The Financial Statements CHAPTER 1 The Financial Statements © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

ACCOUNTING VS. BOOKKEEPING Bookkeeping is the procedural element of accounting that processes the accounting data © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

DECISION MAKERS WHO USE ACCOUNTING INFORMATION Individuals Businesses Investors and Creditors Government Regulatory Agencies Taxing Authorities Nonprofit Organizations © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

ETHICAL CONSIDERATIONS Ethical standards in accounting are designed to produce accurate information for decision making The result of ethical behavior by accountants is information that people can rely on for decision making © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

TYPES OF BUSINESS ORGANIZATIONS Partnerships Join two or more persons together as co-owners Are business entities, but not legal entities Have debt for which each partner is personally liable © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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) © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

ACCOUNTING PRINCIPLES AND CONCEPTS The FASB works with the SEC (Securities and Exchange Commission) and the AICPA (American Institute of Certified Public Accountants) © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

KEY ACCOUNTING ORGANIZATIONS Public Sector Law creates the SEC to regulate the stock and bond market in the U.S. Private Sector The FASB determines generally accepted accounting principles Private Sector Accountants apply GAAP through the AICPA GAAP governs accounting information © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

ACCOUNTING PRINCIPLES AND CONCEPTS The stable-monetary-unit concept States that each dollar has the same purchasing power as any other dollar at any other time © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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) Assets held by the owners of the business © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

THE ACCOUNTING EQUATION Paid-in (contributed) capital is The amount invested in the corporation by its owners Comprised basically of common stock © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

COMPONENTS OF RETAINED EARNINGS Revenues for the Period - Expenses for the Period Start of the Period = End of the Period Beginning Balance of Retained Earnings Net Income (Loss) for the Period Dividends for the Period Ending Balance of Retained Earnings + - - = © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

INFORMATION REPORTED ON THE FINANCIAL STATEMENTS © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

Question Answer Financial Statement 1. 2. 3. 4. © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

INCOME STATEMENT The income statement (statement of earnings) reports the company’s revenues, expenses, and net income or net loss for the period © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

INCOME STATEMENT © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

INCOME STATEMENT Revenues are Expenses are Increases in retained earnings from delivering goods or services to customers or clients Expenses are Decreases in retained earnings that result from operations © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

INCOME STATEMENT Operating expenses Advertising Depreciation The cost to promote the company’s 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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

STATEMENT OF RETAINED EARNINGS © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

BALANCE SHEET The balance sheet (statement of financial position) reports the company’s assets, liabilities, and owners’ equity © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

BALANCE SHEET © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

ASSETS Current assets are Current assets include 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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

ASSETS Long-term assets are Long-term assets include Those assets which the company expects to hold longer then the next 12 months or the business’s normal operating cycle if longer than one year Long-term assets include Property Equipment © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

ASSETS Intangible assets are Other 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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

LIABILITIES Current liabilities are Current liabilities include Debts payable within one year or within the business’s normal operating cycle if longer than a year Current liabilities include Notes payable, short term Accounts payable Accrued expenses payable Income taxes payable © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

LIABILITIES Long-term liabilities are Long-term liabilities include Debts not payable within one year or within the business’s normal operating cycle if longer than a year Long-term liabilities include Notes payable, long term Bonds payable © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

STATEMENT OF CASH FLOWS The statement of cash flows reports the company’s cash inflows and outflows from operating, investing, and financing activities © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

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 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

RELATIONSHIPS AMONG THE FINANCIAL STATEMENTS © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren

END OF CHAPTER 1 © 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison & Horngren