Chapter 1:
The Financial Statements
Why is Accounting is the Language of
Business?
Accounting is an information system that:
Measures business activities
Processes data into reports
Communicates results to decision makers
The Flow of Accounting Information
Who uses accounting information?
Individuals
Investorsand creditors
Regulatory bodies
Nonprofit organizations
Two Kinds of Accounting
Financial Accounting Managerial Accounting
For decision makers For managers inside
outside the entity the entity
Investors Budgets
Creditors Forecasts
Government agencies Projections
The public
The Various Forms of Business Organization
Organizing a Business
Proprietorship
Single owner
Tend to be small retail stores or solo providers
of professional services
Personally labile for all business’s debts
Distinct entity for accounting purposes
Organizing a Business
Partnership
Two or more parties as co-owners
Income and losses “flow through” to partners
Many are small or medium-sized companies
Generalpartnerships have mutual agency and
unlimited liability
Inlimited-liability partnerships, only liable up
to the investment put in
Organizing a Business
Limited-Liability Company
Business (not owners) is liable for debts
May have one owner or many, called members
Members have limited liability
Income “flows through” to members
Organizing a Business
Corporation
Owned by stockholders (shareholders)
Able to raise large sums of capital by issuing
stock
Formed under state law
Legally distinct from its owners
Stockholders have no personal obligation for
the corporation’s debts, limited liability
Organizing a Business
Corporation
Double taxation
Corporation pays income tax
Shareholders taxed on dividends
Stockholders elect board of directors, which
Sets policy
Appoints officers
Generally Accepted Accounting Principles
Common acronym is GAAP
Rules, principles and concepts that govern
financial accounting in the United States
Financial Accounting Standards Board
(FASB)
◦ Seven-person group primarily responsible for
establishing GAAP
◦ Objective is to provide useful information for
lending and investing decisions
International Financial Reporting Standards
Common acronym is IFRS
Principles and standards increasingly
used throughout the world
International Accounting Standards
Board (IASB)
◦ Responsible for establishing IFRS
Conceptual Foundation of Accounting
Assumptions and Principles
Entity Assumption
An organization stands apart from other organizations and
individuals as a separate economic unit
Continuity (Going-Concern) Assumption
Entity will continue to operate for the foreseeable future
Historical Cost Principle
Assets should be recorded at their actual cost on the date of
purchase
Stable-Monetary-Unit Assumption
Assume the dollar’s purchasing power is stable over time
Recording Business Transactions
Fundamental accounting equation
Stockholder’
Assets Liabilities s
Equity
Resources Amount of Amount of
business assets assets
owns that financed by financed by
have value lenders stockholders
The Accounting Equation
Memorize the accounting equation
Assets = Liabilities + Equity
Think of it like a scale
Both sides always equal
Can be written as: Assets Liabilities
◦ Liabilities = assets – equity Equity
◦ Equity = assets - liabilities
The Accounting Equation
Stockholder’sE
Assets Liabilities quity
DECEMBER 31, 2012
$91,000 84,000
??? $ 7,000
DECEMBER 31, 2013
$145,000 ???
72,000 $73,000
12,000
Assets
Accounts Notes
Cash
Receivable Receivable
Prepaid
Land Buildings
Expenses
Equipment,
Furniture, and
Fixtures
Liabilities
Accounts Notes
Payable Payable
Accrued
Liabilitie
s
Stockholders’ Equity
Common Retained
Revenues
Stock Earnings
Dividend
Expenses
s
Apply the Accounting Equation to
Business Organizations
Owner’s Equity
• The accounting equation can be rewritten as:
• Assets – Liabilities = Owners’ Equity
• Corporation’s equity is called stockholders’
equity and it has two parts:
• Paid-in capital
• Retained earning
Apply the Accounting Equation to
Business Organizations
Owner’s Equity
Paid-in capital Retained Earnings
The amount The amount of earned
stockholders have income kept for use in
invested in the the business.
business.
EXPANDED Accounting Equation
Stockholders’ equity can be broken down into:
◦ Common stock
◦ Retained earnings
Stockholders
Assets Liabilities
Equity
Common
Retained Earnings
Stock
Revenues Expenses Dividends
Components of Retained Earnings
Beginning Retained
Revenue – Expenses = Earnings
± Net Income
or Loss
− Dividends
= Ending
Retained Earnings
Components of Retained Earnings
Revenues
Inflow of resources from delivering goods or services
Increase retained earnings
Expenses
Outflow of resources due to the cost of operations
Decrease retained earnings
Dividends
Distribution of assets to stockholders
Decrease retained earnings
The Financial Statements
Statement
Statement
Income of Balance
of Cash
Statement Retained Sheet
Flows
Earnings
Relationships Among Financial Statements
Income Statement
Net Income
Statement of Retained Earnings
Ending balance
Balance Sheet
Statement of Cash Flows
Information Reported in the Financial Statements
The Income Statement
Shows revenue and expenses for a
period of time
◦ Profit occurs when revenue is greater than
expenses
◦ Loss occurs when revenue is less than
expenses
Net Income
Revenues Expenses
or Net Loss
The Walt Disney Company, Consolidated Statements of Income
The Statement of Retained Earnings
Retained Earnings
Portion of net income reinvested into the
business
Net income increases retained earnings
Net losses and dividends decrease retained
earnings
Net income (net loss) flows from the income
statement to the statement of retained earnings
The Statement of Retained Earnings
Beginning Retained
Earnings
Shows changes to
retained earnings
over time
± Net Income
or Loss
− Dividends
= Ending
Retained Earnings
The Statement of Retained Earnings
Beginning retained earnings
Add: Net income (loss)
Less: Dividends declared___
Ending retained earnings
The Walt Disney Company, Consolidated
Statements of Retained Earnings
The Balance Sheet (also called the
Statement of Financial Position)
Lists assets, liabilities, and stockholders’
equity at a specific date
“Proves” the accounting equation
Stockholders’
Assets Liabilities
Equity
The Balance Sheet
Balance Sheet
Also called the statement of financial
position
Reports three items:
Assets
Liabilities
Stockholders’ equity
Reflects
the company’s position at a specific
moment in time
The Balance Sheet - Assets
Assets
Currentassets – expected to be used or
converted to cash within one business cycle
Examples: cash and cash equivalents, short-
term investments, accounts receivable, prepaid
expenses
Long-term
assets – expected to benefit the
company beyond just the next fiscal year
Examples: property, plant, and equipment, long-
term investments, intangible assets
The Balance Sheet - Assets
The Balance Sheet - Liabilities
Liabilities
Current liabilities – debts due within one
year
Examples: accounts payable, salaries payable,
short-term notes payable, accrued liabilities
Long-term liabilities– debts payable after
one year
Examples: long-term notes payable, long-
term bonds payable
The Balance Sheet - Liabilities
The Balance Sheet - Equity
Equity (Stockholders’ Equity)
Represents the stockholders’ ownership
of the business’s assets
Examples: common stock, additional
paid-in capital, retained earnings,
treasury stock, accumulated other
comprehensive income (loss)
The Balance Sheet - Equity
The Walt Disney Company, Consolidated Balance Sheet
The Statement of Cash Flows
Measures cash receipts and payments
Three types of activities:
Operating activities: cash flows from selling
goods and services to customers
Investing activities: cash flows from
purchasing and selling long-term assets
Financing activities: cash flows from
borrowing or repaying funds or equity
transactions
The Walt Disney Company - Consolidated Statements of
Cash Flows
End of Chapter 1: QUESTIONS?
