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. Describe the primary forms of
business organization.
2. Identify the users and uses of
accounting information.
3. Explain the three principal types of
business activity.
4. Describe the content and purpose of
each of the financial statements.

3
Study Objectives
5. Explain the meaning of assets,
liabilities, and stockholders’ equity,
and state the basic accounting
equation.
6. Describe the components that
supplement the financial statements in
an annual report.

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11
Forms of Business
Organization
 Sole proprietorship

 Partnership

 Corporation

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Sole Proprietorship
 Business owned by
one person
 Simple to establish
 Owner controlled
 Tax advantages
 Owner personally
liable
 Financing difficult

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Partnership
 Two or more owners
 Simple to establish
 Shared control
 Broader skills &
resources
 Tax advantages
 Personal liability

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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

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Users of Financial Information
Internal Users Ask?

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 Users of Financial Information
External
 Investors
 Creditors
 Others
 Regulatory agencies
 Tax authorities
 Customers
 Labor Unions
 Economic planners

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Users of Financial Information
External Users Ask?

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3
11

Types of Business Activity

 Financing

 Investing

 Operating
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Financing Activities
 Borrowing creates
liabilities
 Bank loans
 Debt securities
 Goods on credit or
payables

 Selling stock creates

stockholders’ equity

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 Investing Activities
 Obtaining resources
or assets to operate
the business
 Land
 Buildings
 Vehicles
 Computers
 Furniture
 Equipment

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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!

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 Review
Which is not one of the three forms of
business organization?

a. Sole proprietorship.
b. Creditorship.
c. Partnership.
d. Corporation.
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 Review
Which is not one of the three forms of
business organization?

a. Sole proprietorship.
b. Creditorship.
c. Partnership.
d. Corporation.
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 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.
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 Review
Which is not one of the three primary
business activities?

a. Financing.
b. Operating.
c. Advertising.

d. Investing.
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4
11

Content and Purpose of Financial Statements

 Accountants
communicate with users
through four financial
statements

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 Four Financial Statements

 Income Statement
 Retained Earnings Statement
 Balance Sheet
 Statement of Cash Flows

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 Income Statement

 Reports operating success or failure for

a period.
 Summarizes revenues and expenses
for period: month, quarter, year.
 If revenue > expense = Net Income.
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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

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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!
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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.

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 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

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5
11

Assets
 Resources owned by
the business
 Cash

 Accounts receivable

 Inventories

 Furniture and

fixtures
 Equipment

 Supplies

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Liabilities
 Obligations or debts of business
 Notes payable
 Accounts payable
 Interest payable
 Salaries payable
 Unearned revenue

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 Stockholders’ Equity
 Ownership claims on assets
 Paid-in capital
 Common stock
 Retained earnings

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 Basic Accounting Equation

Assets =
Liabilities + Stockholders’ Equity

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 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?
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 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

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 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

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 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

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6
11

Supplements to the Financial

Statements in an Annual Report
 Management Discussion and Analysis

 Notes to Financial Statements

 Auditor’s report

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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
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Notes to Financial Statements

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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
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Auditor’s Report

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Do It Problem: CSU Corporation
Service revenue
Accounts receivable
$17,000
$4,000
 CSU begins on
Accounts payable $2,000 Jan. 1, 2007
Building rental expense $9,000
Notes payable $5,000
 For year ended
Common stock $10,000 Dec. 31, 2007,
Retained earnings ?
Equipment $16,000 prepare
Insurance expense $1,000  Income
Supplies $1,800
Supplies expense $200
statement
Cash $1,400  Retained
Dividends $600
earnings
statement
 Balance sheet
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 Do It Problem: CSU Corporation
Service revenue
Accounts receivable
$17,000
$4,000
 Action step 1:
Accounts payable $2,000 Report the
Building rental expense
Notes payable
$9,000
$5,000
revenues &
Common stock $10,000 expenses for a
Retained earnings
Equipment
?
$16,000
period of time,
Insurance expense $1,000 Income
Supplies
Supplies expense
$1,800
$200
Statement
Cash $1,400
Dividends $600

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 Do It Problem: CSU Corporation
Service revenue
Accounts receivable
$17,000
$4,000
 Action step 1:
Accounts payable $2,000 Report the
Building rental expense $9,000 revenues &
Notes payable $5,000
Common stock $10,000 expenses for a
Retained earnings ? period of time,
Equipment $16,000
Insurance expense $1,000 Income
Supplies $1,800 Statement
Supplies expense $200
Cash $1,400
Dividends $600

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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
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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
$17,000
$4,000
 Action step 2:
Accounts payable $2,000 Show amounts
Building rental expense
Notes payable
$9,000
$5,000
and causes of
Common stock $10,000 changes in
Retained earnings
Equipment
?
$16,000
retained
Insurance expense $1,000 earnings
Supplies $1,800
Supplies expense $200
 Use Net Income
Cash $1,400 from Income
Dividends $600
Statement
 Dividends
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 Do It Problem: CSU Corporation
CSU Corporation
Retained Earnings Statement
For the Year Ended December 31, 2007

Retained earnings, January 1 $ 0

Add: Net income 6,800
6,800
________
Less: Dividends 600
Retained earnings, Dec. 31 $ 6,200

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Do It Problem: CSU Corporation
Service revenue $17,000
 Action step 3:
Accounts receivable $4,000 Present assets
Accounts payable $2,000
Building rental expense $9,000 and claims to
Notes payable $5,000 those assets at
Common stock $10,000
Retained earnings $6,200 a specific point
Equipment $16,000 in time on the
Insurance expense $1,000
Supplies $1,800 Balance
Supplies expense $200 Sheet
Cash $1,400
Dividends $600  Use $6,200
Retained
earnings from
previous 60
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