1. INTRODUCTION TO FINANCIAL STATEMENTS Accounting, Fifth Edition 1 1

2. Learning Objectives After studying this chapter, you should be able to: 1.Describe the primary forms of business organization. 2.Identify the users and uses of accounting information. 3.Describe the content and purpose of each of the financial statements. 4.Explain the meaning of assets, liabilities, and stockholders’ equity, and state the basic accounting equation. 5.Describe the components that supplement the financial statements in an annual report. 2

3. LO 1 Describe the primary forms of business organization. Forms of Business Organization 3

4. LO 2 Users and Uses of Financial Information Internal Users Illustration 1-1 Questions that internal users ask 4

5. 5

6. Users and Uses of Financial Information LO 2 External Users Illustration 1-2 Questions that external users ask 6

7. Assets Liabilities & Equity Liabilities Equity Assets =+ Accounting Equation 7

8. Land Equipment Buildings Cash Prepaid Expenses Store Supplies Notes Receivable Accounts Receivable Resources owned or controlled by a company Assets – What you OWN 8

9. Taxes Payable Wages Payable Notes Payable Accounts Payable Creditors’ claims on assets Liabilities – What you OWE 9

10. Increases Equity ** Decreases Equity *Investments by the shareholders *Results from the sale of products or services Sales Revenue Interest Income Rent Revenue **Use of assets or services used to generate revenues Salaries Exp Rent Exp Interest Exp Utilities Exp **Returns made to shareholders Shareholders’ Equity – Owners’ Claim to Assets Shareholders’ Equity – Owners’ Claim to Assets 10

11. 1.Cost of renting property. 2.Truck purchased. 3.Notes payable. 4.Issuance of ownership shares. 5.Amount earned from providing service. 6.Amounts owed to suppliers. 1.Expense. 2.Asset. 3.Liabilities. 4.Common stock. 5.Revenue. 6.Liabilities. Solution Classify each item as an asset, liability, common stock, revenue, or expense. LO 3 Explain the three principal types of business activity. Also do Ex 1-8 (a) 11

12. Identifies Records Communicates Relevant Reliable Comparable Accounting is a system that information that is to help users make better decisions. GAAP Why Accounting is Important 12

13. Income Statement* (Revenues – Expenses) Companies prepare four financial statements from the summarized accounting data: Statement of Cash Flows* (Cash) (Ch 13) Retained Earnings Statement* (Income – Dividends) Communicating with Users LO 4 Describe the content and purpose of each of the financial statements. Balance Sheet** (Assets, Liabilities & Equity) * Represents a period of time (i.e. Jan 1 –Dec 31) ** Represents a single point of time (i.e Dec 31) 13

14. Communicating with Users LO 4 Describe the content and purpose of each of the financial statements. Retained Earnings Statement Net income is needed to determine the ending balance in retained earnings. Illustration 1-5 Income Statement Illustration 1-4 14

15. Practice Problem Ex 1-8(b), p 31

16. Communicating with Users LO 4 Describe the content and purpose of each of the financial statements.  Statement shows amounts and causes of changes in retained earnings during the period.  Time period is the same as that covered by the income statement.  Users can evaluate dividend payment practices. Retained Earnings Statement Illustration 1-5 Helpful Hint The heading of this statement identifies the company, the type of statement, and the time period covered by the statement. 16

17. Practice Problem Ex 1-6, p 31

18. Communicating with Users LO 4 Describe the content and purpose of each of the financial statements. Retained Earnings Statement Ending balance in retained earnings is needed in preparing the balance sheet. Balance Sheet 18

19. Communicating with Users Balance Sheet  Reports assets and claims to assets at a specific point in time.  Assets = Liabilities + Stockholders’ Equity.  Lists assets first, followed by liabilities and stockholders’ equity. LO 5 Explain the meaning of assets, liabilities, and stockholders’ equity, and state the basic accounting equation. Illustration 1-7 Helpful Hint The heading of a balance sheet must identify the company, the statement, and the date. 19

20. Practice Problem Ex 1-15, p 33

21. Communicating with Users Balance Sheet Illustration 1-8 Statement of Cash Flows LO 5 Explain the meaning of assets, liabilities, and stockholders’ equity, and state the basic accounting equation. Illustration 1-7 21

