Ch. 1 Synchronotes for
Fundamentals of Financial Accounting, 3e
by Phillips/Libby/Libby
Chapter 1: Business Decisions and Financial Accounting
Organizational Forms:
Three main types of business organizations:
1. Sole proprietorship – a business organization owned by one person. The owner is personally liable for all
debts of the business.
2. Partnership – a business organization owned by two or more people. Each partner is personally liable for
all debts of the business.
3. Corporation – a separate entity from both a legal and accounting perspective. Owners of corporations
(stockholders) are not personally responsible for debts of the corporation.
The Accounting System (Exhibit 1.1)
Accounting is a system of analyzing, recording, summarizing and reporting the results of a business’s activities.
Business and
Financing Activities
Accounting
System
External users
(creditors, investors, etc.)
Accounting Reports
Financial
Managerial
Internal users
(managers, etc.)
The Basic Accounting Equation
Resources Owned …
by the company
Assets =
Resources Owed …
to creditors
to stockholders
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.
Assets are resources controlled by the company that have measurable value and are expected to provide
future benefits to the company. Assets include cash, supplies, furniture, and equipment.
Liabilities are amounts owed by the business to creditors. Liabilities include notes payable and accounts
payable.
Stockholders’ Equity represent owners’ claim to the business resources. Stockholders’ equity includes
contributed capital and retained earnings.
 Retained Earnings include the accumulated net income of the company.
Revenues – Expenses = Net Income
o Revenues arise from sales of goods or services to customers. They are measured at the amount the
business charges the customer.
Ch. 1 - p. 1
o
Expenses are the costs of business necessary to earn revenues. They include wages to employees,
advertising, insurance, and utilities.
Dividends are a distribution of a company’s earnings to its stockholders as a return on their investment.
Assets =
Liabilities
+
Stockholders’ Equity
Dividends are not an expense.
Contributed Capital
Revenues
– Expenses
= Net Income
Retained Earnings
(profit generated)
Dividends
The Financial Statements
(profit distributed)
Refers to four accounting reports, typically prepared in the following order:
1. Income Statement
PIZZA AROMA, INC.
Income Statement
2. Statement of Retained Earnings
For the Month Ended September 30, 2010
Revenues
3. Balance Sheet
Sales Revenue
$ 11,000
4. Statement of Cash Flows
Total Revenue
11,000
Expenses
Supplies Expense
Wages Expense
Rent Expense
Utilities Expense
Insurance Expense
Advertising Expense
Income Tax Expense
Total Expenses
Net Income
The Income Statement
Reports the amount of revenues less expenses for a period of time.
The unit of measure assumption states that results of business
activities should be reported in an appropriate monetary unit.
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.
$
4,000
2,000
1,500
600
300
100
500
9,000
2,000
PIZZA AROMA, INC.
Statement of Retained Earnings
For the Month Ended September 30, 2010
Retained Earnings, Sept. 1, 2010
$
Add: Net Income
2,000
Subtract: Dividends
(1,000)
Retained Earnings, Sept. 30, 2010
$ 1,000
The Balance Sheet
Reports at a point in time:
1. What a business owns (assets).
2. What it owes to creditors (liabilities).
3. What is left over for the owners of the company stock (stockholders’ equity).
The Statement of Cash Flows
Summarizes how a business’s
operating, investing, and
financing activities caused its
cash balance to change over a
particular period of time.
PIZZA AROMA, INC.
Balance Sheet
At September 30, 2010
Assets
Cash
Accounts Receivable
Supplies
Equipment
Total Assets
Liabilities
Accounts Payable
Notes Payable
Total Liabilities
Notes to the Financial
Statements
Stockholders' Equity
Capital
Notes help financial statement Contributed
Retained Earnings
Total Stockholders' Equity
users understand how the
Total Liabilities and Stockholders' Equity
amounts were derived and
what other information may affect their decisions.
$
$
$
$
14,000
1,000
3,000
40,000
58,000
7,000
20,000
27,000
30,000
1,000
31,000
58,000
PIZZA AROMA, INC.
Statement of Cash Flows
For the Month Ended September 30, 2010
Cash Flows from Operating Activities
Cash collected from customers
$
10,000
Cash paid to suppliers and employees
(5,000)
Cash Provided by Operating Activities
5,000
Cash Flows from Investing Activities
Cash paid to buy equipment
(40,000)
Cash Used in Investing Activities
(40,000)
Cash Flows from Financing Activities
Capital contributed by stockholders
30,000
Cash dividends paid to stockholders
(1,000)
Cash borrowed from the bank
20,000
Cash Provided by Financing Activities
49,000
Change in Cash
14,000
Beginning Cash Balance, Sept. 1, 2010
Ending Cash Balance, Sept. 30, 2010
$
14,000
Relationships among the Financial Statements
1. Net income flows from the Income Statement to the Statement of Retained Earnings.
2. Ending Retained Earnings flows from the Statement of Retained Earnings to the Balance Sheet.
3. Cash on the Balance Sheet and Cash at End of Year on the Statement of Cash Flows agree.
Ch. 1 - p. 2
PIZZA AROMA, INC.
Income Statement
For the Month Ended September 30, 2010
Revenues
Sales Revenue
$
11,000
Total Revenue
11,000
Expenses
Supplies Expense
Wages Expense
Rent Expense
Utilities Expense
Insurance Expense
Advertising Expense
Income Tax Expense
Total Expenses
Net Income
$
4,000
2,000
1,500
600
300
100
500
9,000
2,000
PIZZA AROMA, INC.
