Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-1 The Financial Statements Chapter 1

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-2 Learning Objective 1 Use accounting vocabulary

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-3 The Language of Business Accounting is an information system  Measures business activities  Processes data into reports  Communicates results to people and organizations Accounting is used to make decisions

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-4 Users of Accounting Individuals Investors & Creditors Taxing Authorities Nonprofit Organizations

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-5 Financial and Management Accounting FINANCIAL Provides information for external users :  Investors  Bankers  Government agencies MANAGEMENT Provides information for internal users:  Managers of the company

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-6 Ethics in Accounting U.S. companies are required to report relevant and reliable information Recent corporate scandals have emphasized the need for ethical reporting in accounting Companies that sell stock to the public must have an audit by independent accountants  Examination of financial records to ensure reliability

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-7 Forms of Business Organization Proprietorship Partnership Corporation Limited- Liability Company

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-8 Proprietorship Business has a single owner Legally, business is not separate from owner  Owner is personally liable for business debts For accounting, business records are kept separate from personal records

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-9 Partnership Two or more owners Each partner is personally liable for business debts  Can be risky

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-10 Limited Liability Companies (LLCs) Owners are called members Members are not personally liable for business debts  Reduces owners’ risk Today, many non-corporate businesses form as LLCs

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-11 Corporations Owners are stockholders  Stockholders elect Board of Directors Board sets policy and appoint officers  Stockholders not personally liable for corporate debts Formed under state law  Pay income taxes Legally distinct from owners

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-12 E1-13 a. What forms of organization will enable the owners of Quality Environmental to limit their risk of loss to the amount they have invested in the business? Corporations and Limited Liability Companies (LLC)

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-13 E1-13 b. What form of business organization will give Beard the most freedom to manage the business as she wishes? ______________________ The owner wouldn’t have to worry about other owners

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-14 E1-13 c. What form of organization will give creditors the maximum protection in the event that Quality Environmental fails and cannot pay its debts? Hint: Think about liability and number of owners Answer: Partnership

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-15 Learning Objective 2 Learn accounting concepts and principles

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-16 G A A P GAAP is an acronym for Generally Accepted Accounting Principles U.S. GAAP is formulated by the Financial Accounting Standards Board (FASB) FASB’s Conceptual Framework states that accounting should be:  Relevant  Reliable  Comparable  Consistent

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-17 Accounting Concepts Entity  A business is separate from its owners Reliability  Accounting is based on objective evidence Cost  Assets are recorded at cost (not fair value) Going-Concern  Business will continue indefinitely Monetary Unit  Transactions are recorded in a stable currency ($)

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-18 Concept Violated? Kathy Jones owns a coffee shop. Her personal expenses are included in the accounting records. Entity

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-19 Concept Violated? ABC Company owns land. The purchase price is $50,000. A recent appraisal indicates the land is worth $200,000. ABC shows the land in its financial statements at $200,000. ________________________ Which concept deals with the how assets are valued?

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-20 Learning Objective 3 Apply the accounting equation to organizations

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-21 The Accounting Equation = Liabilities Owners’ Equity +

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-22 Assets Economic resources that provide a future benefit Examples:  Cash  Inventory  Equipment  Land  Buildings

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-23 Liabilities Outsiders claims to assets  Include debts payable to creditors Examples:  Accounts payable – liability for goods or services purchased on credit  Notes payable – written promise to pay on a certain date (bank loan)

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-24 Owners’ Equity Owners’ claim on a business Assets minus liabilities  What’s left after debts are paid A corporation’s equity is called stockholders’ equity

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-25 Accounting Equation Example Compute the missing amount from each situation on the following slide Remember:  Assets = Liabilities + Owners’ Equity

Copyright ©2008 Pearson Prentice Hall. All rights reserved 1-26 Accounting Equation Example Assets =Liabilities +Owners’ Equity (a)$50,000$20,000 (b)$30,000$10,000 (c)$40,000$15,000 $70,000 $20,000 $25,000

Copyright ©2008 Pearson Prentice Hall. All rights reserved Shareholders’ 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 1-27

Copyright ©2008 Pearson Prentice Hall. All rights reserved Net Income Revenues  Earned by delivering goods or services Expenses  Costs of doing business  Rent, utilities, insurance Revenues minus expenses equal net income  If expense are greater then revenues, a net loss occurs 1-28

Copyright ©2008 Pearson Prentice Hall. All rights reserved Dividends Distributions of assets (usually cash) to shareholders Decrease Retained Earnings Do NOT impact net income 1-29

