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FINANCIAL
ACCOUNTING
Robert Libby
Patricia A. Libby
Daniel G. Short
George Kanaan
Maureen Gowing
McGraw-Hill Ryerson
© McGraw-Hill Ryerson Limited, 2003
Chapter 1
Financial Statements and
Business Decisions
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The Objectives of Financial
Accounting
Financial statements are the primary
means of communicating financial
information to parties outside the
business organization.
Balance Sheet
Income Statement
Stakeholders
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Business Background
Business owners (called investors or
shareholders) look for two sources of
possible gain:
Sell
ownership
interest in the
future for more
than they
paid.
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Receive a
portion of the
company’s
earnings in cash
(dividends).
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Business Background
Creditors lend money to a company for a
specific length of time and gain by
charging interest on the money loaned.
Loan
Mel’s
Diner
Interest
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Understanding Business
Operations
Manufacturers either make the parts
needed to produce its products or buy
the parts from suppliers.
Manufacturer
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Product
Customer
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Understanding Business
Operations
All businesses should have an
accounting system that . . .
Collects and processes
financial information
about an organization.
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Business
managers
(internal)
Reports
information
to decision
makers.
Investors
(external)
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Understanding Business
Operations
Accounting System
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).
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Information Conveyed in
Financial Statements
The four basic financial statements . . .
Cash Flow Statement
Balance Sheet
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Statement of Retained Earnings
Income Statement
© McGraw-Hill Ryerson Limited, 2003
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
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Let’s look at
MAXIDRIVE
CORP.’s
financial
statements.
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MAXIDRIVE CORP.
Balance Sheet
At December 31, 20A
(In thousands of dollars)
Assets
Cash
$ 4,235
Accounts receivable
5,714
Inventories
8,517
1.
Name
of
entity
Plant and equipment
7,154
(the separate-entity assumption) 981
Land
Total
assets of statement
$ 26,601
2. Title
Liabilities
and Shareholders'
Equity
3. Specific
date
Liabilities
(financial
snapshot at a specific
Accounts payable
point in time)
Notes payable
4. Unit measure
Total liabilities
(thousands of dollars)
Shareholders' Equity
Share capital
Retained earnings
Total shareholders' equity
Total liabilities and shareholders' equity
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$ 7,156
9,000
$ 16,156
$ 2,000
8,445
10,445
$ 26,601
© McGraw-Hill Ryerson Limited, 2003
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

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Amount of financing provided by owners of the corporation and
from earnings.
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The Balance Sheet
Basic Accounting Equation
Assets
= Liabilities + Shareholders’ Equity
Economic
resources =
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Sources of financing . . .
Liabilities: from creditors
Equity: from shareholders.
© McGraw-Hill Ryerson Limited, 2003
Assets are
listed by their
ease of
conversion into
cash.
MAXIDRIVE CORP.
Balance Sheet
At December 31, 20A
(In thousands of dollars)
Assets
Cash
$ 4,235
Accounts receivable
5,714
Inventories
8,517
Plant and equipment
7,154
Land
981
Total assets
$ 26,601
Liabilities and
Shareholders'
Amount
of cashEquity
in the company’s bank
Cash
Liabilities
account.
Accounts
payable
$ 7,156from prior
Accounts
Amounts owed by customers
Notes
payable sales.
9,000
receivable
Total liabilities
Partial and completed but unsold$ 16,156
Inventories
Shareholders'
Equity
products.
Share
$ 2,000
Plantcapital
and
Factories
and
production
machinery.
Retained
earnings
8,445
equipment
Total shareholders' equity
10,445
on which
factories are located.
TotalLand
liabilitiesProperty
and shareholders'
equity
$ 26,601
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MAXIDRIVE CORP.
Balance Sheet
At December 31, 20A
(In thousands of dollars)
Assets
Cash
Accounts receivable
Accounts Amounts Inventories
owed to suppliers for prior
payable purchases.
Plant and equipment
Notes
Amounts owed
Land on written debt
payable contracts. Total assets
Liabilities and Shareholders' Equity
Liabilities
Accounts payable
$
4,235
5,714
8,517
7,154
981
$ 26,601
$ 7,156
Notes payable
9,000
Total liabilities
$ 16,156
Shareholders' Equity
Share capital
Retained earnings
Total shareholders' equity
$ 2,000
8,445
10,445
Total liabilities and shareholders' equity
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$ 26,601
© McGraw-Hill Ryerson Limited, 2003
MAXIDRIVE CORP.
Balance Sheet
At December 31, 20A
(In thousands of dollars)
Assets
Share
capital
Retained
earnings
Cash
Accounts receivable
Inventories
Plant and equipment
Land
Total assets
Liabilities and Shareholders' Equity
Liabilities
Amounts invested in the
business by
Accounts payable
shareholders.
