Chapter 1: Introduction to Financial Statements
Income statement
A financial statement that reports a company's revenues and expenses and resulting net income or net loss for a specific period of time.
Balance sheet
A financial statement that reports the assets and claims to those assets at a specific point in time.
Retained Earnings Statement
A financial statement that summarizes the amounts and causes of changes in retained earnings for a specific time period.
Common stock
Term used to describe the total amount paid in by stockholders for the shares they purchase.
common stock
Term used to describe the total amount paid in by stockholders for the shares they purchase.
Description of results of operations - MD&A - Notes - Auditor's Report
MD&A
DEVELOPED BY IASB - INTERNATIONAL ACCOUNTING STANDARDS BOARD
IFRS - INTERNATIONAL FINANCIAL REPORTING STANDARDS BOARD
Partnership
A business in which two or more persons combine their assets and skills
Basic accounting equation
ASSETS = LIABILITIES + EQUITY
What benefits does a sound accounting system provide to a not-for-profit organization?
Accounting provides at least two benefits to not-for-profit organizations. First, it helps to ensure that money is used in the way that donors intended. Second, it assures donors that their money is not going to waste and thus increases the likelihood of future donations.
Practice Question 18 Which of the following is not one of the three primary business activities? Investing Operating Advertising Financing
Advertising
Liabilities
Amounts owed to creditors in the form of debts and other obligations.
Issuing stock & dividends are / are not recorded on income statement?
Amounts received from issuing stock are not revenues, and amounts paid out as dividends are not expenses. As a result, they are not reported on the income statement.
Certified public accountant (CPA) is
An individual who has met certain criteria and is thus allowed to perform audits of corporations.
Principles-based -IFRS -GAAP
IFRS tends to be simpler in its accounting and disclosure requirements; some people say it is more "principles-based."
CPA
Certified public accountant. An accountant who has fulfilled certain education and experience requirements and passed a rigorous examination. Most CPAs offer auditing, tax, and management consulting services to the general public.
Practice Question 10 Which of the following is not an external user of accounting data? Customers Chief Financial Officer Economic planners Labor unions
Chief Financial Officer
Easier to raise funds -Sole Proprietorship -Partnership -Corporation
Corporation
Q 1.30: C&R Lumber started the year with total assets of $300,000 and total liabilities of $180,000. During the year the business recorded $375,000 in revenues, $240,000 in expenses, and dividends of $50,000. Stockholders' equity at the end of the year was A : $220,000 B : $350,000 C : $175,000 D : $205,000
D $205,000
Q 1.36: "The information system that identifies, records, and communicates the economic events of an organization to interested users" is A a traditional way of looking at accounting B an explanation of internal reporting C the current definition of financial reports D the modern definition of accounting
D the modern definition of accounting
Sole Proprietorship Advantages
Easiest to start Least regulated Single owner keeps all the profits Taxed once as personal income
Which of the following are not considered to be primary users of financial statements in countries outside the U.S.? Economic advisors Private investors Tax authorities Central government planners
Economic advisors
Q 1.38: Notes to the financial statement do NOT have to be quantifiable, or numeric. (T/F)
F
Corporations generally receive more favorable tax treatment than sole proprietorships and partnerships. (T/F)
FALSE
FASB stands for
Financial Accounting Standards Board
Explain the three principal types of business activity.
Financing activities involve collecting the necessary funds to support the business. Investing activities involve acquiring the resources necessary to run the business. Operating activities involve putting the resources of the business into action to generate a profit.
US accounting standards
GAAP (generally accepted accounting principles)
Rules-based -IFRS -GAAP
GAAP is more detailed; some people say it is more "rules-based."
