FINANCIAL ACCOUNTINGFINANCIAL ACCOUNTING

AN INTRODUCTION TO CONCEPTS,AN INTRODUCTION TO CONCEPTS,

METHODS, AND USESMETHODS, AND USES

12th Edition12th Edition

FINANCIAL ACCOUNTINGFINANCIAL ACCOUNTING

AN INTRODUCTION TO CONCEPTS,AN INTRODUCTION TO CONCEPTS,

METHODS, AND USESMETHODS, AND USES

12th Edition12th Edition

Chapter 1 -- Introduction to Business Activities and Overview of Financial

Statements and the Reporting Process

Clyde P. Stickney and Roman L. Weil

LearningLearning Objectives Objectives

1.1. Develop a general understanding of four Develop a general understanding of four principal activities of business firms: (a) principal activities of business firms: (a) establishing goals and strategies, (b) obtaining establishing goals and strategies, (b) obtaining financing, (c) making investments, and (d) financing, (c) making investments, and (d) conducting operations.conducting operations.

2.2. Develop an understanding of the purpose and Develop an understanding of the purpose and content of the three principal financial content of the three principal financial statements that business firms prepare to statements that business firms prepare to measure and report the results of their business measure and report the results of their business activities: (a) balance sheet, (b) income activities: (a) balance sheet, (b) income statement, and (c) statement of cash flows.statement, and (c) statement of cash flows.

1.1. Develop a general understanding of four Develop a general understanding of four principal activities of business firms: (a) principal activities of business firms: (a) establishing goals and strategies, (b) obtaining establishing goals and strategies, (b) obtaining financing, (c) making investments, and (d) financing, (c) making investments, and (d) conducting operations.conducting operations.

2.2. Develop an understanding of the purpose and Develop an understanding of the purpose and content of the three principal financial content of the three principal financial statements that business firms prepare to statements that business firms prepare to measure and report the results of their business measure and report the results of their business activities: (a) balance sheet, (b) income activities: (a) balance sheet, (b) income statement, and (c) statement of cash flows.statement, and (c) statement of cash flows.

Learning ObjectivesLearning Objectives

3.3. Develop a sensitivity to financial reporting Develop a sensitivity to financial reporting issues, including the following: (a) the potential issues, including the following: (a) the potential conflict of interest between management’s self-conflict of interest between management’s self-interest for job security and career enhancement interest for job security and career enhancement with its responsibility to shareholders, (b) the with its responsibility to shareholders, (b) the alternative approaches to establishing alternative approaches to establishing accounting measurement and reporting accounting measurement and reporting standards, and (c) the role of the independent standards, and (c) the role of the independent audit of a firm’s financial statements.audit of a firm’s financial statements.

4.4. Develop a sensitivity to ethical issues in financial Develop a sensitivity to ethical issues in financial reporting using a framework for thinking about reporting using a framework for thinking about ethical questions.ethical questions.

3.3. Develop a sensitivity to financial reporting Develop a sensitivity to financial reporting issues, including the following: (a) the potential issues, including the following: (a) the potential conflict of interest between management’s self-conflict of interest between management’s self-interest for job security and career enhancement interest for job security and career enhancement with its responsibility to shareholders, (b) the with its responsibility to shareholders, (b) the alternative approaches to establishing alternative approaches to establishing accounting measurement and reporting accounting measurement and reporting standards, and (c) the role of the independent standards, and (c) the role of the independent audit of a firm’s financial statements.audit of a firm’s financial statements.

4.4. Develop a sensitivity to ethical issues in financial Develop a sensitivity to ethical issues in financial reporting using a framework for thinking about reporting using a framework for thinking about ethical questions.ethical questions.

ChapterChapter Outline Outline

1.1. Overview of business activities.Overview of business activities.

2.2. Principal financial statements. Principal financial statements.

3.3. Other items in financial reportsOther items in financial reports

4.4. Financial reporting issuesFinancial reporting issues

5.5. Financial reporting process in the Financial reporting process in the United States. United States.

Chapter SummaryChapter Summary

1.1. Overview of business activities.Overview of business activities.

2.2. Principal financial statements. Principal financial statements.

3.3. Other items in financial reportsOther items in financial reports

4.4. Financial reporting issuesFinancial reporting issues

5.5. Financial reporting process in the Financial reporting process in the United States. United States.

Chapter SummaryChapter Summary

List Four Principal Activities of List Four Principal Activities of Business Firms:Business Firms:

