lecture 1
DESCRIPTION
AN INTRODUCTION TO FINANCIAL STATEMENTSTRANSCRIPT
Introduction to Financial StatementsIntroduction to Financial Statements
Chapter 1Chapter 1
MBA Q-4MBA Q-4
Study ObjectivesStudy Objectives
1.1. Describe the primary forms of business Describe the primary forms of business organization.organization.
2.2. Identify the users and uses of accounting Identify the users and uses of accounting information.information.
3.3. Explain the three principal types of business Explain the three principal types of business activity.activity.
4.4. Describe the content and purpose of each of Describe the content and purpose of each of the financial statements.the financial statements.
Study ObjectivesStudy Objectives
5.5. Explain the meaning of assets, liabilities, and Explain the meaning of assets, liabilities, and stockholders’ equity, and state the basic stockholders’ equity, and state the basic accounting equation.accounting equation.
6.6. Describe the components that supplement Describe the components that supplement the financial statements in an annual report.the financial statements in an annual report.
##11 Forms of Business Organization Forms of Business Organization
• Sole proprietorshipSole proprietorship
• PartnershipPartnership
• CorporationCorporation
Sole ProprietorshipSole Proprietorship
• Business owned by one personBusiness owned by one person• Simple to establishSimple to establish• Owner controlledOwner controlled• Tax advantagesTax advantages• Owner personally liableOwner personally liable• Financing difficultFinancing difficult
PartnershipPartnership
• Two or more ownersTwo or more owners• Simple to establishSimple to establish• Shared controlledShared controlled• Broader skills & resourcesBroader skills & resources• Tax advantagesTax advantages• Personal liabilityPersonal liability
CorporationCorporation
• Separate legal entity owned by Separate legal entity owned by stockholdersstockholders
• Easy to transfer ownershipEasy to transfer ownership• Greater capital raising potentialGreater capital raising potential• Lower legal liabilityLower legal liability• Unfavorable tax treatmentUnfavorable tax treatment
Forms of Business Entities Sole
Proprietorship Partnership Corporation
Number of owners 1 2 or more (partners)
Numerous (shareholders)
Legally separate from owners
No No Yes
Owners liable for business debts
Yes Yes No
Profits taxable To the owner To the owners
To the corporation as
earnings; to the owners
when dividends are received
Modified form
“LLC” limits liability of owner; may
increase income tax exposure
“Subchapter S” profits are
taxed at ownership level
only
##22 Users of Financial Information Users of Financial Information
InternalInternal
• Managers who plan, Managers who plan, organize and run a organize and run a businessbusiness– Marketing managersMarketing managers– Production supervisorsProduction supervisors– Finance directorsFinance directors– Company officersCompany officers
Users of Financial InformationUsers of Financial InformationInternal Users Ask?Internal Users Ask?
Cash to pay bills?Cash to pay bills? Cost per unit?Cost per unit?
Give raises?Give raises? Which product is Which product is profitable?profitable?
Examples of Internal Uses of Statement Analysis
Examples of Internal Uses of Statement Analysis
• PlanPlan -- Focus on assessing the current financial position and evaluating potential firm opportunities.
• ControlControl -- Focus on return on investment for various assets and asset efficiency.
• UnderstandUnderstand -- Focus on understanding how suppliers of funds analyze the firm.
• PlanPlan -- Focus on assessing the current financial position and evaluating potential firm opportunities.
• ControlControl -- Focus on return on investment for various assets and asset efficiency.
• UnderstandUnderstand -- Focus on understanding how suppliers of funds analyze the firm.
Users of Financial InformationUsers of Financial InformationExternalExternal
• InvestorsInvestors
• OthersOthers– Regulatory agenciesRegulatory agencies
– Tax authoritiesTax authorities
– CustomersCustomers
– Labor UnionsLabor Unions
– Economic plannersEconomic planners
• CreditorsCreditors
Users of Financial InformationUsers of Financial InformationExternal Users Ask?External Users Ask?
Earning enough?Earning enough? Compare to competition?Compare to competition?
Will the company be able to pay bills Will the company be able to pay bills when due?when due?
Examples of External Uses of Statement Analysis
Examples of External Uses of Statement Analysis
• Trade CreditorsTrade Creditors -- Focus on the liquidity of the firm.
• BondholdersBondholders -- Focus on the long-term cash flow of the firm.
• ShareholdersShareholders -- Focus on the profitability and long-term health of the firm.
• Trade CreditorsTrade Creditors -- Focus on the liquidity of the firm.
• BondholdersBondholders -- Focus on the long-term cash flow of the firm.
• ShareholdersShareholders -- Focus on the profitability and long-term health of the firm.
