Financial Accounting:
Tools for Business Decision Making, 4th Ed.
Kimmel, Weygandt, Kieso
CHAPTER 1
Prepared by
Ellen L. Sweatt
Georgia Perimeter College
1
Chapter 1
AN INTRODUCTION
TO FINANCIAL
STATMENTS
2
Study Objectives
1.
2.
3.
4.
Describe the primary forms of
business organization.
Identify the users and uses of
accounting information.
Explain the three principal types of
business activity.
Describe the content and purpose of
each of the financial statements.
3
Study Objectives
5.
6.
Explain the meaning of assets,
liabilities, and stockholders’ equity,
and state the basic accounting
equation.
Describe the components that
supplement the financial statements in
an annual report.
4
1
Forms of Business
Organization
11
Sole proprietorship
Partnership
Corporation
5
Sole Proprietorship
Business owned by
one person
Simple to establish
Owner controlled
Tax advantages
Owner personally
liable
Financing difficult
6
Partnership
Two or more owners
Simple to establish
Shared control
Broader skills &
resources
Tax advantages
Personal liability
7
Corporation
Separate legal entity
owned by
stockholders
Easy to transfer
ownership
Greater capital
raising potential
Lower legal liability
Unfavorable tax
treatment
8
2
11
Users of Financial Information
Internal
Managers who plan,
organize and run a
business
Marketing managers
Production
supervisors
Finance directors
Company officers
9
Users of Financial Information
Internal Users Ask?
10
Users of Financial Information
External
Investors
Creditors
Others
Regulatory agencies
Tax authorities
Customers
Labor Unions
Economic planners
11
Users of Financial Information
External Users Ask?
12
3
11
Types of Business Activity
Financing
Investing
Operating
13
Financing Activities
Borrowing creates
liabilities
Bank loans
Debt securities
Goods on credit or
payables
Selling stock creates
stockholders’
equity
14
Investing Activities
Obtaining resources
or assets to operate
the business
Land
Buildings
Vehicles
Computers
Furniture
Equipment
15
Operating Activities
Primary activity of
business
Selling goods
Providing services
Manufacturing
Cost of Sales
Advertising
Paying employees
Paying utilities
16
Operating Activities
Revenues are the increases in assets
resulting from the sale of a product or
service
Expenses are the cost of assets
consumed or services used in
generating revenue.
If revenue > expense = Net Income
If revenue < expense = Net Loss!
17
Review
Which is not one of the three forms of
business organization?
a. Sole proprietorship.
b. Creditorship.
c. Partnership.
d. Corporation.
18
Review
Which is not one of the three forms of
business organization?
a. Sole proprietorship.
b. Creditorship.
c. Partnership.
d. Corporation.
19
Review
Which is an advantage of corporations
relative to partnerships and sole
proprietorships?
a. Lower taxes.
b. Harder to transfer ownership
c. Reduced legal liability for investors.
d. Most common form of business
organization.
20
Review
Which is an advantage of corporations
relative to partnerships and sole
proprietorships?
a. Lower taxes.
b. Harder to transfer ownership
c. Reduced legal liability for investors.
d. Most common form of business
organization.
21
Review
Which is not one of the three primary
business activities?
a. Financing.
b. Operating.
c. Advertising.
d. Investing.
22
Review
Which is not one of the three primary
business activities?
a. Financing.
b. Operating.
c. Advertising.
d. Investing.
23
4
11
Content and Purpose of Financial Statements
Accountants
communicate with users
through four financial
statements
24
25
Four Financial Statements
Income Statement
Retained Earnings Statement
Balance Sheet
Statement of Cash Flows
26
Income Statement
Reports operating success or failure for
a period.
Summarizes revenues and expenses
for period: month, quarter, year.
If revenue > expense = Net Income.
27
Income Statement
Do this statement first!
28
Retained Earnings Statement
Shows changes in retained earnings for
period: month, quarter, year
Beginning balance
Add Net Income from income
statement.
Deduct Dividends
Ending balance
29
Retained Earnings Statement
Do this statement second!
30
Balance Sheet
Reports assets and claims to assets.
Claims of creditors, liabilities.
Claims of owners, stockholders’ equity.
Assets = Liabilities + Stockholders’
Equity
Specific date – one point in time!
31
Balance Sheet
From
Retained
Earnings
Statement
32
Statement of Cash Flows
Provides information about cash
receipts and cash payments
Summarizes for period: month,
quarter, year.
Cash effects of operating, investing,
and financing activities.
33
Statement of Cash Flows
Where did the cash come from?
How was cash used during the period?
What was the change in the cash
balance during the period?
A company cannot survive without cash!
34
Statement of Cash Flows..
Agrees
with
Balance
Sheet
35
5
11
Assets
Resources owned by
the business
Cash
Accounts receivable
Inventories
Furniture and
fixtures
Equipment
Supplies
36
Liabilities
Obligations or debts of business
Notes payable
Accounts payable
Interest payable
Salaries payable
Unearned revenue
37
Stockholders’ Equity
Ownership claims on assets
Paid-in capital
Common stock
Retained earnings
38
Basic Accounting Equation
Assets =
Liabilities + Stockholders’ Equity
39
Review
What questions might each of the following
decision makers ask that could be answered
by the financial statements …
Bank loan officer?
Stock investor?
Labor union president?
Federal bank regulator?
