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Fundamentals of Financial Accounting by Phillips, Libby, and Libby.

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Presentation on theme: "Fundamentals of Financial Accounting by Phillips, Libby, and Libby."— Presentation transcript:

1 Fundamentals of Financial Accounting by Phillips, Libby, and Libby.

2 Business Decisions and Financial Reporting
Chapter 1 Business Decisions and Financial Reporting Chapter 1 Business Decisions and Financial Reporting

3 Describe various organizational forms and business decision-makers.
Learning Objective 1 Describe various organizational forms and business decision-makers. Learning objective number 1 is to describe various organizational forms and business decision-makers.

4 Organizational Forms Sole Proprietorship Partnership Corporation
Business organization owned by one person. The owner is personally liable for all debts of the business. Partnership Business organization owned by two or more people. Each partner is personally liable for all debts of the business. Part I There are three types of business organizations. A sole proprietorship is a business organization owned by one person. The owner is personally liable for all the debts of the business. Part II A partnership is a business organization owned by two or more people. Each partner is personally liable for all the debts of the business. Part III A corporation operates a business separate from its owners from both a legal and accounting perspective. Owners of corporations (often called stockholders) are not personally responsible for debts of the corporation. Corporation A separate entity from both a legal and accounting perspective. Owners of corporations (stockholders) are not personally responsible for debts of the corporation.

5 Organizational Forms Corporations Public Companies Private Companies
Have their stock bought and sold on stock exchanges. Private Companies Have their stock bought and sold privately. Corporations may be either public companies or private companies. Public companies have their stock bought and sold on stock exchanges. Private companies have their stock bought and sold privately. Most corporations start out as private companies and will become public companies if they need a lot of financing, which they obtain from selling new stock certificates to investors. Some big name corporations, like Cargill and Chick-Fil-A, haven’t gone public because they get enough financing from private sources.

6 Accounting for Business Decisions
Accounting System Produces Financial Accounting Reports Managerial Accounting Reports Accounting is a system of analyzing, recording, and summarizing the results of a business’s activities. It is such a key part of business that business people typically talk about their companies using accounting terms, which is why they often call it the “language of business.” The accounting system produces two kinds of reports. Managerial accounting reports include detailed financial plans and continuously updated reports about the financial performance of the company. These reports are made available only to employees of the company so that they can make business decisions such as whether to build, buy, or rent a building, whether to continue or discontinue making particular products, how much to pay employees, and how much to borrow. Financial accounting reports are prepared periodically to provide information to people not employed by the business. These external financial statement users are not given access to the detailed internal records of the company, so they rely extensively on the financial statements. Financial statements are accounting reports that summarize the results of business activities. The two primary external users are creditors (such as banks and suppliers) and investors (such as stockholders). Other external users include customers and various local, state, and federal governments. Provided to External Users Creditors Investors Others Internal Users Managers

7 Learning Objective 2 Describe the purpose, structure, and content of the four basic financial statements. Learning objective number 2 is to describe the purpose, structure, and content of the four basic financial statements.

8 The Basic Accounting Equation
Resources Owned . . . by the company Resources Owed . . . to creditors to stockholders Assets = Liabilities + Stockholders' Equity Separate Entity Assumption Requires that a business’s financial reports include only the activities of the business and not those of its stockholders. Part I One of the most central concepts to understanding financial reports is that what a company owns must equal what a company owes to its creditors and stockholders. In accounting, there are special names for what a company owns and what a company owes to creditors and stockholders. Resources owned by the company are called assets. Resources owed to creditors are called liabilities. Resources owed to stockholders are called stockholders’ equity. The relationship between assets, liabilities, and stockholders’ equity is known as the basic accounting equation. Part II The business itself, not the stockholders who own the business, is viewed as owning the assets and owing the liabilities. This is called the separate entity assumption, which requires that a business’s financial reports include only the activities of the business and not those of its stockholders.

9 Assets Resources controlled by the company that have measurable value and are expected to provide future benefits to the company. Assets are resources controlled by the company that have measurable value and are expected to provide future benefits to the company. Assets include things like cash, supplies, furniture, and equipment. Cash Equipment Supplies Furniture

10 Amounts owed by the business to creditors.
Liabilities Amounts owed by the business to creditors. Liabilities are measurable amounts owed to creditors. If a company borrows from a bank, it would owe a liability called a note payable. The business can also owe payments to suppliers who deliver goods and services to the business. Amounts owed to suppliers are called accounts payable because purchases made using credit are said to be “on account.” Notes Payable Accounts Payable

11 Owners’ claim to the business resources.
Stockholders’ Equity Owners’ claim to the business resources. Stockholders’ equity is whatever is left after the liabilities to creditors are reported. In other words, it is the owners’ “claim” to the business. It represents the amount invested and reinvested in the business by its owners. Stock Certificate