Copyright ©2008 Pearson Prentice Hall. All rights reserved Beginning Retained Earnings Revenues Expenses Net Income Dividends Ending Retained Earnings plus minus Equals 1-30

Copyright ©2008 Pearson Prentice Hall. All rights reserved Learning Objective 4 Evaluate business operations 1-31

Copyright ©2008 Pearson Prentice Hall. All rights reserved The Financial Statements Report company’s results to the public Four Statements  Income Statement  Statement of Retained Earnings  Balance Sheet  Statement of Cash Flows 1-32

Copyright ©2008 Pearson Prentice Hall. All rights reserved The Income Statement Measures operating performance for the period Reports revenue and expenses and resulting net income (or loss) Also includes gains and losses 1-33

Copyright ©2008 Pearson Prentice Hall. All rights reserved Statement of Retained Earnings Shows increases and decreases to retained earnings Increase: net income Decrease: dividends 1-34

Copyright ©2008 Pearson Prentice Hall. All rights reserved Balance Sheet Measures financial position Reports assets, liabilities and shareholders’ equity Assets and liabilities are categorized  Current and Long-term 1-35

Copyright ©2008 Pearson Prentice Hall. All rights reserved Balance Sheet Categories Current assets  Converted to cash or used within one year  Cash, Short-term Investments, Accounts Receivable, Inventory Long-term  Property, plant, and equipment  Intangible assets  Investments  Other 1-36

Copyright ©2008 Pearson Prentice Hall. All rights reserved Balance Sheet Categories Current liabilities  Due within one year of balance sheet date  Accounts payable, salaries payable, taxes payable, short-term borrowings Long-term liabilities  Long-term notes payable, mortgage payable 1-37

Copyright ©2008 Pearson Prentice Hall. All rights reserved Balance Sheet Categories Stockholders’ Equity  Paid-in capital Common stock  Retained Earnings 1-38

Copyright ©2008 Pearson Prentice Hall. All rights reserved Statement of Cash Flows Shows inflows and outflows of cash by category:  Operating activities  Investing activities  Financing activities 1-39

Copyright ©2008 Pearson Prentice Hall. All rights reserved Cash Flow Categories Operating  Cash generated from day-to-day business activities  Related to selling goods and services to customers Investing  Cash invested in long-term assets  Related to purchasing and selling plant assets and investments 1-40

Copyright ©2008 Pearson Prentice Hall. All rights reserved Cash Flow Categories Financing  How a company obtains resources to finance business  Related to long-term debt and equity (issuing stock) 1-41

Copyright ©2008 Pearson Prentice Hall. All rights reserved Learning Objective 5 Use financial statements 1-42

Copyright ©2008 Pearson Prentice Hall. All rights reserved Relationships of Financial Statements Net Income (bottom line of Income Statement) flows to Statement of Retained Earnings Ending Retained Earnings flows to Balance Sheet Cash balance from Balance Sheet flows Statement of Cash Flows 1-43 Financial Statements should be prepared in order since the amount on one statement flows the next

Copyright ©2008 Pearson Prentice Hall. All rights reserved INCOME STATEMENT RETAINED EARNINGS STATEMENT BALANCE SHEET STATEMENT OF CASH FLOWS NET INCOME ENDING RETAINED EARNINGS ENDING CASH 1-44

Copyright ©2008 Pearson Prentice Hall. All rights reserved E1-19 a) Common stock  Balance Sheet b) Income tax payable  Balance Sheet c) Dividends  Statement of Retained Earnings d) Income tax expense  Income Statement 1-45

Copyright ©2008 Pearson Prentice Hall. All rights reserved E1-19 e) Ending balance of Retained Earnings  Statement of Retained Earnings AND  Balance Sheet f) Total assets  Balance Sheet g) Long-term debt  _____________________ h) Revenue  Income Statement Which statement reports liabilities?

Copyright ©2008 Pearson Prentice Hall. All rights reserved E1-19 i) Cash spent to acquire the building  Statement of Cash Flows j) Selling, general and administrative expenses  Income Statement k) Adjustment to reconcile net income to cash provided by operating activities  Statement of Cash Flows 1-47

Copyright ©2008 Pearson Prentice Hall. All rights reserved E1-10 l) Ending cash balance  Balance Sheet AND  Statement of Cash Flows m) Current liabilities  Balance Sheet n) Net Income  __________________________ AND  ____________________________ This number is the bottom line on one statement and is an increase to another

Copyright ©2008 Pearson Prentice Hall. All rights reserved End of Chapter One 1-49