Chapter 1 Video Lecture Outline

Accounting Information and Decision Making

PART A: Accounting as a Measurement/Communication Process

Who uses Accounting Information?

Purpose of Accounting: measure the activities of a company and communicate it to others.

BUSINESS ACTIVITIES TO MEASURE

Financing
-creditors
-owners

Investing
-Long term Assets

Operating
Primary operations of the company
-Revenue
-Expenses

Forms of Business Organizations

-Sole proprietorship
-Partnerships
-Corporations

COMMUNICATING THROUGH FINANCIAL STATEMENTS

The Financial Statements

1. Income statement (IS)

2. Statement of Stockholders’ Equity (SSE)

3. Balance sheet (BS)

4. Statement of Cash Flows (SCF)

Financial statements summarize business activities.

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Financial Statement Heading
NAME OF ENTITY
NAME of FINANCIAL STATEMENT
DATE OF FINANCIAL STATEMENT AND PERIOD IT COVERS
UNIT OF MEASURE

The Income Statement (IS)

Example of a heading for an income statement

A, Inc.
Income Statement
For the Year Ended June 30, 20XB
(in thousands of dollars)
“Period Ending”

ELEMENTS OF THE INCOME STATEMENT

Revenues (R)
Sales
Service revenue

Expenses (E)
Salaries expense
Rent expense

Net Income (NI)

The income statement equation is: (Revenue – Expenses = Net Income or Net Loss) R – E = NI

Practice
Rent expense $4,500
Wage expense 2,650
Painting supplies expense 1,950
Painting revenue 12,000
Supplies used 200
Insurance expense 700

Determine Net income: $

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The Statement of Stockholders’ Equity (SSE)
The SSE shows increases and decreases to stockholders’ equity accounts over a period of time.

Stockholders’ Equity (SE) results from two basic categories:

Common Stock: (CS) are amounts invested by the owners.
Retained Earnings: (RE) are accumulated earnings minus distributions to owners

SE = CS + RE

STOCKHOLDERS’ EQUITY

Common Stock + Retained Earnings

Beginning Common Stock Beginning Retained Earnings
+ Issuance of common stock + Net Income or – (Net Loss)
- Dividends Declared
= Ending Common Stock = Ending Retained Earnings

Practice

At the beginning of the year (January 1), Bennett Drilling has $10,000 of common stock
outstanding and retained earnings of $7,200. During the year, Bennett reports net income of
$7,500 and pays dividends of $2,200. In addition, Bennett issues additional common stock for
$7,000. (What is ending Common Stock, ending Retained Earnings and ending Stockholders’
Equity?)

Bennett Drilling
Statement of Stockholders’ Equity
For the year ended December 31, 20XC
Common Stock Retained Earnings Total Stockholders’ Equity

Beginning balance $ $ $

+issuance of common stock

+ net income (net loss)

- dividends

Ending Balance $ $ $

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The Balance Sheet (BS) (aka, The statement of Financial Position)
Example of a heading for a balance sheet
A, Inc.
Balance Sheet
At June 30, 20XB
(in thousands of dollars)
“AT”

ELEMENTS OF THE BALANCE SHEET

Assets (A)
-Owned by the company as a result of past transactions.
- Economic resources expected to provide future benefits to the company
-Examples: Cash, Equipment, Buildings

Liabilities (L)
-Owed by the company as a result of past transactions.
-Future claims on economic resources (either assets or services) of the company.
-Examples: Notes payable, Salaries payable

Stockholders’ Equity (SE)

Stockholders’ Equity results from two basic categories:
Common Stock (CS)
Retained Earnings (RE)

THE ACCOUNTING EQUATION (Balance Sheet Equation)

A = L + SE
CS + RE
Assets = Liabilities + Stockholders’ Equity
Economic resources = Sources of financing
What you have = Where it came from
or
A - L = SE
Net assets = Owners’ equity or Owners’ claim to resources

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 Practice:
Smith Construction has the following account balances at the end of the year:

Equipment $21,000
Accounts payable 2,100
Common stock 10,000
Land 13,000
Supplies 100
Long-term debt 15,000
Cash 5,000
Retained earnings ?

Determine Retained earnings, Total assets, Total Liabilities and Total Stockholders’ Equity by
preparing the balance sheet at the end of the year.

Smith Construction
Balance Sheet
At December 31, 20XC
Assets Liabilities
$ $

Total liabilities $
Stockholders' Equity
$

Total stockholders’ equity

Total assets $ Total liabilities and stockholders' equity $

The Statement of Cash Flows

Categories:

OPERATING ACTIVITIES

INVESTING ACTIVITIES

FINANCING ACTIVITIES

Combining the three categories of net cash inflows and outflows indicates the change in CASH
during the period.

