Chapter_1

Financial Statements and Business Decisions

Learning Objectives

• Understanding Financial Statements:

  • Recognize the information conveyed in each of the four basic financial statements:

    • Balance Sheet

    • Income Statement

    • Statement of Stockholders’ Equity

    • Statement of Cash Flows

  • Understand the use of these statements by decision makers such as investors, creditors, and managers.

• Accounting Principles and Responsibilities:

  • Identify the role of Generally Accepted Accounting Principles (GAAP) in determining financial statement content.

  • Discuss the responsibilities of managers, directors, and auditors in ensuring financial statement accuracy.

Understanding Business and Financial Resources

Potential Returns for Stakeholders

• Investors:

  • Expect returns from dividends and higher future stock prices.

• Creditors:

  • Interested in interest from loans.

• Both groups rely on financial statements to estimate the company's future performance.

Role of Accounting Reports

• External Decision Makers:

  • Rely on financial accounting reports to evaluate the company.

• Internal Decision Makers:

  • Use managerial accounting reports for performance assessment and planning.

Business Activities

• Types of Business Activities:

  • Financing Activities: Obtaining funds to run the business.

  • Investing Activities: Acquiring resources to help in operation.

  • Operating Activities: Day-to-day operations of the business.

Importance of Financial Accounting

• Users of Financial Information:

  • Investors, creditors, and various internal managers (marketing, credit, supply chain, HR) depend on accurate and timely financial data.

Goals for Chapter 1

• Focus on:

  • Content: Understand the categories reported in financial statements.

  • Structure: Learn the basic accounting equation and how elements are organized.

  • Use: Recognize how stockholders and creditors utilize information for decisions.

Overview of Basic Financial Statements

Four Basic Financial Statements

• Balance Sheet:

  • Reports financial position at a specific point in time.

  • Includes assets, liabilities, and stockholders’ equity.

• Income Statement:

  • Reports revenues and expenses over a period to show net income.

• Statement of Stockholders’ Equity:

  • Shows changes in stockholders’ equity accounts, including retained earnings over the reporting period.

• Statement of Cash Flows:

  • Reports cash inflows and outflows categorized by operating, investing, and financing activities.

Financial Statement Structure & Time Periods

• Financial statements can be prepared at various times: yearly, quarterly, or monthly.

• Each financial statement must include:

  • Name of the entity

  • Title of the statement

  • Specific date of the statement

  • Unit of measure (e.g., in millions of dollars)

Detailed Elements of the Balance Sheet

• Assets:

  • Current Assets: Cash, Accounts Receivable, Inventories, etc.

  • Long-term Assets: Equipment, Land, Intangibles.

• Liabilities:

  • Current Liabilities: Accounts Payable, Notes Payable.

  • Long-term Liabilities: Bonds Payable.

• Stockholders' Equity: Includes Common Stock and Retained Earnings.

Understanding the Income Statement

• Elements:

  • Revenues: Cash and receivables from goods/services.

  • Expenses: Costs incurred to earn revenues including wages, rent, etc.

• Net Income Equation: [ ext{Net Income} = ext{Revenues} - ext{Expenses} ]

Statement of Stockholders’ Equity

• Components:

  • Common Stock and Retained Earnings.

• Reflects how equity accounts change over the reporting period due to net income and dividends.

Statement of Cash Flows

• Categories:

  • Cash Flows from Operating, Investing, and Financing Activities.

• Purpose: Indicates the company’s ability to generate cash and finance operations.

Importance of Comprehensive Notes

• Financial statements should always include notes that provide supplemental information and aid in understanding.

GAAP and Its Importance

• What is GAAP?

  • Framework of rules determining how financial statements are prepared and presented.

• Setting GAAP Standards:

  • Governed by the Financial Accounting Standards Board (FASB), based on the guidelines set by the Securities and Exchange Commission (SEC).

Ethical Conduct in Accounting

• Three-Step Ethical Decision Process:

  1. Identify benefits and harms of a decision.

  2. Consider alternative actions.

  3. Choose the action you would want publicized.

• Consequences of Unethical Behavior:

  • Misleading financial statements can result in legal consequences and financial penalties.