uses of accounting information and the financial

8/14/2019 Uses of Accounting Information and the Financial

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Uses of AccountingInformation and the

Financial Statements

Multimedia Slides by: Gail A. Mestas, MAcc, New Mexico State University

Chapter 1


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Copyright Houghton Mifflin Company. All rights reserved. 12

Accounting

is an information system thatmeasures

processescommunicates

financial informationabout an identifiable, economic entity


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Accounting

supplies the informationdecision makers need to make

reasoned choicesamong alternative uses of

scarce resources

in the conduct of business andeconomic activities


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Accounting

Is a link between business activities anddecision makers

Decision makers use accounting information

to make informed decisions about availablealternatives

Measures business activities by recordingdata about them for future use

Is communicated to decision makersthrough reports


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Accounting as an Information System


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7/81Copyright Houghton Mifflin Company. All rights reserved. 17

Business Goals

Profitability

The ability to earn enough income toattract and hold investment capital

Liquidity

Having enough cash available to pay debtswhen they are due



Business Activities

Financing Activities

Investing Activities

Operating Activities



Financing Activities

Activities associated with obtainingadequate funds, or capital, to begin andcontinue operations

Owner investments

Paying a return to owners

Obtaining loans from creditors

Repaying amounts to creditors, plus interest



Investing Activities

Activities associated with spendingfunds to begin and continue operations

Buying resources such as land, buildings,

and equipment needed in the operationof the business

Selling these resources when no longer

needed



Operating Activities

Activities associated with the course ofrunning a business

Selling goods and services

Employing managers and workers

Buying goods and services

Paying taxes



Performance Measures

Indicators Used to determine whether

1. Managers are achieving their business goals

2. Business activities are well managed

Include Earned income

Cash flow

Ratio of expenses to revenue Ratio of money owed to total resources

controlled



Financial and Management Accounting

Accountings role is divided into twocategories

1. Management accounting

2. Financial accounting

The functions of both categoriesoverlap

Primary difference between the two isthe principal users of the information



Management Accounting

Focuses on internal decision makers

Managers and employees

Reporting format is flexible and basedon the type of information needed, suchas budgets and sales forecasts

Used to report past performance andexpected future performance


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Financial Accounting

Focuses on external decision makers

Stockholders

Banks and other creditors

Government regulators

Financial information of company is

reported in the financial statements Used to report directly on goals ofprofitability and liquidity


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Bookkeeping versus Accounting

Bookkeeping

Repetitive,mechanical process

of recording financialtransactions andkeeping financialrecords

Accounting

Bookkeeping a smallpart of accounting

Includes design of aninformation systemto meet users needs

Goals include the

analysis,interpretation, anduse of information


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Decision Makers

fall into three categories

1. Those who manage a business

Finance Investment

Operations and production

Marketing

Human resources Information systems

Accounting


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Decision Makers (contd)

2. Those with a direct financial interest Investors

Creditors

3. Those with an indirect financial interest Tax authorities

Regulatory agencies

Labor unions

Financial advisors

Customers

Economic planners


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Accounting Measurement

Four Basic Questions

1. What is measured?

Business transactions affecting thefinancial position of the business entity

2. When should the measurement be

made? Discussed in Chapter 2, TheRecognition Issue


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Accounting Measurement (contd)

3. What value should be placed onwhat is measured?

Discussed in Chapter 2, The Valuation

Issue

4. How should what is measured beclassified?

Discussed in Chapter 2, TheClassification Issue


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Business Transactions

are economic events that affect thefinancial position of a business entity

Involve an exchange of value

Purchase Sale

Payment

Collection

Events that have the same effect as an exchange

of value Loss from fire, flood, theft

Physical wear and tear on equipment

Accumulation of interest


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Money Measure

Recording of all business transactionsin terms of money

Money is the only factor common to all

business transactions Basic unit of money determined by the

country in which business resides

Exchange rates are used to translatetransactions from one currency toanother


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Separate Entity

A business is distinct from its

Owner(s)

Creditors

Customers

Its financial records and reports should

refer only to its own financial affairs


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Forms of Business Enterprises

