1 Financial

Accounting
Chapter One:
The Financial
Statements

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reserved.
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Learning Objectives
1. Explain why 4. Construct financial
accounting is critical statements and
to business. analyze the
2. Explain and Apply relationships among
underlying them.
accounting concepts, 5. Evaluate business
assumptions and decisions ethically.
principles.
3. Apply the accounting
equation to business
organizations.
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 Learning Objective
1 One
Explain why accounting is critical to
business.

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 Explain why accounting
1 is critical to business

Accounting is an information system that:

• Measures business activities
• Processes data into financial statements and
reports
• Communicates results to decision makers

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 1 Exhibit 1-1 | The Flow of
Accounting Information

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 Who uses accounting
1 information?

• Individuals
• Investors and creditors
• Regulatory bodies
• Nonprofit organizations

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 1 Two Types of Accounting

Financial Accounting Managerial Accounting

• For decision makers • For managers inside
outside the entity the entity
• Investors • Budgets
• Creditors • Forecasts
• Government agencies • Projections
• The public

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 Exhibit 1-2 | The Various
1 Forms of Business
Organization

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 1 Organizing a Business

Proprietorship
• Single owner
• Tend to be small retail stores or solo
providers of professional services
• Personally liable for all business’s debts
• Distinct entity for accounting purposes

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 1 Organizing a Business

Partnership
• Two or more parties as co-owners
• Income and losses “flow through” to partners
• Many are small or medium-sized companies
• General partnerships have mutual agency and
unlimited liability
• In limited-liability partnerships, only liable up to
the investment put in

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 1 Organizing a Business

Limited-Liability Company
• Business (not owners) is liable for debts
• May have one owner or many, called
members
• Members have limited liability
• Income “flows through” to members

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 1 Organizing a Business

Corporation
• Owned by stockholders (shareholders)
• Able to raise large sums of capital by
issuing stock
• Formed under state law
• Legally distinct from its owners
• Stockholders have no personal obligation
for the corporation’s debts, limited liability
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 1 Organizing a Business

Corporation
• Double taxation
• Corporation pays income tax
• Shareholders taxed on dividends
• Stockholders elect board of directors, which
• Sets policy
• Appoints officers

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 Learning Objective
2 Two
Explain and apply underlying
accounting concepts, assumptions,
and principles.

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 Professional
2 Frameworks
Generally Accepted Accounting Principles
(GAAP)
• Formulated by the Financial Accounting Standards
Board (FASB)
International Financial Reporting Standards
(IFRS)
• Formulated by the International Accounting Standards
Board (IASB)

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Exhibit 1-3 | Conceptual Foundation of Accounting

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 Assumptions and
2 Principles
Entity Assumption
• An organization stands apart from other organizations and
individuals as a separate economic unit
Continuity (Going-Concern) Assumption
• Entity will continue to operate for the foreseeable future
Historical Cost Principle
• Assets should be recorded at their actual cost on the date of
purchase
Stable-Monetary-Unit Assumption
• Assume the dollar’s purchasing power is stable over time

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 Learning Objective
3 Three
Apply the accounting equation to
business organizations.

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 The Accounting
3 Equation

Assets = Liabilities + Equity

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 3
Exhibit 1-4 |
The
Accounting
Equation

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 Apply the Accounting
3 Equation to Business
Organizations
The financial statements are based on the accounting equation.

• Resources expected to produce future

Assets benefit

• Outsider claims – debts payable to

Liabilities outsiders

Stockholders’ • Insider claims, stockholders’ interest in

Equity the assets

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 Apply the Accounting
3 Equation to Business
Organizations
Assets Liabilities

• Cash and cash equivalents • Accounts payable

• Inventories • Income taxes payable
• Property, plant, and • Long-term debt
equipment

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 Apply the Accounting
3 Equation to Business
Organizations
Stockholders’ Equity

• The accounting equation can be rewritten as:

• Assets – Liabilities = Stockholders’ Equity
• Corporation’s equity has two parts:
• Paid-in capital
• Retained earning

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 Apply the Accounting
3 Equation to Business
Organizations
Stockholders’ Equity

Paid-in capital Retained Earnings

The amount The amount of earned
stockholders have income kept for use in
invested in the the business.
business.

