CHAPTER 1

Introduction to Financial Statements CHAPTER NOTES

Study Objective 1 - Describe the Primary Forms of Business Organization
A business may be organized as a sole proprietorship, partnership, or corporation  Sole proprietorship a business owned by one person Advantages Simple to establish Owner controlled Tax advantages Disadvantages Proprietor personally liable financing harder to get transfer of ownership may be difficult  Partnership a business owned by more than one person Advantages

easy to start
shared control broader skills and resources tax advantages

 Disadvantages partner can become liable difficult transfer of ownership  Corporation a separate legal entity owned by stockholders Advantages easy to transfer ownership easier to raise funds no personal liability Disadvantages unfavorable tax treatment (double taxation) Go to Do it 1-1 p. 28 Identify each of the following organizational characteristics with the organizational form or forms with which it is associated. a) Easier to transfer ownership. - corporation b) Easier to raise funds. - corporation c) More owner control.

- Sole proprietorship. d) Tax advantages. - Sole proprietorship and partnership. e) No personal legal liabilities - Corporation.

Study Objective 2 - Identify the Users and Uses of Accounting

The primary function of accounting is to provide financial information for decision making. The users of financial information fall into two categories internal and external users. Internal users managers who plan, organize, and run a business. Examples: Marketing managers Production Supervisors Finance Directors Company Officers External users those outside the organization Examples: Investors Creditors Taxing Authorities Customers Labor Unities Regulatory Agencies

GO TO BE 1-2 p. 27 (a) (b) (c) (d) (e)

Ethics in Financial Reporting The Enron, WorldCom, HealthSouth, and AIG financial scandals in recent years led to a general mistrust of financial reporting. U.S. regulators and lawmakers grew concerned that the economy would suffer if investors lost confidence in corporate accounting due to unethical financial reporting. In response, in 2002, Congress passed the SARBANES OXLEY Act (SOX). As a result of SOX, top management must now certify the accuracy of financial information, and penalties for fraudulent financial activity by top management are now much more severe. SOX also calls for increased independence of outside auditors who review the accuracy of corporate financial statements, and increased responsibility of the board of directors in their oversight role.

Study Objective 3 - Explain the Three Principal Types of Business Activity

There are three types of business activity:  Financing activities - to start or expand a business the owner or owners quite often need cash from outside sources. The two primary sources are:

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Borrowing from creditors, which creates a liability (debt financing) Examples: Selling ownership interests in the corporation to shareholders (equity financing)  Investing activities - obtaining assets (resources) needed to operate the business (i.e., buildings, equipment, land, office supplies, etc.)  Operating activities - comprise the primary activities for which the organization is in business Revenue - generated by selling a product or providing a service. Expenses the costs incurred (e.g., advertising, salaries, utilities) in order to earn revenue.

Study Objective 4 - Describe the Content and Purpose of Each of the Financial  Statements
Accountants communicate with users through four financial statements (see p. 11-16 in text)   Income Statement (IS) Reports success or failure of the companys operations during the period Summarizes all revenue and expensies for the period month, quarter, or year. If revenues exceed expenses, the result is a net income. If expenses exceed revenue, the result is a net loss  Retained Earnings Statement (RE) Starts with Beginning Retained Earnings, Adds Net Income (or subtracts Net Loss) and deducts the amount of Dividends for the period. Indicates the change in Retained Earnings during the period (month, quarter, year).  Balance Sheet (BS) Shows relationship between assets and equities at a point in time - on a particular date. Total Assets must = Total Equities (Liabilities + Stockholder=s Equity)  Statement of Cash Flows (CF) Reports the cash effects of a companys operating, investing, and financing activities for a period of time Indicates increase or decrease in cash balance as well as ending cash balance. Interrelationship (interrelatedness) of financial statements (see Illustration 1-9, p. 17) GO TO BE 1-7, p. 31 (a) (b) (c)

(d)

Study Objective 5 - Explain the Meaning of Assets, Liabilities, and Stockholders

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Equity and State the Basic Accounting Equation

 Assets resources owned by a business Provide a Future economic benefit to the company. Examples include: Cash, Accounts Receivable, Inventory, Office Supplies, Equipment, Land, Building   Liabilities debts or obligations of the business Represent the creditors claims to the assets of the company. Examples: Accounts Payable, Notes Payable, Bonds Payable   Stockholders Equity represent the owners claims to the assets of the company. Examples: Common Stock, Preferred Stock, Retained Earnings

GO TO BE 1-10, p. 28 (a) (d) (b) (e) (c) (f)  The BASIC ACCOUNTING EQUATION (and alternate forms): Assets = Equities Assets = Liabilities + Stockholders Equity (PRIMARY FORM USED) Assets Liabilities = Stockholders Equity Assets Stockholders Equity = Liabilites GO TO BE 1-8, p. 28

Liab.

Stk. Eq. = Assets

(a) (b) (c)

$90,000 + $230,000 = 320,000

Assets Stk. Eq. = Liabilities

$170,000 $90,000 = 80,000

Assets - Liabilities $200,000 = Stockholders Equity

$800,000 0.25($800,000) = 600,000

Study Objective 6 - Describe the Components that Supplement the Financial Statements in an Annual Report
Companies traded on an organized stock exchange like the New York Stock exchange or the American Stock Exchange are required to provide shareholders with an annual report. The annual report includes: Financial Statements (four) Income Statement, Retained Earnings Statement, Balance Sheet, & Statement of Cash Flow. Management Discussion and Analysis (MD&A) Covers three major aspects of the company:

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Liquidity, Capital Resources, and Results of Operations. Notes to the Financial Statements Clarify or provide Details about information presented in the financial statements Describe accounting policies or explain uncertainties and contingencies Auditors Report An auditor is a professional accountant (CPA) who conducts an independent examination of the financial accounting data presented (prepared) by the company. If the financial statements are presented in accordance with U.S. Generally Accepted Accounting Principles (or iGAAP), the auditor will express what is referred to as an unqualified opinion. LOOK AT Specimen Financial Statements: Tootsie Roll, Inc.-Appendix A, (at back of textbook p. 746) GO TO Do it! 1-4, p.29 (1) (4) (2) (5) (3) (6) GO TO Do it! 1-3, p. 29 GO TO E 1-1, p. 29 (a) (b) (c) (d) (e) (f) (g) (h)

GOULD CORPORATION Income Statement For the Year Ended Dec 31, 2012 Revenue Service revenue ................................................... Expenses Rent expense ........................................................ Advertising expense ............................................ Supplies expense.................................................. Total expenses .......................................... Net Income .................................................................. GOULD CORPORATION Retained Earnings Statement For the year ended Dec 31, 2012 Retained earnings, January 1 ........................................... Add: Net Income ............................................................ Less: Dividends ................................................................ Retained Earnings, Dec 31 ............................................... GOULD CORPORATION Balance Sheet $ 0 9,300 9,300 2,500 $ 6,800 $25,000 $10,000 4,000 1,700 15,700 $9,300

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Dec 31, 2012 Assets Cash ................................................................................... Accounts receivable .......................................................... Supplies ............................................................................. Equipment ........................................................................ Total assets ........................................................................ Liabilities and Stockholders Equity Liabilities Notes payable ............................................................ Account payable ........................................................ Total liabilities ............................................... Stockholders equity Common stock........................................................... Retained Earnings 12/31 ........................................... Total stockholders equity............................. Total liabilities and stockholders equity ......................... $ 3,100 2,000 1,900 26,800 $33,800

$ 7,000 5,000 $12,000 $15,000 6,800 21,800 $33,800

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