Notesnot
payable
Past earnings
distributed to
shareholders.
Total liabilities
Shareholders' Equity
Share Capital
Retained earnings
Total Shareholders' equity
$
4,235
5,714
8,517
7,154
981
$ 26,601
$ 7,156
9,000
$ 16,156
$ 2,000
8,445
10,445
Total liabilities and shareholders' equity
McGraw-Hill Ryerson
$ 26,601
© McGraw-Hill Ryerson Limited, 2003
MAXIDRIVE CORP.
Balance Sheet
At December 31, 20A
(In thousands of dollars)
Assets
Use $ on the
first item in a
group
and on the
group total.
Cash
Accounts receivable
Inventories
Plant and equipment
Land
Total assets
Liabilities and Shareholders' Equity
Liabilities
Accounts payable
$
4,235
5,714
8,517
7,154
981
$ 26,601
$ 7,156
Notes payable
9,000
liabilities
Assets = LiabilitiesTotal
+ Shareholders’
Equity
Shareholders' Equity
Share capital
Retained earnings
Total shareholders' equity
$ 2,000
8,445
10,445
Total liabilities and shareholders' equity
McGraw-Hill Ryerson
$ 16,156
$ 26,601
© McGraw-Hill Ryerson Limited, 2003
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 20A
(In thousands of dollars)
Revenues
1. Name
of entity
Sales
revenue
$ 37,436
2. Title of statement
Expenses
3. Specific
sheet, this
Cost
of goodsdate
sold(Unlike the balance
$ 26,980
statement
covers
a specified period
of time.)
Selling,
general
and administrative
3,624
4. Unit measure
(in thousands of dollars)
Research
and development
1,982
Interest expense
450
Total expenses
33,036
Income before income taxes
Income tax expense
Net income
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$ 4,400
1,760
$ 2,640
© McGraw-Hill Ryerson Limited, 2003
MAXIDRIVE CORP.
Income Statement
the Year Ended December 31, 20A
TheFor
income
statement is divided into
(In thousands of dollars)
three major captions.
 Revenues


Sales revenue
$ 37,436
Expenses
Cost of goods sold
$ 26,980
Selling, general and administrative
3,624
Research and development
1,982
Interest expense
450
Total expenses
33,036
Income before income taxes
Income tax expense
Net income
McGraw-Hill Ryerson
$ 4,400
1,760
$ 2,640
© McGraw-Hill Ryerson Limited, 2003
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 20A
(In thousands of dollars)
Revenues
Sales revenue
$ 37,436
Expenses
Revenues
are earnings from the sale of goods
Cost of goods sold
$ 26,980
or services.
Selling, general and administrative
3,624
Research
andisdevelopment
1,982
Revenue
recognized in the period
in which
Interest
expense
450
goods
and services are sold, not necessarily
period in which cash is received. 33,036
Totalthe
expenses
Income before income taxes
Income tax expense
Net income
McGraw-Hill Ryerson
$ 4,400
1,760
$ 2,640
© McGraw-Hill Ryerson Limited, 2003
The Income Statement
Revenues
Earnings from the sale of goods or services.
When will the revenue from this
transaction be recognized?
$1,000 sale made
on May 25.
May 2003
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X
Cash from sale
collected on June 10.
X
June 2003
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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
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June 2003
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MAXIDRIVE CORP.
Expenses are theIncome
dollar amount
of resources used
Statement
up by the
to earn
revenues
during
a period.
Forentity
the Year
Ended
December
31, 20A
(In thousands of dollars)
An expense is recognized in the period in which
goods and services are used, not necessarily
Revenues
the period in which cash is paid.
Sales revenue
$ 37,436
Expenses
Cost of goods sold
$ 26,980
Selling, general and administrative
3,624
Research and development
1,982
Interest expense
450
Total pre-tax expenses
33,036
Income before income taxes
Income tax expense
Net income
McGraw-Hill Ryerson
$ 4,400
1,760
$ 2,640
© McGraw-Hill Ryerson Limited, 2003
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 20A
(In thousands of dollars)
Cost of
The cost of the products sold during
Revenues
goods sold this period.
Sales revenue
$ 37,436
Selling,
Expenses
Operating expenses not directly related
general
and sold
Cost
of goods
$ 26,980
to production.
administrative
Selling, general and administrative
3,624
Research and
1,982 new
Research
and development
Expenses incurred to develop
Interest
expense
450
development
products.
Total expenses
33,036
Interest
Pretax income The cost of using borrowed funds.