Three basic forms of businessenterprises

Sole proprietorship

Partnership

Corporation


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Separate Entities

All three forms of businesses areeconomically separate entities fromtheir owners

Financial records and reports refer to thefinancial affairs of the business only

Only the corporation is a legally

separate entity from its owners


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Sole Proprietorships

Business owned by one person

The owner

Receives all profits or losses

Is liable for all obligations of the business Not incorporated

Life of business ends when the owner

Decides to stop operating business

Dies

Is incapacitated


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Partnerships

Business owned by more than one person The partners share all profits or losses according

to an agreed upon formula

At least one partner is liable for all obligations of

the business Not incorporated

Life of business ends when Ownership changes

A partner leaves the business or dies

A new partner is admitted

A partnership is like a sole proprietorship inmost ways, but with two or more owners


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Corporations

Legally and economically separate from itsowners

Business unit chartered by the state and legally

separate from owners (incorporated) Owners (stockholders) do not directly control

operations

Elected board of directors run the corporation

Owners risk of loss limited to amount paid forshares of stock owners are not liable for theobligations of the business


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Organization of a Corporation

Stockholders

Elect the board of directors

Board of directors

Set company policies

Choose corporate officers

Corporate officers Carry out corporate policies by managing

the business


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The Corporate Form of Business


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Stockholders

Share of stock Unit of ownership in a corporation

Maximum number of shares the

corporation is authorized to issue is statedin the articles of incorporation

Outstanding capital stock

Number of shares held by stockholders May be less than the maximum number

authorized


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Stockholders (contd)

To invest in a corporation

Stockholder transfers cash or otherresources to the corporation

Stockholder receives shares of stockrepresenting a proportional share ofownership in the corporation

Stockholder may transfer shares at willMost universal form of capital stock is common stock


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Board of Directors

Duties of the board of directors include

Authorizing contracts

Setting executive salaries

Arranging major loans with banks

Declaring dividends


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Board of Directors (contd)

Dividends

Distributions of resources to thestockholders

Generally in the form of cash

Reward stockholders for their investment inthe company when a profit has been

earnedStockholders are also rewarded througha rise in the market value of the stock


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Board of Directors (contd)

Audit committee

Includes several outside directors

Helps ensure that the board will be objective in

evaluating managements performance Engages the companys independent auditors and

reviews their work

Ensures that

The proper system exists to safeguard the companysassets

Reliable accounting records are kept


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Management

Carries out the corporations policies Runs day-to-day operations

Consists of operating managers

President

Vice presidents

Controller

Treasurer

Secretary


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Management (contd)

Reports the financial results of itsadministration to the

Board of directors

Stockholders

Must make a comprehensive annualreport

Generally prepare reports more often

The annual reports of large public corporations are available to the public


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Financial Position

The economic resources that belongto a company

and the claims against those resources

at a point in time

Economic Resources = Equities


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Developing the Accounting Equation

Economic Resources = Equities

Two types of equitiesCreditors equities and owner's equities,

therefore,

Economic Resources = Creditors Equities+ Owners Equities

In accounting terminologyEconomic resources are called assetsCreditors equities are called liabilities

Assets Liabilities


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Accounting Equation

Assets = Liabilities + Owners EquityTwo sides of equation are always in balance

Assets

Economic resources owned by a company that are expected

to benefit future operations

Liabilities

Obligations of a business to pay cash, transfer assets, orprovide services to other entities in the future

Represent claims of creditors to the assets of the business

Owners Equity

Represents the claims by owners to the assets of thebusiness


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Owners Equity

Equals the residual interest in a companysassets after deducting all liabilities

Also called residual equityornet assets

Defined by rearranging the accountingequation

Assets = Liabilities + Owners Equity

Owners Equity = Assets Liabilities


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Owners Equity (contd)

Stockholders equity

The owners equity of a corporation

Also called shareholders equity

Has two components

Contributed capital

Retained earnings

Assets = Liabilities + Stockholders Equity


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Contributed capital

The amount that stockholders invest in thebusiness

Represented by shares of capital stock


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Contributed capital has two components

Par Value

Amount per share that is entered in the

corporations capital stock account Minimum amount that can be reported as

contributed capital

Additional paid-in capital

The value received for capital stock over its parvalue


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Retained earnings

Represent the equity of the stockholders

Are generated from income-producing

activities of the business

Are kept for use in the business


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Retained earnings are affected by three typesof transactions Revenues

Amounts customers agree to pay the company in returnfor a service or product

Increase retained earnings

Expenses Amounts the company pays out in the process of

providing services or manufacturing products

Decrease retained earnings

Dividends Distributions to stockholders of assets (usually cash)

generated by past earnings

Decrease retained earnings It is important not to confuseexpenses and dividends


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Net income The difference when revenues exceed

expenses

Net loss The difference when expenses exceed

revenues

Generally, a company is successful

if its revenues exceed its expenses

(Loss)IncomeNetdAccumulateEarningsRetained =

BusinesstheofLifeOver theDividends

Three Types of Transactions That Affect


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Three Types of Transactions That AffectRetained Earnings


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Illustrative Transactions for Shannon Realty

Effects of Transactions

on the Accounting Equation


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150Copyright Houghton Mifflin Company. All rights reserved.