GAAP stands for
Generally Accepted Accounting Principles
Income Statement Format
Heading (Business name, Income statement, Dates covered) Total Revenue -Total expenses Net Farm Income from Operations (NFIO) +/- profit or loss of capital assets Net Farm Income (NFI)
Practice Question 29 In which of the following sequences are the financial statements usually prepared? Income statement, retained earnings statement, balance sheet, and statement of cash flows Balance sheet, statement of cash flows, income statement and retained earnings statement Income statement, balance sheet, retained earnings statement, and statement of cash flows Balance sheet, retained earnings statement, statement of cash flows, and income statement
Income statement, retained earnings statement, balance sheet, and statement of cash flows
IASB stands for
International Accounting Standards Board
Corporation Advantages
Limited liability Unlimited life Separation of ownership and management Transfer of ownership is easy Easier to raise capital
Which is the description of ability to fund operations and expansion - MD&A - Notes - Auditor's Report
MD&A
unqualified opinion
Opinion issued by a certified public accountant that means the company's financial statements are, in all material respects, in compliance with GAAP; the auditor has no reservations. Contrast with qualified opinion.
Management's Discussion and Analysis (MD&A)
Pay / Fund / Results a section of the annual report that presents management's views on the company's ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations.
Dividends
Payments of cash from a corporation to its stockholders.
Sarbanes-Oxley Act (SOX)
Regulations passed by Congress to reduce unethical corporate behavior.
Expenses
The cost of assets consumed or services used in the process of generating revenues.
net loss
The difference between total revenue and total expenses when total expenses are greater
Accounting
The information system that identifies, records, and communicates the economic events of an organization to interested users.
accounting
The information system that identifies, records, and communicates the economic events of an organization to interested users.
What section of a cash flow statement shows the cash spent on new equipment during the past accounting period? The financing section The cash flow statement does not give this information The investing section The operating section
The investing section
Question Number Q 1.21: Corporations provide corporate information about ________ to investors. A forecasts of cash needs for the upcoming year B marketing strategies for a product that will be introduced in eighteen months C financial comparisons of operating alternatives D amount of net income retained in the business
amount of net income retained in the business
Certified Public Accountant (CPA) - MD&A - Notes - Auditor's Report
auditors report
unqualified opinion - MD&A - Notes - Auditor's Report
auditors report
Notes to the financial statements
clarify the financial statements and provide additional detail Information in the notes does not have to be quantifiable (numeric). Examples of notes are descriptions of the significant accounting policies and methods used in preparing the statements, explanations of uncertainties and contingencies, and various statistics and details too voluminous to be included in the statements. The notes are essential to understanding a company's operating performance and financial position.
Easier to transfer ownership -Sole Proprietorship -Partnership -Corporation
corporation
No personal legal liability -Sole Proprietorship -Partnership -Corporation
corporation
Three types of activities
financing, investing, operating
Operating Activities include
includes cash receipts and cash payments for transactions relating to revenue and expense activities
Financing Activities
includes cash transactions resulting from the external financing of a business debt financing (borrowing money) / equity financing (issuing shares)
Internal Users
marketing managers, production supervisors, finance directors, and company officers.
In terms of the principal types of business activities, paying salaries expense is an example of operating activities. investing activities. financing activities. advertising activities.
operating activities.
Activities on the Statement of Cash Flows
operating, investing, financing
Q 1.34: An independent ad agency that is owned and operated by an artist, a writer, and a an accountant would most likely be called a .
partnership
Investing Activities
purchase of the resources a company needs in order to operate
Balance Sheet
reports assets and claims to assets at a specific point in time. Claims to assets are subdivided into two categories: claims of creditors and claims of owners. As noted earlier, claims of creditors are called liabilities. The owners' claim to assets is called stockholders' equity.
Simple to establish -Sole Proprietorship -Partnership -Corporation
sole proprietorship & partnership
The financial statements for Harold Corporation contained the following information: Accounts receivable $ 5,000 Sales revenue 75,000 Cash 15,000 Salaries and wages expense 20,000 Rent expense 10,000 How much was Harold's net income? $60,000 $45,000 $15,000 $65,000
$45,000
Which is an advantage of corporations relative to partnerships and sole proprietorships? (a) Lower taxes. (b) Harder to transfer ownership. (c) Reduced legal liability for investors. (d) Most common form of organization.
