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FINANCIAL ACCOUNTING Robert Libby Patricia A. Libby Daniel G. Short Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Chapter 1 Financial Statements and Business Decisions Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 The Objectives of Financial Accounting Financial statements are the primary means of communicating financial information to parties outside the business organization. Balance Sheet Income Statement Stakeholders Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Business Background Business owners (called investors or stockholders) look for two sources of possible gain: Sell Receive a ownership portion of the interest in the company’s future for more earnings in cash than they (dividends). paid. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Business Background Creditors lend money to a company for a specific length of time and gain by charging interest on the money loaned. Loan Dana’s Diner Interest Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Understanding Business Operations Manufacturers either make the parts needed to produce its products or buy the parts from suppliers. Manufacturer Product Customer Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Understanding Business Operations All businesses have an accounting system that . Business managers (internal) Reports information to decision Collects and processes makers. financial information Investors about an organization. (external) Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Understanding Business Operations Accounting System Financial Accounting System Managerial Accounting System (preparation of four basic (preparation of detailed plans, financial statements). forecasts and reports). External Decision Makers Internal Decision Makers (investors, creditors, (managers throughout the suppliers, customers, etc.). organization). Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Information Conveyed in Financial Statements The four basic financial statements . Statement of Cash Flows Statement of Retained Earnings Balance Sheet Income Statement Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Information Conveyed in Financial Statements Most companies prepare financial statements at the end of the quarter (called quarterly reports) and the end of the year (called annual reports). 2001 X Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 Let’s look at MAXIDRIVE CORP.’s financial statements. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 MAXIDRIVE CORP. Balance Sheet At December 31, 20A (In thousands of dollars) Asse ts Cash$ 4,895 Accounts receivable 5,714 Inventories 8,517 Plant 1.and Name equipment of entity 7,154 Land(the separate-entity assumption) 981 Total2. Titleassets of statement $ 27,261 Liabilities3. Specific and Stockholders' date Equity (financialLiabilities snapshot at a specific Accounts pointpayable in time) $ 7,156 Notes payable 9,000 4. Unit measure Total liabilities$ 16,156 (thousands of dollars) Stockholders' Equity Contributed capital$ 2,000 Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity$ 27,261 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 The Balance Sheet BodyBody ofof thethe StatementStatement AssetsAssetsAssets GG EconomicEconomic benefits benefits owned owned by by the the business business as as a a result result of of past past transactions.transactions. LiabilitiesLiabilitiesLiabilities GG DebtsDebts or or obligations obligations of of the the business business that that result result from from past past transactions.transactions. Stockholders’Stockholders’Stockholders’ EquityEquityEquity GG AmountAmount of of financing financing provided provided by by owners owners of of the the business business and and operations.operations. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 The Balance Sheet Basic Accounting Equation AssetsAssets == LiabilitiesLiabilities ++ Stockholders’Stockholders’ EquityEquity Economic Sources of financing . resources = Liabilities: from creditors Equity: from stockholders. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 MAXIDRIVE CORP. Balance Sheet At December 31, 20A (In thousands of dollars) Assets are Asse ts listed by their Cash$ 4,895 Accounts receivable 5,714 ease of Inventories 8,517 conversion Plant and equipment 7,154 into cash. Land 981 Total assets$ 27,261 Liabilities andAmount Stockholders' of cash Equityin the company’s bank Cash account.Liabilities AccountsAccounts payable Amounts owed by customers$ 7,156 from prior Notesreceivable payablesales. 