Financial Statements and Business Decisions

Chapter 01

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
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 Understanding the Business
The Players
Investors Creditors

Managers

1. Purchase parts 2. Manufacture

and labor product

The
Business
Operations
4. Collect cash from 3. Sell products
customers and pay to customers
creditors

1-2
 The Accounting System

Managers
(internal
decision
makers)
Reports
information
Collects and processes to decision
financial information makers Investors
and
Creditors
(external
decision
makers)
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 The Accounting System

Accounting System

Financial Accounting Reports Managerial Accounting Reports

Periodic financial statements and Detailed plans and continuous
related disclosures performance reports

External Decision Makers Internal Decision Makers

Investors, creditors, Managers throughout the
suppliers, customers, etc. organization

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 The Four Basic Financial Statements

1.
1. BALANCE
BALANCESHEET
SHEET––reports
reportsthe
theamount
amountof
ofassets,
assets,liabilities,
liabilities,and
and
stockholders’
stockholders’equity
equityof
ofan
anaccounting
accountingentity
entityat
ataapoint
pointinintime.
time.

2.
2. INCOME
INCOMESTATEMENT
STATEMENT––reports
reportsthe
therevenues
revenuesless
lessthe
theexpenses
expensesof
of
the
theaccounting
accountingperiod.
period.

3.
3. STATEMENT
STATEMENTOF OFRETAINED
RETAINEDEARNINGS
EARNINGS––reports
reportsthe
theway
waythat
thatnet
net
income
incomeand
anddistribution
distributionof
ofdividends
dividendsaffected
affectedthe
thefinancial
financialposition
positionof
of
the
thecompany
companyduring
duringthetheaccounting
accountingperiod.
period.

4.
4. STATEMENT
STATEMENTOF OFCASH
CASHFLOWS
FLOWS––reports
reportsinflows
inflowsand
andoutflows
outflowsof
of
cash
cashduring
duringthe
theaccounting
accountingperiod
periodininthe
thecategories
categoriesof
ofoperating,
operating,
investing,
investing,and
andfinancing.
financing.

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 The Accounting Equation

A = L + SE
(Assets) (Liabilities) (Stockholders’
Equity)

Economic Sources of Financing for Economic

Resources Resources
Liabilities: From Creditors
Stockholders’ Equity: From Stockholders

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 The Balance Sheet
Typical Account Titles

Assets Liabilities
Cash Accounts Payable
Short-Term Investment Accrued Expenses
Accounts Receivable Notes Payable
Notes Receivable Taxes Payable
Inventory (to be sold) Unearned Revenue
Supplies Bonds Payable
Prepaid Expenses
Long-Term Investments Stockholders’ Equity
Equipment Contributed Capital
Buildings Retained Earnings
Land
Intangibles
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 Balance Sheet
MAXIDRIVE CORP.
Balance Sheet
At December 31, 2010
(in thousands of dollars)

ASSETS
Cash $ 4,895
Accounts receivable 5,714
Inventories 8,517
Plant and equipment 7,154
Land 981
Total assets $ 27,261
LIABILITIES
Accounts payable $ 7,156
Notes payable 9,000
Total liabilities 16,156
STOCKHOLDERS' EQUITY
Contributed capital 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
Total liabilities and stockholders' equity $ 27,261
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 The Income Statement
Typical Account Titles

Revenues Expenses
Sales Revenue Cost of Goods Sold
Fee Revenue Wages Expense
Interest Revenue Rent Expense
Rent Revenue Interest Expense
Depreciation Expense
Advertising Expense
Insurance Expense
Repair Expense
Income Tax Expense

1-9
 Income Statement

MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 2010
(in thousands of dollars)
Revenues
Sales revenue $ 37,436
Total revenues 37,436
Expenses
Cost of goods sold expense 26,980
Selling, general, and administrative expense 3,624
Research and development expense 1,982
Interest expense 450
Total expenses 33,036
Operating income 4,400
Income tax expense 1,100
Net income $ 3,300

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 Statement of Retained Earnings

Beginning Retained Earning

Plus: Net Income
Less: Dividends
Ending Retained Earnings

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 Statement of Retained Earnings

MAXIDRIVE CORP.
Statement of Retained Earnings
For the Year Ended December 31, 2010
(in thousands of dollars)
Retained earnings, January 1, 2010 $6,805
Net income for 2010 3,300
Dividends for 2010 (1,000)
Retained earnings, December 31, 2010 $9,105

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 Statement of Cash Flows
MAXIDRIVE CORP.
Statement of Cash Flows
For the Year Ended December 31, 2010
(in thousands of dollars)
Operating activities
Cash collected from customers
Cash paid to suppliers and employees
Cash paid for interest
Cash paid for taxes
Net cash flow from operating activities
Investing Activities
Cash used to purchase equipment
Net cash flow from investing activities
Financing Activities
Cash received from bank loan
Cash dividends paid
Net cash provided by financing activities
Net decrease in cash
Cash at beginning of year
Cash at end of year
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 Relationships Among the Statements
1. Net income from the income statement results
in an increase in ending retained earnings on
the statement of retained earnings.

