Financial Statements
and Business Decisions
Chapter 1
McGraw-Hill/Irwin
© 2009 The McGraw-Hill Companies, Inc.
Accounting –
The Language of Business
Accounting is the information system that...
measures business activities,
processes data into reports, and
communicates results to decision makers.
McGraw-Hill/Irwin
Slide 2
Accounting –
The Language of Business

Accounting is the art of recording, classifying and
summarizing transactions, in terms of money, and
interpreting the results.
McGraw-Hill/Irwin
Slide 3
The Flow of Accounting Information
1. People make decisions.
2. Business transactions occur.
3. Businesses prepare reports to show
the results of their operations.
McGraw-Hill/Irwin
Slide 4
The Accounting System
Collects and processes
financial information
McGraw-Hill/Irwin
Reports
information
to decision
makers
Managers
(internal
decision
makers)
Investors
and
Creditors
(external
decision
makers)
Slide 5
Users of Financial Accounting Information
McGraw-Hill/Irwin
Management
Government
agencies
Competitors
Taxing
authorities
Investors and
creditors
Other
interested
parties
Slide 6
Accounting for Business Transactions
A transaction is any event that both affects
the financial position of the business entity
and can be reliably recorded.
McGraw-Hill/Irwin
Slide 7
The Account
Accounting’s main summary device
is the account, a record of like transactions.
Accounts are grouped in three broad categories,
according to the accounting equation:
Cash
McGraw-Hill/Irwin
Slide 8
The Accounting Equation
A = L + SE
(Assets)
Economic
Resources
(Liabilities)
(Stockholders’
Equity)
Sources of Financing for Economic
Resources
Liabilities: From Creditors
Stockholders’ Equity: From Stockholders
McGraw-Hill/Irwin
Slide 9
The Accounting Equation
Assets are the economic resources
of a business that are expected to
produce a benefit in the future.
Liabilities are “outsider claims,”
or economic obligations
payable to outsiders.
Owners’ equity represents the
“insider claims” of a business.
McGraw-Hill/Irwin
Slide 10
The Four Basic Financial Statements
1. On a company’s
all resources owned and
amounts owed are listed in order of liquidity. The difference between
the resources owned and the amounts owed, represents the
stockholders’ equity in the business.
2. On a company’s
all the revenues earned
from sales to customers are listed along with the expenses incurred
to produce those revenues.
3. On a company’s
accumulated net earnings less the dividends paid to owners
represent reinvestments in the core business.
4. On a company’s
all sources and
uses of cash are listed. Cash is generated by the company’s
operations. Cash is spent on investments in buildings, manufacturing
equipment, and other assets. Financing activities involve amounts
borrowed from long-term creditors and sale of stock to owners.
McGraw-Hill/Irwin
Slide 11
Balance Sheet
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Typical Accounts—The Balance Sheet
McGraw-Hill/Irwin
Assets
Liabilities
Cash
Short-Term Investment
Accounts Receivable
Notes Receivable
Inventory
Supplies
Prepaid Expenses
Long-Term Investments
Equipment
Buildings
Land
Intangibles
Accounts Payable
Accrued Expenses
Notes Payable
Taxes Payable
Unearned Revenue
Bonds Payable
Stockholders’ Equity
Contributed Capital
Retained Earnings
Slide 13
Income Statement
McGraw-Hill/Irwin
Slide 14
Typical Accounts--The Income Statement
Revenues
Sales Revenue
Fee Revenue
Interest Revenue
Rent Revenue
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Expenses
Cost of Goods Sold
Wages Expense
Rent Expense
Interest Expense
Depreciation Expense
Advertising Expense
Insurance Expense
Repair Expense
Income Tax Expense
Slide 15
Statement of
Stockholders’ equity
Elements of the Statement of
Stockholders’ Equity
Common Stock
Retained Earnings
Beginning Retained Earnings
+Net Income
-Dividends
Ending Retained Earnings
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Slide 16
Statement of
Stockholders’ equity
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Slide 17
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
/
McGraw-Hill/Irwin
Note that each of the three cash flow
sources can be positive (net cash inflow) or
negative (net cash outflow).
Slide 18
Statement of Cash Flows
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Slide 19
Notes to Financial Statements
All financial statements
should be accompanied by
notes which provide the
reader with supplemental
information about the
financial condition and
results of operations of the
company.
McGraw-Hill/Irwin
Slide 20
Notes to Financial Statements
Descriptions of the key accounting rules
that apply to the company’s statements.
Additional detail supporting reported
numbers.
Relevant financial information not
disclosed on the statements.
McGraw-Hill/Irwin
Slide 21
Relationships Among the Statements
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1-22
Slide 22
Generally Accepted Accounting Principles
Our accounting system has a long and
distinguished history. An Italian monk named Luca
Pacioli, published the first elements of doubleentry bookkeeping in 1494.
Prior to 1933, the management teams of most
companies were free to choose the accounting
principles used to keep track of its transactions.
McGraw-Hill/Irwin
Slide 23
Generally Accepted Accounting Principles
Securities Act of 1933
Securities and Exchange Act of 1934
The Securities and Exchange Commission (SEC)
has been given broad powers to determine
measurement rules for
financial statements.
McGraw-Hill/Irwin
Slide 24
Generally Accepted Accounting Principles
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.
McGraw-Hill/Irwin
Slide 25
Ensuring the Accuracy of Financial Statements
To ensure the accuracy of the 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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Slide 26
External Auditors
An audit is an examination of
the financial reports to
ensure that they represent
what they claim and
conform with GAAP.
McGraw-Hill/Irwin
Overall, I believe
these financial
statements are
fairly stated.
Slide 27
Ensuring the Accuracy of Financial Statements
To ensure the accuracy of the 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.
McGraw-Hill/Irwin
Slide 28
External Auditors
An audit is an examination of
the financial reports to
ensure that they represent
what they claim and
conform with GAAP.
McGraw-Hill/Irwin
Overall, I believe
these financial
statements are
fairly stated.
Slide 29
Condition Required for Issuance of Unmodified
Opinion

The auditors are able to obtain sufficient
appropriate audit evidence to obtain
reasonable assurance so as to be able to
conclude that the financial statements as
a whole are free from material
misstatements.
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17-30
Slide 30
International Perspective
Since 2002, there has been substantial
movement to develop international financial
reporting standards (IFRS) by the
International Accounting Standards Board
(IASB).
McGraw-Hill/Irwin
Slide 31
End of Chapter 1
© 2008 The McGraw-Hill Companies, Inc.