12 Revenues, Expenses and Net Income
Revenues - Expenses = Net Income Revenues Sales of goods or services to customers. They are measured at the amount the business charges the customer. Expenses The costs of business necessary to earn revenues, including wages to employees, advertising, insurance, and utilities. Revenues are the sales of goods or services to customers. They are measured at the amount the business charges the customer. Expenses are the costs of business necessary to earn revenues, including wages to employees, advertising, insurance, and utilities. Net income is equal to revenues minus expenses. By generating net income, a company increases its stockholders’ equity. Net income can either be left in the company to accumulate (called retained earnings) or paid out to the company’s stockholders for their own personal use (called dividends). If revenues are less than expenses, the business would have a “net loss.”

13 Dividends Payments a company periodically makes to its stockholders as a return on their investment. Dividends are payments a company periodically makes to its stockholders as a return on their investment.

14 Statement of Retained Earnings Statement of Cash Flows
Financial Statements Balance Sheet Income Statement Statement of Retained Earnings The term “financial statements” typically refers to the following four accounting reports: the balance sheet, the income statement, the statement of retained earnings, and the statement of cash flows. Let’s look in more detail at each of these financial statements. Statement of Cash Flows

15 Financial Statement Equations
Assets = Liabilities + Stockholders' Equity Balance Sheet Dividends Revenues - Expenses = Net Income Income Statement The basic accounting equation provides the structure for the balance sheet. Together, these two equations show the link between the balance sheet and the income statement. Part II The arrow from net income to stockholders’ equity indicates that the owners’ equity in the business will increase as net income is generated. Part III These earnings are retained in the company until paid out as dividends.

16 Reports the amount of revenues less expenses for a period of time.
The Income Statement Purpose Reports the amount of revenues less expenses for a period of time. Unit of Measure Results of business activities should be reported in an appropriate monetary unit, which in the United States is the U.S. dollar. Part I The purpose of the income statement is to report the amount of revenues less expenses for a period of time. For Pizza Aroma, revenues are earned from the sale of pizza to customers. Expenses are the costs incurred during the period to earn the revenue. Part II The unit of measure assumption states that results of business activities should be reported in an appropriate monetary unit, which in the United States is the U.S. dollar.

17 Financial Statement Heading
The Income Statement Financial Statement Heading All financial statements start with a heading that answers three questions: Who What When The income statement starts with a heading that answers three questions: who, what, and when.

18 The Statement of Retained Earnings
Purpose Reports the way that net income and the distribution of dividends affected the financial position of the company during the period. The Statement of Retained Earnings reports the way that net income and the distribution of dividends affected the financial position of the company during the period. A more comprehensive statement of stockholders’ equity that explains changes in all stockholders’ equity accounts is provided by large corporations. For Pizza Aroma, most changes in stockholders’ equity relate to generating and distributing earnings, so a statement of retained earnings is just as informative as a detailed statement of stockholders’ equity. The financial statement heading answers the three questions who, what, and when.

19 Reports at a point in time:
The Balance Sheet Purpose Reports at a point in time: What a business owns (assets) What it owes to creditors (liabilities) What is left over for the owners of the company’s stock (stockholders’ equity). The balance sheet reports a company’s financial position at a point in time. You can think of the balance sheet kind of like a picture or a snapshot of what a business owns (called assets), what it owes to creditors (called liabilities), and what is leftover for the owners of the company’s stock (called stockholders’ equity). The financial statement heading answers the three questions who, what, and when.

20 BASIC ACCOUNTING EQUATION Assets = Liabilities + Stockholders’ Equity
The Balance Sheet BASIC ACCOUNTING EQUATION Assets = Liabilities + Stockholders’ Equity The balance sheet “balances” because the resources (assets) equal the claims to the resources (liabilities and stockholders’ equity).

21 The Balance Sheet Assets are listed in order of liquidity, that is, how quickly they are used up or converted into cash. Notes payable are like accounts payable except that they: (1) are not interest free; (2) will not be paid as soon; and (3) are formal written debt contracts. Assets are listed in order of liquidity, that is, how quickly they are used up or converted into cash. Notes payable are like accounts payable except that they: (1) are not interest free; (2) will not be paid as soon; and (3) are formal written debt contracts.