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Practice:
Lincoln Trade has the following cash transactions for the period.

Identify as (O, I, F)
Cash received from sale of products to customers $35,000
Cash received from the bank for long-term loan 40,000
Cash paid to purchase factory equipment (45,000)
Cash paid to merchandise suppliers (11,000)
Cash received from the sale of an idle warehouse 12,000
Cash paid to workers (23,000)
Cash paid for advertisement (3,000)
Cash received for providing services to customers 25,000
Cash paid for dividends to stockholders (5,000)

Beginning cash balance was $4,000. Prepare the Statement of Cash Flows for Lincoln Trade.

Lincoln Trade
Statement of Cash Flows
For the year ending December 31, 20XC
Cash Flows from Operating Activities
Cash inflows:
$

Cash outflows:

Net cash flows from operating activities $

Cash Flows from Investing Activities

Net cash flows from investing activities

Cash Flows from Financing Activities

Net cash flows from financing activities

Net increase in cash
Cash at the beginning of the year
Cash at the end of the year $

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 THE LINKS AMONG FINANCIAL STATEMENTS

Income Statement of Balance Sheet

Statement Stockholders’ Equity

R BCS BRE A = L + SE
-E +issuance +NI CS+RE
NI -DIV
ECS ERE

Statement of Cash Flows

Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Change in cash
Beginning cash balance
Ending cash balance

Practice:
A company receives cash for services performed. How does this transaction affect the financial
statements?

What happens to the Income Statement?

What happens to the Statement of Stockholders’ Equity?

What happens to the Balance Sheet?

What happens to the Statement of Cash Flows?

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Practice: Solve for the missing amounts:
Income Statement Statement of Stockholders’ Equity
Revenues $34,000 Common Retained Stockholders’
stock earnings Equity
Expenses: Beginning $9,000 $6,000 $15,000
Salaries (a) Issuance 1,000 1,000
Administrative 5,000 Net income (d) (d)
Utilities 3,000 Dividends ______ (2,000) (2,000)
Total expenses (b) Ending $10,000 $9,000 $19,000
Net income (c)
Balance Sheet
Assets Liabilities
Cash $3,000 Accounts payable (e)
A/R 5,500 Note payable 41,000
Office supplies 500 Total Liabilities (f)
Prepaid rent 8,000 Stockholders’ Equity
Equipment 45,000 Common stock (g)
Retained earnings (h)
Total Stockholders’ Equity (i)
Total assets $62,000 Total Liabilities and SE (j)

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Other Information Reported to Outsiders

Management & Discussion Analysis (MD&A)

Management is responsible for the financial statements

The Notes
There are three basic types of notes.
1. Descriptions of accounting rules applied in the financial statements.
2. Details about line items in the statements.
3. Disclosures about items not listed in the statements.

PART B: FINANCIAL ACCOUNTING INFORMATION

Importance of Financial Accounting Information

Rules of Financial AccountingGenerally Accepted Accounting Principles (GAAP)

Rule enforcers (and authority to make the rules)Securities and Exchange Commission (SEC)

Rule makers (delegated by the SEC)Financial Accounting Standards Board (FASB)

International Accounting Standards Board (IASB)

Financial Statement Responsibility

Management is responsible for the financial statements

Role of the Auditorprovide a seal of approval

Public Company Accounting Oversight Board (PCAOB)Audits the auditors

OBJECTIVES OF FINANCIAL ACCOUNTING

1. Is useful to present and potential investors and creditors and other users in making
rational investment, credit and similar decisions.
2. Helps decision makers predict amounts, timing, and uncertainty of future cash flows.
3. Provides info about economic resources, claims to those resources, and effects of
transactions which causes changes in those resources and claims to them.

Primary objective: provide useful information to investors and creditors in making decisions.

Part C: Careers in Accounting

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APPENDIX
THE CONCEPTUAL FRAMEWORK: Foundation for Developing Accounting Standards.

Qualitative Characteristics

Decision Usefulness

Relevance
-predictive value
-confirmatory (feedback) value
-materiality (significance)

Faithful Representation (aka Reliability)

- completeness
-neutral
-freedom of error

ENHANCING QUALITATIVE CHARACTERISTICS

Comparable and Consistent
Verifiable
Timely
Understandable

Cost Constraint
-Cost-benefit

Industry practice

UNDERLYING ASSUMPTIONS
Economic Entity assumption (“Separate Entity”)
Monetary Unit assumption—currently we don’t take inflation into consideration
Periodicity assumption
Going Concern assumption

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