Financial Statements and Business Decisions Chapter 1 McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin Slide 2 McGraw-Hill/Irwin Slide 2 Accounting is the information system that... measures business activities, processes data into reports, and communicates results to decision makers. Accounting – The Language of Business

McGraw-Hill/Irwin Slide 3 Accounting – The Language of Business  Accounting is the art of recording, classifying and summarizing transactions, in terms of money, and interpreting the results.

McGraw-Hill/Irwin Slide 4 McGraw-Hill/Irwin Slide 4 The Flow of Accounting Information 3. Businesses prepare reports to show the results of their operations. 2. Business transactions occur.1. People make decisions.

McGraw-Hill/Irwin Slide 5 McGraw-Hill/Irwin Slide 5 Accounting for Business Transactions A transaction is any event that both affects the financial position of the business entity and can be reliably recorded.

McGraw-Hill/Irwin Slide 6 McGraw-Hill/Irwin Slide 6 The Account Cash Accounting’s main summary device is the account, a record of like transactions. Accounts are grouped in three broad categories, according to the accounting equation:

McGraw-Hill/Irwin Slide 7 McGraw-Hill/Irwin Slide 7 The Accounting Equation A = L + SE (Assets) (Liabilities) (Stockholders’ Equity) Economic Resources Sources of Financing for Economic Resources Liabilities: From Creditors Stockholders’ Equity: From Stockholders

McGraw-Hill/Irwin Slide 8 McGraw-Hill/Irwin Slide 8 The Accounting Equation Assets are the economic resources of a business that are expected to produce a benefit in the future. Liabilities are “outsider claims,” or economic obligations payable to outsiders. Owners’ equity represents the “insider claims” of a business.

McGraw-Hill/Irwin Slide 9 McGraw-Hill/Irwin Slide 9 Typical Accounts—The Balance Sheet Assets Cash Short-Term Investment Accounts Receivable Notes Receivable Inventory Supplies Prepaid Expenses Long-Term Investments Equipment Buildings Land Intangibles Liabilities Accounts Payable Accrued Expenses Notes Payable Taxes Payable Unearned Revenue Bonds Payable Stockholders’ Equity Contributed Capital Retained Earnings

McGraw-Hill/Irwin Slide 10 McGraw-Hill/Irwin Slide 10 Typical Accounts--The Income Statement Revenues Sales Revenue Fee Revenue Interest Revenue Rent Revenue Expenses Cost of Goods Sold Wages Expense Rent Expense Interest Expense Depreciation Expense Advertising Expense Insurance Expense Repair Expense Income Tax Expense

McGraw-Hill/Irwin Slide 11 McGraw-Hill/Irwin Slide 11 The Four Basic Financial Statements

McGraw-Hill/Irwin Slide 12 McGraw-Hill/Irwin Slide 12 Notes to Financial Statements All financial statements should be accompanied by notes which provide the reader with supplemental information about the financial condition and results of operations of the company.

McGraw-Hill/Irwin Slide 13 McGraw-Hill/Irwin Slide 13 Notes to Financial Statements Descriptions of the key accounting rules that apply to the company’s statements. Additional detail supporting reported numbers. Relevant financial information not disclosed on the statements.

McGraw-Hill/Irwin Slide 14 McGraw-Hill/Irwin Slide 14 The Accounting System Collects and processes financial information Reports information to decision makers Managers (internal decision makers) Investors and Creditors (external decision makers)

McGraw-Hill/Irwin Slide 15 McGraw-Hill/Irwin Slide 15 Individuals External Users of Accounting Information Businesses Investors and creditors Government regulatory agencies Taxing authorities Nonprofit organizations

McGraw-Hill/Irwin Slide 16 McGraw-Hill/Irwin Slide 16 Management Users of Financial Statements Marketing managers and credit managers use customers’ financial statements to decide whether to extend credit. Purchasing managers use suppliers’ financial statements to decide whether suppliers have the resources to meet the demand for products. Employees’ union and human resource managers use the company’s financial statements as a basis for contract negotiations pay rates.

McGraw-Hill/Irwin Slide 17 McGraw-Hill/Irwin Slide 17 Generally Accepted Accounting Principles Our accounting system has a long and distinguished history. An Italian monk named Luca Pacioli, published the first elements of double- entry bookkeeping in Prior to 1933, the management teams of most companies were free to choose the accounting principles used to keep track of its transactions.

McGraw-Hill/Irwin Slide 18 McGraw-Hill/Irwin Slide 18 The Securities and Exchange Commission (SEC) has been given broad powers to determine measurement rules for financial statements. 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 Securities Act of 1933 Securities and Exchange Act of 1934 Generally Accepted Accounting Principles

McGraw-Hill/Irwin Slide 19 McGraw-Hill/Irwin Slide 19 Generally Accepted Accounting Principles Currently, the Financial Accounting Standards Board (FASB) is recognized as the body to formulate GAAP. Currently, the Financial Accounting Standards Board (FASB) is recognized as the body to formulate GAAP. The SEC has worked closely with the accounting profession to work out the detailed rules that have become known as GAAP. The SEC has worked closely with the accounting profession to work out the detailed rules that have become known as GAAP.