##33 Types of Business Activity Types of Business Activity
• FinancingFinancing
• InvestingInvesting
• OperatingOperating
Financing ActivitiesFinancing Activities
• Borrowing createsBorrowing creates liabilitiesliabilities– Bank loansBank loans– Debt securitiesDebt securities– Goods on credit or payablesGoods on credit or payables
• Selling stockSelling stock creates creates stockholders’ equitystockholders’ equity
Investing ActivitiesInvesting Activities• Obtaining resources or Obtaining resources or
assets assets to operate the to operate the businessbusiness– LandLand– BuildingsBuildings– VehiclesVehicles– ComputersComputers– FurnitureFurniture
Operating ActivitiesOperating Activities• Primary activity of businessPrimary activity of business
– Selling goodsSelling goods– Providing servicesProviding services– ManufacturingManufacturing– Cost of SalesCost of Sales– AdvertisingAdvertising– Paying employeesPaying employees– Paying utilitiesPaying utilities
Operating ActivitiesOperating Activities
• RevenueRevenue is generated from sales or is generated from sales or servicesservices
• ExpensesExpenses are the cost of doing business are the cost of doing business
• If revenue If revenue >> expense expense == Net IncomeNet Income
• If revenue If revenue << expense expense == Net Loss!Net Loss!
##44 Describe Content and Purpose of Describe Content and Purpose of
Financial StatementsFinancial Statements• Accountants communicate
with users through four financial statements
• Income StatementIncome Statement
• Retained Earnings StatementRetained Earnings Statement
• Balance SheetBalance Sheet
• Statement of Cash FlowsStatement of Cash Flows
Income Statement or Statement of Income Statement or Statement of Profit and LossProfit and Loss
• Reports operating success or failure for a Reports operating success or failure for a
period.period.
• Summarizes revenues and expenses for Summarizes revenues and expenses for
period: period: month, quarter, or year.month, quarter, or year.
• If revenue If revenue >> expense expense == Net Income.Net Income.
A summary of a firm’s revenues and expenses over a specified period, ending with net income or loss for the period.
Income StatementIncome Statement
Do this statement first!Do this statement first!
Retained Earnings StatementRetained Earnings Statement
• Shows changes in retained earnings for Shows changes in retained earnings for period: period: month, quarter, or yearmonth, quarter, or year
• Beginning balanceBeginning balance
• AddAdd Net Income from income Net Income from income statement!statement!
• Deduct DividendsDeduct Dividends
• Ending balanceEnding balance
A financial statement outlining the changes in retained earnings for a specified period.
Retained Earnings StatementRetained Earnings Statement
Do this statement second!Do this statement second!
Balance Sheet or Statement of Balance Sheet or Statement of Financial PositionFinancial Position
• Reports Reports assetsassets and claims to assets. and claims to assets.
• Claims of creditors, Claims of creditors, liabilitiesliabilities..
• Claims of owners, Claims of owners, stockholders’ equitystockholders’ equity..
• AssetsAssets = Liabilities + Stockholders’ Equity= Liabilities + Stockholders’ Equity
• Specific date – Specific date – one point in time!one point in time!
A summary of a firm’s financial position on a given date that shows total assets = total
liabilities + owners’ equity.
Balance SheetBalance Sheet
From From Retained Retained Earnings Earnings StatementStatement
Statement of Cash FlowsStatement of Cash Flows
• Provides information about cash receipts and cash Provides information about cash receipts and cash
paymentspayments
• Summarizes for period: Summarizes for period: month, quarter, or year.month, quarter, or year.
• Cash effects of operating, investing, and financing Cash effects of operating, investing, and financing
activities.activities.
A statement that gives the aggregate data regarding all cash inflows a company receives from both its ongoing
operations and external investment sources, as well as all cash outflows that pay for business activities and
investments during a given quarter.
Statement of Cash FlowsStatement of Cash Flows
• Where did the cash come from?Where did the cash come from?
• How was cash used during the period?How was cash used during the period?
• What was the change in the cash What was the change in the cash
balance during the period?balance during the period?
• You can’t survive without cash!You can’t survive without cash!
Statement of Cash FlowsStatement of Cash Flows
Agrees Agrees
withwith Balance Balance SheetSheet
#5#5 Explain the Meaning of Explain the Meaning of Assets, Liabilities, and Assets, Liabilities, and Stockholders’ Equity. Stockholders’ Equity.
