Introduction to Financial Statements

1. CHAPTER Introduction to Financial Statements 1

2. Forms of Business Organizations • Proprietorship:simple to establish, owner-controlled • Partnership:simple to establish, shared control, broader skills and resources • Corporation:easier to transfer ownership, easier to attract investors, no personal liability, tax advantages possible

3. Users of Financial Information • Internal Users • Managers plan, organize and run a business

4. Primary users Users of Financial Information • External Users • Investors • Creditors • Others • Tax authorities • Regulatory agencies • Customers • Labour unions • Economic planners

5. Ethics in Financial Reporting • Ethical dilemmas in financial reporting • e.g., Enron • To solve an ethical dilemma • Recognize situation and ethical issues • Identify and analyse principal elements • Identify alternatives and determine impact on stakeholders

6. 3 Types of Business Activities • Financing • Investing • Operating

7. Financing Activities • Borrowing money (debt) • Selling shares (equity)

8. Investing Activities • Obtaining the resources or assets needed to operate the business for the long term • Examples • Purchase or sale of investments • Purchase or sale of long-lived assets such as property, plant and equipment and intangible assets

9. Operating Activities • Operating activities are the main activities for which the organization is in business

10. Accounting Equation Assets= Liabilities + Shareholders’ Equity

11. Basic Terms • Assets - resources owned by a business • Liabilities - obligations of the business • Shareholders’ equity • Share capital- represents the primary ownership interest in a corporation • Retained earnings– accumulated earnings of the corporation that have not been distributed to shareholders

12. Revenues • Revenuesarise from the sale of a product or service • Revenues result in an inflow of assets

13. Expenses • Expenses are the costs of assets consumed or the costs of services used to generate revenues • Examples • Cost of goods sold • Operating expenses • Interest expense

14. Net Earnings • Net earnings (or net income) is the amount by which revenues exceed expenses (Net loss is the amount by which expenses exceed revenues)

15. Financial Accounting Statements • Statement of Earnings (also called Income Statement) • Reports the results of operations for a specific period of time • Statement of Retained Earnings • Reports the changes in retained earnings for a specific period of time

16. Financial Accounting Statements • Balance Sheet • Reports the assets, liabilities, and shareholders’ equity as at a specific point in time • Cash Flow Statement • Reports the cash receipts and payments for a specific period of time

17. CSU CORPORATIONStatement of EarningsYear Ended December 31, 2004 First: Statement of Earnings • Name of company • Name of statement • Period of time covered

18. CSU CORPORATIONStatement of EarningsYear Ended December 31, 2004 • List revenues

19. CSU CORPORATIONStatement of EarningsYear Ended December 31, 2004 • List and total the expenses. Note that income tax is shown separately from other expenses.

20. CSU CORPORATIONStatement of EarningsYear Ended December 31, 2004 • Subtract expenses from revenues to obtain net earnings (loss)

21. CSU CORPORATIONStatement of Retained EarningsYear Ended December 31, 2004 Second: Statement of Retained Earnings • Name of company • Name of statement • Period of time covered (same period as statement of earnings)

22. CSU CORPORATIONStatement of Retained EarningsYear Ended December 31, 2004 • Start with beginning retained earnings (same as ending retained earnings of prior period)

23. CSU CORPORATIONStatement of Retained EarningsYear Ended December 31, 2004 • Add net earnings (subtract loss) from the current year (see Statement of Earnings) • Subtotal

24. CSU CORPORATIONStatement of Retained EarningsYear Ended December 31, 2004 • Subtract current year’s dividends (if any) and total

25. CSU CORPORATIONBalance Sheet December 31, 2004 Third: Balance Sheet • Name of company • Name of statement • Date (as at a specific point in time)

26. CSU CORPORATIONBalance Sheet December 31, 2004 • List the assets and total

27. CSU CORPORATIONBalance Sheet December 31, 2004 • List the liabilities and subtotal

28. CSU CORPORATIONBalance Sheet December 31, 2004 • List shareholders’ equity; subtotal • Add shareholders’ equity to liabilities; total

29. CSU CORPORATIONBalance Sheet December 31, 2004

30. Stop and Check • Total assets must equal total liabilities and shareholders’ equity

31. Financial Accounting Statements In what order are financial statements prepared? Presented? WHY?

32. CSU CORPORATION Statement of EarningsYear Ended December 31, 2004 Net earnings is needed for the Statement of Retained Earnings

33. CSU CORPORATION Statement of Retained EarningsYear Ended December 31, 2004 Ending retained earnings is needed for the Balance Sheet

34. CSU CORPORATION Balance Sheet December 31, 2004

35. CSU CORPORATION Cash Flow StatementYear Ended December 31, 2004

36. CSU CORPORATION Cash Flow StatementYear Ended December 31, 2004(Continued)

37. Assumptions Monetary unit Economic entity Time period Going concern Generally accepted accounting principles Cost Full disclosure Assumptions and Principles in Financial Reporting

38. Monetary Unit Assumption • Only those things that can be expressed in terms of money should be included in the accounting records

39. Economic Entity • Every economic entity can be separately identified and accounted for

40. Time Period Assumption • The economic life of a business can be divided into artificial time periods

41. Going Concern Assumption • The business will continue operating long enough to carry out its existing objectives

42. Cost Principle • Assets should be recorded at cost

43. Full Disclosure Principle • Circumstances and events that make a difference to financial statement users should be disclosed