22. Answers:  Where did cash come from during the period?  How was cash used during the period?  What was the change in the cash balance during the period? Communicating with Users Statement of Cash Flows Illustration 1-8 LO 5 Helpful Hint The heading identifies the company, the type of statement, and the time period covered by the statement. Negative numbers are shown in parentheses. 22

23. LO 1 Analyze the effect of business transactions on the basic accounting equation. Accounting Equation & Fin’l Statements Illustration 3-2 Expanded accounting equation Income Statement

24. LO 1 Analyze the effect of business transactions on the basic accounting equation. Accounting Equation & Fin’l Statements Illustration 3-2 Expanded accounting equation Net Income/Income Statement Stmt of Retained Earnings

25. LO 1 Analyze the effect of business transactions on the basic accounting equation. Accounting Equation & Fin’l Stmts Illustration 3-2 Expanded accounting equation Net Income/Income Statement Stmt of Retained Earnings Balance Sheet

26. U.S. companies that are publicly traded must provide shareholders with an annual report. The annual report always includes:  Financial statements.  Management discussion and analysis.  Notes to the financial statements.  Auditor's report. Other Elements of an Annual Report LO 6 Describe the components that supplement the financial statements in an annual report. 26

27. Management Discussion and Analysis Management discussion and analysis (MD&A) covers the company’s ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations. Management must highlight favorable or unfavorable trends and identify significant events and uncertainties that affect these three factors. Other Elements of an Annual Report LO 6 Describe the components that supplement the financial statements in an annual report. 27

28. Other Elements of an Annual Report Notes to the Financial Statements Illustration 1-11  Clarify the financial statements.  Provide additional detail. Notes are essential to understanding a company’s operating performance and financial position. LO 6 28

29. Auditor’s Report Other Elements of an Annual Report LO 6 Illustration 1-12 Auditor’s opinion as to the fairness of the presentation of the financial position and results of operations and their conformance with generally accepted accounting principles. 29

30. U.S.Global Rule MakerFASB (Fin’l Acctg Stds Board) issues broad & specific US accounting principles. IASB (Int’l Acctg Stds Board ) issues preferred accounting practices in other countries. RulesGAAP (Generally Accepted Accounting Principles) IFRS (Int’l Financial Reporting Standards) Police/EnforcersSEC (Securities & Exchange Commission) IFRS not enforceable BUT recommended. US Reqm’tsUS GAAP req’d for US SEC Registrants IFRS or GAAP for non- US SEC Registrants It seems unlikely that IFRS will be mandated soon given the new SEC Chairman’s focus on investor protections & securities law enforcement. However US GAAP & IFRS accounting standards continue to converge SO US companies are being impacted by IFRS. (Apr 2013) Setting Accounting Rules 30

31. Key Points  IFRS tends to be simpler in its accounting and disclosure requirements; some people say it is more “ principles-based. ” GAAP is more detailed; some people say it is more “ rules-based. ”  International standards are referred to as International Financial Reporting Standards (IFRS), developed by the International Accounting Standards Board (IASB). Over 115 countries require or permit use of IFRS.  Recent events in the global capital markets underscore the importance of financial disclosure and transparency not only in the United States but in markets around the world. As a result, many are examining which accounting and financial disclosure rules should be followed. LO 7 Describe the impact of international accounting standards on U.S. financial reporting. 31

32. Ethics In Financial Reporting United States regulators and lawmakers were very concerned that the economy would suffer if investors lost confidence in corporate accounting because of unethical financial reporting.  Recent financial scandals include: Enron, WorldCom, HealthSouth, AIG, and others.  Congress passed Sarbanes-Oxley Act of 2002.  Effective financial reporting depends on sound ethical behavior. Users and Uses of Financial Information LO 2 Identify the users and uses of accounting information. 32

33. Beliefs that distinguish right from wrong Accepted standards of good and bad behavior Ethics Users and Uses of Financial Information Ethics In Financial Reporting 33

34.  Identify ethical concerns  Analyze options  Make ethical decision Use personal ethics to recognize ethical concern. Consider all good and bad consequences. Choose best option after weighing all consequences. Guidelines to Ethical Decisions 34