chapter
1 Financial Statements
and Business Decisions
Financial Accounting
9e
Libby • Libby • Hodge
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1-1
Exhibit 1.1
The Accounting System and Decision Makers
Accounting System
Financial Accounting Reports
Periodic financial statements
and related disclosures
Managerial Accounting Reports
Detailed plans and continuous
performance reports
provided to
External Decision Makers
Evaluate the company
Creditors
Investors
Internal Decision Makers
Run the company
Managers
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Business Activities
Financing
Activities
Operating
Activities
Investing
Activities
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The Four Basic Financial Statements
BALANCE SHEET – reports the amount of assets, liabilities, and
stockholders’ equity of an accounting entity at a point in time.
INCOME STATEMENT – reports the revenues less the expenses of the
accounting period.
STATEMENT OF STOCKHOLDERS’ EQUITY – reports the changes in each
of the company’s stockholders’ equity accounts, including the change
in the retained earnings balance caused by net income and dividends
during the reporting period.
STATEMENT OF CASH FLOWS – reports inflows and outflows of cash
during the accounting period in the categories of operating, investing,
and financing.
The notes are an integral part of these financial statements.
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Balance Sheet
Assets
Cash
Short-Term Investments
Accounts Receivable
Notes Receivable
Inventory (to be sold)
Supplies
Prepaid Expenses
Long-Term Investments
Equipment
Buildings
Land
Intangibles
Elements of the
Balance Sheet
Liabilities
Accounts Payable
Accrued Expenses
Notes Payable
Taxes Payable
Unearned Revenue
Bonds Payable
Stockholders’ Equity
Common Stock
Retained Earnings
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Exhibit 1.2
Balance Sheet
EXPLANATION
LE-NATURE’S INC.
Balance Sheet
At December 31, 2012
(in millions of dollars)
Assets:
Cash
Accounts receivable
Inventories
Property, plant, and equipment
Total assets
Liabilities and stockholders’ equity:
Liabilities
Accounts payable
Notes payable to banks
Total liabilities
Stockholders’ equity
Common stock
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
Name of the entity
Title of the statement
Specific date of the statement
Unit of measure
$ 10.6
6.6
51.2
459.0
$527.4
$ 26.0
381.7
407.7
55.7
64.0
119.7
$527.4
Resources controlled by the company
Amount of cash in the company’s bank accounts
Amounts owed by customers from prior sales
Ingredients and beverages ready for sale
Factories, production equipment, and land
Total amount of company’s resources
Sources of financing for company’s resources
Financing supplied by creditors
Amounts owed to suppliers for prior purchases
Amounts owed to banks on written debt contracts
Financing provided by stockholders
Amounts invested in the business by stockholders
Past earnings not distributed to stockholders
Total sources of financing for company’s resources
The notes are an integral part of these financial statements.
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The Accounting Equation
A = L + SE
Assets
Economic
Resources
Liabilities
Stockholders’
Equity
Sources of Financing for Resources
Liabilities: From Creditors
Stockholders’ Equity: From Stockholders
The balance sheet reports a company's assets, liabilities, and
stockholders' equity at a specific point in time.
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Income Statement
Elements of the
Income
Statement
Revenues
Cash and promises received
from delivery of goods and
services.
Examples:
Sales Revenue
Fee Revenue
Interest Revenue
Rent Revenue
Expenses
Resources used to earn
period’s revenues.
Examples:
Cost of Goods Sold
Wages Expense
Rent Expense
Depreciation Expense
Insurance Expense
Repair Expense
Income Tax Expense
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Exhibit 1.3
Income Statement
EXPLANATION
LE-NATURE’S INC.
Income Statement
For the Year Ended December 31, 2012
(in millions of dollars)
Revenues
Sales revenue
Expenses
Cost of goods sold
Selling, general, and administrative
Name of the entity
Title of the statement
Accounting period
Unit of measure
$275.1
Cash and promises received from sale of beverages
140.8
Cost to produce beverages sold
Other operating expenses (utilities, delivery costs, etc.)
expenses
77.1
Interest expense
Income before income taxes
Income tax expense
Net income
Cost of using borrowed funds
17.2
40.0
17.1
$ 22.9
Income taxes on period’s income before income taxes
Revenues earned minus expenses incurred
The notes are an integral part of these financial statements.
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Statement of Stockholders’ Equity
Elements of the Statement of
Stockholders’ Equity
Common Stock
Retained Earnings
Beginning Common Stock
Beginning Retained Earnings
+Stock Issuance
+Net Income
Ending Common Stock
−Dividends
Ending Retained Earnings
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Exhibit 1.4
Statement of Stockholders’ Equity
EXPLANATION
LE-NATURE’S INC.
Statement of Stockholders’ Equity
For the Year Ended December 31, 2012
(in millions of dollars)
Balance December 31, 2011
Net income for 2012
Dividends for 2012
Balance December 31, 2012
Name of the entity
Title of the statement
Accounting period
Unit of measure
Common
Stock
Retained
Earnings
$55.7
$43.1
22.9
(2.0)
$64.0
$55.7
Last period’s ending balances
Net income reported on the income statement
Dividends declared during the period
Ending balances on the balance sheet
The notes are an integral part of these financial statements.