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 3
Exhibit 1-5 | The Components
of Retained Earnings

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 Components of
3 Retained Earnings
Revenues
• Inflow of resources from delivering goods or services
• Increase retained earnings
Expenses
• Outflow of resources due to the cost of operations
• Decrease retained earnings
Dividends
• Distribution of assets to stockholders
• Decrease retained earnings
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 Learning Objective
4 Four
Construct financial statements and
analyze the relationships among
them.

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 4

Exhibit 1-6 | Information Reported in the

Financial Statements
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 Order of the Financial
4 Statements

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 The Income Statement
4 Measures Operating
Performance

The income statement reports revenues

and expenses for the period.
• The bottom line net income (loss) for the period

Net income = Total Revenues & Gains – Total Expenses & Losses

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 4

Exhibit 1-7 | The Walt Disney Company, Consolidated

Statements of Income
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 The Statement of
4 Retained Earnings

• Portion of net income reinvested into the business

• Net income increases retained earnings

• Net losses and dividends decrease retained earnings

• Net income (net loss) flows from the income statement

to the statement of retained earnings

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 The Statement of
4 Retained Earnings

Beginning retained earnings

Add: Net income (loss)
Less: Dividends declared___
Ending retained earnings

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 Exhibit 1-8 | The Walt Disney

4 Company, Consolidated
Statements of Retained
Earnings

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 4 The Balance Sheet
• Also called the statement of financial
position
• Reports three items:
• Assets
• Liabilities
• Stockholders’ equity
• Reflects the company’s position at a
specific moment in time
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 The Balance Sheet -
4 Assets
• Current assets – expected to be used or
converted to cash within one business cycle
• Examples: cash and cash equivalents, receivables,
inventories, and prepaid expenses
• Long-term assets – expected to benefit the
company beyond just the next fiscal year
• Examples: property, plant, and equipment, long-
term investments, and intangible assets

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 The Balance Sheet -
4 Assets

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 The Balance Sheet -
4 Liabilities
• Current liabilities – debts due within one year
• Examples: accounts payable, salaries payable,
short-term notes payable, accrued liabilities
• Long-term liabilities– debts payable after one
year
• Examples: long-term notes payable, long-term
bonds payable

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 The Balance Sheet -
4 Liabilities

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 The Balance Sheet -
4 Equity

• Represents the stockholders’ ownership

of the business’s assets
• Examples: common stock, additional
paid-in capital, retained earnings,
treasury stock, accumulated other
comprehensive income (loss)

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 The Balance Sheet -
4 Equity

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 4
Exhibit 1-9 |
The Walt
Disney
Company,
Consolidated
Balance Sheets

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 The Statement of
4 Cash Flows
• Reports cash receipts and cash payments
• Three types of activities:
• Operating activities: cash flows from selling goods
and services to customers
• Investing activities: cash flows from purchasing and
selling long-term assets
• Financing activities: cash flows from borrowing or
repaying funds or equity transactions

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 4
Exhibit 1-10 |
The Walt
Disney
Company,
Consolidated
Statements
of Cash
Flows

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 Exhibit 1-11 | Relationships
4 among the Financial
Statements (in millions of $)

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 Exhibit 1-11 | Relationships
4 among the Financial
Statements (in millions of $)

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 Learning Objective
5 Five
Evaluate business decisions
ethically.

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 Evaluate Business
5 Decisions Ethically
Three factors influence business and accounting decisions.

Decision should maximize the economic

Economic benefits

Free societies are governed by laws

Legal written to provide clarity and prevent
abuse of others’ rights

Recognizes that even when economically

Ethical profitable and legal, some actions still
may not be right
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 AICPA Code of
5 Professional Conduct
• The American Institute of Certified Public
Accountants (AICPA) provides the industry a
Code of Professional Conduct with these
principles:
• Responsibilities
• Public Interest
• Integrity
• Objectivity and Independence
• Due Care
• Scope and Nature of Services
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 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise,
without the prior written permission of the publisher.
Printed in the United States of America.

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