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FINANCIALACCOUNTINGRobert LibbyPatricia A. LibbyDaniel G. ShortIrwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

Chapter 1Financial Statements andBusiness DecisionsIrwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

The Objectives of FinancialAccountingFinancial statements are the primarymeans of communicating financialinformation to parties outside thebusiness organization.Balance SheetIncome StatementStakeholdersIrwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

Business BackgroundBusiness owners (called investors orstockholders) look for two sources ofpossible gain:Sellownershipinterest in thefuture for morethan theypaid.Irwin/McGraw-HillReceive aportion of thecompany’searnings in cash(dividends). The McGraw-Hill Companies, Inc., 2001

Business BackgroundCreditors lend money to a company for aspecific length of time and gain bycharging interest on the money loaned.LoanDana’sDinerInterestIrwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

Understanding BusinessOperationsManufacturers either make the partsneeded to produce its products or buythe parts from omer The McGraw-Hill Companies, Inc., 2001

Understanding BusinessOperationsAll businesses have an accountingsystem that . . .Collects and processesfinancial informationabout an ernal)Reportsinformationto decisionmakers.Investors(external) The McGraw-Hill Companies, Inc., 2001

Understanding BusinessOperationsAccounting SystemFinancial Accounting System(preparation of four basicfinancial statements).Managerial Accounting System(preparation of detailed plans,forecasts and reports).External Decision Makers(investors, creditors,suppliers, customers, etc.).Internal Decision Makers(managers throughout theorganization).Irwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

Information Conveyed inFinancial StatementsThe four basic financial statements . . .Statement of Cash FlowsBalance SheetIrwin/McGraw-HillStatement of Retained EarningsIncome Statement The McGraw-Hill Companies, Inc., 2001

Information Conveyed inFinancial StatementsMost companies prepare financialstatements at the end of the quarter(called quarterly reports) and the endof the year (called annual reports).2001XIrwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

Let’s look aw-Hill The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Balance SheetAt December 31, 20A(In thousands of dollars)AssetsCash 4,895Accounts receivable5,714Inventories8,517of entityPlant 1.andNameequipment7,154(the separate-entity assumption) 981LandTotalassets of statement 27,2612. TitleLiabilitiesand Stockholders'Equity3. SpecificdateLiabilities(financial snapshot at a specificAccounts payable 7,156point in time)Notes payable9,0004. Unit measureTotal liabilities 16,156(thousandsof dollars)Stockholders' EquityContributed capitalRetained earningsTotal stockholders' equityTotal liabilities and stockholders' equityIrwin/McGraw-Hill 2,0009,10511,105 27,261 The McGraw-Hill Companies, Inc., 2001

The Balance SheetBodyBody ofof thethe StatementStatementAssetsAssets ansactions.transactions.LiabilitiesLiabilities s’ EquityEquity erations.operations.Irwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

The Balance SheetBasic Accounting EquationAssetsAssets LiabilitiesLiabilities Stockholders’Stockholders’ EquityEquityEconomicresources Irwin/McGraw-HillSources of financing . . .Liabilities: from creditorsEquity: from stockholders. The McGraw-Hill Companies, Inc., 2001

