Introduction to Financial Accounting 8th Edition PowerPoint Presentation

1. Introduction to Financial Accounting8th EditionPowerPoint Presentation Slides prepared by: Eddie Metrejean, MTAX, CPA The University of Mississippi Images provided by New Vision Technology 1-800-387-0732 nvtech.com

2. Chapter 1 Accounting: The Language of Business

3. Learning Objectives After studying this chapter, you should be able to: • Explain how accounting information assists in making decisions. • Describe the components of the balance sheet. • Analyze business transactions and relate them to changes in the balance sheet. • Classify operating, investing, and financing activities in a cash flow statement.

4. Learning Objectives After studying this chapter, you should be able to: • Compare features of proprietorships, partnerships, and corporations. • Describe auditing and how it enhances the value of financial information. • Distinguish between public and private accounting. • Evaluate the role of ethics in the accounting process.

5. Introduction • Accounting - a process of identifying, recording, summarizing, and reporting economic information to decision makers in the form of financial statements • Financial accounting - focuses on the specific needs of decision makers external to the organization, such as stockholders, suppliers, banks, and government agencies

6. The Nature of Accounting • The accounting system is a series of steps performed to analyze, record, quantify, accumulate, summarize, classify, report, and interpret economic events and their effects on an organization and to prepare the financial statements.

7. The Nature of Accounting • Accounting systems are designed to meet the needs of the decision makers who use the financial information. • Every business maintains some type of accounting system. • These accounting systems may be very complex or very simple, but the real value of any accounting system lies in the information that the system provides.

8. Accounting as an Aid toDecision Making • Accounting information is useful to anyone who makes decisions that have economic results. • Managers want to know if a new product will be profitable. • Owners want to know which employees are productive. • Investors want to know if a company is a good investment. • Legislators want to know how a proposed law will affect budgets. • Creditors want to know if they should extend credit, how much to extend, and for how long.

9. Accounting as an Aid toDecision Making • Accounting helps in decision making by showing where and when money has been spent, by evaluating performance, and by showing the implications of choosing one plan instead of another. • Fundamental relationships in the decision-making process: Accountant’s analysis and recording Financial statements Event Users

10. Financial and Management Accounting • The major distinction between financial and management accounting is the users of the information. • Financial accounting serves external users, such as investors, creditors, and suppliers. • Management accounting serves internal users, such as top executives, management, and administrators within organizations.

11. Financial and Management Accounting • The primary questions about an organization’s success that decision makers want to know are: What is the financial picture of the organization on a given day? How well did the organization do during a given period?

12. Financial and Management Accounting • Accountants answer these primary questions with three major financial statements. • Balance sheet – shows financial picture on a given day • Income statement – shows performance over a given period • Statement of cash flows – shows performance over a given period

13. Financial and Management Accounting • Annual report - a document prepared by management and distributed to current and potential investors to inform them about the company’s past performance and future prospects • The annual report is one of the most common sources of financial information used by investors and managers.

14. Financial and Management Accounting • The annual report usually includes: • A letter from corporate management • A discussion and analysis by management of recent economic events • Footnotes that explain many elements of the financial statements in more detail • The report of the independent auditors • A statement of management’s responsibility for preparation of the financial statements • Other corporate information

15. Financial and Management Accounting • In many cases, annual reports take a long time to produce and are not widely available to people who want them. • The Internet allows companies to have a Web site where they provide direct access to the annual report.