1.1. Establishing goals and strategies,Establishing goals and strategies,

2.2. Obtaining financing,Obtaining financing,

3.3. Making investments, andMaking investments, and

4.4. Conducting operations.Conducting operations.

1.1. Establishing goals and strategies,Establishing goals and strategies,

2.2. Obtaining financing,Obtaining financing,

3.3. Making investments, andMaking investments, and

4.4. Conducting operations.Conducting operations.

Establishing Goals and StrategiesEstablishing Goals and Strategies

Maximize return to Maximize return to shareholdersshareholders

Provide stimulating Provide stimulating lifelong work for lifelong work for employeesemployees

Contribute to and Contribute to and integrate with integrate with national goals and national goals and policiespolicies

Maximize return to Maximize return to shareholdersshareholders

Provide stimulating Provide stimulating lifelong work for lifelong work for employeesemployees

Contribute to and Contribute to and integrate with integrate with national goals and national goals and policiespolicies

Considers Considers competitorscompetitors

Consider barriersConsider barriers Consider demandConsider demand Consider regulationConsider regulation Recognize Recognize

management management process not an process not an individual processindividual process

Considers Considers competitorscompetitors

Consider barriersConsider barriers Consider demandConsider demand Consider regulationConsider regulation Recognize Recognize

management management process not an process not an individual processindividual process

Obtaining Financing and Making Obtaining Financing and Making Investments Investments

Financing comes from two sources, Financing comes from two sources, owners or creditorsowners or creditors

Investments are made in the Investments are made in the following:following:– Land, buildings, equipmentLand, buildings, equipment– Patents, licenses, contractual rightsPatents, licenses, contractual rights– Stock and bonds of other organizationsStock and bonds of other organizations– InventoriesInventories– Accounts ReceivableAccounts Receivable

Financing comes from two sources, Financing comes from two sources, owners or creditorsowners or creditors

Investments are made in the Investments are made in the following:following:– Land, buildings, equipmentLand, buildings, equipment– Patents, licenses, contractual rightsPatents, licenses, contractual rights– Stock and bonds of other organizationsStock and bonds of other organizations– InventoriesInventories– Accounts ReceivableAccounts Receivable

What are the Four Areas of What are the Four Areas of Conducting Operations?Conducting Operations?

Overview of Business ActivitiesOverview of Business Activities

Purpose and Content of the Three Purpose and Content of the Three Principal Financial Statements:Principal Financial Statements:

a)a) Balance sheet,Balance sheet,

b)b) Income statement,Income statement,

c)c) Statement of cash flows,Statement of cash flows,

d)d) Notes to the financial statements, Notes to the financial statements, including various supporting including various supporting schedules,schedules,

e)e) Opinion of the independent certified Opinion of the independent certified public accountant.public accountant.

a)a) Balance sheet,Balance sheet,

b)b) Income statement,Income statement,

c)c) Statement of cash flows,Statement of cash flows,

d)d) Notes to the financial statements, Notes to the financial statements, including various supporting including various supporting schedules,schedules,

e)e) Opinion of the independent certified Opinion of the independent certified public accountant.public accountant.

Review Balance SheetReview Balance Sheet

Snap shot in timeSnap shot in time Asset, liabilities, owners’ equityAsset, liabilities, owners’ equity Retained earningsRetained earnings Assets = Liabilities + Owners’ Assets = Liabilities + Owners’

EquityEquity Historical valuationHistorical valuation Analysis of the balance sheetAnalysis of the balance sheet

Snap shot in timeSnap shot in time Asset, liabilities, owners’ equityAsset, liabilities, owners’ equity Retained earningsRetained earnings Assets = Liabilities + Owners’ Assets = Liabilities + Owners’

EquityEquity Historical valuationHistorical valuation Analysis of the balance sheetAnalysis of the balance sheet

Balance Sheet Balance Sheet Snapshot of investing and financing Snapshot of investing and financing

activities at a moment in time.activities at a moment in time. Basic Accounting Equation:Basic Accounting Equation:

Assets = Liabilities + Shareholders’ Assets = Liabilities + Shareholders’ EquityEquity

which is the same idea aswhich is the same idea as

Investing = FinancingInvesting = Financing

Resources = Sources of ResourcesResources = Sources of Resources

Liabilities = Claims on ResourcesLiabilities = Claims on Resources

Snapshot of investing and financing Snapshot of investing and financing activities at a moment in time.activities at a moment in time.