Assets arelisted by theirease ofconversioninto cash.MAXIDRIVE CORP.Balance SheetAt December 31, 20A(In thousands of dollars)AssetsCash 4,895Accounts receivable5,714Inventories8,517Plant and equipment7,154Land981Total assets 27,261Liabilities andStockholders'Amountof cashEquityin the company’s bankCashLiabilitiesaccount.Accountspayable 7,156from priorAccountsAmounts owed by customersNotespayablesales.receivable9,000Total liabilitiesPartial and completed but unsold 16,156InventoriesStockholders'product. EquityContributed 2,000Plant and capitalFactories and production machinery.Retainedearnings9,105equipmentTotal stockholders' equity11,105Landon whichequityfactories are located.TotalliabilitiesPropertyand stockholders' 27,261Irwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Balance SheetAt December 31, 20A(In thousands of dollars)AssetsCashAccounts receivableAccounts Amounts Inventoriesowed to suppliers for priorpayable purchases.Plant and equipmentNotesAmounts owedLand on written debtpayable contracts. Total assetsLiabilities and Stockholders' EquityLiabilitiesAccounts payable 4,8955,7148,5177,154981 27,261 7,156Notes payable9,000Total liabilities 16,156Stockholders' EquityContributed capitalRetained earningsTotal stockholders' equity 2,0009,10511,105Total liabilities and stockholders' equityIrwin/McGraw-Hill 27,261 The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Balance SheetAt December 31, 20A(In thousands of dollars)AssetsCashAccounts receivableInventoriesPlant and equipmentLandTotal assetsLiabilities and Stockholders' EquityContributed Amounts invested in theLiabilitiesbusiness byAccounts tpayablePast earningsdistributed toTotal liabilitiesstockholders. 7,1569,000 16,156Stockholders' EquityContributed capitalRetained earningsTotal stockholders' equity 2,0009,10511,105Total liabilities and stockholders' equityIrwin/McGraw-Hill 4,8955,7148,5177,154981 27,261 27,261 The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Balance SheetAt December 31, 20A(In thousands of dollars)AssetsUse on thefirst item in agroupand on thegroup total.CashAccounts receivableInventoriesPlant and equipmentLandTotal assetsLiabilities and Stockholders' EquityLiabilitiesAccounts payable 4,8955,7148,5177,154981 27,261 7,156Notes payable9,000liabilitiesAssets LiabilitiesTotal Stockholders’EquityStockholders' EquityContributed capitalRetained earningsTotal stockholders' equity 2,0009,10511,105Total liabilities and stockholders' equityIrwin/McGraw-Hill 16,156 27,261 The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Income StatementFor the Year Ended December 31, 20A(In thousands of dollars)RevenuesSalesrevenue 37,4361. Nameof entityExpenses2. Title of statement3. Specificsheet, thisCostof goodsdatesold(Unlike the balance 26,980statementcoversa specified periodof time.)Selling,generaland administrative3,6244. Unit measure(in thousands of dollars)Researchand development1,982Interest expense450Total expenses33,036Pretax incomeIncome tax expenseNet incomeIrwin/McGraw-Hill 4,4001,100 3,300 The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Income StatementFor the Year Ended December 31, 20AThe income statement is divided into(In thousands of dollars)three major captions.! Revenues"#Sales revenue 37,436ExpensesCost of goods sold 26,980Selling, general and administrative3,624Research and development1,982Interest expense450Total expenses33,036Pretax incomeIncome tax expenseNet incomeIrwin/McGraw-Hill 4,4001,100 3,300 The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Income StatementFor the Year Ended December 31, 20A(In thousands of dollars)RevenuesSales revenue 37,436ExpensesRevenues are earnings from the sale of goodsCost of goods sold 26,980orservices.Selling, general and venuerecognized in the periodin whichInterestexpense450goodsand services are sold, not necessarilyperiod in which cash is received. 33,036TotaltheexpensesPretax incomeIncome tax expenseNet incomeIrwin/McGraw-Hill 4,4001,100 3,300 The McGraw-Hill Companies, Inc., 2001

The Income Statement!RevenuesEarnings from the sale of goods or services.When will the revenue from thistransaction be recognized? 1,000 sale madeon May 25th.May 2001Irwin/McGraw-HillXCash from salecollected on June 10th.XJune 2001 The McGraw-Hill Companies, Inc., 2001

The Income Statement!RevenuesEarnings from the sale of goods or services.When will the revenue from thistransaction be recognized? 1,000 revenuerecognized in MayMay 2001Irwin/McGraw-HillJune 2001 The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Expenses are theIncomedollar amountof resources usedStatementup by theto earnrevenuesduringa period.Forentitythe YearEndedDecember31, 20A(In thousands of dollars)An expense is recognized in the period in whichgoods and services are used, not necessarilyRevenuesthe period in which cash is paid.Sales revenue 37,436ExpensesCost of goods sold 26,980Selling, general and administrative3,624Research and development1,982Interest expense450Total expenses33,036Pretax incomeIncome tax expenseNet incomeIrwin/McGraw-Hill 4,4001,100 3,300 The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Income StatementFor the Year Ended December 31, 20A(In thousands of dollars)RevenuesCost ofThe cost of the products sold thisgoodssold period.Salesrevenue 37,436ExpensesSelling,Operating expenses not directly relatedCostofgoodssold 26,980general andto production.Selling,general and administrative3,624administrativeResearch and development1,982Research and Expenses incurred to develop newInterest expense450development products.Total expenses33,036InterestThe cost of using borrowed funds.Pretaxincome 4,400expenseIncometaxtax expense1,100IncomeIncome taxes on current period’s pretaxNetexpenseincome 3,300income. The McGraw-Hill Companies, Inc., 2001Irwin/McGraw-Hill