16. The Balance Sheet • The balance sheet shows the financial position of a company at a particular point in time. • The balance sheet is sometimes referred to as the statement of financial position or the statement of financial condition. • The left side lists assets – the right side lists liabilities and owners’ equity

17. The Balance Sheet • The balance sheet equation: Assets = Liabilities + Owners’ Equity or Owners’ Equity = Assets - Liabilities

18. The Balance Sheet • Elements of the balance sheet: • Assets - resources of the firm that are expected to increase or cause future cash flows (everything the firm owns) • Liabilities - obligations of the firm to outsiders or claims against its assets by outsiders (debts of the firm) • Owners’ Equity - the residual interest in, or remaining claims against, the firm’s assets after deducting liabilities (rights of the owners)

19. The Balance Sheet STEVENS COMPANY Balance Sheet June 30, 2002 Assets Liabilities Current assets: Current liabilities: Cash $ 4,525 Accounts payable $ 9,800 Accounts receivable 2,040 Wages payable 3,765 Total current assets $ 6,565 Total liabilities $13,565 Plant assets: Land $ 9,755 Equipment 6,500 Owner’s Equity Total plant assets 16,255 Hamilton, capital 9,255 Total liabilities and Total assets $22,820 owner’s equity $22,820 ============= =============

20. Balance Sheet Transactions • The balance sheet is affected by every transaction that an entity encounters. • Each transaction has counterbalancing entries that keep total assets equal to total liabilities and owners’ equity, i.e., the balance sheet equation and the balance sheet must alwaysbe balanced.

21. Balance Sheet Transactions • A balance sheet could be prepared after every transaction, but this practice would be awkward and unnecessary. • Therefore, balance sheets are usually prepared monthly or on some other periodic schedule.

22. Transaction Analysis • Transactions are recorded in accounts, which are summary records of the changes in particular assets, liabilities, or owners’ equity. • The account balance is the total of all entries to the account.

23. Transaction Analysis • For each transaction, the accountant determines: • Which specific accounts are affected • Whether the account balances are increased or decreased • The amount of the change in each account

24. Transaction Analysis Some definitions to remember: • Inventory - goods held by a firm for resale to customers • Account payable - a liability that results from the purchase of goods or services on account • Compound entry - a transaction that affects more than two accounts • Creditor - one to whom money is owed • Debtor - one who owes money

25. Introduction to Statementof Cash Flows • Companies do three basic things. • They invest in assets to conduct business. • They raise money to finance these assets. • They use the assets and the money they raise to operate the business. • These transactions can be classified into one of three categories – operating, investing, and financing activities.

26. Introduction to Statementof Cash Flows • Operating activities – include sale and purchase of goods and payment of items such as rent, taxes, and interest • Investing activities – include acquiring and selling assets and securities held for investment purposes • Financing activities – include obtaining resources from owners and creditors and repaying amounts borrowed

27. Introduction to Statementof Cash Flows • The statement of cash flows gives a direct picture of where cash came from and where cash went. • Preparation of the statement of cash flows • List the activities that increased (inflow) or decreased (outflow) cash. • Place each inflow or outflow into the proper categories.

28. Types of Ownership • Three basic forms of ownership: • Sole proprietorships • Partnerships • Corporations

29. Types of Ownership Sole Proprietorship • A separate organization with a single owner • Tend to be small retail establishments and individual professional or service business • The sole proprietorship is an individual entity that is separate and distinct from the personal activities of the owner.

30. Types of Ownership Partnership • An organization that joins two or more individuals who act as co-owners • Dentists, doctors, attorneys, and accountants tend to conduct their activities as partnerships. • The partnership is an individual entity that is separate and distinct from the personal activities of each of the partners.

31. Types of Ownership Corporation • An “artificial entity” created under state laws • Corporations have limited liability - corporate creditors have claims against corporate assets only. • Individual investors are at risk only up to the amount they have invested in the corporation. Creditors cannot hold investors liable for the corporation’s debts.

32. Types of Ownership Corporation • Owners are called shareholders or stockholders. • Publicly owned vs. privately owned corporations • Public - Shares in the ownership are sold to the public on a stock exchange; the corporation can have many thousands of shareholders. • Private - Shares in the ownership are owned by families, small groups of shareholders, or a single shareholder and are not sold to the public.

33. Types of Ownership • Management by the owners: • Sole proprietorship - The owner is an active manager in day-to-day operation of the business. • Partnership - Partners are usually active managers in day-to-day operations of the business. • Corporation - Shareholders usually do not participate in the day-to-day operations of the business – shareholders elect a board of directors who hires a management team.