Basic Accounting Equation:Basic Accounting Equation:

Assets = Liabilities + Shareholders’ Assets = Liabilities + Shareholders’ EquityEquity

which is the same idea aswhich is the same idea as

Investing = FinancingInvesting = Financing

Resources = Sources of ResourcesResources = Sources of Resources

Liabilities = Claims on ResourcesLiabilities = Claims on Resources

Relationship between Balance Relationship between Balance Sheet and Income Statement Sheet and Income Statement

The income statement links the The income statement links the balance sheet at the beginning of balance sheet at the beginning of the period with the balance sheet the period with the balance sheet at the end of the period.at the end of the period.

Retained Earnings is increased by Retained Earnings is increased by net income and decreased by net income and decreased by dividends.dividends.

The income statement links the The income statement links the balance sheet at the beginning of balance sheet at the beginning of the period with the balance sheet the period with the balance sheet at the end of the period.at the end of the period.

Retained Earnings is increased by Retained Earnings is increased by net income and decreased by net income and decreased by dividends.dividends.

Income StatementIncome Statement

Indicates earning or profitIndicates earning or profit Reports amounts for a period of timeReports amounts for a period of time

– Typically one yearTypically one year Explain the following conceptsExplain the following concepts

– RevenueRevenue– ExpensesExpenses

How is classification accomplished?How is classification accomplished? How is the income statement related How is the income statement related

to the balance sheet?to the balance sheet?

Indicates earning or profitIndicates earning or profit Reports amounts for a period of timeReports amounts for a period of time

– Typically one yearTypically one year Explain the following conceptsExplain the following concepts

– RevenueRevenue– ExpensesExpenses

How is classification accomplished?How is classification accomplished? How is the income statement related How is the income statement related

to the balance sheet?to the balance sheet?

Income Statement Income Statement

Results of the operating activities Results of the operating activities of a firm for a specific time period.of a firm for a specific time period.

Basic Income Equation:Basic Income Equation:

Net Income = Revenues - ExpensesNet Income = Revenues - Expenses RevenuesRevenues are the inflows of assets are the inflows of assets

from selling goods and services.from selling goods and services. ExpensesExpenses are the outflows of assets are the outflows of assets

used in generating revenues.used in generating revenues.

Results of the operating activities Results of the operating activities of a firm for a specific time period.of a firm for a specific time period.

Basic Income Equation:Basic Income Equation:

Net Income = Revenues - ExpensesNet Income = Revenues - Expenses RevenuesRevenues are the inflows of assets are the inflows of assets

from selling goods and services.from selling goods and services. ExpensesExpenses are the outflows of assets are the outflows of assets

used in generating revenues.used in generating revenues.

Income Statement Income Statement

Statement of Cash FlowsStatement of Cash Flows

ClassificationClassification

– OperationsOperations

– InvestingInvesting

– FinancingFinancing

Discuss its relationship to Discuss its relationship to the Balance Sheet.the Balance Sheet.

ClassificationClassification

– OperationsOperations

– InvestingInvesting

– FinancingFinancing

Discuss its relationship to Discuss its relationship to the Balance Sheet.the Balance Sheet.

Who are Primary Participants in the Who are Primary Participants in the Reporting Process?Reporting Process?

1.1. Business firms and their managersBusiness firms and their managers

2.2. Accounting standards setting and Accounting standards setting and regulatory bodiesregulatory bodies

3.3. Independent auditorsIndependent auditors

4.4. Security analysts and other users Security analysts and other users of financial statementsof financial statements

1.1. Business firms and their managersBusiness firms and their managers

2.2. Accounting standards setting and Accounting standards setting and regulatory bodiesregulatory bodies

3.3. Independent auditorsIndependent auditors

4.4. Security analysts and other users Security analysts and other users of financial statementsof financial statements

Financial Reporting IssuesFinancial Reporting Issues

a)a) The multiple uses of financial The multiple uses of financial accounting reportsaccounting reports

b)b) The alternative approaches to The alternative approaches to establishing accounting establishing accounting measurement and reporting measurement and reporting standardsstandards

c)c) The role of the independent audit of a The role of the independent audit of a business firm’s financial statements business firm’s financial statements

d)d) The role of financial reporting in an The role of financial reporting in an efficient capital marketefficient capital market

a)a) The multiple uses of financial The multiple uses of financial accounting reportsaccounting reports

b)b) The alternative approaches to The alternative approaches to establishing accounting establishing accounting measurement and reporting measurement and reporting standardsstandards

c)c) The role of the independent audit of a The role of the independent audit of a business firm’s financial statements business firm’s financial statements

d)d) The role of financial reporting in an The role of financial reporting in an efficient capital marketefficient capital market

