Principles of Accounting

Kimmel • Weygandt • Kieso

Introduction to Financial
Statements
Chapter 1

Prepared by Carol A. Hartley

Providence College
 Study Objectives
1. Describe the primary forms of business
organization.
2. Identify the users and uses of accounting
information.
3. Explain the three principal types of
business activity.
4. Describe the content and purpose of each
of the financial statements.
 Study Objectives
5. Explain the meaning of assets, liabilities,
and stockholders’ equity, and state the
basic accounting equation.
6. Describe the components that supplement
the financial statements in an annual
report.
#
1 Forms of Business
Organization

• Sole proprietorship

• Partnership

• Corporation
 Sole Proprietorship

• Business owned by one person

• Simple to establish
• Owner controlled
• Tax advantages
• Owner personally liable
• Financing difficult
 Partnership
• Two or more owners
• Simple to establish
• Shared controlled
• Broader skills & resources
• Tax advantages
• Personal liability
 Corporation

• Separate legal entity owned by

stockholders
• Easy to transfer ownership
• Greater capital raising potential
• Lower legal liability
• Unfavorable tax treatment
#
2 Users of Financial Information
Internal
• Managers who plan,
organize and run a
business
– Marketing managers
– Production supervisors
– Finance directors
– Company officers
Users of Financial Information
Internal Users Ask?

Cash to pay bills? Cost per unit?

Give raises? Which product is

profitable?
 Users of Financial Information
External
• Investors
• Creditors
• Others
– Regulatory agencies
– Tax authorities
– Customers
– Labor Unions
– Economic planners
Users of Financial Information
External Users Ask?

Earning enough? Compare to competition?

Will the company be able to pay bills

when due?
#
3 Types of Business Activity

• Financing

• Investing

• Operating
Financing Activities
• Borrowing creates liabilities
– Bank loans
– Debt securities
– Goods on credit or payables

• Selling stock creates

stockholders’ equity
 Investing Activities
• Obtaining resources or
assets to operate the
business
– Land
– Buildings
– Vehicles
– Computers
– Furniture
 Operating Activities
• Primary activity of business
– Selling goods
– Providing services
– Manufacturing
– Cost of Sales
– Advertising
– Paying employees
– Paying utilities
 Operating Activities

• Revenue is generated from sales or

services

• Expenses are the cost of doing business

• If revenue > expense = Net Income

• If revenue < expense = Net Loss!

#
4 Describe Content and Purpose
of Financial Statements
• Accountants communicate
with users through four
financial statements
• Income Statement
• Retained Earnings Statement
• Balance Sheet
• Statement of Cash Flows
 Income Statement

• Reports operating success or failure for a

period.
• Summarizes revenues and expenses for
period: month, quarter, or year.
• If revenue > expense = Net Income.
 Income Statement

Do this statement first!

 Retained Earnings Statement
• Shows changes in retained earnings for
period: month, quarter, or year
• Beginning balance
• Add Net Income from income
statement!
• Deduct Dividends
• Ending balance
Retained Earnings Statement

Do this statement second!

 Balance Sheet
• Reports assets and claims to assets.
• Claims of creditors, liabilities.
• Claims of owners, stockholders’ equity.
• Assets = Liabilities + Stockholders’ Equity
• Specific date – one point in time!
Balance Sheet

From
Retained
Earnings
Statement
 Statement of Cash Flows
• Provides information about cash
receipts and cash payments
• Summarizes for period: month, quarter,
or year.
• Cash effects of operating, investing,
and financing activities.
 Statement of Cash Flows
• Where did the cash come from?
• How was cash used during the period?
• What was the change in the cash
balance during the period?
• You can’t survive without cash!
Statement of Cash Flows

Agrees
with
Balance
Sheet
#5 Explain the Meaning of
Assets, Liabilities, and
Stockholders’ Equity.

State the Basic Accounting

Equation
 Assets
• Resources owned by the
business
– Cash
– Accounts receivable
– Inventories
– Building
– Furniture and fixtures
– Equipment
– Supplies
 Liabilities
• Obligations or debts of business
– Notes payable
– Accounts payable
– Interest payable
– Salaries payable
– Unearned revenue
 Stockholders’ Equity
• Ownership claims on assets
• Paid-in capital
– Common stock
• Retained earnings
 Basic Accounting Equation

Assets =
Liabilities + Stockholders’ Equity
#
6 Components that Supplement
the Financial Statements in an
Annual Report

• Managements Discussion and Analysis

• Notes to Financial Statements

• Auditor’s report
Management’s Discussion and
Analysis covers three items:
1. Liquidity
2. Capital resources
3. Results of operations
Management’s Discussion and
Analysis
 Notes to Financial Statements
• Explanatory notes and supplementary
schedules
• Clarifies information in financial statements
• Expands with additional detail
• Describes accounting policies
• Explains uncertainties and contingencies
Notes to Financial Statements
 Auditor’s Report
• Certified Public Accountant – CPA
• Auditor (CPA) conducts independent
examination of financial statements
• Fair representation?
• Follow generally accepted accounting
principles (GAAP)?
• Unqualified opinion
Auditor’s Report
 Monetary Unit Assumption

