balance Sheet reports the financial position of an entity at a particular point in time.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-10 The Balance Sheet Basic Accounting Equation Assets = Liabilities + Stockholders’ Equity

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-11 Assets are listed by their ease of conversion into cash. Assets are economic resources owned by the business as a result of past transactions.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-12 The Income Statement reports the revenues less expenses of the accounting period.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-13 Revenues June 2003 Cash from sale collected on June 10th. X May 2003 $1,000 sale made on May 25th. X When will the revenue from this transaction be recognized? Earnings from the sale of goods or services.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-14 Statement of Cash Flows Because revenues reported do not always equal cash collected and expenses reported do not always equal cash paid... net income is usually not equal to the change in cash for the period.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-15 The Statement of Cash Flows reports the inflows and outflows of cash during the period in the categories of operating, investing, and financing.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-16 Relationship Among the Financial Statements Net income from the income statement increases ending retained earnings on the statement of retained earnings.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-17 Notes  Notes provide supplemental information about the financial condition of a company.  Three basic types of notes:  Description of accounting rules applied.  Presentation of additional detail about an item on the financial statements.  Provides additional information about an item not on the financial statements.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-18 Decision makers need to understand accounting measurement rules. Decision makers need to understand accounting measurement rules. Responsibilities for the Accounting Communication Process Effective communication means that the recipient understands what the sender intends to convey.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-19 The Securities and Exchange Commission (SEC) has been given broad powers to determine measurement rules for financial statements. Securities Act of 1933 Securities and Exchange Act of 1934 Generally Accepted Accounting Principles (GAAP)

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-20 Independent Auditors Auditors express an opinion as to the fairness of the financial statement presentation. Independent auditors have responsibilities that extend to the general public. Overall, I believe these financial statements are fair.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-21 Independent Auditors An audit involves... Examining the financial reports to ensure compliance with GAAP. Examining the underlying transactions incorporated into the financial statements. Expressing an opinion as to the fairness of presentation of financial information.

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 2-22 Accounts An organized format used by companies to accumulate the dollar effects of transactions. CashEquipmentInventory Notes Payable

© 2004 The McGraw-Hill Companies McGraw-Hill/Irwin 1-23 End of Chapter 1