Financial Reporting in the U.S. Financial Reporting in the U.S. Legal authority to set accounting Legal authority to set accounting

standards lies with the Securities and standards lies with the Securities and Exchange Commission (SEC)Exchange Commission (SEC)

The SEC looks to the Financial Accounting The SEC looks to the Financial Accounting Standards Board (FASB), for leadership in Standards Board (FASB), for leadership in establishing standardsestablishing standards

Pronouncements of the FASB are called Pronouncements of the FASB are called Generally Accepted Accounting Standards Generally Accepted Accounting Standards (GAAP)(GAAP)

Since 1973, the FASB has issued 159 Since 1973, the FASB has issued 159 statements and several conceptual papersstatements and several conceptual papers

Legal authority to set accounting Legal authority to set accounting standards lies with the Securities and standards lies with the Securities and Exchange Commission (SEC)Exchange Commission (SEC)

The SEC looks to the Financial Accounting The SEC looks to the Financial Accounting Standards Board (FASB), for leadership in Standards Board (FASB), for leadership in establishing standardsestablishing standards

Pronouncements of the FASB are called Pronouncements of the FASB are called Generally Accepted Accounting Standards Generally Accepted Accounting Standards (GAAP)(GAAP)

Since 1973, the FASB has issued 159 Since 1973, the FASB has issued 159 statements and several conceptual papersstatements and several conceptual papers

Classification of Cash Flows Classification of Cash Flows

OperationsOperations: cash from customers : cash from customers less cash paid in carrying out the less cash paid in carrying out the firm’s operating activitiesfirm’s operating activities

InvestingInvesting: cash paid to acquire : cash paid to acquire noncurrent assets less amounts noncurrent assets less amounts from any sale of noncurrent assetsfrom any sale of noncurrent assets

FinancingFinancing: cash from issues of : cash from issues of long-term debt or new capital less long-term debt or new capital less dividendsdividends

OperationsOperations: cash from customers : cash from customers less cash paid in carrying out the less cash paid in carrying out the firm’s operating activitiesfirm’s operating activities

InvestingInvesting: cash paid to acquire : cash paid to acquire noncurrent assets less amounts noncurrent assets less amounts from any sale of noncurrent assetsfrom any sale of noncurrent assets

FinancingFinancing: cash from issues of : cash from issues of long-term debt or new capital less long-term debt or new capital less dividendsdividends

Inflows and Outflows of CashInflows and Outflows of Cash

Other Items in Annual Reports & Other Items in Annual Reports & Financial Reporting IssuesFinancial Reporting Issues

Supporting schedules Supporting schedules and notesand notes

Auditor’s opinionAuditor’s opinion

Supporting schedules Supporting schedules and notesand notes

Auditor’s opinionAuditor’s opinion

Users and uses of Users and uses of financial reportsfinancial reports

Authority for Authority for establishing establishing acceptable accounting acceptable accounting standardsstandards

The role of an audit of The role of an audit of a firm’s financial a firm’s financial statementsstatements

Efficiency of capital Efficiency of capital marketsmarkets

Users and uses of Users and uses of financial reportsfinancial reports

Authority for Authority for establishing establishing acceptable accounting acceptable accounting standardsstandards

The role of an audit of The role of an audit of a firm’s financial a firm’s financial statementsstatements

Efficiency of capital Efficiency of capital marketsmarkets

Auditor’s OpinionAuditor’s Opinion

Firms whose common stock is publicly Firms whose common stock is publicly traded are required to get an opinion by traded are required to get an opinion by an independent auditor who: an independent auditor who:

1.1. Assesses the effectiveness of the firm’s Assesses the effectiveness of the firm’s internal control system for measuring and internal control system for measuring and reporting business transactionsreporting business transactions

2.2. Assesses whether the financial statements Assesses whether the financial statements and notes present fairly a firm’s financial and notes present fairly a firm’s financial position, results of operations, and cash flows position, results of operations, and cash flows in accordance with generally accepted in accordance with generally accepted accounting principlesaccounting principles

Firms whose common stock is publicly Firms whose common stock is publicly traded are required to get an opinion by traded are required to get an opinion by an independent auditor who: an independent auditor who:

1.1. Assesses the effectiveness of the firm’s Assesses the effectiveness of the firm’s internal control system for measuring and internal control system for measuring and reporting business transactionsreporting business transactions

2.2. Assesses whether the financial statements Assesses whether the financial statements and notes present fairly a firm’s financial and notes present fairly a firm’s financial position, results of operations, and cash flows position, results of operations, and cash flows in accordance with generally accepted in accordance with generally accepted accounting principlesaccounting principles

The Opinion LetterThe Opinion Letter The first paragraph indicates the financial The first paragraph indicates the financial

statements covered by the opinion and that the statements covered by the opinion and that the responsibility for the statements rests with responsibility for the statements rests with management.management.

