Chapter 1

Business Decisions and Financial Reporting

McGraw-Hill/Irwin

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objective 1

Describe various organizational forms and business decisionmakers.

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Organizational Forms
Sole Proprietorship Partnership
Business organization owned by one person. The owner is personally liable for all debts of the business. Business organization owned by two or more people. Each partner is personally liable for all debts of the business. A separate entity from both a legal and accounting perspective. Owners of corporations (stockholders) are not personally responsible for debts of the corporation.
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Corporation

Organizational Forms
Corporations

Public Companies
Have their stock bought and sold on stock exchanges.

Private Companies
Have their stock bought and sold privately.

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Accounting for Business Decisions Accounting System

Produces

Financial Accounting Reports

Managerial Accounting Reports

Provided to

External Users Creditors Investors Others

Internal Users Managers

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Learning Objective 2

Describe the purpose, structure, and content of the four basic financial statements.

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The Basic Accounting Equation

Resources Owned . . . by the company to creditors Resources Owed . . . to stockholders

Separate Entity Assumption

Requires that a businesss financial reports include only the activities of the business and not those of its stockholders.
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Assets
Resources controlled by the company that have measurable value and are expected to provide future benefits to the company.

Cash Supplies Furniture

Equipment

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Liabilities
Amounts owed by the business to creditors.

Notes Payable

Accounts Payable

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Stockholders Equity
Owners claim to the business resources.

Stock Certificate

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Revenues, Expenses and Net Income

Revenues
Sales of goods or services to customers. They are measured at the amount the business charges the customer.

Expenses
The costs of business necessary to earn revenues, including wages to employees, advertising, insurance, and utilities.

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Dividends
Payments a company periodically makes to its stockholders as a return on their investment.

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Financial Statements
Balance Sheet Income Statement
Statement of Retained Earnings Statement of Cash Flows
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Financial Statement Equations

Balance Sheet

Income Statement

Dividends

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The Income Statement

Purpose Reports the amount of revenues less expenses for a period of time.
PIZZA AROMA, INC. Income Statement For the Month Ended September 30, 2008 Revenues Sales revenue $ 11,000 Total revenue 11,000 Expenses Supplies expense Wages expense Rent expense Utilities expense Insurance expense Advertising expense Total expenses Net income 4,000 2,000 2,000 600 300 100 9,000 2,000

Unit of Measure
Results of business activities should be reported in an appropriate monetary unit, which in the United States is the U.S. dollar.

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The Income Statement

Financial Statement Heading
All financial statements start with a heading that answers three questions: Who
PIZZA AROMA, INC. Income Statement For the Month Ended September 30, 2008 Revenues Sales revenue $ 11,000 Total revenue 11,000 Expenses Supplies expense Wages expense Rent expense Utilities expense Insurance expense Advertising expense Total expenses Net income 4,000 2,000 2,000 600 300 100 9,000 2,000

What
When

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The Statement of Retained Earnings

Purpose Reports the way that net income and the distribution of dividends affected the financial position of the company during the period.
PIZZA AROMA, INC. Statement of Retained Earnings For the Month Ended September 30, 2008 Retained earnings, Sept. 1, 2008 $ Add: Net income 2,000 Subtract: Dividends (1,000) Retained earnings, Sept. 30, 2008 $ 1,000

The financial statement heading answers the three questions who, what, and when.

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The Balance Sheet

Purpose Reports at a point in time: 1. What a business owns (assets) 2. What it owes to creditors (liabilities)
PIZZA AROMA, INC. Balance Sheet At September 30, 2008 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities Accounts payable Notes payable Total liabilities Stockholders' Equity Contributed capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity $ 14,000 1,000 3,000 40,000 $ 58,000 $ 7,000 20,000 27,000

3. What is left over for the owners of the companys stock (stockholders equity).

30,000 1,000 31,000 $ 58,000

The financial statement heading answers the three questions who, what, and when.
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The Balance Sheet

PIZZA AROMA, INC. Balance Sheet At September 30, 2008 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities Accounts payable Notes payable Total liabilities Stockholders' Equity Contributed capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity $ 14,000 1,000 3,000 40,000 $ 58,000 $ 7,000 20,000 27,000

30,000 1,000 31,000 $ 58,000

BASIC ACCOUNTING EQUATION Assets = Liabilities + Stockholders Equity

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The Balance Sheet

Assets are listed in order of liquidity, that is, how quickly they are used up or converted into cash. Notes payable are like accounts payable except that they: (1) are not interest free; (2) will not be paid as soon; and (3) are formal written debt contracts.
PIZZA AROMA, INC. Balance Sheet At September 30, 2008 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities Accounts payable Notes payable Total liabilities Stockholders' Equity Contributed capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity $ 14,000 1,000 3,000 40,000 $ 58,000 $ 7,000 20,000 27,000

30,000 1,000 31,000 $ 58,000

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The Statement of Cash Flows

Purpose
Summarizes how a businesss operating, investing and financing activities caused its cash balance to change over a particular period of time.
PIZZA AROMA, INC. Statement of Cash Flows For the Month Ended September 30, 2008 Cash Flows from Operating Activities Cash collected from customers $ 10,000 Cash paid to suppliers and employees (5,000) Cash provided by operating activities 5,000 Cash Flows from Investing Activities Cash paid to buy equipment (40,000) Cash used in investing activities (40,000) Cash Flows from Financing Activities Capital contributed by stockholders 30,000 Cash dividends paid to stockholders (1,000) Cash borrowed from the bank 20,000 Cash provided by financing activities 49,000 Change in cash 14,000 Beginning cash balance, Sept. 1, 2008 Ending cash balance, Sept. 30, 2008 $ 14,000

The financial statement heading answers the three questions who, what, and when.
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PIZZA AROMA, INC. Income Statement For the Month Ended September 30, 2008 Revenues Sales revenue $ 11,000 Total revenue 11,000 Expenses Supplies expense Wages expense Rent expense Utilities expense Insurance expense Advertising expense Total expenses Net income

Relationships Among the Financial Statements

Net income flows from the Income Statement to the Statement of Retained Earnings.