22 The Statement of Cash Flows
Purpose Summarizes how a business’s operating, investing and financing activities caused its cash balance to change over a particular period of time. The fourth financial statement is the Statement of Cash Flows. It includes only those activities that result in cash changing hands. The statement is divided into three categories of business activities. The operating section reports cash transactions directly related to running the business to earn profit. This section includes cash transactions such as cash received from customers and cash paid for supplies, wages, repairs, advertising, and utilities. The investing section reports cash transactions involving buying and selling productive resources with long lives, such as buildings, land, equipment, and tools. The financing section reports cash transactions related to borrowing from or repaying creditors and receiving cash from or paying cash to stockholders. Pizza Aroma’s income statement showed positive net income of $2,000, but net income is not necessarily equal to cash because revenues are reported when earned and expenses when incurred regardless of when cash is received or paid. The financial statement heading answers the three questions who, what, and when.

23 Relationships Among the Financial Statements
Net income flows from the Income Statement to the Statement of Retained Earnings. The goal of the next few slides is to show how the four statements fit together. First, the income statement reports the results of business operations for the accounting period. The net income from the income statement flows to the statement of retained earnings.

24 Relationships Among the Financial Statements
Ending Retained Earnings flows from the Statement of Retained Earnings to the Balance Sheet. The ending retained earnings balance for the period is also reported on the balance sheet. If we did not report the ending retained earnings balance on the balance sheet, our balance sheet would not balance.

25 Relationships Among the Financial Statements
Cash on the balance sheet and Cash at End of Year on the statement of cash flows agree. Cash on the Balance Sheet and Cash at End of Year on the Statement of Cash Flows agree.

26 Notes to the Financial Statements
Notes help financial statement users understand how the amounts were derived and what other information may affect their decisions. The four basic financial statements are not complete without notes to help financial statement users understand how the amounts were derived and what other information may affect their decisions. We will talk more about notes in a later chapter.

27 Explain how financial statements are relevant to users.
Learning Objective 3 Explain how financial statements are relevant to users. Learning objective number 3 is to explain how financial statements are relevant to users.

28 Relevance to Financial Statement Users
Creditors Investors Is the company generating enough cash to make payments on its loans? Does the company have enough assets to cover its liabilities? What is the immediate return on my contributions (through dividends)? What is the long-term return (by selling my stock in the market)? Here is how creditors and investors use financial statements. Creditors are mainly interested in assessing two things: (1) Is the company generating enough cash to make payments on its loans? (2) Does the company have enough assets to cover its liabilities? Investors look for either an immediate return on their contributions to a company (through dividends) or a long-term return (by selling stock certificates at a price higher than what they were bought for).

29 Describe factors that enhance the reliability of financial reporting.
Learning Objective 4 Describe factors that enhance the reliability of financial reporting. Learning objective number 4 is to describe factors that enhance the reliability of financial reporting.

30 Generally Accepted Accounting Principles (GAAP)
GAAP are the underlying rules for financial reporting and are established by the Financial Accounting Standards Board (FASB) under the authority granted by the Securities and Exchange Commission (SEC). SEC FASB Generally Accepted Accounting Principles are the underlying rules for financial reporting and are established by the Financial Accounting Standards Board under the authority granted by the Securities and Exchange Commission. Companies use and follow Generally Accepted Accounting Principles when preparing their financial statements. GAAP

31 Generally Accepted Accounting Principles (GAAP)
Under authority granted by the SEC, The Public Company Accounting Oversight Board (PCAOB) establishes the rules used by auditors, who report on whether a company’s financial statements are, in fact, prepared following GAAP. PCAOB SEC FASB Under authority granted by the Securities Exchange Commission, The Public Company Accounting Oversight Board establishes the rules used by auditors, who report on whether a company’s financial statements are, in fact, prepared following GAAP. Auditors report whether companies used GAAP Auditing Rules GAAP

32 Accounting Ethics Sarbanes-Oxley Act of 2002
Top managers sign a report certifying their responsibilities for the financial statements Maintain an audited system of internal controls to ensure accuracy in accounting reports Although financial statement fraud is a fairly rare event, you may have heard about several high-profile accounting frauds that occurred a few years ago, including Enron, WorldCom, Global Crossing, and Xerox. Investigators discovered that their top managers had led financial statements users astray by misrepresenting their companies’ financial results. In response to these frauds, the U.S. Congress stepped in to create the Sarbanes-Oxley Act of 2002, which has had a huge impact on managers and auditors of public companies. The Act requires that the top managers sign a report certifying their responsibilities for the financial statements, maintain an audited system of internal controls to ensure accuracy in accounting reports, and maintain an independent committee to ensure managers cooperate with auditors. Maintain an independent committee to ensure managers cooperate with auditors

33 Chapter 1 Supplement Accounting Careers

34 Source: www.collegegrad.com/careers/all.shtml
According to the government’s Labor Department, accounting is one of the fastest growing fields, with 49,000 new jobs a year expected to be added through This graphic summarizes the career opportunities available in private and public accounting. Source:

35 End of Chapter 1 End of chapter 1.


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