CHAPTER 1

FINANCIAL STATEMENTS
AND BUSINESS DECISIONS
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin

Copyright 2014 by The McGraw-Hill Companies, Inc. All

UNDERSTANDING THE BUSINESS

Stockholders
Potential Return for
Stockholders:
Dividends
Higher future stock prices

Creditors

Potential Return for

Creditors:
Interest
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THE ACCOUNTING SYSTEM

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BUSINESS ACTIVITIES
Financing Activities
Ex: Borrow money
from bank

Investing Activities
Ex: Purchase
equipment

Operating Activities
Ex: Sell merchandise
to customers

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THE FOUR BASIC FINANCIAL

STATEMENTS
BALANCE
BALANCESHEET
SHEETreports
reportsthe
theamount
amountof
ofassets,
assets,liabilities,
liabilities,and
and
stockholders
stockholdersequity
equityof
ofan
anaccounting
accountingentity
entityat
ataapoint
pointinintime.
time.
INCOME
INCOMESTATEMENT
STATEMENTreports
reportsthe
therevenues
revenuesless
lessthe
theexpenses
expensesof
ofthe
the
accounting
accountingperiod.
period.
STATEMENT
STATEMENTOF
OFSTOCKHOLDERS
STOCKHOLDERSEQUITY
EQUITYreports
reportsthe
thechanges
changesinin
each
eachof
ofthe
thecompanys
companysstockholders
stockholdersequity
equityaccounts,
accounts,including
includingthe
the
change
changeininthe
theretained
retainedearnings
earningsbalance
balancecaused
causedby
bynet
netincome
incomeand
and
dividends
dividendsduring
duringthe
thereporting
reportingperiod.
period.
STATEMENT
STATEMENTOF
OFCASH
CASHFLOWS
FLOWSreports
reportsinflows
inflowsand
andoutflows
outflowsof
ofcash
cash
during
duringthe
theaccounting
accountingperiod
periodininthe
thecategories
categoriesof
ofoperating,
operating,investing,
investing,
and
andfinancing.
financing.
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BALANCE SHEET
Elements of the Balance Sheet
Assets
Cash
Short-Term Investment
Accounts Receivable
Notes Receivable
Inventory (to be sold)
Supplies
Prepaid Expenses
Long-Term Investments
Equipment
Buildings
Land
Intangibles

Liabilities
Accounts Payable
Accrued Expenses
Notes Payable
Taxes Payable
Unearned Revenue
Bonds Payable
Stockholders Equity
Common Stock
Retained Earnings
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THE ACCOUNTING EQUATION

A = L + SE

Assets

Economic
Resources

Liabilities

Stockholders
Equity

Sources of Financing for Economic

Resources
Liabilities: From Creditors
Stockholders Equity: From Stockholders
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BALANCE SHEET

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INCOME STATEMENT
Elements of the Income Statement
Revenues
Sales Revenue
Fee Revenue
Interest Revenue
Rent Revenue

Expenses
Cost of Goods Sold
Wages Expense
Rent Expense
Interest Expense
Depreciation Expense
Advertising Expense
Insurance Expense
Repair Expense
Income Tax Expense
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INCOME STATEMENT

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STATEMENT OF
STOCKHOLDERS EQUITY
Elements of the Statement
of Stockholders Equity

Common Stock

Retained Earnings

Beginning Retained Earnings

+Net Income
-Dividends
Ending Retained Earnings

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STATEMENT OF
STOCKHOLDERS EQUITY

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STATEMENT OF CASH FLOWS

Elements of the Statement
of Cash Flows

Cash Flows from Operating Activities

Cash Flows from Investing Activities
Cash Flows from Financing Activities

+/

Note that each of the three cash flow

sources can be positive (net cash inflow)
or negative (net cash outflow).
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STATEMENT OF CASH FLOWS

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RELATIONSHIPS AMONG THE

STATEMENTS

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NOTES
Did you notice a sentence at the
bottom of each financial statement?