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Statement of Cash Flows
Elements of the Statement of Cash Flows
Cash Flows from Operating Activities
Cash Flows from Investing Activities
Cash Flows from Financing Activities
/
Note that each of the three cash flow
sources can be positive (net cash
inflow) or negative (net cash outflow)
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Exhibit 1.5
Statement of Cash Flows
EXPLANATION
LE-NATURE’S INC.
Statement of Cash Flows (Summary)
For the Year Ended December 31, 2012
(in millions of dollars)
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Net increase (decrease) in cash
Cash balance December 31, 2011
Cash balance December 31, 2012
$ 87.5
(125.5)
47.0
9.0
1.6
$ 10.6
Name of the entity
Title of the statement
Accounting period
Unit of measure
Cash flows directly related to earning income
Cash flows from purchase/sale of plant, equipment, & investments
Cash flows from investors and creditors
Change in cash during the period
Last period’s cash on the balance sheet
Ending cash on the balance sheet
The notes are an integral part of these financial statements.
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Exhibit 1.6
Relationships Among Le-Nature’s Statements
Statement of Stockholders’ Equity
Income Statement
Revenues
− Expenses
Net Income
$ 275.1
252.2
$ 22.9
Statement of Cash Flows
+/− Cash Flows from Operating
Activities
$ 87.5
+/− Cash Flows from Investing
Activities
(125.5)
+/− Cash Flows from Financing
Activities
47.0
Change in Cash
9.0
+ Cash at Beginning of Period
1.6
Cash at End of Period
$ 10.6
1
Beginning
+ Net Income
− Dividends
Ending
Common
Stock
$55.7
$55.7
Retained
Earnings
$43.1
22.9
(2.0)
$64.0
Balance Sheet
3
Cash
Other Assets
Total Assets
Liabilities
Common Stock
Retained Earnings
Total Liabilities &
Stockholders’ Equity
$ 10.6
516.8
$527.4
$407.7
55.7
64.0
2
$527.4
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Notes
Did you notice a sentence at the bottom of each financial statement?
All financial statements should be accompanied by notes that provide
the reader with supplemental information to help the reader better
understand the financial statements.
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Exhibit 1.7
Summary of the Four Basic Financial Statements
Financial Statement
Purpose
Structure
Examples of Content
Balance Sheet
(Statement of
Financial Position)
Reports the financial position
(economic resources and
sources of financing) of an
accounting entity at a point
in time.
Cash, accounts receivable,
plant and equipment, longterm debt, common stock
Income Statement
(Statement of Income,
Statement of Earnings,
Statement of Operations)
Reports the accountant’s
primary measure of
economic performance
during the accounting period.
Sales revenue, cost of goods
sold, selling expense, interest
expense
Statement of
Stockholders’ Equity
Reports changes in the
company’s common stock
and retained earnings during
the accounting period.
Beginning and ending
stockholders’ equity
balances, stock issuances,
net income, dividends
Statement of Cash Flows
(Cash Flow Statement)
Reports inflows (receipts)
and outflows (payments) of
cash during the accounting
period in the categories of
operating, investing, and
financing.
Cash collected from
customers, cash paid to
suppliers, cash paid to
purchase equipment, cash
borrowed from banks
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Rules that Determine Content of Financial Statements
Generally
Accepted
Accounting
Principles
(GAAP)
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History of Financial Reporting
• Our accounting system has a long and distinguished history. Luca
Pacioli, an Italian monk and mathematician, published the first
elements of double-entry bookkeeping in 1494.
• Prior to 1933, the management teams of most companies were
largely free to choose their own financial reporting practices.
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Generally Accepted Accounting Principles
The Securities and Exchange Commission (SEC)
has been given broad powers to determine
measurement rules for financial statements.
The SEC has worked closely with the accounting profession
to work out the detailed rules that have become known as GAAP.
Currently, the Financial Accounting Standards Board (FASB) is
recognized as the body to formulate GAAP.
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Generally Accepted Accounting Principles
Companies incur the cost of preparing the financial statements and
bear the following economic consequences of their publication:
 Effects on the selling price of stock
 Effects on the amount of bonuses received by managers
and other employees
 Loss of competitive information to other companies
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International Perspective
Since 2002, there has been substantial movement toward the
adoption of International Financial Reporting Standards (IFRS).
Examples of jurisdictions requiring the use of IFRS:
• European Union
• Australia and New Zealand
• Hong Kong, India, Malaysia, and South
Korea
• Israel and Turkey
• Brazil and Chile
• Canada and Mexico
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Ethical Conduct
Three-Step Process for Making Ethical Decisions
1.
Identify the benefits of a decision (often to the manager or
employee involved) and who will be harmed (other employees,
owners, creditors, the environment).
2.
Identify alternative courses of action.
3.
Choose the one you would like your family and friends to see
reported on your local news.
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Consequences of Unethical Behavior
After it was determined that the financial
statements for Le-Nature’s Inc. were misleading,
the consequences for the defendants were severe.
What if the
numbers are
wrong?
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Responsibility and the Need for Controls
To ensure the accuracy of a company’s financial information,
management:
 Maintains a system of controls.
 Hires external independent auditors.
 Forms a committee of the board of directors to review these
other two safeguards.
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Supplement A: Types of Business Entities
Sole Proprietorship: owned by a single individual
Partnership: owned by two or more individuals
Corporation: ownership represented by shares of stock
Advantages of a Corporation:
Limited liability
Continuity of life
Ease of transfer of ownership
Opportunity to raise large amounts of money
Disadvantage of a Corporation:
Double taxation
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