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Financial Accounting:
Tools for Business Decision Making, 4th Ed.
Kimmel, Weygandt, Kieso
CHAPTER 1
Prepared by
Ellen L. Sweatt
Georgia Perimeter College
1
Chapter 1
AN INTRODUCTION
TO FINANCIAL
STATMENTS
2
Study Objectives
1.
2.
3.
4.
Describe the primary forms of
business organization.
Identify the users and uses of
accounting information.
Explain the three principal types of
business activity.
Describe the content and purpose of
each of the financial statements.
3
Study Objectives
5.
6.
Explain the meaning of assets,
liabilities, and stockholders’ equity,
and state the basic accounting
equation.
Describe the components that
supplement the financial statements in
an annual report.
4
1
Forms of Business
Organization
11

Sole proprietorship

Partnership

Corporation
5
Sole Proprietorship






Business owned by
one person
Simple to establish
Owner controlled
Tax advantages
Owner personally
liable
Financing difficult
6
Partnership






Two or more owners
Simple to establish
Shared control
Broader skills &
resources
Tax advantages
Personal liability
7
Corporation





Separate legal entity
owned by
stockholders
Easy to transfer
ownership
Greater capital
raising potential
Lower legal liability
Unfavorable tax
treatment
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2
11
Users of Financial Information
Internal

Managers who plan,
organize and run a
business




Marketing managers
Production
supervisors
Finance directors
Company officers
9
Users of Financial Information
Internal Users Ask?
10
Users of Financial Information
External



Investors
Creditors
Others





Regulatory agencies
Tax authorities
Customers
Labor Unions
Economic planners
11
Users of Financial Information
External Users Ask?
12
3
11
Types of Business Activity

Financing

Investing

Operating
13
Financing Activities

Borrowing creates
liabilities




Bank loans
Debt securities
Goods on credit or
payables
Selling stock creates
stockholders’
equity
14
Investing Activities

Obtaining resources
or assets to operate
the business






Land
Buildings
Vehicles
Computers
Furniture
Equipment
15
Operating Activities
 Primary activity of
business
 Selling goods
 Providing services
 Manufacturing
 Cost of Sales
 Advertising
 Paying employees
 Paying utilities
16
Operating Activities




Revenues are the increases in assets
resulting from the sale of a product or
service
Expenses are the cost of assets
consumed or services used in
generating revenue.
If revenue > expense = Net Income
If revenue < expense = Net Loss!
17
Review
Which is not one of the three forms of
business organization?
a. Sole proprietorship.
b. Creditorship.
c. Partnership.
d. Corporation.
18
Review
Which is not one of the three forms of
business organization?
a. Sole proprietorship.
b. Creditorship.
c. Partnership.
d. Corporation.
19
Review
Which is an advantage of corporations
relative to partnerships and sole
proprietorships?
a. Lower taxes.
b. Harder to transfer ownership
c. Reduced legal liability for investors.
d. Most common form of business
organization.
20
Review
Which is an advantage of corporations
relative to partnerships and sole
proprietorships?
a. Lower taxes.
b. Harder to transfer ownership
c. Reduced legal liability for investors.
d. Most common form of business
organization.
21
Review
Which is not one of the three primary
business activities?
a. Financing.
b. Operating.
c. Advertising.
d. Investing.
22
Review
Which is not one of the three primary
business activities?
a. Financing.
b. Operating.
c. Advertising.
d. Investing.
23
4
11
Content and Purpose of Financial Statements

Accountants
communicate with users
through four financial
statements
24
Four Financial Statements

Income Statement

Retained Earnings Statement

Balance Sheet

Statement of Cash Flows
25
Income Statement



Reports operating success or failure for
a period.
Summarizes revenues and expenses
for period: month, quarter, year.
If revenue > expense = Net Income.
26
Income Statement
Do this statement first!
27
Retained Earnings Statement

Shows changes in retained earnings for
period: month, quarter, year

Beginning balance

Add Net Income from income
statement.

Deduct Dividends

Ending balance
28
Retained Earnings Statement
Do this statement second!
29
Balance Sheet

Reports assets and claims to assets.

Claims of creditors, liabilities.

Claims of owners, stockholders’ equity.


Assets = Liabilities + Stockholders’
Equity
Specific date – one point in time!
30
Balance Sheet
From
Retained
Earnings
Statement
31
Statement of Cash Flows


Provides information about cash
receipts and cash payments
Summarizes for period: month,
quarter, year.

Cash effects of operating, investing,
and financing activities.
32
Statement of Cash Flows

Where did the cash come from?

How was cash used during the period?

What was the change in the cash
balance during the period?

A company cannot survive without cash!
33
Statement of Cash Flows..
Agrees
with
Balance
Sheet
34
5
11
Assets

Resources owned by
the business
 Cash
 Accounts receivable
 Inventories
 Furniture and
fixtures
 Equipment
 Supplies
35
Liabilities

Obligations or debts of business





Notes payable
Accounts payable
Interest payable
Salaries payable
Unearned revenue
36
Stockholders’ Equity