34. Advantages and Disadvantages of Forms of Ownership Corporations • Advantages • Limited liability • Easy transfer of ownership - shares of stock can be bought and sold easily on stock exchanges • Ease of raising ownership capital because of many potential stockholders • Continuity of existence - life of the corporation continues even if its ownership changes

35. Advantages and Disadvantages of Forms of Ownership Corporations • Disadvantages • Possibility of double taxation - corporation pays tax at the entity level and its owners pay taxes on distributions of earnings to them

36. Advantages and Disadvantages of Forms of Ownership Proprietorships and Partnerships • Advantages • No taxation at the entity level - income of sole proprietorship and partnership is attributed to the owners as individual taxpayers

37. Advantages and Disadvantages of Forms of Ownership Proprietorships and Partnerships • Disadvantages • Unlimited liability - creditors of the business can look to the owners’ personal assets for repayment • Not easy to transfer ownership • Not easy to raise ownership capital with few owners • No continuity of existence - changes in ownership terminate the proprietorship or partnership

38. Accounting for Owners’ Equity Proprietorships and Partnerships vs. Corporations • Owners’ equities for proprietorships and partnerships are called capital. • Owners’ equity for a corporation is called stockholders’ equity or shareholders’ equity.

39. Accounting for Owners’ Equity • In a corporation, the total capital investment actively invested by the owners is called paid-in capital. • Paid-in capital consists of two parts: • Capital stock at par value • Paid-in capital in excess of par value

40. The Meaning of Par Value • Par value (stated value) - a dollar amount printed on each stock certificate • Stock is usually issued and sold at more than par value. • Paid-in capital in excess of par value - the difference between the total amount received for the stock (issue price or sales price) and the par value

41. The Meaning of Par Value • The following formulas show the components of total paid-in capital: Total paid-in capital Capital stock at par Paid-in capital in excess of par + = Capital stock at par Number of shares issued Par value per share x =

42. The Meaning of Par Value • The following formulas show the components of total paid-in capital: Paid-in capital in excess of par Total paid-in capital Capital stock at par = – Total paid-in capital Number of shares issued Average issue price per share = x

43. The Meaning of Par Value • Par value was originally a measure of protection for investors because it established a minimum legal liability of a stockholder. • The creditors would be assured that the corporation would have at least a minimum amount of ownership capital because the investors agreed to invest at least par value. • Capital stock is sometimes called common shares or common stock.

44. The Meaning of Par Value • Some investors purchase stock directly from the corporation (as in the previous discussion). • The company records cash received and records the par value and paid-in capital in excess of par. • Usually, stock transactions involve two or more individuals. • In that case, the corporation does not record anything except the change in ownership.

45. Stockholders and theBoard of Directors • In the corporate form of business, management activities and ownership activities are kept separate. • The board of directors is the link between the owners (stockholders) and the actual managers. • The board has the responsibility to ensure that management acts in the interests of the stockholders.

46. Stockholders and theBoard of Directors • The relationship among owners, managers, and the board of directors: Stockholders Elect Board of Directors Appoint Managers

47. Stockholders and theBoard of Directors • The board of directors is elected by the stockholders. • Management is appointed by the board of directors • Therefore, the interests of both the stockholders and management are usually represented on the board of directors.

48. Credibility and the Role of Auditing • Corporate management prepares the financial statements. • In some cases, management may have incentives to make the company’s performance look better than it actually is. • Investors must be able to rely on the financial statements to show an accurate picture of the company.

49. Credibility and the Role of Auditing • One way to solve the credibility problem is to introduce an honorable, expert third party. • The auditor examines the information that managers use to prepare the financial statements and provides assurances about the credibility of the statements. • These assurances should make the investors more comfortable about using the information to guide their investing activity.

50. The Certified Public Accountant • Providing credibility to financial statements requires individuals who have: • The technical knowledge to assess financial statements and determine their quality • The reputation for integrity and independence that assures they will honestly tell interested parties if management has not produced fair financial statements • The accounting profession has such individuals.