financial accounting robert libby patricia a. libby daniel g. short

FINANCIAL ACCOUNTING

Robert LibbyPatricia A. LibbyDaniel G. Short

Chapter 1

Financial Statements and Business Decisions

© 2004 The McGraw-Hill CompaniesMcGraw-Hill/Irwin

1-3

Understanding the Business

Owner-Managers

Founders of the business who also function as managers are called Owner-Mangers.

Creditors

Creditors lend money for a specific period of time and gain by charging interest on the money they lend.

Investors

Investors buy ownership in the company in the form of stock.


1-4

Understanding the Business

Investors purchase stock (or ownership) in businesses hoping to gain in two

ways:Sell

ownershipinterest in the

future for morethan they

paid.

Receive aportion of thecompany’s

earnings in cash(dividends).


1-5

The Accounting System

Collects and processesfinancial information

Reportsinformationto decision

makers

Managers(internal)

Investors and

Creditors(external)


1-6

The Accounting System

Accounting System

Financial Accounting SystemPeriodic financial statements and

related disclosures

Managerial Accounting SystemDetailed plans and continuous

performance reports

External Decision MakersInvestors, creditors,

suppliers, customers, etc.

Internal Decision MakersManagers throughout the

organization


1-7

The Four Basic Financial Statements

Income StatementBalance Sheet

Statement of Cash Flows Statement of Retained Earnings

Financial statements summarize the financial activities of the business.


1-8

The Four Basic Financial Statements

Companies can prepare financial statements at the end of the year,

quarter or month.

2003

X

Financial statements prepared at the end of the year are called annual

reports.


1-9

Let’s look at MAXIDRIVE

CORP.’s financial

statements.


1-10MAXIDRIVE CORP.Balance Sheet

At December 31, 2003(in thousands of dollars)

AssetsCash 4,895$ Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets 27,261$

Liabilities and Stockholders' Equity

Liabilities

Accounts payable 7,156$

Notes payable 9,000

Total liabilities 16,156$

Stockholders' EquityContributed capital 2,000$ Retained earnings 9,105 Total stockholders' equity 11,105

Total liabilities and stockholders' equity 27,261$

1. Name of entity2. Title of statement3. Specific date4. Unit of measure

The Balance Sheet

reports the financial

position of an entity at a particular

point in time.


1-11

The Balance Sheet

Basic Accounting Equation

Assets = Liabilities + Stockholders’ EquityAssets = Liabilities + Stockholders’ Equity






Liabilities


Notes payable 9,000




Assets are listed by their

ease ofconversion into

cash.

CashAmount of cash in the company’s bank accounts.

Accounts receivable

Amounts owed by customers from prior sales.

InventoriesParts and completed but unsold products.

Plant and equipment

Factories and production machinery.

Land Land on which factories are built.

Assets are economic resources

owned by the business as a result of past transactions.






Liabilities


Notes payable 9,000




Liabilities are debts or

obligations of the business

that result from past

transactions.

Accounts payable

Amounts owed to suppliers for prior purchases.

Notes payable

Amounts owed on written debt contracts.






Liabilities


Notes payable 9,000




Contributed capital

Amounts invested in the business by stockholders.

Retained earnings

Past earnings not distributed to stockholders.

Equity is the amount of financing

provided by owners of the business and

earnings.






Liabilities


Notes payable 9,000




Use $ on the first item in a

groupand on the group total.

Assets = Liabilities + Stockholders’ Equity


1-16

1. Name of entity2. Title of statement 3. Specific date (Unlike the balance sheet, this statement covers a specified period of time.)4. Unit of measure


1-17The Income Statement reports the

revenues less expenses of the accounting period.


1-18

Revenues are earnings from the sale of goods or services to customers.

Revenue is recognized in the period in whichgoods and services are sold, not necessarily

the period in which cash is received.


1-19

Revenues

June 2003

Cash from salecollected on June 10th.

XMay 2003

$1,000 sale madeon May 25th.

X

When will the revenue from thistransaction be recognized?

Earnings from the sale of goods or services.


1-20

Revenue

May 2003

$1,000 revenue$1,000 revenuerecognized in Mayrecognized in May

June 2003

When will the revenue from thistransaction be recognized?

Earnings from the sale of goods or services.


1-21

Expenses are the dollar amount of resources usedup by the entity to earn revenues during a period.

An expense is recognized in the period in whichgoods and services are used, not necessarily

the period in which cash is paid.


1-22

Cost of goods sold

The cost to produce products sold this period.

Selling, general and

administrative

Operating expenses not directly related to production.

Research and development

Expenses incurred to develop new products.

Interest expense

The cost of using borrowed funds.

Income tax expense

Income taxes on current period’s pretax income.


1-23

Expenses

May 2003 June 2003

May 11 paid $75 cashfor newspaper ad.

X

Ad appearson June 8th.

X

The dollar amount of resources usedup by the entity to earn revenues

during a period.

When will the expense for thistransaction be recognized?


1-24

Expenses

May 2003 June 2003

Advertising expenseAdvertising expenserecorded in June.recorded in June.

The dollar amount of resources usedup by the entity to earn revenues

during a period.

When will the expense for thistransaction be recognized?


1-25

If expenses exceed revenues,we report net loss.


