Understanding Accounting: A Language of Financial Communication

1. Chapter 1 Accounting as a Form of Communication Financial Accounting 4e by Porter and Norton

2. Decisions Made with Financial Information Add new product line?? Invest?? Build new plant?? Borrow $$?? Loan $$?? Extend credit $$?? Start new business?? Sell stocks or bonds??

3. What is Accounting? Identifying Economic Information to various users Measuring Communicating

4. Banks Creditors Current and Potential Owners Financial Analysts Suppliers Trade Organizations Government Agencies Internal and ExternalUsers of Accounting Information Internal Users - Management

5. 1-14 The Accounting Equation Basic Accounting Equation Assets = Liabilities + Stockholders’ Equity Economic Sources of financing . . . resources Liabilities: from creditors Equity: from stockholders. =

6. Economic Resources Creditors' Claims to Assets Owners' Claims to Assets = + The Accounting Equation Assets = Liabilities + Owners’ Equity (or Stockholders' Equity) Accounts payable Notes payable Capital stock Retained earnings Examples: Cash Accounts receivable Inventory

7. 1-13 The Balance Sheet Body of the Statement • Assets • Economic benefits owned by the business as a result of past transactions. • Liabilities • Debts or obligations of the business that result from past transactions. • Stockholders’ Equity • Amount of financing provided by owners of the business and operations.

8. 1. Name of entity 2. Title of statement 3. Specific date 4. Unit of measure The Balance Sheet reports the financial position of an entity at a particular point in time.

9. Assets are economic resources owned by the business as a result of past transactions. Assets are listed by their ease of conversion into cash.

10. 1-15 Assets are listed by their ease of conversion into cash.

11. Liabilities are debts or obligations of the business that result from past transactions.

12. 1-16

13. Equity is the amount of financing provided by owners of the business and earnings.

14. 1-17

15. 1-18 Assets = Liabilities + Stockholders’ Equity Use $ on the first item in a group and on the group total.

16. 1. Name of entity 2. Title of statement 3. Specific date (Unlike the balance sheet, this statement covers a specified period of time.) 4. Unit of measure

17. 1-20

18. Revenues are earnings from the sale of goods or services to customers. Revenue is recognized in the period in which goods and services are sold, not necessarily the period in which cash is received.

19. Expenses are the dollar amount of resources used up by the entity to earn revenues during a period. An expense is recognized in the period in which goods and services are used, not necessarily the period in which cash is paid.

20. If expenses exceed revenues, we report net loss.

21. 1-32

22. 1. Name of entity 2. Title of statement 3. Specific date (Like the income statement, this statement covers a specified period of time.) 4. Unit of measure

23. The Statement of Retained Earnings reports the way that net income and the distribution of dividends affect the financial position of the company during a period.

24. 1-35

25. 1. Name of entity 2. Title of statement 3. Specific date (Like the income statement and statement of retained earnings, this statement covers a specified period of time.) 4. Unit of measure

26. The Statement of Cash Flows reports the inflows and outflows of cash during the period in the categories of operating, investing, and financing.

27. The statement ends with a reconciliation of Cash.

28. Relationship Among the Financial Statements Net income from the income statement increases ending retained earnings on the statement of retained earnings.

29. Relationship Among the Financial Statements Ending retained earnings from the statement of retained earnings is one of the components of stockholders’ equity on the balance sheet.

30. Relationship Among the Financial Statements The change in cash on the statement of cash flows added to the beginning of the year balance in cash equals the ending balance in cash on the balance sheet.

31. GAAP FASB SEC AICPA The Rules of the Game • The rules • The rule makers • The rule enforcers • The CPA regulators

32. Financial Statement Assumptions Economic Entity Cost Principle Time Period Going Concern Monetary Unit

33. Owners’ Books & Records Business Books & Records Economic Entity Concept • Each entity has its own books, records and financial statements that are separate from owners • No intermingling of personal and business assets and liabilities or income and expenses

34. Cost Principle • Record assets at cost paid to acquire them • Continue to value assets at historical cost until sold • More objective than market value

35. Going Concern • Assume business will continue indefinitely into the foreseeable future • Justifies use of historical cost

36. Monetary Unit • How we measure (e.g. U.S. dollar, Japanese yen, Mexican peso, etc.) • Assumes economic measure is relatively stable; no adjustment for inflation made in financial statements

37. Time Period Assumption • Assumes it is possible to break up an entity’s earnings in discrete time periods (a month, quarter, year) • Necessary to provide users with financial results on a timely basis • Requires use of estimates

38. Where Accountants Work • Private Business • Nonprofit Organizations • Public Accounting • audit • tax • management consulting • Educational Institutions

39. End of Chapter 1