(c) Reduced legal liability for investor
Which of the following is an example of a financing activity? (a) Issuing shares of common stock. (b) Selling goods on account. (c) Buying delivery equipment. (d) Buying inventory.
(a) Issuing shares of common stock.
What section of a statement of cash flows indicates the cash spent on new equipment during the past accounting period? (a) The investing activities section. (b) The operating activities section. (c) The financing activities section. (d) The statement of cash flows does not give this information.
(a) The investing activities section.
Which of the following statements is true? (a) Under IFRS, the term income refers to what would be called revenues and gains under GAAP. (b) The term income is not used under IFRS. (c) The term income refers only to gains on investments. (d) Under IFRS, expenses include distributions to owners.
(a) Under IFRS, the term income refers to what would be called revenues and gains under GAAP.
The element of a corporation's annual report that describes the corporation's accounting methods is/are the: (a) notes to the financial statements. (b) management discussion and analysis. (c) auditor's report. (d) income statement.
(a) notes to the financial statements.
IFRS is considered to be more: (a) principles-based and less rules-based than GAAP. (b) rules-based and less principles-based than GAAP. (c) detailed than GAAP. (d) None of the above
(a) principles-based and less rules-based than GAAP.
IFRS is considered to be more: (a) principles-based and less rules-based than GAAP. (b) rules-based and less principles-based than GAAP. (c) detailed than GAAP. (d) None of the above.
(a) principles-based and less rules-based than GAAP.
Which statement presents information as of a specific point in time? (a) Income statement. (b) Balance sheet. (c) Statement of cash flows. (d) Retained earnings statement.
(b) Balance sheet.
Which is not one of the three forms of business organization? (a) Sole proprietorship. (b) Creditorship. (c) Partnership. (d) Corporation.
(b) Creditorship.
The element of the annual report that presents an opinion regarding the fairness of the presentation of the financial position and results of operations is/are the: (a) income statement. (b) auditor's opinion. (c) balance sheet. (d) comparative statements.
(b) auditor's opinion.
Which is not one of the three primary business activities? (a) Financing. (b) Operating. (c) Advertising. (d) Investing.
(c) Advertising.
Which financial statement reports assets, liabilities, and stockholders' equity? (a) Income statement. (b) Retained earnings statement. (c) Balance sheet. (d) Statement of cash flows.
(c) Balance sheet.
Which of the following statements is false? (a) IFRS is based on a conceptual framework that is similar to that used to develop GAAP. (b) Assets are defined by the IASB as resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. (c) Non-U.S. companies that trade shares in U.S. markets must reconcile their accounting with GAAP. (d) Proprietorships, partnerships, and corporations are also found in countries that use IFRS.
(c) Non-U.S. companies that trade shares in U.S. markets must reconcile their accounting with GAAP.
The Sarbanes-Oxley Act determines: (a) international tax regulations. (b) internal control standards as enforced by the IASB. (c) internal control standards of U.S. publicly traded companies. (d) U.S. tax regulations.
(c) internal control standards of U.S. publicly traded companies.
As of December 31, 2014, Stoneland Corporation has assets of $3,500 and stockholders' equity of $1,500. What are the liabilities for Stoneland Corporation as of December 31, 2014? (a) $1,500. (b) $1,000. (c) $2,500. (d) $2,000.
(d) $2,000.
. (LO 4) The financial statements for Joseph Corporation contained the following information. Accounts receivable $ 5,000 Sales revenue 75,000 Cash 15,000 Salaries and wages expense 20,000 Rent expense 10,000 What was Joseph Corporation's net income? (a) $60,000. (b) $15,000. (c) $65,000. (d) $45,000.
(d) $45,000.
Which of the following is not a reason why a single set of high-quality international accounting standards would be beneficial? (a) Mergers and acquisition activity. (b) Financial markets. (c) Multinational corporations. (d) GAAP is widely considered to be a superior reporting system.