$ 4,400
expense
Income tax expense
1,100
Income tax Income taxes on the current period’s
Net income
$Ryerson
3,300
©
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Limited, 2003
McGraw-Hill Ryerson
expense
pre-tax income.
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?
Paid $75 cash on May 11
for newspaper ad.
X
May 2003
McGraw-Hill Ryerson
Ad appears
on June 8.
X
June 2003
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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?
Advertising expense
recognized in June.
May 2003
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June 2003
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MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 20A
(In thousands of dollars)
Revenues
Sales revenue
$ 37,436
Expenses
Cost of goods sold
$ 26,980
Selling, general and administrative
3,624
Research and development
1,982
Interest expense
450
Total pre-tax expenses
33,036
When revenues exceed expenses,
Income before income taxes
we
report
net
income.
Income tax expense
Net income
McGraw-Hill Ryerson
$ 4,400
1,760
$ 2,640
© McGraw-Hill Ryerson Limited, 2003
MAXIDRIVE CORP.
Income Statement
For the Year Ended December 31, 20A
(In thousands of dollars)
Revenues
Sales revenue
$ 37,436
Expenses
Cost of goods sold
$ 26,980
Selling, general and administrative
3,624
Research and development
1,982
Interest expense
450
Total pre-tax expenses
33,036
Income before income taxes
$ 4,400
When
exceed revenues, 1,760
Income
taxexpenses
expense
we report net loss.
Net income
$ 2,640
© McGraw-Hill Ryerson Limited, 2003
McGraw-Hill Ryerson
Statement of Retained Earnings
Income of the corporation
Shareholders
McGraw-Hill Ryerson
Retained Earnings
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MAXIDRIVE CORP.
Statement of Retained Earnings
For the Year Ended December 31, 20A
(In thousands of dollars)
Retained earnings, January 1, 20A
$ 6,805
Net
income
for 20A
3,300
1. Name
of entity
Dividends
for 20A
(1,000)
2. Title of statement
3. Specificearnings,
date (likeDecember
the income31,
statement,
Retained
20A $ this
9,105
statement covers a specified period of time.)
4. Unit measure (in thousands of dollars)
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MAXIDRIVE CORP.
Statement of Retained Earnings
For the Year Ended December 31, 20A
(In thousands of dollars)
Retained earnings, January 1, 20A
Net income for 20A
Dividends for 20A
$ 6,805
2,640
(1,000)
Retained earnings, December 31, 20A
$ 8,445
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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.
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MAXIDRIVE CORP.
Cash Flow Statement
For the Year Ended December 31, 20A
(In thousands of dollars)
Cash flows from operating activities:
Cash collected from customers
$
33,563
Cash paid to suppliers and employees
(30,854)
1.
Name of entity
Cash paid for interest
(450)
2.
Title
Cash
paidof
forstatement
taxes
(1,190)
3.
dateoperating
(like the
income statement$and1,069
NetSpecific
cash flow from
activities
Cash flow
from investing
activities: earnings, this
statement
of retained
Cash paid to purchase equipment
$
(1,625)
statement covers a specified period
of time.)
Net cash flow from investing activities
(1,625)
4. Unit measure (in thousands of dollars)
Cash flow from financing activities:
Cash received from bank loan
Cash paid for dividends
$
1,400
(1,000)
Net cash flow from financing activities
Net decrease in cash during the year
Cash at beginning of the year
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Ryersonat
Cash
end of the year
400
$
(816)
5,051
© McGraw-Hill $
Ryerson 4,235
Limited, 2003
MAXIDRIVE CORP.
Cash Flow Statement
For the Year Ended December 31, 20A
(In thousands of dollars)
Cash flows from operating activities:
Cash collected from customers
Cash paid to suppliers and employees
Cash paid for interest
Cash paid for taxes
Net cash flow from operating activities
Cash flow from investing activities:
Cash paid to purchase equipment
Net cash flow from investing activities
Cash flow from financing activities:
Cash received from bank loan
Cash paid for dividends
$
33,563
(30,854)
(450)
(1,190)
$
$
(1,625)
(1,625)
$
1,400
(1,000)
Net cash flow from financing activities
Net decrease in cash during the year
400
$
Cash at beginning of the year
Cash at end of the year
McGraw-Hill Ryerson
1,069
(816)
5,051
$
4,235
© McGraw-Hill Ryerson Limited, 2003
Cash Flow Statement
For the Year Ended December 31, 20A
(In thousands of dollars)
Cash flows from operating activities:
Cash collected from customers
Cash paid to suppliers and employees
Cash paid for interest
Cash paid for taxes
Net cash flow from operating activities
Cash flow from investing activities:
Cash paid to purchase equipment
Net cash flow from investing activities
Cash flow from financing activities:
$
33,563
(30,854)
(450)
(1,190)
$
$
1,069
(1,625)
Cash flows directly related to(1,625)
Cash received income
from bank loan are shown
$
1,400
earning
in the
Cash paid for dividends
(1,000)
section.