4,000 2,000 2,000 600 300 100 9,000 2,000

PIZZA AROMA, INC. Statement of Retained Earnings For the Month Ended September 30, 2008 Retained earnings, Sept. 1, 2008 $ Add: Net income 2,000 Subtract: Dividends (1,000) Retained earnings, Sept. 30, 2008 $ 1,000

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PIZZA AROMA, INC. Income Statement For the Month Ended September 30, 2008 Revenues Sales revenue $ 11,000 Total revenue 11,000 Expenses Supplies expense Wages expense Rent expense Utilities expense Insurance expense Advertising expense Total expenses Net income

Relationships Among the Financial Statements

Ending Retained Earnings flows 4,000 2,000 from the 2,000 600 Statement of 300 100 Retained 9,000 $ 2,000 Earnings to the Balance Sheet.
PIZZA AROMA, INC. Balance Sheet At September 30, 2008 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities Accounts payable Notes payable Total liabilities Stockholders' Equity Contributed capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity $ 14,000 1,000 3,000 40,000 $ 58,000 $ 7,000 20,000 27,000

PIZZA AROMA, INC. Statement of Retained Earnings For the Month Ended September 30, 2008 Retained earnings, Sept. 1, 2008 $ Add: Net income 2,000 Subtract: Dividends (1,000) Retained earnings, Sept. 30, 2008 $ 1,000

30,000 1,000 31,000 $ 58,000

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Relationships Among the Financial Statements

PIZZA AROMA, INC. Statement of Cash Flows For the Month Ended September 30, 2008 Cash Flows from Operating Activities Cash collected from customers $ 10,000 Cash paid to suppliers and employees (5,000) Cash provided by operating activities 5,000 Cash Flows from Investing Activities Cash paid to buy equipment (40,000) Cash used in investing activities (40,000) Cash Flows from Financing Activities Capital contributed by stockholders 30,000 Cash dividends paid to stockholders (1,000) Cash borrowed from the bank 20,000 Cash provided by financing activities 49,000 Change in cash 14,000 Beginning cash balance, Sept. 1, 2008 Ending cash balance, Sept. 30, 2008 $ 14,000

PIZZA AROMA, INC. Balance Sheet At September 30, 2008 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities Accounts payable Notes payable Total liabilities Stockholders' Equity Contributed capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity $ 14,000 1,000 3,000 40,000 $ 58,000 $ 7,000 20,000 27,000

Cash on the Balance Sheet and Cash at End of Year on the Statement of Cash Flows agree.

30,000 1,000 31,000 $ 58,000

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Notes to the Financial Statements

Notes help financial statement users understand how the amounts were derived and what other information may affect their decisions.
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Learning Objective 3

Explain how financial statements are relevant to users.

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Relevance to Financial Statement Users

Creditors
(1) Is the company generating enough cash to make payments on its loans? (2) Does the company have enough assets to cover its liabilities?

Investors
(1) What is the immediate return on my contributions (through dividends)? (2) What is the longterm return (by selling my stock in the market)?

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Learning Objective 4

Describe factors that enhance the reliability of financial reporting.

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Generally Accepted Accounting Principles (GAAP)

GAAP are the underlying rules for financial reporting and are established by the Financial Accounting Standards Board (FASB) under the authority granted by the Securities and Exchange Commission (SEC).

SEC

FASB

GAAP
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Generally Accepted Accounting Principles (GAAP)

Under authority granted by the SEC, The Public Company Accounting Oversight Board (PCAOB) establishes the rules used by auditors, who report on whether a companys financial statements are, in fact, prepared following GAAP.

PCAOB

SEC

FASB

Auditing Rules

Auditors report whether companies used GAAP

GAAP
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Accounting Ethics
Sarbanes-Oxley Act of 2002
Top managers sign a report certifying their responsibilities for the financial statements Maintain an audited system of internal controls to ensure accuracy in accounting reports

Maintain an independent committee to ensure managers cooperate with auditors

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Chapter 1 Supplement
Accounting Careers

McGraw-Hill/Irwin

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Overview of Career Choices in Accounting Private Accounting Public company Private company Nonprofit organization Public Accounting

Type of Organization

CPA firm

Multinational Mid-sized Small

Size of Organization

"Big 4" (international partnerships): Deloitte & Touche, Ernst & Young, KPMG, PricewaterhouseCoopers Regional Local (partnership or proprietorship)

Auditing (assurance services) Taxation General accounting Consulting such as forensic Budgeting (fraud) accounting, computer Cost accounting systems security, outsourcing, Taxation Functions and Specializations bookkeeping services, and Internal auditing industry specialization Others (e.g., finance, information (e.g., high tech, banking, systems, forecasting) mergers and acquisitions, and communications) $30,000-$43,000* $36,000-$52,000* depending on type, size, depending on size, geographic Starting Salaries geographic location, and location, and functional area or functional area specialization Chief Financial Officer (CFO), Senior Accountant, Controller, Treasurer, Typical Senior Positions Manager, Director of Accounting Partner

Source: www.collegegrad.com/careers/all.shtml

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End of Chapter 1

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