1-26

MAXIDRIVE CORP.Statement of Retained Earnings

For the Year Ended December 31, 2003(in thousands of dollars)

Retained earnings, January 1, 2003 6,805$ Net income for 2003 3,300 Dividends for 2003 (1,000) Retained earnings, December 31, 2003 9,105$

1. Name of entity2. Title of statement 3. Specific date (Like the income statement, this statement covers a specified period of time.)4. Unit of measure


1-27




The Statement of Retained Earnings reports the way that net income and the distribution of dividends affect the financial position of the company during a period.


1-28

Statement of Cash Flows

Because revenues reported do not always equal

cash collected. . .

. . . and expensesreported do not

always equalcash paid . . .

net income isusually not equal

to the changein cash forthe period.


1-29MAXIDRIVE CORP.


For the Year Ended December 31, 2003

(in thousands of dollars)

Cash flows from operating activities: Cash collected from customers 33,563$ Cash paid to suppliers and employees (30,854) Cash paid for interest (450) Cash paid for taxes (1,190) Net cash flow from operating activities 1,069$ Cash flow from investing activities: Cash paid to purchase equipment (1,625)$ Net cash flow from investing activities (1,625)

Cash flow from financing activities:

Cash received from bank loan 1,400$

Cash paid for dividends (1,000)

Net cash flow from financing activities 400

Net decrease in cash during the year (156)$

Cash at beginning of the year 5,051

Cash at end of the year 4,895$

1. Name of entity2. Title of statement 3. Specific date (Like the income statement and statement of retained earnings, this statement covers a specified period of time.)4. Unit of measure


1-30MAXIDRIVE CORP.












The Statement of Cash Flows reports the inflows and outflows of cash during the period in the

categories of operating, investing, and financing.


1-31MAXIDRIVE CORP.











Cash flows directly related to earning income are shown in the

operating section.


1-32MAXIDRIVE CORP.












Cash flows related to the acquisition or sale of productive

assets are shown in the investing section.


1-33MAXIDRIVE CORP.












Cash flows from or to investors or creditors are shown in the

financing section.


1-34MAXIDRIVE CORP.












The statement ends with a reconciliation of Cash.


1-35Relationship Among the Financial Statements




Net income from the income statement increases ending

retained earnings on the statement of retained

earnings.






Ending retained earnings from the statement of

retained earnings is one of the components of

stockholders’ equity on the balance sheet.

MAXIDRIVE CORP.Balance Sheet




Liabilities


Notes payable 9,000






The change in cash on the statement of cash flows added to the beginning of the year balance in cash equals the ending

balance in cash on the balance sheet.

MAXIDRIVE CORP.Balance Sheet




Liabilities


Notes payable 9,000




MAXIDRIVE CORP.













1-38

Notes Notes provide supplemental

information about the financial condition of a company.

Three basic types of notes:Description of accounting rules

applied.Presentation of additional detail

about an item on the financial statements.

Provides additional information about an item not on the financial statements.


1-39

Management Uses of Financial Statements

Marketing managers and credit managers use customers’ financial statements to decide

whether to extend credit.

Purchasing managers use suppliers’ financial statements to decide whether suppliers have the

resources to meet our demand for products.

Employees’ union and human resource managers use the company’s financial

statements as a basis for contract negotiations over pay rates.


1-40

Price/Earnings Ratio

Price/Earnings Ratio =Market Price (of the Company)

Net Income

This ratio is one method for estimating

the value of a company.


1-41

Decision makers need to understandDecision makers need to understandaccounting measurement rules.accounting measurement rules.

Decision makers need to understandDecision makers need to understandaccounting measurement rules.accounting measurement rules.

Responsibilities for the Accounting Communication Process

Effective communication means that the recipient understands what the

sender intends to convey.


1-42

The Securities and Exchange Commission (SEC)has been given broad powers to determine

measurement rules for financial statements.

Securities Act of 1933Securities and Exchange Act of 1934

Generally Accepted Accounting Principles (GAAP)


1-43


Currently, the Financial AccountingStandards Board (FASB) is recognized

as the body to formulate GAAP.

The SEC has worked closely with theaccounting profession to

work out the detailed rules that havebecome known as GAAP.


1-44


Companies incur the cost of preparing the financial statements and bear the

following economic consequences . . .

Effects on the selling price of stock. Effects on the amount of bonuses received by managers and other employees. Loss of competitive information to other companies.


1-45

To ensure the accuracy of the company’sfinancial information, management:

Maintains a system of controls. Hires outside independent auditors. Forms a board of directors to review these two safeguards.

Management Responsibility and the Demand for Auditing


1-46

Independent Auditors

Auditors express an opinion as to the fairness of the financial statement presentation.

Independent auditors have responsibilities that extend to the general public.

Overall, I believethese financialstatements are

fair.


1-47

Independent Auditors

An audit involves . . .Examining the financial reports

to ensure compliance with GAAP.

Examining the underlying transactions incorporated into the financial statements.

Expressing an opinion as to the fairness of presentation of financial information.


1-48Ethics, Reputation, and Legal Liability

The American Institute of Certified Public Accountants requires that all members adhere to a professional code of ethics.


1-49

A CPA’s reputation for honesty and competence is his/her most important asset.

Like physicians, CPAs have

liability for malpractice.

Ethics, Reputation, and Legal Liability


1-50

End of Chapter 1

financial accounting robert libby patricia a. libby daniel g. short

Documents

short slide

organization slide

business decisions slide

earnings financial statements

creditors external slide

financial position

financial activities

investors investors