Ownership claims on assets

Paid-in capital


Common stock
Retained earnings
37
Basic Accounting Equation
Assets =
Liabilities + Stockholders’ Equity
38
Review
What questions might each of the following
decision makers ask that could be answered
by the financial statements …
Bank loan officer?
Stock investor?
Labor union president?
Federal bank regulator?
39
Review
Which of the following is not a correct
representation of the accounting equation?
a. Assets = Liabilities + Stockholders’ Equity
b. Assets - Liabilities = Stockholders’ Equity
c. Assets + Stockholders’ Equity = Liabilities
d. Assets - Stockholders’ Equity = Liabilities
40
Review
Which of the following is not a correct
representation of the accounting equation?
a. Assets = Liabilities + Stockholders’ Equity
b. Assets - Liabilities = Stockholders’ Equity
c. Assets + Stockholders’ Equity = Liabilities
d. Assets - Stockholders’ Equity = Liabilities
41
Review
Using the accounting equation, answer the
following question.
If Liabilities = $10,000 and
Stockholders’ Equity = $20,000
Then Assets = $30,000
$30,000 = $10,000 + $20,000
42
Review
Using the accounting equation, answer the
following question.
If Assets = $75,000
And Liabilities = $35,000
Then Stockholders’ Equity = $40,000
$75,000 = $35,000 + $40,000
43
6
11
Supplements to the Financial
Statements in an Annual Report

Management Discussion and
Analysis

Notes to Financial Statements

Auditor’s report
44
Management’s Discussion and
Analysis covers three items:
1.
Liquidity
2.
Capital resources
3.
Results of operations
45
Management’s Discussion and
Analysis
46
Notes to Financial Statements





Explanatory notes and supplementary
schedules
Clarifies information in financial
statements
Expands with additional detail
Describes accounting policies
Explains uncertainties and contingencies
47
Notes to Financial Statements
48
Auditor’s Report





Certified Public Accountant – CPA
Auditor (CPA) conducts independent
examination of financial statements
Fair representation?
Follow generally accepted accounting
principles (GAAP)?
Unqualified opinion
49
Auditor’s Report
50
Do It Problem: CSU Corporation
Service revenue
Accounts receivable
Accounts payable
Building rental expense
Notes payable
Common stock
Retained earnings
Equipment
Insurance expense
Supplies
Supplies expense
Cash
Dividends
$17,000
$4,000
$2,000
$9,000
$5,000
$10,000
?
$16,000
$1,000
$1,800
$200
$1,400
$600


CSU begins on
Jan. 1, 2007
For year ended
Dec. 31, 2007,
prepare



Income
statement
Retained
earnings
statement
Balance sheet
51
Do It Problem: CSU Corporation
Service revenue
Accounts receivable
Accounts payable
Building rental expense
Notes payable
Common stock
Retained earnings
Equipment
Insurance expense
Supplies
Supplies expense
Cash
Dividends
$17,000
$4,000
$2,000
$9,000
$5,000
$10,000
?
$16,000
$1,000
$1,800
$200
$1,400
$600

Action step 1:
Report the
revenues &
expenses for a
period of time,
Income
Statement
52
Do It Problem: CSU Corporation
Service revenue
Accounts receivable
Accounts payable
Building rental expense
Notes payable
Common stock
Retained earnings
Equipment
Insurance expense
Supplies
Supplies expense
Cash
Dividends
$17,000
$4,000
$2,000
$9,000
$5,000
$10,000
?
$16,000
$1,000
$1,800
$200
$1,400
$600

Action step 1:
Report the
revenues &
expenses for a
period of time,
Income
Statement
53
Do It Problem: CSU Corporation
Create the heading
Name of the
company
CSU Corporation
Name of the
Income Statement
statement
For the Year Ended December 31, 2007
Period
of time
54
Do It Problem: CSU Corporation
CSU Corporation
Income Statement
For the Year Ended December 31, 2007
Revenues
Service revenue
$17,000
List the revenues
Use dollar signs to denote U.S. currency
55
Do It Problem: CSU Corporation
CSU Corporation
Income Statement
For the Year Ended December 31, 2007
Revenues
Service revenue
$17,000
Expenses
Rent expense
$9,000
Insurance expense
1,000
Supplies expense
200
________
Total expenses
10,200
List the expenses & underline sub-totals
Do It Problem: CSU Corporation
CSU Corporation
Income Statement
For the Year Ended December 31, 2007
Revenues
Service revenue
$17,000
Expenses
Rent expense
$9,000
Insurance expense
1,000
Supplies expense
200
________
Total expenses
10,200
________
Net Income
$
6,800
________
________
Calculate net income: revenues - expenses
Do It Problem: CSU Corporation
Service revenue
Accounts receivable
Accounts payable
Building rental expense
Notes payable
Common stock
Retained earnings
Equipment
Insurance expense
Supplies
Supplies expense
Cash
Dividends
$17,000
$4,000
$2,000
$9,000
$5,000
$10,000
?
$16,000
$1,000
$1,800
$200
$1,400
$600



Action step 2:
Show amounts
and causes of
changes in
retained
earnings
Use Net Income
from Income
Statement
Dividends
58
Do It Problem: CSU Corporation
CSU Corporation
Retained Earnings Statement
For the Year Ended December 31, 2007
Retained earnings, January 1
Add: Net income
Less: Dividends
Retained earnings, Dec. 31
$
0
6,800
6,800
600
________
$ 6,200
59
Do It Problem: CSU Corporation
Service revenue
Accounts receivable
Accounts payable
Building rental expense
Notes payable
Common stock
Retained earnings
Equipment
Insurance expense
Supplies
Supplies expense
Cash
Dividends
$17,000
$4,000
$2,000
$9,000
$5,000
$10,000
$6,200
$16,000
$1,000
$1,800
$200
$1,400
$600


Action step 3:
Present assets
and claims to
those assets at
a specific point
in time on the
Balance Sheet
Use $6,200
Retained
earnings from
previous
statement!
60
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