Lecture Accounting: What the numbers mean (5/e) - Chapter 2: Financial statements and accounting concepts/principles

After reading this chapter, you should be able to answer the following questions: What are generally accepted accounting principle? What kind of information is reported on each financial statement and how are the financial statements related? What are transactions? What is the meaning and usefulness of the accounting equation? What are meanings of the captions in the financial statements?...

CHAPTER FINANCIAL STATEMENTS AND ACCOUNTING CONCEPTS/PRINCIPLES McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objectives What are generally accepted accounting principle? What kind of information is reported on each financial statement and how are the financial statements related? What are transactions? What is the meaning and usefulness of the accounting equation? What are meanings of the captions in the financial statements? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objectives Why is cash flow important? What are the limitations of financial statements? What is an annual report and why is it issued? What are some of the business practices related to organizations? McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã McGrawưHill/Irwin What kind of information is reported on each financial statement and how are the financial statements related? âTheMcGrawưHillCompanies,Inc.,2002 Financial Statements ã Result of a process that begins with an economic event • The event becomes a recorded transaction • The transaction becomes part of a firm’s financial statements McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 The Financial Statements • Balance Sheet – financial position at the end of the period • Income Statement – earnings for the period • Statement of Changes in Owners’ Equity – investments by and distributions to owners during the period • Statement of Cash Flows – cash flows for the period McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Process Transactions McGraw­Hill/Irwin Procedures for sorting,  classifying, and  presenting (bookkeeping) Selection of alternative  methods of reflecting the  effects of certain  transactions(accounting) Financial statements âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã What are transactions? What is the meaning and usefulness of the accounting equation? McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Transactions ã Economic interchanges between entities ã Examples are: – A sale – A purchase – Receipts of cash by borrower – Payment of cash by lender McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Balance Sheet ã Financial position at the end of a period A snapshot at a point in time • Also called Statement of Financial Position • Contains three parts: – Assets – Liabilities – Owners’ Equity • Assets = Liabilities + Owners’ Equity McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Cash Flows from Investing Activities • Cash used to purchase long-lived assets • Cash received from sales of long-lived assets • Other changes in cash investments McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Cash Flows from Financing Activities • Cash raised from the sale of long-term debt and common stock • Cash paid to reduce long-term debt and stock outstanding McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Financial Statement Relationships ã All financial statements are related • Net Income from the Income Statement affects Retained Earnings on the Balance Sheet • The Income Statement and the Balance Sheet affect the Statement of Cash Flows McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã What are generally accepted accounting principles? McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Concepts and Principles ã Accounting Entity – entity for which financial statements are being prepared – can be a proprietorship, partnership, corporation, or group of corporations • Going Concern – presumption that the entity will continue to operate in the future • Unit of Measurement – in the United States, the dollar is the measurement unit for all transactions McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Concepts and Principles ã Cost Principle – transactions are recorded at their original cost as measured in dollars • Objectivity – a given transaction should be recorded in the same way in all situations • Accounting Period – the period of time selected for recording results • Matching – expenses are matched with the revenues that produced them McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Concepts and Principles ã Accrual Accounting – revenue recognized at the time of sale and expenses recognized when incurred • Consistency – maintaining the method of accounting for a particular type of transaction • Full Disclosure – all necessary information is presented in the financial statements and notes so investors will not be misled McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Concepts and Principles ã Materiality absolute exactness is not necessary as long as not misleading • Conservatism – make judgments and estimates that result in lower profits and asset valuations rather than higher profits and higher asset valuations McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã What are the limitations of financial statements? McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Limitations of Financial Statements • Financial statements not reflect qualitative economic variables • Balance sheet does not reflect current values • Estimates are used in many areas of accounting McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 More Limitations of Financial Statements • Two firms may use different accounting methods, making comparisons difficult • Inflation is not included in accounting procedures • Financial statements not reflect opportunity costs McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã McGrawưHill/Irwin What is an annual report and why is it issued? ©The McGraw­Hill Companies, Inc., 2002 Annual Report • Distributed to shareholders • Contains: – Financial statements – External auditor’s report – Footnotes and explanatory comments – Letters from the CEO and president McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 Learning Objective • What are some of the business practices related to organizations? McGrawưHill/Irwin âTheMcGrawưHillCompanies,Inc.,2002 Business Practices ã ã ã ã Organizing a business – Sole proprietorship – Partnership – Corporation Fiscal Year – annual reporting period Par value – arbitrary value assigned to stock; no relationship to value Parent and subsidiary corporations – parent owns at least a majority of the stock of another corporation McGraw­Hill/Irwin ©The McGraw­Hill Companies, Inc., 2002 ... What are transactions? What is the meaning and usefulness of the accounting equation? What are meanings of the captions in the financial statements? McGraw­Hill/Irwin ? ?The? ?McGraw­Hill Companies, Inc., 2002... methods of reflecting? ?the? ? effectsofcertain transactions (accounting) Financial statements âTheMcGrawưHillCompanies,Inc.,2002 Learning Objective ã What are transactions? What is the meaning and usefulness of the accounting. .. Objectives What are generally accepted accounting principle? What kind of information is reported on each financial statement and how are the financial statements related? What are transactions? What