State the Basic Accounting State the Basic Accounting EquationEquation
AssetsAssets• Resources owned by the businessResources owned by the business
– CashCash– Accounts receivableAccounts receivable– InventoriesInventories– BuildingBuilding– Furniture and fixturesFurniture and fixtures– EquipmentEquipment– SuppliesSupplies
LiabilitiesLiabilities
• Obligations or debts of businessObligations or debts of business– Notes payableNotes payable– Accounts payableAccounts payable– Interest payableInterest payable– Salaries payableSalaries payable– Unearned revenueUnearned revenue
Stockholders’ EquityStockholders’ Equity
• Ownership claims on assetsOwnership claims on assets• Paid-in capitalPaid-in capital
– Common stockCommon stock
• Retained earningsRetained earnings
Basic Accounting EquationBasic Accounting Equation
Assets = Assets =
Liabilities + Stockholders’ EquityLiabilities + Stockholders’ Equity
##66 Components that Supplement Components that Supplement the Financial Statements in an the Financial Statements in an
Annual ReportAnnual Report
• Managements Discussion and AnalysisManagements Discussion and Analysis
• Notes to Financial StatementsNotes to Financial Statements
• Auditor’s reportAuditor’s report
Management’s Discussion and Management’s Discussion and Analysis covers three items:Analysis covers three items:
1.1. LiquidityLiquidity
2.2. Capital resourcesCapital resources
3.3. Results of operationsResults of operations
Management’s Discussion and Management’s Discussion and AnalysisAnalysis
Notes to Financial StatementsNotes to Financial Statements
• Explanatory notes and supplementary Explanatory notes and supplementary schedulesschedules
• Clarifies information in financial statementsClarifies information in financial statements• Expands with additional detailExpands with additional detail• Describes accounting policiesDescribes accounting policies• Explains uncertainties and contingenciesExplains uncertainties and contingencies
Notes to Financial StatementsNotes to Financial Statements
Auditor’s ReportAuditor’s Report
• Certified Public Accountant – CPACertified Public Accountant – CPA• Auditor (CPA) conducts independent Auditor (CPA) conducts independent
examination of financial statementsexamination of financial statements• Fair representation?Fair representation?• Follow Follow generally accepted accounting generally accepted accounting
principlesprinciples (GAAP)?(GAAP)?• Unqualified opinionUnqualified opinion
Auditor’s ReportAuditor’s Report
Monetary Unit AssumptionMonetary Unit Assumption
• Only what can be expressed in moneyOnly what can be expressed in money• Assumes unit of measure stays constantAssumes unit of measure stays constant
© PhotoDisc/Getty Images© PhotoDisc/Getty Images
Economic Entity AssumptionEconomic Entity Assumption
• Economic events identified with unitEconomic events identified with unit• Separately identified apart from ownerSeparately identified apart from owner
Time Period AssumptionTime Period Assumption
• Divide life of business into artificial time Divide life of business into artificial time periodsperiods
• Monthly, quarterly, yearlyMonthly, quarterly, yearly
Going Concern AssumptionGoing Concern Assumption
• Divide life of business into artificial time Divide life of business into artificial time periodsperiods
• Monthly, quarterly, yearlyMonthly, quarterly, yearly
Cost PrincipleCost Principle
• Assets must be recorded at costAssets must be recorded at cost• Verifiable vs. subjectiveVerifiable vs. subjective
Full Disclosure PrincipleFull Disclosure Principle
• All circumstances and events that would All circumstances and events that would make a difference to users must be make a difference to users must be discloseddisclosed
Do It Problem: CSU CorporationDo It Problem: CSU Corporation
Service revenue $17,000Accounts receivable $4,000Accounts payable $2,000Building rental expense $9,000Notes payable $5,000Common stock $10,000Retained earnings ?Equipment $16,000Insurance expense $1,000Supplies $1,800Supplies expense $200Cash $2,000Dividends $600
• CSU begins on CSU begins on Jan. 1, 2005Jan. 1, 2005
• For year ended For year ended Dec. 31, 2005Dec. 31, 2005, , prepareprepare– Income statementIncome statement
– Retained earnings Retained earnings statementstatement
– Balance sheetBalance sheet
Do It Problem: CSU CorporationDo It Problem: CSU Corporation
Service revenue $17,000Accounts receivable $4,000Accounts payable $2,000Building rental expense $9,000Notes payable $5,000Common stock $10,000Retained earnings ?Equipment $16,000Insurance expense $1,000Supplies $1,800Supplies expense $200Cash $2,000Dividends $600
• Action step 1Action step 1: : Report the Report the revenues & revenues & expenses for a expenses for a period of time, period of time, Income StatementIncome Statement
Do It Problem: CSU CorporationDo It Problem: CSU Corporation
