Chapter 1 Into to Financial Statements Six learning objectives 1 Describe the primary forms of business organization a Sole proprietorship i Simple to establish ii Owner controlled iii Tax advantages b Partnership i Simple to establish ii Shared control iii Broader skills and resources iv Tax advantages c Corporation i An incorporated business entity that has filed articles of incorporation in a state of domicile 1 Advantages 2 Disadvantages a Can attract large amounts of capital investment b Allows for an easy transfer of ownership c Can attract professional management d Provides stockholders with limited liability e Survives the death of its owner s continuity of life a Corporations are subject to more gov regulations b Share holders can have difficulty knowing whether management is making decisions in shareholders best interests c Corporations are subject to income taxation double taxation i Easier to transfer ownership ii Easier to raise funds iii No personal liability 2 Identify the users and uses of accounting information a Accounting The information system that identifies records and communicates the economic events of an organization to interested users Its purpose is to provide economic information as inputs for decision making by users of the information b Users are divided into 2 groups i Internal Users Users working inside the business 1 Marketing 2 Management 3 Finance 4 Human Resources ii External Users Users working outside the business 1 Creditors Banks Bank users 2 Investors Stock Holders c Users and uses of Financial Information i Ethics in Financial Reporting 1 United states regulators and lawmakers were very concerned that the economy would suffer if investors lost confidence in corporate accounting because of unethical financial reporting a Recent financial scandals include Enron WorldCom HealthSouth AIG And others b Congress passed Sarbanes Oxley Act of 2002 SOX i Resulted in 1 Top management must now certify the accuracy of financial information 2 Penalties for fraudulent activity was 3 4 increased Independence of auditors was increased Increased oversight by the board of directors must occur including the boards selection and supervision of the independent auditor c Effective financial reporting depends on sound ethical 2 3 steps to Solving an ethical dilemma a Recognize an ethical situation and the ethical issues behavior involved situation i i Use personal ethics to identify and solve ethical situations and issues b Identify and analyze the principal elements in the Identify the stakeholders persons or groups who may be harmed or benefited ask What are the responsibilities and obligations of the parties involved c Identify the alternatives and weigh the impact of each alternative on various stakeholders i Considering all consequences select the most ethical alternative 3 Explain the three principal types of business activity a All businesses are involved in three types of activity i Financing 1 Two primary sources of outside funds are a Borrowing money debt financing i Liabilities amounts owed by a business ii Creditors party to whom amounts are owed iii Notes payable and Bonds payable are different types of liabilities b Issuing selling shares of stock for cash i Dividends payments to stockholders ii Investing 1 Purchase of resources a company needs to operate a Computers delivery trucks furniture building etc Property plant and equipment b Assets resources owned by a business c Investments purchasing ownership of stocks or bonds expecting a fluctuation in price 1 Once a business has the assets it needs it can begin its operations Items commonly affected by operations include a Revenues amounts earned from the sale of products iii Operating ex Sales revenue service revenue and interest revenue Inventory goods available for sale to customers b c Receivables right to receive money from another party ex Accounts receivable are owed by customers interest receivable is owed by debtors d Expenses cost of assets consumed or services used e Liabilities arising from expenses and represent amounts owed to another party f Net income the excess of revenues over expenses g Net loss the excess of expenses over revenues b Accounting information system System that keeps track of the results of each of these business activities 4 Describe the content and purpose of each of the financial statements i Businesses record data related to 1 Sales 2 Purchases 3 Collections 4 Payments ii This data is fed into the company s information system I e accounting records and company books iii From the information system Reports and summaries that are generated include 1 Financial statements 2 Production and cost reports 3 Income tax returns b Companies prepare four financial statements from the summarized accounting data Income statement i ii Retained Earnings Statement iii Balance Sheet iv Statement of Cash Flows c Financial Statements i Income statement Revenues Expenses Net income 1 Reports revenues and expenses for a specific period of time 2 Net income revenues exceed expenses 3 Net loss expenses exceed revenues 4 Past net income provides information for predicting future net income ii Statement of Stockholders Equity Beginning equity Owner contributions Net income Dividends Ending Equity 1 Also called Retained Earnings Statement 2 Net Income is needed to determine the ending balance in retained earnings iii Balance Sheet Assets Liabilities Equity 1 Reports assets and claims to assets at a particular moment in 2 Ending balance in retained earnings is needed in preparing time the balance sheet iv Statement of Cash flows Cash inflows Cash outflows Net cash flow 5 Explain the meaning of assets liabilities and stockholders equity and state the basic accounting equation a Assets items owned by a business b Liabilities debit to someone else c Stockholders equity capital received from investors in exchange for stock donated capital and retained earnings d Basic accounting equation Assets Liabilities Equity A L E i Should always be balanced on both sides 6 Describe the components that supplement the financial statements in an annual a U S companies that are publicly traded must provide shareholders with an report annual report i The annual report always includes 1 Financial Statements 2 Management discussion and analysis MD A a Covers the company s ability to pay near term obligations its ability to fund operations and expansions and its results of operations b Management must
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