McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-1 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 2-1 © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 2 Financial Statements and Accounting Concepts/Principles

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-2 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 2-2 Transactions are economic interchanges between entities that are accounted for and reflected in financial statements. L O 1 Financial Statements

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-3 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 2-3 Accounts Account balances are then used in the preparation of financial statements. Cash Accounts Receivable Accounts Payable Transactions are summarized in accounts. L O 1 Accounts are used to organize like-kind transactions.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-4 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 2-4 Financial Statements In addition to the financial statements, the annual report will probably include several accompanying notes or explanations of the accounting policies used and detailed information about many of the amounts and captions shown in the financial statements. L O 2

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-5 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 2-5 Balance Sheet-Elements L O 3 Liabilities are amounts owed to other entities. Assets represent the amount of resources owned by the entity. Equity is the ownership right of the owner(s) of the entity in the assets that remain after deducting the liabilities.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-6 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 2-6 Balance Sheet L O 3 Current assets are those assets that are likely to be converted into cash or used to benefit the entity within one year. Current liabilities are those liabilities that are to be paid within one year.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-7 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 2-7 Balance Sheet LiabilitiesEquityAssets =+ L O 3

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-8 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 2-8 Income Statement The income statement shows the profit (or loss) for the period of time under consideration. L O 4 Revenues result from the entity’s operating activities (e.g., selling merchandise). Costs and expenses are incurred in generating revenues and operating the entity. Costs and expenses are incurred in generating revenues and operating the entity. Gains and losses are also reported on the income statement and result from non- operating activities, rather than from the day-to-day operating activities that generate revenues and expenses.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-9 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 2-9 Statement of Changes in Owners’ Equity This financial statement shows the detail of owners’ equity and explains the changes that occurred in the components of owners’ equity during the year. L O 4

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Statement of Cash Flows The purpose of this financial statement is to identify the sources and uses of cash during the year. L O 4

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Financial Statement Relationships and the Accounting Equation If assets equal $300,000 and liabilities equal $125,000, what is owners’ equity? Owners’ equity equals $175,000 ($300,000 - $125,000) L O 4 Now, suppose that total assets increase $12,000 during the year and total liabilities decrease $3,000 during the year. Owners’ equity must have increased by $15,000. Since owners’ equity was $175,000 at the beginning of the year, it must be $190,000 at the end of the year.

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Balance Sheet L O 4

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Income Statement L O 4

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Statement of Changes in Owners’ Equity L O 4

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Statement of Cash Flows L O 4

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved Accrual Accounting Vs. Cash Flows L O 6 Revenue Recognition -Timing is the Key Cash flow recognizes: Cash flow recognizes: Accrual accounting recognizes: Accrual accounting recognizes: Revenue when payment is received for services rendered or products sold. Revenue when payment is received for services rendered or products sold. Revenue when revenue is earned, at the point of sale of services or products. Revenue when revenue is earned, at the point of sale of services or products. Expenses when they are paid. Expenses when they are paid. Expenses when they are incurred. Expenses when they are incurred.