Statement of Retained Earnings
For the Month Ended September 30, 2010
Retained Earnings, Sept. 1, 2010
$
Add: Net Income
2,000
Subtract: Dividends
(1,000)
Retained Earnings, Sept. 30, 2010
$ 1,000
PIZZA AROMA, INC.
Balance Sheet
At September 30, 2010
Assets
Cash
Accounts Receivable
Supplies
Equipment
Total Assets
Liabilities
Accounts Payable
Notes Payable
Total Liabilities
$ 14,000
1,000
3,000
40,000
$ 58,000
$
7,000
20,000
27,000
Stockholders' Equity
Contributed Capital
30,000
Retained Earnings
1,000
Total Stockholders' Equity
31,000
Total Liabilities and Stockholders' Equity $ 58,000
PIZZA AROMA, INC.
Statement of Cash Flows
For the Month Ended September 30, 2010
Cash Flows from Operating Activities
Cash collected from customers
$
10,000
Cash paid to suppliers and employees
(5,000)
Cash Provided by Operating Activities
5,000
Cash Flows from Investing Activities
Cash paid to buy equipment
(40,000)
Cash Used in Investing Activities
(40,000)
Cash Flows from Financing Activities
Capital contributed by stockholders
30,000
Cash dividends paid to stockholders
(1,000)
Cash borrowed from the bank
20,000
Cash Provided by Financing Activities
49,000
Change in Cash
14,000
Beginning Cash Balance, Sept. 1, 2010
Ending Cash Balance, Sept. 30, 2010
$
14,000
Using Financial Statements
Creditors are primarily interested in assessing:
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 are primarily interested in assessing:
1. What immediate return (through dividends) on my contributions?
2. What is the long-term return (through stock price increases resulting from the company’s profits)?
External Financial Reporting
The main goal is to provide useful financial information to external users for decision making. The factors that
affect whether information is useful are:
Useful
Faithful
Representation
Relevant
Comparable Verifiable Timely Understandable
Accounting Standards
The accounting rules in the United States are similar, for the most part, to those used elsewhere in the world,
but some important differences exist. The following organizations are responsible for developing accounting
rules that are known by the abbreviations shown below.
United States
FASB
(Financial Accounting Standards Board)
GAAP
(Generally Accepted Accounting Principles)
Where?
Who?
What?
World
IASB
(International Accounting Standards Board)
IFRS
(International Financial Reporting Standards)
Ch. 1 - p. 3
Exercises
M1-13 Preparing a Statement of Retained Earnings
Stone Culture Corporation was organized on January 1, 2009. For its first two years of operations, it reported
the following:
On the basis of the data given, prepare a statement of retained earnings for 2009 (its first year of operations)
and 2010. Show computations.
Net income for 2009
$ 36,000
Net Income for 2010
45,000
Dividends for 2009
15,000
Dividends for 2010
20,000
Total assets at the end of 2009
125,000
Total assets at the end of 2010
242,000
Ch. 1 - p. 4
E1-3 Preparing a Balance Sheet
DSW is a designer shoe warehouse, selling some of the most luxurious and fashionable shoes at prices that
people can actually afford. Its balance sheet, at November 1, 2008, contained the following items (in
thousands).
Accounts Receivable
11,888
Cash
45,570
Contributed Capital
Notes Payable
Other Assets
Other Liabilities
291,248
99,044
494,294
79,148
Property, Plant and Equipment
233,631
Retained Earnings
179,538
Total Assets
785,383
Total Liabilities & Stockholders' Equity
?
Required:
1. Prepare the balance sheet as of November 1, solving for the missing amount.
2. As of November 1, did most of the financing for assets come from creditors or stockholders?
Ch. 1 - p. 5
E1-6 Preparing an Income Statement and Inferring Missing Values
Regal Entertainment Group operates movie theaters and food concession counters throughout the United
States. Its income statement for the quarter ended June 26, 2008, reported the following amounts (in
thousands):
Admissions Revenues
$
455,700
Net Income
?
Concessions Expenses
25,500
Other Expenses
233,800
Concessions Revenues
188,900
Other Revenues
31,200
Film Rental Expenses
247,000
Rent Expense
90,000
Gen. & Admin. Expenses
65,700
Total Expenses
?
Required:
1. Solve for the missing amounts and prepare an Income Statement for the quarter ended June 26, 2008. TIP:
First put the items in the order they would appear on the Income Statement and then solve for the missing
values.
2. What is Regal’s main source of revenue and biggest expense?
Ch. 1 - p. 6
E1-8 Inferring Values Using the Income Statement and Balance Sheet Equations
Review the chapter explanations of the income statement and the balance sheet equations. Apply these
equations in each of the following independent cases to compute the two missing amounts for each case.
Assume that it is the end of the first full year of operations for the company.
TIP: First identify the numerical relations among the columns using the balance sheet and income statement
equations. Then compute the missing amounts.
Independent
Cases
A
Total
Revenues
$
100,000 $
B
80,000
D
50,000
Net Income
(Loss)
82,000
80,000
C
E
Total
Expenses
$
12,000
86,000
81,000
Total Assets
Total
Liabilities
150,000 $
70,000
112,000
104,000
Stockholders'
Equity
60,000
26,000
13,000
22,000
77,000
(6,000)
73,000
28,000
Ch. 1 - p. 7