All financial statements

should be accompanied by
notes which provide the
reader with supplemental
information about the financial
condition and results of
operations of the company.
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FINANCIAL STATEMENT SUMMARY

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RESPONSIBILITIES FOR THE ACCOUNTING

COMMUNICATION PROCESS

The Rules
Generally
Accepted
Accounting
Principles
(GAAP)
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HOW ARE GENERALLY ACCEPTED

ACCOUNTING PRINCIPLES DETERMINED?
Our accounting system has a long
and distinguished history. An
Italian monk and mathematician,
Luca Pacioli, published the first
elements of double-entry
bookkeeping in 1494.
Prior to 1933, the management
teams of most companies were
largely free to choose their own
financial reporting practices.
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GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES
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.

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GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES
The SEC has worked closely with the
accounting profession to
work out the detailed rules that have
become known as GAAP.

Currently, the Financial Accounting Standards Board

(FASB) is recognized as the body to formulate GAAP.

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GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES
Companies incur the cost of
preparing the financial statements
and bear the following economic
consequences of their publication . . .
Effects on the selling price of stock.
Effects on the amount of bonuses
received by managers and other employees.
Loss of competitive information to other
companies.

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INTERNATIONAL PERSPECTIVE
The International Accounting Standards Board and
Global Convergence of Accounting Standards
Since 2002, there has been substantial movement toward the adoption of
International Financial Reporting Standards (IFRS) issued by the
International Accounting Standards Board (IASB).
Examples of jurisdictions requiring the use of IFRS either currently or by 2012:
European Union
Israel and Turkey
Australia and New Zealand
Brazil and Chile
Canada and Mexico
Hong Kong, India, Malaysia, & South Korea
In the United States, the Securities and Exchange Commission now allows
foreign companies whose stock is traded in the U.S. to use IFRS and is
considering requiring the use of IFRS for U.S. domestic companies by 2015.
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ETHICAL CONDUCT
Three Step Process for Making Ethical Decisions
1. Identify the benefits of a decision (often to the
manager or employee involved) and who will
be harmed (other employees, owners,
creditors, the environment).
2. Identify alternative courses of action.
3. Choose the one you would like your family and
friends to see reported on your local news.

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ENSURING THE ACCURACY OF

FINANCIAL STATEMENTS
To ensure the accuracy of the companys
financial information, management:
Maintains a system of controls.
Hires external independent auditors.
Forms a committee of the board of directors
to review these other two safeguards.

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EXTERNAL AUDITORS
An audit is an examination
of the financial reports to
ensure that they represent
what they claim and
conform with GAAP.

Overall, I believe
these financial
statements are
fairly stated.

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WHAT IF THE NUMBERS ARE

WRONG?
After it was determined that the financial statements for Le-Natures
were misleading, the consequences for the defendants were severe.

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SUPPLEMENT A: TYPES OF BUSINESS

ENTITIES
Sole
Sole Proprietorship:
Proprietorship: owned
owned by
by aa single
single individual.
individual.
Partnership:
Partnership: owned
owned by
by two
two or
or more
more individuals.
individuals.
Corporation:
Corporation: ownership
ownership represented
represented by
by shares
shares of
of stock.
stock.
Advantages
Advantages of
of aa Corporation:
Corporation:

Limited
Limited liability
liability

Continuity
Continuity of
of life
life

Ease
Ease of
of transfer
transfer of
of ownership
ownership

Opportunity
Opportunity to
to raise
raise large
large amounts
amounts of
of money
money
Disadvantage
Disadvantage of
of aa Corporation:
Corporation:

Double
Double taxation
taxation
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SUPPLEMENT B: EMPLOYMENT IN THE

ACCOUNTING PROFESSION TODAY
Professional
Designations
CPA
CMA
CIA

Career Opportunities
Public Accounting
Audit and Assurance Services
Management Consulting Services
Tax Services
Employment by Organizations
Internal accounting
External reporting
Tax planning
Various other functions
Employment in the Public and Notfor-Profit Sector
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END OF CHAPTER 1

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