(d) GAAP is widely considered to be a superior reporting system.
Which statement about users of accounting information is incorrect? (a) Management is considered an internal user. (b) Taxing authorities are considered external users. (c) Present creditors are considered external users. (d) Regulatory authorities are considered internal users.
(d) Regulatory authorities are considered internal users.
Which of the following did not result from the Sarbanes-Oxley Act? (a) Top management must now certify the accuracy of financial information. (b) Penalties for fraudulent activity increased. (c) Independence of auditors increased. (d) Tax rates on corporations increased.
(d) Tax rates on corporations increased.
Stockholders' equity represents: (a) claims of creditors. (b) claims of employees. (c) the difference between revenues and expenses. (d) claims of owners.
(d) claims of owners.
Net income will result during a time period when: (a) assets exceed liabilities. (b) assets exceed revenues. (c) expenses exceed revenues. (d) revenues exceed expenses.
(d) revenues exceed expenses.
INTERRELATIONSHIPS OF STATEMENTS
1. The retained earnings statement uses the results of the income statement. Tootsie Roll reported net income of $43,938,000 for the period. Net income is added to the beginning amount of retained earnings to determine ending retained earnings. 2. The balance sheet and retained earnings statement are also interrelated. Tootsie Roll reports the ending amount of $114,269,000 on the retained earnings statement as the retained earnings amount on the balance sheet. 3. Finally, the statement of cash flows relates to information on the balance sheet. The statement of cash flows shows how the Cash account changed during the period. It shows the amount of cash at the beginning of the period, the sources and uses of cash during the period, and the $78,612,000 of cash at the end of the period. The ending amount of cash shown on the statement of cash flows must agree with the amount of cash on the balance sheet.
Q 1.35: Bradley Company began the year with retained earnings of $2,000,000. During the year, the company issued $500,000 of common stock, recorded expenses of $3,500,000, and paid dividends of $300,000. If Bradley's ending retained earnings was $2,300,000, what was the company's revenue for the year?
A $4,100,000
Q 1.31: If a stockholder wants to read a fair depiction of a company's financial position and operating results, it should read the ________ in the annual report.
A auditor's report
Corporation
A business organized as a separate legal entity owned by stockholders.
Corporation
A business owned by stockholders who share in its profits but are not personally responsible for its debts
Income Statement
A financial statement showing the revenue and expenses for a fiscal period. Revenues and then expenses For the Month Ended October 31, 2014.
Statement of Cash Flows
A financial statement that provides financial information about the cash receipts and cash payments of a business for a specific period of time. operating, investing, and financing
Auditor's Report
A report prepared by an independent outside auditor stating the auditor's opinion as to the fairness of the presentation of the financial position and results of operations and their conformance with generally accepted accounting principles.
Auditor's report
A report prepared by an independent outside auditor stating the auditor's opinion as to the fairness of the presentation of the financial position and results of operations and their conformance with generally accepted accounting principles.
Annual report
A report prepared by corporate management that presents financial information including financial statements, a management discussion and analysis section, notes, and an independent auditor's report.
annual report
A report prepared by corporate management that presents financial information including financial statements, a management discussion and analysis section, notes, and an independent auditor's report.
Management discussion and analysis (MD&A)
A section of the annual report that presents management's views on the company's ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations.
What are the primary forms of business organization. Describe each
A sole proprietorship is a business owned by one person. A partnership is a business owned by two or more people associated as partners. A corporation is a separate legal entity for which evidence of ownership is provided by shares of stock.
Describe the content and purpose of each of the financial statements.
An income statement presents the revenues and expenses of a company for a specific period of time. A retained earnings statement summarizes the changes in retained earnings that have occurred for a specific period of time. A balance sheet reports the assets, liabilities, and stockholders' equity of a business at a specific date. A statement of cash flows summarizes information concerning the cash inflows (receipts) and outflows (payments) for a specific period of time.