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• Only what can be expressed in money

• Assumes unit of measure stays constant
 Economic Entity Assumption

• Economic events identified with unit

• Separately identified apart from owner
 Time Period Assumption

• Divide life of business into artificial time

periods
• Monthly, quarterly, yearly
 Going Concern Assumption

• Divide life of business into artificial time

periods
• Monthly, quarterly, yearly
 Cost Principle

• Assets must be recorded at cost

• Verifiable vs. subjective
 Full Disclosure Principle

• All circumstances and events that would

make a difference to users must be
disclosed
Do It Problem: CSU Corporation
Service revenue $17,000 • CSU begins on
Accounts receivable $4,000
Accounts payable $2,000 Jan. 1, 2005
Building rental expense
Notes payable
$9,000
$5,000
• For year ended
Common stock $10,000 Dec. 31, 2005,
Retained earnings ?
Equipment $16,000
prepare
Insurance expense $1,000 – Income statement
Supplies $1,800
Supplies expense $200 – Retained earnings
Cash $2,000 statement
Dividends $600
– Balance sheet
Do It Problem: CSU Corporation
Service revenue $17,000 • Action step 1:
Accounts receivable $4,000
Accounts payable $2,000 Report the
Building rental expense $9,000 revenues &
Notes payable $5,000
Common stock $10,000 expenses for a
Retained earnings ? period of time,
Equipment $16,000
Insurance expense $1,000 Income Statement
Supplies $1,800
Supplies expense $200
Cash $2,000
Dividends $600
Do It Problem: CSU Corporation
Service revenue $17,000 • Action step 1:
Accounts receivable $4,000
Accounts payable $2,000 Report the
Building rental expense $9,000 revenues &
Notes payable $5,000
Common stock $10,000 expenses for a
Retained earnings ? period of time,
Equipment $16,000
Insurance expense $1,000 Income Statement
Supplies $1,800
Supplies expense $200
Cash $2,000
Dividends $600
Do It Problem: CSU Corporation

Create the heading

Name of the
company CSU Corporation
Name of the
Income Statement
statement
For the Year Ended December 31, 2005
Period
of time
Do It Problem: CSU Corporation
CSU Corporation
Income Statement
For the Year Ended December 31, 2005
Revenues
Service revenue $17,000

List the revenues

Use dollar signs to denote U.S. currency
Do It Problem: CSU Corporation
CSU Corporation
Income Statement
For the Year Ended December 31, 2005
Revenues
Service revenue $17,000
Expenses
Rent expense $9,000
Insurance expense 1,000
Supplies expense 200
________
Total expenses 10,200
________
List the expenses & underline sub-totals
Do It Problem: CSU Corporation
CSU Corporation
Income Statement
For the Year Ended December 31, 2005
Revenues
Service revenue $17,000
Expenses
Rent expense $9,000
Insurance expense 1,000
Supplies expense 200
________
Total expenses 10,200
________
Net Income $ 6,800
________
________
Calculate net income: revenues - expenses
Do It Problem: CSU Corporation
Service revenue $17,000 • Action step 2:
Accounts receivable $4,000
Accounts payable $2,000 Show amounts
Building rental expense $9,000 and causes of
Notes payable $5,000
Common stock $10,000 changes in
Retained earnings ? retained earnings
Equipment $16,000
Insurance expense $1,000 • Use Net Income
Supplies $1,800
Supplies expense $200
from Income
Cash $2,000 Statement
Dividends $600
• Dividends
Do It Problem: CSU Corporation
CSU Corporation
Retained Earnings Statement
For the Year Ended December 31, 2005

Retained earnings, January 1 $ 0

Add: Net income 6,800

________
6,800
Less: Dividends 600
________
Retained earnings, Dec. 31 $ 6,800
________
________
Do It Problem: CSU Corporation
Service revenue $17,000 • Action step 3:
Accounts receivable $4,000 Present assets and
Accounts payable $2,000
Building rental expense $9,000 claims to those
Notes payable $5,000 assets at a
Common stock $10,000
Retained earnings $6,800 specific point in
Equipment $16,000 time on the
Insurance expense $1,000
Supplies $1,800 Balance Sheet
Supplies expense
Cash
$200
$2,000
• Use $6,800
Dividends $600 Retained earnings
from previous
statement!
 CSU CORPORATION
Balance Sheet
December 31, 2005
Assets
Cash $ 2,000
Accounts receivable 4,000
Supplies 1,800
Equipment 16,000
Total assets $23,800
Liabilities and Stockholders’ Equity
Liabilities
Accounts payable $ 2,000
Notes payable 5,000
Total liabilities 7,000
Stockholders’ equity
Common stock $10,000
Retained earnings 6,800
Total Stockholders’ equity 16,800
Total liabilities and stockholders’ equity $23,800