1. ACF 101-102 Introductory Financial Accounting Introductory Financial Statement Analysis
Lecture 7

2. Learning Outcome
Present information demonstrating quality and clarity of expression, use of terminology, knowledge of format, aptness for the user group. Use of practical and/or numerical and analytical skills (in IT and/or quantitative methods) to produce accounting statements and analyse reports.

3. Topics
Differences in accounting statements for different forms of business
Sole Traders
Partnerships
Limited Liability Companies.

4. Compare the features of sole proprietorships, partnerships, and corporations….

5. A sole proprietorship is a separate organization with a single owner
A sole proprietorship is a separate organization with a single owner. A proprietorship is an individual entity that is separate and distinct from the proprietor.

6. A partnership is a special form of organization that joins two or more individuals together as co-owners. Each partnership is an individual entity that is separate from the personal activities of each partner.

7. Corporations are organizations created under state law with an unlimited number of owners. A corporation is a legal entity as well as an accounting entity.

8. A publicly owned corporation is one in which shares of ownership (capital stock certificates) are sold to the public. The owners of the corporation are then identified as shareholders or stockholders.

9. A privately owned corporation is owned by families, a small group of shareholders, or single individuals. Its shares of ownership are not publicly sold.

10. Advantages of the corporate form of ownership include the following: 
a. Limited liability (i.e., corporation creditors ordinarily have claims against the corporate assets only, not against the personal assets of the owners) of owners
b. Ease of transfer of ownership 
c. Ease in raising ownership capital 
d. Continuity of existence 
e. Separation of ownership and management

11. One of the potential disadvantages of the corporate form of ownership is that the corporation is taxed as a separate entity.

12. Identify how the owners’ equity section in a corporate balance sheet differs from that in a sole proprietorship or a partnership…

13. Comparative Ownership Features
Sole proprietorship – a single owner
Partnership – two or more co-owners
Corporation – created under (U.S.) state laws
Publicly owned – Owned by the public through the sale of shares; potentially thousands of owners
Privately owned – Owned by families or a small group of shareholders; shares are not sold or traded

14. Advantages of a Corporation
Limited liability (claims against corporate assets only – not personal assets of managers)
Easy transfer of ownership
Ability to raise capital from thousands
Continuity of existence
Prestige

15. Disadvantages of a Corporation
Unfavorable tax laws (double taxation on distributed earnings)
Regulation

16. Differences in Reporting Owners’ Equity

17. Proprietorships and Partnerships
Owners’ equities = “Capital”
Owners’ equities are recorded in the capital account

18. Corporations
Owners’ equities (Residual interests in the company) also called Stockholders’/Shareholders’ equity
Total capital investment = Paid-in capital (e.g., $20)
Common stock recorded at par/stated value
Par/stated value = what is printed on the stock
One share × $5 par value = $5
Paid-in capital in excess of par value
One share × ($20 – $5 par value) = $15

19. Differences in Reporting Owners’ Equity
Shareholders elect a board of directors to look out for their interests
Board of Directors
Often include outsiders such as CEOs and presidents of other corporations, academics, attorneys, and community representatives
Can also include insiders – company’s CEO, CFO, etc.
Majority must be independent if stock is regulated
Set strategic direction of the company
Senior Managers – run day to day operations

20. Ethics, Unearned Revenue and Revenue Recognition
When uncertainty prevails, conservatism suggests selecting measurement methods that
Understate assets
Overstate liabilities
Understate Equity (and net income) by
Understating revenue and gains
Overstating expenses and losses
It is unethical to knowingly overstate assets or equity (net income)

21. The Adjusting Process in Perspective
The complete accounting cycle now becomes
Transactions
Documentation
Journal
Ledger
Unadjusted
Trial Balance
Journalize and
Post Adjustments
Adjusted
Trial Balance
Financial
Statements

22. The Adjusting Process in Perspective
Each adjusting entry affects at least
One income statement account
One balance sheet account
The Cash account is not adjusted
The end-of-period adjustment process is reserved for implicit transactions, which anchor the accrual basis of accounting

23. The Adjusting Process in Perspective
Advance Cash
Payments for
Future
Services to be
Received
Noncash
Assets in the
Balance Sheet
Expenses in
the Income
Statement
Transformed
by adjustments
into
When unexpired costs expire
Create
Liabilities
in the
Balance Sheet
Revenues in
the Income
Statement
When revenues received in advance are earned
Advance Cash
Collections in
advance for
future
Services
Transformed
by adjustments into
Create

24. The Adjusting Process in Perspective
Passing of time
and the
continuous use
of services
before paying
for them
Should be recorded by adjustments as increases in
Expenses
in the
Income
Statement
and
Liabilities
in the
Balance Sheet
Cash
Payments
Until decreased later by

25. Adjusting Process in Perspective
Passing of time
and the
continuous
rendering of
services
Should be recorded by adjustments as increases in
Revenues
in the
Income
Statement
and
Noncash
assets
In the Balance
Sheet
Cash
Collections
Until decreased later by

26. Classified Balance Sheet
A classified balance sheet groups asset, liability, and owners’ equity accounts into subcategories
Assets are classified into two groups:
Current assets
Noncurrent (or long-term) assets
Liabilities are classified into
Current liabilities
Noncurrent (or long-term) liabilities

27. Classified Balance Sheet

28. Classified Balance Sheet
Current assets = assets expected to be converted to cash, sold, or consumed during the next 12 months (or within an operating cycle if longer)
Current liabilities = liabilities expected to be paid within the next year (or operating cycle if longer)
Both are generally listed in the order in which they are likely to be converted/consumed or paid during the coming year

29. Classified Balance Sheet
Liquidity is a company’s ability to pay its immediate financial obligations with cash and near- cash assets
The current ratio evaluates a company’s liquidity
Chan Audio’s current ratio is
Current assets
Current liabilities
Current Ratio
$532,500
$232,870
= 2.3

30. Classified Balance Sheet
Working capital is the excess of current assets over current liabilities
Chan Audio’s working capital is
$532,500 - $232,870 = $299,630
The quick (acid test) ratio removes Inventory (and other less liquid assets such as Prepaid Expenses) from the numerator of the calculation
Chan Audio’s quick ratio is
$532,500 – $260,200
$232,870
= 1.2

31. Classified Balance Sheet
A balance sheet may be presented in
Condensed format - just totals of current and long-term categories
Detailed format - the accounts that make up current and long-term categories
Report format - presents all the accounts vertically
Account format - lists assets to the left and liabilities and owners’ equity to the right

32. Income Statement Formats Single step - lists revenues and deducts expenses without drawing any intermediate subtotals

33. Income Statement Formats Multiple step - lists revenues and deducts expenses while drawing intermediate informative subtotals

34. Income Statement Formats
In a multiple-step income statement, Intermediate and informative subtotals usually include the following:
Gross profit (gross margin) - excess of sales revenue over the cost of the inventory that was sold
Operating expenses - recurring expenses that pertain to the firm’s routine, ongoing operations
Operating income - the difference between the usual and frequent in- and outflows
Other (Nonoperating) items – not related to the firm’s principal operations, i.e., the unusual and/or infrequent flows