Chapter 1 Business Decisions & Financial Accounting

Accounting

A system of analyzing, recording, and summarizing the results of business’s activities and then reporting the results to decision makers.

(Financial Accounting)

Investors, creditors, IRS/SEC, board of directors.

Who are the decision makers for external?

(Managerial Accounting)

Executives, managers, and employees

Who are the decision makers for Internal?

Balance sheet, statement of retained earnings, statement of cash flows, income statement

what are the 4 financial statements?

Balance Sheet

Reports the financial position of an accounting entity at a point in time.

Also called the “statement of financial position”

Reports assets, liabilities, and stockholders’ equity

Separate entity assumption

Assets = Liabilities + Stockholder’s Equity

Balance Sheet: Basic Accounting Equation

Statement of Retained Earnings

Reports how net income and the distribution of dividends affected the financial position of the company this accounting period.

Beginning RE + Net Income - Dividends = Ending RE

Statement of Retained Earnings: Retained Earnings Equation

a) $450,000

b) $1,150,000

Retained Earnings Example:

Football Fans, Inc. just ended its first year of business. Their reported net income for the year was $500,000, and they paid $50,000 in dividends at the end of the year. What is the retained earnings balance at the end of the year?

Assuming that Football Fans earns net income of $700,000 in their second year of business and pays no dividends during that year, what is the retained earnings balance at the end of their second year of business?

Income Statment

Reports revenues less expenses for the accounting period

Shows net income (aka net profit, net earnings, the bottom line)

Also called “statement of income”, “statement of earnings”, and “statement of operations.”

Unit of measure assumption

Revenue - Expenses = Net Income

Income Statement: Net Income Equation

NI = R - E

210 510 300

ERE = BRI + NI - DIV

190 0 210 20

A = L + SE- CC= 210 -RE= 190

750 350 400

Comprehensive FS Example

Information Corporation had the following balances at the end of its first year of operations:

Total revenues….$510 million

Total dividends….$ 20 million

Total assets……….$750 million

Total liabilities…..$350 million

Total contributed capital….$210 million

What did Information report for ending retained earnings and total expenses at the end of that year?

Statement of Cash Flows

Reports inflows and outflows of cash during the accounting period

Provides information about cash flows not provided by accrual-based net income.

Reports cash flows from operating, investing, and financing activities

Cash flows from operating activities

core bussiness

Cash flows from investing activities

PPE = Property Plant Equipment

Investments = in other companies

Cash flows from financing activities

debt (L) and stock (SE) own stock

Exception of cash flows

interest on debt in considered OPERATING

1) Investing outflow

2) operating inflow

3) finance inflow

4) operating outflow

5) finance outflow

6) investing inflow

Example: Matching Cash Flow Statement Items to Business Activity Categories

___Purchase of a new building

___ Cash received from customers

___ Cash received from issuing stock

___ Cash paid to suppliers

___ Cash paid on a long term note payable

___ Cash received from selling equipment

Supplemental

information about the financial condition of a company, without which the financial statements cannot be fully understood

GAAP

Generally Accepted Accounting Principles

The measurement rules used to develop the information in the financial statements in the United States

SEC

the federal agency with the power to determine the rules

FASB

the private body that actually writes the rules

IFRS

rules of accounting created by IASB for international use

Management

is primarily responsible for the information contained in the financial statements

Role of auditors

Companies use an internal control system to support an ethical environment

Incorporation advantage

• Ability to raise capital

• Ease of ownership transfer

• Limited liability of stockholder

Incorporation disadvantages

• Double taxation of dividends