The Income Statement" ExpensesThe dollar amount of resources usedup by the entity to earn revenuesduring a period.When will the expense for thistransaction be recognized?May 11 paid 75 cashfor newspaper ad.XMay 2001Irwin/McGraw-HillAd appearson June 8th.XJune 2001 The McGraw-Hill Companies, Inc., 2001

The Income Statement" ExpensesThe dollar amount of resources usedup by the entity to earn revenuesduring a period.When will the expense for thistransaction be recognized?Advertising expenserecorded in June.May 2001Irwin/McGraw-HillJune 2001 The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Income StatementFor the Year Ended December 31, 20A(In thousands of dollars)RevenuesSales revenue 37,436ExpensesCost of goods sold 26,980Selling, general and administrative3,624Research and development1,982Interest expense450revenues exceed expenses,TotalWhenexpenses33,036Pretax income we report net income.Income tax expenseNet incomeIrwin/McGraw-Hill 4,4001,100 3,300 The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Income StatementFor the Year Ended December 31, 20A(In thousands of dollars)RevenuesSales revenue 37,436ExpensesCost of goods sold 26,980Selling, general and administrative3,624Research and development1,982Interest expense450Total expenses33,036Pretax income 4,400Whenexceed revenues, 1,100Incometaxexpensesexpensewe report net loss.Net income 3,300Irwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

Statement of Retained EarningsIncome of the yRetaien neter dpriseRetained Earnings The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Statement of Retained EarningsFor the Year Ended December 31, 20A(In thousands of dollars)Retained earnings, January 1, 20A 6,805Netincomefor 20A3,3001. Nameof entityDividendsfor 20A(1,000)2. Title of statementRetainedDecember31,statement,20A 9,1053. Specificearnings,date (Likethe incomethisstatement covers a specified period of time.)4. Unit measure (in thousands of dollars)Irwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

MAXIDRIVE CORP.Statement of Retained EarningsFor the Year Ended December 31, 20A(In thousands of dollars)Retained earnings, January 1, 20ANet income for 20ADividends for 20ARetained earnings, December 31, 20AIrwin/McGraw-Hill 6,8053,300(1,000) 9,105 The McGraw-Hill Companies, Inc., 2001

Notes Notes provide supplementalinformation about the financialcondition of a company. Three types . . .➊Describe accounting rules applied.➋Present additional detail about anitem on the financial statements.➌Provide additional informationabout an item not on the financialstatements.Irwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

Responsibilities for the AccountingCommunication ProcessEffective communication means thatthe recipient understands what thesender intends to convey.Decision makers need to understandaccounting measurement rules.Irwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

Generally Accepted AccountingPrinciples (GAAP)Securities Act of 1933Securities and Exchange Act of 1934The Securities and Exchange Commission (SEC)has been given broad powers to determinemeasurement rules forfinancial statements.Irwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

Generally Accepted AccountingPrinciples (GAAP)The SEC has worked closely with theaccounting profession towork out the detailed rules that havebecome known as GAAP.Currently, the Financial AccountingStandards Board (FASB) is recognizedas the body to formulate GAAP.Irwin/McGraw-Hill The McGraw-Hill Companies, Inc., 2001

Generally Accepted AccountingPrinciples (GAAP)Companies are interested inGAAP because methods ofreporting can have the followingeconomic consequences . . .! Affect the selling price of stock." Affect the amount of bonuses receivedby managers and other employees.# Cause a loss of competitive advantage.Irwin/McGraw-Hill The McGraw-Hill Companies, Inc.,