McGraw-Hill/Irwin Slide 20 McGraw-Hill/Irwin Slide 20 International Perspective Since 2002, there has been substantial movement to develop international financial reporting standards (IFRS) by the International Accounting Standards Board (IASB).

© 2008 The McGraw-Hill Companies, Inc. End of Chapter 1

McGraw-Hill/Irwin Slide 22  More About Financial Statements

McGraw-Hill/Irwin Slide 23 McGraw-Hill/Irwin Slide 23 Balance Sheet

McGraw-Hill/Irwin Slide 24 McGraw-Hill/Irwin Slide 24 The Balance Sheet Assets Cash Short-Term Investment Accounts Receivable Notes Receivable Inventory (to be sold) Supplies Prepaid Expenses Long-Term Investments Equipment Buildings Land Intangibles Liabilities Accounts Payable Accrued Expenses Notes Payable Taxes Payable Unearned Revenue Bonds Payable Stockholders’ Equity Contributed Capital Retained Earnings Typical Accounts

McGraw-Hill/Irwin Slide 25 McGraw-Hill/Irwin Slide 25 Income Statement

McGraw-Hill/Irwin Slide 26 McGraw-Hill/Irwin Slide 26 The Income Statement Revenues Sales Revenue Fee Revenue Interest Revenue Rent Revenue Expenses Cost of Goods Sold Wages Expense Rent Expense Interest Expense Depreciation Expense Advertising Expense Insurance Expense Repair Expense Income Tax Expense Typical Accounts

McGraw-Hill/Irwin Slide 27 McGraw-Hill/Irwin Slide 27 Statement of Retained Earnings MAXIDRIVE CORP. Statement of Retained Earnings For the Year Ended December 31, 2010 (in thousands of dollars) Retained earnings, January 1, 2010 $6,805 Net income for ,300 Dividends for 2009 (1,000) Retained earnings, December 31, 2010 $9,105

McGraw-Hill/Irwin Slide 28 McGraw-Hill/Irwin Slide 28 Statement of Retained Earnings Beginning Retained Earnings Plus: Net Income Less: Dividends Ending Retained Earnings

McGraw-Hill/Irwin Slide 29 McGraw-Hill/Irwin Slide 29 Statement of Cash Flows

McGraw-Hill/Irwin Slide 30 Statement of Cash Flows  Distinguishes between cash received from or used for: ---Operating activities ---Investing activities and ---Financing activities

McGraw-Hill/Irwin Slide 31 McGraw-Hill/Irwin Slide 31 Information Reported on the Financial Statements 1. How well did the company perform (or operate) during the period? Revenues – Expenses Net income (Net loss) Income statement QuestionAnswer Financial Statement 2. Why did the company’s retained earnings change during the period? Beg. retained earnings + Net income (or – Net loss) - Dividends Ending retained earnings Statement of retained earnings

McGraw-Hill/Irwin Slide 32 McGraw-Hill/Irwin Slide 32 Information Reported on the Financial Statements 3. What is the company’s financial position at the end of the period? Assets = Liabilities + Owners’ equity Balance sheet QuestionAnswer Financial Statement 4. How much cash did the company generate and spend during the period? Operating cash flows ± Investing cash flows ± Financing cash flows Increase or decrease in cash Statement of cash flows

McGraw-Hill/Irwin Slide 33 McGraw-Hill/Irwin Slide 33 Relationships Among the Statements 1.Net income from the income statement results in an increase in ending retained earnings on the statement of retained earnings. Income Statement Revenues $ 15,500 Statement of Retained Earnings Expenses (8,500) Beginning retained earnings $ 59,000 Net income $ 7,000 Net income 7,000 Dividends (2,500) Ending retained earnings $ 63,500

McGraw-Hill/Irwin Slide 34 McGraw-Hill/Irwin Slide 34 Relationships Among the Statements 2.Ending retained earnings from the statement of retained earnings is one of the two components of stockholders’ equity on the balance sheet. Statement of Retained Earnings Balance Sheet Beginning retained earnings $ 59,000 Cash $ 14,000 Net income 7,000 Other assets 171,500 Dividends (2,500) Total assets $ 185,500 Ending retained earnings $ 63,500 Liabilities $ 42,000 Stockholders' Equity Common stock 80,000 Retained earnings 63,500 Total liabilities and equity $ 185,500

McGraw-Hill/Irwin Slide 35 McGraw-Hill/Irwin Slide 35 Relationships Among the Statements 3.The change in cash on the statement of cash flows is added to the beginning-of-year balance in cash to arrive at end-of-year cash on the balance sheet. Statement of Cash Flows Balance Sheet Cash flows from operating activities $ 21,000 Cash $ 14,000 Cash flows from investing activities (16,000) Other assets 171,500 Cash flows from financing activities 3,500 Total assets $ 185,500 Increase in cash $ 8,500 Liabilities $ 42,000 Beginning cash balance 5,500 Stockholders' Equity Ending cash balance $ 14,000 Common stock 80,000 Retained earnings 63,500 Total liabilities and equity $ 185,500