Explain the meaning of assets, liabilities, and stockholders' equity
Assets are resources owned by a business. Liabilities are the debts and obligations of the business. Liabilities represent claims of creditors on the assets of the business. Stockholders' equity represents the claims of owners on the assets of the business. Stockholders' equity is subdivided into two parts: common stock and retained earnings.
Q 1.32: ________ sold to investors that must be repaid at a particular date some years in the future are called bonds payable. A : Obligations from a bank B : Debt securities C : Preferred stocks D : Common stocks
B Debt securities
Question Number Q 1.39: Which of the following statements about the components of an annual report is true? A : Companies are not required to provide annual reports to stockholders. B : The management discussion and analysis (MD & A) section of an annual report covers various financial aspects of a company. C : Information in the notes to the financial statement must be quantifiable, or numeric. D : An auditor within the company must review the information in an annual report.
B The management discussion and analysis (MD & A) section of an annual report covers various financial aspects of a company.
What are the benefits to the company and to the employees of making the financial statements available to all employees? Marketing department Finance department production department human resource department
If employees can read and use financial reports, a company will benefit in the following ways. The marketing department will make better decisions about products to offer and prices to charge. The finance department will make better decisions about debt and equity financing and how much to distribute in dividends. The production department will make better decisions about when to buy new equipment and how much inventory to produce. The human resources department will be better able to determine whether employees can be given raises. Finally, all employees will be better informed about the basis on which they are evaluated, which will increase employee morale.
Identify the users and uses of accounting information.
Internal users are managers who need accounting information to plan, organize, and run business operations. The primary external users are investors and creditors. Investors (stockholders) use accounting information to help them decide whether to buy, hold, or sell shares of a company's stock. Creditors (suppliers and bankers) use accounting information to assess the risk of granting credit or loaning money to a business. Other groups who have an indirect interest in a business are taxing authorities, customers, labor unions, and regulatory agencies.
IFRS stand for
International Financial Reporting Standards
External Users
Investors / owners Creditors / suppliers / bankers taxing authorities / IRS customers (for warranties labor unions (for wages / benefits) regulatory agencies / SEC / FTC
Why are financial statement users interested in net income?
Investors are interested in a company's past net income because it provides useful information for predicting future net income. Investors buy and sell stock based on their beliefs about a company's future performance.
MD&A stands for & is
Management Discussion and Analysis; A section of a company's annual report in which management discusses numerous aspects of the company, both past and present presents management's views on the company's ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations. Management must highlight favorable or unfavorable trends and identify significant events and uncertainties that affect these three factors. This discussion obviously involves a number of subjective estimates and opinions
Why might a company's stockholders be interested in its environmental and social performance?
Many companies now recognize that being a socially responsible organization is not only the right thing to do, but it also is good for business. Many investment professionals understand, for example, that environmental, social, and proper corporate governance of companies affects the performance of their investment portfolios. For example, British Petroleum's oil spill disaster is a classic example of the problems that can occur for a company and its stockholders. BP's stock price was slashed, its dividend reduced, its executives replaced, and its reputation badly damaged. It is interesting that socially responsible investment funds are now gaining momentum in the marketplace such that companies now recognize this segment as an important investment group.
Many people feel that there is a need for one set of international accounting standards. Here is why:
Multinational corporations. Today's companies view the entire world as their market. For example, Coca-Cola, Intel, and McDonald's generate more than 50% of their sales outside the United States, and many foreign companies, such as Toyota, Nestlé, and Sony, find their largest market to be the United States. Mergers and acquisitions. The mergers between Fiat/Chrysler and Vodafone/Mannesmann suggest that we will see even more such business combinations in the future. Information technology. As communication barriers continue to topple through advances in technology, companies and individuals in different countries and markets are becoming more comfortable buying and selling goods and services from one another. Financial markets. Financial markets are of international significance today. Whether it is currency, equity securities (stocks), bonds, or derivatives, there are active markets throughout the world trading these types of instruments.