Assets

CashCommon

Stock

1. Invested $50,000 in Shannon Realty, Inc., in exchange for

5,000 shares of $10 par value common stock

1. $50,000 $50,000

Owners Investments

A = $50,000 L + SE = $50,000

Notice that the accounting equationAssets = Liabilities + Stockholders Equity

orA = L + SE

is always in balance


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Assets

CashCommon

StockBuildingLand

A = $50,000 L + SE = $50,000

2. Purchased a lot for $10,000 and a small building on the lot

for $25,000

1. $50,000 $50,0002. 35,000 $10,000 $25,000

$15,000 $10,000 $25,000 $50,000

Purchase of Assets with Cash

This transaction only affects one side of the

accounting equation Assets

Whenever a transaction affects only one sideof the accounting equation, the total on eachside of the equal sign remains unchanged

Purchase of Assets by Incurring a


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Assets

CashCommon

StockSupplies BuildingLand A/P

A = $50,500 L + SE = $50,500

3. Purchased office supplies for $500 on credit

1. $50,000 $50,0002. 35,000 $10,000 $25,000

3. $500 $500

$15,000 $500 $10,000 $25,000 $500 $50,000

Purchase of Assets by Incurring aLiability

f


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Assets

CashCommon


A = $50,300 L + SE = $50,300

4. Paid $200 of the $500 owed for supplies

1. $50,000 $50,0002. 35,000 $10,000 $25,000

3. $500 $5004. 200 200

$14,800 $500 $10,000 $25,000 $300 $50,000

Payment of a Liability

R


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Assets

CashCommon


A = $51,800 L + SE = $51,800

5. Earned and received a commission of $1,500 in cash

Retained

Earnings1. $50,000 $50,0002. 35,000 $10,000 $25,000

3. $500 $5004. 200 2005. 1,500 $1,500

$16,300 $500 $10,000 $25,000 $300 $50,000 $1,500

Revenues

R


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Assets

CashCommon

StockSuppliesA/R BuildingLand A/P

A = $53,800 L + SE = $53,800

6. Earned a commission of $2,000 to be received at a later

date

Retained

Earnings1. $50,000 $50,0002. 35,000 $10,000 $25,000

3. $500 $5004. 200 2005. 1,500 $1,5006. $2,000 2,000

$16,300 $2,000 $500 $10,000 $25,000 $300 $50,000 $3,500

Revenues

C ll ti f A t R i bl


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Assets

CashCommon


A = $53,800 L + SE = $53,800

7. Received $1,000 from client for commission earned

earlier in the month

Retained

Earnings1. $50,000 $50,0002. 35,000 $10,000 $25,000

3. $500 $5004. 200 2005. 1,500 $1,5006. $2,000 2,000

7. 1,000 1,000

$17,300 $1,000 $500 $10,000 $25,000 $300 $50,000 $3,500

Collection of Accounts Receivable

E


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Assets

CashCommon


A = $52,800 L + SE = $52,800

8. Paid $1,000 to rent equipment for office

Retained

Earnings1. $50,000 $50,0002. 35,000 $10,000 $25,000

3. $500 $5004. 200 2005. 1,500 $1,5006. $2,000 2,000

7. 1,000 1,0008. 1,000 1,000

$16,300 $1,000 $500 $10,000 $25,000 $300 $50,000 $2,500

Expenses

E


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Assets

CashCommon


A = $52,400 L + SE = $52,400

9. Paid $400 in wages to part-time helper

Retained

Earnings1. $50,000 $50,0002. 35,000 $10,000 $25,000

3. $500 $5004. 200 2005. 1,500 $1,5006. $2,000 2,000

7. 1,000 1,0008. 1,000 1,000

9. 400 400$15,900 $1,000 $500 $10,000 $25,000 $300 $50,000 $2,100

Expenses

E


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Assets

CashCommon


A = $52,400 L + SE = $52,400

10. Recorded utilities expense of $300 incurred in December

but not yet paid

Retained

Earnings1. $50,000 $50,0002. 35,000 $10,000 $25,000

3. $500 $5004. 200 2005. 1,500 $1,5006. $2,000 2,000

7. 1,000 1,0008. 1,000 1,000

9. 400 40010. 300 300

$15,900 $1,000 $500 $10,000 $25,000 $600 $50,000 $1,800

Expenses

Di id d


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Assets

CashCommon


A = $51,800 L + SE = $51,800

11. Declared and paid a $600 dividend

Retained

Earnings1. $50,000 $50,0002. 35,000 $10,000 $25,000

3. $500 $5004. 200 2005. 1,500 $1,5006. $2,000 2,000

7. 1,000 1,0008. 1,000 1,000

9. 400 40010. 300 30011. 600 600

$15,300 $1,000 $500 $10,000 $25,000 $600 $50,000 $1,200

Dividends

Communications Through Financial


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gStatements

Four Major Financial Statements Income Statement

Statement of Retained Earnings

Balance Sheet

Statement of Cash Flows

I St t t


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Income Statement

Summarizes revenues earned andexpenses incurred over a period of time

Dated For the Month Ended

Purpose to measure a companysperformance over a period of time

Shows whether or not a companyachieved its profitability goal

Income Statement ( td)


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Income Statement (contd)

Considered by many to be most importantfinancial statement