Income Statement
Revenues $ 37,436 Statement of Retained Earnings
Expenses 34,136 Beginning retained earnings $ 6,805
Net income $ 3,300 Net income 3,300
Dividends (1,000)
Ending retained earnings $ 9,105

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 Relationships Among the Statements
2. Ending retained earnings from the statement of
retained earnings is one of the two components
of stockholders’ equity on the balance sheet.

Statement of Retained Earnings Balance Sheet

Beginning retained earnings $ 6,805 Cash $ 4,895
Net income 3,300 Other assets 22,366
Dividends (1,000) Total assets $ 27,261
Ending retained earnings $ 9,105 Liabilities $ 16,156
Contributed Capital 2,000
Retained earnings 9,105
Total liabilities and equity $ 27,261

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 Relationships Among the Statements
3. The change in cash on the statement of
cash flows is added to the beginning-of-year
balance in cash to arrive at end-of-year
cash on the balance sheet.
Statement of Cash Flows Balance Sheet
Cash flows from operating activities $ 1,069 Cash $ 4,895
Cash flows from investing activities (1,625) Other assets 22,366
Cash flows from financing activities 400 Total assets $ 27,261
Change in cash $ (156) Liabilities $ 16,156
Beginning cash balance 5,051 Contributed Capital 2,000
Ending cash balance $ 4,895 Retained earnings 9,105
Total liabilities and equity $ 27,261

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 Notes
All financial statements
should be accompanied
by notes which provide
the reader with
supplemental
information about the
financial condition and
results of operations of
the company.

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 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 the demand for products.

Employees’ union and human resource

managers use the company’s financial
statements as a basis for contract negotiations
over pay rates.

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 Summary of the Financial Statements

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 Responsibilities for the Accounting
Communication Process

The Rules

Generally
Accepted
Accounting
Principles (GAAP)

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 How are Generally Accepted
Accounting Principles Determined?
Our accounting system has a long
and distinguished history. An
Italian monk named Luca Pacioli,
published the first elements of
double-entry bookkeeping in 1494.
Prior to 1933, the management
teams of most companies were
largely free to choose their own
financial reporting practices.

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 Generally Accepted Accounting
Principles
Securities Act of 1933
Securities and Exchange Act of 1934

The Securities and Exchange Commission (SEC)

has been given broad powers to determine
measurement rules for
financial statements.

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 Generally Accepted Accounting
Principles

The SEC has worked closely with the

accounting profession to
work out the detailed rules that have
become known as GAAP.

Currently, the Financial Accounting Standards Board

(FASB) is recognized as the body to formulate GAAP.

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 Generally Accepted Accounting
Principles

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.

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 International Perspective
International Financial Reporting Standards

Since 2002, there has been substantial movement toward the

adoption of International Financial Reporting Standards (IFRS)
issued by the International Accounting Standards Board (IASB).

Examples of jurisdictions requiring the use of IFRS either currently or

by 2012 include:
• European Union
• Australia and New Zealand
• Hong Kong, India, Malaysia, and South Korea
• Israel and Turkey
• Brazil and Chile
• Canada and Mexico
In the United States, the Securities and Exchange Commission now
allows foreign companies whose stock is traded in the U.S. to use IFRS
and is considering requiring the use of IFRS for U.S. domestic
companies by 2014.
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 Management Responsibility and the
Demand for Auditing
To ensure the accuracy of the company’s
financial information, management:
 Maintains a system of controls.
 Hires outside independent auditors.
 Forms a committee of the board of directors to
review these two safeguards.

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 Independent Auditors
 Auditors express an opinion
as to the fairness of the Overall, I believe
financial statements. these financial
statements are
 Independent auditors have fairly stated.
responsibilities that extend
to the general public.
 The PCAOB issues detailed
auditing standards that
auditors must follow.

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 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.

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 Ethics, Reputation, and Legal Liability

The American Institute of Certified

Public Accountants requires that all
members adhere to a professional code
of ethics.

Code of
Ethics

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 Ethics, Reputation, and Legal Liability
A CPA’s reputation for honesty and
competence is his/her most important asset.

Like physicians, CPAs have

liability for malpractice.
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 Supplement A: Types of Business
Entities
Sole
Sole Proprietorship:
Proprietorship: owned
owned by by aa single
single individual.
individual.
Partnership:
Partnership: owned
owned by
by two
two or
or more
more individuals.
individuals.
Corporation:
Corporation: ownership
ownership represented
represented by
by shares
shares of
of stock.
stock.
Advantages
Advantages of of aa Corporation
Corporation

Limited
Limited liability
liability

Continuity
Continuity of
of life
life

Ease
Ease of
of transfer
transfer of of ownership
ownership

Opportunity
Opportunity to
to raise
raise large
large amounts
amounts of
of money
money
Disadvantage
Disadvantage of of aa Corporation
Corporation

Double
Double taxation
taxation
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 Supplement B: Employment in the
Accounting Profession Today

Career Opportunities
Professional Public Accounting
Designations Audit and Assurance Services
CPA Management Consulting Services
Tax Services
CMA Employment by Organizations
Internal accounting
CIA External reporting
Tax planning
Various other functions
Employment in the Public and Not-
for-Profit Sector
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 End of Chapter 01

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