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Financial Statements and Business Decisions

Financial Statements and Business Decisions. Chapter 1. Founders of the business who also function as managers are called Owner-Mangers. Owner-Managers. Creditors lend money for a specific period of time and gain by charging interest on the money they lend. Creditors.

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Financial Statements and Business Decisions

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  1. FinancialStatementsandBusinessDecisions Chapter 1

  2. Founders of the business who also function as managers are called Owner-Mangers. Owner-Managers Creditors lend money for a specific period of time and gain by charging interest on the money they lend. Creditors Investors buy ownership in the company in the form of stock. Investors Understanding the Business

  3. Investors purchase stock (or ownership) in businesses hoping to gain in two ways: Sell ownership interest in the future for more than they paid. Receive a portion of the company’s earnings in cash (dividends). Understanding the Business

  4. Manufacturers either make the parts needed to produce its products or buy the parts from suppliers. The Business Operations Manufacturer Final Product Customer

  5. Learning Objectives Recognize the information conveyed in each of the four basic financial statements and the way that it is used by different decision makers (investors, creditors, and managers). LO1

  6. Managers (internaldecisionmakers) Reports information to decision makers Collects and processes financial information Investors and Creditors (externaldecisionmakers) The Accounting System

  7. Financial Accounting System Periodic financial statements and related disclosures Managerial Accounting System Detailed plans and continuous performance reports External Decision Makers Investors, creditors, suppliers, customers, etc. Internal Decision Makers Managers throughout the organization The Accounting System Accounting System

  8. Statement of Retained Earnings Statement of Cash Flows Balance Sheet Income Statement The Four Basic Financial Statements Financial statements summarize the financial activities of the business.

  9. Companies can prepare financial statements at the end of the year, quarter or month. The Four Basic Financial Statements Financial statements prepared at the end of the year are called annual reports.

  10. Let’s look at MAXIDRIVE CORP.’s financial statements.

  11. 1. Name of entity 2. Title of statement 3. Specific date 4. Unit of measure The Balance Sheet reports the financial position of an entity at a particular point in time.

  12. Basic Accounting Equation EconomicResources Sources of Financing forEconomic Resources The Balance Sheet Assets = Liabilities + Stockholders’ Equity

  13. Assets are economic resources owned by the business as a result of past transactions. Assets are listed by their ease of conversion into cash.

  14. Liabilities are debts or obligations of the business that result from past transactions.

  15. Equity is the amount of financing provided by owners of the business and earnings.

  16. Assets = Liabilities + Stockholders’ Equity Use $ on the first item in a group and on the group total.

  17. 1. Name of entity 2. Title of statement 3. Specific period of time (Unlike the balance sheet, this statement covers a specified period of time.) 4. Unit of measure

  18. The Income Statement reports the revenues minus expenses of the accounting period.

  19. Revenues are earnings from the sale of goods or services to customers. Revenue is recognized in the period in which goods and services are sold, not necessarily the period in which cash is received.

  20. $1,000 sale made on May 25th. Cash from sale collected on June 10th. X X May 2006 June 2006 Revenues Earnings from the sale of goods or services. When will the revenue from this transaction be recognized?

  21. Revenues Earnings from the sale of goods or services. When will the revenue from this transaction be recognized? $1,000 sale made on May 25th. X May 2006

  22. 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.

  23. May 11 paid $75 cash for newspaper ad. Ad appears on June 8th. X X May 2006 June 2006 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?

  24. 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? Advertising expense recorded in June. X June 2006

  25. If expenses exceed revenues, we report net loss.

  26. 1. Name of entity 2. Title of statement 3. Specific period of time (Like the income statement, this statement covers a specified period of time.) 4. Unit of measure

  27. The Statement of Retained Earnings reports the way that net income and the distribution of dividends affect the financial position of the company during a period.

  28. Statement of Cash Flows Because revenues reported do not always equal cash collected. . . . . . and expenses reported do not always equal cash paid . . . net income is usually not equal to the change in cash for the period.

  29. 1. Name of entity 2. Title of statement 3. Specific period of time (Like the income statement, this statement covers a specified period of time.) 4. Unit of measure

  30. The Statement of Cash Flows reports the inflows and outflows of cash during the period in the categories of operating, investing, and financing.

  31. Cash flows directly related to earning income are shown in the operating section.

  32. Cash flows related to the acquisition or sale of productive assets are shown in the investing section.

  33. Cash flows from or to investors or creditors are shown in the financing section.

  34. The statement ends with a reconciliation of Cash.

  35. Relationship Among the Financial Statements Net income from the income statement increases ending retained earnings on the statement of retained earnings.

  36. Relationship Among the Financial Statements Ending retained earnings from the statement of retained earnings is one of the components of stockholders’ equity on the balance sheet.

  37. Relationship Among the Financial Statements The change in cash on the statement of cash flows added to the beginning of the year balance in cash equals the ending balance in cash on the balance sheet.

  38. Notes provide supplemental information about the financial condition of a company. Three basic types of notes: Description of accounting rules applied. Presentation of additional detail about an item on the financial statements. Provide additional information about an item not on the financial statements. Notes

  39. 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 our demand for products. Employees’ union and human resource managers use the company’s financial statements as a basis for contract negotiations over pay rates. Management Uses of Financial Statements

  40. 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.

  41. Learning Objectives Identify the role of generally accepted accounting principles (GAAP) in determining the content of financial statements. LO2

  42. 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.

  43. 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 of most companies were free to choose the accounting principles used to keep track of its transactions.

  44. Generally Accepted Accounting Principles (GAAP) 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.

  45. Generally Accepted Accounting Principles (GAAP) 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.

  46. Generally Accepted Accounting Principles (GAAP) 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.

  47. International Perspective Since 2002, there has been substantial movement to develop international financial reporting standards by the International Accounting Standards Board (IASB).

  48. Learning Objectives Distinguish the roles of managers and auditors in the accounting communication process. LO3

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