9,000 Total liabilitiesPartial and completed but unsold$ 16,156 Inventories Stockholders'product. Equity ContributedPlant and capital$ 2,000 Factories and production machinery. Retainedequipment earnings 9,105 Total stockholders' equity 11,105 TotalLand liabilities Property and stockholders' on which equity factories are located.$ 27,261 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 MAXIDRIVE CORP. Balance Sheet At December 31, 20A (In thousands of dollars) Asse ts Cash$ 4,895 Accounts receivable 5,714 Accounts Amounts Inventoriesowed to suppliers for prior 8,517 payable purchases.Plant and equipment 7,154 Notes Amounts owedLand on written debt 981 payable contracts. Total assets$ 27,261 Liabilities and Stockholders' Equity Liabilities Accounts payable$ 7,156 Notes payable 9,000 Total liabilities$ 16,156 Stockholders' Equity Contributed capital$ 2,000 Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity$ 27,261 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 MAXIDRIVE CORP. Balance Sheet At December 31, 20A (In thousands of dollars) Asse ts Cash$ 4,895 Accounts receivable 5,714 Inventories 8,517 Plant and equipment 7,154 Land 981 Total assets$ 27,261 Liabilities and Stockholders' Equity Contributed Amounts invested in theLiabilities business by capital stockholders.Accounts payable$ 7,156 Retained Past earningsNotes not payable distributed to 9,000 earnings stockholders. Total liabilities$ 16,156 Stockholders' Equity Contributed capital$ 2,000 Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity$ 27,261 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 MAXIDRIVE CORP. Balance Sheet At December 31, 20A (In thousands of dollars) Asse ts Use $ on the Cash$ 4,895 first item in a Accounts receivable 5,714 Inventories 8,517 group Plant and equipment 7,154 and on the Land 981 group total. Total assets $ 27,261 Liabilities and Stockholders' Equity Liabilities Accounts payable$ 7,156 Notes payable 9,000 Assets = Liabilities Total + Stockholders’ liabilities Equity $ 16,156 Stockholders' Equity Contributed capital$ 2,000 Retained earnings 9,105 Total stockholders' equity 11,105 Total liabilities and stockholders' equity $ 27,261 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 MAXIDRIVE CORP. Income Statement For the Year Ended December 31, 20A (In thousands of dollars) Revenues Sales1. Name revenue of entity $ 37,436 Expenses2. Title of statement Cost3. Specific of goods date sold (Unlike the balance$ 26,980 sheet, this Selling,statement general covers and administrative a specified period 3,624 of time.) Research4. Unit measure and development (in thousands of dollars) 1,982 Interest expense 450 Total expenses 33,036 Pretax income$ 4,400 Income tax expense 1,100 Net income $ 3,300 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 MAXIDRIVE CORP. Income Statement TheFor income the Year statement Ended December is divided 31, 20A into (In thousands of dollars) three major captions. ! Revenues Sales revenue$ 37,436 " Expenses Cost of goods sold$ 26,980 Selling, general and administrative 3,624 Research and development 1,982 Interest expense 450 Total expenses 33,036 Pretax income$ 4,400 Income tax expense 1,100 # Net income $ 3,300 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 MAXIDRIVE CORP. Income Statement For the Year Ended December 31, 20A (In thousands of dollars) Revenues Sales revenue$ 37,436 RevenuesExpenses are earnings from the sale of goods Cost of goods sold$ 26,980 or services. Selling, general and administrative 3,624 ResearchRevenue and is development recognized in the period 1,982 in which Interestgoods expense and services are sold, not necessarily 450 Totalthe expenses period in which cash is received. 33,036 Pretax income$ 4,400 Income tax expense 1,100 Net income $ 3,300 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 The Income Statement !!RevenuesRevenues Earnings from the sale of goods or services. When will the revenue from this transaction be recognized? $1,000 sale made Cash from sale on May 25th. collected on June 10th. X X May 2001 June 2001 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 The Income Statement !!RevenuesRevenues Earnings from the sale of goods or services. When will the revenue from this transaction be recognized? $1,000 revenue recognized in May May 2001 June 2001 Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001 MAXIDRIVE CORP. Expenses are theIncome dollar amountStatement of resources used up by theFor entity the Year to earn Ended revenues December during 31, 20A a period. (In thousands of dollars) An expense is recognized in the period in which goods and services are used, not necessarily Revenues the period in which cash is paid. Sales revenue$ 37,436 Expenses Cost of goods sold$ 26,980 Selling, general and administrative 3,624 Research
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