40
Review
Which of the following is not a correct
representation of the accounting equation?
a. Assets = Liabilities + Stockholders’ Equity
b. Assets - Liabilities = Stockholders’ Equity
c. Assets + Stockholders’ Equity = Liabilities
d. Assets - Stockholders’ Equity = Liabilities
41
Review
Which of the following is not a correct
representation of the accounting equation?
a. Assets = Liabilities + Stockholders’ Equity
b. Assets - Liabilities = Stockholders’ Equity
c. Assets + Stockholders’ Equity = Liabilities
d. Assets - Stockholders’ Equity = Liabilities
42
Review
Using the accounting equation, answer the
following question.
If Liabilities = $10,000 and
Stockholders’ Equity = $20,000
Then Assets = $30,000
$30,000 = $10,000 + $20,000
43
Review
Using the accounting equation, answer the
following question.
If Assets = $75,000
And Liabilities = $35,000
Then Stockholders’ Equity = $40,000
$75,000 = $35,000 + $40,000
44
6
11
Supplements to the Financial
Statements in an Annual Report
Management Discussion and
Analysis
Notes to Financial Statements
Auditor’s report
45
Management’s Discussion and
Analysis covers three items:
1.
Liquidity
2.
Capital resources
3.
Results of operations
46
Management’s Discussion and
Analysis
47
Notes to Financial Statements
Explanatory notes and supplementary
schedules
Clarifies information in financial
statements
Expands with additional detail
Describes accounting policies
Explains uncertainties and contingencies
48
Notes to Financial Statements
49
Auditor’s Report
Certified Public Accountant – CPA
Auditor (CPA) conducts independent
examination of financial statements
Fair representation?
Follow generally accepted accounting
principles (GAAP)?
Unqualified opinion
50
Auditor’s Report
51
Do It Problem: CSU Corporation
Service revenue
Accounts receivable
Accounts payable
Building rental expense
Notes payable
Common stock
Retained earnings
Equipment
Insurance expense
Supplies
Supplies expense
Cash
Dividends
$17,000
$4,000
$2,000
$9,000
$5,000
$10,000
?
$16,000
$1,000
$1,800
$200
$1,400
$600
CSU begins on
Jan. 1, 2007
For year ended
Dec. 31, 2007,
prepare
Income
statement
Retained
earnings
statement
Balance sheet
52
Do It Problem: CSU Corporation
Service revenue
Accounts receivable
Accounts payable
Building rental expense
Notes payable
Common stock
Retained earnings
Equipment
Insurance expense
Supplies
Supplies expense
Cash
Dividends
$17,000
$4,000
$2,000
$9,000
$5,000
$10,000
?
$16,000
$1,000
$1,800
$200
$1,400
$600
Action step 1:
Report the
revenues &
expenses for a
period of time,
Income
Statement
53
Do It Problem: CSU Corporation
Service revenue
Accounts receivable
Accounts payable
Building rental expense
Notes payable
Common stock
Retained earnings
Equipment
Insurance expense
Supplies
Supplies expense
Cash
Dividends
$17,000
$4,000
$2,000
$9,000
$5,000
$10,000
?
$16,000
$1,000
$1,800
$200
$1,400
$600
Action step 1:
Report the
revenues &
expenses for a
period of time,
Income
Statement
54
Do It Problem: CSU Corporation
Create the heading
Name of the
company
CSU Corporation
Name of the
Income Statement
statement
For the Year Ended December 31, 2007
Period
of time
55
Do It Problem: CSU Corporation
CSU Corporation
Income Statement
For the Year Ended December 31, 2007
Revenues
Service revenue
$17,000
List the revenues
Use dollar signs to denote U.S. currency
56
Do It Problem: CSU Corporation
CSU Corporation
Income Statement
For the Year Ended December 31, 2007
Revenues
Service revenue
$17,000
Expenses
Rent expense
$9,000
Insurance expense
1,000
Supplies expense
200
________
Total expenses
10,200
List the expenses & underline sub-totals
Do It Problem: CSU Corporation
CSU Corporation
Income Statement
For the Year Ended December 31, 2007
Revenues
Service revenue
$17,000
Expenses
Rent expense
$9,000
Insurance expense
1,000
Supplies expense
200
________
Total expenses
10,200
________
Net Income
$
6,800
________
________
Calculate net income: revenues - expenses
Do It Problem: CSU Corporation
Service revenue
Accounts receivable
Accounts payable
Building rental expense
Notes payable
Common stock
Retained earnings
Equipment
Insurance expense
Supplies
Supplies expense
Cash
Dividends
$17,000
$4,000
$2,000
$9,000
$5,000
$10,000
?
$16,000
$1,000
$1,800
$200
$1,400
$600
Action step 2:
Show amounts
and causes of
changes in
retained
earnings
Use Net Income
from Income
Statement
Dividends
59
Do It Problem: CSU Corporation
CSU Corporation
Retained Earnings Statement
For the Year Ended December 31, 2007
Retained earnings, January 1
Add: Net income
Less: Dividends
Retained earnings, Dec. 31
$
0
6,800
6,800
600
________
$ 6,200
60
Do It Problem: CSU Corporation
Service revenue
Accounts receivable
Accounts payable
Building rental expense
Notes payable
Common stock
Retained earnings
Equipment
Insurance expense
Supplies
Supplies expense
Cash
Dividends
$17,000
$4,000
$2,000
$9,000
$5,000
$10,000
$6,200
$16,000
$1,000
$1,800
$200
$1,400
$600
Action step 3:
Present assets
and claims to
those assets at
a specific point
in time on the
Balance Sheet
Use $6,200
Retained
earnings from
previous
statement!
61
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