Net cash flowoperating
from financing activities
400
Net decrease in cash during the year
$
Cash at beginning of the year
Cash at end of the year
McGraw-Hill Ryerson
(816)
5,051
$
4,235
© McGraw-Hill Ryerson Limited, 2003
MAXIDRIVE CORP.
Cash Flow Statement
For the Year Ended December 31, 20A
(In thousands of dollars)
Cash flows
related to the
Cash
flows from operatingor
activities:
acquisition
sale
of
productive
Cash collected from customers
$
33,563
Cash paid to suppliers and employees
(30,854)
assets
are
shown
in
the
Cash paid for interest
(450)
Cash paid for taxes
(1,190)
investing
section.
Net cash flow from operating activities
$
1,069
Cash flow from investing activities:
Cash paid to purchase equipment
Net cash flow from investing activities
Cash flow from financing activities:
Cash received from bank loan
Cash paid for dividends
$
(1,625)
(1,625)
$
1,400
(1,000)
Net cash flow from financing activities
Net decrease in cash during the year
400
$
Cash at beginning of the year
Cash at end of the year
McGraw-Hill Ryerson
(816)
5,051
$
4,235
© McGraw-Hill Ryerson Limited, 2003
MAXIDRIVE CORP.
Cash Flow Statement
For the Year Ended December 31, 20A
(In thousands of dollars)
Cash flows from operating activities:
Cash collected from customers
Cash paid to suppliers and employees
Cash paid for interest
Cash paid for taxes
Net cash flow from operating activities
Cash flow from investing activities:
Cash paid to purchase equipment
Net cash flow from investing activities
Cash flow from financing activities:
$
33,563
(30,854)
(450)
(1,190)
Cash flows from or to investors
$
1,069
or creditors are shown in the
$
(1,625)
financing section.
(1,625)
Cash received from bank loan
Cash paid for dividends
$
1,400
(1,000)
Net cash flow from financing activities
Net decrease in cash during the year
400
$
Cash at beginning of the year
Cash at end of the year
McGraw-Hill Ryerson
(816)
5,051
$
4,235
© McGraw-Hill Ryerson Limited, 2003
MAXIDRIVE CORP.
Cash Flow Statement
For the Year Ended December 31, 20A
(In thousands of dollars)
Cash flows from operating activities:
Cash collected from customers
Cash paid to suppliers and employees
Cash paid for interest
Cash paid for taxes
Net cash flow from operating activities
Cash flow from investing activities:
Cash paid to purchase equipment
Net cash flow from investing activities
Cash flow from financing activities:
$
33,563
(30,854)
(450)
(1,190)
$
$
(1,625)
The statement ends with a
Cash received from bank loan
$
1,400
of Cash.
Cash paidreconciliation
for dividends
(1,000)
Net cash flow from financing activities
Net decrease in cash during the year
McGraw-Hill Ryerson
(1,625)
400
$
Cash at beginning of the year
Cash at end of the year
1,069
(816)
5,051
$
4,235
© McGraw-Hill Ryerson Limited, 2003
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 not on the financial
statements.
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Price/Earnings Ratio
Price/Earnings Ratio =
Market Price (of the Company)
Net Income
This ratio is one
method for estimating
the value of a
company.
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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.
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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 in the United States.
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Generally Accepted Accounting
Principles (GAAP)
The Ontario Securities Commission (OSC)
has been given broad powers to determine
measurement rules for
financial statements in Canada.
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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.
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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.
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Management Responsibility and
the Demand for Auditing
To ensure the accuracy of the company’s records:
 Management maintains a system of controls.
 Management hires an outside independent auditor.
 The board of directors reviews these two safeguards.
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Independent Auditors
 Auditors express an
opinion as to the
fairness of the financial
statement presentation.
 Independent auditors
have responsibilities
that extend to the
general public.
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Overall, I believe
these financial
statements are
fair.
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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.
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Accounting Designations
Chartered Accountant = CA
Certified General Accountant = CGA
Certified Management Accountant = CMA
Certified Public Accountant = CPA*
(* in USA only)
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Ethics, Reputation, and
Legal Liability
In Canada all Accounting Institutes
require that all members adhere to a
professional code of ethics.
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Ethics, Reputation, and
Legal Liability
The reputation for honesty and competence
is the most important asset of an
accountant.
Like physicians, all accountants have
liability for malpractice.
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End of Chapter 1
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