The second paragraph affirms that the auditor The second paragraph affirms that the auditor followed auditing standards and practices followed auditing standards and practices generally accepted by the accounting profession generally accepted by the accounting profession unless otherwise noted and described.unless otherwise noted and described.

The third paragraph has the auditor’s opinion- - The third paragraph has the auditor’s opinion- - unqualified or qualified.unqualified or qualified.

Qualified opinionsQualified opinions are either a disclaimer of opinion are either a disclaimer of opinion or an adverse opinion.or an adverse opinion.

The first paragraph indicates the financial The first paragraph indicates the financial statements covered by the opinion and that the statements covered by the opinion and that the responsibility for the statements rests with responsibility for the statements rests with management.management.

The second paragraph affirms that the auditor The second paragraph affirms that the auditor followed auditing standards and practices followed auditing standards and practices generally accepted by the accounting profession generally accepted by the accounting profession unless otherwise noted and described.unless otherwise noted and described.

The third paragraph has the auditor’s opinion- - The third paragraph has the auditor’s opinion- - unqualified or qualified.unqualified or qualified.

Qualified opinionsQualified opinions are either a disclaimer of opinion are either a disclaimer of opinion or an adverse opinion.or an adverse opinion.

The Four Participants in the The Four Participants in the Financial Reporting Process.Financial Reporting Process.

1.1. Business firms and their Business firms and their managersmanagers

2.2. Accounting standards Accounting standards setting and regulatory setting and regulatory bodiesbodies

3.3. Independent auditorsIndependent auditors

4.4. Security analysts and Security analysts and other users of financial other users of financial statementsstatements

1.1. Business firms and their Business firms and their managersmanagers

2.2. Accounting standards Accounting standards setting and regulatory setting and regulatory bodiesbodies

3.3. Independent auditorsIndependent auditors

4.4. Security analysts and Security analysts and other users of financial other users of financial statementsstatements

SECSEC

FASBFASB

GAAPGAAP

Compilation of accounting rules, procedures and practices

An agency of the federal government, that has the legal authority to set acceptable accounting methods and standards in the U.S.

Private sector body, for leadership in establishing accounting standards

An International Perspective An International Perspective

The process of setting accounting The process of setting accounting standards vary widely around the world standards vary widely around the world resulting in a diverse set of accounting resulting in a diverse set of accounting principles.principles.

Globalization of economies has increased Globalization of economies has increased the need for comparable and the need for comparable and understandable financial information.understandable financial information.

The International Accounting Standards The International Accounting Standards Committee (IASC) issues Committee (IASC) issues recommendations for minimum recommendations for minimum standards. standards.

The process of setting accounting The process of setting accounting standards vary widely around the world standards vary widely around the world resulting in a diverse set of accounting resulting in a diverse set of accounting principles.principles.

Globalization of economies has increased Globalization of economies has increased the need for comparable and the need for comparable and understandable financial information.understandable financial information.

The International Accounting Standards The International Accounting Standards Committee (IASC) issues Committee (IASC) issues recommendations for minimum recommendations for minimum standards. standards.

Chapter Summary Chapter Summary This chapter provided a broad This chapter provided a broad

overview of business activities and overview of business activities and how they are reflected in basic how they are reflected in basic financial statements.financial statements.

The three basic financial The three basic financial statements were introduced.statements were introduced.

Further chapters examine the Further chapters examine the concepts and procedures that concepts and procedures that underlie each statement.underlie each statement.

This chapter provided a broad This chapter provided a broad overview of business activities and overview of business activities and how they are reflected in basic how they are reflected in basic financial statements.financial statements.

The three basic financial The three basic financial statements were introduced.statements were introduced.

Further chapters examine the Further chapters examine the concepts and procedures that concepts and procedures that underlie each statement.underlie each statement.

Rapid Review - True or FalseRapid Review - True or False

The four principle business activities of a business firm are

(a) establishing goals and strategies (b) obtaining financing

(c) making investments (d) conducting operations

An income statement provides information about a firm’s cash-generating ability.

An income statement provides information about a firm’s profitability. Cash-generating ability information is provided by the Statement of Cash Flows.

Most independent auditors’ opinions are unqualified.