Financial Statements

and Business Decisions

Chapter 1

McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

 Understanding the Business
The Players
Investors Creditors

Managers

1. Purchase parts 2. Manufacture

and labor product
The
Business
Operatio
ns
4. Collect cash from 3. Sell products
customers and pay to customers
creditors

McGraw-Hill/Irwin Slide 3
 The Accounting System

Accounting System

Financial Accounting System Managerial Accounting System

Periodic financial statements and Detailed plans and continuous
related disclosures performance reports

External Decision Makers Internal Decision Makers

Investors, creditors, Managers throughout the
suppliers, customers, etc. organization

McGraw-Hill/Irwin Slide 4
 The Four Basic Financial Statements
1. On a company’s BALANCE SHEET, all resources owned and
amounts owed are listed in order of liquidity. The difference between
the resources owned and the amounts owed, represents the
stockholders’ equity in the business.what u have and wher u get it
from
2. On a company’s INCOME STATEMENT, all the revenues earned
from sales to customers are listed along with the expenses incurred
to produce those revenues.
3. On a company’s STATEMENT OF RETAINED EARNINGS
accumulated net earnings less the dividends paid to owners
represent reinvestments in the core business.
4. On a company’s STATEMENT OF CASH FLOWS, all sources and
uses of cash are listed. Cash is generated by the company’s
operations. Cash is spent on investments in buildings, manufacturing
equipment, and other assets. Financing activities involve amounts
borrowed from long-term creditors and sale of stock to
owners.inflows and outflows
McGraw-Hill/Irwin Slide 5
 The Accounting Equation

A = L + SE
(Assets) (Liabilities) (Stockholders’
Equity)

Economic Sources of Financing for Economic

Resources Resources
Liabilities: From Creditors
Stockholders’ Equity: From Stockholders

McGraw-Hill/Irwin Slide 6
 Relationships Among the Statements
1. Net income from the income statement results in
an increase in ending retained earnings on the
statement of retained earnings.

         
Income Statement      
Revenues $ 15,500   Statement of Retained Earnings
Expenses (8,500)   Beginning retained earnings $ 59,000
Net income $ 7,000   Net income 7,000
      Dividends (2,500)
      Ending retained earnings $ 63,500
         

McGraw-Hill/Irwin Slide 7
 Relationships Among the Statements
2. Ending retained earnings from the statement of retained
earnings is one of the two components of stockholders’ equity
on the balance sheet.

Statement of Retained Earnings   Balance Sheet

Beginning retained $   Cash $
earnings 59,000 14,000
Net income   Other assets
7,000 171,500
Dividends   Total assets $
(2,500) 185,500
Ending retained earnings $   Liabilities $
63,500 42,000
      Stockholders' Equity  
      Common stock
80,000
      Retained earnings
63,500
      Total liabilities and $
McGraw-Hill/Irwin equity 185,500 Slide 8
 Relationships Among the Statements
3. The change in cash on the statement of cash
flows is added to the beginning-of-year balance
in cash to arrive at end-of-year cash on the
balance sheet.

Statement of Cash Flows   Balance Sheet

Cash flows from operating $   Cash $
activities 21,000 14,000
Cash flows from investing   Other assets
activities (16,000) 171,500
Cash flows from financing   Total assets $
activities 3,500 185,500
Increase in cash $   Liabilities $
8,500 42,000
Beginning cash balance   Stockholders' Equity  
5,500
Ending cash balance $   Common stock
14,000 80,000
      Retained earnings
63,500
      Total liabilities and $
equity 185,500
McGraw-Hill/Irwin           Slide 9
 Management Uses of Financial
Statements
Marketing managers and credit managers use
customers’ financial statements to decide whether
to extend credit.

Purchasing managers use suppliers’ financial

statements to decide whether suppliers have the
resources to meet the demand for products.

Employees’ union and human resource managers

use the company’s financial statements as a basis
for contract negotiations regarding pay rates.

McGraw-Hill/Irwin Slide 10
 Generally Accepted Accounting
Principles

Securities Act of 1933

Securities and Exchange Act of 1934

The Securities and Exchange Commission (SEC)

has been given broad powers to determine
measurement rules for
financial statements.

McGraw-Hill/Irwin Slide 11
 Generally Accepted Accounting
Principles

The SEC has worked closely with the

accounting profession to
work out the detailed rules that have
become known as GAAP.

Currently, the Financial Accounting

Standards Board (FASB) is recognized
as the body to formulate GAAP.

McGraw-Hill/Irwin Slide 12
 Generally Accepted Accounting
Principles

Companies incur the cost of preparing

the financial statements and bear the
following economic consequences . . .

 Effects on the selling price of stock.

 Effects on the amount of bonuses
received by managers and other employees.
 Loss of competitive information to other
companies.

McGraw-Hill/Irwin Slide 13
 Independent Auditors

Auditors express an Overall, I believe

opinion as to the these financial
fairness of the financial statements are
fair.
statement
presentation.
Independent auditors
have responsibilities
that extend to the
general public.

McGraw-Hill/Irwin Slide 14
End of Chapter 1

© 2009 The McGraw-Hill Companies, Inc.