Chapter One

1. Chapter One Elements of Financial Statements

2. Title Role of Accounting in Society Should I invest money in IBM or General Motors? Accounting provides information that is useful in answering questions about resource allocation.

3. Market-Based Allocations A market is a group of people or entities organized to exchange things of value.

4. Resource users Transform resources into desirable products Control the distribution of resources Market-Based Allocations Consumers Conversion Agents Resource Owners

5. Profit Income Earnings Market-Based Allocations Here are some common terms for the added value created in the transformation process:

7. Investors Creditors Financial Resources Conversion agents need financial resources (money) to establish and operate their businesses.

8. Liquidation If a business fails, any resources (assets) it still has are returned to the resource providers (investors and creditors). The process of dividing remaining assets and returning them to resource providers is called business liquidation.

9. Physical Resources In their most primitive form, physical resources are called natural resources. Owners of physical resources seek to sell those resources to profitable business because profitable businesses are more likely to be able to pay for them.

10. Labor Resources Labor resources include intellectual as well as physical labor.Workers seek relationships with businesses (conversion agents) that have high earnings potential because these businesses are better able to provide rewards (pay high wages).

11. Financial Accounting Focused on the needs of external users Managerial Accounting Focused on the needs of internal users Types of Accounting Information

12. Nonbusiness Resource Allocation Not all entities allocate resources based on profitability. Organizations that are not motivated by profit are called not-for-profit entities. Government, foundations, religious groups, the Peace Corps, and various benevolent organizations allocate resources based on humanitarian concerns.

13. Nonbusiness Resource Allocation Not all entities allocate resources based on profitability. Organizations that are not motivated by profit are called not-for-profit entities. Other organizations allocate resources to support art, music, dance, and theater.

15. Measurement Rules Accountants establish measurement and reporting rules that businesses use to facilitate communication. Generally Accepted Accounting Principles

16. Business Owner Bank Reporting Entities Financial accounting reports disclose the financial activities of particular individuals or organizations described as reporting entities. Each entity is treated as a separate reporting unit.

17. Financial Statements Income Statement Statement of Changes in Equity FASB Balance Sheet Statement of Cash Flows

18. Elements of Financial Statements • Assets • Liabilities • Equity • Contributed Capital • Revenue • Expenses • Distributions • Net Income • Gains • Losses The elements represent broad categories. We will discuss elements 1-8 in this chapter. We will save elements 9 and 10 for a later chapter.

19. Elements of Financial Statements • Assets—Cash, Equipment, Buildings, Land • Liabilities • Equity • Contributed Capital • Revenue • Expenses • Distributions • Net Income • Gains • Losses Subclassifications of the elements are frequently called accounts. Accounts are reported in the financial statements.

20. Accounting Equation Assets = Claims • Claims on the assets are from two sources: • Creditors (liabilities) • Investors or owners (equity). Assets = Liabilities + Equity

21. Accounting Equation Assets = Liabilities + Equity

22. Common Stock + Retained Earnings Accounting Equation Assets = Liabilities + Equity Assets = Liabilities + Stockholders' Equity

23. Recording Business Events Under the Accounting Equation • Businesses obtain assets from three sources: • Owners • Creditors • Profitable Operations Now, let’s look at the effects of asset source transactions on the accounting equation.

24. Event 1: Rustic Camp Sites (RCS) was formed on January 1, 2004, when it acquired $120,000 cash from issuing common stock. • RCS increases assets (cash). • RCS increases stockholders’ equity (common stock). Asset Source Transaction Double-Entry Bookkeeping

25. Event 2: RCS acquired an additional $400,000 of cash by borrowing from a creditor. • RCS increases assets (cash). • RCS increases liabilities (notes payable). Asset Source Transaction

26. Event 3: RCS paid $500,000 cash to purchase land. • RCS decreases assets (cash). • RCS increases assets (land). Asset Exchange Transaction

27. Event 4: RCS obtained $85,000 cash by leasing campsites to customers. • RCS increases assets (cash). • RCS increases stockholders’ equity (retained earnings). Asset Source Transaction

28. Event 5: RCS paid $50,000 cash for operating expenses such as salaries, rent, and interest. • RCS decreases assets (cash). • RCS decreases stockholders’ equity (retained earnings). Asset Use Transaction

29. Event 6: RCS paid $4,000 in cash dividends to its owners. • RCS decreases assets (cash). • RCS decreases stockholders’ equity (retained earnings). Asset Use Transaction

30. Event 7: The land that RCS paid $500,000 to purchase had an appraised market value of $525,000 on December 31, 2004. Historical Cost Concept Reliability Concept Requires that most assets be reported at the amount paid for them (their historical cost) regardless of increases in market value. Information is reliable if it can be independently verified. Appraised values are opinions and will vary from appraiser to appraiser.

31. Summary of Transactions Color Code Legend Green = numbers used in the statement of cash flows Red = numbers used in the balance sheet Blue = numbers used in the income statement Now, let’s prepare the financial statements for RCS using the data presented above.

32. Preparing Financial Statements Matching Concept Net Loss Accounting Period

33. Preparing Financial Statements

34. Preparing Financial Statements Liquidity

35. Preparing Financial Statements Operating Investing Financing

36. Statement of Cash Flows Classifications

37. Horizontal Financial Statements Model

38. Price-Earnings Ratio Market Price Per Share Earnings Per Share = Price-Earnings Ratio Earnings per share (EPS), in its simplest form, is computed by dividing the company’s net income by the number of shares of common stock outstanding. A higher price-earnings ratio means that investors are willing to pay a premium for a company’s stock because of optimistic future growth prospects.

39. Alternative Year Earnings – Base Year Earnings Base Year Earnings Measuring Growth Through Percent Analysis The following earnings information was taken from the 2002 and 2003 income statements of Cammeron, Inc. and Diller Enterprises.

40. Service Businesses Merchandising Businesses Manufacturing Businesses Business Entities

41. Annual Reports • Financial Statements • Notes • Auditor’s Report –Chapter 2 • Management’s Discussion and Analysis (MD&A)—Chapter 4 Traditionally, large companies have distributed expensive annual reports with many color photographs. Increasingly, however, companies are issuing more modest annual reports or are simply distributing their 10-K reports.

42. Special Terms in Real-World Reports The financial statements of real-world companies include numerous items relating to advanced topics that are not covered in introductory accounting textbooks. However, we encourage you to look for annual reports in the library, from your employer, or on the Internet. The best way to learn accounting is to use it.

43. End of Chapter One