Also called Statement of retained earnings

Statement of operations

Profit and loss statement

First financial statement to be prepared in a

sequence Net income figure used to prepare statement

of retained earnings

Income Statement


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Income Statement

For

RevenuesNet income figure used to preparestatement of retained earnings

Date reflectsrevenues andexpenses incurred

over a period of time



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Shows changes in retained earningsover a period of time


Uses net income figure from incomestatement

End of period balance in RetainedEarnings account used to preparebalance sheet

Statement of Retained Earnings (contd)


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Statement of Retained Earnings (contd)

Many companies use a statement ofstockholders equity or shareholdersequity in place of the statement of

retained earnings Is a more comprehensive statement

Incorporates changes in all stockholders equity

accounts



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S

For t

Retained earnin

Date reflects changes in retainedearnings over a period of time

Net income figure fromincome statement

Ending retained earningsfigure used to prepare thebalance sheet

Balance Sheet


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Balance Sheet

Shows the financial position of a company ona certain date

Dated as of a certain date

Also called the statement of financial position

Presents view of business as holder of assetsthat are equal to the claims against thoseassets

Claims consist of liabilities and stockholdersequity

Balance Sheet

Date reflects account


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Balance Sheet

Assets

Cash $

Accounts receivable

Date reflects accountbalances as of acertain date

Balance in Cashaccount used instatement of cashflows

Retained earnings figure from thestatement of retained earnings



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Shows cash flows into and out of abusiness over a period of time


Focuses on whether the business metits liquidity goal

Explains how the Cash accountchanged during the period



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SSta

For the Mo

Cash flows from operating act

Net incomeAdjustments to reconcile net

flows from operating activiti

Beginswith net

incomefromincomestatement

Cash at end of monthsame as Cash accountbalance on balance sheet

Date reflectscash flowsover a period

of time

Dividendsfrom thestatementof retainedearnings

Generally Accepted Accounting


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Principles (GAAP)

The conventions, rules, and proceduresnecessary to define accounting practiceat a particular time

Developed to provide guidelines forfinancial accounting

Are altered as better methods evolve or

circumstances change

Financial Statements, GAAP, and the


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Examination of a company'sfinancial statements

Prepared by independentcertified public accountant

(CPA)

CPA should have nocompromising ties withcompany

Ascertains that financial

statements prepared inaccordance with GAAP

Implies that investors andcreditors can rely on financialstatements

Summary of financial affairs of abusiness

Prepared by management ofcompany

Management has an interest incompany performance; notindependent

Should be prepared in

accordance with GAAP

Independent CPAs Report (Audit)

Financial Statements Audit

How to Read an Annual Report


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How to Read an Annual Report

The SEC requires the management ofthe public to report each year tostockholders on their companies

performance, this report called annualreport.

It contains the companys annual

financial statements and other data.

The components of an annual Report


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The components of an annual Report

Letter to the Stockholders

Financial highlights

Description of the company

Managements discussion and analysis.

Financial statements

Reports of Management responsibilities

Report of certified Public Accountants.


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W l


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WalgreenCo.s

IncomeStatements

Walgreen


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WalgreenCo.s

Statements of

StockholdersEquity

Walgreen


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WalgreenCo.s

Balance

Sheets

Walgreen


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WalgreenCo.s

Statements

of CashFlows


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uses of accounting information and the financial

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