FINANCIAL ACCOUNTING Robert Libby Patricia A. Libby Daniel G. Short George Kanaan Maureen Gowing
Chapter 1 Financial Statements and Business Decisions
Balance Sheet Income Statement Stakeholders The Objectives of Financial Accounting Financial statements are the primary means of communicating financial information to parties outside the business organization.
Sell ownership interest in the future for more than they paid. Receive a portion of the company’s earnings in cash (dividends). Business Background Business owners (called investors or shareholders) look for two sources of possible gain:
Loan Interest Business Background Creditors lend money to a company for a specific length of time and gain by charging interest on the money loaned. Mel’s Diner
Understanding Business Operations Manufacturers either make the parts needed to produce its products or buy the parts from suppliers. Manufacturer Product Customer
Business managers (internal) Reports information to decision makers. Investors (external) Understanding Business Operations All businesses should have an accounting system that . . . Collects and processes financial information about an organization.
Financial Accounting System (preparation of four basic financial statements). Managerial Accounting System (preparation of detailed plans, forecasts and reports). External Decision Makers (investors, creditors, suppliers, customers, etc.). Internal Decision Makers (managers throughout the organization). Understanding Business Operations Accounting System
Information Conveyed in Financial Statements The four basic financial statements . . . Statement of Retained Earnings Cash Flow Statement Balance Sheet Income Statement
Information Conveyed in Financial Statements Most companies prepare financial statements at the end of the month, the end of the quarter (called quarterly reports) and the end of the year (called annual reports). 2003 X
1. Name of entity (the separate-entity assumption) 2. Title of statement 3. Specific date (financial snapshot at a specific point in time) 4. Unit measure (thousands of dollars)
The Balance Sheet Body of the Statement • Assets • Economic resources controlled by the entity as a result of past transactions from which future economic benefits may be obtained. • Liabilities • Debts or obligations of the entity that result from past transactions. Shareholders’ Equity • Amount of financing provided by owners of the corporation and from earnings.
The Balance Sheet Basic Accounting Equation Assets = Liabilities + Shareholders’ Equity Economic Sources of financing . . . resources Liabilities: from creditors Equity: from shareholders. =
Assets are listed by their ease of conversion into cash.
Assets = Liabilities + Shareholders’ Equity Use $ on the first item in a group and on the group total.
1. Name of entity 2. Title of statement 3. Specific date (Unlike the balance sheet, this statement covers a specified period of time.) 4. Unit measure (in thousands of dollars)
Revenues are earnings from the sale of goods or services. Revenue is recognized in the period in which goods and services are sold, not necessarily the period in which cash is received.
$1,000 sale made on May 25. Cash from sale collected on June 10. X X May 2003 June 2003 The Income Statement • Revenues Earnings from the sale of goods or services. When will the revenue from this transaction be recognized?
The Income Statement • Revenues Earnings from the sale of goods or services. When will the revenue from this transaction be recognized? $1,000 revenue recognized in May May 2003 June 2003
Expenses are the dollar amount of resources used up by the entity to earn revenues during a period. An expense is recognized in the period in which goods and services are used, not necessarily the period in which cash is paid.
Paid $75 cash on May 11 for newspaper ad. Ad appears on June 8. X X May 2003 June 2003 The Income Statement • Expenses The dollar amount of resources used up by the entity to earn revenues during a period. When will the expense for this transaction be recognized?
The Income Statement • Expenses The dollar amount of resources used up by the entity to earn revenues during a period. When will the expense for this transaction be recognized? When will the expense for this transaction be recognized? Advertising expense recognized in June. May 2003 June 2003
When revenues exceed expenses, we report net income.
When expenses exceed revenues, we report net loss.
Statement of Retained Earnings Income of the corporation Retained by the corporation Dividends Shareholders Retained Earnings
1. Name of entity 2. Title of statement 3. Specific date (like the income statement, this statement covers a specified period of time.) 4. Unit measure (in thousands of dollars)
Cash Flow Statement Because revenues reported do not always equal cash collected. . . . . . and expenses reported do not always equal cash paid . . . Income is usually not equal to the change in cash for the period.
1. Name of entity 2. 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 measure (in thousands of dollars)
Cash flows directly related to earning income are shown in the operating section.
Cash flows related to the acquisition or sale of productive assets are shown in the investing section.
Cash flows from or to investors or creditors are shown in the financing section.
Notes • Notes provide supplemental information about the financial condition of a company. • Three types . . . • Describe accounting rules applied. • Present additional detail about an item on the financial statements. • Provide additional information about an item noton the financial statements.
Market Price (of the Company) Net Income Price/Earnings Ratio = Price/Earnings Ratio This ratio is one method for estimating the value of a company.
Responsibilities for the Accounting Communication Process Effective communication means that the recipient understands what the sender intends to convey. Decision makers need to understand accounting measurement rules.
Generally Accepted Accounting Principles (GAAP) Securities Act of 1933 Securities and Exchange Act of 1934 TheSecurities and Exchange Commission (SEC) has been given broad powers to determine measurement rules for financial statements in the United States.
Generally Accepted Accounting Principles (GAAP) TheOntarioSecurities Commission (OSC) has been given broad powers to determine measurement rules for financial statements in Canada.
Generally Accepted Accounting Principles (GAAP) The OSC has worked closely with the accounting profession to work out the detailed rules that have become known as GAAP. Currently, the Accounting Standards Board (AcSB)is recognized as the body to formulate GAAP in Canada.
Generally Accepted Accounting Principles (GAAP) Companies are interested in GAAP because methods of reporting can have the following economic consequences . . . • Affect the selling price of shares. • Affect the amount of bonuses received by managers and other employees. • Cause a loss of competitive advantage.
Management Responsibility and the Demand for Auditing • To ensure the accuracy of the company’s records: • Managementmaintains a system of controls. • Managementhires an outside independent auditor. • The board of directors reviews these two safeguards.
Independent Auditors Overall, I believe these financial statements are fair. • Auditors express an opinion as to the fairness of the financial statement presentation. • Independent auditors have responsibilities that extend to the general public.
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.
Accounting Designations Chartered Accountant = CA Certified General Accountant = CGA Certified Management Accountant = CMA Certified Public Accountant = CPA* (* in USA only)