Assets
Resources owned by a business.
Retained Earnings Statement Format
Retained Earnings, Jan 1 Add: Net income Less: Dividends Retained Earnings, Dec 31
SOX & year
Sarbanes-Oxley Act of 2002
Forms of Business Organizations
Sole Proprietorship Partnership Corporation
In which forms of business organization are the owners personally liable for all the debts of the business? Sole proprietorships and partnerships All of the answer choices are correct Sole proprietorships and corporations Partnership and corporation
Sole proprietorships and partnerships
Describe the components that supplement the financial statements in an annual report.
The management discussion and analysis provides management's interpretation of the company's results and financial position as well as a discussion of plans for the future. Notes to the financial statements provide additional explanation or detail to make the financial statements more informative. The auditor's report expresses an opinion as to whether the financial statements present fairly the company's results of operations and financial position.
Which of the following is required as a result of SOX? Public companies must present audited financial statements. Companies that go bankrupt must repay shareholders for loss investments. All shareholders now have an oversight role of the company's financial activities. Top management must certify the financial statements for their company.
Top management must certify the financial statements for their company.
the relative use of business forms will vary across countries. (T/F)
True Because the choice of business organization is influenced by factors such as legal environment, tax rates and regulations, and degree of entrepreneurism, the relative use of each form will vary across countries.
Partnership Advantages
Two or more owners More capital available Relatively easy to start Income taxed once as personal income
How might accounting help you?
You will need to understand financial reports in any business with which you are associated. Whether you become a manager, a doctor, a lawyer, a social worker, a teacher, an engineer, an architect, or an entrepreneur, a working knowledge of accounting is relevant.
Question Number Q 1.26: Which of the following statements is NOT true? Select all that apply. A The management discussion and analysis section does not have to highlight unfavorable trends or present uncertainties that will affect its ability to fund operations. B Publicly traded U.S. companies must provide an annual report to their shareholders when operating conditions change significantly. C Notes to the financial statements do not need to be included in the annual report because that information is only for internal users.
a / c
Sole Proprietorship
a business owned and managed by a single individual
Q 1.22: An owner who wants to have limited liability should form a A a proprietorship B a corporation C a sole proprietorship D a partnership
a corporation
Q 1.29: Which of the following would NOT be considered internal users of accounting information for a company? A : bank officers B : marketing representatives C : employees D : technology support managers
a) bank officers
Financial Statements
income statement, statement of retained earnings, balance sheet, statement of cash flows Financial reports that summarize the financial condition and operations of a business
SOX applies to
large public companies listed on U.S. exchanges -not foreign There is a continuing debate as to whether non-U.S. companies should have to comply with this extra layer of regulation. Debate about international companies (non-U.S.) adopting SOX-type standards centers on whether the benefits exceed the costs. The concern is that the higher costs of SOX compliance are making the U.S. securities markets less competitive.
Descriptions of significant accounting policies - MD&A - Notes - Auditor's Report
notes
Which provides explanations of uncertainties and contingencies - MD&A - Notes - Auditor's Report
notes
Q 1.25: Where would the company explain the accounting methods it used to prepare its information in the annual report? A notes to the financial statements B auditor's report C balance sheet D management discussion and analysis section
notes to the financial statements
tax advantages -Sole Proprietorship -Partnership -Corporation
sole proprietorship and partnership
retained earnings
the amount of net income retained in the corporation
An internal human resources director for a company would be most likely to need information about A : how much a company should charge for its products B : which product line is most profitable C : whether any product line should be eliminated D : the average pay raise that the company can afford to give its employees
the average pay raise that the company can afford to give its employees
net income
the difference between total revenue and total expenses when total revenue is greater
statement of cash flows provides answers to these simple but important questions: hint: main things the statement displays
• Where did cash come from during the period? • How was cash used during the period? • What was the change in the cash balance during the period?