Service revenue $17,000Accounts receivable $4,000Accounts payable $2,000Building rental expense $9,000Notes payable $5,000Common stock $10,000Retained earnings ?Equipment $16,000Insurance expense $1,000Supplies $1,800Supplies expense $200Cash $2,000Dividends $600
• Action step 1Action step 1: : Report the Report the revenues & revenues & expenses for a expenses for a period of time, period of time, Income StatementIncome Statement
Do It Problem: CSU CorporationDo It Problem: CSU Corporation
CSU CorporationCSU CorporationIncome StatementIncome Statement
For the Year Ended December 31, 2005For the Year Ended December 31, 2005
Create the headingCreate the heading
Name of the Name of the statementstatement
Name of the Name of the companycompany
Period Period of timeof time
Do It Problem: CSU CorporationDo It Problem: CSU Corporation
CSU CorporationCSU CorporationIncome StatementIncome Statement
For the Year Ended December 31, 2005For the Year Ended December 31, 2005RevenuesRevenues
Service revenueService revenue $17,000$17,000
List the revenuesList the revenues
Use dollar signs to denote U.S. currencyUse dollar signs to denote U.S. currency
Do It Problem: CSU CorporationDo It Problem: CSU Corporation
CSU CorporationCSU CorporationIncome StatementIncome Statement
For the Year Ended December 31, 2005For the Year Ended December 31, 2005RevenuesRevenues
Service revenueService revenue $17,000$17,000ExpensesExpenses
Rent expenseRent expense $9,000$9,000Insurance expenseInsurance expense 1,000 1,000Supplies expenseSupplies expense 200 200
Total expensesTotal expenses 10,200 10,200
________________
List the expenses & underline sub-totalsList the expenses & underline sub-totals________________
Do It Problem: CSU CorporationDo It Problem: CSU Corporation
CSU CorporationCSU CorporationIncome StatementIncome Statement
For the Year Ended December 31, 2005For the Year Ended December 31, 2005RevenuesRevenues
Service revenueService revenue $17,000$17,000ExpensesExpenses
Rent expenseRent expense $9,000$9,000Insurance expenseInsurance expense 1,000 1,000Supplies expenseSupplies expense 200 200
Total expensesTotal expenses 10,200 10,200Net IncomeNet Income $ 6,800$ 6,800
Calculate net income: revenues - expensesCalculate net income: revenues - expenses
________________________________
________________________________
Do It Problem: CSU CorporationDo It Problem: CSU Corporation
Service revenue $17,000Accounts receivable $4,000Accounts payable $2,000Building rental expense $9,000Notes payable $5,000Common stock $10,000Retained earnings ?Equipment $16,000Insurance expense $1,000Supplies $1,800Supplies expense $200Cash $2,000Dividends $600
• Action step 2Action step 2: : Show amounts Show amounts and causes of and causes of changes in changes in retained earningsretained earnings
• Use Net Income Use Net Income from Income from Income StatementStatement
• DividendsDividends
Do It Problem: CSU CorporationDo It Problem: CSU Corporation
CSU CorporationCSU CorporationRetained Earnings StatementRetained Earnings Statement
For the Year Ended December 31, 2005For the Year Ended December 31, 2005
Retained earnings, January 1Retained earnings, January 1 $ 0$ 0
Add: Net incomeAdd: Net income 6,800 6,800 6,8006,800
Less: DividendsLess: Dividends 600 600Retained earnings, Dec. 31 Retained earnings, Dec. 31 $ 6,800$ 6,800________________________________
________________
________________
Do It Problem: CSU CorporationDo It Problem: CSU Corporation
Service revenue $17,000Accounts receivable $4,000Accounts payable $2,000Building rental expense $9,000Notes payable $5,000Common stock $10,000Retained earnings $6,800Equipment $16,000Insurance expense $1,000Supplies $1,800Supplies expense $200Cash $2,000Dividends $600
• Action step 3Action step 3: : Present assets and Present assets and claims to those claims to those assets at a assets at a specific point in specific point in time on the time on the Balance SheetBalance Sheet
• Use $6,800 Use $6,800 Retained earnings Retained earnings from previous from previous statement!statement!
CSU CORPORATION CSU CORPORATION Balance SheetBalance Sheet
December 31, 2005 December 31, 2005AssetsAssets
CashCash $ 2,000$ 2,000Accounts receivableAccounts receivable 4,000 4,000SuppliesSupplies 1,800 1,800EquipmentEquipment 16,000 16,000Total assets Total assets $23,800$23,800
Liabilities and Stockholders’ EquityLiabilities and Stockholders’ EquityLiabilitiesLiabilities
Accounts payableAccounts payable $ 2,000$ 2,000Notes payableNotes payable 5,0005,000
Total liabilitiesTotal liabilities 7,000 7,000Stockholders’ equityStockholders’ equity
Common stockCommon stock $10,000$10,000Retained earningsRetained earnings 6,8006,800
Total Stockholders’ equityTotal Stockholders’ equity 16,80016,800Total liabilities and stockholders’ equityTotal liabilities and stockholders’ equity $23,800$23,800