ACCT 3100 Unit 1

Financial statements are used by several interested stakeholders. List three or more potential external users of financial statements. Explain how each constituent on your list might use financial statement information in their decision making process.

(a) lenders for measuring the risk and return of loans; (b) shareholders for assessing the return and risk in acquiring shares; (c) analysts for assessing investment potential. (d) Other users are auditors, consultants, officers, directors for overseeing management, employees for judging employment opportunities, regulators, unions, suppliers, and appraisers.

GAAP is based on the concept of accrual accounting. Define and describe accrual accounting

Accrual accounting means that we record revenues when earned, and record expenses when they are incurred. Accrual accounting does not rely on cash flows in determining when items are revenues or expenses. This is why net income (a GAAP measure) differs from cash from operations

What are accrued liabilities? Provide an example

An accrued liability is an obligation for expenses that have been incurred but not yet paid for with cash. Examples include wages that have been earned by employees and not yet paid, interest owing on a bank loan, and potential future warranty claims for products sold to customers. When the liability is recognized on the balance sheet, a corresponding expense is recognized in the income statement.

The accounting equation (Assets = Liabilities + Equity) is a fundamental business concept. Explain what this equation reveals about a company's sources and uses of funds and the claims on company resources.

An organization's financing activities (liabilities and equity = sources of funds) are used to pay for the company's investing activities (assets = uses of funds). An organization's assets cannot be more or less than its liabilities and equity combined. This means: assets = liabilities + equity. This relation is called the accounting equation (sometimes called the balance sheet equation), and it applies to all organizations at all times.

Define and explain the concept of financial statement articulation. What insight comes from understanding articulation?

Articulation refers to the fact that the four financial statements are linked to each other and that changes in one statement affect the other three. For example, net income reported on the income statement is linked to the statement of retained earnings, which in turn is linked to the balance sheet. Understanding how the financial statements articulate helps us to analyze transactions and events and to understand how events affect each financial statement separately and all four together.

Companies prepare four primary financial statements. What are those financial statements and what information is typically conveyed in each?

The four main financial statements are: income statement, balance sheet, statement of stockholders' equity, and statement of cash flows. The income statement provides information about the company's revenues, expenses and profitability over a period of time. The balance sheet lists the company's assets (what it owns), liabilities (what it owes), and stockholders' equity (the residual claims of its owners) as of a point in time. The statement of stockholders' equity reports on the changes to each stockholders' equity account during the period. The statement of cash flows identifies the sources (inflows) and uses (outflows) of cash, that is, where the company got its cash from and what it did with it. Together, the four statements provide a complete picture of the financial condition of the company.

Does a statement of cash flows report on a period of time or at a point in time? Explain the information conveyed in the statement of cash flows.

The statement of cash flows reports on the cash inflows and outflows relating to a company's operating, investing, and financing activities over a period of time. The sum of these three activities yields the net change in cash for the period. This statement is a useful complement to the income statement, which reports on revenues and expenses, but which conveys relatively little information about cash flows.